Montejo Corporation expects sales to be $ 12 million, operating costs other than depreciation are expected to be 75 percent of sales, and depreciation to be $ 1.5 million during the next year. All sales revenues will be collected in cash, and costs other than depreciation must be paid during the year. Montejo's interest expense is expected to be $ 1 million, and it is taxed at a 40 percent rate.
a) Set up an income statement and a cash flow statement for Montejo. What is the expected cash flow from operations?
b) Suppose congress changed the tax laws so that Montejo's depreciation expenses doubled, but no other changes occurred. What would happen to the net income and cash flow from operations expected during the year?
c) Suppose that congress, rather than increasing Montejo's depreciation, reduced it by 50 percent. How would the income and cash flows be affected?
d) If this company belonged to you, would you prefer that congress increase or decrease the depreciation expense allowed your company? describe why.