The Menendez Corporation expects to have sales of $12 million in 2006. Costs other than depreciation and amortization are expected to be 75 percent of sales; depreciation and amortization expenses are expected to be $1.5 million. All sales revenues will be collected in cash, and costs other than depreciation and amortization must be paid for during the year. The corporate tax rate is 40 percent.
a. Set up an income statement. What is the expected net cash flow?
b. Suppose Congress changed the tax laws so that depreciation and amortization expenses doubled and that there were no changes in operations. What would happen to reported profit and net cash flow?
c. Now suppose Congress reduced depreciation and amortization expense by 50 percent. What is the change in net income? What is the change in net cash flow?
d. Would you prefer that Congress double or halve depreciation and amortization expenses? Why?
e. Would a doubling of deprecation and amortization expenses possibly have an adverse effect on stock price and on the ability to borrow money? Explain.