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Question 1
Which of the following statements is CORRECT?
a.
The more depreciation a firm reports, the higher its tax bill, other things held constant.
b.
People sometimes talk about the firm’s net cash flow, which is shown as the lowest entry on the income statement, hence it is often called “the bottom line.”
c.
Depreciation reduces a firm’s cash balance, so an increase in depreciation would normally lead to a reduction in the firm’s net cash flow.
d.
Net cash flow (NCF) is often defined as follows:
Net Cash Flow = Net Income + Depreciation and Amortization Charges.
e.
Depreciation and amortization are not cash charges, so neither of them has an effect on a firm’s reported profits.
Question 2
Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined. Which of the following could explain this performance?
a.
The company’s operating income declined.
b.
The company’s expenditures on fixed assets declined.
c.
The company’s cost of goods sold increased.
d.
The company’s depreciation and amortization expenses declined.
e.
The company’s interest expense increased.
Question 3
Below are the 2008 and 2009 year-end balance sheets for Wolken Enterprises:
Assets:
2009 2008
Cash
$ 200,000 $ 170,000
Accounts receivable
864,000 700,000
Inventories
2,000,000 1,400,000
Total current assets $ 3,064,000 $2,270,000
Net fixed assets 6,000,000 5,600,000
Total assets $ 9,064,000 $7,870,000
Liabilities and equity:
Accounts payable $ 1,400,000 $1,090,000
Notes payable 1,600,000 1,800,000
Total current liabilities $ 3,000,000 $2,890,000
Long-term debt 2,400,000 2,400,000
Common stock 3,000,000 2,000,000
Retained earnings 664,000 580,000
Total common equity $ 3,664,000 $2,580,000
Total liabilities and equity $ 9,064,000 $7,870,000
Wolken has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year non-callable, long-term debt in 2008. As of the end of 2009, none of the principal on this debt had been repaid. Assume that the company’s sales in 2008 and 2009 were the same. Which of the following statements must be CORRECT?
a. Wolken increased its short-term bank debt in 2009.
b. Wolken issued long-term debt in 2009.
c. Wolken issued new common stock in 2009.
d. Wolken repurchased some common stock in 2009.
e. Wolken had negative net income in 2009.
Question 4
A start-up firm is making an initial investment in new plant and equipment. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is co nsidering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law, which of the following would occur in the year following the change?Answer
a. The firm’s operating income (EBIT) would increase.
b. The firm’s taxable income would increase.
c. The firm’s net cash flow would increase.
d. The firm’s tax payments would increase.
e. The firm’s reported net income would increase.
Question 5
Below is the common equity section (in millions) of Teweles Technology’s last two year-end balance sheets:
2009 2008
Common stock $2,000 $1,000
Retained earnings 2,000 2,340
Total common equity $4,000 $3,340
Teweles has never paid a dividend to its common stockholders.
Which of the following statements is CORRECT?
a. The company’s net income in 2009 was higher than in 2008.
b. Teweles issued common stock in 2009.
c. The market price of Teweles’ stock doubled in 2009.
d. Teweles had positive net income in both 2008 and 2009, but the company’s net income in 2009 was lower than it was in 2008.
e. The company has more equity than debt on its balance sheet.
Question 6
Which of the following would be most likely to occur in the year after Congress, in an effort to increase tax revenue, passed legislation that forced companies to depreciate equipment over longer lives? Assume that sales, other operating costs, and tax rates are not affected, and assume that the same depreciation method is used for tax and stockholder reporting purposes.Answer
a. Companies’ net operating profits after taxes (NOPAT) would decline.
b. Companies’ physical stocks of fixed assets would increase.
c. Companies’ net cash flows would increase.
d. Companies’ cash positions would decline.
e. Companies’ reported net incomes would decline.
Question 7
For managerial purposes, i.e., making decisions regarding the firm’s operations, the standard financial statements as prepared by accountants under Generally Accepted Accounting Principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm’s operations. Related to these modifications, which of the following statements is CORRECT?
a. The standard statements make adjustments to reflect the effects of inflation on asset values, and these adjustments are normally carried into any adjustment that managers make to the standard statements.
b. The standard statements focus on accounting income for the entire corporation, not cash flows, and the two can be quite different during any given accounting period. However, for valuation purposes we need to discount cash flows, not accounting income. Moreover, since many firms have a number of separate divisions, and since division managers should be compensated on their divisions’ performance, not that of the entire firm, information that focuses on the divisions is needed. These factors have led to the development of information that is focused on cash flows and the operations of individual units.
c. The standard statements provide useful information on the firm’s individual operating units, but management needs more information on the firm’s overall operations than the standard statements provide.
d. The standard statements focus on cash flows, but managers are less concerned with cash flows than with accounting income as defined by GAAP.
e. The best feature of standard statements is that, if they are prepared under GAAP, the data are always consistent from firm to firm. Thus, under GAAP, there is no room for accountants to “adjust” the results to make earnings look better.
Question 8
Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet?
a. The company repurchases common stock.
b. The company pays a dividend.
c. The company issues new common stock.
d. The company gives customers more time to pay their bills.
e. The company purchases a new piece of equipment.
Question 9
Which of the following items is NOT included in current assets?
a. Accounts receivable.
b. Inventory.
c. Bonds.
d. Cash.
e. Short-term, highly liquid, marketable securities.
Question 10
Which of the following statements is CORRECT?Answer
a. Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity financing over debt financing, and this causes companies’ debt ratios to be lower than they would be if interest and dividends were both deductible.
b. Interest paid to an individual is counted as income for tax purposes and taxed at the individual’s regular tax rate, which in 2008 could go up to 35%, but dividends received were taxed at a maximum rate of 15%.
c. The maximum federal tax rate on corporate income in 2008 was 50%.
d. Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by selling new common stock or by retaining earnings. The cost of debt capital is the interest paid on the debt, and the cost of the equity is the dividends paid on the stock. Both of these costs are deductible from income when calculating income for tax purposes.
e. The maximum federal tax rate on personal income in 2008 was 50%.
Question 11
Which of the following statements is CORRECT?
Answer
a. The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus, the federal government receives no tax revenue from these businesses.
b. All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code.
c. Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm’s income as personal income and pay taxes on that income.
d. Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes. Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the income and stockholders were taxed again on the income when it was paid to them as dividends.
e. All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income.
Question 12
Which of the following statements is CORRECT?
a. The focal point of the income statement is the cash account, because that account cannot be manipulated by “accounting tricks.”
b. The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP).
c. The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC).
d. If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be identical to its reported net cash flow.
e. The income statement for a given year, say 2007, is designed to give us an idea of how much the firm earned during that year.
Question 13
Assume that Congress recently passed a provision that will enable Bev’s Beverages Inc. (BBI) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or tax rate. Prior to the new provision, BBI’s net income after taxes was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BBI’s financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.Answer
a. The provision will reduce the company’s net cash flow.
b. The provision will increase the company’s tax payments.
c. Net fixed assets on the balance sheet will increase.
d. The provision will increase the company’s net income.
e. Net fixed assets on the balance sheet will decrease.
Question 14
Which of the following statements is CORRECT?Answer
a. In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.
b. Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity.
c. In the statement of cash flows, a decrease in accounts payable is reported as a use of cash.
d. In the statement of cash flows, depreciation charges are reported as a use of cash.
b. In the statement of cash flows, a decrease in inventories is reported as a use of cash.
Question 15
Assume that Pappas Company commenced operations on January 1, 2010, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes. The company planned to depreciate its fixed assets over 15 years, but in December 2010 management realized that the assets would last for only 10 years. The firm’s accountants plan to report the 2010 financial statements based on this new information. How would the new depreciation assumption affect the company’s financial statements?
a. The firm’s reported net fixed assets would increase.
b. The firm’s EBIT would increase.
c. The firm’s reported 2010 earnings per share would increase.
d. The firm’s cash position in 2010 and 2011 would increase.
e. The firm’s net liabilities would increase.
Question 16
Taggart Technologies is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Taggart pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?Answer
a. The ROA will decline.
b. Taxable income will decrease.
c. The tax bill will increase.
d. Net income will decrease.
e. The times interest earned ratio will decrease.
Question 17
Companies E and P each reported the same earnings per share (EPS), but Company E’s stock trades at a higher price. Which of the following statements is CORRECT?
a. Company E probably has fewer growth opportunities.
b. Company E is probably judged by investors to be riskier.
c. Company E must have a higher market-to-book ratio.
d. Company E must pay a lower dividend.
e. Company E trades at a higher P/E ratio.
Question 18
If a bank loan officer were considering a company’s request for a loan, which of the following statements would you consider to be CORRECT?
a. The lower the company’s EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.
b. Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.
c. Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.
d. The lower the company’s TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.
e. Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.
Question 19
If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., “grading” the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant.
a.
The division’s basic earning power ratio is above the average of other firms in its industry.
b. The division’s total assets turnover ratio is below the average for other firms in its industry.
c. The division’s debt ratio is above the average for other firms in the industry.
d. The division’s inventory turnover is 6, whereas the average for its competitors is 8.
e. The division’s DSO (days’ sales outstanding) is 40, whereas the average for its competitors is 30.
Question 20
Companies HD and LD are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company HD has the higher debt ratio. Which of the following statements is CORRECT?
a. Company HD has a lower total assets turnover than Company LD.
b. Company HD has a lower equity multiplier than Company LD.
c. Company HD has a higher fixed assets turnover than Company B.
d. Company HD has a higher ROE than Company LD.
e. Company HD has a lower operating income (EBIT) than Company LD.
Question 21
Which of the following statements is CORRECT?
a. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be the same.
b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.
c. If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price earnings ratio.
d. If Firm X’s P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and also to be expected to grow at a faster rate.
e. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same.
Question 22
Which of the following statements is CORRECT?
a. If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses.
b. A firm’s use of debt will have no effect on its profit margin on sales.
c. If two firms differ only in their use of debt—i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates—but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.
d. The debt ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable.
e. If two firms differ only in their use of debt—i.e., they have identical assets, sales, operating costs, and tax rates—but one firm has a higher debt ratio, the firm that uses more debt will have a higher profit margin on sales.
Question 23
Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company’s total assets or operating income. Which of the following effects would occur as a result of this action?
a. The company’s current ratio increased.
b. The company’s times interest earned ratio decreased.
c. The company’s basic earning power ratio increased.
d. The company’s equity multiplier increased.
e. The company’s debt ratio increased.
Question 24
HD Corp. and LD Corp. have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, HD uses more debt than LD. Which of the following statements is CORRECT?
a. Without more information, we cannot tell if HD or LD would have a higher or lower net income.
b. HD would have the lower equity multiplier for use in the Du Pont equation.
c. HD would have to pay more in income taxes.
d. HD would have the lower net income as shown on the income statement.
e. HD would have the higher net income as shown on the income statement.
Question 25
Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both companies have positive net incomes. Company HD has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?
a. Company HD pays less in taxes.
b. Company HD has a lower equity multiplier.
c. Company HD has a higher ROA.
d. Company HD has a higher times interest earned (TIE) ratio.
e. Company HD has more net income.
Question 26
Which of the following statements is CORRECT?
a. A reduction in inventories held would have no effect on the current ratio.
b. An increase in inventories would have no effect on the current ratio.
c. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
d. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
e. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.
Question 27
Which of the following statements is CORRECT?
a. The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
b. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.
c. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE.
d. Holding bonds is better than holding stock for investors because income from bonds is taxed on a more favorable basis than income from stock.
e. All else equal, increasing the debt ratio will increase the ROA.
Question 28
Which of the following statements is CORRECT?
a. If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.
b. If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.
c. Other things held constant, the higher a firm’s expected future growth rate, the lower its P/E ratio is likely to be.
d. The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA).
e. If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average.
Question 29
Considered alone, which of the following would increase a company’s current ratio?
a. An increase in net fixed assets.
b. An increase in accrued liabilities.
c. An increase in notes payable.
d. An increase in accounts receivable.
e. An increase in accounts payable.
Question 30
A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?
a. Reduce the company’s days’ sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
b. Use cash to repurchase some of the company’s own stock.
c. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
d. Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.
e. Use cash to increase inventory holdings.
