Question 1

Prezas Company's balance sheet showed total current assets of $4,250, all of which were required in operations. Its current liabilities consisted of $975 of accounts payable, $600 of 6% short-term notes payable to the bank, and $250 of accrued wages and taxes. What was its net operating working capital?
A) $2,874
B) $3,025
C) $3,176
D) $3,335
E) $3,502

Accepted Answer

Net operating working capital is calculated as follows: 
Net operating working capital = (Total current assets − cash) − (total current liabilities − notes payable) 
Net operating working capital = ($4,250 - $0) - ($975 + $250 - $600) 
Net operating working capital = $3,025

Question 2

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.
A) Nantell's taxable income will be lower.
B) Nantell's operating income (EBIT) will increase.
C) Nantell's cash position will improve (increase).
D) Nantell's reported net income for the year will be lower.
E) Nantell's tax liability for the year will be lower.

Accepted Answer

The answer of The Nantell Corporation just purchased an expensive...

Question 3

Which of the following statements is CORRECT?
A) Since depreciation increases the firm's net cash provided by operating activities, the more depreciation a company has, the larger its retained earnings will be, other things held constant.
B) A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.
C) Common equity includes common stock and retained earnings, less accumulated depreciation.
D) The retained earnings account as reported on the balance sheet shows the amount of cash that is available for paying dividends.
E) If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.

Accepted Answer

Retained earnings represent the portion of a company's profits that are kept by the company rather than paid out as dividends to shareholders. Therefore, a company can have a large amount of retained earnings listed on its balance sheet, but still need to borrow cash to address its cash flow needs or make required payments. This is because retained earnings on the balance sheet do not represent actual cash on hand, but rather profits that have been retained within the company.

Question 4

Which of the following statements is CORRECT?
A) Dividends paid reduce the net income that is reported on a company's income statement.
B) 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.
C) If a company issues new long-term bonds to purchase fixed assets during the current year, this will increase both its reported current assets and current liabilities at the end of the year.
D) Accounts receivable are reported as a current liability on the balance sheet.
E) 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.

Accepted 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 will not affect net income on the income statement. Instead, they are a distribution of profits that have already been reported on the income statement and retained earnings. Choice A is incorrect as dividends paid do not affect the net income shown on the income statement. Choice B is incorrect as purchasing marketable securities with bank deposits will increase the current assets on the balance sheet. Choice C is incorrect as issuing long-term bonds will increase the long-term liabilities and fixed assets, but not the current assets and liabilities. Choice D is incorrect as accounts receivable are reported as a current asset on the balance sheet, not a liability.

Question 5

Which of the following statements is most correct?
A) Retained earnings, as reported on the balance sheet, represents the amount of cash a company has available to pay out as dividends to shareholders.
B) 70% of the interest received by corporations is excluded from taxable income.
C) 70% of the dividends received by corporations is excluded from taxable income.
D) Because taxes on long-term capital gains are not paid until the gain is realized, investors must pay the top individual tax rate on that gain.
E) The corporate tax system favors equity financing, as dividends paid are deductible from corporate taxes.

Accepted Answer

70% of the dividends received by corporations is excluded from taxable income under the qualified dividend tax rate. Retained earnings on the balance sheet represent the accumulation of profits that have not been paid out to shareholders, but are available for future investments or distributions. Option B is incorrect, as only a portion of dividends received by corporations are excluded from taxable income, not interest. Option D is also incorrect, as long-term capital gains are subject to a separate tax rate that is often lower than the top individual tax rate. Option E is misleading, as dividends paid are not deductible from corporate taxes, but rather are paid out of after-tax earnings.

Question 6

Bauer Software's current balance sheet shows total common equity of $5,125,000. The company has 530,000 shares of stock outstanding, and they sell at a price of $27.50 per share. By how much do the firm's market and book values per share differ?
A) $17.83
B) $18.72
C) $19.66
D) $20.64
E) $21.67

Accepted Answer

The answer of Bauer Software's current balance sheet shows total...

Question 7

Assume that Besley Golf Equipment commenced operations on January 1, 2011, 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 2011 management realized that the assets would last for only 10 years. The firm's accountants plan to report the 2011 financial statements based on this new information. How would the new depreciation assumption affect the company's financial statements?
A) The firm's reported net fixed assets would increase.
B) The firm's EBIT would increase.
C) The firm's reported 2011 earnings per share would increase.
D) The firm's cash position in 2011 and 2012 would increase.
E) The provision will increase the company's tax payments.

Accepted Answer

The answer of Assume that Besley Golf Equipment commenced operations...

Question 8

Rao Construction recently reported $20.50 million of sales, $12.60 million of operating costs other than depreciation, and $3.00 million of depreciation. It had $8.50 million of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. What was Rao's operating income, or EBIT, in millions?
A) $3.21
B) $3.57
C) $3.97
D) $4.41
E) $4.90

Accepted Answer

The answer of Rao Construction recently reported $20.50 million of...

Question 9

Assume that Congress recently passed a provision that will enable Bev's Beverages Inc. (BBI) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or the tax rate. Prior to the new provision, BBI's net income was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BBI's financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
A) The provision will reduce the company's cash flow.
B) The provision will increase the company's tax payments.
C) The provision will increase the firm's operating income (EBIT).
D) The provision will increase the company's net income.
E) Net fixed assets on the balance sheet will decrease.

Accepted Answer

The answer of Assume that Congress recently passed a provision...

Question 10

Last year, Delip Industries had (1) negative 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?
A) The company had a sharp increase in its inventories.
B) The company had a sharp increase in its accrued liabilities.
C) The company sold a new issue of common stock.
D) The company made a large capital investment early in the year.
E) The company had a sharp increase in depreciation expenses.

Accepted Answer

Selling a new issue of common stock would result in an increase in cash on the balance sheet, while not necessarily improving cash flow from operations or free cash flow.

Question 11

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?
A) The firm's operating income (EBIT) would increase.
B) The firm's taxable income would increase.
C) The firm's cash flow would increase.
D) The firm's tax payments would increase.
E) The firm's reported net income would increase.

Accepted Answer

The answer of A start-up firm is making an initial...

Question 12

Which of the following statements is CORRECT?
A) Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm either sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors.
B) Assets other than cash are expected to produce cash over time, and the amount of cash they eventually produce must be the same as the amounts at which the assets are carried on the books.
C) 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, all reported income comes in the form of cash, and reported costs likewise are consistent with cash outlays. Therefore, there will not be a substantial difference between a firm's reported profits and its actual cash flow for the same period.
D) 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.
E) EPS stands for earnings per share, while DPS stands for dividends per share. We would normally expect to see DPS exceed EPS.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 13

For managerial purposes, i.e., making decisions regarding the firm's operations, the standard financial statements as prepared by accountants under generally accepted accounting principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm's operations. Related to these modifications, which of the following statements is CORRECT?
A) The standard statements make adjustments to reflect the effects of inflation on asset values, and these adjustments are normally carried into any adjustment that managers make to the standard statements.
B) The standard statements focus on accounting income for the entire corporation, not cash flows, and the two can be quite different during any given accounting period. However, the firm's value is based on its future cash flows. After all, future cash flows tells us how much the firm can distribute to its investors.
C) The standard statements provide useful information on the firm's individual operating units, but management needs more information on the firm's overall operations than the standard statements provide.
D) The standard statements focus on cash flows, but managers should be less concerned with cash flows than with accounting income as defined by GAAP.
E) The best feature of standard statements is that, if they are prepared under GAAP, the data are always consistent from firm to firm. Thus, under GAAP, there is no room for accountants to "adjust" the results to make earnings look better.

Accepted Answer

The statement that best reflects the modifications made to standard financial statements for managerial purposes is B. The standard statements focus on accounting income, which may not accurately reflect the future cash flows of the firm. As such, managers may modify the financial statements to focus on metrics that are more relevant to making business decisions, such as future cash flows.

Question 14

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.
A) Companies' after-tax operating profits would decline.
B) Companies' physical stocks of fixed assets would increase.
C) Companies' cash flows would increase.
D) Companies' cash positions would decline.
E) Companies' reported net incomes would decline.

Accepted Answer

The answer of Which of the following would be most...

Question 15

Which of the following statements is CORRECT?
A) An increase in accounts receivable is added to net income in the operating activities section because if accounts receivable increase, then when they are collected cash will come into the firm.
B) In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and net operating working capital. Free cash flow is the amount of cash that could be withdrawn without harming the firm's ability to operate and to produce future cash flows.
C) The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that add to or subtract from cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt.
D) The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line."
E) Most rapidly growing companies have positive free cash flows because cash flows from existing operations will exceed fixed assets and working capital needed to support the growth.

Accepted Answer

The statement in B correctly describes free cash flow (FCF) and its importance in finance. A is incorrect because an increase in accounts receivable is not added to net income, but rather subtracted from net income in the operating activities section. C is incorrect because a negative net cash provided by operating activities does not necessarily mean the firm will soon go bankrupt - it could simply indicate a temporary cash flow issue. D is incorrect because the earnings are not the next-to-last line on the income statement, but rather the first line after the subtractions for cost of goods sold and operating expenses. E is incorrect because rapidly growing companies often have negative free cash flow as they invest heavily in fixed assets and working capital to support their growth.

Question 16

Brown Fashions Inc.'s December 31, 2011 balance sheet showed total common equity of $4,050,000 and 200,000 shares of stock outstanding. During 2011, the firm had $450,000 of net income, and it paid out $100,000 as dividends. What was the book value per share at 12/31/11, assuming no common stock was either issued or retired during 2011?
A) $20.90
B) $22.00
C) $23.10
D) $24.26
E) $25.47

Accepted Answer

The book value per share is calculated by dividing the total common equity by the number of shares outstanding. Total common equity is $4,050,000 and there are 200,000 shares, so the book value per share is $4,050,000 / 200,000 = $20.25. However, the net income of $450,000 increases the equity, and after paying $100,000 in dividends, the retained earnings increase by $350,000. Thus, the new equity is $4,050,000 + $350,000 = $4,400,000. The book value per share is $4,400,000 / 200,000 = $22.00.

Question 17

Which of the following statements is CORRECT?
A) The current cash flow from existing assets is highly relevant to investors. However, since the value of the firm depends primarily upon its growth opportunities, accounting net income projections from those opportunities are the only relevant future flows with which investors are concerned.
B) Two metrics that are used to measure a company's financial performance are net income and free cash flow. Accountants tend to emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on free cash flows as they do on net income.
C) To estimate the net cash provided by operations, depreciation must be subtracted from net income because it is a non-cash charge that has been added to revenue.
D) 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 discourage the use of debt financing by corporations.
E) If Congress changed depreciation allowances so that companies had to report higher depreciation levels for tax purposes in 2012, this would lower their free cash flows for 2012.
Multiple Choice: Problems
A good bit of relatively simple arithmetic is involved in some of these problems, and although the calculations are simple, it will take students some time to set up the problem and do the arithmetic. We allow for this when assigning problems for a timed test.
Also, students must use a number of definitions to answer some of the questions. To avoid excessive memorization, we provide students with a list of formulas and definitions for use on exams. Problems with * in the topic line are nonalgorithmic.

Accepted Answer

Both net income and free cash flow are important metrics for measuring a company's financial performance, but while accountants tend to focus on net income, finance professionals tend to give equal weight to free cash flow.

Question 18

Last year Besset Company's operations provided a negative cash flow, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company's financial statements were prepared under generally accepted accounting principles (GAAP)?
A) The company repurchased some of its common stock.
B) The company dramatically increased its capital expenditures.
C) The company retired a large amount of its long-term debt.
D) The company sold some of its fixed assets.
E) The company had high depreciation expenses.

Accepted Answer

The company sold some of its fixed assets, which would provide a cash inflow and increase the cash balance on the balance sheet. The other options would not necessarily result in an increase in cash on the balance sheet.

Question 19

The CFO of Daves 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 that carry a 7% interest rate. 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?
A) The company's taxable income would fall.
B) The company's interest expense would remain constant.
C) The company would have less common equity than before.
D) The company's net income would increase.
E) The company would have to pay less taxes.

Accepted Answer

The answer of The CFO of Daves Industries plans to...

Question 20

Which of the following statements is CORRECT?
A) Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations.
B) After-tax operating income is calculated as EBIT(1 - T) + Depreciation.
C) Two firms with identical sales and operating costs but with different amounts of debt and tax rates will have different operating incomes by definition.
D) If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow.
E) Retained earnings as reported on the balance sheet represent cash and, therefore, are available to distribute to stockholders as dividends or any other required cash payments to creditors and suppliers.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Quiz 3: Financial Statements

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is most correct?

Bauer Software's current balance sheet shows total common equity of $5,125,000. The company has 530,000 shares of stock outstanding, and they sell at a price of $27.50 per share. By how much do the firm's market and book values per share differ?

Last year, Delip Industries had (1) negative 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?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?