hard · Investment Banking
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 $120, equal to the cash dividends received net of tax, while the $300 equity income is recognized in net income and reversed out as non-cash, net of the dividend
- CFO rises by $300, since equity-method income of 30%×$1,000 is the investor's economic share and flows through operating cash flow
- CFO rises by $120, because the $300 equity-method income is added to net income and the full $400 dividend is recorded as a financing inflow
- CFO rises by $90, equal to after-tax equity income of $300×(1−25%), with dividends treated as a return of capital outside CFO
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