Standard Deviation and Cash Flow

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Chapter 12 Problems

1.Cash flow (LO2) Assume a corporation has earnings before depreciation and taxes of $100,000, depreciation of $50,000, and that it has a 30 percent tax bracket. Compute its cash flow using the format below.

Earnings before depreciation and taxes_____ Depreciation_____
Earnings before taxes_____
Taxes @ 30%_____
Earnings after taxes_____
Depreciation_____

12-1.Solution:

Earnings before depreciation and taxes$100,000
Depreciation– 50,000
Earnings before taxes50,000
Taxes @ 30% 15,000
Earnings after taxes35,000
Depreciation+ 50,000
Cash flow$ 85,000

2.Cash flow (LO2)
a.In problem 1, how much would cash flow be if there were only $10,000 in depreciation? All other factors are the same. b.How much cash flow is lost due to the reduced depreciation between Problems 1 and 2a?

3.Cash flow (LO2) Assume a firm has earnings before depreciation and taxes of $500,000 and no depreciation. It is in a 40 percent tax bracket. a.Compute its cash flow.
b.Assume it has $500,000 in depreciation. Recompute its cash flow. c.How large a cash flow benefit did the depreciation provide?

12-3.Solution:

a.Earnings before depreciation and taxes$ 500,000
Depreciation– 0
Earnings before taxes500,000
Taxes @ 40%– 200,000
Earnings after taxes300,000
Depreciation– 0
Cash flow$300,000

b.Earnings before depreciation and taxes$500,000
Depreciation–500,000
Earnings before taxes0
Taxes @ 40% 0
Earnings after taxes0
Depreciation 500,000
Cash flow$500,000

c.$500,000- $300,000 = $200,000 or (.40 x $500,000).

4.Cash flow (LO2) Assume a firm has earnings before depreciation and taxes of $400,000 and depreciation of $100,000. a.If it is in a 35 tax bracket, compute its cash flow. b.If it is in a 20 tax bracket, compute its cash flow.

12-4.Solution:

a.Earnings before depreciation and taxes$400,000
Depreciation 100,000
Earnings before taxes300,000
Taxes @ 35%105,000
Earnings after taxes195,000
Depreciation+100,000
Cash flow$295,000

b.Earnings before depreciation + taxes$400,000
Depreciation 100,000
Earnings before taxes300,000
Taxes @ 20% 60,000
Earnings after taxes240,000
Depreciation+100,000
Cash flow340,000

5.Cash flow versus earnings (LO2) A1 Quick, the president of a New York Stock Exchange-listed firm, is very short term oriented and interested in the immediate consequences of his decisions. Assume a project that will provide an increase of $2 million in cash flow because of favorable tax consequences, but carries a two-cent decline in earning per share because of a write-off against first quarter earnings. What decision might Mr. Quick make?

12-5.Solution:

A1 Quick

Being short term oriented, he may make the mistake of turning down the project even though it will increase cash flow because of his fear of investors’ negative reaction to the more widely reported quarterly decline in earnings per share. Even though this decline will be temporary, investors might interpret it as a negative signal.

6.Payback method (LO3) Assume a $200,000 investment and the following cash flows for two products:

|Year |Product X |Product Y | |1 |$60,000 |$40,000 | |2 |90,000 |70,000...
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