TEST BANK CHAPTER 03 FINANCIAL STATEMENTS CASH FLOW AND TAXES

REFERENCES: 3-3 The Income Statement LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE S

Trang 1

This chapter has a lot of definitions They are important, but we don't like to make students memorize too many of them early in the course We let our students use a formula sheet that includes the key definitions.

Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in multiple-choice questions.

Multiple Choice: True/False

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

KEYWORDS: Bloom’s: Knowledge

5 Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could behigher or lower than the amounts at which the assets are carried on the books

a True

b False

ANSWER: True

KEYWORDS: Bloom’s: Knowledge

6 The amount shown on the December 31, 2015, balance sheet as "retained earnings" is equal to the firm's net income for

2015 minus any dividends it paid

Trang 2

LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet

NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills

STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows

United States - OH - DISC.FOFM.BRIG.16.06 - Finance function

TOPICS: Balance sheet

KEYWORDS: Bloom’s: Knowledge

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

REFERENCES: 3-3 The Income Statement

LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement

TOPICS: Income statement

KEYWORDS: Bloom's: Comprehension

8 If we were describing the income statement and the balance sheet, it would be correct to say that the income statement

is more like a video while the balance sheet is more like a snapshot

NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking

Trang 3

11 Consider the following balance sheet, for Games Inc Because Games has $800,000 of retained earnings, we know thatthe company would be able to pay cash to buy an asset with a cost of $200,000

Accounts receivable 250,000 Total CL 200,000$

RATIONALE: Note that the firm has only $50,000 of cash It would have to either sell assets or borrow

$150,000 to pay cash for the new asset That might not be possible

REFERENCES: 3-5 Statement of Stockholders’ Equity

LEARNING OBJECTIVES: FOFM.BRIG.16.03.05 - Statement of Stockholders' Equity

TOPICS: Retained earnings

12 Typically, the statement of stockholders' equity starts with total stockholders' equity at the beginning of the year, adds net income, subtracts dividends paid, and ends up with total stockholders' equity at the end of the year Over time, a profitable company will have earnings in excess of the dividends it pays out, and will result in a substantial amount of retained earnings shown on the balance sheet

TOPICS: Stockholders' equity statement

Trang 4

13 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.

REFERENCES: 3-7 Free Cash Flow

LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow

TOPICS: Free cash flow

14 The value of any asset is the present value of the cash flows the asset is expected to provide The cash flows a business

is able to provide to its investors is its free cash flow This is the reason that FCF is so important in finance

15 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

a True

b False

RATIONALE: There is no reason to think that net income would be equal to FCF For example, a company

that is not growing might report zero net income yet have high FCF because of depreciation

Trang 5

16 The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision.

REFERENCES: 3-9 Income Taxes

LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes

17 Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes

18 The balance sheet 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

LEARNING OBJECTIVES: FOFM.BRIG.16.03.00 - Comprehensive

TOPICS: Financial statements

19 Assume that two firms are both following generally accepted accounting principles Both firms commenced operationstwo years ago with $1 million of identical fixed assets, and neither firm sold any of those assets or purchased any new

Trang 6

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.

a True

b False

RATIONALE: One firm might choose to use straight-line depreciation, the other an accelerated method, and

this would lead to differences in reported depreciation and therefore reported net fixed assets

REFERENCES: 3-2 The Balance Sheet

20 Net operating working capital is equal to current assets minus the difference between current liabilities and notes payable This definition assumes that the firm has no "excess" cash

TOPICS: Net operating working capital

21 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."

Trang 7

22 The statement of cash flows has four main sections, one each for operating, investing, and financing activities, and onethat shows a summary of the cash and cash equivalents at the end of the year.

REFERENCES: 3-4 Statement of Cash Flows

LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows

TOPICS: Statement of cash flows

23 An increase in accounts payable represents an increase in net cash provided by operating activities just like borrowing money from a bank An increase in accounts payable has an effect similar to taking out a new bank loan However, these two items show up in different sections of the statement of cash flows to reflect the difference between operating and financing activities

24 An increase in accounts receivable represents an increase in net cash provided by operating activities because

receivables will produce cash when they are collected

Trang 8

25 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 represent increases or decreases to cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it isnegative, the firm is almost certain to soon go bankrupt

a True

b False

RATIONALE: Rapidly growing firms often require additions to inventory and receivables that are larger

than net income, with the deficit being made up by borrowings and/or the sale of new stock

26 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 in the net income calculation

27 Two metrics that are used to measure a company's financial performance are net income and cash flow Accountants emphasize net income as calculated in accordance with generally accepted accounting principles Finance people

generally put at least as much weight on cash flows as they do on net income

Trang 9

TOPICS: Cash flow and net income

28 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 If the firm has sufficient retained earnings, it can purchase assets and pay for them with cash from retained earnings

29 The retained earnings account on the balance sheet does not represent cash Rather, it represents part of the

stockholders' claims against the firm's existing assets Put another way retained earnings are stockholders' reinvested earnings

30 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 changes in net

operating working capital

Trang 10

31 Free cash flow is the amount of cash that if withdrawn would harm the firm's ability to operate and to produce future cash flows

32 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 deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant

33 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

Trang 11

34 Because the U.S tax system is a progressive tax system, a taxpayer's marginal and average tax rates are the same

35 The alternative minimum tax (AMT) was created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions

36 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 specific changes in accounts over that period of time

Trang 12

Multiple Choice: Conceptual

Please note that some of the answer choices, or answers that are very close, are used in different questions This has caused us no difficulties, but please take this into account when you make up exams.

37 Which of the following statements is CORRECT?

a 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

b The balance sheet gives us a picture of the firm's financial position at a point in time

c The income statement gives us a picture of the firm's financial position at a point in time

d The statement of cash flows tells us how much cash the firm must pay out in interest during the year

e The statement of cash needs tells us how much cash the firm will require during some future period, generally

a month or a year

REFERENCES: 3-1 Financial Statements and Reports

LEARNING OBJECTIVES: FOFM.BRIG.16.03.01 - Financial Statements and Reports

OTHER: Multiple Choice: Conceptual

a Assets other than cash are expected to produce cash over time, and the amounts of cash they eventually

produce should be exactly the same as the amounts at which the assets are carried on the books

b 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

c The annual report is an internal document prepared by a firm's managers solely for the use of its

creditors/lenders

d The four most important financial statements provided in the annual report are the balance sheet, income

statement, cash budget, and statement of stockholders' equity

e Prior to the Enron scandal in the early 2000s, companies would put verbal information in their annual reports, along with the financial statements That verbal information was often misleading, so today annual reports can contain only quantitative information: audited financial statements

REFERENCES: 3-1 Financial Statements and Reports

LEARNING OBJECTIVES: FOFM.BRIG.16.03.01 - Financial Statements and Reports

Trang 13

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

b The balance sheet for a given year tells us how much money the company earned during that year

c The difference between the total assets reported on the balance sheet and the liabilities 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)

d If a company's statements were prepared in accordance with generally accepted accounting principles

(GAAP), the market value of the stock equals the book value of the stock as reported on the balance sheet

e The assets section of a typical company's balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last

40 Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?

a The company repurchases common stock

b The company pays a dividend

c The company issues new common stock

d The company gives customers more time to pay their bills

e The company purchases a new piece of equipment

Trang 14

41 Which of the following items is NOT normally considered to be a current asset?

TOPICS: Current assets

42 Which of the following items cannot be found on a firm's balance sheet under current liabilities?

a Accounts payable

b Short-term notes payable to the bank

c Accrued wages

d Cost of goods sold

e Accrued payroll taxes

TOPICS: Current liabilities

a The focal point of the income statement is the cash account, because that account cannot be manipulated by

"accounting tricks."

b The reported income of two otherwise identical firms cannot be manipulated by different accounting

procedures provided the firms follow generally accepted accounting principles (GAAP)

c The reported income of two otherwise identical firms must be identical if the firms are publicly owned,

provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC)

d If a firm follows generally accepted accounting principles (GAAP), then its reported net income will be

identical to its reported cash flow

Trang 15

e The income statement for a given year is designed to give us an idea of how much the firm earned during that year.

44 Below are the 2013 and 2014 year-end balance sheets for Tran Enterprises:

The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt

in 2013 As of the end of 2014, none of the principal on this debt had been repaid Assume that the company's sales in

2013 and 2014 were the same Which of the following statements must be CORRECT?

a The firm increased its short-term bank debt in 2014

b The firm issued long-term debt in 2014

c The firm issued new common stock in 2014

d The firm repurchased some common stock in 2014

e The firm had negative net income in 2014

Trang 16

45 On its 12/31/14 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

a If the company lost money in 2014, it must have paid dividends

b The company must have had zero net income in 2014

c The company must have paid out half of its 2014 earnings as dividends

d The company must have paid no dividends in 2014

e Dividends could have been paid in 2014, but they would have had to equal the earnings for the year

46 Below is the common equity section (in millions) of Timeless Technology's last two year-end balance sheets:

The firm has never paid a dividend to its common stockholders Which of the following statements is CORRECT?

a The company's net income in 2014 was higher than in 2013

b The firm issued common stock in 2014

c The market price of the firm's stock doubled in 2014

d The firm had positive net income in both 2013 and 2014, but its net income in 2014 was lower than it was in 2013

e The company has more equity than debt on its balance sheet

Trang 17

a Typically, a firm's DPS should exceed its EPS

b Typically, a firm's net income should exceed its EBIT

c If a firm is more profitable than average, we would normally expect to see its stock price exceed its book valueper share

d If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation

e The more depreciation a firm has in a given year, the higher its EPS, other things held constant

TOPICS: EPS, DPS, BVPS, and stock price

a The more depreciation a firm reports, the higher its tax bill, other things held constant

b People sometimes talk about the firm's cash flow, which is shown as the lowest entry on the income statement,hence it is often called "the bottom line."

c Depreciation reduces a firm's cash balance, so an increase in depreciation would normally lead to a reduction

in the firm's cash flow

d Operating income is derived from the firm's regular core business Operating income is calculated as Revenuesless Operating costs Operating costs do not include interest or taxes

e Depreciation is not a cash charge, so it does not have an effect on a firm's reported profits

TOPICS: Depreciation, EBIT, and CF

Trang 18

49 Which of the following factors could explain why Michigan Energy's cash balance increased even though it had a negative cash flow last year?

a The company sold a new issue of bonds

b The company made a large investment in new plant and equipment

c The company paid a large dividend

d The company had high depreciation expenses

e The company repurchased 20% of its common stock

50 Analysts who follow Howe Industries recently noted that, relative to the previous year, the company's net cash provided from operations increased, yet cash as reported on the balance sheet decreased Which of the following factors could explain this situation?

a The company cut its dividend

b The company made large investments in fixed assets

c The company sold a division and received cash in return

d The company issued new common stock

e The company issued new long-term debt

51 Austin Financial recently announced that its net income increased sharply from the previous year, yet its net cash provided from operations declined Which of the following could explain this performance?

a The company's dividend payment to common stockholders declined

b The company's expenditures on fixed assets declined

Trang 19

c The company's cost of goods sold increased.

d The company's depreciation expense declined

e The company's interest expense increased

TOPICS: Cash flow and net income

a The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets

b The statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit

c The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects

of changes in working capital

d The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock

e The statement of cash flows shows how much the firm's cash, the total of currency, bank deposits, and term liquid securities (or cash equivalents), increased or decreased during a given year

a In the statement of cash flows, a decrease in accounts receivable is subtracted from net income in the operatingactivities section

b Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity

c In the statement of cash flows, a decrease in accounts payable is subtracted from net income in the operating activities section

d In the statement of cash flows, depreciation is subtracted from net income in the operating activities section

Trang 20

e In the statement of cash flows, a decrease in inventories is subtracted from net income in the operating

activities section

a Most rapidly growing companies have positive free cash flows because cash flows from existing operations

generally exceed fixed asset purchases and changes to net operating working capital

b Changes in working capital have no effect on free cash flow

c Free cash flow (FCF) is defined as follows:

FCF = EBIT(1 − T) + Depreciation

− Capital expenditures required to sustain operations

− Required changes in net operating working capital

d Free cash flow (FCF) is defined as follows:

FCF = EBIT(1 − T) + Capital expenditures

e Managers should be less concerned with free cash flow than with accounting net income Accounting net income

is the "bottom line" and represents how much the firm can distribute to all its investors, both creditors and

stockholders

a Actions that increase reported net income will always increase cash flow

b One way to increase EVA is to generate the same level of operating income but with less total invested capital

c One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free

d One way to increase EVA is to achieve the same level of operating income but with more total invested capital obtained at a higher cost of capital

Trang 21

e If a firm reports positive net income, its EVA must also be positive.

RATIONALE: Statement b is true, because the EVA equation: EVA = EBIT(1 − T) − (After-tax cost of capital

%) (Investor-supplied operating capital) implies that lowering the operating capital, all else equal, lowers capital costs and thus increases EVA

REFERENCES: 3-8 MVA and EVA

LEARNING OBJECTIVES: FOFM.BRIG.16.03.08 - MVA and EVA

TOPICS: EVA, cash flow, and NI

a MVA stands for market value added, and it is defined as follows:

MVA = (Shares outstanding)(Stock price) + Book value of common equity

b 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

c MVA gives us an idea about how much value a firm's management has added during the last year

d EVA gives us an idea about how much value a firm's management has added over the firm's life

e EVA stands for economic value added, and it is defined as follows:

EVA = NOPAT − (Total invested capital)(AT cost of capital %)

RATIONALE: Statement e gives the correct equation for EVA The other statements are false

REFERENCES: 3-8 MVA and EVA

LEARNING OBJECTIVES: FOFM.BRIG.16.03.08 - MVA and EVA

57 Which of the following statements is most correct?

a Corporations are allowed to exclude 70% of their interest income from corporate taxes

b Corporations are allowed to exclude 70% of their dividend income from corporate taxes

c Individuals pay taxes on only 30% of the income realized from municipal bonds

d Individuals are allowed to exclude 70% of their interest income from their taxes

e Individuals are allowed to exclude 70% of their dividend income from their taxes

RATIONALE: Statement a is false, corporations cannot exclude interest income from corporate taxes

Trang 22

Statement b is true, because the 70% exclusion rule gets around the issue of triple taxation Statements c, d, and e are false, because individuals pay no taxes on municipal bond incomeand individuals cannot exclude 70% of their income from either interest or dividends.

58 A loss incurred by a corporation

a Must be carried forward unless the company has had 2 loss years in a row

b Can be carried back 2 years, then carried forward up to 20 years following the loss

c Can be carried back 5 years and forward 3 years

d Cannot be used to reduce taxes in other years except with special permission from the IRS

e Can be carried back 3 years or forward 10 years, whichever is more advantageous to the firm

TOPICS: Carry-back, carry-forward

a Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity

financing over debt financing, and this causes companies' debt ratios to be lower than they would be if interest and dividends were both deductible

b Interest paid to an individual is counted as income for federal tax purposes and taxed at the individual's regulartax rate, which in 2014 could go up to 39.6%, but qualified dividends received were taxed at a maximum tax rate of 15% for individuals earning less than $400,000 and married taxpayers filing jointly earning less than

$450,000

c The maximum federal tax rate on corporate income in 2014 was 50%

d Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by

selling new common stock or by retaining earnings The cost of debt capital is the interest paid on the debt,

and the cost of the equity is the dividends paid on the stock Both of these costs are deductible from income when calculating income for tax purposes

e The maximum federal tax rate on personal income in 2014 was 50%

Trang 23

DIFFICULTY: MODERATE

a The income of certain small corporations that qualify under the Tax Code is completely exempt from corporateincome taxes Thus, the federal government receives no tax revenue from these businesses, even though they report high accounting profits

b All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code

c Small corporations that qualify under the Tax Code can elect not to pay corporate taxes, but then each

stockholder must report his or her pro rata shares of the firm's income as personal income and pay taxes on that income

d Congress recently changed the tax laws to make dividend income received by individuals exempt from incometaxes Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the corporation's income and stockholders were taxed again on this income when it was paid to them as dividends

e All corporations other than non-profits are subject to corporate income taxes, which are 15% for the lowest amounts of income and 38% for the highest income amounts

61 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

RATIONALE: Statement a is false, because retained earnings represent the cumulative accrued value to

shareholders that a firm has amassed Statement b is false, because interest income does

Trang 24

not benefit from tax exclusion Statement c is true, because dividend income does benefit from tax exclusion Statement d is false, because long-term capital gains are taxed at the L-T capital gains rate, which depends upon the investor's taxable income but is usually

significantly lower than personal tax rates Statement e is false, because the tax deductibility

of interest paid shows the tax system favors debt financing

62 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

REFERENCES: Comprehensive

TOPICS: Cash flow and FCF

63 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

Trang 25

TOPICS: Changes in depreciation

64 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

65 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

Trang 26

66 Assume that Besley Golf Equipment commenced operations on January 1, 2014, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes The company planned to depreciateits fixed assets over 15 years, but in December 2014 management realized that the assets would last for only 10 years Thefirm's accountants plan to report the 2014 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 2014 earnings per share would increase

d The firm's cash position in 2014 and 2015 would increase

e The provision will increase the company's tax payments

67 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

Trang 27

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

69 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 cashflows 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 withaccounting income as defined by GAAP

e The best feature of standard statements is that, if they are prepared under GAAP, the data are always consistentfrom firm to firm Thus, under GAAP, there is no room for accountants to "adjust" the results to make earningslook better

Trang 28

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

71 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

DIFFICULTY: CHALLENGING

Trang 29

72 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

TOPICS: Changes in leverage

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 producemust 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 seeDPS exceed EPS

Trang 30

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 the change

in 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 dividendsthe 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

a Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the companyhas 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

Trang 31

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

TOPICS: Cash flow and taxes

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 $17.83

b $18.72

c $19.6

Trang 32

Book value per share = Total book equity/Number of shares $9.67

KEYWORDS: Bloom's: Evaluation

OTHER: Multiple Choice: Problem

78 Brown Fashions Inc.'s December 31, 2014, balance sheet showed total common equity of $4,050,000 and 200,000 shares of stock outstanding During 2014, the firm had $450,000 of net income, and it paid out $100,000 as dividends What was the book value per share at 12/31/14, assuming no common stock was either issued or retired during 2014?

Trang 33

KEYWORDS: Bloom’s: Analysis

79 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?

80 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?

Trang 34

RATIONALE: Sales $20.50

Note that operating income is before interest and taxes

81 Brown Office Supplies recently reported $15,500 of sales, $8,250 of operating costs other than depreciation, and

$1,750 of depreciation It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state incometax rate was 40% How much was the firm's earnings before taxes (EBT)?

82 Vasudevan Inc recently reported operating income of $2.75 million, depreciation of $1.20 million, and had a tax rate

Trang 35

of 40% The firm's expenditures on fixed assets and net operating working capital totaled $0.6 million How much was its free cash flow, in millions?

83 Over the years, O'Brien Corporation's stockholders have provided $20,000,000 of capital, when they purchased new issues of stock and allowed management to retain some of the firm's earnings The firm now has 1,000,000 shares of common stock outstanding, and it sells at a price of $38.50 per share How much value has O'Brien's management added

to stockholder wealth over the years, i.e., what is O'Brien's MVA?

RATIONALE: Total book value of equity

Stock price per shareShares outstandingMarket value of equity = Stock price × Number of shares

Trang 36

MVA = Market value of equity − Book value of equity

United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills

STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows

84 Wu Systems has the following balance sheet How much net operating working capital does the firm have?

_ Retained earnings 500

Net operating working capital = Current assets − (Current liabilities − Notes payable) NOWC = $1,300.00 − $550 NOWC = $750

Định dạng
Số trang	72
Dung lượng	188,33 KB