Assume a project has earnings before depreciation and taxes of $15,000, depreciation of $25,000, and that the firm has a 25% combined tax bracket. What are the after-tax cash flows for the project?

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Quizplus · Accepted Answer

The after-tax cash flow is calculated as: Earnings before depreciation and taxes + Depreciation - Taxes. Taxes are calculated on the earnings before depreciation and taxes minus depreciation. Here, taxes = ($15,000 - $25,000) * 25% = -$2,500 (a negative tax implies a tax credit). So, the after-tax cash flow = $15,000 + $25,000 - (-$2,500) = $42,500. However, the correct calculation should consider the tax savings due to depreciation, not adding the full depreciation back. Correctly, it should be: Earnings before taxes - Taxes + Depreciation = $15,000 - (($15,000 - $25,000) * 25%) + 0 = $15,000 + $2,500 = $17,500. The depreciation is not added back after tax calculation because it's a non-cash expense already accounted for in the tax savings.

Assume a Project Has Earnings Before Depreciation and Taxes of $15,000