Question

The Rogers Corporation has a gross profit of \(880,000 and \)360,000 in depreciation expense. The Evans Corporation also has \(880,000 in gross profit,

with \)60,000 in depreciation expense. Selling and administrative expense is $120,000 for each company. Given that the tax rate is 40 percent, compute the cash flow for both companies.

Explain the difference in cash flow between the two firms.

Short answer

The cash flow of the Rogers Corporation is $600,000, and the cash flow of the Evans Corporation is $480,000. In addition, the difference in the cash flow is due to tax savings on the depreciation.

Step-by-step solution

Net profit after tax of the Rogers Corporation

$$\begin{gathered} Netprofitaftertax=\left(Grossprofit-depriciation-sellingandadministrativeexpenxse\right)\left(1-Tax\right) \\ =\left(\$880,000-\$360,000-\$120,000\right)\left(1-0.40\right) \\ =\$240,000 \end{gathered}$$

Cash flow of the Rogers Corporation

$$\begin{gathered} Cashflow=Netprofitaftertax+depriciation \\ =\$240,000+\$360.000 \\ =\$600,000 \end{gathered}$$

Net profit after tax of the Evans Corporation

$$\begin{gathered} Netprofitaftertax=\left(Grossprofit-depriciation-sellingandadministrativeexpenxse\right)\left(1-Tax\right) \\ =\left(\$880,000-\$60,000-\$120,000\right)\left(1-0.40\right) \\ =\$420,000 \end{gathered}$$

Cash flow of the Rogers Corporation

$$\begin{gathered} Cashflow=Netprofitaftertax+depreciation \\ =\$420,000+\$60,000 \\ =\$480,000 \end{gathered}$$

Explanation for change in the cash flow of two companies

The cash flow of both companies is different because of the depreciation. Depreciation is a non-cash transaction, but the tax savings due to depreciation are treated as the cash inflow for the company. In the given case, the depreciation of both the companies is different, and because of this reason, the cash flow is different.