Last year, Michelson Manufacturing reported $10, 250 of sales, $3, 500 of operating costs other than depreciation, and $1, 250 of depreciation.The company had no amortization charges, it had $3, 500 of bonds outstanding that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 35%.This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $725.By how much will the depreciation change cause the firm's net after-tax income and its net cash flow to change? Note that the company uses the same depreciation calculations for tax and stockholder reporting purposes.

Question

Quizplus · Accepted Answer

This problem can be worked very easily¾just multiply the increase in depreciation by (1 - T)to get the decrease in net income, and then add to the change in income the change in depreciation to get the change in net cash flow:
 11ea1b84_8b77_84b0_a54a_09985741d263_TB3581_00 
We can also get the answer the long way, which explains things in more detail:
 11ea1b84_8b77_84b1_a54a_4506dd50f00a_TB3581_00 We like this problem because it illustrates that an increase in depreciation will decrease the firm's net income yet increase its net cash flow, and cash is king.

Last Year, Michelson Manufacturing Reported $10, 250 of Sales, $3