Can someone answer the following two questions for me:
How does a $10 increase in inventory affect the three financial statements (.4 marginal tax)
How does a $10 increase in inventory in the 3rd year of a DCF model affect the overall value of the company? (.4 tax)
I checked previous threads but they give conflicting answers. Thank you
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Here's what I think:
1) $10 increase in inventory:
IS: nothing BS: inventory increases by $10 and cash decrease by $10 OR AP increases by $10 CF: if paid for in cash, a decrease of $10 from operating CF since Inventories goes up by $10 (if paid through AP, then AP increases by $10, Inventory increases by $10, then it's a cash, $0 change in cash flows)
http://blog.accountingcoach.com/inventory-reported/
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Thanks for the detailed response BepBep. Gave you a silver banana.
ib interview: How would increase in depreciation affect DCF valuation? (Originally Posted: 01/05/2016)
I am really confused by this. I don't know the answer but it seems like that depreciation affect DCF. Does increase in depreciation lead to increase in DCF valuation? Since we are adding back the full amount of depreciation expense to EBIT?
Conceptually, I don't understand how increased depreciation makes a company more valuable. Can somebody help?
Depreciation is a non-cash expense. Even though it lowers net income, in reality it is not a cash outflow. However, more depreciation expense means the company pays less in taxes. Therefore, FCF increases with a depreciation increase.
This is correct. Main thing is that depreciation increases cash flows through its reduction of taxable income.
Depreciation is a non-cash expense. No one physically goes to a company and takes money from a piece of equipment because it has depreciation. So since it is subtracted when you calculate EBIT, you need to add it back because that cash was never actually lost. That's how I think about it at least. So when a company has a lot of depreciation, it can increase your FCF. But, another way to look at it is this, if a big company has a lot of depreciation, yes that would get added back to FCF, but, you could have a massive Capex to update and maintain those machines because they break down after a while. That, in some cases, can decrease your amount of FCF even with the amount of depreciation added back to EBIT.
Depreciation can increase due to many reasons. If it just magically increases without capex increases, DCF output will increase because you pay less tax. Tax saving can be temporary but money now is always worth more than tomorrow.
If depreciation increases due to capex increases, DCF output should increase too assuming the NPV of new capex > 0.
Conceptually, lower depreciation expense = lower tax expense = higher cash flow = higher DCF.
You may say that the purpose of depreciation expense is to force companies to mark down assets in order to reflect their "fair value", but in reality companies want it for tax purposes.
Nope.
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Does a change in depreciation have any affect on a DCF model? (Originally Posted: 10/07/2013)
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Question: Does depreciation affect FCF? and how does the FCF factors into the DCF model?
gluck.
It will affect cash taxes.
yeah dude
Cash flow will change depending on whether depreciation expense goes up or down due to the impact of taxes. The actual depreciation itself has no impact as it is non-cash. I guess you could make the argument that the useful life of assets changes so capex will vary as well.
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Deferred tax followup question to the "$10 increase in depreciation" question (Originally Posted: 12/31/2013)
Anyone experience this in an analyst interview? Can someone clarify the concept/best way to answer? If they ask "now imagine the tax is not expensed right away" or something.
Is your question, what if the increase in $10 depreciation is only for book purpose and not for tax purpose? Assuming 40% tax rate IS: -4 (taxes +4) CFO: -4 NI +4 (from inc. in DTL) = 0 BS: Cash unchanged, DTL +4, RE -4 Someone please correct me if I'm wrong.
Deferred tax does not mean that they don’t pay it right away, it means that there is a difference between book and taxable income, resulting in a DTL or a DTA.
So to use tdotmonkey's example of a $10 difference in depreciation between book and taxable income: Depreciation flows through the 3 statements the same as it would for any other $10 depreciation question. IS: -6 ($10*1-.40) SCF: +4 (-6 NI +10 Depr) BS: Assets -6 (net PP&E -10, Cash +4) and L+E -6 (R/E -6)
Now if book and taxable income are different, we have to book a DTL or DTA. If book income is higher (say by $10 pretax), we have a DTL of 6, which is balanced through R/E -6. If taxable income is higher (same $10 pretax), we have a DTA of 6, which is balanced through R/E +6.
Think of it this way. The company pays taxes based on its taxable income, not book income. So if they choose to recognize depreciation differently for book purposes, it has to show up on the books somewhere. A DTA arises when Taxable income > Book income (because we have actually paid more taxes than our books show) and a DTL arises when Book income > Taxable income (because we have actually paid less than our books show). In both cases, the deferred tax is balanced through R/E—for DTA R/E would be higher by the same amount, and for DTL R/E would be lower by the same amount.
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