Question
1. Which of the following statements is CORRECT?
Answer
The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses.
MVA gives us an idea about how much value a firm's management has added during the last year.
MVA stands for market value added, and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity.
EVA stands for economic value added, and it is defined as follows:
EVA = EBIT(1 - T) - (Investor-supplied op. capital) x (A - T cost of capital).
EVA gives us an idea about how much value a firm's management has added over the firm's life.
2. Which of the following statements is CORRECT?
Answer
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.
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.
All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code.
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.
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.
3. Which of the following statements is CORRECT?
Answer
The statement of cash flows shows how much the firm's cash?the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)?increased or decreased during a given year.
The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.
The statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit.
The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital.
The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock.
4. Which of the following statements is CORRECT?
Answer
If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance.
Dividends paid reduce the net income that is reported on a company's income statement.
If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.
If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.
Accounts receivable are reported as a current liability on the balance sheet.
5. Assume that Congress recently passed a provision that will enable Barton's Rare Books (BRB) 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, BRB's net income after taxes was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BRB'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
Net fixed assets on the balance sheet will decrease.
The provision will reduce the company's net cash flow.
The provision will increase the company's tax payments.
Net fixed assets on the balance sheet will increase.
The provision will increase the company's net income.
6. DeYoung Devices Inc., a new high-tech instrumentation firm, is building and equipping a new manufacturing facility. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is considering 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
The firm's reported net income would increase.
The firm's operating income (EBIT) would increase.
The firm's taxable income would increase.
The firm's net cash flow would increase.
The firm's tax payments would increase.
7. Which of the following items cannot be found on a firm's balance sheet under current liabilities?
Answer
Accrued payroll taxes.
Accounts payable.
Short-term notes payable to the bank.
Accrued wages.
Cost of goods sold.
8. Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?
Answer
The company purchases a new piece of equipment.
The company repurchases common stock.
The company pays a dividend.
The company issues new common stock.
The company gives customers more time to pay their bills.
9. Which of the following statements is CORRECT?
Answer
The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.
The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholders' equity.
The balance sheet gives us a picture of the firm's financial position at a point in time.
The income statement gives us a picture of the firm's financial position at a point in time.
The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits.
10. Which of the following statements is CORRECT?
Answer
The income statement for a given year, say 2012, is designed to give us an idea of how much the firm earned during that year.
The focal point of the income statement is the cash account, because that account cannot be manipulated by "accounting tricks."
The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP).
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).
If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be identical to its reported net cash flow.
11. Danielle's Sushi Shop last year had (1) a negative net cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation?
Answer
The company had a sharp increase in its depreciation and amortization expenses.
The company had a sharp increase in its inventories.
The company had a sharp increase in its accrued liabilities.
The company sold a new issue of common stock.
The company made a large capital investment early in the year
12. Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash flow last year, even though the cash on its balance sheet increased?
Answer
The company repurchased 20% of its common stock.
The company sold a new issue of bonds.
The company made a large investment in new plant and equipment.
The company paid a large dividend.
The company had high amortization expenses.
13. Which of the following statements is CORRECT?
Answer
If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.
Since depreciation is a source of funds, the more depreciation a company has, the larger its retained earnings will be, other things held constant.
A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.
Common equity includes common stock and retained earnings, less accumulated depreciation.
The retained earnings account as shown on the balance sheet shows the amount of cash that is available for paying dividends.
14. Which of the following statements is CORRECT?
Answer
A typical industrial company's balance sheet lists the firm's assets that will be converted to cash first, and then goes on down to list the firm's longest lived assets last.
The balance sheet for a given year, say 2012, is designed to give us an idea of what happened to the firm during that year.
The balance sheet for a given year, say 2012, tells us how much money the company earned during that year.
The difference between the total assets reported on the balance sheet and the debts reported on this statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in accordance with generally accepted accounting principles (GAAP).
For most companies, the market value of the stock equals the book value of the stock as reported on the balance sheet.
15. Analysts following Armstrong Products recently noted that the company's operating net cash flow increased over the prior year, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation?
Answer
The company issued new long-term debt.
The company cut its dividend.
The company made a large investment in a profitable new plant.
The company sold a division and received cash in return.
The company issued new common stock.
16. Cordelion Communications 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 Cordelion pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?
Answer
The times interest earned ratio will decrease.
The ROA will decline.
Taxable income will decrease.
The tax bill will increase.
Net income will decrease.
17. Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000. What was its total assets turnover ratio (TATO)?
Answer
2.03
2.13
2.25
2.36
2.48
18. Which of the following statements is CORRECT?
Answer
All else equal, increasing the debt ratio will increase the ROA.
The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
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.
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.
Holding bonds is better than holding stock for investors because income from bonds is taxed on a more favorable basis than income from stock.
19. A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?
Answer
Use cash to increase inventory holdings.
Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
Use cash to repurchase some of the company's own stock.
Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.
20. 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.
Answer
The division's DSO (days' sales outstanding) is 40, whereas the average for its competitors is 30.
The division's basic earning power ratio is above the average of other firms in its industry.
The division's total assets turnover ratio is below the average for other firms in its industry.
The division's debt ratio is above the average for other firms in the industry.
The division's inventory turnover is 6, whereas the average for its competitors is 8.
21. Which of the following statements is CORRECT?
Answer
"Window dressing" is any action that improves a firm's fundamental, long-run position and thus increases its intrinsic value.
Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing."
Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."
Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of "window dressing."
Using some of the firm's cash to reduce long-term debt is an example of "window dressing."
22. You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT?
Answer
Its total assets turnover must equal the industry average.
Its total assets turnover must be above the industry average.
Its return on assets must equal the industry average.
Its TIE ratio must be below the industry average.
Its total assets turnover must be below the industry average.
23. Which of the following would indicate an improvement in a company's financial position, holding other things constant?
Answer
The current and quick ratios both increase.
The inventory and total assets turnover ratios both decline.
The debt ratio increases.
The profit margin declines.
The EBITDA coverage ratio declines.
24. A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger?
Answer
Increase inventories while holding sales and cost of goods sold constant.
Increase accounts receivable while holding sales constant.
Increase EBIT while holding sales constant.
Increase accounts payable while holding sales constant.
Increase notes payable while holding sales constant.
25. Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company Heidee has the higher debt ratio. Which of the following statements is CORRECT?
Answer
Company Heidee has a lower operating income (EBIT) than Company LD.
Company Heidee has a lower total assets turnover than Company Leaudy.
Company Heidee has a lower equity multiplier than Company Leaudy.
Company Heidee has a higher fixed assets turnover than Company Leaudy.
Company Heidee has a higher ROE than Company Leaudy.
26. Which of the following statements is CORRECT?
Answer
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.
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.
Other things held constant, the higher a firm's expected future growth rate, the lower its P/E ratio is likely to be.
The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA).
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.
27. Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant?
Answer
The total assets turnover decreases.
The TIE declines.
The DSO increases.
The EBITDA coverage ratio increases.
The current and quick ratios both decline.
28. Considered alone, which of the following would increase a company's current ratio?
Answer
An increase in accounts payable.
An increase in net fixed assets.
An increase in accrued liabilities.
An increase in notes payable.
An increase in accounts receivable.
29. 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?
Answer
Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.
The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.
Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.
Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.
The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.
30. The Cavendish Company 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?
Answer
The company's debt ratio increased.
The company's current ratio increased.
The company's times interest earned ratio decreased.
The company's basic earning power ratio increased.
The company's equity multiplier increased.
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