Question

The owner of a bicycle repair shop forecasts revenues of $236,000 a year. Variable costs will be $69,000, and rental costs for the shop are $49,000 a year. Depreciation on the repair tools will be $29,000. The tax rate is 40%.

a.	Calculate operating cash flow for the year by using all three methods: (a) adjusted accounting profits; (b) cash inflow/cash outflow analysis; and (c) the depreciation tax shield approach.

Method	Operating Cash Flow
Adjusted accounting profits	$
Cash inflow/cash outflow analysis
Depreciation tax shield approach

b.	Are the above answers equal?
	Yes No

Answer 1

Income Statement
Particulars	Amount ($)
Revenues	2,36,000
Less: Variable costs	69,000
Less: Rental Costs	49,000
Less: Depreciation Expense	29,000
Before Tax Profit	89,000
Less: Tax at 40%	35,600
Net Income	53,400

(a)-Operating Cash Flow using the adjusted accounting profits

Operating Cash Flow = Net Income + Depreciation Expenses

= $53,400 + $29,000

= $82,400

(a)-Operating Cash Flow using the Cash inflow/cash outflow analysis

Operating Cash Flow = Total revenue – Variable costs – Rental costs – Taxes

= $236,000 - $69,000 - $49,000 - $35,600

= $82,400

(a)-Operating Cash Flow using the Depreciation tax shield approach

Operating Cash Flow = [(Revenues – Variable costs – Rental costs) x (1 – Tax Rate)] + [Depreciation x Tax Rate]

= [($236,000 - $69,000 - $49,000) x (1 – 0.40)] + [$29,000 x 0.40]

= [$118,000 x 0.60] + [$29,000 x 0.40]

= $70,800 + $11,600

= $82,400

(b)-“YES”. All the 3 methods gives equal operating cash flow of $82,400