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

LiquidAssets10

A firm has net sales of $3,500, earnings after taxes (EAT) of $1,000, depreciation expense of $500, cost of goods sold (COGS) of $1,500, and cash taxes of $500. Also, inventory decreased by $100, and accounts receivable increased by $300. What is the firm's cash flow from operations?

A) $1,200.

B) $1,800.

C) $1,300.

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Indirect Method
EAT	+1,000
Depreciation	+500
Change in Inv.	+ 100 a source
Change in Accts. Rec.	(300) a use
CFO	1,300

Direct Method
Net Sales	+3,500
Change in Accts. Rec.	(300) a use
COGS	(1,500)
Cash Taxes	(500)
Change in Inv.	+100 a source
CFO	1,300

LiquidAssets10

The Red Company’s balance sheet as of December 31, 2004 was as follows:

	Dec. 31, 2003	Dec. 31, 2004
Cash	$1,500,000	$1,900,000
Accounts Receivable	3,000,000	3,400,000
Inventory	2,300,000	2,500,000
Property, Plant & Equipment	16,700,000	19,700,000
Less Accumulated Depreciation	(5,300,000)	(8,200,000)
Total Assets	$18,200,000	$19,300,000
Accounts Payable	$2,100,000	$1,900,000
Interest Payable	800,000	1,200,000
Income Taxes Payable	1,000,000	800,000
Notes Payable	2,700,000	2,900,000
Deferred Income Taxes	2,600,000	2,900,000
Common Stock	1,000,000	1,000,000
Retained Earnings	8,000,000	8,600,000
	$18,200,000	$19,300,000

Red’s interest expense was $900,000 and income tax expense was $1,000,000 in 2004. Red prepares its Statements of Cash Flows using the direct method.The other cash outflows section of Cash Flow from Operations (CFO) for 2004 would total:

A) $2,100,000.

B) $1,700,000.

C) $1,400,000.

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Other cash outflows is the third step in calculating CFO using the direct method. It consists of Cash taxes paid + Cash interest paid.
Cash interest paid = interest expense less increase in interest payable: ($900,000 – (1,200,000 - $800,000) =) $500,000.

Cash taxes paid =		tax expense of $1,000,000
	+	decrease in income taxes payable (1,000,000-800,000) = 200,000
	-	increase in deferred income taxes (2,600,000-2,900,000) = 300,000
		$900,000

Other cash outflows = $500,000 + 900,000 = $1,400,000

LiquidAssets10

Financial information for Jefferson Corp. for the year ended December 31st, was as follows:

Sales	$3,000,000
Purchases	1,800,000
Inventory at Beginning	500,000
Inventory at Ending	800,000
Accounts Receivable at Beginning	300,000
Accounts Receivable at Ending	200,000
Accounts Payable at Beginning	100,000
Accounts Payable at Ending	100,000
Other Operating Expenses Paid	400,000

Based upon this data and using the direct method, what was Jefferson Corp.’s cash flow from operations (CFO) for the year ended December 31st?

A) $900,000.

B) $1,200,000.

C) $800,000.

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CFO = sales $3,000,000 – change in accounts receivable ($200,000 – $300,000) – purchases $1,800,000 – other cash operating expenses $400,000 = $900,000.
Note that no adjustment for inventories is necessary because purchases are given. From the inventory equation, P = COGS + EI - BI.

LiquidAssets10

Capital Corp.’s activities in the year 2005 included the following:

• 
  At the beginning of the year, Capital purchased a cargo plane from Aviation Partners for $10 million in exchange for $2 million cash, $3 million in Capital Corp. bonds and $5 million in Capital Corp. preferred stock.
• 
  Interest of $150,000 was paid on the bonds, and dividends of $250,000 were paid on the preferred stock.
• 
  At the end of the year, the cargo plane was sold for $12,000,000 cash to Standard Company. Proceeds from the sale were used to pay off the $3 million in bonds held by Aviation Partners.

On Capital Corp.’s Statement of Cash Flow for the year ended December 31, 2005, cash flow from investments (CFI) related to the above activities is:

A) $6,750,000.

B) $9,750,000.

C) $10,000,000.

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Investing cash of $2 million was used to purchase the cargo plane. Proceeds from the sale of the plane were a source of $12 million of investing cash. Net CFI is $12 million − $2 million = $10 million. The interest payment is included in cash from operations (CFO) and the dividend payment in cash from financing (CFF). Redemption of the bonds is a use of cash from financing (CFF).