What happens to Cash after a $100 asset write-down with a 40% tax rate?

• A. Cash increases by $40
• B. Cash decreases by $60
• C. Cash remains unchanged
• D. Cash decreases by $40

Answer: (A)

In the scenario of a $100 asset write-down with a tax rate of 40%, it is essential to understand the impact on the financial statements, particularly regarding cash flow.

When an asset is written down, it results in a loss that can reduce taxable income. In this case, the asset write-down of $100 creates a loss that lowers taxable income. Given the 40% tax rate, the tax savings from this write-down would be calculated as follows: 40% of $100 equals $40. This amount represents the tax benefit gained because the write-down reduces the tax liability.

Since this tax benefit results in additional cash flow, cash effectively increases by this amount. Therefore, after the write-down, you would see an increase in cash by $40 due to the tax effect. This reflects how losses can create cash inflows by reducing tax obligations.

Overall, the correct answer demonstrates how asset write-downs not only impact balance sheets but also directly influence cash flow through tax savings.