1.

Two methods can be used to construct a statement of cash flows: the direct method & the indirect
method. Under the indirect method, data from three financial statements are used. These statements
include ____ (A) ____ & ____ (B) ____.
A = two balance sheets, one statement of cash flows or one balance sheet
B = two statement of cash flow, one income statement or two income statements
2. During the year, Intergalactic Broadcasting Co. issued 5,000 shares of preferred stock for $25 per
share. This transaction is classified as an
A. Investing cash flow
B. Financing cash flow
C. Operating cash flow
3. Chicago Pork Producers Inc. sold its old computer system for 70,000. This transaction is classified
as an
A. Investing cash flow
B. Financing cash flow
C. Operating cash flow
4. A firm engages in a variety of activities that generate & require cash payment. The following questions
presents examples of these activities. Classify each transaction according to its serving as a source of cash
to the firm (cash inflow) or a use of cash (cash outflow).
A. Tomorrow is the last day of a 2 week pay period. Tomorrow, the wages payable account’s current
balance of 254K will reset to $0 as the wages are paid to the company’s workers. The company now
owes its employees the most recent week’s salary. Is this a Source or Use?
B. During the year, Intergalactic Broadcasting Co. relocated its corporate HQ & purchased a new
office building. Is this a Source or Use?
5. A company reports net sales of $2,500 million. Assume that there were no non-cash sales.
Operating costs (excluding depreciation & amortization) were 65% of its total revenues.
Depreciation & Amortization charges were 5% of total sales.
Interest charges were 15% of EBIT with a tax rate of 40%.
The company’s current cash flow is?
A. $382 million
B. $507 million
C. $253 million
D. $637 million
6. Company A uses long-term debt to finance its assets & Company B uses capital generated from
shareholders to finance assets. Which company would be considered a financially leveraged firm, A
or B?
7. Which of the following is true about the leveraging effect?
A. Using leverages reduces the potential of gains & losses
B. Using leverage can generate shareholder wealth, but if a company fails to make payments on its
debt, credit default can reduce shareholder wealth
8. Niagular Corp. just reported a net income of $9,000,000 & its current stock price is $31.25 per share.
Niagular Corp. is forecasting an increase of 25% for its net income next year, but it also expects it will have
to issue 2,500,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,000,000)
A. If the forecast turns out to be correct & its price-to-earnings (P/E) ratio does not change, what do
they expect their stock price to be one year from now?
1: $26.87
2: $31.25
3: $20.15
4: $33.59
B. One year later its stock is trading at $38.42 & the company reports its common equity value as
$42,992,000. Its market-to-book (M/E) ratio is?
1: 1.16x
2: 7.16x
3: 17.16x
4: 10.74x
9. Which of the following statements is TRUE about market ratios?
A. Companies with high research & development expenses tend to have LOW P/E ratios
B. Companies with high research & development expenses tend to have HIGH P/E ratios

Expert Answer
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General guidance
Concepts and reason
Cash flow statement: Cash flow statement is one of the financial statement of the company. Cash flow statement
consists details of net changes in cash during the period. It shows the cash flow generated from different transactions
undertaken during the year. The cash flow statement consists of cash flow from operating activity, cash flow from
investing activity and cash flow from financing activity. It shows both cash inflow and outflow from all the
transactions.
Fundamentals
Operating activities: The cash flow generated from the main business operation of the company are classified as
cash flow from operating activities. The cash flow from operating activities can be prepared in two ways that is by
direct method and indirect method. In the direct method of cash flow preparation the cash inflow from customers,
payment made to suppliers and payment made for operating expenses are shown. While in indirect method the cash
flow from operating activities is calculated by taking the net income from business operation and adding back the
non cash expenses or revenue to the net income statement as these do not impact the cash flow. Also the changes in
working capital are considered while preparing the cash flow statement as the working capital changes are also
operating related.
Investing activities: The cash flow generated from sale or purchase of asset are classified under cash flow from
investing activities. These cash flow relates to the investment made by the company.
Financing activities: The cash inflow or outflow occurred due to borrowing or repaying the finances are classified
under financing activities. These cash flow relates to the finance obtain by the company.
 Show less 
FIRST STEP | ALL STEPS | ANSWER ONLY

Step-by-step
Step 1 of 3
1.
Calculation of cash flow from operating activities begins with net income and to the net income non cash expenses
are added and then adjustment is made for working capital changes and therefore the financial statements required to
prepare cash flow statement would include current year income statement and current year and previous year
balance sheet.
Thus, the indirect method of cash flow statement would require two balance sheet current year and previous year
and current year income statement.
The statement required to prepare cash flow statement are two balance sheet and one income statement.

Explanation | Hint for next step

Cash flow from operating activities is cash generated from business operation. The income statement of the
company provides details of expenses and revenue from the business and therefore income statement is used to
calculate the cash flow from operation. The cash used or provided by the working capital is also part of cash flow
from operating activities and therefore for changes in working capital the two comparative balance sheet is used to
calculate cash flow from operation.

Step 2 of 3
Company issues preference shares to finance its business operation. The issue of preference share would increase the
finance of the company that is cash flow and therefore is classified as cash flow from financing activity.
Thus, issue of preference share is classified as cash flow from financing activity.
Issue of preference share is classified as cash flow from financing activity.

Explanation | Hint for next step

Companies issue preference stock so as to raise funds for its business operation. The preferred stock is part of
stockholder’s equity and the purchaser of preference shares are the owners of the company. With issue of preference
shares company would receive cash and therefore will increase the cash balance of the company. Since the
preference shares are issued for financing the business operation, it is classified as cash flow from financing activity.

Step 3 of 3
Computers are the fixed assets of the company which are used in business operation or helps in generating revenue.
The purchase of asset is classified as cash outflow from investing activity and so the sale of computer would also be
classified as cash flow from investing activity.
Thus, the sale of computer is classified as cash flow from investing activity.
The sale of computer is classified as cash flow from investing activity.

Explanation
Company has sold its old computer system for $70,000 which means there would be cash inflow for the company
from sale of computer. The computer are fixed assets of the company and therefore the sale of old computer system
would be classified as cash inflow from investing activity.

Answer
The statement required to prepare cash flow statement are two balance sheet and one income statement.
Issue of preference share is classified as cash flow from financing activity.
The sale of computer is classified as cash flow from investing activity.
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