Practiced one out loud? Paste your answer into the free self-check and get a score in 30 seconds
What the interviewer is testing
Whether you know when a cost is capitalized and how the choice moves EBITDA, net income and the cash flow statement, even though the cash paid is the same.
Answer framework
- Expense: costs that benefit only the current period hit the income statement immediately.
- Capitalize: costs that benefit more than one year become an asset, such as PP&E or capitalized software, then are depreciated or amortized.
- Income statement: capitalizing raises current EBITDA and net income, then spreads the cost over time.
- Cash flow: capitalized costs appear as capex in investing; expensed costs reduce cash from operations.
- Total cash spent is the same; timing of expense and tax deductions differs.
Sample answer
The test is how long the benefit lasts. A cost that is used up in the period, such as salaries or rent, is expensed. A cost that will benefit several years, such as a machine or a building, is capitalized: it goes on the balance sheet as an asset and is depreciated over its useful life.
Take a $10M machine with a five-year life and a 25% tax rate. If it is capitalized, the first year shows $2M of depreciation, so EBITDA is unchanged and net income falls by $1.5M. On the cash flow statement, net income is down $1.5M, depreciation adds back $2M, so operating cash flow is up $0.5M, and capex in investing is $10M, giving net cash down $9.5M. If it were expensed, EBITDA would fall by $10M and net income by $7.5M, all in operating cash flow, so cash would fall by $7.5M, since the full deduction saves more tax in year one.
That is why analysts watch capitalization choices. Aggressively capitalizing costs, such as software development, makes EBITDA and operating cash flow look stronger, so comparing companies may require adjusting EBITDA or looking at free cash flow after capex.
Likely follow-ups
Common mistakes
- Saying capitalizing saves cash; the cash paid is the same.
- Putting capex in operating cash flow.
- Forgetting the tax timing difference.
- Ignoring capitalization differences when comparing EBITDA across companies.
IB Interview: Top 30 Questions covers the 30 most-asked investment banking interview questions with model answers. 13 pages, free on Gumroad.
Get the free Top 30Next step: Score your answers against 50 IB rubrics, $9. 50 investment banking questions, one rubric each, PDF on Gumroad.
Related questions
Based on question #21 in the full question bank.