Ch. 2

The cash flow to creditors includes the firm's cash:

outflow when interest is paid on outstanding debt

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Oscar's Dog Treats had a cash flow to creditors of $2,840, a cash flow to stockholders of $1,630 last year. The firm spent a net of $1,420 on fixed assets and reduced net working capital by $330. What was the operating cash flow?

$5,560

Given the tax rates as shown, what is the average tax rate for a firm with taxable income of $218,700?

31.34%

U.S. corporate taxes switch to a constant flat-rate tax once the average tax rate reaches:

35%

Which one of these equations is an accurate expression of the balance sheet?

Stockholders' equity = Assets -Liabilities

One of the reasons why cash flow analysis is popular is because:

it is difficult to manipulate, or spin the cash flows

Net capital spending is equal to the:

net change in fixed assets plus depreciation

Which one of these statements is correct?

Earnings per share can be negative but dividends per share cannot

Which one of these is a non-cash item?

depreciation

Deep Water Mining added $411 to retained earnings last year on sales of $24,646. The administrative expenses were $4,370, depreciation was $812, dividends paid were $285, and the interest expense was $103. What was the cost of goods sold if the firm's tax rate was 35 percent?

$18,290

At the beginning of the year, a firm has current assets of $16,200 and current liabilities of $13,280. At the end of the year, the current assets are $14,800 and the current liabilities are $14,210. What is the change in net working capital?

$2,330

Which one of the following statements concerning liquidity is correct?

Balance sheet accounts are listed in order of decreasing liquidity

Operating cash flow is defined as:

EBIT + Depreciation - Taxes

Why is cash flow management important?

GAAP accounting principles allow significant subjective decisions to be made in many key areas. The use of cash flow as a metric to evaluate a company comes from the idea that there is less subjectivity involved and therefore, it is harder to spin the numbers.

Define liquidity and explain what a firm would need to do to ensure all of the current assets displayed on its balance sheet are liquid.

Liquid assets are those that can be sold quickly with little or no loss in value. To ensure the current assets are liquid, the firm needs to review its accounts receivable to ensure the accounts are collectible and also review its inventory to ensure it is salable for at least the amount at which it is recorded.

Assuming the number of shares outstanding remains constant, an increase in dividends per share will reduce the:

addition to retained earnings

Which one of these will increase the book value of the stockholders' equity in a profitable, non-dividend paying firm? Assume no shares of stock are repurchased or sold.

an increase in earnings per share

Cash flow to stockholders is defined as:

cash dividends paid plus repurchases of equity minus new equity financing

In the accounting statement of cash flows, which one of these is calculated by adding back noncash expenses to net income and adjusting for changes in current assets and liabilities?

cash flow from operating activities

Which one of these terms refers to the firm's interest payments less any net new borrowing?

cash flow to creditors

Earnings per share will increase when:

depreciation decreases

When you are making a financial decision, the most relevant tax rate is the ____ rate.

marginal

The cash flow resulting from a firm's ongoing, normal business activities is referred to as the:

operating cash flow

An increase in treasury stock:

results from a repurchase of outstanding shares of stock

Liquidity is:

valuable to a firm even though liquid assets tend to be less profitable to own

Earnings per share:

will increase if net income increases and number of shares outstanding decreases

For a firm with long-term debt, net income is equal to:

Dividends + Addition to retained earnings

Cash flow from assets:

can be positive, negative, or equal to zero

A firm's dividend payments less any net new equity raised is referred to as the firm's:

cash flow to stockholders

Free cash flow is:

cash that the firm can distribute to creditors and stockholders

Net working capital is defined as:

current assets minus current liabilities

Which one of the following is a current liability?

debt payable to a mortgage company in nine months

All else held constant, the earnings per share will:

decrease as the number of shares outstanding increase

Depreciation for a profitable firm:

decreases net income by less than $1 for every $1 of depreciation expense

Assets are listed on the balance sheet in order of:

decreasing liquidity

Capital spending is equal to:

ending net fixed assets minus beginning net fixed assets plus depreciation

Which one of these accounts is classified as a current asset on the balance sheet?

inventory

Book value:

is based on historical cost

The carrying value or book value of assets:

is determined under GAAP and is based on the cost of the asset

Which term defines the tax rate that applies to the next dollar of taxable income earned?

marginal

If you sell an asset, you are most apt to receive which value for that asset?

market value

According to the Generally Accepted Accounting Principles, costs are:

matched with revenues

An increase in total assets:

must be offset by an equal increase in liabilities and stockholders' equity

The statement of cash flows consists of the cash flows from:

operations, investing activities, and financing activities

The cash flow to stockholders must be positive when:

the cash flow from assets is positive and also exceeds the cash flow to creditors

Explain why the income statement is not a good representation of cash flow.

Most income statements contain some noncash items, so these must be accounted for when calculating cash flows. More importantly, however, since GAAP is used to create income statements, revenues and expenses are booked when they accrue, not when their corresponding cash flows occur.

The income statement:

includes noncash expenses

An asset that can be quickly converted into cash without significant loss in value is referred to as being:

liquid

A firm starts its year with a positive net working capital. During the year, the firm acquires more short-term debt than it does short-term assets. This means that:

the ending net working capital can be positive, negative, or equal to zero

According to generally accepted accounting principles (GAAP), revenue is recognized as income when:

the transaction is complete and the goods or services are delivered

Depreciation is classified as a noncash item because no cash is spent when depreciation is recorded. Why are expenses that have been accrued, but not yet paid, not also considered to be noncash items and therefore excluded from operating cash flow just as depreciation is excluded?

Accrued expenses that have not been paid will appear in accounts payable and the change in net working capital. Via the change in net working capital, these unpaid expenses are subtracted from the operating cash flow to determine the cash flow of the firm. This method allows for the computation of the cash flows based solely on financial statement information. Depreciation, on the other hand, is the expensing of a fixed asset cost that was paid for when the asset was acquired.

Note that in all of our cash flow computations to determine cash flow of the firm, we never include the addition to retained earnings. Why not? Is this an oversight?

The addition to retained earnings is not a cash flow. It is simply an accounting entry that links the income statement to the balance sheet and allows the balance sheet to balance. Any additions to retained earnings will show up as cash flow changes in other balance sheet accounts.

Total assets are $1,450, fixed assets are $790, long-term debt is $750, and short-term debt is $300. What is the amount of current assets?

$660

Awnings Incorporated has beginning net fixed assets of $234,100 and ending net fixed assets of $243,600. Assets valued at $42,500 were sold during the year. Depreciation was $62,500. What is the amount of net capital spending?

$72,000

The tax rates are as shown. Your firm currently has taxable income of $83,200. How much additional tax will you owe if you increase your taxable income by $24,600?

$8,754

Why is interest expense excluded from the operating cash flow calculation?

Operating cash flow is designed to represent the cash flow a firm generates from its day-to-day operating activities. Interest expense arises from a financing decision and thus is considered as a cash flow to creditors.

Discuss the difference between book values and market values on the balance sheet and explain the best method for determining the value of a firm to its stockholders.

The accounts on the balance sheet are generally carried at historical cost, not market values. Although the book value of current assets and current liabilities may closely approximate market values, the same cannot be said for the rest of the balance sheet accounts. Ultimately, stockholders should focus on the firm's stock price, which is a market value measure, for the value of their investment in the firm.

On a balance sheet, deferred taxes are classified as:

a long-term liability

The cash flow of the firm must be equal to:

cash flow to stockholders plus cash flow to creditors

Martha's Enterprises spent $4,100 to purchase equipment three years ago. This equipment is currently valued at $2,700 on today's balance sheet but could actually be sold for $3,200. Net working capital is $400 and long-term debt is $2,300. Assuming the equipment is the firm's only fixed asset, what is the book value of shareholders' equity?

$800

Brad's Company has equipment with a book value of $500 that could be sold today at a 50 percent discount. Its inventory is valued at $450 and could be sold to a competitor for that amount. The firm has $100 in cash and customers owe the firm $250, all of which is collectible. What is the current market value of the firm's assets?

$1,050

A firm has $820 in inventory, $3,200 in fixed assets, $1,210 in accounts receivable, $890 in accounts payable, and $360 in cash. What is the amount of the net working capital?

$1,500

Mart's Boutique has sales of $820,000 and costs of $540,000. Interest expense is $36,000 and depreciation is $59,000. The tax rate is 35 percent. What is the net income?

$120,250

Last year, Webster Farms had annual revenue of $87,200, depreciation of $11,600, cost of goods sold of $54,700, and administrative expenses of $8,300. The firm paid $3,200 in dividends and paid taxes of $4,300. What was the operating cash flow?

$19,900

Thompson's Jet Skis has operating cash flow of $11,618. Depreciation is $2,345 and interest paid is $395. A net total of $485 was paid on long-term debt. The firm spent $6,180 on fixed assets and decreased net working capital by $420. What is the cash flow of the firm?

$5,858

Your firm has total sales of $22,980, costs of $14,715, and depreciation of $6,045. The tax rate is 34 percent. There are no interest expenses or other income. What is the operating cash flow?

$7,510.20

Last year, Johnson Mills had annual revenue of $37,800, cost of goods sold of $23,200, and administrative expenses of $6,300. The firm paid $700 in dividends and had a tax rate of 35 percent. The firm added $2,810 to retained earnings. The firm had no long-term debt. What was the depreciation expense?

$2,900

Peggy Grey's Cookies had net income of $8,110. The firm paid out 30 percent of the net income to its shareholders as dividends. During the year, the company repurchased $500 worth of common stock. What is the cash flow to stockholders?

$2,933

At the beginning of the year, long-term debt of a firm is $2,400 and total debt is $3,150. At the end of the year, long-term debt is $2,800 and total debt is $4,370. The interest paid is $40. What is the amount of the cash flow to creditors?

$360

Pete's Boats has beginning long-term debt of $840 and ending long-term debt of $790. The beginning and ending total debt balances are $1,220 and $1,360, respectively. The interest paid is $30. What is the amount of the cash flow to creditors?

$80

Interpret, in words, what cash flow of the firm represents by discussing operating cash flow, changes in net working capital, and additions to fixed assets.

Operating cash flow is the cash flow a firm generates from its day-to-day operations. In other words, it is the cash inflow generated as a result of putting the firm's assets to work. Changes in net working capital and fixed assets represent investments a firm makes in these assets. That is, a firm typically takes some of the cash flow it generates from using assets and reinvests it in new assets. Cash flow of the firm, then, is the cash flow a firm generates by employing its assets, net of any acquisitions.

Explain the difference between product costs and period costs as they relate to the income statement. Are these terms synonymous with short-run and long-run?

Product costs are the total production costs incurred during a period - raw materials, direct labor, and manufacturing overhead - and are reported as cost of goods sold. Period costs are costs - management and office salaries, office expenses, insurance - that are allocated to a time period and are recorded as selling, general, and administrative expenses. The terms short-run and long-run are used to differentiate between fixed and variable costs, depending upon the length of time required to vary the cost amount.

Sometimes when businesses are critically delinquent on their tax liabilities, the tax authority comes in and literally seizes the business by chasing all of the employees out of the building and changing the locks. What does this tell you about the importance of taxes relative to our discussion of cash flow? Why might a business owner want to avoid such an occurrence?

Taxes must be paid in cash, and in this case, they are one of the most important components of cash flow. The reputation of a business can undergo irreparable harm if word gets out that the tax authorities have confiscated the business, even if only for a couple of hours until the business owner can come up with the money to clear up the tax problem. The bottom line is if the owner can't come up with the cash, the tax authority has effectively put them out of business.

Under generally accepted accounting principles (GAAP), a firm's assets are reported at:

historical cost less accumulated depreciation

Which one of the following assets is generally the most liquid?

accounts receivable

Which one of the following accounts is included in stockholders' equity?

accumulated retained earnings

The financial statement summarizing a firm's accounting performance over a period of time is the:

income statement

An increase in which one of the following will cause the operating cash flow to increase for a profitable firm?

depreciation

As seen on an income statement:

depreciation reduces both the pretax income and the net income

Noncash items refer to:

expenses charged against revenues that do not directly affect cash flow