Finance 101 (Quizes and practice 03)

Last year Firm X had sales of $100,000, labor costs of $30,000, material costs of $30,000, and depreciation of $10,000. Assume that labor and material costs were paid in cash. The tax rate on its net income was 40%. What was the firm's net income?

18,000 EBIT= 100,000-30,000-30,000-10,000=30,000 EBT=30,000 NET income = 30,000-(40% of EBT)

The annual report includes which of the following statements?

a. A balance sheet for the latest year and possibly for several prior years. b. An income statement for the latest year and possibly for several prior years. c. A statement of cash flows for the latest year. d. A statement of stockholders' equity for the latest year. e. All of these are correct. (right answer is e)

Retained earnings refer to the portion of a corporation's profits that are paid out to shareholders.

False: Retained Earnings are what the company keeps from the share of earningings

A firm has current assets consisting of $100 cash, $300 of accounts receivable, and $400 of inventories. Its current liabilities include $200 of accounts payable, $100 of accrued wages and taxes, and $200 of notes payable to its bank. The cash balance is not considered "excess" cash. What is its NOWC?

$500 net operating working capital (NOWC) (NOWC) = (Current assets-"Excess" Cash)-(Current Liabilities-Notes Payable) (300+400-100)-(200+100-200) = 500

If a firm began the year showing $10 million as retained earnings on its balance sheet, had $2 million of net income for the year, and paid $3 million in dividends, what would be the amount of its retained earnings at the end of the year?

9,000,000 RE = 10+2-3

The assets of Dallas & Associates consist entirely of current assets and net plant and equipment. The firm has total assets of $2.8 million and net plant and equipment equals $2.4 million. It has notes payable of $140,000, long-term debt of $755,000, and total common equity of $1.45 million. The firm does have accounts payable and accruals on its balance sheet. The firm only finances with debt and common equity, so it has no preferred stock on its balance sheet. Write out your answers completely. For example, 25 million should be entered as 25,000,000. Enter negative amounts, if any, with a minus sign. A) What is the company's total debt? B) What is the amount of total liabilities and equity that appears on the firm's balance sheet?

A = 895000 B

Corporate tax

Corporate Corporations earn most of their income from operations; however, they may also receive interest and dividend income. Interest income is taxed as ordinary income; however, dividend income is taxed more favorably. 70% of dividend received is excluded from taxable income, while the remaining 30% is taxed at the ordinary tax rate. For businesses, interest payments are regarded as an expense so they are tax deductible; however, dividend payments are not tax deductible. Consequently, our tax system encourages debt financing over financing. Depreciation expense is tax deductible, so the larger the depreciation, the lower the taxable income, the lower the taxes, and the higher the firm's operating cash flow. The projected 2013 tax rate schedule for corporations is shown below.

total investor supplied capital

EVA = EBIT (1-T) - (Total Investor capital * WACC) Total investor-supplied capital = Notes payable + Long-term debt + Common Equity + Retained Earnings

Market value added

EVA/MVA The financial statements reflect historical data, but managers' performance must be evaluated on the basis of market values. To provide this information, financial analysts have developed two measures: Market Value Added (MVA) and Economic Value Added (EVA). Market Value Added represents the difference between the money stockholders have invested in the firm versus the cash they could receive if the firm were sold. The equation for MVA is:

Economic Value added

Economic Value Added is sometimes called "economic profit ", and it is closely related to MVA. The equation for EVA is: EVA = EBIT(1 - T) - (Total invested capital x After-tax percentage cost of capital) Note that total invested capital is equal to the sum of notes payable, long-term debt, and total common equity. EVA differs from net income because EVA has a deduction for the cost of equity. Positive EVA on an annual basis helps ensure that MVA is also positive. EVA can be determined for divisions as well as for the firm as a whole, so it is useful for establishing reasonable compensation for divisional managers as well as top company officers.

Last year Firm X had sales of $100,000, labor costs of $30,000, material costs of $30,000, and depreciation of $10,000. Assume that labor and material costs were paid in cash. The tax rate on its net income was 40%. Assume that the firm made no capital expenditures and had no changes in net operating working capital during the year. What was Firm X's free cash flow?

FCF = [EBIT (1-T) + Depreciation and Amoritization] - Required capital expenditures and increase in NOWC EBIT= 100,000-30,000-30,000-10,000=30,000 FCF=[30,000(1-.4)+10,000]-(0+0)= 28,000

Free cash flow (FCF) is the cash flow from operations, after investments necessary to maintain future cash flows, that is available for payment to investors, and it is found using the following equation. True or false?

FCF = [EBIT (1-T) + Depreciation and Amoritization] - Required capital expenditures and increase in NOWC True

After the recent corporate scandals, Congress and the SEC tightened reporting rules and began to impose stiff penalties on corporations and their officers who circulated misleading information. Consequently, we can be positive that the information firms publish in their annual reports and release to the press is accurate and truthful, and that all numbers were calculated in a consistent manner by different firms. True or false?

False

Depreciation is an annual charge against income that reflects the estimated dollar cost of capital equipment used up but doesn't represent an actual cash outlay. As a result, net income is not adjusted by depreciation in the statement of cash flows. True or false?

False

If a firm buys $100,000 of materials and $50,000 of labor services, it typically must pay cash for these items during the current year. If its income statement shows a $50,000 depreciation expense, this expense also requires a cash payment. True or false?

False

progressive

Federal Income Taxes Individuals and firms pay out a significant portion of their income as taxes, so taxes are important in both personal and corporate decisions. Our tax system is progressive.

annual report

The focus on financial statements in finance is how managers and investors interpret and use them. A firm's annual report contains both verbal and quantitative information. The quantitative information consists of four financial statements: (1) Balance Sheet, (2) Income Statement, (3) Statement of Cash Flows, and (4) Statement of Stockholders' Equity.

Capital gains are taxed and capital losses are not.

True

Economic value added (EVA) is equal to EBIT(1 - T), or NOPAT, minus the dollar cost of all the firm's total invested capital. The primary difference between EVA and accounting net income is that only the cost of debt (interest charges) is deducted when calculating accounting net income whereas the cost of common equity is also deducted when finding EVA. True or false?

True

Stockholders' equity consists of paid-in capital, which is the amount of money the firm has raised by issuing newly created shares to stockholders, and retained earnings, which is the sum of all past earnings minus all past dividends. True or false?

True

Which of the following statements regarding free cash flows is NOT CORRECT?

a. Basically, free cash flow is a measure of how much money a company has that's not currently tied up in keeping itself afloat. b. FCF = [EBIT(1 - T) + Depreciation and Amortization] - [Capital Expenditures + ΔNOWC] c. Free cash flow is the "extra money" that the firm has available to spend on things like paying investors. d. Negative free cash flow is always bad and indicative that the firm will be bankrupt soon. There is never a good reason for a firm to have negative free cash flow. (Right Answer is d)

capital expenditures

CapEx = Property and equipment (current period) - Property and equipment (prior period) + Depreciation (current period)

statement of stockholders' equity

Changes in stockholders' equity during an accounting period are reported in the statement of stockholders' equity. Changes in stockholders' equity can come from new stock issues, stock repurchases, net income, and dividends paid.

Balance Sheet

The balance sheet shows the firm's assets and claims against those assets. In other words, assets are equal to liabilities and equity. Assets are shown in order of their liquidity and claims are listed in the order of when they must be paid. Current assets include cash and their equivalents, accounts receivable , and inventory, while long-term assets are those whose useful lives exceed one year. Liabilities are divided into current liabilities and long-term debt. We differentiate between total debt and total liabilities. A company's total debt includes both its short-term and long-term interest bearing liabilities. Total liabilities equal total debt plus the company's "free" liabilities. Net working capital is the difference between current assets and current liabilities, while net operating working capital is equal to current assets less the difference between current liabilities and notes payable. Net Worth is capital supplied by common stockholders and represents ownership.

Income Statement

The income statement reports on operations over a period of time. Companies' operating performances can be compared by looking at each firm's EBIT, often referred to as operating income. A typical stockholder focuses on the bottom line of the income statement, earnings per share . The income statement is tied to the balance sheet through the retained earnings account. Net income minus dividends paid is equal to the retained earnings for the year, and this amount is added to the cumulative retained earnings from prior years to obtain the year-end retained earnings balance.

total common equity

=common stock+retained earnings

Which of the following accounts is EXCLUDED when calculating net operating working capital?

a. Accruals b. Notes payable to banks c. Accounts payable d. Inventories e. Accounts receivable (Right answer is b)

Which of the following is not something that corporations can do with their profits?

a. Pay income tax to the government b. Pay them to shareholders c. Hold profits within the firm d. They can do all of these. (right answer is d)

Which of the following does NOT increase cash and cash equivalents during the year?

a. Repayment of long-term bonds b. An increase in accounts payable c. An increase in notes payable d. A decrease in accounts receivable e. A decrease in inventories (Right answer is a)

NWC

current assets - current liabilities

EBIT

earnings before interest and taxes =Sales Revenues-Operating costs

MVA

MVA = (Shares outstanding × Stock price) - Total common equity Shareholder wealth is maximized when this difference is maximized . The higher a firm's MVA, the better the job management is doing for its shareholders.

Statement of cash flows

Management's goal is to maximize the firm's stock price. The value of any asset, including a share of stock, is based on the cash flows the asset is expected to produce. Therefore, managers strive to maximize the cash flows available to investors. The statement of cash flows shows how much cash a firm is generating. It is divided into four parts: (1) Operating activities, (2) Long-Term Investing activities, (3) Financing activities, and (4) Summary.

free cash flow

Free Cash Flow The focus on traditional financial statements is data rather than cash flow. However, cash flow is important to investors, managers, and stock analysts. Therefore, decision makers and security analysts need to modify financial statement data provided to them. An important modification is the concept of free cash flow (FCF). Many analysts regard FCF as being the single and most important number that can be developed from the income statements, even more important than net income. The equation for free cash flow is: FCF = [EBIT(1 - T) + Depreciation and amortization] - [Capital expenditures + ΔNet operating working capital] Free cash flow is the cash flow actually available for payments to all investors (stockholders and debtholders) after the company has made investments in fixed assets, new products, and operating working capital . A negative FCF means that the company does not have sufficient internal funds to finance its investments in fixed assets and working capital, and that it will have to raise new money in the capital markets to pay for these investments. Negative FCF is not always bad. If FCF is negative because after-tax operating income is negative this is bad, because the company is probably experiencing operating problems. Exceptions to this might be startup companies, companies incurring significant expenses to launch a new product line, and high-growth companies—with large capital investments.

capital asset

Individual Individuals pay taxes on wages, on investment income, and on the profits of proprietorships and partnerships. Taxable income is defined as gross income less a set of exemptions and deductions. In 2013, the personal exemption is $3,900 per person. A capital gain (loss) is the profit (loss) from the sale of a capital asset for more (less) than its purchase price. In 2013, for most taxpayers a long-term capital gain is taxed at a maximum rate of 15%, while a short term capital gain is taxed as ordinary income [For single taxpayers with incomes over $400,000 and married taxpayers filing jointly with incomes over $450,000, the maximum tax rate on long-term capital gains has increased to 20%.]. Investment income consists of dividend and interest income. Interest income (except interest on state and local government debt which is exempt from federal taxes) is taxed as ordinary income while dividends are taxed at the same rate as long-term capital gains. Generally, interest payments are not tax deductible for individuals except for interest on home mortgages within certain limits. Projected 2013 tax rate schedules are shown for single individuals and married couples filing jointly.

If a corporation had positive income and thus paid taxes in 2013 and 2012, but it incurred a loss in 2014, it could carry that loss back to those 2 prior years, reduce the taxable income in those years, and receive a credit (in the form of a refund check) for any overpayments of past taxes. Moreover, if its 2014 loss was greater than the taxable income in those past 2 years, then it could carry the loss forward to reduce income in 2015 and beyond—up to 20 years. True or false?

True

The balance sheet summarizes the assets that the firm owns and the debt and equity capital that was used to finance those assets. The assets are divided into those expected to be used within a year and those expected to be used for more than one year. Similarly, liabilities and capital are divided into those items that must be paid off within a year and those that have longer maturities. True or false?

True