CFA Practice Question

CFA Practice Question

The following data are taken from the Ultimate Omega's financial statements ending Dec 31, 2020:

Increase in inventories: 220
Stock's repurchased: 135
Provision for warranty expenses: 15
Depreciation: 90
Interest paid: 35
Outstanding bonds retired: 225
After-tax gain on bond retirement: 25
Net Income: 430
Tax rate: 40%

What was Ultimate Omega's operating cash flow in 2020?
A. 290
B. 240
C. 305
Explanation: In this case, OCF = 430 - 220 + 15 + 90 - 25 = 290. Note a few important things: Warranty provision is a non-cash expense and must be added back to net income. Gain on bond retirement is an extraordinary item and is part of financing cash flow. Hence, it must be subtracted from net income to obtain income from continuing operations. Stock repurchase and bond retirement are financing cash flows. Note that tax rate is not relevant in the indirect method since it has already been factored in the net income figure.

User Contributed Comments 16

User Comment
jamiejamie what about the INTEREST?
pablo ... and unclear whether warranty provision is a balance sheet item or the movement in a balance sheet item
shasha stock repurchase and bond retirement will not be factored in the net income figure, ie. they are not P&L accounts. but gain / loss of stock repurchase and bond retirement is P&L accounts.
shasha i mean, deduct the actual cash movement of $25/.6 of gain from CFO, and add it to CFF.
shasha hey, anybody found something strange here? just noticed that we should add back before-tax gain on bond retirement to net income, just like we do the same on depreciation cost, amortization cost, they're all before-taxed, right? the actual cash inflow is $25/.6 for the gain!! this is really killing me, for last minute review you found you're still not clear from errors!
shasha with further thinking, i believe we do add $25/.6 to CFF, but we still deduct only $25 from net income to get CFO, the balance goes to deferred tax or adjusts effective tax rate. hope this time i get the final solution. otherwise, would like to hear advice, anybody?
Aimy I think the correct answer should be CFO=430-220+15+90-35-25=255. deduct 25 directly becos it is already after-tax.
maro Aimy. Interest paid is already taken into account in the calculation of net income . However , by the new rule, gain from retirement of bond is now considered as part of income from continuing operations and should be subtracted from net income in the computation of CFO. Answer is : 430 -220+15+90-25 = 290
dimos I agree with maro. But why the explanation of analystnotes say that gain from retirement of bonds is still extraordinary item?
mishis Gains and losses from the early retirement of debt were treated as extraordinary items but SFAS No. 145 (2002) now requires them to be treated as part of continuing operations.
uviolet jamiejamie, interest is already included in net income. so need to adjust it
shiva5555 haha I subtracted 35 and added 25 instead of 15 and 25, but still got the right answer. Hope my luck holds on test day.
jimmy454 how is gain on bond retirement included? its financing CF
birdperson maro - thank you!
GBolt93 Jimmy it's included in Net Income, therefore you have to take it out of CFO since it should be a CFI
pigletin interest paid is used in direct method
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