Depreciation increases by 10 with a 40% tax rate; cash flow from operations changes by what amount?

Depreciation increases by 10 with a 40% tax rate; cash flow from operations changes by what amount?

• A. Increases by 4
• B. Increases by 10
• C. Decreases by 4
• D. No change

Answer: (A)

The key idea is that depreciation is a non-cash expense, but it still affects cash flow through taxes and the indirect-method adjustment. If depreciation rises by 10, pretax income falls by 10. With a 40% tax rate, taxes decrease by 0.40 × 10 = 4, so net income falls by 10 − 4 = 6. For cash flow from operations using the indirect method, you add back the full depreciation as a non-cash charge (+10). The net effect on CFO is the change in net income plus the back-added depreciation: (−6) + 10 = +4. So cash flow from operations increases by 4.

The key idea is that depreciation is a non-cash expense, but it still affects cash flow through taxes and the indirect-method adjustment. If depreciation rises by 10, pretax income falls by 10. With a 40% tax rate, taxes decrease by 0.40 × 10 = 4, so net income falls by 10 − 4 = 6. For cash flow from operations using the indirect method, you add back the full depreciation as a non-cash charge (+10). The net effect on CFO is the change in net income plus the back-added depreciation: (−6) + 10 = +4. So cash flow from operations increases by 4.