Question 1

Which of the following statements about net working capital (NWC)is correct?

Accepted Answer

Net working capital (NWC) is calculated as current assets minus current liabilities. If current liabilities exceed current assets, the result is a negative NWC. This can indicate liquidity issues as the company may have trouble meeting short-term obligations. Therefore, statement D is the correct statement.

Question 2

Amy wants to know if inventory is increasing as a percentage of total assets.Which one of these statements most easily provides the information she is seeking?

Accepted Answer

The common-size balance sheet expresses each item as a percentage of total assets. By comparing the percentage of inventory over time, Amy can determine if inventory is increasing as a percentage of total assets. The other statements do not provide this specific information.

Question 3

Which of the following is more likely to be correct if market value of equity is less than book value of equity?

Accepted Answer

When the market value of equity is less than the book value, it often indicates that investors have a pessimistic view of the company's future earning potential, suggesting they expect lower earnings or financial difficulties.

Question 4

What happens to the market value of a firm's equity as the book value of the firm's equity increases?

Accepted Answer

The market value of a firm's equity is determined by various factors, such as the company's financial performance, growth prospects, macroeconomic factors, investor sentiment, and industry trends. While the book value of equity is an important metric, it does not necessarily determine the market value of a company's equity. Market value is often driven by investor perception of future growth and profitability, which may deviate significantly from the book value. As a result, there is no set relationship between the two, and the market value may increase, decrease or remain constant relative to the book value depending on multiple factors.

Question 5

When subtracting an asset's accumulated depreciation from its historic cost,the resulting value is termed the:

Accepted Answer

The resulting value when subtracting accumulated depreciation from historic cost is the book value of the asset. This represents the remaining value of the asset that has not yet been depreciated. It is not the market value of the asset, depreciation expense, or current asset value.

Question 6

If market values of equity exceed book values of equity,then:

Accepted Answer

When market values of equity exceed book values of equity, it implies that investors have a positive perception of the company's future earnings potential, leading to a higher demand for its shares and hence a higher market value. This indicates an expectation of attractive profit potential in the future. It does not necessarily imply that the equity has been depreciated too rapidly, or that the firm is using accrual-based accounting, or that the firm is holding too much cash.

Question 7

ABC Corp.'s balance sheet shows its long-term debt to be $20 million.The debt was issued with a 10% interest rate,and the current interest rate is 7%.Based on this information alone,the market value of this debt is most likely:

Accepted Answer

When the current interest rate is lower than the coupon rate of the debt, the market value of the debt is likely to be more than its face value, as investors are willing to pay a premium for the higher interest payments.

Question 8

Which one of the following expense categories is subtracted from total revenues to help arrive at a firm's EBIT?

Accepted Answer

Depreciation is a non-cash expense that reduces the value of an asset over its useful life. It is subtracted from total revenues to calculate earnings before interest and taxes (EBIT). The other options (cash dividends, interest expense, tax liability) are all cash expenses that are subtracted from EBIT to arrive at net income.

Question 9

Which of the following statements about depreciation is correct

Accepted Answer

Depreciation is a non-cash expense that is subtracted from revenue to calculate accounting profit. However, it does not represent an actual cash outflow, so to calculate the cash produced by the business, it is necessary to add back the depreciation charge to accounting profits.

Question 10

If market interest rates have increased since a company last borrowed long-term funds,the market value of these long-term funds will likely be:

Accepted Answer

When market interest rates increase, the value of existing long-term debt decreases. This is because the interest rate on the existing debt is lower than the prevailing market rate, making it less attractive to potential investors. As a result, the market value of the long-term funds will likely be less than their book value.

Question 11

Depreciation expense is used to:

Accepted Answer

Depreciation expense is used to allocate the historical cost of an asset over its useful life. It represents the wear and tear, and decline in value of the asset over time.

Question 12

Which of the following values would most likely interest a shareholder?

Accepted Answer

Shareholders are most likely interested in the market value of equity as it represents the current value of their investment in the company. Book value of equity, retained earnings, and net working capital may also be important metrics for shareholders, but they do not directly represent the value of their investment in the company.

Question 13

A balance sheet may be considered backward-looking from the perspective that it:

Accepted Answer

A balance sheet records the historic values of assets, liabilities, and equity at a specific point in time. It does not provide information about future performance or net income. Therefore, it is considered backward-looking.

Question 14

In which of the following balance-sheet entries are you least likely to find a difference between market value and book value?

Accepted Answer

Cash is a highly liquid asset that is regularly valued at market value, meaning there is less likely to be a difference between market value and book value. Inventory and Land, on the other hand, may have vastly different market and book values, depending on factors like supply and demand, location, and deterioration. Shareholders' equity is also unlikely to have the same market and book value, as market conditions and investor sentiment can impact a company's stock price.

Question 15

According to GAAP,assets and liabilities are typically recorded on the balance sheet at:

Accepted Answer

GAAP requires assets and liabilities to be recorded at historical cost less depreciation. This means that assets are initially recorded at their purchase price, and then adjusted over time to account for depreciation, while liabilities are initially recorded at their face value and remain unchanged over time. Market value or salvage value may be used for certain assets in specific circumstances, but the general rule is to use historical cost less depreciation.

Question 16

Market-value balance sheets differ from book-value balance sheets in that market values:

Accepted Answer

Market-value balance sheets reflect investors' expectations for the value of a company's assets and liabilities, which may be different from their book values based on factors such as future earnings potential and market conditions. Market values are not necessarily higher or lower than book values, and they do not necessarily reflect GAAP accounting.

Question 17

Perhaps the best method for estimating the market value of shareholders' equity is to:

Accepted Answer

The most accurate method for estimating the market value of shareholders' equity is by multiplying the number of shares outstanding by the current market price of each share. This method takes into account the current market demand and perception of the company, which affects the stock price. The other options, such as reviewing the balance sheet, income statement, and retained earnings, provide relevant information but do not provide an accurate estimation of the market value of shareholders' equity.

Question 18

Which of the following statements about depreciation is correct?

Accepted Answer

Depreciation reduces the book value of assets, which is the value of the asset on the company's balance sheet. It is a non-cash expense, meaning it does not affect cash balances or directly impact net income. However, it does indirectly affect net income through its impact on the asset's value and the related calculations such as depreciation tax deductions. It is not subtracted from cost of goods sold.

Question 19

Which of the following statements is true for a corporation with $1 million market value of equity,$2 million market value of assets,and 1,000 shares of outstanding stock?

Accepted Answer

The market value of liabilities is calculated as the market value of assets minus the market value of equity, which is $2 million - $1 million = $1 million.

Question 20

The existence of goodwill on a corporate balance sheet indicates that the corporation has:

Accepted Answer

Goodwill is an intangible asset that represents the excess of the purchase price over the fair value of the net assets acquired in a business combination. Therefore, the existence of goodwill on a corporate balance sheet indicates that the corporation has acquired intangible assets from past acquisitions. Goodwill does not directly represent past profitability, depreciation of tangible assets, or retained earnings resulting from past income.

Quiz 3: Accounting and Finance

Which of the following statements about net working capital (NWC) is correct?