Calculate The Operating Cash Flow For The Year

Calculate the operating cash flow for the year by using all three methods:

In tackling the problem of estimating the operating cash flow (OCF) for Tubby Toys’ new line of rubber ducks, we employ three methodologies: adjusted accounting profits, cash inflow/cash outflow analysis, and the depreciation tax shield approach. The provided data indicates sales of $7.60 million, operating costs of $4.60 million, depreciation of $1.60 million, and a tax rate of 35%.

Cleaned assignment instructions

Assume the tax rate is 35%. a. Calculate the operating cash flow for the year by using all three methods: (a) adjusted accounting profits; (b) cash inflow/cash outflow analysis; and (c) the depreciation tax shield approach. (Enter your answers in millions rounded to 2 decimal places.) Method Cash Flow Adjusted accounting profits $ million Cash inflow/cash outflow analysis million Depreciation tax shield approach million b. Are the above answers equal? Yes No

Paper For Above instruction

The calculation of operating cash flow (OCF) is a fundamental aspect of financial analysis, providing insight into the cash-generating ability of a firm's core operations. Utilizing multiple methods to estimate OCF ensures that the analysis is robust and accurate. This paper explores these methods using Tubby Toys’ scenario and demonstrates the calculations involved in each approach.

Adjusted Accounting Profits Method involves deriving net income before taxes and depreciation, then adjusting for non-cash expenses and taxes. First, we determine the taxable income. The earnings before interest and taxes (EBIT) are calculated as:

  • Sales = $7.60 million
  • Operating costs = $4.60 million
  • Depreciation = $1.60 million

EBIT = Sales - Operating costs - Depreciation = $7.60M - $4.60M - $1.60M = $1.40 million

Taxes are then computed as 35% of EBIT:

Tax = 0.35 × $1.40 million = $0.49 million

Net income (after taxes) = EBIT - Taxes = $1.40 million - $0.49 million = $0.91 million

Adjusted accounting profits add back depreciation (a non-cash expense):

OCF (a) = Net income + Depreciation = $0.91 million + $1.60 million = $2.51 million

Cash Inflow/Cash Outflow Analysis focuses directly on cash flows from operating activities. Starting with sales, subtract operating costs and taxes while adding back depreciation:

  • Cash Operating Expenses = Operating costs $4.60 million
  • Pre-tax operating income = $7.60M - $4.60M = $3.00 million
  • Tax on operating income = 35% of $3.00 million = $1.05 million
  • Net cash operating income = $3.00 million - $1.05 million = $1.95 million
  • Add back depreciation (non-cash expense): $1.60 million

Thus, OCF (b) = Net cash income + Depreciation = $1.95 million + $1.60 million = $3.55 million

Depreciation Tax Shield Approach calculates OCF based solely on the tax savings due to depreciation:

Depreciation tax shield = Depreciation × Tax rate = $1.60 million × 0.35 = $0.56 million

We then compute the taxable income adjusted for depreciation and taxes, or more straightforwardly, recall that OCF equals EBIT + Depreciation minus taxes or, alternatively, depreciation × (1 - tax rate) plus depreciation tax shield. Given the approach's standard formula, OCF can be expressed as:

OCF = (EBIT + Depreciation) × (1 - Tax rate) + Depreciation × Tax rate

Applying the precise value, or simplified as:

OCF = EBIT × (1 - tax rate) + Depreciation × (tax rate + 1 - tax rate) = EBIT × (1 - 0.35) + Depreciation × 0.35

Replacing EBIT = $1.40M, the calculation yields:

OCF = ($1.40M × 0.65) + ($1.60M × 0.35) = $0.91 million + $0.56 million = $1.47 million

However, to align with the common depreciation tax shield approach, the OCF is often computed as:

OCF = (Sales - Operating costs) × (1 - tax rate) + Depreciation × tax rate

Thus, the OCF via the tax shield approach is approximately:

$3.00 million × 0.65 + $1.60 million × 0.35 = $1.95M + $0.56M = $2.51 million

Comparison of the Results indicates that the adjusted accounting profits method and the depreciation tax shield approach both approximate an OCF of $2.51 million, while the cash inflow/cash outflow method estimates around $3.55 million. These discrepancies often result from differing assumptions about taxes and cash flows, highlighting the importance of choosing the appropriate method for specific financial evaluations.

Conclusion: The answer to whether the above answers are equal is 'No' due to differences in calculation assumptions and methods.

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