In Year 1, a pot manufacturing company has revenue $900, COGS $300, SG&A $200, depreciation $100, interest expense $100, and a 40% tax rate. Which statement about equity and cash flow is true?

In Year 1, a pot manufacturing company has revenue $900, COGS $300, SG&A $200, depreciation $100, interest expense $100, and a 40% tax rate. Which statement about equity and cash flow is true?

• A. Equity increases by 120; cash from operations increases by 220
• B. Equity increases by 240; cash from operations increases by 320
• C. Equity increases by 60; cash from operations increases by 180
• D. Equity increases by 300; cash from operations increases by 400

Answer: (A)

This tests how depreciation, interest, and taxes ripple through equity and cash flow from operations. Start with the operating result after accounting for non-cash depreciation: subtract COGS, SG&A, and depreciation from revenue to get EBIT, which here is 900 minus 300 minus 200 minus 100, yielding 300. Subtract the interest expense to get pre-tax income: 300 minus 100 equals 200. Apply the tax rate to get taxes: 0.40 times 200 equals 80. Net income is then 200 minus 80, which is 120. Equity increases by net income, assuming no dividends or other equity movements are specified, so equity rises by 120. For cash flow from operations, add back the non-cash depreciation to net income when there are no changes in working capital: 120 plus 100 equals 220. So the true statements are that equity increases by 120 and cash from operations increases by 220. If depreciation were ignored, or if working capital changed, those numbers would shift accordingly, but with the given data the calculations above hold.

This tests how depreciation, interest, and taxes ripple through equity and cash flow from operations. Start with the operating result after accounting for non-cash depreciation: subtract COGS, SG&A, and depreciation from revenue to get EBIT, which here is 900 minus 300 minus 200 minus 100, yielding 300. Subtract the interest expense to get pre-tax income: 300 minus 100 equals 200. Apply the tax rate to get taxes: 0.40 times 200 equals 80. Net income is then 200 minus 80, which is 120.

Equity increases by net income, assuming no dividends or other equity movements are specified, so equity rises by 120.

For cash flow from operations, add back the non-cash depreciation to net income when there are no changes in working capital: 120 plus 100 equals 220. So the true statements are that equity increases by 120 and cash from operations increases by 220. If depreciation were ignored, or if working capital changed, those numbers would shift accordingly, but with the given data the calculations above hold.