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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Free cash flow

McMahon Inc. reported the following on the company’s statement of cash flows in Year 2 and Year 1:

  Year 2 Year 1
Net cash flow from operating activities $294.000 $280,000
Net cash flow used for investing activities (224,000) (252.000)
Net cash flow used for financing activities (63,000) (42.000)

Seventy percent of the net cash flow used for investing activities was used to replace existing capacity.

a. Determine McMahon’s free cash flow for both years.

b. Has McMahon s free cash flow improved or declined from Year 1 to Year 2?

a.

To determine

Free cash flow:

Free cash flow is defined as an evaluation of financial performance of a company. It shows the cash which is generated after paying on capital expenditures. Such cash is used for production, expansion, development of new products, and acquisitions.

The following formula is used to calculate free cash flow.

Free cash flow = (Net cash provided by operating activitiesCash payments planned for investments in long-term assets)

To Determine: M’s free cash flow for both years.

Explanation

Free cash flow is the balance of cash from operating activities. This balance remains after the payment of “long-term assets”.

It signifies the amount of cash which leftover in the business after meeting the above expenditures in acquisition and expansion of business.

Working notes:

Calculate the net cash used for investing activities for Year 1:

Net cash used for investing activities for Year 1}=(Net cash used for investing activities for Year 1×Percentage used to replace exisating capacity)=($252,000×70

b.

To determine

To Explain: Whether free cash flow has improved or declined from Year 1 to Year 2.

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