Sample Questions DDD had Accumulated Depreciation of $620,000 at the beginning of fiscal year 2003. At the end of fiscal year 2003 it had a balance of $710,000. If in 2003 DDD retired no old assets, bought no new assets, and used an average l0% depreciation rate, the fixed assets of DDD at the beginning of fiscal year 2003 were:

QUESTION

Sample Questions

1. DDD had Accumulated Depreciation of $620,000 at the beginning of fiscal year 2003. At the end of fiscal year 2003 it had a balance of $710,000. If in 2003 DDD retired no old assets, bought no new assets, and used an average l0% depreciation rate, the fixed assets of DDD at the beginning of fiscal year 2003 were:

1. $800,000

*b. $900,000

1. $1,330,000
2. $6,200,000

2. In accrual-basis accounting, product warranty expenses are recorded
3. When the product is produced

*b. When the product is sold

1. When full payment for the sale is collected
2. When actual expenses per the warranty are incurred

3. Which of the following is NOT a leading economic indicator:
4. New housing building permits
5. Stock prices
6. Initial claims for unemployment

*d.         Gross Domestic Product (GDP)

4. You have estimated the following relation between annual changes in per-capita GDP (CGDP, measured in percentage points) and per-capita annual expenditures clothing- (CLT, measured in dollars per annum):

CLT= 80+ 72*CGDP

Macro-analysts predict that next year’s per-capita GDP will be $21,000 versus this year’s level of $20,000. Moreover, the current population of 250 million is expected to grow next year by 1%. If no change in the price level is projected for next year, based on these relations you predict that total expenditures on clothing next year will be

1. $100,000 million
2. $110,000million

*c.          $111,100 million

1. $120,000 million

5.

Suppose the firm decides to increase its dividend payout from 50% to l00%. What will be the effect of this change on the Free Cash Flows (FCF) of the firm?

1. The FCF will decrease as a result of higher interest on Debt.

*b. The FCF is not affected by the financial decisions of the firm.

1. The FCF will decrease as a result of the reduction on Cash and Marketable Securities
2. The FCF will be higher since the shareholders receive higher returns.

ANSWER

Effect of Increasing Dividend Payout on Free Cash Flows (FCF) of a Firm

Introduction

In financial decision-making, companies often consider various factors that can impact their cash flows and overall financial health. One such decision is changing the dividend payout ratio, which determines the portion of profits distributed to shareholders as dividends. This essay explores the effect of increasing the dividend payout from 50% to 100% on the Free Cash Flows (FCF) of a firm.

Explanation

Free Cash Flow (FCF) represents the cash available to a company after covering all operating expenses, taxes, and investments required to maintain or expand its operations (Fernando, 2023). FCF is an important indicator of a company’s financial performance and its ability to generate surplus cash.

Increasing the dividend payout ratio from 50% to 100% means that the company will distribute all its profits as dividends to shareholders. This decision has implications for the firm’s cash flow position.

Contrary to the assumption in option (a), increasing the dividend payout does not directly impact the FCF through higher interest on debt. The interest on debt remains constant over the specified years in the given scenario.

Option (b) correctly states that the FCF is not affected by the financial decisions of the firm. The FCF is determined by the company’s operational activities and capital expenditure requirements, not by dividend payouts (Marques, 2019). The decision to increase the dividend payout does not affect the FCF because it represents cash available after all necessary expenses and investments have been accounted for.

Option (c) suggests that the FCF will decrease as a result of the reduction in cash and marketable securities. However, there is no indication in the provided information that increasing the dividend payout leads to a reduction in cash and marketable securities. Therefore, this option is not applicable in the given scenario.

Option (d) proposes that the FCF will be higher since shareholders receive higher returns (The Information Content of Dividend Changes: Cash Flow Signaling, Overinvestment, and Dividend Clienteles on JSTOR, n.d.). While increasing the dividend payout may lead to higher returns for shareholders, it does not directly impact the FCF. The FCF is derived from operational cash flows and is unaffected by the distribution of profits as dividends.

Conclusion

Based on the given scenario, increasing the dividend payout from 50% to 100% does not have any direct effect on the Free Cash Flows (FCF) of the firm. The FCF remains unchanged as it is primarily determined by the operational activities and capital expenditure requirements of the company. Financial decisions such as dividend payouts primarily impact the distribution of profits to shareholders but do not alter the FCF.

References

Fernando, J. (2023). Free Cash Flow (FCF): Formula to Calculate and Interpret It. Investopedia. https://www.investopedia.com/terms/f/freecashflow.asp 

Marques, M. T. (2019). Impact of accounting choice of dividends on the company’s value: Initial evidences. https://www.redalyc.org/journal/3071/307160601001/html/ 

The Information Content of Dividend Changes: Cash Flow Signaling, Overinvestment, and Dividend Clienteles on JSTOR. (n.d.). https://www.jstor.org/stable/2331110