What Is The Free Cash Flow For 2013? 2. Suppose Congress Cha

What is the free cash flow for 2013? 2. Suppose Congress changed the tax laws so that Berndt’s depreciation expenses doubled. No changes in operations occurred. What would happen to reported profit and to net cash flow?

Evaluate the free cash flow for the year 2013 of the company based on the provided financial data. Then, analyze the impact of a hypothetical legislative change where depreciation expenses are doubled, considering the effects on reported profit and net cash flow, assuming no other operational modifications occur.

Paper For Above instruction

Understanding the nuances of free cash flow (FCF) and its determinants is vital for assessing a company's financial health and operational efficiency. Similarly, analyzing how changes in accounting practices, such as depreciation, influence reported profits and cash flows provides insight into the firm's financial statements' transparency and the influence of tax policies. This paper explores these issues in detail, focusing on the case scenario provided.

Calculating Free Cash Flow for 2013

Free cash flow (FCF) represents the cash generated by a company's operations after accounting for capital expenditures needed to maintain or expand its asset base. It is a crucial indicator of financial flexibility, ability to pay dividends, reduce debt, or pursue growth initiatives. The general formula for FCF is:

FCF = Operating Cash Flow - Capital Expenditures

Alternatively, when detailed data is available, a common approach is to derive FCF starting from net income, adjusting for non-cash expenses like depreciation and changes in working capital, and subtracting capital expenditures. The formula often used is:

FCF = Net Income + Non-Cash Charges (Depreciation & Amortization) - Changes in Working Capital - Capital Expenditures

Based on the provided data, the specific figures for 2013 are inferred as follows:

  • Net income: $87,960
  • Depreciation and amortization: $18,960
  • Changes in working capital: This can be approximated using the change in current assets and current liabilities. The change in current assets is (2013 assets minus 2012 assets): $1,468,800 - $2,886,592 = -$1,417,792, indicating a significant decrease. Similarly, the change in current liabilities is $481,600 - $1,328,960 = -$847,360. However, these large-end amounts suggest focusing on net working capital changes for accuracy, possibly approximated as (Current assets - current liabilities) for each year:

Working capital 2013: $1,124,000 - $481,600 = $642,400

Working capital 2012: $1,946,802 - $1,328,960 = $617,842

The change in working capital is thus approximately: $642,400 - $617,842 = $24,558 (an increase, representing a use of cash).

Capital expenditures (CapEx) are typically reflected in the net change in gross fixed assets adjusted for depreciation. The net fixed assets increased from $344,800 in 2012 to $939,790 in 2013, a change of $594,990. Since depreciation expense is $18,960, the CapEx can be approximated as:

CapEx = Change in Net Fixed Assets + Depreciation Expense = $594,990 + $18,960 = $613,950

Putting these components together to estimate FCF:

FCF = $87,960 + $18,960 - $24,558 - $613,950 = -$531,588

This negative FCF indicates that the firm's free cash flow for 2013 is approximately -$531,588, primarily due to significant capital expenditures exceeding cash generated from operations. This aligns with the substantial investment in fixed assets during the year, reflective of expansion or modernization efforts.

Impact of Doubling Depreciation Expenses on Profit and Cash Flow

If Congress changes tax laws so that depreciation expenses are doubled, with all other operational variables remaining unchanged, several consequences follow:

  • Reported Profit: Depreciation is a non-cash expense that reduces taxable income. Doubling depreciation would increase total depreciation expenses from $18,960 to $37,920. As a result, earnings before tax (EBT) would decrease by approximately the additional depreciation amount, reducing net income accordingly.
  • Net Cash Flow: Although depreciation is a non-cash charge and does not directly affect cash flows, its increase indirectly impacts cash flow through tax savings. Higher depreciation expenses lead to lower taxable income, reducing taxes paid. Specifically, with a 40% tax rate, the tax savings would be:
Extra depreciation = $37,920 - $18,960 = $18,960

Tax savings = $18,960 × 40% = $7,584

Operating cash flows are increased by this tax shield because the actual cash paid for taxes decreases. Therefore, the net effect on cash flow would be an increase of $7,584 due to the increased depreciation expense, assuming no other changes.

In summary, tripling depreciation expenses would lower reported profits (net income) due to increased expenses, but would increase net cash flow because of the resulting tax savings. This scenario exemplifies how accounting choices influence financial metrics and how tax regulations interrelate with financial reporting.

Conclusion

The analysis indicates that the company's free cash flow in 2013 is negative, primarily due to large capital investments needed for asset expansion. The hypothetical depreciation increase, while reducing taxable income and reported profits, would improve cash flow through tax savings. These insights emphasize the importance of understanding both cash flow metrics and accounting practices for accurate financial assessment, guiding strategic decisions and valuation processes.

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