Question

Which of the following statements is CORRECT?

a. The current cash flow from existing assets is highly relevant to investors. However, since the value of the firm depends primarily upon its growth opportunities, accounting net income projections from those opportunities are the only relevant future flows with which investors are concerned.

b. Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to discourage the use of debt financing by corporations.

c. To estimate the net cash provided by operations, depreciation must be subtracted from net income because depreciation is a non-cash charge that has been added to revenue.

d. Two metrics that are used to measure a company's financial performance are net income and free cash flow. Accountants tend to emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on free cash flows as they do on net income.

e. If Congress changed depreciation allowances so that companies had to report higher depreciation levels for tax purposes in 2019, companies would have lower free cash flows in 2019.

Answer 1

The correct statement is

d. Two metrics that are used to measure a company's financial performance are net income and free cash flow. Accountants tend to emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on free cash flows as they do on net income.

Depreciation is a non cash expense and hence, added back to net income

Increase in depreciation will lead to higher free cash flows due to higher tax savings on depreciation

Since interest is tax deductible, it encourages use of debt financing

Future cash flows are relevant rather than income