Question

Review the data given in Problem 16-1A and the completed statement of cash flows (which should be in their notes) to answer the following questions:

1. What is Winner’s Edge cash flow from operating activities for 2006? (Answer: $163,300)

2. What much cash was used to pay dividends in 2006? (Answer: $52,000)

3. What amount of cash was paid to purchase equipment? (Answer: $120,000)

4. Can we assume all of the equipment purchases were to maintain productive capacity? (Answer: no)

Assume that 20% of the asset purchases were to maintain productive capacity; the remaining purchases were made to expand operations. Also, ask your students to assume that the purchase of land was made to expand operations. Based on these assumptions, free cash flow would be calculated as follows:

Cash flow from operations $163,300

Less: Cash invested in equipment to maintain productive capacity $24,000

Cash used for dividends 52,000

76,000

Free cash flow $ 87,300

Winner’s Edge operations in 2006 did generate sufficient cash flow to pay dividends and maintain productive capacity.

Answer 1

Cash flow from operations $163,300

Less: Cash invested in equipment to maintain productive capacity 20% x 120,000 = $24,000

Free cash flow = $163,300 - $24,00 = $139,300

Positive cash flow is considered favorable. The Company that has free cash flow is able to fund internal growth, retire debt, pay dividends and benefit from financial flexibility.

Winner’s Edge operations in 2006 did generate sufficient cash flow to pay dividends and maintain productive capacity.

A valuable tool for evaluating the cash flows of the business is free cash flow. Free cash flow measures the operating cash flows available o the company to use after purchasing property plant & equipment necessary to maintain current productive capacity. The free cash flow as a percent of cash flow from operating activities is $139,300/ $163,300 =85% in 2006.