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 CHART I MUST FILL IN.
Gross profit
Selling and admin expense Depreciation Operating profit
Taxes
Earnings after tax
Plus depreciation expense
Cash Flow
To calculate the cash flow for both companies, we'll need to fill in the chart based on the provided information:
Company 1 - The Monley Corporation of New Jersey:
Gross profit: $980,000
Selling and administrative expense: $120,000
Depreciation expense: $260,000
Operating profit: Gross profit - Selling and administrative expense - Depreciation expense
Company 2 - The Majors Corporation of Nebraska:
Gross profit: $980,000
Selling and administrative expense: $120,000
Depreciation expense: $60,000
Operating profit: Gross profit - Selling and administrative expense - Depreciation expense
Now, let's calculate the values in the chart:
For Company 1:
Gross profit: $980,000
Selling and administrative expense: $120,000
Depreciation expense: $260,000
Operating profit: $980,000 - $120,000 - $260,000 = $600,000
Taxes: Tax rate (40%) * Operating profit = 0.4 * $600,000 = $240,000
Earnings after tax: Operating profit - Taxes = $600,000 - $240,000 = $360,000
Plus depreciation expense: Depreciation expense = $260,000
Cash Flow: Earnings after tax + Depreciation expense = $360,000 + $260,000 = $620,000
For Company 2:
Gross profit: $980,000
Selling and administrative expense: $120,000
Depreciation expense: $60,000
Operating profit: $980,000 - $120,000 - $60,000 = $800,000
Taxes: Tax rate (40%) * Operating profit = 0.4 * $800,000 = $320,000
Earnings after tax: Operating profit - Taxes = $800,000 - $320,000 = $480,000
Plus depreciation expense: Depreciation expense = $60,000
Cash Flow: Earnings after tax + Depreciation expense = $480,000 + $60,000 = $540,000
The difference in cash flow between the two firms is that the Monley Corporation (Company 1) has a higher cash flow of $620,000 compared to the Majors Corporation (Company 2) which has a cash flow of $540,000. This difference in cash flow can be attributed to the higher depreciation expense of $260,000 for Company 1 compared to the $60,000 depreciation expense for Company 2. Depreciation is a non-cash expense that reduces taxable income. As a result, Company 1 benefits from a larger depreciation expense, resulting in a lower taxable income and ultimately higher cash flow after taxes compared to Company 2.