FIN 534 Week 3 Quiz 2 Chapters 2 and 3
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FIN 534 Week 3 Quiz 2 Chapters 2 and 3

 
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Quiz 2: Chapters 2 and 3

 

1. 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.

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

 

c.  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.

 

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 income and stockholders were taxed again on the income when it was paid to them as dividends.

 

e. 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.

                                                                                                                       

 

2.  Analysts who follow Howe Industries recently noted that, relative to the previous year, the company’s operating net cash flow 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 a large investment in a profitable new plant.  

 

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.

                                                                                                                      

3. 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.

 

a. The provision will reduce the company’s net cash flow.

 

b. The provision will increase the company’s tax payments.

 

c. Net fixed assets on the balance sheet will increase.

 

d.  The provision will increase the company’s net income.

e. Net fixed assets on the balance sheet will decrease.

                                                                                                                       

 

4. 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, 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.

 

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 are 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.

                                                                                                                       

 

5. 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’ net operating profits after taxes (NOPAT) would decline.

 

b.  Companies’ physical stocks of fixed assets would increase.

 

c.  Companies’ net cash flows would increase.

 

d. Companies’ cash positions would decline.

 

f.  Companies’ reported net incomes would decline.

                                                                                                                                              

6. Last year, Tucker Technologies had (1) a negative net 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 its depreciation and amortization expenses.

                                                                                                                      

 

7. 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.                                                                                                   

 

 

8. 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 net cash flow.

 

e. The income statement for a given year, say 2007, is designed to give us an idea of how much the firm earned during that year.

 

9. 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 net fixed assets as shown on the balance sheet will be higher at the end of the year.

 

c. Nantell’s cash position will improve (increase).

 

d. Nantell’s reported net income after taxes for the year will be lower.

 

e. Nantell’s tax liability for the year will be lower.

                                                                                                                         

 

10. Which of the following statements is CORRECT?

 

a. In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.

 

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 reported as a use of cash.

 

d. In the statement of cash flows, depreciation charges are reported as a use of cash.

 

e. In the statement of cash flows, a decrease in inventories is reported as a use of cash.

         

                                                                              

11. Which of the following statements is CORRECT?

 

a. Since depreciation is a source of funds, 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 shown 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.

                            

12. Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined.  Which of the following could explain this performance?

 

a. The company’s operating income declined.

 

b. The company’s expenditures on fixed assets declined.

 

c. The company’s cost of goods sold increased.

 

d. The company’s depreciation and amortization expenses declined.

 

e. The company’s interest expense increased.

           

                                                                                                                       

13. Which of the following statements is CORRECT?

 

a. Operating cash flow (OCF) is defined as follows:

OCF = EBIT(1-T) - Depreciation and Amortization.

 

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 and Amortization                                              

- 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)+ Depreciation and Amortization + Capital expenditures.

Operating cash flow is the same as free cash flow (FCF).

                                                                                                                       

 

14. 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.

                                                                                                                          

 

15. Which of the following statements is CORRECT?

 

a. 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.

 

b. MVA gives us an idea about how much value a firm’s management has added during the last year.

 

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

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

 

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

EVA = EBIT(1-T) – (Investor-supplied op. capital) x (A-T cost of capital).

  

e. EVA gives us an idea about how much value a firm’s management has added over the firm’s life.

                                                                                                                      

16. 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.

                                                                                                                                                   

 

17. If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., “grading” the manager), which of the following situations would be likely to cause the manager to receive a better grade?  In all cases, assume that other things are held constant.

 

a. The division’s basic earning power ratio is above the average of other firms in its industry.

 

b. The division’s total assets turnover ratio is below the average for other firms in its industry.

 

c. The division’s debt ratio is above the average for other firms in the industry.

 

d. The division’s inventory turnover is 6, whereas the average for its competitors is 8.

 

e. The division’s DSO (days’ sales outstanding) is 40, whereas the average for its competitors is 30.

                                                                                                                                                  

 

 

18. 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?

 

The ROA will decline.

 

Taxable income will decrease.

 

The tax bill will increase.

 

Net income will decrease.

 

The times interest earned ratio will decrease.

 

 

19. 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.

 

 

20. 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.

         

 

21. 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.

 

 

 

22. 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.

         

 

23. Safeco’s current assets total to $20 million versus $10 million of current liabilities, while Risco’s current assets are $10 million versus $20 million of current liabilities.  Both firms would like to “window dress” their end-of-year financial statements, and to do so they tentatively plan to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts.  Which of the statements below best describes the results of these transactions?

  

a. The transactions would raise Safeco’s financial strength as measured by its current ratio but lower Risco’s current ratio.

b. The transactions would lower Safeco’s financial strength as measured by its current ratio but raise Risco’s current ratio.

 

c. The transaction would have no effect on the firm’ financial strength as measured by their current ratios.

 

d. The transaction would lower both firm’ financial strength as measured by their current ratios.

 

e. The transaction would improve both firms’ financial strength as measured by their current ratios.

                                                           

 

24. Companies E and P each reported the same earnings per share (EPS), but Company E’s stock trades at a higher price. Which of the following statements is CORRECT?

 

a. Company E probably has fewer growth opportunities.

 

b. Company E is probably judged by investors to be riskier.

 

c. Company E must have a higher market-to-book ratio.

 

d. Company E must pay a lower dividend.

 

e. Company E trades at a higher P/E ratio.

 

 

25. A firm wants to strengthen its financial position.  Which of the following actions would increase its current ratio?

 

a. Reduce the company’s days’ sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.

 

b. Use cash to repurchase some of the company’s own stock.

 

c. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.

 

d. Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

 

e. Use cash to increase inventory holdings.

 

 

26. Amram Company’s current ratio is 1.9.  Considered alone, which of the following actions would reduce the company’s current ratio?

 

a. Borrow using short-term notes payable and use the proceeds to reduce accruals.

 

b. Borrow using short-term notes payable and use the proceeds to reduce long-term debt.

c. Use cash to reduce accruals.

 

d. Use cash to reduce short-term notes payable.

 

e. Use cash to reduce accounts payable.

                                                                                                                                              

 

27. 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.

                                                                                                                                             

 

28. 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.

                                                                                                                                                   

 

29. 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.

                                                                                                                      

 

30. Which of the following would, generally, indicate an improvement in a company’s financial position, holding other things constant?

 

a. The TIE declines.

 

b. The DSO increases.

 

c. The EBITDA coverage ratio increases.

 

d. The current and quick ratios both decline.

 

e. The total assets turnover decreases.

 

 

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