The Berndt Corporation expects to have sales of $12 million. Costs other than depreciation are expected to be 75% of sales, and depreciation is expected to be $1.5 million. All sales revenue 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 40%. Berndt has no debt.

a. Construct an income statement. What is Berndts expected net cash flow?

Solution: computation of the following

The income statement is expected net cash flow

Sales 12,000,000

Costs other then depreciation 9,000,000 75% of sales

Depreciation 1,500,000

Income before tax 1,500,000

Tax (40%) 600,000

Net Income 900,000

Net cash flow = net income + depreciation (since depreciation is non cash)

= 900,000 + 1,500,000

= $2,400,000

b. Suppose Congress changed the tax laws so that Berndts depreciation expenses doubled. No changes in operations occurred. What would happen to reported profit and to net cash flow?

Solution: computation of the following

When depreciation doubles, it will become 3,000,000 and so the income before tax would be zero and so would be profit.

Net cash flow = net Income + depreciation = 0+3,000,000 = $3,000,000

The net cash flow will increase due to reduction in taxes due to increase in depreciation.

c. Now suppose that Congress, instead of doubling Berndts depreciation, reduced it by 50%. How would profit and net cash flow be affected?

Solution: computation of the following

Now the new depreciation is 750,000. Income before tax would be 2,250,000 and the net income would be 1,350,000.

Net cash flow = 1,350,000+750,000 = $2,100,000

The net cash flow reduces due to higher taxes being