1. The Klaven Corporation has operating income (EBIT) of $750,000. The company's depreciation expense is $200,000. Klaven is 100 percent equity financed, and it faces a 40 percent tax rate. What is the company's net income? What is its net cash flow?
2. The Menendez Corporation expects to have sales of $12 million. Costs other than depreciation are expected to be 75 percent of sales, and depreciation is expected to be $1.5 million. All sales revenues will be collected in cash, and costs other than depreciation must be paid for during the year. Menendez's federal-plus-state tax rate is 40 percent.
a. Set up an income statement. What is Menendez's expected net cash flow?
b. Suppose Congress changed the tax laws so that Menendez's depreciation expenses doubled. No changes in operations occurred. What would happen to reported profit and to net cash flow?
c. Now suppose that Congress, instead of doubling Menendez's depreciation, reduced it by 50 percent. How would profit and net cash flow be affected?
d. If this were your company, would you prefer Congress to cause your depreciation expense to be doubled or halved? Why?