Cash ﬂow to creditors must increase when:
A) A ﬁrm increases its long-term debt by more than its interest expense in any given year.
B) The cash ﬂow to stockholders is constant and the cash ﬂow from assets increases.
C) The operating cash ﬂow increases and the cash ﬂow to stockholders decreases.
D) The interest rate on the ﬁrm's debt decreases.
E) A ﬁrm borrows more than it repays in any one given year.

Question

Quizplus · Accepted Answer

Cash flow to creditors is the cash flow that goes towards paying interest on a firm's debt. It is calculated as the firm's interest expense minus any net new borrowing. Therefore, if the firm increases its long-term debt by more than its interest expense, the cash flow to creditors will decrease, not increase. If the operating cash flow increases and the cash flow to stockholders decreases, it may or may not result in an increase in cash flow to creditors depending on the firm's net new borrowing. However, if the cash flow to stockholders is constant and the cash flow from assets increases, it means that the firm is generating more cash from its operations. This cash can be used to pay down debt, which will increase the cash flow to creditors. Therefore, choice B is the best answer.

Cash ﬂOw to Creditors Must Increase When