The investment banking interview question we’re going to go over today is “How does $10 increase in depreciation affect the financial statements?” This is a critical question. It’s so important because it’s the foundation of 3-statement accounting questions. Here’s how you should answer it.
“Starting with the Income Statement, Depreciation goes up by $10, which causes Pre-Tax Income to decrease by 10. Assuming a 20% tax rate, Net Income decreases by 8.
On the Cash Flow Statement, under Cash Flow from Operations, Net Income decreases by 8. But we need to add back the $10 increase in Depreciation because it’s a non-cash expense. And so Cash Flow from Operations increases by 2. No changes to Cash Flow from Investing and Cash Flow from Financing, so total Net Change in Cash goes up by 2.
On the Balance Sheet, under the Assets side, Cash and Cash Equivalents increases by 2. But PP&E decreases by 10 because of the extra Depreciation. So Total Assets decreases by 8. Under the Liabilities and Equity Side, Retained Earnings decreases by 8 due to Net Income. And the Balance Sheet balances.”
That’s how you should answer this question: “How does $10 increase in depreciation affect the financial statements”. Here’s something really important. Anytime you get these how-does-this-affect-three-financial-statements question, you have to be thoughtful about the structure of your answer. Getting the answer right is the basics. You also have to prove to the interviewer that you can organize your thoughts into a very organized manner, like what we just demonstrated.