The Monley Corporation of New Jersey has gross profits of $980,000 and $260,000 in depreciation expense. The Majors Corporation of Nebraska also has $980,000 in gross profit, with $60,000 in depreciation expense. Selling and administrative expense is $120,000 for each company.
Compute the cash flow for both companies with a tax rate of 40%. Explain the difference in cash flow between the two firms.
THIS IS THE TABLE I MUST FILL IN.
Gross profit Selling and admin expense
Depreciation Operating profit
Taxes
Earnings after tax
Plus depreciation expense
Cash Flow
To compute the cash flow for both companies, let's fill in the table step-by-step:
For Monley Corporation of New Jersey:
Gross profit: $980,000
Selling and administrative expense: $120,000
Depreciation: $260,000
1. Operating profit:
Operating profit is calculated by subtracting selling and administrative expense and depreciation from gross profit.
Operating profit = Gross profit - Selling and administrative expense - Depreciation
Operating profit = $980,000 - $120,000 - $260,000
Operating profit = $600,000
2. Taxes:
Taxes are calculated using the tax rate of 40% on the operating profit.
Taxes = Tax rate * Operating profit
Taxes = 0.40 * $600,000
Taxes = $240,000
3. Earnings after tax:
Earnings after tax is calculated by subtracting taxes from the operating profit.
Earnings after tax = Operating profit - Taxes
Earnings after tax = $600,000 - $240,000
Earnings after tax = $360,000
4. Plus depreciation expense:
To calculate cash flow, we need to add depreciation expense to earnings after tax.
Cash Flow = Earnings after tax + Depreciation
Cash Flow = $360,000 + $260,000
Cash Flow = $620,000
For Majors Corporation of Nebraska:
Gross profit: $980,000
Selling and administrative expense: $120,000
Depreciation: $60,000
1. Operating profit:
Operating profit = Gross profit - Selling and administrative expense - Depreciation
Operating profit = $980,000 - $120,000 - $60,000
Operating profit = $800,000
2. Taxes:
Taxes = Tax rate * Operating profit
Taxes = 0.40 * $800,000
Taxes = $320,000
3. Earnings after tax:
Earnings after tax = Operating profit - Taxes
Earnings after tax = $800,000 - $320,000
Earnings after tax = $480,000
4. Plus depreciation expense:
Cash Flow = Earnings after tax + Depreciation
Cash Flow = $480,000 + $60,000
Cash Flow = $540,000
The difference in cash flow between the two firms is due to the differing depreciation expenses. Monley Corporation has higher depreciation expenses ($260,000) compared to Majors Corporation ($60,000). As a result, Monley Corporation's cash flow is higher ($620,000) than that of Majors Corporation ($540,000).
To compute the cash flow for both companies, you need to follow these steps:
1. Calculate the operating profit:
Operating Profit = Gross Profit - Selling and Administrative Expense
2. Calculate the taxes:
Taxes = Tax Rate x (Operating Profit - Depreciation)
3. Calculate the earnings after tax:
Earnings After Tax = Operating Profit - Taxes
4. Add back the depreciation expense to get the cash flow:
Cash Flow = Earnings After Tax + Depreciation Expense
Now, let's calculate the cash flow for both companies:
For the Monley Corporation of New Jersey:
Gross profit = $980,000
Selling and administrative expense = $120,000
Depreciation expense = $260,000
1. Operating Profit = $980,000 - $120,000 = $860,000
2. Taxes = 0.40 x ($860,000 - $260,000) = $240,000
3. Earnings After Tax = $860,000 - $240,000 = $620,000
4. Cash Flow = $620,000 + $260,000 = $880,000
For the Majors Corporation of Nebraska:
Gross profit = $980,000
Selling and administrative expense = $120,000
Depreciation expense = $60,000
1. Operating Profit = $980,000 - $120,000 = $860,000
2. Taxes = 0.40 x ($860,000 - $60,000) = $320,000
3. Earnings After Tax = $860,000 - $320,000 = $540,000
4. Cash Flow = $540,000 + $60,000 = $600,000
The difference in cash flow between the two firms is primarily due to the difference in depreciation expense. The Monley Corporation has higher depreciation expense ($260,000) compared to the Majors Corporation ($60,000). Since depreciation expense is added back to calculate cash flow, the Monley Corporation has a higher cash flow ($880,000) compared to the Majors Corporation ($600,000). Additionally, the taxes paid by the Monley Corporation ($240,000) are lower than the taxes paid by the Majors Corporation ($320,000), further contributing to the difference in cash flow.