Corporate Finance Quiz: Non Cash Expenses And Adjustments
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Non Cash Expenses And AdjustmentsQuestion 1 of 20

A project's financial projections for the upcoming year include EBIT of $200,000, depreciation of $40,000, and a tax rate of 25%. The project will also require an increase in inventory of $30,000 and an increase in accounts payable of $10,000. The project has no capital expenditures planned for the year. What is the project's free cash flow (FCF) for the year?

$190,000
$210,000
$170,000
$150,000
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Corporate Finance Quiz

Corporate Finance Quiz: Non Cash Expenses And Adjustments

Practice Non Cash Expenses And Adjustments in Corporate Finance with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

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This quiz focuses on Non Cash Expenses And Adjustments, giving you a quick way to practice the rules, question types, and explanations that matter most for Corporate Finance.

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Question 1

A project's financial projections for the upcoming year include EBIT of $200,000, depreciation of $40,000, and a tax rate of 25%. The project will also require an increase in inventory of $30,000 and an increase in accounts payable of $10,000. The project has no capital expenditures planned for the year. What is the project's free cash flow (FCF) for the year?

  1. $190,000
  2. $210,000
  3. $170,000 (correct answer)
  4. $150,000
Explanation: Free cash flow (FCF) is calculated as FCF = OCF - Capital Expenditures - Change in Net Working Capital.
  1. Calculate Operating Cash Flow (OCF): OCF = EBIT(1-T) + Depreciation = $200,000 * (1 - 0.25) + $40,000 = $150,000 + $40,000 = $190,000.
  2. Calculate Change in Net Working Capital (ΔNWC): ΔNWC = ΔCurrent Assets - ΔCurrent Liabilities = ΔInventory - ΔAccounts Payable = $30,000 - $10,000 = $20,000. This is an investment (a use of cash).
  3. Calculate FCF: FCF = $190,000 - $0 (CapEx) - $20,000 (ΔNWC) = $170,000.

Question 2

A company purchased an asset 3 years ago for $200,000. It has been depreciating it using the straight-line method over a 5-year life with an assumed salvage value of $20,000. The company now sells the asset for $100,000. If the company's tax rate is 30%, what is the after-tax cash flow from this sale?

  1. $94,000
  2. $100,000
  3. $102,400
  4. $97,600 (correct answer)
Explanation:
  1. Calculate annual depreciation: (Cost - Salvage Value) / Life = ($200,000 - $20,000) / 5 = $36,000 per year.
  2. Calculate accumulated depreciation after 3 years: 3 * $36,000 = $108,000.
  3. Calculate the book value at the time of sale: Cost - Accumulated Depreciation = $200,000 - $108,000 = $92,000.
  4. Calculate the taxable gain: Sale Price - Book Value = $100,000 - $92,000 = $8,000.
  5. Calculate the tax on the gain: Gain * Tax Rate = $8,000 * 0.30 = $2,400.
  6. Calculate the after-tax cash flow from the sale: Sale Price - Tax on Gain = $100,000 - $2,400 = $97,600.

Question 3

A manufacturing company acquires a new asset for $500,000 with an estimated 5-year useful life and no salvage value. The company's marginal tax rate is 25%. If the company decides to use the double-declining balance (DDB) method for depreciation in Year 1 instead of the straight-line (SL) method, what will be the impact on its operating cash flow (OCF) for that year?

  1. OCF will increase by $100,000.
  2. OCF will increase by $25,000. (correct answer)
  3. OCF will decrease by $75,000.
  4. OCF will decrease by $25,000.
Explanation: First, calculate the depreciation under both methods for Year 1. Straight-line depreciation = $500,000 / 5 = $100,000. For DDB, the rate is 2 / 5 = 40%. DDB depreciation = $500,000 * 40% = $200,000. The switch to DDB increases depreciation expense by 100,000(100,000 (200,000 - $100,000). This additional non-cash expense reduces taxable income by $100,000, creating a tax shield. The tax savings, which increase OCF, are calculated as: Increase in Depreciation * Tax Rate = $100,000 * 0.25 = $25,000. Therefore, OCF increases by $25,000.

Question 4

A firm reports Net Income of $150,000. Its financial statements also show depreciation expense of $50,000, interest expense of $20,000, and a marginal tax rate of 30%. Using the standard capital budgeting definition, what is the firm's operating cash flow (OCF)?

  1. $200,000
  2. $164,000
  3. $186,000
  4. $214,000 (correct answer)
Explanation: The standard definition for operating cash flow (OCF) in a capital budgeting context is OCF = EBIT(1-T) + Depreciation. To find EBIT, we must work backwards from Net Income. First, find Earnings Before Tax (EBT): EBT = Net Income / (1 - T) = $150,000 / (1 - 0.30) = $214,286. Next, find Earnings Before Interest and Taxes (EBIT): EBIT = EBT + Interest Expense = $214,286 + $20,000 = $234,286. Now, apply the OCF formula: OCF = $234,286 * (1 - 0.30) + $50,000 = $164,000 + $50,000 = $214,000.

Question 5

Epsilon Corp. provides the following financial data for the recent fiscal year:

  • Net Income: $500,000
  • Depreciation Expense: $80,000
  • Amortization of Patent: $20,000
  • Gain on Sale of Equipment: $30,000
  • Increase in Accounts Receivable: $40,000
  • Decrease in Accounts Payable: $15,000

Based on the information provided for Epsilon Corp., what is its Cash Flow from Operations (CFO)?

  1. $570,000
  2. $575,000
  3. $545,000
  4. $515,000 (correct answer)
Explanation: To calculate Cash Flow from Operations (CFO) using the indirect method, start with Net Income and adjust for non-cash items and changes in net working capital.
  1. Start with Net Income: $500,000
  2. Add back non-cash expenses: +$80,000 (Depreciation) + $20,000 (Amortization)
  3. Subtract non-operating gains included in Net Income: -$30,000 (Gain on Sale)
  4. Adjust for changes in working capital: -$40,000 (Increase in A/R is a use of cash) - $15,000 (Decrease in A/P is a use of cash) CFO = $500,000 + $80,000 + $20,000 - $30,000 - $40,000 - $15,000 = $515,000.

Question 6

The following is a partial Statement of Cash Flows for Phoenix Corp. (in thousands): Net Income: $1,200 Cash Flow from Operations: $4,500 Adjustments to Reconcile Net Income to CFO: Depreciation & Amortization: ? Changes in Working Capital: ($200) Gain on Sale of Assets: ($100)

Based on the partial statement of cash flows for Phoenix Corp., what was the company's depreciation and amortization expense?

  1. $3,300
  2. $3,200
  3. $3,400
  4. $3,600 (correct answer)
Explanation: The reconciliation of Net Income to Cash Flow from Operations follows the formula: CFO = NI + Non-Cash Charges +/– WC changes +/– other adjustments. We can rearrange this to solve for the unknown Depreciation & Amortization (D&A). $4,500 (CFO) = $1,200 (NI) + D&A - $200 (WC) - $100 (Gain) $4,500 = $900 + D&A D&A = $4,500 - $900 D&A = $3,600 (in thousands).

Question 7

A company is evaluating a new machine that will increase annual revenues by $300,000 and annual cash operating costs by $120,000. The machine will have an annual depreciation expense of $60,000 for tax purposes. The company's marginal tax rate is 25%. What is the annual operating cash flow (OCF) from this machine?

  1. $135,000
  2. $150,000 (correct answer)
  3. $90,000
  4. $195,000
Explanation: Operating cash flow can be calculated using the tax shield approach: OCF = (Sales - Costs)(1 - T) + (Depreciation * T).
  1. Incremental pre-tax profit from operations = $300,000 (Revenue) - $120,000 (Costs) = $180,000.
  2. After-tax profit from operations = $180,000 * (1 - 0.25) = $135,000.
  3. Depreciation tax shield = $60,000 (Depreciation) * 0.25 (Tax Rate) = $15,000.
  4. OCF = $135,000 + $15,000 = $150,000. Alternatively, using the NOPAT + Depreciation approach: OCF = (Sales - Costs - Depreciation)(1-T) + Depreciation = ($180,000 - $60,000)(0.75) + $60,000 = $120,000 * 0.75 + $60,000 = $90,000 + $60,000 = $150,000.

Question 8

Two firms, Firm A and Firm B, are in the same industry and are identical except that Firm A uses an aggressive, accelerated depreciation schedule for its assets, while Firm B uses a more conservative, straight-line method. Assuming it is early in the assets' lives, how would Firm A's Price-to-Earnings (P/E) ratio and Enterprise Value-to-EBITDA (EV/EBITDA) ratio most likely compare to Firm B's?

  1. P/E will be higher, and EV/EBITDA will be lower.
  2. P/E will be lower, and EV/EBITDA will be comparable.
  3. P/E will be higher, and EV/EBITDA will be comparable. (correct answer)
  4. P/E will be comparable, and EV/EBITDA will be higher.
Explanation: Firm A has higher depreciation expense. This leads to lower reported Earnings (Net Income). Assuming the market prices the two firms similarly (same Price), Firm A's P/E ratio (Price / Earnings) will be higher due to the smaller denominator. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Since the only difference is the depreciation method, and depreciation is added back to calculate EBITDA, their EBITDA values will be identical. Assuming their Enterprise Values (EV) are also similar, their EV/EBITDA ratios will be comparable.

Question 9

A company sells a piece of equipment for $70,000. The equipment was originally purchased for $150,000 and has an accumulated depreciation of $95,000 at the time of sale. The company's tax rate is 21%. What are the respective impacts on the company's Cash Flow from Operations (CFO) and Cash Flow from Investing (CFI) as a result of this transaction?

  1. CFO decreases by $15,000; CFI increases by $70,000. (correct answer)
  2. CFO is unaffected; CFI increases by $66,850.
  3. CFO decreases by $11,850; CFI increases by $70,000.
  4. CFO increases by $3,150; CFI increases by $55,000.
Explanation:
  1. Calculate Book Value: $150,000 - $95,000 = $55,000
  2. Calculate Gain: $70,000 - $55,000 = $15,000 pre-tax gain
  3. CFI Impact: The full cash proceeds of $70,000 are classified as investing cash flow
  4. CFO Impact: In the indirect method, the $15,000 pre-tax gain that was included in Net Income must be subtracted out since it's not an operating cash flow. This causes CFO to decrease by $15,000. While there is a tax payment on the gain, it flows through CFO as part of total income taxes paid, making the net CFO impact equal to the full gain amount that must be removed.

Question 10

For its most recent fiscal year, a company reported the following:

  • Earnings Before Interest and Taxes (EBIT): $1,000,000
  • Depreciation & Amortization Expense: $150,000
  • Capital Expenditures: $250,000
  • Increase in Net Working Capital: $50,000
  • Marginal Tax Rate: 30%

Based on the provided data, what is the company's Free Cash Flow to the Firm (FCFF)?

  1. $400,000
  2. $550,000 (correct answer)
  3. $600,000
  4. $700,000
Explanation: Free Cash Flow to the Firm (FCFF) is calculated using the formula: FCFF = EBIT(1-T) + Depreciation - Capital Expenditures - Change in NWC.
  1. Calculate NOPAT: EBIT(1-T) = $1,000,000 * (1 - 0.30) = $700,000.
  2. Apply the full formula: FCFF = $700,000 + $150,000 - $250,000 - $50,000 = $550,000.

Question 11

A pharmaceutical company acquires a patent for $10 million, which it will amortize on a straight-line basis over its 10-year useful economic life. In the first year, how does this amortization affect the company's Earnings Before Interest and Taxes (EBIT) and its Cash Flow from Operations (CFO), assuming no other changes?

  1. EBIT decreases and CFO decreases.
  2. EBIT decreases and CFO increases. (correct answer)
  3. EBIT is unaffected and CFO decreases.
  4. EBIT decreases and CFO is unaffected.
Explanation: Annual amortization expense is $10 million / 10 years = $1 million. As an operating expense, amortization reduces EBIT by $1 million. However, amortization is a non-cash charge. When calculating CFO using the indirect method (starting from Net Income), the full amortization amount is added back. The net effect on CFO is the tax shield provided by the expense. Change in CFO = -Amortization * (1-T) + Amortization = Amortization * T. Since the tax rate (T) is positive, the impact on CFO is positive (an increase). Therefore, EBIT decreases while CFO increases.

Question 12

A company uses an accelerated depreciation method (e.g., MACRS) for tax purposes and the straight-line method for financial reporting. In the early years of an asset's life, what is the most likely outcome of this practice?

  1. A deferred tax asset is created, and cash taxes paid are higher than reported income tax expense.
  2. A deferred tax asset is created, and cash taxes paid are lower than reported income tax expense.
  3. A deferred tax liability is created, and cash taxes paid are higher than reported income tax expense.
  4. A deferred tax liability is created, and cash taxes paid are lower than reported income tax expense. (correct answer)
Explanation: In the early years, accelerated depreciation for tax purposes is greater than straight-line depreciation for reporting purposes. This makes taxable income lower than book pre-tax income. Consequently, the actual cash taxes paid (based on taxable income) are lower than the income tax expense reported on the income statement (based on book income). This timing difference, where the company pays less tax now but will pay more later, creates a deferred tax liability.

Question 13

A project requires an initial investment in equipment of $1,200,000. The equipment will be depreciated using the straight-line method over 8 years to a zero salvage value. The company's marginal tax rate is 22%. What is the present value of the depreciation tax shield for this project, assuming a discount rate of 10%?

  1. $33,000
  2. $264,000
  3. $176,052 (correct answer)
  4. $800,239
Explanation: This is a multi-step problem.
  1. Calculate annual depreciation: $1,200,000 / 8 years = $150,000 per year.
  2. Calculate the annual tax shield: Annual Depreciation * Tax Rate = $150,000 * 0.22 = $33,000 per year.
  3. Calculate the present value of this 8-year annuity. Using the PV of an annuity formula: PV = C * [1 - (1+r)^-n] / r. PV = $33,000 * [1 - (1.10)^-8] / 0.10 = $33,000 * 5.3349 = $176,052.

Question 14

A company's Net Income for the year is $800,000. Included in this figure is a $50,000 pre-tax loss from the sale of a warehouse. The company's depreciation expense was $120,000 and its tax rate is 30%. Assuming no other adjustments for non-cash items or working capital, what is the company's Cash Flow from Operations?

  1. $920,000
  2. $870,000
  3. $970,000 (correct answer)
  4. $955,000
Explanation: To calculate CFO from Net Income (indirect method), we must add back non-cash expenses and losses.
  1. Start with Net Income: $800,000
  2. Add back depreciation expense (a non-cash charge): +$120,000
  3. Add back the pre-tax loss on the sale of the warehouse. The loss reduced Net Income, but it was not an operating cash outflow (the cash proceeds are reported in CFI). Therefore, the full pre-tax loss must be added back: +$50,000. CFO = $800,000 + $120,000 + $50,000 = $970,000.

Question 15

Titan Corp. and Atlas Inc. are identical in every respect (e.g., revenue, costs, assets, tax rates) except for their depreciation method. Titan uses the straight-line method, while Atlas uses an accelerated depreciation method for a recently acquired major asset. In the first few years of the asset's life, which of the following statements is most likely true?

  1. Atlas will have a higher Net Income and higher operating cash flow.
  2. Atlas will have a lower Net Income and lower operating cash flow.
  3. Atlas will have a lower Net Income but a higher operating cash flow. (correct answer)
  4. Atlas will have a higher Net Income but a lower operating cash flow.
Explanation: In the early years, an accelerated method results in higher depreciation expense than the straight-line method. The higher expense leads to lower reported EBIT and thus lower Net Income for Atlas. However, operating cash flow (OCF = EBIT(1-T) + Depreciation) will be higher. Although the EBIT(1-T) component is lower, the increase in the depreciation tax shield (and the higher add-back of depreciation) more than compensates, leading to higher OCF for Atlas.

Question 16

A technology firm acquires a patent for $450,000. The patent has a remaining legal life of 15 years, but the company expects it to generate significant economic benefits for only the next 9 years. The company's tax rate is 21%. What is the annual impact of the patent's amortization on the company's operating cash flow (OCF)?

  1. An increase of $50,000
  2. A decrease of $39,500
  3. An increase of $10,500 (correct answer)
  4. An increase of $6,300
Explanation: Intangible assets like patents should be amortized over their useful economic life, not their legal life, if the economic life is shorter.
  1. Annual amortization = $450,000 / 9 years = $50,000.
  2. Amortization is a non-cash expense that shields other income from taxes. The cash flow impact is the value of this tax shield.
  3. Tax Shield = Amortization Expense * Tax Rate = $50,000 * 0.21 = $10,500. This tax saving represents a cash inflow, so OCF increases by $10,500.

Question 17

Due to a change in technology, a company determines that one of its manufacturing machines is impaired. The machine has a book value of $500,000 but a current fair value of only $100,000. The company records an impairment charge of $400,000. The company's tax rate is 25%, but this specific impairment charge is non-tax-deductible. What is the immediate impact of recording this charge on the company's total cash flow?

  1. A decrease of $400,000.
  2. No impact on total cash flow. (correct answer)
  3. An increase of $100,000.
  4. A decrease of $300,000.
Explanation: An impairment charge is a non-cash expense. It reduces Net Income on the income statement, but it is added back when calculating Cash Flow from Operations because no cash actually left the company. Since the problem explicitly states the charge is non-tax-deductible, there is no associated tax shield or cash tax savings. Therefore, the net effect on the company's total cash flow is zero.

Question 18

A company reports operating cash flow (OCF) of $750,000. Its income statement shows EBIT of $900,000 and a tax rate of 20%. Assuming no changes in working capital, what was the company's depreciation expense for the period?

  1. $30,000 (correct answer)
  2. $110,000
  3. $150,000
  4. -$30,000
Explanation: Using the simplified OCF formula: OCF = EBIT(1 - T) + Depreciation. This approach assumes no changes in working capital and that all other non-cash items are captured in depreciation. $750,000 = $900,000 × (1 - 0.20) + Depreciation $750,000 = $900,000 × 0.80 + Depreciation $750,000 = $720,000 + Depreciation Depreciation = $750,000 - $720,000 = $30,000

Question 19

A company incurs $2,000,000 in development costs. Management has a choice: expense the entire cost this year, or capitalize it and amortize it straight-line over 4 years. The company's tax rate is 25%. Compared to expensing, what would be the impact on Cash Flow from Operations (CFO) in the first year if the company chooses to capitalize the cost?

  1. CFO would be $1,625,000 higher. (correct answer)
  2. CFO would be $1,500,000 lower.
  3. CFO would be $375,000 higher.
  4. CFO would be unaffected.
Explanation: Let's analyze the CFO impact of each choice. Expensing Option: The $2M is an operating expense. This reduces taxable income by $2M, creating a tax shield of $2M * 0.25 = $500,000. The cash outflow is the after-tax cost of $2,000,000 * (1 - 0.25) = $1,500,000. So, CFO is reduced by $1,500,000. Capitalizing Option: The $2M cash outflow is a capital expenditure, classified under Cash Flow from Investing (CFI), not CFO. In Year 1, CFO is affected only by the tax shield from amortization. Amortization = $2M / 4 = $500,000. Tax shield = $500,000 * 0.25 = $125,000. This increases CFO by $125,000. The difference in CFO is: (CFO from Capitalizing) - (CFO from Expensing) = 125,000−(−125,000 - (-1,500,000) = $1,625,000 higher.

Question 20

TechVenture Inc. reported the following for 2023: software development costs of $1.2 million were capitalized and are being amortized over 4 years, goodwill impairment of $800,000 was recognized, and patent amortization of $200,000 was recorded. The company also wrote off $150,000 in obsolete inventory and recorded $300,000 in stock-based compensation expense.

What is the total amount of non-cash expenses that should be added back to net income when calculating operating cash flow using the indirect method?

  1. $1,450,000 (correct answer)
  2. $1,600,000
  3. $1,750,000
  4. $1,300,000
Explanation: Non-cash expenses to add back: software amortization ($1,200,000 ÷ 4 = 300,000),goodwillimpairment(300,000), goodwill impairment (800,000), patent amortization (200,000),andstock−basedcompensation(200,000), and stock-based compensation (300,000). Total: $300,000 + $800,000 + $200,000 + $300,000 = $1,450,000. The inventory write-off reduces working capital and doesn't require an add-back since it represents a loss of actual asset value. Choice B incorrectly includes the inventory write-off. Choice C incorrectly uses total software costs instead of annual amortization. Choice D omits stock-based compensation.