FIN 534 quiz 2 week 3
Rating A
Question 1
Which of the following statements is CORRECT?
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 tax purposes and taxed at the individual’s regular tax rate, which in 2008 could go up to 35%, but dividends received were taxed at a maximum rate of 15%.
c. The maximum federal tax rate on corporate income in 2008 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.
d. The maximum federal tax rate on personal income in 2008 was 50%.
Question 2
Which of the following statements is CORRECT?
The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of retained earnings.
The balance sheet gives us a picture of the firm’s financial position at a point in time.
The income statement gives us a picture of the firm’s financial position at a point in time.
The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits.
The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.
Question 3
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?
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.
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, for valuation purposes we need to discount cash flows, not accounting income. Moreover, since many firms have a number of separate divisions, and since division managers should be compensated on their divisions’ performance, not that of the entire firm, information that focuses on the divisions is needed. These factors have led to the development of information that is focused on cash flows and the operations of individual units.
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.
The standard statements focus on cash flows, but managers are less concerned with cash flows than with accounting income as defined by GAAP.
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.
Question 4
On its 2010 balance sheet, Barngrover Books 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 2010, they must have paid dividends.
b. The company must have had zero net income in 2010.
c. The company must have paid out half of its earnings as dividends.
d. The company must have paid no dividends in 2010.
e. Dividends could have been paid in 2010, but they would have had to equal the earnings for the year.
Question 5
Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet?
The company repurchases common stock.
The company pays a dividend.
The company issues new common stock.
The company gives customers more time to pay their bills.
The company purchases a new piece of equipment.
Question 6
The CFO of Shalit 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. 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?
The company’s taxable income would fall.
The company’s interest expense would remain constant.
The company would have less common equity than before.
The company’s net income would increase.
The company would have to pay less taxes.
Question 7
Which of the following factors could explain why Dellva Energy had a negative net cash flow last year, even though the cash on its balance sheet increased?
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 amortization expenses.
e. The company repurchased 20% of its common stock.
Question 8
Which of the following statements is CORRECT?
Since depreciation is a source of funds, the more depreciation a company has, the larger its retained earnings will be, other things held constant.
A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.
Common equity includes common stock and retained earnings, less accumulated depreciation.
The retained earnings account as shown on the balance sheet shows the amount of cash that is available for paying dividends.
If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.
Question 9
Below is the common equity section (in millions) of Teweles Technology’s last two year-end balance sheets:
2009 2008
Common stock $2,000 $1,000
Retained earnings 2,000 2,340
Total common equity $4,000 $3,340
Teweles has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?
a. The company’s net income in 2009 was higher than in 2008.
b. Teweles issued common stock in 2009.
c. The market price of Teweles’ stock doubled in 2009.
d. Teweles had positive net income in both 2008 and 2009, but the company’s net income in 2009 was lower than it was in 2008.
e. The company has more equity than debt on its balance sheet.
Question 10
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 tax rate. Prior to the new provision, BBI’s net income after taxes 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.
The provision will reduce the company’s net cash flow.
The provision will increase the company’s tax payments.
Net fixed assets on the balance sheet will increase.
The provision will increase the company’s net income.
Net fixed assets on the balance sheet will decrease.
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 net cash flow would increase.
d. The firm’s tax payments would increase.
e. The firm’s reported net income would increase.
Question 12
Which of the following statements is CORRECT?
The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus, the federal government receives no tax revenue from these businesses.
All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code.
Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm’s income as personal income and pay taxes on that income.
Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes. Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the income and stockholders were taxed again on the income when it was paid to them as dividends.
All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income.
Question 13
Which of the following statements is CORRECT?
a. One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital.
b. If a firm reports positive net income, its EVA must also be positive.
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 generate the same level of operating income but with less investor-supplied capital.
e. Actions that increase reported net income will always increase net cash flow.
Question 14
Which of the following statements is CORRECT?
The more depreciation a firm reports, the higher its tax bill, other things held constant.
People sometimes talk about the firm’s net cash flow, which is shown as the lowest entry on the income statement, hence it is often called “the bottom line.”
Depreciation reduces a firm’s cash balance, so an increase in depreciation would normally lead to a reduction in the firm’s net cash flow.
Net cash flow (NCF) is often defined as follows:
Net Cash Flow = Net Income + Depreciation and Amortization Charges.
Depreciation and amortization are not cash charges, so neither of them has an effect on a firm’s reported profits.
Question 15
Which of the following items is NOT included in current assets?
Accounts receivable.
Inventory.
Bonds.
Cash.
Short-term, highly liquid, marketable securities.
Question 16
A firm’s new president wants to strengthen the company’s financial position. Which of the following actions would make it financially stronger?
a. Increase accounts receivable while holding sales constant.
b. Increase EBIT while holding sales constant.
c. Increase accounts payable while holding sales constant.
d. Increase notes payable while holding sales constant.
e. Increase inventories while holding sales constant.
Question 17
Which of the following statements is CORRECT?
a. Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of “window dressing.” Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of “window dressing.”
b. Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of “window dressing.”
c. Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of “window dressing.”
d. Using some of the firm’s cash to reduce long-term debt is an example of “window dressing.”
e. “Window dressing” is any action that improves a firm’s fundamental, long-run position and thus increases its intrinsic value.
to be an example of “window dressing.”
Question 18
Which of the following statements is CORRECT?
a. If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.
b. If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.
c. Other things held constant, the higher a firm’s expected future growth rate, the lower its P/E ratio is likely to be.
d. The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA).
e. If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average.
Question 19
Which of the following statements is CORRECT?
a. If a security analyst saw that a firm’s days’ sales outstanding (DSO) was higher than the industry average and was also increasing and trending still higher, this would be interpreted as a sign of strength.
b. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days’ sales outstanding (DSO) will increase.
c. There is no relationship between the days’ sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things.
d. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.
e. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days’ sales outstanding will decline.
Question 20
Taggart Technologies is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Taggart pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?
a. The ROA will decline.
b. Taxable income will decrease.
c. The tax bill will increase.
d. Net income will decrease.
e. The times interest earned ratio will decrease.
Question 21
Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company’s total assets or operating income. Which of the following effects would occur as a result of this action?
a. The company’s current ratio increased.
b. The company’s times interest earned ratio decreased.
c. The company’s basic earning power ratio increased.
d. The company’s equity multiplier increased.
e. The company’s debt ratio increased.
Question 22
Which of the following statements is CORRECT?
a. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be the same.
b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.
c. If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price earnings ratio.
d. If Firm X’s P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and also to be expected to grow at a faster rate.
e. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same.
Question 23
Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both companies have positive net incomes. Company HD has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?
a. Company HD pays less in taxes.
b. Company HD has a lower equity multiplier.
c. Company HD has a higher ROA.
d. Company HD has a higher times interest earned (TIE) ratio.
e. Company HD has more net income.
Question 24
You observe that a firm’s ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT?
a. Its total assets turnover must be above the industry average.
b. Its return on assets must equal the industry average.
c. Its TIE ratio must be below the industry average.
d. Its total assets turnover must be below the industry average.
e. Its total assets turnover must equal the industry average.
Question 25
Which of the following would indicate an improvement in a company’s financial position, holding other things constant?
a. The inventory and total assets turnover ratios both decline.
b. The debt ratio increases.
c. The profit margin declines.
d. The EBITDA coverage ratio declines.
e. The current and quick ratios both increase.
Question 26
A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?
a. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2)lead to an increase in accounts receivable.
b. Issue new common stock and use the proceeds to increase inventories.
c. Speed up the collection of receivables and use the cash generated to increase inventories.
d. Use some of its cash to purchase additional inventories.
e. Issue new common stock and use the proceeds to acquire additional fixed assets.
Question 27
If a bank loan officer were considering a company’s request for a loan, which of the following statements would you consider to be CORRECT?
a. The lower the company’s EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.
b. Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.
c. Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.
d. The lower the company’s TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.
e. Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.
Question 28
Companies HD and LD are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company HD has the higher debt ratio. Which of the following statements is CORRECT?
a. Company HD has a lower total assets turnover than Company LD.
b. Company HD has a lower equity multiplier than Company LD.
c. Company HD has a higher fixed assets turnover than Company B.
d. Company HD has a higher ROE than Company LD.
e. Company HD has a lower operating income (EBIT) than Company LD.
Question 29
Which of the following statements is CORRECT?
a. Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will increase.
b. Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Without additional information, we cannot tell what will happen to the ROE.
c. The modified Du Pont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE.
d. Other things held constant, an increase in the debt ratio will result in an increase in the profit margin on sales.
e. Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will decrease.
Question 30
Considered alone, which of the following would increase a company’s current ratio?
a. An increase in net fixed assets.
b. An increase in accrued liabilities.
c. An increase in notes payable.
d. An increase in accounts receivable.
e. An increase in accounts payable.
