Question

Assessing the quality of reported earnings using cash flow data. Prior to the dominance of Netflix, Blockbuster was the leading movie rental company in the U.S. In 1989, Lee J. Seidler, a senior analyst with Bear Stearns & Co., issued a research report critical of Blockbuster’s earnings. Mr. Seidler observed that although Blockbuster’s 1988 net income was $15.5 million and its cash flow from operating activities was $48.4 million, his review of the firm’s cash flow data revealed that Blockbuster’s purchases of new videocassette rental inventory had been classified as an "investing activity" rather than as "operating activity" on the company’s statement of cash flows. Presented below is selected financial statement for Blockbuster (in millions of dollars): Blockbuster Cash Flow 1988 1987 Net Income $15.5 $4.09 Cash Flow from Operations 48.3 10.3 Purchases of videocassettes rental inventory (51.3) (14.3) Do you agree with Blockbuster’s decision to classify its videocassette inventory purchases as an "investing activity"? Why or Why not? How does Blockbuster’s cash flow classification of its video inventory purchases affect its cash flow from operations? In general, discuss how the statement of cash flow data can be used to help evaluate a company’s reported earnings?

Answer 1

Follows are the solution to this question:

Step-by-step explanation:

In 1988 blockbusters generated by operational cash flow exceeding $3 for each and every dollar of sales, which is defined in the below table:

1988 1987

`\left\begin{array}{ccc} \text{cash flow from opeations(a)}&\$ \ 48.30 & 10.30 \\\text{net income(b)} &\$ \ 15.50 &4.09 \\ratio( (a)/(b)) &\$ \ 3.12 &2.52\end{array}\right`

So, Mr. Seidler 's problem will be whether the cashflow for vidoe rentals will be reported throughout the operating activities or Whether investment.

For the cash flow of such a behavioral pattern blockbuster, its ratio indicates also that blockbuster lost $0.19 for its net revenues reported by looks of mr. seidler in 1988 to each dollar in cash, as blockbuster was its world's largest video shop chain, getting its key sales from of the movie streaming of its operations.

1988 1987

`\left\begin{array}{ccc} \text{cash flow from opeations(as report)}&\$ \ 48.30 & 10.30 \\\text{less:videocasette purchases} &\$ \ 15.30 &4.09 \\Cash \ flow &\$ \ 3.00 &4.00\end{array}\right`

`\left\begin{array}{ccc} \text{cash flow from opeations(a)}&\$ \ 3.00 & 4.00 \\\text{net income(b)} &\$ \ 15.50 &4.09 \\ratio( (a)/(b)) &\$ \ 0.19 &0.98\end{array}\right`

It rate means which, Business retains stores since video cassettes have relatively low economic lives as the operational cash flow is much more consistent with the expected existence-generating sales of the asset.