Question 1 Which of the following statements is C...

Question 1

Which of the following statements is CORRECT?

Answer

  The balance sheet for a given year, say 2008, is designed to give us an idea of what happened to the firm during that year.
  The balance sheet for a given year, say 2008, 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.
  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.

2 points

Question 2

Which of the following statements is CORRECT?

Answer

  Operating cash flow (OCF) is defined as follows:
OCF = EBIT(1-T) – Depreciation and Amortization.
  Changes in working capital have no effect on free cash flow.
  Free cash flow (FCF) is defined as follows:
FCF = EBIT(1 – T)
+ Depreciation and Amortization
- Capital expenditures required to sustain operations
- Required changes in net operating working capital.
  Free cash flow (FCF) is defined as follows:
FCF = EBIT(1-T)+ Depreciation and Amortization + Capital expenditures.
  Operating cash flow is the same as free cash flow (FCF).

2 points

Question 3

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

  Companies’ net operating profits after taxes (NOPAT) would decline.
  Companies’ physical stocks of fixed assets would increase.
  Companies’ net cash flows would increase.
  Companies’ cash positions would decline.
  Companies’ reported net incomes would decline.

2 points

Question 4

The CFO of Shalit Industries plans to have the company issue $300 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur?

Answer

  The company’s taxable income would fall.
  The company’s interest expense would remain constant.
  The company would have less common equity than before.
  The company’s net income would increase.
  The company would have to pay less taxes.

2 points

Question 5

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 points

Question 6

Which of the following statements is CORRECT?

Answer

  In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.
  Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity.
  In the statement of cash flows, a decrease in accounts payable is reported as a use of cash.
  In the statement of cash flows, depreciation charges are reported as a use of cash.
  In the statement of cash flows, a decrease in inventories is reported as a use
of cash.

2 points

Question 7

Which of the following items is NOT included in current assets?

Answer

  Accounts receivable.
  Inventory.
  Bonds.
  Cash.
  Short-term, highly liquid, marketable securities.

2 points

Question 8

Which of the following statements is CORRECT?

Answer

  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.
  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.

2 points

Question 9

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?

Answer

  The firm’s reported net fixed assets would increase.
  The firm’s EBIT would increase.
  The firm’s reported 2010 earnings per share would increase.
  The firm’s cash position in 2010 and 2011 would increase.
  The firm’s net liabilities would increase.

2 points

Question 10

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?

Answer

  The company’s operating income declined.
  The company’s expenditures on fixed assets declined.
  The company’s cost of goods sold increased.
  The company’s depreciation and amortization expenses declined.
  The company’s interest expense increased.

2 points

Question 11

Which of the following factors could explain why Dellva Energy had a negative net cash flow last year, even though the cash on its balance sheet increased?

Answer

  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.
  The company repurchased 20% of its common stock.

2 points

Question 12

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 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 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.
  The firm’s reported net income would increase.

2 points

Question 13

The Nantell Corporation just purchased an expensive piece of equipment. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.

Answer

  Nantell’s taxable income will be lower.
  Nantell’s net fixed assets as shown on the balance sheet will be higher at the end of the year.
  Nantell’s cash position will improve (increase).
  Nantell’s reported net income after taxes for the year will be lower.
  Nantell’s tax liability for the year will be lower.

2 points

Question 14

Which of the following statements is CORRECT?

Answer

  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.
  The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.

2 points

Question 15

Which of the following statements is CORRECT?

Answer

  One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital.
  If a firm reports positive net income, its EVA must also be positive.
  One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free.
  One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital.
  Actions that increase reported net income will always increase net cash flow.

2 points

Question 16

Other things held constant, which of the following alternatives would increase
a company’s cash flow for the current year?

Answer

  Increase the number of years over which fixed assets are depreciated for tax purposes.
  Pay down the accounts payables.
  Reduce the days’ sales outstanding (DSO) without affecting sales or operating costs.
  Pay workers more frequently to decrease the accrued wages balance.
  Reduce the inventory turnover ratio without affecting sales or operating costs.

2 points

Question 17

Which of the following statements is CORRECT?

Answer

  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.
  A firm’s use of debt will have no effect on its profit margin on sales.
  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.
  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.
  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.

2 points

Question 18

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?

Answer

  Company HD pays less in taxes.
  Company HD has a lower equity multiplier.
  Company HD has a higher ROA.
  Company HD has a higher times interest earned (TIE) ratio.
  Company HD has more net income.

2 points

Question 19

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?

Answer

  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.
  The company’s debt ratio increased.

2 points

Question 20

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?

Answer

  Without more information, we cannot tell if HD or LD would have a higher or lower net income.
  HD would have the lower equity multiplier for use in the Du Pont equation.
  HD would have to pay more in income taxes.
  HD would have the lower net income as shown on the income statement.
  HD would have the higher net income as shown on the income statement.

2 points

Question 21

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 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.
  The division’s DSO (days’ sales outstanding) is 40, whereas the average for its competitors is 30.

2 points

Question 22

Which of the following statements is CORRECT?

Answer

  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.
  All else equal, increasing the debt ratio will increase the ROA.

2 points

Question 23

Which of the following statements is CORRECT?

Answer

  If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be the same.
  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.
  If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price earnings ratio.
  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.
  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.

2 points

Question 24

Walter Industries’ current ratio is 0.5. Considered alone, which of the following actions would increase the company’s current ratio?

Answer

  Borrow using short-term notes payable and use the cash to increase inventories.
  Use cash to reduce accruals.
  Use cash to reduce accounts payable.
  Use cash to reduce short-term notes payable.
  Use cash to reduce long-term bonds outstanding.

2 points

Question 25

Amram Company’s current ratio is 1.9. Considered alone, which of the following actions would reduce the company’s current ratio?

Answer

  Borrow using short-term notes payable and use the proceeds to reduce accruals.
  Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
  Use cash to reduce accruals.
  Use cash to reduce short-term notes payable.
  Use cash to reduce accounts payable.

2 points

Question 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.

2 points

Question 27

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 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.
  Its total assets turnover must equal the industry average.

2 points

Question 28

A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?

Answer

  Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2)lead to an increase in accounts receivable.
  Issue new common stock and use the proceeds to increase inventories.
  Speed up the collection of receivables and use the cash generated to increase inventories.
  Use some of its cash to purchase additional inventories.
  Issue new common stock and use the proceeds to acquire additional fixed assets.

2 points

Question 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

  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.
  Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.

2 points

Question 30

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?

Answer

  Company HD has a lower total assets turnover than Company LD.
  Company HD has a lower equity multiplier than Company LD.
  Company HD has a higher fixed assets turnover than Company B.
  Company HD has a higher ROE than Company LD.
  Company HD has a lower operating income (EBIT) than Company LD.

 

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