Question

Which of the following statements is CORRECT? a. Most rapidly growing companies have positive free cash flows because cash flows from existing operations will exceed fixed assets and working capital needed to support the growth. b. In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and the change in net operating working capital. Free cash flow is the amount of cash that could be withdrawn without harming the firm's ability to operate and to produce future cash flows. c. The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that add to or subtract from cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt. d. An increase in accounts receivable is added to net income in the operating activities section because if accounts receivable increase, then when they are collected cash will come into the firm. e. The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line."

Answer 1

The correct statement:

b. In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and the change in net operating working capital. Free cash flow is the amount of cash that could be withdrawn without harming the firm's ability to operate and to produce future cash flows.

Step-by-step explanation:

Statement 'a' is not correct because a rapidly growing company may experience negative and not positive free cash flows due to the huge investment in fixed assets and working capital to support the growth.

Statement 'c' could have been correct but for the conclusion that a negative cash flows will certainly lead a firm to go bankrupt. A firm can easily source for additional funding from other organizations, its stockholders, and financial institutions to smoothen the problems created by negative cash flows.

Statement 'd' is not correct as an increase in accounts receivable is a cash outflow instead of a cash inflow, which is indicated by a reduction in accounts receivable. Finally, "the bottom line" refers to the net income and not the dividends paid out of income. This makes statement 'e' to be incorrect as well, thus leaving only statement 'b' as the only true statement.