Question

Which of the following statements are correct?

a. All else equal, an increase in accounts receivable and/or an increase in depreciation in a given year decrease a firm’s unlevered cash flows in that year.

b. A company’s Return on Equity (ROE) is a poor measure of the company’s performance during the year.

c. The Internal Rate of Return (IRR) of an investment opportunity that requires a deposit of £100 today and pays £250 two years from today is higher than 60%.

d. If a company’s accounts receivable are expected to remain outstanding for 180 days and the company’s annual revenues are £100 million, the accounts receivable of the company are £25 million.

Answer 1

a. is not correct because an increase in Depreciation will cause nothing. This is because Depreciation is a non-cash expense.

b. is correct because Return on Equity can increase if we increase profits or if we decrease the equity. Hence, if we increase leverage i.e. increase debt and reduce equity we can increase out ROE without changing the profit.

c The IRR will be calculated as:

-100 + 250/(1+r)^2 = 0 Hence, r = 58.11. Hence, c is also false.

d. False because the receivables turnover will be = 360/180 =2. Hence, the accounts receivables will be = 100/2 = 25 million.

Only B is correct.