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Chapter 3 - Solutions Overview: Problem Length Problem #s {S} 1, 3 {M} 2, 7, 8, 12, 13 {L} 4 - 6, 9 - 11, 14, 15 1.{S}a. Palomba Pizza Stores Statement of Cash Flows Year Ended December 31, 2000 Cash Flows from Operating Activities: Cash Collections from Customers Cash Payments to Suppliers Cash Payments for Salaries Cash Payments for Interest Net Cash from Operating Activities Cash Flows from Investing Activities: Sales of Equipment Purchase of Equipment Purchase of Land Net Cash for Investing Activities Cash Flows from Financing Activities: Retirement of Common Stock Payment of Dividends Net Cash for Financing Activities Net Increase in Cash Cash at Beginning of Year Cash at End of Year $ 250,000 (85,000) (45,000) (10,000) 38,000 (30,000) (14,000) (25,000) (35,000) $ 110,000 (6,000) (60,000) $ 44,000 50,000 $ 94,000 b. Cash Flow from Operations (CFO) measures the cash generating ability of operations, in addition to profitability. If used as a measure of performance, CFO is less subject to distortion than net income. Analysts use the CFO as a check on the quality of reported earnings, although it is not a substitute for net income. Companies with high net income and low CFO may be using overly aggressive income recognition techniques. The ability of a firm to generate cash from operations on a consistent basis is one indication of the financial health of the firm. Analysts search for trends in CFO to indicate future cash conditions and 3-1 potential liquidity or solvency problems. Cash Flow from Investing Activities (CFI) reports how the firm is investing its excess cash. The analyst must consider the ability of the firm to continue to grow and CFI is a good indication of the attitude of management in this area. This component of total cash flow includes the capital expenditures made by management to maintain and expand productive capacity. Decreasing CFI may be a forecast of slower future growth. Cash Flow from Financing (CFF) indicates the sources of financing for the firm. For firms that require external sources of financing (either borrowing or equity financing) it communicates management's preferences regarding financial leverage. Debt financing indicates future cash requirements for principal and interest payments. Equity financing will cause future earnings per share dilution. For firms whose operating cash flow exceeds investment needs, CFF indicates whether that excess is used to repay debt, pay (or increase) cash dividends, or repurchase outstanding shares. c. Cash payments for interest should be classified as CFF for purposes of analysis. This classification separates the effect of financial leverage decisions from operating results. It also facilitates the comparison of Palomba with other firms whose financial leverage differs.... View Full Document

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