Corporate Finance Quiz: Ebit Ebitda And Operating Cash Flow
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Ebit Ebitda And Operating Cash FlowQuestion 1 of 20

GlobalTech reported the following cash flow statement items: Net Income $78 million, Depreciation and Amortization $42 million, Stock-based Compensation 9million,ChangesinWorkingCapital−9 million, Changes in Working Capital -15 million, Gain on Sale of Subsidiary $25 million, Deferred Tax Benefit $8 million, and Impairment Charges $12 million.

To calculate GlobalTech's core operating EBITDA for valuation purposes, which adjustments should be made to the reported operating cash flow of $109 million?

Add back $15 million working capital change and subtract $25 million gain, resulting in $99 million
Add back $15 million working capital change and subtract $17 million after-tax gain, resulting in $107 million
Add back $23 million in working capital and non-cash items, subtract $25 million gain, resulting in $107 million
Add back $15 million working capital change, subtract $25 million gain, add $8 million deferred taxes, resulting in $107 million
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Corporate Finance Quiz

Corporate Finance Quiz: Ebit Ebitda And Operating Cash Flow

Practice Ebit Ebitda And Operating Cash Flow in Corporate Finance with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Ebit Ebitda And Operating Cash Flow, giving you a quick way to practice the rules, question types, and explanations that matter most for Corporate Finance.

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Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

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Question 1

GlobalTech reported the following cash flow statement items: Net Income $78 million, Depreciation and Amortization $42 million, Stock-based Compensation 9million,ChangesinWorkingCapital−9 million, Changes in Working Capital -15 million, Gain on Sale of Subsidiary $25 million, Deferred Tax Benefit $8 million, and Impairment Charges $12 million.

To calculate GlobalTech's core operating EBITDA for valuation purposes, which adjustments should be made to the reported operating cash flow of $109 million?

  1. Add back $15 million working capital change and subtract $25 million gain, resulting in $99 million (correct answer)
  2. Add back $15 million working capital change and subtract $17 million after-tax gain, resulting in $107 million
  3. Add back $23 million in working capital and non-cash items, subtract $25 million gain, resulting in $107 million
  4. Add back $15 million working capital change, subtract $25 million gain, add $8 million deferred taxes, resulting in $107 million
Explanation: Operating cash flow of 109Mincludes:NetIncome(109M includes: Net Income (78M) + D&A (42M)+Stockcomp(42M) + Stock comp (9M) + Working capital (-15M)+otheritems.TogetcoreoperatingEBITDA:Removetheworkingcapitalimpact(+15M) + other items. To get core operating EBITDA: Remove the working capital impact (+15M) since EBITDA excludes working capital changes. Remove the non-operating gain (-$25M) since it's not from core operations. The deferred tax benefit and other items are operating-related. Core operating EBITDA = $109M + $15M - $25M = $99M. Choice B incorrectly uses after-tax gain adjustment. Choice C incorrectly adds back other non-cash items. Choice D incorrectly adds back deferred taxes which are already properly reflected.

Question 2

An analyst states that EBITDA is a 'pre-leverage' and 'pre-tax' measure of performance. Which of the following business decisions would have a direct impact on a company's EBITDA?

  1. Refinancing existing debt at a lower interest rate.
  2. Implementing a new, highly efficient manufacturing process that lowers cost of goods sold. (correct answer)
  3. Moving the corporate headquarters to a country with a lower corporate tax rate.
  4. Executing a large share buyback program financed with cash on hand.
Explanation: EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a measure of a company's core operational profitability. A new manufacturing process that lowers the cost of goods sold directly increases the company's gross profit and operating profit (EBIT), and therefore also increases EBITDA. The other choices relate to financing (interest, share buybacks) or tax decisions, which are specifically excluded from the EBITDA calculation.

Question 3

A company is considering two mutually exclusive projects. Project A is capital-intensive with high initial depreciation charges. Project B is labor-intensive with lower depreciation. Both projects are expected to generate the same EBIT (Earnings Before Interest and Taxes) for the first three years. Assuming a positive tax rate and no changes in working capital, which statement accurately compares the projects' cash flows in their initial years?

  1. Project A will generate higher operating cash flow (OCF) due to a larger depreciation tax shield. (correct answer)
  2. Project B will generate higher operating cash flow (OCF) because it has lower non-cash expenses.
  3. Both projects will have the same operating cash flow (OCF) because their EBIT is identical.
  4. Both projects will have the same EBITDA, which means their cash flows are effectively equivalent.
Explanation: Operating Cash Flow can be calculated as EBIT(1−T)+DepreciationEBIT(1-T) + \text{Depreciation}. Since both projects have the same EBIT and tax rate (T), the term EBIT(1−T)EBIT(1-T) is equal for both. However, Project A has higher depreciation. This higher depreciation provides a larger tax shield (Depreciation * T), which increases the OCF. Therefore, Project A will have a higher OCF. EBITDA would be higher for Project A, but it is not equivalent to OCF.

Question 4

For the most recent fiscal year, a rapidly expanding retail company reported a positive EBITDA of $10 million. However, its Operating Cash Flow (OCF) was negative $3 million. The company has negligible interest expense and a low effective tax rate. Which of the following is the most plausible explanation for this significant divergence?

  1. A substantial build-up of inventory and accounts receivable to support higher sales volume. (correct answer)
  2. The company paid a large, special cash dividend to its equity investors during the year.
  3. The company incurred a large, non-cash restructuring charge that significantly reduced net income.
  4. The company uses an accelerated depreciation method for its new stores and equipment.
Explanation: Operating Cash Flow (OCF) is calculated by starting with Net Income, adding back non-cash charges like depreciation, and adjusting for changes in net working capital. EBITDA is a proxy for pre-tax, pre-interest cash flow before working capital adjustments. A large negative OCF despite positive EBITDA is often explained by a significant investment in net working capital, such as increases in inventory and accounts receivable, which represent a use of cash. This is common for rapidly growing companies. Dividends are a financing activity. A non-cash charge would be added back to Net Income, increasing OCF. Accelerated depreciation would increase the D&A add-back and the depreciation tax shield, both of which would increase OCF, not decrease it.

Question 5

An analyst observes that a company's EBITDA has been growing at 10% annually for three years, but its stock price has been flat. A deeper look reveals that Operating Cash Flow (OCF) has been declining over the same period. Which of the following would not be a plausible explanation for the divergence between EBITDA and OCF trends?

  1. The company has been aggressively recognizing revenue, leading to a ballooning of accounts receivable.
  2. The company has been capitalizing operating expenses, such as software development costs.
  3. The company's interest expense and cash tax payments have been increasing significantly.
  4. The company has been repurchasing a large number of its own shares on the open market. (correct answer)
Explanation: Share repurchases are a financing activity and do not affect the calculation of Operating Cash Flow (OCF) or EBITDA. The other three choices all describe scenarios that can create a divergence between EBITDA and OCF. A) Rising accounts receivable is a use of operating cash, which would decrease OCF relative to EBITDA. B) Capitalizing expenses boosts EBITDA but the cash outflow is still real (it's just moved to investing cash flow), which can mask underlying cash performance. C) Increasing cash interest and taxes are deductions that bridge the gap between EBITDA and OCF; if they rise faster than EBITDA, OCF can decline.

Question 6

An analyst has gathered the following selected financial data for Apex Industries for the year ended December 31, 20X2 (in millions). Refer to the information provided below.

Income Statement Data:

  • Revenue: $1,000
  • Cost of Goods Sold: $600
  • SG&A Expense: $100
  • Depreciation Expense: $50
  • Interest Expense: $30
  • Tax Rate: 25%

Balance Sheet Changes:

  • Increase in Accounts Receivable: $20
  • Increase in Inventory: $15
  • Increase in Accounts Payable: $10

Based on the financial data provided, what is Apex Industries' Cash Flow from Operations (CFO) for 20X2?

  1. $190 million (correct answer)
  2. $215 million
  3. $240 million
  4. $250 million
Explanation: The calculation requires multiple steps using the indirect method for Operating Cash Flow (also called Cash Flow from Operations or CFO).
  1. Calculate EBIT: (EBIT = \text{Revenue} - \text{COGS} - \text{SG&A} - \text{Depreciation} = 1000−1000 - 600 - 100−100 - 50 = $250).
  2. Calculate EBT: (EBT = EBIT - \text{Interest} = 250−250 - 30 = $220).
  3. Calculate Net Income (NI): (NI = EBT \times (1 - T) = 220×(1−0.25)=220 \times (1 - 0.25) = 165).
  4. Calculate Change in Net Working Capital (ΔNWC): (ΔNWC = ΔAR + ΔInventory - ΔAP = 20+20 + 15 - 10=10 = 25). An increase in NWC is a use of cash.
  5. Calculate CFO: (CFO = NI + \text{Depreciation} - ΔNWC = 165+165 + 50 - 25=25 = 190). Distractor B is NI + Depreciation, ignoring NWC. Distractor C makes a sign error on NWC (adds instead of subtracts). Distractor D is the company's EBIT.

Question 7

An analyst is comparing a capital-intensive telecommunications company with a software company. The software company capitalizes its software development costs and amortizes them over time. Why might the analyst prefer to use the EV/EBITDA multiple for the telecom company but find EV/EBIT more appropriate for the software company?

  1. EBITDA is better for the telecom firm because its depreciation is very high and may not reflect its true maintenance capital expenditures.
  2. EBIT is better for the software firm because amortization of capitalized software is a critical, recurring expense reflecting product investment. (correct answer)
  3. EBITDA is preferred for technology companies because it is always a higher number, leading to lower valuation multiples.
  4. EBIT is preferred for capital-intensive firms as it correctly penalizes them for their high levels of depreciation.
Explanation: For a software company, capitalized software development is a core part of its business model—it's how new products are created. The subsequent amortization, while non-cash, represents the real economic cost of using up that previously capitalized investment. Ignoring this by using EBITDA would overstate the company's profitability. Therefore, EBIT, which includes this critical amortization expense, is often seen as a more meaningful measure. Conversely, for a capital-intensive utility or telecom firm, depreciation charges are massive and can be lumpy depending on investment cycles, and may not align with the annual cash required for maintenance (maintenance capex), making EBITDA a potentially better starting point for analysis.

Question 8

A company reports a significant non-cash restructuring charge of $50 million, which is included in its SG&A expenses. How will this charge affect the company's EBIT, EBITDA, and Operating Cash Flow (OCF)?

  1. EBIT decreases, EBITDA is unchanged, and OCF is unchanged.
  2. EBIT decreases, EBITDA decreases, and OCF decreases.
  3. EBIT decreases, EBITDA is unchanged, and OCF increases.
  4. EBIT decreases, EBITDA decreases, and OCF is unchanged (or increases). (correct answer)
Explanation:
  1. EBIT: The restructuring charge is an operating expense, so it directly reduces EBIT.
  2. EBITDA: EBITDA is calculated as EBIT + D&A. Since the restructuring charge is not Depreciation or Amortization, it is not added back. Therefore, the decrease in EBIT flows through, causing EBITDA to decrease as well. (Note: Analysts often calculate an "Adjusted EBITDA" that adds back such charges, but standard EBITDA would include it).
  3. OCF: In the indirect method for OCF, we start with Net Income. The charge reduces NI. However, because the charge is non-cash, its full amount is added back in the reconciliation to OCF. The charge also creates a tax shield (reduces taxes by Charge * Tax Rate), which is a real cash saving. The net effect on OCF is an increase equal to the tax shield. Therefore, OCF is either unchanged (ignoring tax effect in simple analysis) or increases.

Question 9

In the first year of an asset's life, a company switches its depreciation method from straight-line to double-declining balance. Assuming the company has positive earnings and a constant tax rate, what is the impact of this accounting change on its EBIT, EBITDA, and Operating Cash Flow (OCF) in that first year?

  1. EBIT decreases, EBITDA is unchanged, OCF increases. (correct answer)
  2. EBIT decreases, EBITDA decreases, OCF decreases.
  3. EBIT is unchanged, EBITDA is unchanged, OCF increases.
  4. EBIT decreases, EBITDA is unchanged, OCF is unchanged.
Explanation:
  1. EBIT: Accelerated depreciation (like double-declining balance) results in higher depreciation expense in the early years compared to straight-line. Since depreciation is an operating expense, higher depreciation leads to lower EBIT.
  2. EBITDA: EBITDA is calculated as EBIT + Depreciation & Amortization. While EBIT is lower, the D&A add-back is correspondingly higher. These two effects cancel each other out, leaving EBITDA unchanged.
  3. OCF: The higher depreciation expense, while non-cash, creates a larger tax shield (i.e., it reduces taxable income, thus reducing the amount of cash taxes paid). Lower cash tax payments result in a higher Operating Cash Flow. Therefore, OCF increases.

Question 10

A company has a debt covenant requiring its Debt-to-EBITDA ratio to remain below 3.0x. The company's management is considering a sale-and-leaseback of its headquarters building. The transaction would generate significant cash proceeds and replace its current depreciation and interest expense with a single operating lease payment. How would this transaction likely affect the company's compliance with the covenant?

  1. It would improve compliance by reducing debt without affecting EBITDA.
  2. It would worsen compliance because the new lease payment will reduce EBITDA while debt reduction may be limited. (correct answer)
  3. It would improve compliance because the cash proceeds will increase EBITDA.
  4. It would have no effect on compliance since it is a non-operating transaction.
Explanation: In a sale-and-leaseback transaction, the company receives cash proceeds that can be used to pay down debt (reducing the numerator). However, the previous expenses associated with owning the building (depreciation and interest on any mortgage) did not affect EBITDA, while the new operating lease payment is an operating expense that directly reduces EBITDA (increasing the denominator). The reduction in EBITDA typically has a more significant negative impact on the ratio than the debt reduction has a positive impact, making covenant compliance worse.

Question 11

An analyst is concerned about a company's quality of earnings after observing that its EBITDA margin has increased for three consecutive years, while its operating cash flow margin (OCF/Sales) has steadily declined. Which of the following corporate actions would most likely explain this divergence and justify the analyst's concern?

  1. Aggressively paying down long-term debt to reduce interest expense.
  2. Extending more generous credit terms to customers to drive sales growth. (correct answer)
  3. Shifting production to a lower-cost overseas facility.
  4. Adopting a more conservative depreciation policy for new assets.
Explanation: Extending generous credit terms can boost reported revenue and thus EBITDA, but it leads to a slower collection of cash and a rapid increase in accounts receivable. A significant increase in accounts receivable is a use of operating cash flow. This directly explains how EBITDA margin could rise (due to higher sales) while the OCF margin falls (due to cash not being collected). This practice, sometimes called 'channel stuffing,' is a classic red flag for low-quality earnings. Paying down debt is a financing activity. Shifting production would likely improve both EBITDA and OCF. A more conservative (slower) depreciation policy would increase EBIT and EBITDA but have a negative impact on OCF due to a smaller tax shield.

Question 12

A firm has an EBIT of $200 million and a depreciation expense of $50 million. Its tax rate is 25%. The firm has no debt. It then acquires another company in a transaction that adds $40 million in amortization expense per year, but does not change EBIT. What is the effect of the acquisition on the firm's annual Operating Cash Flow (OCF)?

  1. OCF increases by $10 million. (correct answer)
  2. OCF increases by $30 million.
  3. OCF increases by $40 million.
  4. OCF remains unchanged.
Explanation: This question tests the understanding of the amortization tax shield. The formula for OCF can be expressed as EBIT(1−T)+D&AEBIT(1-T) + D\&A. Before acquisition: OCF = $200M(1 - 0.25) + $50M = $150M + $50M = $200M. After acquisition: EBIT is unchanged at $200M. However, the new amortization expense is tax-deductible, reducing taxable income. So, technically, the reported EBIT would change. Let's assume the stem means operating income before this new amortization is unchanged. The new EBT would be $200M - $40M = $160M. A better way is to consider the change. The new amortization expense of $40M is non-cash but tax-deductible. It creates a tax shield of \40M \times 25% = $10M$. This tax saving is a real increase in cash flow. Therefore, the firm's OCF increases by $10 million.

Question 13

A company's reported provision for income taxes on its income statement is $10 million. However, the cash taxes actually paid to the government during the period were $12 million. How would this difference impact the calculation of Operating Cash Flow (OCF) starting from Net Income?

  1. It would not impact the calculation, as OCF uses the tax provision from the income statement.
  2. The calculation would need to be adjusted by subtracting the increase in deferred tax assets. (correct answer)
  3. The OCF would be $2 million lower than an estimate using a formula like EBIT(1-T) + D&A.
  4. The OCF calculation would add back the $2 million difference as a non-cash charge.
Explanation: The difference between tax expense (provision) and cash taxes paid is captured by the change in deferred tax assets/liabilities on the balance sheet. If cash taxes paid (12M)aregreaterthanthetaxexpense(12M) are greater than the tax expense (10M), it means the company paid more in cash than it recognized as an expense. This difference of $2M would typically be reflected as an increase in deferred tax assets or a decrease in deferred tax liabilities. In the indirect OCF calculation (starting from Net Income), an increase in an operating asset (like deferred tax assets) is a use of cash and must be subtracted. Therefore, the calculation must be adjusted by subtracting this increase in deferred tax assets.

Question 14

A manufacturing company decides to capitalize a major plant overhaul cost of $5 million rather than expensing it immediately. The capitalized cost will be depreciated over 5 years. In the first year following this decision, what is the most likely impact on the company's reported metrics compared to if they had expensed the cost?

  1. EBITDA will be higher, but Operating Cash Flow will be unchanged.
  2. EBIT will be higher, and Operating Cash Flow will be higher. (correct answer)
  3. EBITDA will be unchanged, but Operating Cash Flow will be higher.
  4. EBIT will be lower, and Operating Cash Flow will be unchanged.
Explanation: Capitalizing the $5M cost instead of expensing it has two primary effects in the first year. First, the $5M operating expense is replaced by a $1M depreciation expense (assuming 5-year straight-line). This increases both EBIT (by $4M) and EBITDA (by $5M since depreciation is added back). Second, the $5M cash outflow is classified as an Investing Activity (Capital Expenditure) instead of an Operating Activity. This reclassification leads to a higher reported Operating Cash Flow (OCF) by $5M compared to if the cost had been expensed. Therefore, both EBIT and OCF will be higher.

Question 15

Company A and Company B operate in the same industry and have identical revenue and EBIT margins. Company A uses finance leases for its major equipment, while Company B uses operating leases. How would their key metrics most likely compare?

  1. Company A will have higher EBITDA but lower Operating Cash Flow.
  2. Company B will have higher EBITDA and higher Operating Cash Flow.
  3. Company A will have higher EBITDA and higher Operating Cash Flow. (correct answer)
  4. Company B will have higher EBIT but lower EBITDA.
Explanation: Under standard accounting rules (like IFRS 16 or ASC 842), both finance and operating leases are capitalized on the balance sheet. However, for the income statement, a finance lease shows depreciation and interest expense, whereas an operating lease shows a single lease expense. The single lease expense for an operating lease is an operating expense that reduces EBITDA. For a finance lease, the costs (depreciation and interest) are recorded below the EBITDA line. Therefore, Company A (finance lease) will report higher EBITDA. For the cash flow statement, the entire payment for an operating lease is an operating outflow. For a finance lease, the payment is split between an interest portion (operating outflow) and a principal portion (financing outflow). This means Company A will also report a higher Operating Cash Flow because a large part of the cash payment is classified as a financing activity.

Question 16

An analyst is evaluating a company that recently shifted its business model, resulting in a significantly shorter cash conversion cycle. Assuming all else remains constant, how would this change most likely affect the relationship between the company's EBITDA and its Operating Cash Flow (OCF)?

  1. The gap between EBITDA and OCF will likely narrow, with OCF becoming closer to EBITDA. (correct answer)
  2. The gap between EBITDA and OCF will likely widen, with OCF falling further below EBITDA.
  3. EBITDA will decrease to match the lower investment required in working capital.
  4. There will be no change in the relationship, as the cash conversion cycle affects financing, not operations.
Explanation: A shorter cash conversion cycle means the company needs less cash tied up in working capital (inventory and accounts receivable net of accounts payable). The primary difference between EBITDA and OCF is the adjustment for taxes, interest, and changes in net working capital. By reducing the need for investment in working capital, the negative adjustment from EBITDA to OCF will be smaller, or could even become positive. This narrows the gap and brings OCF closer to EBITDA.

Question 17

A private equity firm is considering a leveraged buyout of a target company. The firm plans to use a significant amount of debt to finance the acquisition. When assessing the target's ability to service this new debt, why would the private equity firm primarily focus on EBITDA rather than EBIT or Net Income?

  1. EBITDA represents the cash available to all stakeholders before the effects of capital structure and taxes. (correct answer)
  2. EBITDA is a more accurate measure of profitability because it excludes non-cash depreciation expenses.
  3. Net Income is distorted by interest expense, making it unsuitable for analyzing a post-buyout entity.
  4. EBITDA is a standardized GAAP measure, whereas EBIT can be calculated in multiple ways.
Explanation: EBITDA is a proxy for a company's operating cash flow before considering its capital structure (interest expense) and tax regime. In a leveraged buyout, the capital structure will be completely changed. Therefore, a measure that shows the cash-generating potential of the core business, independent of the old financing and tax decisions, is most useful. This pre-leverage, pre-tax cash flow figure (EBITDA) can then be used to assess how much debt the business can support under a new capital structure.

Question 18

MegaCorp's financial statements show the following information for the current year: Operating Income (EBIT) of $95 million, Depreciation of $22 million, Amortization of $8 million, Interest Expense of $15 million, Tax Expense of $18 million, Increase in Accounts Receivable of $12 million, Decrease in Inventory of $8 million, Increase in Accounts Payable of $5 million, and Capital Expenditures of $45 million.

If MegaCorp's actual reported operating cash flow is $89 million, which adjustment most likely explains the difference between the calculated operating cash flow and the reported figure?

  1. A $3 million stock-based compensation expense was excluded from the calculation
  2. A $6 million gain on asset disposal was included in operating income (correct answer)
  3. A $4 million provision for bad debt was not properly accounted for
  4. A $2 million foreign exchange translation adjustment affected cash flows
Explanation: First, calculate expected OCF: Net Income = EBIT (95M)−Interest(95M) - Interest (15M) - Taxes ($18M) = $62M. Add back D&A: $62M + $22M + $8M = 92M.Workingcapitalchanges:−92M. Working capital changes: -12M (AR increase) + $8M (Inventory decrease) + 5M(APincrease)=+5M (AP increase) = +1M. Expected OCF = $92M + $1M = $93M. Reported OCF is $89M, so there's a $4M difference. A $6M gain on disposal would inflate operating income by $6M, but since it's not a cash operating item, removing it would reduce OCF by approximately $6M × (1 - tax rate). With taxes, the net effect would be about $4-5M reduction, explaining the difference. The other options create smaller discrepancies.

Question 19

InnovateCorp's EBITDA has grown from $150 million to $180 million over two years, while its operating cash flow has declined from $125 million to $115 million over the same period. Depreciation expense remained constant at $35 million annually. Which scenario most likely explains this divergence?

  1. The company recognized $20 million in one-time restructuring charges in the current period
  2. The company's effective tax rate increased from 20% to 30% due to changes in tax legislation
  3. Interest expenses increased by $25 million due to additional debt financing for expansion
  4. Working capital increased by approximately $40 million due to rapid revenue growth and extended payment terms (correct answer)
Explanation: When analyzing divergence between EBITDA growth and declining operating cash flow, focus on the key difference: EBITDA is an accounting measure, while operating cash flow reflects actual cash movements including working capital changes. Let's trace through the numbers. EBITDA grew by 30million(30 million (180M - $150M). Since depreciation stayed constant at $35 million, EBIT also increased by $30 million. For operating cash flow to decline by 10million(10 million (125M to $115M) despite higher EBIT, something must be absorbing significant cash. Option D correctly identifies the culprit: a $40 million working capital increase. When companies grow rapidly and extend payment terms, they tie up cash in accounts receivable and inventory while potentially delaying payments to suppliers. This working capital build-up directly reduces operating cash flow without affecting EBITDA, explaining the divergence perfectly. Option A is wrong because restructuring charges would actually reduce EBITDA (they're typically included in operating expenses), making the divergence even more puzzling. Option B fails because tax rate changes affect both EBIT (after taxes) and operating cash flow proportionally - they wouldn't create this specific pattern. Option C misses the mark since interest expenses don't impact either EBITDA or operating cash flow; they appear below the operating line in financial statements. Remember this pattern: when EBITDA rises but operating cash flow falls, immediately examine working capital changes. Rapid growth often creates cash flow pressure as companies invest in receivables and inventory to support sales expansion.

Question 20

Two companies in the same industry have identical EBITDA of $200 million. Company Alpha has higher depreciation expenses due to newer equipment, while Company Beta has higher amortization due to recent acquisitions. If Alpha's D&A is $60 million and Beta's is $45 million, and both face a 30% tax rate with no interest expenses, which statement about their relative financial metrics is most accurate?

  1. Alpha's operating cash flow exceeds Beta's by $4.5 million due to depreciation tax shields
  2. Beta's net income exceeds Alpha's by $10.5 million, but Alpha's cash flow is higher (correct answer)
  3. Alpha's operating cash flow exceeds Beta's by $10.5 million due to higher depreciation
  4. Both companies have identical operating cash flows since EBITDA is the same
Explanation: Alpha: EBIT = $200M - $60M = $140M; Net Income = $140M × 0.7 = $98M; OCF = $98M + $60M = $158M. Beta: EBIT = $200M - $45M = $155M; Net Income = $155M × 0.7 = $108.5M; OCF = $108.5M + $45M = $153.5M. Beta's NI exceeds Alpha's by 10.5M(10.5M (108.5M - $98M). Alpha's OCF exceeds Beta's by 4.5M(4.5M (158M - 153.5M). The higher D&A gives Alpha a larger tax shield (60M × 0.3 = $18M vs $45M × 0.3 = $13.5M), creating a $4.5M OCF advantage, but Beta has $10.5M higher net income. Choice B correctly identifies both effects.