LOS e: Analyze why and how cash flow from operations is used to assess the ability of an issuer to service its debt obligations and to assess the financial flexibility of a company.

Q1. Discretionary cash flow is defined as:

A)   net income + noncash expenses ± changes in current assets and current liabilities (excluding cash).

B)   net income + depreciation +/– other noncash items + decrease (increase) in noncash current assets + increase (decrease) in nondebt current liabilities - capital expenditures - cash dividends.

C)   net income + noncash expenses - noncash revenue items included in net income.

Q2. Which of the following statements addressing the use of cash flow analysis to assess the ability of the issuer to service its debt is FALSE?

A)   The ratio of cash flow from operations to long-term debt is an indicator of a firm's flexibility with regard to financing decisions.

B)   Discretionary cash flow can be used to determine the company's ability to pay down its debt obligation.

C)   The level of discretionary cash flow indicates how safe is the company's dividend.

Q3. Which of the following statements about the ratio of cash flow from operations to capital expenditures is FALSE?

A)   The higher the ratio, the greater the financial flexibility.

B)   An increasing ratio may imply that the firm has recently expanded but has not yet generated the increased cash flow from operations necessary to bring the ratio back to its normal level.

C)   This ratio is especially useful for capital intensive firms and utility companies.

Q4. Discretionary cash flow is defined as (net earnings + depreciation + deferred income taxes ? noncash revenue items included in net earnings ? increase in adjusted noncash working capital ? capital expenditures ? cash dividends). This definition is equivalent to which of the following?

A)   Cash from financing ? dividends payable.

B)   Free operating cash flow ? cash dividends.

C)   Cash from investing ? cash from operations (CFO).

LOS e: Analyze why and how cash flow from operations is used to assess the ability of an issuer to service its debt obligations and to assess the financial flexibility of a company. fficeffice" />

Q1. Discretionary cash flow is defined as:

A)   net income + noncash expenses ± changes in current assets and current liabilities (excluding cash).

B)   net income + depreciation +/– other noncash items + decrease (increase) in noncash current assets + increase (decrease) in nondebt current liabilities - capital expenditures - cash dividends.

C)   net income + noncash expenses - noncash revenue items included in net income.

Correct answer is B)         

Discretionary cash flow = net income + depreciation +/– other noncash items + decrease (increase) in noncash current assets + increase (decrease) in nondebt current liabilities - capital expenditures - cash dividends.

It represents the cash flow available to a firm after it has funded its basic operating requirements.

Q2. Which of the following statements addressing the use of cash flow analysis to assess the ability of the issuer to service its debt is FALSE?

A)   The ratio of cash flow from operations to long-term debt is an indicator of a firm's flexibility with regard to financing decisions.

B)   Discretionary cash flow can be used to determine the company's ability to pay down its debt obligation.

C)   The level of discretionary cash flow indicates how safe is the company's dividend.

Correct answer is A)

When it comes to financing decisions, an indicator of financial flexibility is the ratio of cash flow from operations to capital expenditures.

Q3. Which of the following statements about the ratio of cash flow from operations to capital expenditures is FALSE?

A)   The higher the ratio, the greater the financial flexibility.

B)   An increasing ratio may imply that the firm has recently expanded but has not yet generated the increased cash flow from operations necessary to bring the ratio back to its normal level.

C)   This ratio is especially useful for capital intensive firms and utility companies.

Correct answer is B)

A declining ratio may indicate that the firm has gone through a major capital expansion and needs more time before cash flow from operations will increase enough to bring the ratio back up again.

Q4. Discretionary cash flow is defined as (net earnings + depreciation + deferred income taxes ? noncash revenue items included in net earnings ? increase in adjusted noncash working capital ? capital expenditures ? cash dividends). This definition is equivalent to which of the following?

A)   Cash from financing ? dividends payable.

B)   Free operating cash flow ? cash dividends.

C)   Cash from investing ? cash from operations (CFO).

Correct answer is B)

CFO = net earnings + depreciation + deferred income taxes ? noncash revenue items included in net earnings ? increase in adjusted noncash working capital. Hence, discretionary cash flow = CFO ? capital expenditures

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