Question

1. Do liabilities that arise during the operating cycle always have a maturity of less than one year?

2. How is an investment decision analyzed from a cash standpoint?

3. Why do we say that, as a general rule, operating cash flow should be positive? Provide a simple example that demonstrates that operating cash flow can be negative during periods of strong growth, start-up periods and in the event of strong seasonal fluctuations.

4. What mechanism pushes market value towards present value?

5. The main manufacturers of telephony equipment (Ericsson, Nokia, etc.) provided telecoms operators (Deutsche Telekom, Swisscom, etc.) with substantial supplier credit lines in order to assist them in financing the construction of their UMTS networks. State your views

Answer 1

1. Do liabilities that arise during the operating cycle always have a maturity of less than one year?

Solution: Yes, the liabilities arising during the operating cycle are mostly creditors (payables for raw material and other consumables) and short term borrowing (working capital borrowing). Both have maturity of one year. Working capital loans are renewed every year. Payables are supposed to be paid within a year in normal operating condition of the Company otherwise it may impact the day to day operation of the Company.

2. How is an investment decision analysed from a cash standpoint?

Solution: Two major concepts to evaluate investment decisions in corporate finance are NPV (Net present value) and IRR (Internal rate of return) approach. Both NVP and IRR calculation involves calculation of cash flows.

NPV= C0+C1/(1+r) +-------+Cn/(1+r) ^n

r=discount rate

Cn=Net cash flow at Nth year= (Cash Inflow-Cash outflow) at Nth year

IRR is the discount rate at which NPV of all future cash flows becomes zero. Therefore IRR calculation involves calculation of cash flows.

3.Why do we say that, as a general rule, operating cash flow should be positive? Provide a simple example that demonstrates that operating cash flow can be negative during periods of strong growth, start-up periods and in the event of strong seasonal fluctuations?

Solution:  

Positive cash flows from operation shows that company is at least recovering its operational expenses and after adjusting working capital changes company is generating positive cash flow. If cash flow from operation is negative, it becomes difficult for the company to continue its operation because it creates immediate liquidity issue.

Strong Growth Period/Start-up period: During strong growth period and start-up period, companies focus on acquiring customers even by giving discount at the cost of the products or incurring significant expenditure on promotional expenses leading to operational losses. Which in turn results in negative cash flow from operation.

4.What mechanism pushes market value towards present value?

Solution: Discounting mechanism in the stock market pushes the market value to present value. Stock market discounts for all the happening pertaining to a specific company and corrects the market value to present value.