Question 1

Which of the following statements is CORRECT?
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 Revenues less 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.

Accepted Answer

Option D is correct, as operating income is indeed calculated as revenues minus operating costs, and operating costs do not include interest or taxes. Option A is incorrect because higher depreciation leads to lower taxable income and, hence, a lower tax bill. Option B is incorrect because the bottom line refers to the net income or profit after all expenses, including taxes and interest, have been deducted. Option C is incorrect because depreciation is a non-cash expense that adds back to the firm's cash balance. Option E is incorrect because depreciation can affect a firm's reported profits indirectly through its impact on taxes and net income.

Question 2

Which of the following statements is CORRECT?
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 value per 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.

Accepted Answer

This statement is correct because a firm's profitability is one of the key drivers of its stock price. If a firm is more profitable than average, it indicates that it is able to generate higher earnings and cash flows, which should raise investor confidence and increase demand for the stock, driving up its price. Book value per share, on the other hand, reflects the value of a firm's assets minus its liabilities and is not directly related to profitability. Therefore, if a firm is more profitable than most other firms, we would not necessarily expect to see its book value per share exceed its stock price.

Question 3

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

The answer of Last year, Delip Industries had (1) negative...

Question 4

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.

Accepted Answer

The answer of Analysts who follow Howe Industries recently noted...

Question 5

Which of the following statements is CORRECT?
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 investor-supplied 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 investor-supplied capital obtained at a higher cost of capital.
E) If a firm reports positive net income, its EVA must also be positive.

Accepted Answer

Option A is incorrect as actions that increase reported net income may not translate into cash flow, for example, the depreciation expense. Option C is incorrect as EVA recognizes that equity capital has an opportunity cost. Option D is incorrect as EVA measures the excess return generated by the firm over its cost of capital, rather than the absolute level of return. Option E is incorrect as a firm can have positive net income but negative EVA if the cost of capital exceeds the return generated. Option B is correct as EVA measures the ability of a firm to generate returns on its investor-supplied capital, and a higher EVA can be achieved by generating the same operating income with less capital.

Question 6

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

According to the current tax code, 70% of the dividends received by corporations is excluded from taxable income, making it the most correct statement among the options provided. Option A is incorrect because retained earnings represent the profits a company has kept and reinvested back into the business. Option B is incorrect as there is no provision in the tax code that excludes 70% of interest received by corporations from taxable income. Option D is incorrect because investors pay a lower tax rate on long-term capital gains. Finally, option E is not true as dividends paid are not deductible from corporate taxes.

Question 7

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.

Accepted Answer

The answer of Which of the following statements is most...

Question 8

Which of the following statements is CORRECT?
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:

Accepted Answer

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

Question 9

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.

Accepted Answer

Cost of goods sold is an expense item, not a liability item, and therefore would not appear on a balance sheet under current liabilities.

Question 10

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.

Accepted Answer

According to the tax code, a loss incurred by a corporation can be carried back up to 2 years and carried forward up to 20 years following the loss. This allows the corporation to offset income in those years and reduce the overall tax liability.

Question 11

Which of the following statements is CORRECT?
A) 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, 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 income taxes. 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.

Accepted Answer

Small corporations that qualify under the Tax Code can elect to not pay corporate taxes through the S Corporation election. In this case, the income of the corporation is passed through to the stockholders as personal income and taxed on their individual tax returns. This avoids double taxation of corporate income.

Question 12

Which of the following statements is CORRECT?
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.

Accepted Answer

Free cash flow is calculated as EBIT(1 - T) + Depreciation - Capital expenditures - Required changes in net operating working capital.

Question 13

Which of the following statements is CORRECT?
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.
E) The income statement for a given year, say 2012, is designed to give us an idea of how much the firm earned during that year.

Accepted Answer

The income statement is a financial statement that summarizes a company's revenues and expenses for a specific period, such as a year. Its main purpose is to show how much the company earned (or lost) during that period. The other statements (such as the balance sheet and cash flow statement) provide additional information about the company's financial position and cash flows, but the income statement is focused on earnings. Choices A, B, C, and D are incorrect because they are either false or incomplete statements about accounting procedures and principles.

Question 14

Which of the following statements is CORRECT?
A) In the statement of cash flows, a decrease in accounts receivable is subtracted from net income in the operating activities 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.
E) In the statement of cash flows, a decrease in inventories is subtracted from net income in the operating activities section.

Accepted Answer

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

Question 15

Which of the following statements is CORRECT?
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 short-term liquid securities (or cash equivalents)--increased or decreased during a given year.

Accepted Answer

The statement of cash flows shows the change in the firm's cash during a given period, which includes cash flows from operations, investing activities (such as buying or selling fixed assets), and financing activities (such as borrowings and issuing new stock). It also reflects the effects of changes in working capital. Option A is incorrect because the statement of cash flows does reflect the effects of buying or selling fixed assets. Option B is incorrect because it does not show where the firm's cash is located, but rather how much cash the firm has. Option C is incorrect because it does reflect the effects of changes in working capital. Option D is incorrect because it does reflect cash obtained from issuing new stock.

Question 16

On its 12/31/12 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 2012, it must have paid dividends.
B) The company must have had zero net income in 2012.
C) The company must have paid out half of its 2012 earnings as dividends.
D) The company must have paid no dividends in 2012.
E) Dividends could have been paid in 2012, but they would have had to equal the earnings for the year.

Accepted Answer

If retained earnings remained the same, any net income earned in 2012 must have been paid out as dividends, meaning dividends equaled earnings.

Question 17

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 federal tax purposes and taxed at the individual's regular tax rate, which in 2011 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 2011 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 2011 was 50%.

Accepted Answer

Interest paid is counted as income for federal tax purposes and taxed at the individual's regular tax rate, which could go up to 35%, while dividends received were taxed at a maximum rate of 15% in 2011. Options A, C, D, and E are incorrect statements.

Question 18

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 19

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.
C) The company's cost of goods sold increased.
D) The company's depreciation expense declined.
E) The company's interest expense increased.

Accepted Answer

The increase in net income could be due to a decline in depreciation expense, which would reduce expenses and increase net income without affecting cash flow. The decline in net cash provided from operations could be due to the fact that depreciation expense is added back to net income in the indirect method of cash flow statement, so a decline in depreciation expense would reduce the amount of cash provided from operations.

Question 20

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.

Accepted Answer

Selling a new issue of bonds would bring in cash and increase the company's cash balance, even if it had a negative cash flow from operations.

Quiz 3: Financial Statements

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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?

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?

Which of the following statements is CORRECT?

Which of the following statements is most correct?

Which of the following statements is most correct?

Which of the following statements is CORRECT?

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

A loss incurred by a corporation

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?

Which of the following statements is CORRECT?

On its 12/31/12 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?

Which of the following statements is CORRECT?

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?

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