Why does finance add back depreciation and amortization in its measure of economic returns?

The Finance Perspective
Why finance is obsessed with cash and the future
Please note that some questions may have more than one answer.
1. You oversee the purchasing department of Best Buy, the electronics and appliance retailer, and are concerned about the funding gap in your cash conversion
cycle. Which of the following will not reduce the
funding gap?
A. Increasing the payable period
B. Increasing sales
C. Decreasing receivables collection period
D. Decreasing days inventory
2. Which of the following is a disagreement between finance and accounting? (Choose all that apply.)
A. What constitutes economic returns (net profit or free cash flows)
B. How to value assets (historical cost or future cash flows)
C. Where to record inventory
D. How to value equity (book value or market value)
3. In 2016, Pfizer invested $350 million in a new plant in China. For which of the following present values of the plant’s cash flows does that decision make sense? (Choose all that apply.)
A. $300 million
B. $400 million
C. $500 million
D. All of the above
4. You are considering starting up a Five Guys Burgers & Fries franchise, which you estimate will cost $250,000. You expect to make considerable free cash flow for the next five years, after which you will sell off the franchise for $200,000. The discounted values of those cash flows are $90,000, $80,000, $70,00$60,000, and $180,000 (which includes the fifth-year cash flow, as well as the proceeds of the sale), respec-
tively. Which of the following is likely to be the net
present value of your investment?
A. $180,000
B. $230,000
C. $480,000
D. $600,000
5. Why does finance add back depreciation and amortization in its measure of economic returns?
A. Depreciation is highly uncertain and should not
be counted.
B. Companies often overspend for assets, leading
depreciation to be too high.
C. Depreciation isn’t a cash expense.
D. Depreciation appears on the balance sheet, not the income statement.
6. One share of Facebook stock is being traded at $150. If so, which of the following does the stock market believe to be true?
A. The present value of all future free cash flows from Facebook’s business, after netting out cash and debt, implies a Facebook stock value of $150.
B. You can always sell a share of Facebook stock for at
least $150.
C. The net present value of buying one unit of Face-
book stock is $150.
D. The discount rate on future cash flows used to value Facebook stock is 15 percent.
7. United States Steel Corporation has a receivables collection period of thirty-three days, a days inventory of sixty-eight days, and a payables period of forty-nine
days. How long is its funding gap?
A. –14 days
B. 52 days
C. 84 days
D. 150 days
8. If your supplier offers you a 2 percent discount if you pay twenty days earlier than you would have other wise, how much is the supplier implicitly charging you for a twenty-day loan?
A. 0 percent
B. 1 percent
C. 2 percent
D. This is a discount, not a loan, so there is no implied interest rate.
9. Your company builds a new plant with an investment of $100 million and an expected present value from its future cash flows of $150 million. Two years later,
it becomes apparent that the new product isn’t selling as well as expected, and the present value of future cash flows at that point is only worth $50 million.
Should the company shut down the plant?
A. Yes, the net present value is now negative.
B. No, the present value is still $50 million.
10. Which of the following is true about free cash flow?
A. It is for equity providers only and is tax adjusted.
B. It is for all capital providers and is tax adjusted.
C. It is for equity providers only and is not tax
adjusted.
D. It is for all capital providers and is not tax adjusted

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