The Daily Technical #53: What is the difference between CAGR and IRR?

Good morning. Welcome to the 53rd edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
How would a $10 increase in depreciation flow through the financial statements?

The depreciation expense will be embedded within either the cost of goods sold or the operating expenses line item on the income statement.

IS: When depreciation increases by $10, EBIT would decrease by $10. Assuming a 30% tax rate, net income will decline by $7.

CFS: At the top of the cash flow statement, net income has decreased by $7, but the $10 depreciation will be added back since it's a non-cash expense. The net impact on the ending cash balance will be a positive $3 increase.

BS: PP&E will decrease by $10 from the depreciation, while cash will be up by $3 on the assets side. On the L&E side, the $7 reduction in net income flows through retained earnings. The balance sheet remains in balance as both sides went down by $7.

Common Mistakes

1. Forgetting the Non-cash Nature of Depreciation: Always remember to add depreciation back on the cash flow statement to avoid errors.

2. Misbalancing the Balance Sheet: It's easy to calculate the PP&E reduction but forget how it affects the equity through retained earnings. Always double-check that both sides of the balance sheet equilibrate the changes.

3. Ignoring Tax Implications: Overlooking the impact of taxes on net income can skew your numbers. Stick with the given tax rate—here, 30%—to correctly portray the net effect.

TL;DR

• Income Statement: $10 increase in depreciation → -$10 EBIT → -$7 Net Income (at 30% tax)

• Cash Flow Statement: Start with -$7 Net Income, add back +$10 depreciation = Net +$3 cash impact

• Balance Sheet (Total -$7 both sides): Assets: -$10 PP&E, +$3 cash Liabilities & Equity: -$7 retained earnings

• Key Insight: While depreciation reduces profit by $7, it actually increases cash by $3 due to tax shield

TODAY’S QUESTION
What is the difference between CAGR and IRR?

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