ANSWERS TO QUICK QUIZ QUESTIONS:
1) This question is not answered correctly by most of you so I think I owe you a second
Recall that from our Class 2 that Operating Cash Flows (OCF) of a firm are the
cash flows that reflect the daily operational activities of the firm (purchases, sales,
any other cash flows that stem from operation facilities of the firm). Also note that
cash flow is a financial term, meaning that it has to reflect market value, which the
term cash itself represents.
Earnings Before Interest and Taxes (EBIT) is our starting point to get the OCF.
However EBIT includes an accounting item which does not represent a cash flow:
depreciation. Depreciation is an item related to the useful life of an asset and is the
way to erase that asset from the ‘book’ gradually, as time erodes the value of the asset
(think of the cars that a car rental company owns, as they wear out). Depreciation
does not represent a cash flow. It is a non-cash item. In fact the cash flow that reflects
the cost of an asset is the purchase price and this cash flow includes all the possible
depreciation deductions that you may have in the future. However, depreciation is
included in the EBIT calculation and is a negative item in it. So, to not to include
depreciation in a cash flow item, the OCF, depreciation must be added to EBIT (since
depreciation contributes to the calculation of EBIT as a subtracted item, we reverse its
effect and its contribution to OCF becomes zero after this addition). Secondly, we
make another adjustment to EBIT, by subtracting taxes paid over the period that
EBIT was calculated. The name EBIT itself makes it clear that this item does not
include taxes paid, and since taxes are cash outflows (unless it is a tax refund), we
have to deduct taxes from the ‘EBIT+depreciation’ term to get to OCF of a firm.
It follows that the answer to the question is ‘Dividends Paid’, the choice (A) in the
FV (in 12 years) is given and is $20000
PV is $12000
t (# of periods that compounding or discounting takes place) =12
Our aim here is to find the interest rate (also called the discount rate) that is implicit in
From the most basic formula associated with time value of money, we have
FV t PV (1 r )t
For the purpose of this question, a small algebraic manipulation is what we need to leave
‘r’ alone at the left hand side (or your favorite side) of the equality.
r t 1
Now it is the time to plug in the given values to get the variable demanded.
The calculator says r should equal 0.04348 (which is 4.348% interest rate).
3) This question gives the following information,
FV (in 13 years) is given and is $8000
t = 13
r = 6%= 0.06
The most basic form of the formula (that has PV as the only variable at one side) applies
(1 r )t
And again, plugging in the values, it is easy to get PV= $ 3750.712
4) The answer is A. Annuity is stream of constant cash flows that go on for a finite period
of time into the future.