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Chapter 4

Cash Flow
Financial Planning

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All rights reserved.

Depreciation is the allocation of the historic cost
of an asset over time
Non-cash expense
Use MACRS for tax purposes
Can use other methods for financial reporting
What are other depreciation methods?

Shorter depreciable life preferred to longer


Depreciable Value of Asset

Depreciable Value = Cost + Delivery + Installation
Delivery and installation can be significant amount
Want to be able to depreciate as much as possible

Table 4.1 First Four Property

Classes under MACRS

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Table 4.2 Rounded Depreciation Percentages by

Recovery Year Using MACRS for First Four
Property Classes

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Depreciation: An Example
Baker Corporation acquired, for an installed cost of $40,000, a
machine having a recovery period of 5 years. Using the applicable
MACRS rates, the depreciation expense each year is as follows:

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Depreciation Example
Your company purchases a new piece of
equipment for $20,000. Delivery costs
$2,000 and installation costs $3,000.
The piece of equipment has a 5-year
depreciable live.
Calculate the annual depreciation expense
using the depreciation table.

Section 179 Deduction

Section 179 of the IRS tax code allows businesses to deduct
the full purchase price of qualifying equipment and/or
software purchased or financed during the tax year.
That means that if you buy (or lease) a piece of qualifying
equipment, you can deduct the FULL PURCHASE PRICE
from your gross income.
It's an incentive created by the U.S. government to encourage
businesses to buy equipment and invest in themselves.

Section 179 Deduction Limits

Limit of $139,000 in equipment, software, and
vehicles WRITTEN OFF for 2012
Limit of $560,000 in equipment purchases for
The deduction begins to phase out dollar-fordollar after $560,000 is spent by a given
business, so this makes it a true small and
medium-sized business deduction.

Cash Flow The Accounting


Depreciation or other non-cash expenses

Why do we add depreciation back to NPAT?

Cash Flow The Finance


How is this different from the accounting definition?

Cash Flow Example

A company has $100,000 of earnings before
interest and taxes. Interest expense is
$10,000 and taxes are 34%. The company
also has depreciation expense of $12,000.
What is the cash flow for this company using
the accounting definition and the finance

Table 4.3
Inflows and Outflows of Cash

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The Financial Planning Process

The financial planning process begins with long-term,
or strategic, financial plans that in turn guide the
formulation of short-term, or operating, plans and
Two key aspects of financial planning are cash planning
and profit planning.
Cash planning involves the preparation of the firms cash
Profit planning involves preparation of pro forma statements.

2012 Pearson Prentice Hall. All rights reserved.