Question

Income and Cash Flow Analysis

The Berndt Corporation expects to have sales of $14 million. Costs other than depreciation are expected to be 80% of sales, and depreciation is expected to be $1.4 million. All sales revenues will be collected in cash, and costs other than depreciation must be paid for during the year. Berndt's federal-plus-state tax rate is 35%. Berndt has no debt.

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 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.
II. 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.
III. 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.
IV. 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.
V. 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.

Answer 1

Solution:

The compay has revenue of $14 million. While cost are 80% of the revenue.

Lets see the net Income statement

Revenue = $14 Milllion

Cost = 80% of revenue = 0.8*14 = 11.2

Profit before depreciation = 14-11.2 =2.8 million

Cash flow is 2.8 million

If we subtract Deprecation then we get net income.

So, if we have higher depreciation then we will have lower net income and higher Cashflow. Cashflow is the fund that can be withdrawn and is more important as compared to the net income .

Option II looks correct