CFA Practice Question

CFA Practice Question

Firm A and Firm B have identical transactions for a year except for two transactions. The two transactions are: 1) Firm A has a depreciation expense (for PP and E) of $5,000. 2) Firm B purchases new equipment for $10,000 cash. Assume that the tax rate is 40% and depreciation is allowed as an expense for tax purposes. Firm A's Net Income for the year is:
A. lower than Firm B's Net Income by $3,000.
B. higher than Firm B's Net Income by $3,000.
C. same as firm B's Net Income.
Explanation: Net Income is lower by 5,000 due to Depreciation Expense, however taxes are lower by 40%, that is 2,000, given a net lower amount of 3,000.

User Contributed Comments 3

User Comment
Mariana80 So the $10,000 new equipment purchase by Firm B doesn't affect its NI at all? Why?
michaeloa3 It looks like the $10,000 cash for new equipment would be Investing Cash Flow, so wouldn't lower net income.
santibanez The investment is not an expense account. When buying it am asset account is being debited (equipment increases) and another asset is credited (cash decreases) w/o P&L effect

You would need an expense/revenue account to have an effect on P&L
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