Depreciation, Income Taxes, and Cash Flow Mr. Brandt, president of the Bremen Shipping Company, read a newspaper story that stated: "The Frankfurt Steel Company had a cash flow last year of 1,500,000 DM, consisting of 1,000,000 DM of net income plus 500,000 DM of depreciation. New plant facilities helped the cash flow, because depreciation was 25% higher than in the preceding year." "Cash flow" is frequently used as a syn- onym for "cash provided by operations," which, in turn, is cash revenue less cash operating expenses and income taxes. (DM stands for deutsch mark, the German unit of currency at the time this state- ment was made.) Brandt was encouraged by the quotation because Bremen Shipping Company had just acquired a vast amount of new transportation equipment. These acquisitions had placed a severe financial strain on the company. Brandt was heartened because he believed that the added cash flow from the depreciation of the new equipment should ease the financial pressures on the company. The income before income taxes of the Bremen Shipping Company last year (20X8) was 200,000 DM. Depreciation was 200,000 DM; it will also be 200,000 DM on the old equipment in 20X9. Revenue in 20X8 was 2.1 million DM (all in cash), and operating expenses other than deprecia- tion were 1.7 million DM (all in cash). The company expects the new equipment to help increase revenue by 1 million DM in 20X9. Operating expenses other than depreciation will increase by 800,000 DM. 1. Suppose depreciation on the new equipment for financial reporting purposes is 100,000 DM. What would be the cash flow from operations (cash provided by operations) for 20X9? Show computations. Ignore income taxes. 2. Repeat requirement 1, assuming that the depreciation on the new equipment is 50,000 DM. Ignore income taxes. 3. Assume an income tax rate of 30%.

(a) Repeat requirement 1;

(b) repeat requirement 2. Assume that the same amount of depreciation is shown for tax purposes and for financial reporting purposes. 4. In your own words, state as accurately as possible the effects of depreciation on cash flow. Comment on preceding requirements 1, 2, and 3 to bring out your points. This is a more important requirement than requirements 1, 2, and 3.