Cashflow: Take out a loan

Suppose you take out a $20000 loan in time period zero at 6%. You will make a single payment on the loan in time period one. When you face a 50% tax rate, what is the change in net cash in time period one?

Answer

There are a few pieces to work through. First, we are only looking at time period one, when you make the single payment. Second, we are not looking at net income, but we do need it to find the change in net cash flow.

Start with the calculations needed for net income. Only part of the 20000 (1.06) =$21200 payment shows up in the income statement, the $1200 in interest expense. That expense lowers taxes by $1200*.5= $600 and results in a reduction of net income of $600.

That reduction in net income feeds into net cash flow as a reduction in cash, -$600. There is also an outflow of cash from finance, because of the principal payment, of $20000. The total reduction in net cash is $20600. You see that as -$20600 at the bottom of the cash flow statement.

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