Question

For each of the following three transactions by a firm, calculate the effect on each of the following items: “Operating” Cash Flow, ΔNet Working Capital, Net Capital Spending, Cash Flow from Assets, Cash Flow to Creditors, and Cash Flow to Shareholders. If an item is completely unaffected by the transaction, you should not mention the item; however, if an item is affected in multiple ways that have a net effect of $0, you must report the $0. (1) The firm purchases a hotel for $1 million in cash. (2) The firm purchases $108,000 of inventory, all on credit. (3) The firm issues $2.3 million of common stock in exchange for cash.

Answer 1

Solution:-

Case 1: The firm purchases a hotel for $1 million in cash

Purchasing hotel is a capital expenditure and shall have the following impacts:

• Increase in net capital spending by $1 million
• Decrease in cash flow from assets by $1 million

Case 2: The firm purchases $108,000 of inventory, all on credit

The impacts of the transaction are as follows:

• Increase in operating cash flow by $108,000
• Decrease in net working capital by $108,000
• Increase in cash flow from assets by $108,000

Case 3: The firm issues $2.3 million of common stock in exchange of cash

The impacts of the transaction are as follows:

• Decrease in cash flow to shareholders by $2.3 million