Financial Analysis Homework 2 Alina Grün

1. Net Cash Flow

Answer a) is right: If a company issues (long-term) debts, the company will get more cash 
Cash inflow
Answer b) is wrong: If a company repurchases common stock, it must use money to pay for the
repurchases decreasing cash – Cash outflow
Answer c) is right: If a company sells assets, there would be an increase in cash and a decrease in
other assets but the total assets would remain the same.
Since Answer a) and c) are correct the right answer is e).

2. Net Cash Flow

Answer a) is wrong: If a company issued new common stock it would increase cash on balance
sheet.
Answer b) is wrong: If accompany issued long-term debt, cash on the balance sheet would
increase.
Answer c) is wrong: If a company sold assets, cash on the balance sheet would increase.
Answer d) is right: If a company bought assets, cash would decrease as the cash is used to pay
the assets and net cash flow would not be affected.
Answer e) is wrong: If the company eliminated its dividend it means that the company didn’t pay
dividends, cash on the balance sheet would increase.

3. Net Cash Flow

Formula: Net Cash Flow = Net Income+ Depreciation and Amortization
Answer a) is wrong: If a company had sold a division and received cash, cash on the balance
sheet would have increased.
Answer b) is wrong: If a company cut its dividend, it would have more cash left over from net
income and the cash on the balance sheet would have increased.
Answer c) is right: If a company made an investment in plant &equipment, it would have larger
depreciation expense that means that the net cash flow would increase. But the company had to
pay for the equipment; the cash on the balance sheet would decline.

4. Net Cash Flow and net income

RE = RE last year + Net income – dividends
$32000 = $700.000 + x – 0  Net Income = $-380.000

Answer a) is right: According to the balance sheet the retained earnings declined and because of
the formula above we can see that RE depends on NI and Div. Div. were not paid, so RE declined
because NI was negative.
Answer b) is wrong: The NI was negative and not positive.
Answer c) is wrong: Because of the formula NCF = NI + Depr. and Amort. We can say that the
depreciation expenses were higher than $150,000.
NCF = Net Income + Depreciation
$150.000 = $-380.000 + Dep  $530.000
Answer d) is wrong: A decrease in retained earnings doesn’t mean that cash on the balance
sheet declined.
Answer e) is wrong: We calculated NI for 2002 ($-380,000) and we know that NCF in 2002 was
$150,000. It was possible to calculate the Depr. of $530,000 but we do not know anything about
NCF for 2001.

5. Net Cash Flow and Net Income

Answer a) is wrong: If the company`s interest expense increased the NI would reduce.
Answer b) is right: If the company`s depreciation and amortization expenses declined the NI
would increase but NCF would decrease.
Answer c) is wrong: If the company`s operating income declined the NI would also decline.
Answer d) and e) are wrong.

6. Net Cash Flow and net income

Answer a) is right: An increase in depreciation means that the company bought more assets,; the
NI decreases on the balance sheet and the NCF increases.
Answer b) is wrong: If the interest expense will decline, the NI will increase.
Answer c) is wrong: If the non cash revenues increase, the NCF will decrease.
Answer d) and e) are wrong.

7. Net Cash Flow, Free Cash Flow, and Cash

Formula:
Net Cash Flow = NI + Depr. and Amort.
Free ash Flow = EBIT (1+T) + Depr. and Amort. – Capital Expenditures –NOWC(Net operating
working capital)

Answer a) is wrong: If the depr. and amort. expenses would increase both, Net Cash Flow and
Free Cash Flow would increase and may reduce taxes. This is no explanation why NCF and FCF
are negative with an increase in cash flow.
Answer b) is wrong: If the company had a sharp increase in its inventories that would mean that
that cash on the balance sheet would decrease or remain the same, as inventories could be paid
with cash or accounts payable.
Answer c) is right: If company sells common stock the cash will increase, but has no impact on
NCF and FCF.

8. Current Assets
Current Assets are: Cash, accounts receivable, inventories and total current assets.
Answer a) is wrong: Accounts payable are current liabilities.
Answer b) is right: Inventories are part of current assets.
Answer c) is right: Accounts receivable are part of current assets.
Therefore answer d) is right, as b) and c) are right.
Answer e) is wrong.
9. Balance Sheet
Formula: Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends

Answer c) is right: Just because the change between Retained earnings of 2001 and 2002 were
zero, it does not mean that Net income or dividends were zero.

10. Balance sheet

Answer a) is wrong: If the company had issued preferred stock, the value of preferred stock
would increase.
Answer b) is right: The amount of common stock increased from 2001 to 2002 that means that
the company issued common stock in 2002.
Answer c) is wrong: Because of the formula RE + NI – DP = RE 2002  $2340 + x +$0 =$2000 
NI = - 340 we know, that the NI was negative.
Answer d) and e) are wrong.

11. Balance sheet

Answer a) is right: If a company issues new common stock, that means it sells stock to
shareholders and receives cash in return.
Answer b) is wrong: If a company repurchases common stock, the company spends money 
reduce cash on balance sheet.
Answer c) is wrong: If the company pays a dividend to its shareholders, it is reducing its cash on
the balance sheet.
Answer d) is wrong: If the company is purchasing new equipment, it is spending money and
reducing cash on the balance sheet.

12. Balance sheet

Answer a) is wrong: Since retained earnings in 2001 and 2002 are positive and dividends are zero,
net income must be positive (retained earnings= Ni – Dividends).
Answer b) is right: Since the account of common stock increased in 2002 from $1,000,000 to
$1,500,000 that means that new common stock were issued in 2002.
Answer c) is wrong: Since the account of long-term debt did not change from 2001 to 2002.

13. Changes in depreciation

Answer c) is right: Depreciation is a source of cash, in the statement of cash flows. A decrease in
depreciation would mean a decrease in cash.
Answer a) is wrong: The physical stock of assets would not change.
Answer b) is wrong: In the income statement, depreciation is deducted from sales. If
depreciation will decrease, net com will increase.

14. Changes in depreciation

Answer a) is right: The company would be pay more taxes, as the net income would increase.
Answer b) is wrong: The cash position of the company would decrease, as the taxes would
increase because the net position will increase.
Answer c) is right: The net income will increase as the company would pay less depreciation
deduction. The NI would increase, the taxes would increase and the cash position would
decrease.
Answer d) is right, as a) and c) are right.

15. Changes in depreciation

Answer a) is right: In the income statement, depreciation is deducted from sales; the higher
depreciation is, the lower NI will be.
Answer b) is wrong: The net cash flow will increase, as there will be a higher cash outflow.
Answer c) is right: If the net income decreases the taxes will decreases, too. Increased
depreciation has an impact on tax-deductibility.
Answer d) is right, as a) and c) are right.

16. Changes in depreciation

Answer a) is wrong: An increase in depreciation expenses would have an impact on NI. The
higher the depreciation is, the lower NI will be.
Answer b) is wrong: The net cash flow will increase, as there will be a higher cash outflow.
Answer c) is wrong: If the net income decreases the taxes will decreases, too. Increased
depreciation has an impact on tax-deductibility.
Answer d) is wrong and that is why answer e) is right: None of the answers is right.

17. Changes in depreciation

Answer a) is right: A decrease in depreciation expenses means an increase in net income. Less
depreciation deducted  more NI.
Answer b) is right: The higher the net income is, the higher the taxes will be.
Answer c) is right: Actually, deprecation has no effect on physical assets; therefore gross fixed
assets will remain unchanged. But, if the depreciation expense is lower, the net fixed assets will
increase because accumulated depreciation at the end of the year will be lower.
Answer d) is wrong and therefore answer e) is right, as a), b) and c) are right.

18. Depreciation, net income, cash flow and taxes

Answer a) is right: An increase in depreciation expenses would have an impact on NI. The higher
the depreciation is, the lower NI will be.
Answer b) is wrong: The net cash flow will increase, as there will be a higher cash outflow.
Answer c) is right: If the net income decreases the taxes will decreases, too. Increased
depreciation has an impact on tax-deductibility.
Answer d) is right, as a) and b) are correct.

19. Financial statements

Answer a) is wrong: Accounts receivable illustrates current assets n the balance sheet.
Answer b) is wrong: Dividends are paid out of net income, not before net income.
Answer c) is right: If the company pays more dividends than the current net income of the
company is, the retained earnings will decline.

20. Book and market values per share

Answer a) is right: Book value per share = common equity/shares. $700,000,000/$35,000,000 =
$20 book value per share.
Answer b) is right: It is written, that the company has significant growth potentials. The company
has assets on the left side of the balance sheet whose market values are greater than the book
values. It is likely, that the company`s market value per share would be greater than $20.
Answer c) is right, as a) and b) are right.

21. EBIT, net income and operating cash flow

Answer a) is right: OCF = EBIT (1-T) + DEP and AMORT. If depreciation and amortization expenses
increase, EBIT would decline by DEP and AMORT, but OCF would go up by DEP and AMORT, so
the net change to OCF would be: DEP and AMORT – (DEP and AMORT)*(1-T) = DEP and AMORT –
(DEP and AMORT) + (DEP and AMORT)*(T) = (DEP and AMORT) * (T). So OCF would increase by
this amount, but EBIT and NI would decline.

22. EVA, cash flow, and net income

Answer a) is wrong: DA decreases  Net income increases but Net cash flow decreases if the
decrease in DA is greater than the increase in net income
Answer b) is right: If Operating income is less capital with the operating income  EVA increases
EVA = EBIT (1-T) – (After-tax cost of capital)*(Total investor-supplied operating capital)
Answer c) is wrong: EVA equation includes the cost of capital  doesn’t assume equity capital is
free.
Answer d) and e) is wrong.