Which of the following statements addressing the use of cash flow analysis to assess the ability of the issuer to service its debt is FALSE? A) The ratio of cash flow from operations to long-term debt is an indicator of a firm’s flexibility with regard to financing decisions. B) The statement of cash flows allows the analyst to assess a firm’s financial flexibility. C) Discretionary cash flow can be used to determine the company’s ability to pay down its debt obligation. D) The level of discretionary cash flow indicates how safe is the company’s dividend.
D) By elimination
I don’t even know what D means.
I would say A debt service coverage = (Free ops. CF + Interest) / (interest + annual principal repayment)
I’m in for D as well.
A? Because it doesn’t take into account cap expenditures required to maintain operations as a going concern?
d sounds good too, but I’m keeping a
D, by elimination and because it makes no sense.
Your answer: D was incorrect. The correct answer was A) The ratio of cash flow from operations to long-term debt is an indicator of a firm’s flexibility with regard to financing decisions.
And the explanation…
I was actually wondering why you guys thought d didn’t make sense but I can’t address it until tomorrow morning cause I’m on mybphone now.
We take the Free Operating cash flow and distribute the dividends, the movey left after all of this is called the DISCRETIONARY cash flow. So I seriously don’t understand why D could not be ans answers. How does it matter to shareholders if the DCF is 10m in year1 and 2m in year2, when they have already hogged the money before hand and are burping now. This is sick and I would want Black Swan to come back to this with the good detailed description tomorrow (and stop using his phone to reply to AF posts haha )
dinesh…you’re right… discretionary cash flow is after dividends have been paid…so it doesn’t indicate the safety of the dividends…the free operating cash flow does…
What if discretionary cash flows goes from positive in one year to negitive in the next year… and that trend continues… eventually is will have an impact on the level of dividends paid by a firm
ok, I’m back on my phone but I’ll try to give the abreviated reasoning. As discretionary CF is after dividends, it essentially indicates the available “cushion” stockholders have that protects them their dividends. In other words a large discretionary CF means that if you face a reduction in future OCF this is the cushion of protection your dividends have. What DCF has that OCF doesn’t are the capital expenditures figured in. Like any historical measure, DCF is limited in its predictive value, but that’s the gist of it. Additionally, if DCF is negative it indicates a low likelyhood that you will be able to continue meeting this level of dividend payment without interfering with your ability to maintain a going concern unless conditions change. Also, as interest takes priority over dividends, especialy if debt covenants exist, this indicates security of interest to debt holders as well. You can almost think of the company as one large CDO with different tranches in order of seniority being debt, equity, and DCF with each tranche offering added security to the one before it.
by DCF I mean discretionary cash flows. It didn’t come out as cleanly as I wanted cause I can only see a line at at time on my phone. Also, I realize their are other differences between OCF and DCF but just highlighted the most important inthis case-cap ex.