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The Nantell Corporation just purchased an expensive piece of equipment. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
a. Nantell’s taxable income will be lower.
b. Nantell’s operating income (EBIT) will increase.
c. Nantell’s cash position will improve (increase).
d. Nantell’s reported net income for the year will be lower.
e. Nantell’s tax liability for the year will be lower.

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Tundexi

Nantell’s operating income will increase as a result of this Congressional action

Initially, the firm plans to depreciate over 5 years but the Congress pass a law that states company must depreciate over 7 years

  • Because of this, decrease in depreciation amount will increase the net taxable income, so, Nantell’s taxable income will not be lower.  

  • The decrease in depreciation will result to increase the operating income, thus, Nantell’s operating income (EBIT) will increase

  • We knew depreciation is a non-cash activity and it will not effect the cash. So, Nantell’s cash position will not increase nor improve.

  • It is well know that decrease in depreciation amount will increase the net income, so, Nantell’s reported net income for the year cannot be lower.

  • The decrease in depreciation amount will increase the net taxable income, therefore increasing the tax liability on net taxable income. So, Nantell’s tax liability cannot be lower.

Learn about the congress action here

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