How does the sale of PPE after 3 years affect three statements?
Assume that the company purchased PPE at the beginning of Year 1 for $100. The annual depreciation is $20. The tax rate is 40%. How would it affect the three statements at the end of Year 3 if the company sells the PPE for $70 at the end of Year 3?
This is a question asked during the interview of an IBD summer interview. I am puzzled by the third year answer as I could not make the balance sheet balance.
Many thanks!
IS: $30 gain- 40% tax = NI up $18
CFS: Cash up 18 - 30 (gain) + 70 (sale of PPE) = $58
BS: Cash up $58, PPE down 40. Equity up $18 Overall, assets increase by $18 and Equity increases by $18, so the balance sheet balances.
wouldn't you need to factor in the $20 in depreciation in the IS and Cash from Ops?
The question only asks how the sale affects the statements. If you want to look at how the purchase in general affects the three statements, yes.
Pre-tax income would be 20 higher, NI would be $12 higher, and you'd have to add back $20 on the CFS for depreciation.
I think, to Ricyan's point, that you are already factoring in depreciation within the sale, because you are recognizing the $30 gain, which you calculated by taking BV ($100 - $60 = $40) and comparing it to the sale price of $70, resulting in $70 - $40 = $30 worth of a gain.
In any case, I agree with your solution above.
The question only asks how the sale affects the statements. If you want to look at how the purchase in general affects the three statements, yes.
Pre-tax income would be $20 higher, NI would be $12 higher, and you'd have to add back $20 on the CFS for depreciation.
If sold to New York State, positive impact. IS->increase revenue, high margins, increase NI. CFS/BS->cash up.
If sold to Federal Government, neutral or negative impact. IS->new revenue at low or negative gross margins, displaces capacity for other manufacturing, net impact decreases NI. CFS->cash down. BS->initial negative impact but increases probability of bailout for industry thus improves funding risk.
This is my stab.
IS: Pre-tax up $10 ($30 gain - $20 depreciation). NI: up $8 (20% tax rate)
CF: Add back depreciation, cash now up $28, but subtract gain on sale cash down -$2, but then add cash from sale, so cash is now up a net $68
BS: Cash up $68 but PPE down $60 so assets are up net $8. Net income flows into retained earnings in SE which is up $8.
Everything balances but not sure if you record the depreciation and gain simultaneously as the $20 depreciation increases the gain on sale from $10 to $30 which is important.
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