Question 1

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 presently do, other things held constant.

Accepted Answer

False

Question 2

The time dimension is important in financial statement analysis. The balance sheet shows the firm's financial position at a given point in time, the income statement shows results over a period of time, and the statement of cash flows reflects changes in the firm's accounts over that period of time.

Accepted Answer

This statement is true. The balance sheet reflects the firm's financial position at a specific date, the income statement shows results over a period of time (such as a year), and the statement of cash flows reflects changes in the firm's accounts over that period of time. Understanding the time dimension is important for financial statement analysis, as it can help analysts identify trends and patterns in a company's financial performance over time.

Question 3

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 information about the financial performance and position of the company, which is used by investors to make informed decisions about investing in the company. This information helps investors form expectations about the firm's future earnings and dividends and assess the risk associated with investing in the company. Therefore, the annual report is an important tool in finance.

Question 4

Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could be higher or lower than the values at which these assets are carried on the books.

Accepted Answer

Assets such as property, inventory, and investments are expected to generate cash flows over time, but the actual amounts of cash generated could be higher or lower than the values at which they are recorded on the books. This is why companies need to regularly reassess the value of their assets and make adjustments as necessary.

Question 5

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

Since interest paid is deductible, it reduces the corporation's taxable income and lowers its tax liability. On the other hand, dividends paid are not deductible, meaning they are paid using after-tax profits. Therefore, corporations tend to rely more on debt financing to take advantage of the tax deduction on interest payments.

Question 6

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 require an actual outflow of cash. Therefore, it must be added back to net income in order to calculate the actual cash flow from operations.

Question 7

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 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 8

Total net operating capital is equal to net fixed assets.

Accepted Answer

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

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

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 11

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

This statement is true. The income statement reflects profits based on accrual accounting, which includes non-cash items such as depreciation and accounts receivable. Meanwhile, cash flow statements provide a more accurate reflection of actual cash inflows and outflows during a period.

Question 12

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 financial health and ability to generate returns in the short term.

Question 13

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

Accepted Answer

This statement is known as the accounting equation and is a fundamental principle of accounting. The total assets of a company must always be equal to the sum of its liabilities and equity.

Question 14

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

Accepted Answer

The four basic financial statements are the income statement, balance sheet, statement of cash flows, and statement of stockholders' equity. They are typically included in an annual report.

Question 15

The fact that 70% of the dividends received by a corporation is excluded from its taxable income encourages firms to use more debt financing than they would in the absence of this tax law provision.

Accepted Answer

This statement is incorrect. The tax law provision in question actually encourages corporations to use more equity financing, not debt financing. This is because dividends received from stock investments are eligible for the exclusion, while interest paid on debt is not. Therefore, corporations may prefer to pay dividends to their shareholders rather than taking on more debt to finance their operations.

Question 16

Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid out to stockholders as dividends. Retained earnings are kept in cash or near cash accounts and, thus, these cash accounts, when added together, will always be equal to the firm's total retained earnings.

Accepted Answer

Retained earnings represent the cumulative amount of net income earned by a company that is retained by the company rather than distributed to its shareholders as dividends. However, retained earnings are not necessarily held in cash or near-cash accounts. They can be reinvested in the business, used to pay down debt, or allocated for any other purpose decided by the company. The statement that these accounts will always equal the firm's total retained earnings in cash terms is incorrect.

Question 17

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

Net operating profit after taxes (NOPAT) is calculated by subtracting all operating expenses, including taxes, from operating revenues. It does not include interest income or interest expense.

Question 18

In accounting, emphasis is placed on determining net income in accordance with generally accepted accounting principles. In finance, the primary emphasis is also on net income because that is what investors use to value the firm. However, a secondary financial consideration is cash flow, because cash is needed to operate the business.

Accepted Answer

In finance, the primary emphasis is often on cash flow rather than net income. This is because cash flow is crucial for assessing the liquidity and operational efficiency of a business, and it is essential for meeting the company's obligations and for investment opportunities.

Question 19

Net operating working capital is equal to operating current assets minus operating current liabilities.

Accepted Answer

Net operating working capital (NOWC) is calculated as operating current assets (such as accounts receivable and inventory) minus operating current liabilities (such as accounts payable and accrued expenses).

Question 20

The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of stockholders' claims against the firm's existing assets. This implies that retained earnings are in fact stockholders' reinvested earnings.

Accepted Answer

Retained earnings represent the portion of a company's net income that is reinvested back into the business, and belong to the stockholders as a component of their equity stake in the company. They are not actual cash held in a separate account but rather an accumulated value that increases or decreases as net income or losses are generated.

Quiz 2: Financial Statements, Cash Flow, and Taxes