Understanding the concept of cash flows and the difference between cash flows and net income is critical to the financial health of a business organization. To this end, (1) choose whether the following statements are true or false or (2) select the correct answer from the list of possible answers.

True or False: The term net income refers to the movement of cash into and out of a business or project.

False

True

True or False: Managers add value to a firm when they invest cash to acquire assets. These assets are in turn used to produce goods or services that produce streams of cash flows that are smaller than the cost of the assets.

False

True

True or False: Financial managers are called on to make investment, financing, and dividend decisions for their firms. Their financing decisions affect the left-hand side of the firms balance sheet.

False

True

The critical nature of cash flows is reflected in the expression: Cash flow is king! Identify which of the following statements is false.

One advantage of using cash flow, as opposed to net income, as an indicator of manager and investment performance is that it is unambiguous and less able to be inappropriately manipulated.

The value of a capital investment, such as a piece of machinery or a division within the firm, should be based on the discounted, or todays, value of the cash flows expected to be generated by the investment minus the cost of the investment.

An emphasis on cash flows, rather than accounting-based measures of performance, makes it more likely that the objective of maximizing shareholder wealth will be achieved.

One of the leading causes of failure of new and rapidly growing businesses is an overabundance of internally generated cash flows.

The proper formula for the calculation of a cash flow (CF) based on a firms net income (NI) and its noncash expenses is:

NI = CF + Deprecation Expense + Deferred Taxes

CF = NI + Noncash Expenses

CF = NI Depreciation Expense Deferred Taxes

CF = NI Noncash Expenses