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050Depreciation expense rises by Rs 10 crore and the tax rate is 25%. Walk the change through the income statement, the cash flow statement and the balance sheet.Millennium ManagementNew York · 2024
Try it first
What happens to cash?
Show the worked solution
Net income falls Rs 7.5 crore, cash rises Rs 2.5 crore, PP&E falls Rs 10 crore and equity falls Rs 7.5 crore. Pre-tax profit drops Rs 10 crore and tax drops Rs 2.5 crore, so net income is down Rs 7.5 crore. The cash flow statement adds back the Rs 10 crore of depreciation, so cash is up Rs 2.5 crore. Assets fall Rs 7.5 crore net, matching the fall in retained earnings.
Why does a non-cash expense raise cash?
A shopkeeper who can deduct the wear on her delivery van from her taxable income pays less tax, even though no money went out for the wear itself. Depreciation moves no cash, but it is deductible, so it cuts the tax bill, and the tax saved is real cash: 25% of Rs 10 crore, Rs 2.5 crore. That is the one cash effect in the whole question; everything else is accounting.
Rs 10 crore of extra depreciation cuts net income by Rs 7.5 crore, the add-back turns that into a Rs 2.5 crore rise in cash, and on the balance sheet cash up 2.5 and PP&E down 10 leave assets down 7.5, matching equity, because a non-cash expense raises cash by the tax it saves. How do you say it in the room in thirty seconds?
Go statement by statement, in the order the numbers flow. Income statement: pre-tax profit down 10, tax down 2.5, net income down 7.5. Cash flow: start at minus 7.5, add back 10, cash up 2.5. Balance sheet: cash up 2.5, PP&E down 10, assets down 7.5; equity down 7.5 through retained earnings; it balances. End on the balance, because that is the check the interviewer is waiting for.
Statement Line Change, Rs crore Income statement Pre-tax profit -10.0 Income statement Tax -2.5 Income statement Net income -7.5 Cash flow Operating cash flow +2.5 Balance sheet Cash / PP&E +2.5 / -10.0 Balance sheet Retained earnings -7.5 Every line follows from two facts: depreciation is deductible at 25%, and it moves no cash. Say the assumption: the tax return uses the same depreciation as the books. If the higher charge is only in the books, cash tax does not fall, the Rs 2.5 crore goes to a deferred tax asset instead, and cash does not move at all.
Where candidates lose it
The two classic slips are saying cash does not change because depreciation is non-cash, and letting net income fall the full Rs 10 crore by forgetting tax. Both come from rushing the first line.
The quieter loss is not closing the balance sheet. Candidates who say assets fall Rs 10 crore then cannot match equity. Cash up 2.5 is the piece that makes it balance.
What the interviewer asks next
- Now walk through a Rs 10 crore rise in inventory funded by cash.
- What if the extra depreciation is not deductible for tax?
- How does the change affect EBITDA and free cash flow?
Asked at Millennium Management, Investment Research, New York, 2024 (Wall Street Oasis):
Nothing as much, technical questions were super basic like $10 depreciation
