Got asked this question in an interview
Hi all,
I was interviewing at a Bulge Bracket (Snr Analyst role) got to the 3rd round and met with the VP and a Senior Associate, all is going well, few brainteasers and basic Corp Finance stuff. Then the VP glances at the SA and says lets ask him the 'question'. "You have a model and someone has incorrectly inputted $100million as OPEX when it should be CAPEX. Please rectify and tell me what impact this has on the 3 financial statements". I'm like this isn't too bad. I asked a few questions, i.e. are we depreciating in the first year. Made assumption on depreciation rate = 10% and corporate tax rate 30% and asset was purchased in cash. I walk through the Income Statement - no issues. (depreciation $10mill, pay tax on the $90mill ($27mill), remainder is Net Income ($63mill). I get to Cash flow (CFOA) bring in net income from income statement, add back depreciation..then the discussion went down the toilet. The VP was adamant that I should not be adding depreciation back citing some random reasons which I didnt understand. So yeah I'm a noob but I was trying to logically explain my view that its a non cash expense, you don't physically pay it (already expensed when asset was purchased) and so therefore you need to add it in. Anyways they didn't buy it. I continued to Balance Sheet - it didn't balance not sure why but the VP's view was that it was because of the depreciation add back has skewed my retained earnings blah blah. Also I added the asset under PPE as $100mill, then a contra asset of accumulated depreciation of $10mill - he said that was wrong and it should be PPE as $90mill, then accumulated depreciation of $10mill. He said I was closeeee but not close enough So I left feeling like a cacapoo and hence didn't make the cut for the role.
Can someone please run me through the answer so I can feel a bit better about myself and get some closure.
Thanks in advance primates.
CAPEX purchase does not go on the income statement at all... if you assume u purchased the equipment at the beginning of the period and incurred depreciation of 10%... pretax income down by $10, NI down by $7 (assuming 30%)...on CF NI down $7, add back depreciation so CFO up $3 then subtract off capex purchase in CFI...net cash down $97. BS - cash down 97, PPE up 90 (100-10 dep) so assets down 7, SE down 7 from NI going into retained earnings and everything balances
But capex now is on the income statement...
Thanks JGRW - what confused me is the part in the question that said $100mill was in opex in correctly. So what I did was increase my gross profit by $100mill (because we had $100mill in there incorrectly) and worked the income statement back from that. Btw on the BS portion what is SE? Is that a typo for RE?
SE is stockholders equity
So I think the issue here is that you probably shouldn't have included depreciation at all. The Capex is more like a time 0 action, whereas straight-line depreciation will then occur after 1 year of use (in this case it should be ignored since it sounds like we are time 0).
I/s: +100 Mil for OPEX; so Pre-tax income +100MM; Net Income + 70MM CFS: CFO Start w/ NI + 70 MM ; CFI we are down -100MM (for Capex) so overall cash is now at -30MM B/S: Assets = -30MM Cash, +100MM PP&E (Overall $70MM) ; Liabilities= no change; RE= +70MM (from NI). Everything now balances.
I believe your logic with adding back 100MM for OPEX into the I/S is correct, I just think you probably shouldn't have included depreciation at all. Hope my jab at the answer makes sense!
Sounds like they were screwing with you to be honest. They probably wanted to see how you'd react and then how you'd handle telling someone that's interviewing you that they're wrong and explain why (adding depreciation back has no bearing on RE because the only thing that affect RE is net income/dividends, for instance).
GP + 100 from opex correction -> NI + 70 at 30% tax -> CF + 70 -> BS - Cash + 70, RE + 70 balances D&A -10 -> NI -7 (30% tax) -> CFO -7+10=+3, CFI = -100, CF = -97 -> Cash -97, PP&E +100-10 = + 90, A = -7, RE =-7 balances
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