Question 1

Net operating profit after taxes (NOPAT) is the amount of net income a company would generate from its operations if it had no interest income or interest expense.

Accepted Answer

This is the correct definition of NOPAT. It excludes interest income and expense from net income to show the company's true operating profitability.

Question 2

If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, this would probably encourage companies to use more debt financing than they currently do, other things held constant.

Accepted Answer

False

Question 3

Total net operating capital is equal to net fixed assets.

Accepted Answer

Total net operating capital includes both net fixed assets and working capital (current assets minus current liabilities).

Question 4

Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations.

Accepted Answer

This statement is true. The deductibility of interest expenses but not dividend payments creates a tax advantage for debt financing. By issuing debt, a company can reduce its taxable income and hence lower its tax liability. On the other hand, paying dividends does not provide a tax benefit, as the corporation's income has already been taxed. Therefore, corporations may be motivated to take on more debt to finance their operations, which could increase their financial risk.

Question 5

On the balance sheet, total assets must always equal total liabilities plus equity.

Accepted Answer

This is the fundamental accounting equation and the basis for the balance sheet. Total assets represent what a company owns, while total liabilities and equity represent how those assets are financed. Therefore, they must always be equal.

Question 6

In Canada, amortization is a similar concept as depreciation and can be applied to both tangible and intangible assets.

Accepted Answer

Amortization in Canada refers to the process of spreading out the cost of an asset over its useful life for accounting purposes. It is similar to depreciation but can also apply to intangible assets like patents and trademarks.

Question 7

The current cash flow from existing assets is highly relevant to the investor. However, since the value of the firm depends primarily upon its growth opportunities, profit projections from those opportunities are the only relevant future flows with which investors are concerned.

Accepted Answer

While growth opportunities and their profit projections are crucial, investors also consider the current cash flow from existing assets as it reflects the firm's present health and ability to generate revenue, which is fundamental for sustaining operations and funding future growth.

Question 8

The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.

Accepted Answer

The annual report provides detailed financial information about the company's past performance, current status, and future plans. This information is crucial for investors in determining whether to invest in the company, and what return they can expect on their investment. The financial statements in the annual report also provide insight into the company's profitability, liquidity, and solvency, which helps investors assess the riskiness of their investment. Therefore, the annual report is an important tool in finance for investors.

Question 9

The interest and dividends paid by a corporation are considered to be deductible operating expenses;
hence, they decrease the firm's tax liability.

Accepted Answer

Interest paid by a corporation can be considered a deductible expense, which can decrease the firm's tax liability, but dividends paid are not deductible and do not affect the corporation's taxes.

Question 10

Since investors use net income to value the firm, cash flow becomes a secondary consideration simply because cash is for operation only.

Accepted Answer

This statement is false. Cash flow is an important consideration for investors because it represents the actual cash available to the company for operations, investments, and dividends. Net income does not necessarily equal cash flow, as it may include non-cash items such as depreciation expenses. Additionally, a company with positive cash flow may be in a better position to weather unforeseen events or investment opportunities than a company with negative cash flow.

Question 11

Income statements must be prepared only on an annual basis.

Accepted Answer

Income statements can be prepared on a monthly or quarterly basis as well, depending on the needs of the business.

Question 12

The balance sheet is a financial statement that measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time.

Accepted Answer

The statement should be reversed. The balance sheet measures the firm's financial position at a point in time, while the income statement measures the flow of funds into and out of various accounts over time.

Question 13

Retained earnings are the existing shareholders' reinvested profit and do not represent cash.

Accepted Answer

Retained earnings are the portion of net profit that a company keeps and reinvests in the business instead of paying out as dividends to shareholders. This means that retained earnings are not distributed as cash to shareholders, but are instead reflected in the value of the company's shares.

Question 14

The fact that interest income received by a corporation is 50% taxable encourages firms to use more debt financing than equity financing.

Accepted Answer

The statement is incorrect. Interest income received by a corporation is fully taxable, while dividend income from equity investment is eligible for a lower tax rate. Therefore, firms may use more equity financing than debt financing to benefit from the lower tax rate on dividend income.

Question 15

Consider the balance sheet of Wilkes Industries as shown below. Because Wilkes has $800,000 of retained earnings, the company would be able to pay cash to buy an asset with a cost of $200,000.

Accepted Answer

The answer of Consider the balance sheet of Wilkes Industries...

Question 16

The value of goodwill on intangible assets is calculated according to the impairment rule instead of a fixed annual charge.

Accepted Answer

Goodwill is tested for impairment annually or whenever there is an indication of impairment. The impairment test compares the carrying amount of the goodwill with its recoverable amount, which is the higher of its fair value less costs to sell and its value in use. If the carrying amount exceeds the recoverable amount, the goodwill is considered impaired and must be written down to its recoverable amount. This calculation is based on the impairment rule and is not a fixed annual charge.

Question 17

The FIFO method leads to a higher balance sheet inventory value, but a lower cost of goods sold in the income statement.

Accepted Answer

This is because the FIFO method assumes that the items sold are the ones that were purchased earlier, which leads to a higher cost of goods sold for newer items and a lower cost of goods sold for older items. As a result, the inventory value on the balance sheet will be higher as it includes the cost of newer items, while the cost of goods sold in the income statement will be lower.

Question 18

To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue.

Accepted Answer

Depreciation is a non-cash expense that reduces net income but does not involve the actual expenditure of cash. Therefore, it must be added back to net income when calculating the cash flow from operations.

Question 19

The income statement shows the difference between a firm's income and its costs-i.e., its profits- during a specified period of time. However, not all reported income comes in the form or cash, and reported costs likewise may not correctly reflect cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period.

Accepted Answer

The statement correctly points out that reported profits may differ from actual cash flow due to non-cash income and non-cash costs.

Question 20

The annual report contains four basic financial statements: the income statement, balance sheet, statement of cash flows, and statement of retained earnings.

Accepted Answer

The annual report typically includes these four basic financial statements.

Quiz 2: Financial Statements, Cash Flow, and Taxes