Question

C. Now suppose that Congress changed the tax law such that, instead of doubling Berndt's depreciation, it was reduced it by 50%. How would profit and net cash flow be affected? I. If depreciation were halved, taxable income and taxes would decline but net cash flow would rise. II. If depreciation were halved, taxable income, taxes, and net cash flow would all decline. III. If depreciation were halved, taxable income and net cash flow would rise but taxes would fall. IV. If depreciation were halved, taxable income and taxes would rise but net cash flow would fall. V. If depreciation were halved, taxable income, taxes, and net cash flow would all rise. -Select- d. If this were your company, would you prefer Congress to cause your depreciation expense to be doubled or halved? Why? I. You should prefer to have lower depreciation charges and therefore higher net income. Net income represents the funds that are available to the owners to withdraw from the firm and, therefore, net income should be more important to them than net cash flows. II. You should prefer to have higher depreciation charges and therefore higher net income. Net cash flows are the funds that are available to the owners to withdraw from the firm and, therefore, cash flows should be more important to them than net income. III. You should prefer to have higher depreciation charges and therefore higher cash flows. Net cash flows are the funds that are available to the owners to withdraw from the firm and, therefore, cash flows should be more important to them than net income. IV. You should prefer to have lower depreciation charges and therefore higher cash flows. Net cash flows are the funds that are available to the owners to withdraw from the firm and, therefore, cash flows should be more important to them than net income. V. You should prefer to have higher depreciation charges and therefore higher net income. Net income represents the funds that are available to the owners to withdraw from the firm and, therefore, net income should be more important to them than net cash flows. -Select-
Answer First Picture please

Answer 1

c.ANSWER:

IV. If depreciation were halved, taxable income and taxes would rise but net cash flow will fall

As depreciation express decreases, Income before taxes increases . Consequently, Taxes and Net Income increases. But Depreciation tax shield (Depreciation*Tax Rate) decreases . Hence, Cash flow falls.

d. ANSWER:

III.You should prefer to have higher depreciation charges and therefore higher cash flows. Net cash flows are the funds available to the owners to withdraw from the firm, and therefore, cash flows should be more important to them than net income.

Higher depreciation means higher depreciation tax shield , hence higher cash flows

	a	INCOME STATEMENT
		Sales	$13,000,000
		Cost other than depreciation	$9,100,000	(70%*13 million)
		Earning Before depreciation and taxes	$3,900,000
		Depreciation expense	$1,950,000
		Before tax Income	$1,950,000
		Tax Expenses(35%)	$682,500
		Net Income	$1,267,500
		NET INCOME	$1,267,500
		Add: Depreciation (Non cash expenses)	$1,950,000
		Expected Net Cash Flow	$3,217,500
	b	ANSWER:
		V.If depreciation is doubled, taxable income and taxes will be zero and Cash Flow would rise
	b	Sales	$13,000,000
		Cost other than depreciation	$9,100,000
		Earning Before depreciation and taxes	$3,900,000
		Depreciation expense	$3,900,000
		Before tax Income	$0
		Tax Expenses(35%)	$0
		Net Income	$0
		NET INCOME	$0
		Add: Depreciation (Non cash expenses)	$3,900,000
		Expected Net Cash Flow	$3,900,000