Question

The estimated sales of any investment were $175,000, the cost was $93,000 and the depreciation cost was $24,800 per year. The tax rate is 23%. Use four approaches to operating cash flows to find operating cash flows and see if they have the same results.
In other words, calculate the operating cash flows separately from the basic approach, the bottom-up approach, the top-down approach, and the tax-saving approach.

Answer 1

Answer:-

Operating Cash flow

Operating cash flow refers to the amount of cash that is generated through the regular business activities.

The main four approaches to find out the operating cash flow are:-

1.) Basic Approach

Operating Cash flow ( OCF) = EBIT - Taxes + Depreciation

2.) Bottom- Up Approach

Operating Cash flow ( OCF) = Net income + Depreciation

3.) Top- Down Approach

Operating Cash flow ( OCF) = Sales - Cost - Taxes

4.) Tax- Saving Approach

Operating Cash flow ( OCF) = ( Sales - Cost )( 1 - Tax) + ( Depreciation x Tax )

The following data are given in the problem:-

Sales = $175,000

Cost =  $93,000

Depreciation cost = $24,800

To calculate EBiT the formula is given by, ( here, EBIT is treated as EBT because the interest rate is not given)

EBIT =  Sales - cost  - Depreciation

EBIT = $175,000 -  $93,000 - $24,800

= $ 57,200

Tax rate @ 23% = $ 57,200 x 0.23 = $ 13,156

To calculate  Net Income the formula is given by,

EAT or  Net income = EBIT - Tax rate  

= $ 57,200 - $ 13,156

= $ 44,044

1.) Basic Approach

Operating Cash flow ( OCF) = EBIT - Taxes + Depreciation

where, EBIT = Earnings before Interest and Tax

Operating Cash flow ( OCF) = 57,200 - 13,156 + 24,800

= $ 68,844

2.) Bottom- Up Approach

Operating Cash flow ( OCF) = Net income + Depreciation

= 44,044 + 24,800

= $ 68,844

3.) Top- Down Approach

Operating Cash flow ( OCF) = Sales - Cost - Taxes

= 175,000 -  93,000 - 13,156

= $ 68,844

4.) Tax- Saving Approach

Operating Cash flow ( OCF) = ( Sales - Cost )( 1 - Tax rate ) + ( Depreciation x Tax rate )

=  (175,000 -  93,000) ( 1- 0.23) + 24,800 x 0.23

= 63,140 + 5,704

= $ 68,844

In all the four approaches the Operating Cash flow = $ 68,844