Account Question: Capex with debt
I have seen similar questions posted before, but no one has fully answered it out:
How would you account for a 10,000 capex purchase, with a 10 year straightline no salvage value depreciation, funded by taking on debt that pays 10% interest. Also assume 40% tax rate
Here is what I thought it would be
At time 0
IS: No effect
CF: No Effect
BS: (Assets up by 10,000 and liabilities up by 10,000)
At the end of year 1
IS: (Int exp up by 1,000; Dep exp up by 1000, NI down by 1,200)
CF: (Tax Shield Cash up 800, Int Cash down 1,000)
BS: (Assets down by 1,200[ -1,000 (A/D)-1,000(int cash)+800 (tax cash]; Equity down 1,200)
This assumes 0% return on your capex in the first year.
can you explain why the tax shield cash is up 800?
I'm no help, but may I ask where 800 tax shield comes from (better yet, where I can review this kinda stuff)
On the Statement of CFs, I believe that NI would decrease 1200, but you would add back the depreciation of 1000, giving a net change in the OCF of -200. Also, I'm pretty sure you do not include interest on the statement of CFs. On the BS, though I may be approaching this differently, you would have an increase of your liabilities of 1000, a decrease in R/E of 1200 (via NI), and a net decrease of 200 in your assets (-1000 for A/D, +800 tax shield)
Actually, after rereading your post, I realize what you did for the balance sheet and think it is correct --- for the previous two posters, i believe the tax shield of 800 comes from when you take out the int. expense and the depcreciation. assuming a tax rate of 40% -- you can multiply the total increase in expenses (2000) by (1-t) to find the total decrease in NI. therefore, you would have 2000(1-.4) = 1200, which is shown as the decrease in NI, and the remaining 800 is the tax shield, which is considered a source of cash. On the BS, I derrived an overall decrease of 200 from the 800 increase in cash and the 1000 decrease via A/D. I do not think that the tax shield is included in the statement of cash flows though...
Can someone else verify this though? Sorry, I realize my post is all over the place - I have a difficult time describing accounting in words haha.
You guys are essentially right. To make it as simple as possible:
I/S: Depreciation Expense +1000 and Interest Expense +1000 so Earnings Before Taxes -2000 and Net Income -1200.
C/F: Net Income -1200 and Depreciation +1000 so net cash effect is -200.
B/S: Cash (Asset) -200 and PPE (Asset) -1000 via accumulated depreciation. Retained Earnings (Equity) -1200 and so we balance.
As far as how to review this stuff, I would consult any intro accounting book.
ex-banker is correct.
Just to elaborate 1 point, the -1200 in equity is due o the -1200 Net Income. The Net Income flows through the retained earnings section of the Equity section of the Balance sheet.
Where to study this stuff - an intermediate or intro acconting book. I know I used a book in college written by Kieso, my professors (at both schools I attended) swore by his books. ANY basic financial (not managerial) accounting book will teach you this, but if you're picking one up for no reason other than study, I guess I'll recommend one written by Kieso.
OH....if you're purchasing it only for self-study save a few bucks and get a 3 or 5 year old book. Accounting hasn't changed, don't pay for the newest edition.
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