Financial flexibility is poor due to negative free cash flow PROBLEM 5 6 a

Financial flexibility is poor due to negative free

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Financial flexibility is poor due to negative free cash flow.
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PROBLEM 5-6 (a) LANSBURY INC. Statement of Cash Flows For the Year Ended December 31, 2010 Cash flows from operating activities       Net income ........................................................... $32,000       Adjustments to reconcile net income to       net cash provided by operating activities             Depreciation expense .................................... 11,000             Gain on sale of investments ......................... (3,400)             Increase in account receivable                ($41,600 – $21,200) .....................................  (20,400 )  (12,800 )       Net cash provided by operating activities ......... 19,200 Cash flows from investing activities       Sale of investments ............................................. 15,000       Purchase of land ..................................................  (18,000 )       Net cash used by investing activities ................ (3,000) Cash flows from financing activities       Issuance of common stock ................................. 20,000       Retirement of notes payable ............................... (16,000)       Payment of cash dividends ................................    (8,200 )       Net cash used by financing activities ................    (4,200 ) Net increase in cash .................................................. 12,000 Cash at beginning of year .........................................   20,000 Cash at end of year .................................................... $32,000 Noncash investing and financing activities       Land purchased through issuance of $30,000 of bonds
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PROBLEM 5-6 (Continued) (b) LANSBURY INC. Balance Sheet December 31, 2010 Assets Liabilities and Stockholders’ Equity Cash $32,000 Accounts payable $30,000 Accounts     receivable 41,600 Long-term notes   payable 25,000 (4) Investments 20,400 (1) Bonds payable 30,000 (5) Plant   assets (net) 70,000 (2) Common stock 120,000 (6) Land     88,000 (3) Retained earnings     47,000 (7) $252,000 $252,000 (1)  $32,000 – ($15,000 – $3,400) (2)  $81,000 – $11,000 (3)  $40,000 + $18,000 + $30,000 (4)  $41,000 – $16,000 (5)  $0 + $30,000 (6)  $100,000 + $20,000 (7)  $23,200 + $32,000 – $8,200 (c) Cash   flow   information   is   useful   for   assessing   the   amount, timing, and uncertainty of future cash flows. For example, by showing   the   specific   inflows   and   outflows   from   operating activities, investing activities, and financing activities, the user has   a   better   understanding   of   the  liquidity   and   financial flexibility of the enterprise. Similarly, these reports are useful in providing feedback about the flow of enterprise resources. This information should help users make more accurate predictions of   future   cash   flow.   In   addition,   some   individuals   have expressed concern about the quality of the earnings because the   measurement   of   the   income   depends   on   a   number   of accruals and estimates which may be somewhat subjective. As a result,   the   higher   the   ratio   of   cash   provided   by   operating
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activities to net income, the more comfort some users have in the reliability of the earnings. In this problem the ratio of cash provided by operating activities to net income is 60% ($19,200  ÷ $32,000).
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PROBLEM 5-6 (Continued) An analysis of Lansbury free cash flow indicates it is negative as shown below: Free Cash Flow Analysis Net cash provided by operating activities .............................. $19,200 Less:   Purchase of land .......................................................... (18,000)   Dividends .......................................................................    (8,200 )
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