What is the primary reason why the cash flow from assets (CFA) is adjusted when used to value a firm

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19-07-2022
Business

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What is the primary reason why the cash flow from assets (CFA) is adjusted when used to value a firm

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Tutorconsortium323 Tutorconsortium323 · Answer 1 · 2022-07-27T11:15:13+02:00

The correct option is C. Net working capital (NWC) is excluded from firm valuations so the change in NWC must be added back to the "normal" CFA calculation

What is Cash Flow From Assets ?

Cash flow from assets is a term used in finance and investments. It refers to a calculation that only counts cash transactions. It is calculated as net income plus non-cash .

Cash flow from assets is the aggregate total of all cash flows related to the assets of a business. This information is used to determine the net amount of cash being spun off by or used in the operations of a business.

The concept is comprised of the following three types of cash flows:

Cash flow generated by operations-This is net income plus all non-cash expenses, which usually include depreciation and amortization.
Changes in working capital-This is the net change in accounts receivable, accounts payable, and inventory during the measurement period. An increase in working capital uses cash, while a decrease produces cash.

Changes in fixed assets-This is the net change in fixed assets before the effects of depreciation.

Cash flow from assets = Operating cash flow - Change in Net Working Capital - Net capital spending

--> Operating cash flow = EBIT + Depreciation - Taxes

--> Net Capital spending = Ending Net fixed assets - Beginning net fixed assets + Depreciation,

--> Change in Net Working Capital = Ending Net Working Capital - Beginning Net Working Capital

Therefore, we can say that the correct option is C.

Your question is incomplete, but most probably your full question was:

What is the primary reason why the cash flow from assets (CFA) is adjusted when used to value a firm? (choose one)

A. The CFA must be lowered by the amount of the noncash expenses to ascertain a more accurate firm value.

B. Depreciation is a non-cash expense so both it and the depreciation tax shield must be eliminated from the CFA.

C. Net working capital (NWC) is excluded from firm valuations so the change in NWC must be added back to the "normal" CFA calculation

D. Interest expense is a financing cost and thus the tax benefit of this expense needs to be eliminated from the CFA.

E. CFA is normally based on historical performance but since firm valuations are forward looking the CFA must be adjusted for timing.

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