Question

Instructor - Lead Question

Metro Bus Company had $400,000 of revenue and $401,000 of expense (including depreciation) for the current year resulting in a $1,000 net loss. All revenues were received in cash. All expenses were paid in cash, except for depreciation of $181,000. At the end of the year, the Balance Sheet shows $225,000 of Cash and $1,775,000 of other assets. The Company has no debt and all of the busses are modern - there is no plan to purchase more busses. Although there is sufficient Retained Earnings and they historically have paid dividends of $25,000, Management has decided against paying a dividend to stockholders in the current year. Instead, they issue a statement to their stockholders, explaining that "with a $1,000 net loss, Management feels there is insufficient cash for the dividend."

What is the Company's cash flow? What is the difference between cash flow and net income? Evaluate the accuracy of Management's statement: "with a $1,000 net loss, Management feels there is insufficient cash for the dividend." Evaluate the plan to skip the dividend. How would your response change if the stockholders were (a) common stockholders, (b) non-cumulative preferred, or (c) cumulative preferred?

Answer 1

Calculation of Company's cash flow

Particulars	Amount (in $)
Net Loss	(-)1,000
Add: Depreciation	181,000
Cash flow from Operating activity	180,000

Cash flow measures the cash going in or out due to day to day operations of the company during the period.

While, net income is the profit earned during the period through business operations. It includes cash and non cash transactions.

Not agreed with the statement that Management feels that there is a loss of $ 1,000 and have insufficient cash for dividend payout.

Management should pay dividend due to below reaons:

a) No plan of expansion. All the buses are modern and purchased of new buses are not required.

b) Having net loss is low as 0.25% of revenue.

c) Positive cash flow from operation i.e. $ 180,000.

d) Having sufficient cash to pay dividend. Year end cash balance is $ 225,000.

e) Company has no debt to repay.

f) Historically, company pays dividend every year. In case of non payment of dividend due to marginal loss, it would adversely impact the shareholder trust in the company.

Decision remains same whether shareholders are common or non-cumulative preferred or cumulative preferred.