After Tax Operating Cashflows

CFA Level II Corporate Finance
#1

Hi Guys, I am struggling to understand the After-tax operating cashflows formula please can anyone clarify its proper use and explain why depreciation is involved. CF= (S - C - D) (1 - t) + D

I do not understand why depreciation is being used. Firstly it is an accounting principle rather than an actual payment measure whereby you may just pay upfront for an asset. Secondly why is it added back on? Very confused with this formula.

#2

Try some numbers:

  • Sales = 1,000
  • Cash expenses = 600
  • Depreciation = 100
  • Tax rate = 30%

Calculate your after-tax cash flow by subtracting your cash outflows from your cash inflows.

Then calculate it using the formula.

I think that you’ll see what’s happening.