# Cash Flow Questions

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QS 16-1

The statement of cash flows is one of the four primary financial statements.

1. Describe the content and layout of a statement of cash flows, including its three sections.

2. List at least three transactions classified as investing activities in a statement of cash flows.

3. List at least three transactions classified as financing activities in a statement of cash flows.

4. List at least three transactions classified as significant noncash financing and investing activities in the statement of cash flows.

QS 16-2

C2

Classify the following cash flows as operating, investing, or financing activities:

1. Sold long-term investments for cash.

2. Received cash payments from customer.

3. Paid cash for wages and salaries.

4. Purchased inventories for cash

5. Paid cash dividends.

6. Issued common stock for cash

7. Received cash interest on a note.

8 . Paid cash interest on outstanding bond

9. Received cash from sale of land at a loss.

10. Paid cash for property taxes on building.

QS 16-9

Analyses of sources

and uses of cash A1 A2

Financial data from three competitors in the same industry follow.

1. Which of the three competitors is in the strongest position as shown by its statement of cash flows?

2. Analyze and discuss the strength of Z-Best's cash flow on total assets ratio to that of Lopez.

Kazaam Company, a merchandiser, recently completed its calendar-year 2005 operations. For the year,

(1) all sales are credit sales, (2) all credits to Accounts Receivable reflect cash receipts from customers,

(3) all purchases of inventory are on credit, (4) all debits to Accounts Payable reflect cash

payments for inventory, and (5) Other Expenses are paid in advance and are initially debited to Prepaid

Expenses. Kazaam's balance sheets and income statement follow:

Additional Information on Year 2005 Transactions

a. The loss on the cash sale of equipment is $5,125 (details in b).

b. Sold equipment costing $46,875, with accumulated depreciation of $28,125, for $13,625 cash.

c. Purchased equipment costing $96,375 by paying $25,000 cash and signing a long-term note payable

for the balance.

d. Borrowed $3,750 cash by signing a short-term note payable.

e. Paid $31,375 cash to reduce the long-term notes payable.

f. Issued 2,500 shares of common stock for $18 cash per share.

g. Declared and paid cash dividends of $62,125.

Required

1. Prepare a complete statement of cash flows; report its operating activities using the indirect method.

Disclose any noncash investing and financing activities in a note.

Analysis Component

2. Analyze and discuss the statement of cash flows prepared in part 1, giving special attention to the

wisdom of the cash dividend payment.

Check Cash from operating

activities, $33,375

BTN 16-1 Refer to Krispy Kreme's financial statements in Appendix A to answer the

following:

1. Is Krispy Kreme's statement of cash flows prepared under the direct method or the indirect method?

2. For each fiscal year 2003, 2002, and 2001, is the amount of cash provided by operating activities

more or less than the cash paid for dividends?

3. What is the largest amount in reconciling the difference between net income and cash flow from

operating activities in 2003? In 2002? In 2001?

4. Identify the largest cash flows for investing and for financing activities in 2003 and in 2002.

Obtain Krispy Kreme's financial statements for a fiscal year ending after February 2, 2003, from

either its Website (KrispyKreme.com) or the SEC's EDGAR database (WWW.SEC.gov). Since

February 2, 2003, what are Krispy Kreme's largest cash outflows and cash inflows in the investing

and in the financing sections of its statement of cash flow?

Cash provided (used) by operating activities 80000 70000 (34000)

Cash provided (used) by investing activities

Proceeds from sale of operating assets 36000

Purchase of operating assets (38000) (35000)

Cash provided (used) by financing activities

Proceeds from issuance of debt 33000

Repayment of debt (7000)

Net increase (decrease) in cash 35000 35000 35000

Average total assets 800000 650000 400000

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QS 16-1

The statement of cash flows is one of the four primary financial statements.

1. Describe the content and layout of a statement of cash flows, including its three sections.

The statement of cash flows reports the cash (and cash equivalent) activities of a business for a specific accounting period. The cash flows are classified into operating, investing, and financing activities. The net change in cash as well as the beginning and ending cash balances are also reported on the statement.

2. List at least three transactions classified as investing activities in a statement of cash flows.

1. Sales of fixed assets

2. Purchase of fixed assets

3. Purchase of securities as investment

3. List at least three transactions classified as financing activities in a statement of cash flows.

1. Issue of new common stock

2. Payment of dividends

3. Retirement of bonds payable

4. List at least three transactions classified as significant noncash financing and investing activities in the statement of cash flows.

1. Exchange of common stock for fixed assets

2. Settling bonds payable by common stock

3. Settling debt by paying non-cash assets

QS 16-2

C2

Classify the following cash flows as operating, investing, or financing activities:

1. Sold long-term investments for cash. FINANCING This is investing since the investments are sold

2. Received cash payments from customer. OPERATING

3. Paid cash for wages and salaries. OPERATING

4. Purchased inventories for cash INVESTING - This is operating as it ...

#### Solution Summary

The solution explains various questions relating to cash flow

Capital Budgeting- 30 questions on Capital Budgeting- Discounted Payback, NPV, Investment, IRR, modified , point of indifference, internal rate of return (MIRR), WACC, risk-adjusted discount rate

Please assist me with the following problems relating to discounted payback, NPV, investments and more.

1. Haig Aircraft is considering a project which has an up-front cost paid today at t = 0. The project will generate positive cash flows of $60,000 a year at the end of each of the next five years. The project's NPV is $75,000 and the company's WACC is 10 percent. What is the project's simple, regular payback?

2. Lloyd Enterprises has a project which has the following cash flows:

Year Cash Flow

0 -$200,000

1 50,000

2 100,000

3 150,000

4 40,000

5 25,000

The cost of capital is 10 percent. What is the project's discounted payback?

3. Davis Corporation is faced with two independent investment opportunities. The corporation has an investment policy which requires acceptable projects to recover all costs within 3 years. The corporation uses the discounted payback method to assess potential projects and utilizes a discount rate of 10 percent. The cash flows for the two projects are:

Project A Project B

Year Cash Flow Cash Flow

0 -$100,000 -$80,000

1 40,000 50,000

2 40,000 20,000

3 40,000 30,000

4 30,000 0

Which investment project(s) does the company invest in?

4. You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5, $3,000 per year for Years 6-8, and $2,000 per year for Years 9 and 10. If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?

5. Shannon Industries is considering a project which has the following cash flows:

Year Cash Flow

0 ?

1 $2,000

2 3,000

3 3,000

4 1,500

The project has a payback of 2.5 years. The firm's cost of capital is 12 percent. What is the project's net present value NPV?

6. Below are the returns of Nulook Cosmetics and "the market" over a three-year period:

Year Nulook Market

1 9% 6%

2 15 10

3 36 24

Nulook finances internally using only retained earnings, and it uses the Capital Asset Pricing Model with a historical beta to determine its cost of equity. Currently, the risk-free rate is 7 percent, and the estimated market risk premium is 6 percent. Nulook is evaluating a project which has a cost today of $2,028 and will provide estimated cash inflows of $1,000 at the end of the next 3 years. What is this project's MIRR?

7. Two projects being considered by a firm are mutually exclusive and have the following projected cash flows:

Project A Project B

Year Cash Flow Cash Flow

0 ($100,000) ($100,000)

1 39,500 0

2 39,500 0

3 39,500 133,000

Based only on the information given, which of the two projects would be preferred, and why?

8. Genuine Products Inc. requires a new machine. Two companies have submitted bids, and you have been assigned the task of choosing one of the machines. Cash flow analysis indicates the following:

Machine A Machine B

Year Cash Flow Cash Flow

0 -$2,000 -$2,000

1 0 832

2 0 832

3 0 832

4 3,877 832

What is the internal rate of return for each machine?

9. A company is analyzing two mutually exclusive projects, S and L, whose cash flows are shown below:

Years 0 1 2 3 4

S -1,100 900 350 50 10

L -1,100 0 300 500 850

The company's cost of capital is 12 percent, and it can get an unlimited amount of capital at that cost. What is the regular IRR (not MIRR) of the better project? (Hint: Note that the better project may or may not be the one with the higher IRR.)

10. Your company is planning to open a new gold mine which will cost $3 million to build, with the expenditure occurring at the end of the year three years from today. The mine will bring year-end after-tax cash inflows of $2 million at the end of the two succeeding years, and then it will cost $0.5 million to close down the mine at the end of the third year of operation. What is this project's IRR?

11. Belanger Construction is considering the following project. The project has an up-front cost and will also generate the following subsequent cash flows:

t = 1 $400

t = 2 500

t = 3 200

The project's payback is 1.5 years, and it has a cost of capital of 10 percent. What is the project's modified internal rate of return (MIRR)?

12. The following cash flows are estimated for two mutually exclusive projects:

Project A Project B

Year Cash Flow Cash Flow

0 -$100,000 -$110,000

1 60,000 20,000

2 40,000 40,000

3 20,000 40,000

4 10,000 50,000

When is Project B more lucrative than Project A? (That is, over what range of costs of capital (r) does Project B have a higher NPV than Project A?)

13. Martin Fillmore is a big football star who has been offered contracts by two different teams. The payments (in millions of dollars) he receives under the two contracts are listed below:

Team A Team B

Year Cash Flow Cash Flow

0 $8.0 $2.5

1 4.0 4.0

2 4.0 4.0

3 4.0 8.0

4 4.0 8.0

Fillmore is committed to accepting the contract which provides him with the highest net present value (NPV). At what discount rate would he be indifferent between the two contracts?

14. Your company is considering two mutually exclusive projects, X and Y, whose costs and cash flows are shown below:

Project X Project Y

Year Cash Flow Cash Flow

0 -$2,000 -$2,000

1 200 2,000

2 600 200

3 800 100

4 1,400 75

The projects are equally risky, and the firm's cost of capital is 12 percent. You must make a recommendation, and you must base it on the modified IRR (MIRR). What is the MIRR of the better project?

15. A company's balance sheets show a total of $30 million long-term debt with a coupon rate of 9 percent. The yield to maturity on this debt is 11.11 percent, and the debt has a total current market value of $25 million. The balance sheets also show that that the company has 10 million shares of stock; the total of common stock and retained earnings is $30 million. The current stock price is $7.5 per share. The current return required by stockholders, rS, is 12 percent. The company has a target capital structure of 40 percent debt and 60 percent equity. The tax rate is 40%. What weighted average cost of capital should you use to evaluate potential projects?

16. A company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the firm's weighted average cost of capital.

rd = 6%

Tax rate = 40%

P0 = $25

Growth = 0%

D0 = $2.00

(The following information applies to the next six problems.)

Rollins Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find rs. The firm's marginal tax rate is 40 percent.

17. What is Rollins' component cost of debt?

18. What is Rollins' cost of preferred stock?

19. What is Rollins' cost of common stock (rs) using the CAPM approach?

20. What is the firm's cost of common stock (rs) using the DCF approach?

21. What is Rollins' cost of common stock using the bond-yield-plus-risk-premium approach?

22. What is Rollins' WACC?

23. Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity. The firm expects to earn $600 in after-tax income during the coming year, and it will retain 40 percent of those earnings. The current market price of the firm's stock is P0 = $28; its last dividend was D0 = $2.20, and its expected growth rate is 6 percent. Allison can issue new common stock at a 15 percent flotation cost. What will Allison's marginal cost of equity capital (not the WACC) be if it must fund a capital budget requiring $600 in total new capital?

24. Hamilton Company's 8 percent coupon rate, quarterly payment, $1,000 par value bond, which matures in 20 years, currently sells at a price of $686.86. The company's tax rate is 40 percent. Based on the nominal interest rate, not the EAR, what is the firm's component cost of debt for purposes of calculating the WACC?

25. The Target Copy Company is contemplating the replacement of its old printing machine with a new model costing $60,000. The old machine, which originally cost $40,000, has 6 years of expected life remaining and a current book value of $30,000 versus a current market value of $24,000. Target's corporate tax rate is 40 percent. If Target sells the old machine at market value, what is the initial after-tax outlay for the new printing machine?

26. Real Time Systems Inc. is considering the development of one of two mutually exclusive new computer models. Each will require a net investment of $5,000. The cash flow figures for each project are shown below:

Period Project A Project B

1 $2,000 $3,000

2 2,500 2,600

3 2,250 2,900

Model B, which will use a new type of laser disk drive, is considered a high-risk project, while Model A is of average risk. Real Time adds 2 percentage points to arrive at a risk-adjusted cost of capital when eval¬uating a high-risk project. The cost of capital used for average-risk projects is 12 percent. Find the NPV of Model A and Model B.

27. Klott Company encounters significant uncertainty with its sales volume and price in its primary product. The firm uses scenario analysis in order to determine an expected NPV, which it then uses in its budget. The base case, best case, and worse case scenarios and probabilities are provided in the table below. What is Klott's expected NPV, standard deviation of NPV, and coefficient of variation of NPV?

Probability Unit Sales Sales NPV

of Outcome Volume Price (In Thousands)

Worst case 0.30 6,000 $3,600 -$6,000

Base case 0.50 10,000 4,200 +13,000

Best case 0.20 13,000 4,400 +28,000

28. Pierce Products is deciding whether it makes sense to purchase a new piece of equipment. The equipment costs $100,000 (payable at t = 0). The equipment will provide before-tax cash inflows of $45,000 a year at the end of each of the next four years (t = 1, 2, 3, 4). The equipment can be depreciated according to the following schedule:

t = 1: 0.33

t = 2: 0.45

t = 3: 0.15

t = 4: 0.07

At the end of four years the company expects to be able to sell the equipment for a salvage value of $10,000 (after-tax). The company is in the 40 percent tax bracket. The company has an after-tax cost of capital of 11 percent. Since there is more uncertainty about the salvage value, the company has chosen to discount the salvage value at 12 percent. What is the net present value of purchasing the equipment?

29. Your company is considering a machine that will cost $1,000 at Time 0 and which can be sold after 3 years for $100. To operate the machine, $200 must be invested at Time 0 in inventories; these funds will be recovered when the machine is retired at the end of Year 3. The machine will produce sales revenues of $900/year for 3 years; variable operating costs (excluding depreciation) will be 50 percent of sales. Operating cash inflows will begin 1 year from today (at Time 1). The machine will have depreciation expenses of $500, $300, and $200 in Years 1, 2, and 3, respectively. The company has a 40 percent tax rate, enough taxable income from other assets to enable it to get a tax refund from this project if the project's income is negative, and a 10 percent cost of capital. Inflation is zero. What is the project's NPV?

30. The Unlimited, a national retailing chain, is considering an investment in one of two mutually exclusive projects. The discount rate used for Project A is 12 percent. Further, Project A costs $15,000, and it would be depreciated using MACRS. It is expected to have an after-tax salvage value of $5,000 at the end of 6 years and to produce after-tax cash flows (including depreciation) of $4,000 for each of the 6 years. Project B costs $14,815 and would also be depreciated using MACRS. B is expected to have a zero salvage value at the end of its 6-year life and to produce after-tax cash flows (including depreciation) of $5,100 each year for 6 years. The Unlimited's marginal tax rate is 40 percent. What risk-adjusted discount rate will equate the NPV of Project B to that of Project A?

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