CFA CFA Level 1 Need help to understand on “Reinvestment Coverage Ratio”

# Need help to understand on “Reinvestment Coverage Ratio”

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• CFA Level 1
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Question
The following partial common-size cash flow statement and coverage ratio information is available for a company:

Cash Flow Statement for the Year Ended 31 December

 Percentage of Net Revenues 2016 Cash flows from operating activities Â Â Â Cash received from customers 118.7% Â Â Â Cash paid to suppliers and employees (81.4) Â Â Â Dividends received 0.2 Â Â Â Net interest and other financial expenses paid (3.8) Â Â Â Taxes paid (5.2) Â Â Â Net cash from operating activities 28.5 Â Â Â Cash paid for long-term assets (13.4) Â Â Â Other investing activities (3.1) Â Â Â Net cash used in investing activities (16.5) Â Â Â Dividends paid (8.5) Â Â Â Other financing activities 3.8 Â Â Â Net cash flow used in financing activities (4.7) Â Â Â Net change in cash 7.3%

Cash Flow Coverage Ratios

 2015 Dividend payment 3.69 Investing and financing 0.82 Reinvestment 2.18

Compared with 2015, the most appropriate conclusion an analyst can make about 2016 is that the companyâ€™s ability to use operating cash flows to:

1. Â pay dividends decreased.
2. acquire assets, pay debts, and make distributions to owners decreased.
3. acquire assets improved.

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Solution

A is correct.Â The companyâ€™s dividend payment coverage ratio worsened; therefore, the company was less able to pay dividends from operating cash flows. Calculations are as follows:

 Coverage Ratio Definition and Calculation 2016 2015 Interpretation Dividend payment Cash flow from operations Ã· Dividends paid 28.5 Ã· 8.5 = 3.35 3.69 Ability to pay dividends decreased Investing and financing Cash flow from operations Ã· Cash outflows for investing and financing 28.5 Ã· (16.5 + 4.7) = 1.34 0.82 Ability to acquire assets, pay debts and make distributions improved Reinvestment Cash flow from operations Ã· Cash paid for long term assets 28.5 Ã· 13.4 = 2.13 2.18 Ability to acquire assets decreased

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Need help on “Reinvestment” located within the solution. My understanding is both items “Cash paid for long-term assets” & “Other investing activities” are considered as investment. Shouldn’t both be used to get –> Reinvestment Coverage Ratio?

Hope someone would help me to understand on this.

Thank you!

• 0

The cash reinvestment ratio, also known as the cash flow reinvestment ratio, is a valuation ratio used to measure the percentage of annual cash flow that the company invests back into the business as a new investment

“Reinvestment” here does not mean investing activities, but rather the act of reinvesting capital back into the core business.

So it makes sense that to calculate the reinvestment ratio you include cash paid for long-term assets (reinvestment back into the company) but not ‘other investing activities’.

Hope that helps!