Question

The owner of a bicycle repair shop forecasts revenues of $184,000 a year. Variable costs will be $56,000, and rental costs for the shop are $36,000 a year. Depreciation on the repair tools will be $16,000. The tax rate is 35%.

a.	Calculate operating cash flow for the year by using all three methods: (a) adjusted accounting profits; (b) cash inflow/cash outflow analysis; and (c) the depreciation tax shield approach.

Method	Operating Cash Flow
Adjusted accounting profits	$
Cash inflow/cash outflow analysis
Depreciation tax shield approach

b.	Are the above answers equal?
	Yes No

Answer 1

a.

Method	Operating Cash Flow
Adjusted accounting profits	$61,600
Cash inflow/cash outflow analysis	$61,600
Depreciation tax shield approach	$61,600
b. Yes

Workings

Revenue	$184,000
Less- Variable cost	$ 56000
Less- Rental cost	$ 36000
Less- Depreciation	$ 16000
Pre Tax Profit	$ 76000
Less- Tax (@ 40%)	$ 30400
Net Income	$ 45600

Adjusted Accounting Profit = Net income + depreciation

= $45,600 + $16,000

= $61,600

Cash inflow/cash outflow analysis = Revenue − rental costs − variable costs − taxes

= $184,000 − $56,000 − $36,000 − $30,400

= $61,600

Depreciation tax shield approach = [(Revenue − rental costs − variable costs) × (1 − 0.40)] + (depreciation × 0.40)

= [($184,000 − $36,000 − $56,000) * 0.60] + ($16,000 * 0.40)

= $55,200 + $6,400

= $61,600