hard · Investment Banking accounting
A firm uses the equity method for a 30%-owned associate. This year the associate earns $1,000 and pays out $400 in total dividends. The investor's tax rate is 25% (assume associate earnings are taxed to the investor only when distributed).
On the investor's statements, what is the effect on its CFO, and how is the equity-method line handled?
- CFO rises by $90 — the $120 of cash dividends received less the $30 of tax paid on that distribution — while the $300 of equity income is recognized in net income and reversed out of CFO as a non-cash accrual
- CFO rises by $300, since equity-method income of 30%×$1,000 is treated as the investor's full economic share flowing directly through operating cash flow this period
- CFO rises by $120, because the $300 equity-method income is added directly to net income each period and the full $400 associate dividend is instead recorded as a financing cash inflow
- CFO rises by $225, equal to after-tax equity income of $300×(1−25%), with the associate’s cash dividends treated entirely as a return of capital that sits outside CFO reporting altogether
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