lecture 06 - Business Finance Lecture 6 Review of the...

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27 Business Finance Lecture 6 Review of the Previous Lecture ± Income Statement ± Generally Accepted Accounting Principles (GAAP) ± Non-cash Items ± Time and Costs ± Taxes ± Average vs. Marginal Tax Rate ± Flat Tax Rate Topics under Discussion ± Taxes (Cont.) ± Depreciation as a Tax Shield ± Financial Cash Flows ± Cash Flow From Assets ± Cash Flow to Creditors ± Cash Flow to Stockholders ± Cash Flow Statement Depreciation as a Tax Shield ± Although depreciation is not a new source of funds, it provides the important function of shielding part of our income from taxes. ± Again, we take the same two corporations – one charges off $100,000 in depreciation, other charges off none. Depreciation as a Tax Shield Corporation A Corporation B Earnings before depreciation & taxes $400,000 $400,000 - Depreciation 100,000 0 Earning before taxes (taxable income) 300,000 400,000 - Taxes @35% 105,000 140,000 Earning after taxes $195,000 $260,000 + Dep. charged without cash outlay 100,000 0 Cash flow $295,000 $260,000 Difference $35,000
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28 It can also be computed as: Depreciation x Tax rate $100,000 x 35% = $35,000 Depreciation as a Tax Shield ± Corporation A enjoys $35,000 more in cash flow, since depreciation shielded $100,000 from taxation in Corporation A and saved $35,000 in taxes, which eventually appeared in cash flows. Financial Cash Flow ± In finance, the most important item that can be extracted from financial statements is the actual cash flow of the firm. ± Since there is no magic in finance, it must be the case that the cash received from the firm’s assets must equal the cash flows to the firm’s creditors and stockholders. Cash Flows to creditors
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This note was uploaded on 08/04/2011 for the course ACCT 501 taught by Professor Na during the Spring '11 term at Virtual University of Pakistan.

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lecture 06 - Business Finance Lecture 6 Review of the...

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