Bad5shah

Which of the following statements regarding depreciation expense in the cash flow statements is CORRECT? Depreciation is added back to net income when determining CFO using:

A) either the direct or indirect methods.

B) the indirect method.

C) the direct method.

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Depreciation is a non-cash expense. Only in the indirect method is depreciation added back to net income when determining CFO because net income is only used in the indirect method and not the direct method. The direct method instead starts with cash sales and works down the income statement.

Bad5shah

Juniper Corp. has the following transactions in 2005.

• Juniper’s equipment with a book value of $55,000 was sold for $85,000 cash.
• 
  A parcel of land was purchased for $100,000 worth of Juniper common stock.
• 
  ABC company paid Juniper preferred dividends of $40,000.
• 
  Juniper declared and paid a $100,000 cash dividend.

Using the indirect method, what is cash flow from financing (CFF) for Juniper for 2005?

A) -$60,000.

B) -$100,000.

C) -$15,000.

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The only item involving cash flow from financing (CFF) was the payment of a cash dividend by Juniper. The sale of equipment affects cash flow from investing (CFI), the purchase of land has no effect on cash, and the preferred dividends received are cash flow from operations.

Bad5shah

Selected information from Rockway, Inc.’s U.S. GAAP financial statements for the year ended December 31, included the following (in $):

	2004	2005
Sales	17,000,000	21,000,000
Cost of Goods Sold	11,000,000	15,000,000
Interest Paid	800,000	1,000,000
Current Income Taxes Paid	700,000	1,000,000
Accounts Receivable	3,000,000	2,500,000
Inventory	2,400,000	3,000,000
Property, Plant & Equip.	2,000,000	16,000,000
Accounts Payable	1,000,000	1,400,000
Long-term Debt	8,000,000	9,000,000
Common Stock	4,000,000	5,000,000

Using the direct method, cash provided or used by operating activities(CFO) in the year 2005 was:

A) $6,300,000.

B) $4,300,000.

C) $5,300,000.

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Cash provided or used by operating activities under the direct method is computed by adding cash inflows and subtracting cash inputs and cash outflows. Operating Cash inflows for Rockway Inc. for 2005 came from sales ($21,000,000) and decrease in accounts receivable ($3,000,000 − $2,500,000 = $500,000) for net cash inflows of ($21,000,000 + $500,000 =) $21,500,000. Operating cash inputs were cost of goods sold ($15,000,000), plus the increase in inventory ($3,000,000 − $2,400,000 = $600,000) less the increase in accounts payable, (which is a source of funds) ($1,000,000 − $1,400,000 = -$400,000) for net cash inputs of ($15,000,000 + $600,000 - $400,000 =) $15,200,000. Other operating cash outflows were interest paid ($1,000,000) and current income taxes paid ($1,000,000) totaling ($2,000,000). Cash provided by operations was ($21,500,000 − $15,200,000 − $2,000,000 =) $4,300,000. Changes in property, plant and equipment, long-term debt and common stock do not affect cash from operations.

Bad5shah

John Stone, CFA, is an investment advisor specializing in the preparation of company and industry reports for high net worth customers at Learmon Brothers. Currently, Stone is preparing a report on Soft Corporation, a rapidly growing software company. The explosive growth of this company was financed primarily by an initial public offering in which 3,000,000 shares were issued at a price of $20 per share on June 27, 2004. Soft Corporation received additional capital when employee stock options for 1,000,000 shares at a price of $10 were exercised on January 1, 2005. Stone realizes the importance of cash flow on a company's financial health and would like to include a projected statement of cash flows for 2005. Soft Corporation financial statements are presented in Tables 1 and 2. Included are the actual statements for the year ending December 31, 2004.

Table 1
Soft Corporation Balance Sheets
as of December 31
(in millions)
		Actual 2004	Projected 2005
Cash		$24.0	$26.0
Accounts Receivable		17.0	24.0
Inventory		100.0	150.0
PP&E		100.0	125.0
Accumulated depreciation		(30.0)	(35.0)
	Total Assets	$211.0	$290.0
Accounts payable		$91.0	$101.0
Long-term debt		20.0	40.0
Common stock		80.0	90.0
Retained earnings		20.0	59.0
	Total liabilities and equity	$211.0	$290.0

Table 2
Soft Corporation Income Statement
for Years Ended December 31
(in millions except per share data)
		Actual 2004	Projected 2005
Sales		$80.0	$198.0
COGS		(38.0)	(90.0)
	Gross profit	$42.0	$108.0
SG&A		(13.0)	(30.0)
Depreciation		(3.0)	(5.0)
	Operating expenses	$(16.0)	$(35.0)
Interest expense		$(4.0)	$(5.0)
Pretax Income		22.0	68.0
Income tax expense		(7.0)	(25.0)
Net income		$15.0	$43.0
EPS		$2.0	$4.3
Average shares outstanding (millions)		7.5	10.0
Dividends per share		$0.1	$0.4

Under the indirect method, what will Stone find Soft Corporation's projected net change in cash to be for the year ending December 31, 2005?

A) $2,000,000.

B) $9,000,000.

C) $4,000,000.

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Using the easiest method of all, the difference in the cash account at the end of 2004 and the cash balance projected for the end of 2005 is $26.0 million - $24.0 million = $2.0 million. If the cash balances were not available, the change in cash could be calculated using the indirect method. Starting with cash flow from operations (CFO) in $ millions projected for 2005:

Net Income	43
Add: Noncash Expenses or Losses
Depreciation	5
Add: Changes in Current Assets and Liabilities
Less: Increase in Accounts Receivable	-7
Less: Increase in Inventory	-50
Plus: Increase in Accounts Payable	10
Net Cash Flow from Operations (CFO)	1
Increase in Property Plant & Equipment	-25
Net Cash Flow from Investing (CFI)	-25
Increase in Long-Term Debt	20
Increase in Common Stock	10
Less: Dividends Paid (10 million × $0.40)	- 4
Net Cash Flow from Financing (CFF)	26

Net Cash Flow = CFO + CFI + CFF = 1 – 25 + 26 = $2 million.

LiquidAssets10

Which of the following is CORRECT about the consideration of depreciation in the operations section of a cash flow statement?

Direct Method

Indirect Method

A) Does not consider Does not consider

B) Does not consider Considers

C) Considers Considers

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The indirect method must add back depreciation expense because the starting point is net income. Since the direct method does not begin with net income it does not need to consider non-cash expenses such as depreciation.

LiquidAssets10

An analyst has gathered the following information about a company:

Income Statement for the Year 2004
Sales							$1,500
Expenses
	COGS					$1,300
	Depreciation					30
	Int. Expenses					40
					Total expenses		1,370
Income from cont. op.							130
				Gain on sale			30
Income before tax							160
Income tax							64
Net Income							$96

Additional Information:
Dividends paid	$30
Common stock sold	20
Equipment purchased	50
Bonds issued	80
Fixed asset sold for (original cost of $100 with accumulated depreciation of $70)	60
Accounts receivable decreased by	30
Inventory decreased by	20
Accounts payable increased by	20
Wages payable decreased by	10

What is the cash flow from operations?

A) $156.

B) $170.

C) $135.

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Net Income		+$96
Depreciation		+30
Gain on sale of asset		-30
Accts. Rec.		+30
Inventory		+20
Accts. Payable		+20
Wage/Pay		-10
	CFO	+$156

LiquidAssets10

An analyst contemplates using the indirect method to create the projected statement of cash flows. She decides to research the differences between the direct and indirect methods. Which of the following is least likely a component of the statement of cash flows under the direct method?

A) Payment of dividends.

B) Net income.

C) Property, Plant, & Equipment.

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Property, Plant, & Equipment and payment of dividends are components of the statement of cash flows under both the direct and indirect methods. Net income is the first figure under the indirect method, but it is not a part of the statement of cash flows under the direct method. The correct response is net income.

LiquidAssets10

An analyst contemplates using the indirect methods to create the projected statement of cash flows. She decides to research the differences between the direct and indirect methods. Which of the following statements is most accurate? Under the:

A) direct method, depreciation must be added to cash collections because it is a non-cash expense.

B) indirect method, changes in accounts receivable are already included in the net income figure.

C) indirect method, depreciation must be added to net income, because it is a non-cash expense.

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The indirect method begins with net income, which has already included all cash and non-cash expenses. Therefore, under the indirect method, depreciation must be added to net income, because it is a non-cash expense.

LiquidAssets10

Determine the cash flow from operations given the following table.

Item	Amount
Cash payment of dividends	$30
Sale of equipment	$25
Net income	$25
Purchase of land	$15
Increase in accounts payable	$20
Sale of preferred stock	$25
Increase in deferred taxes	$5
Profit on sale of equipment	$15

A) $20.

B) $45.

C) $35.

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Using the indirect method, CFO = Net income 25 + increase in accounts payable 20 + increase in deferred taxes 5 − profit on sale of equipment 15 = $35. Increases in accounts payable and deferred taxes are sources of operating cash that are not included in net income and must be added. Profit on sale of equipment is a CFI item that must be removed from net income.
No adjustment needs to be made for cash payment of dividends (CFF), sale of preferred stock (CFF), or purchase of land (CFI) because they are not included in net income. Only the profit on sale of equipment, not the full proceeds from sale, is included in net income.

LiquidAssets10

Determine the cash flow from financing given the following table.

Item	Amount
Cash payment of dividends	$30[/td]
Sale of equipment	$10
Net income	$25
Purchase of land	$15
Increase in accounts payable	$20
Sale of preferred stock	$25
Increase in deferred taxes	$5
Profit on sale of equipment	$15

A) -$5.

B) $15.

C) $20.

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CFF = 25(Sale of Stock) − 30(Div Paid) = -$5