Montejo Corporation expects 2012 sales to be $12 million. Operating costs other than depreciation are expected to be 75 percent of sales, and depreciation is expected to be $1.5 million in 2012. All sales revenues will be collected in cash, and costs other than depreciation must be paid during the year. Montejo's interest expense is expected to be $1 million, and it is taxed at a 40 percent rate.
a. Set up an income statement and a cash flow statement (use two columns on one page) for Montejo. What is the expected cash flow from operations?
b. Suppose Congress changed the tax laws so that Montejo's depreciation expenses doubled in 2012, but no other changes occurred. What would happen to the net income and cash flow from operations expected in 2012?
c. Suppose that Congress, rather than increasing Montejo's 2012 depreciation, reduced it by 50 percent. How would the income and cash flows be affected?
d. If this company belonged to you, would you prefer that Congress increase or decrease the depreciation expense allowed your company? Explain why.