A company has NOLs of 100 and generates Pre-Tax Income of 200 this year, with a 40% tax rate. What are Net Income and Cash taxes, considering the NOLs?

• A. Net Income 120; Cash Taxes 40; Deferred Tax Asset decreases by 40; Cash from Ops +160
• B. Net Income 120; Cash Taxes 80; No DTA impact; Cash from Ops +120
• C. Net Income 80; Cash Taxes 40; DTA increases; Cash from Ops +120
• D. Net Income 160; Cash Taxes 60; DTA decreases; Cash from Ops +100

Answer: (A)

Using an NOL to offset current-year income reduces the tax you owe this year. Start with pretax income of 200 and an NOL carryforward of 100, so taxable income becomes 100. At a 40% tax rate, the current tax expense is 40. Net income is the pretax income minus this tax expense: 200 − 40 = 160. The cash taxes paid in the year are the same 40, since that’s the actual cash outlay for taxes.

The use of the NOL affects the deferred tax asset: you’ve realized the tax benefit from part of the NOL, so the DTA decreases by the tax effect of that benefit, which is 40. Therefore, the DTA balance decreases by 40. For cash flow from operations, if no other noncash items or changes in working capital are specified, you’d start from net income of 160.

In short: Net income 160, cash taxes 40, DTA decreases by 40, and cash from operations would be 160.