Question

Premium Excavators had $14 million in sales last year. Cost of goods sold was $8 million, depreciation expense was $2 million, interest payments on outstanding debt was $1 million, and the firm’s tax rate was 21%.

1. What was the firm’s net income?
2. What was the firm’s cash flow?
3. What would happen to net income and cash flow if depreciation were increased by $1 million?
4. Would you expect the change in depreciation o have a positive or negative impact on the firm’s stock price?
5. What would be the impact on net income if depreciation was $1 million and interest expense was $2 million?
6. What would be the impact on cash flow if depreciation was $1 million and interest expense was $2 million?

Answer 1

What was the firm's net income?

Income Statement
Particulars	Amount (in Mn$)
Sales	14
Less: COGS	8
Contribution	6
Less: Fixed Costs
Depreciation	2
EBIT	4
Less: Interest	1
EBT	3
Less" Taxes@21%	0.63
EAT/Net Income	2.37

What was the firm's cash flow?
EAT/Net income+Non Cash Expenses
EAT/Net income+Depreciation
2.37+2= 4.37

What would happen to Net Income and cash flow if Depreciation was increased by $1Million?
Current Depreciatio= 2+1= 3.

Income Statement
Particulars	Amount (in Mn$)
Sales	14
Less: COGS	8
Contribution	6
Less: Fixed Costs
Depreciation	3
EBIT	3
Less: Interest	1
EBT	2
Less" Taxes@21%	0.42
EAT/Net Income	1.58

EAT/Net income+Non Cash Expenses
EAT/Net income+Depreciation
1.58+3= 4.58

Would you expect the change in depreciation has a positive or negative impact on the firm’s stock price?
after changing depreciation expense from the $2Mn to $3Mn the Net income falls from $2.37Mn to $1.58 so definitely there is a fall in the Firm's stock price.

What would be the impact on net income if depreciation was $1 million and interest expense was $2 million?

Income Statement
Particulars	Amount (in Mn$)
Sales	14
Less: COGS	8
Contribution	6
Less: Fixed Costs
Depreciation	1
EBIT	5
Less: Interest	2
EBT	3
Less" Taxes@21%	0.63
EAT/Net Income	2.37

What would be the impact on cash flow if depreciation was $1 million and interest expense was $2 million?
EAT/Net income+Non Cash Expenses
EAT/Net income+Depreciation
2.37+1= 4.37