Please, kindly provide answers, most especially, to part C SteelTubes had sales
ID: 2568121 • Letter: P
Question
Please, kindly provide answers, most especially, to part C
SteelTubes had sales of $300 million this year. Expenses were $250 million. Aside from these figures, the company also invested in new mills for carbon steel tubing, complete with peripheral loading, straightening, and coiling equipment plus facility reconfiguration totaling $14 million. SteelTubes believes the usable life of the mill will be only seven years, owing to technological advances. There were no other financial considerations.
a. Looking strictly at cash flows, what will be reported as the financial gain or loss? Is this a fair representation of financial performance?
b. If for internal financial reporting, the manufacturer writes off equal amounts of the capital investment over the usable life, starting this year, what will be the financial gain or loss of this year? What is the depreciation method being used in this case?
c. On letter “b” were those real cash flows? How does this relate to taxes and what is the impact of the depreciation method?
Explanation / Answer
a. In financial terms the gain from the given information is $50 million, as the difference between sales and expenses is $50 million.
But since the question says 'looking strictly at cash flows' (which means the net cash inflows) the gain is $36 million ($50 million - $14 million investment). This will be correct only if all the expenses are cash expenses and there is no book expense like depreciation.
b. If we use the straight line method of depreciation , the annual depreciation will be $2 million . The fianancial gain will be $48 million ($50 million - $2 million towards depreciation).
c. As mentioned under (a) above , the real cash flows are $36 million, if all the expenses are cash expenses. In 'b' above we have made a depreciation adjustment of $2 million.
This depreciation will help in reducing the tax liability as depreciation is allowed as an expense under income tax laws. The amount of reduction in tax liability will be the same over the life of the asset , whatever the depreciation method used. But under declining balance method , the company can claim higher depreciation in the intial periods so the income tax liability will be leeser in the initial period of investment compared to later periods. Under the straight line method , the tax benefit is equally spread ovet the life of the asset.