Question

A proposed new project has projected sales of $189,000, costs of $91,000, and depreciation of $25,000. The tax rate is 23 percent. Calculate operating cash flow using the four different approaches. (Do not round intermediate calculations.)

EBIT+ DEPRICIATION-TAXES

TOP-down

TAX-shield

bottom-up

Answer 1

Approach	Operating Cash Flow
EBIT + Depreciation - Taxes	$81,210
Top=down	$81,210
Tax-shield	$81,210
Bottom-up	$81,210

Workings

Income Statement

Income Statement
Particulars	Amount ($)
Sales	1,89,000
Less: Costs	91,000
Less: Depreciation Expense	25,000
Earnings Before Interest & Tax	73,000
Less: Tax at 23%	16,790
Net Income	56,210

(1)-Operating Cash Flow using “EBIT + Depreciation – Taxes” Approach

Operating Cash Flow = EBIT + Depreciation Expenses – Tax Expenses

= $73,000 + $25,000 - $16,790

= $81,210

(2)-Operating Cash Flow using Top-Down Approach

Operating Cash Flow = Sales – Costs – Tax Expenses

= $189,000 - $91,000 - $16,790

= $81,210

(3)-Operating Cash Flow using Tax Shield Approach

Operating Cash Flow = [(Sales – Costs) x (1 – Tax Rate)] + [Depreciation x Tax Rate]

= [($189,000 - $91,000) x (1 - 0.23)] + [$25,000 x 0.23]  

= [$98,000 x 0.77] + [$25,000 x 0.23]

= $75,460 + $5,750

= $81,210

(4)-Operating Cash Flow using Bottom-Up Approach

Operating Cash Flow = Net Income + Depreciation Expenses

= $56,210 + $25,000

= $81,210

NOTE

The Operating Cash Flow calculated using each of the four different approaches will give the same Operating Cash Flow of $81,210.