Answer 5

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It is only tax deductible depreciation and amortization that affects your cash flows. Consequently, you should compute the operating income after tax deductible depreciation and add back only the tax deductible depreciation. For example, assume that you have EBITDA of 500 million, tax deductible depreciation of $ 100 million and non-tax deductible amortization of 50 million. You should use operating income of 400 million (500 less 100) to compute your after tax operating income and then add back only the tax deductible depreciation. What, you may wonder, is the harm in using all depreciation since you add it back anyway? If you subtract out 150 from the EBITDA to get an operating income of 350 million, compute the taxes on 350 million and then add back the entire depreciation and amortization back, you will give the non-tax deductible amortization a tax benefit.

If you had a choice, you would much rather based you cashflow estimates on the income and depreciation reported in the tax books than in the reporting books. When companies use different depreciation methods in their tax and reporting books, and you have access only to the latter, your cashflow estimates will be skewed by your use of the reported (rather than the tax) depreciation



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