Chapter 2

What are the four financial statements that all public companies must produce?

1. balance sheet 2. income statement 3. statement of cash flows 4. statement of stockholdersʹ equity

Convex Industries has inventories of $218 million, current assets of $1.4 billion, and current liabilities of $504 million. What is its quick ratio?

2.35 Explanation: ($1400 - $218)/$504 = 2.35

Company A has current assets of $42 billion and current liabilities of $41 billion. Company B has current assets of $2.7 billion and current liabilities of $1.8 billion. Which of the following statements is correct, based on this information? A) Company A is less likely than Company B to have sufficient working capital to meet its short-term needs. B) Company A has greater leverage than Company B. C) Company A has less leverage than Company B. D) Company A and Company B have roughly equivalent enterprise values.

A) Company A is less likely than Company B to have sufficient working capital to meet its short-term needs.

A small company has current assets of $112,000 and current liabilities of $117,000. Which of the following statements about that company is most likely to be true? A) Since net working capital is negative, the company will not have enough funds to meet its obligations. B) Since net working capital is high, the company will likely have little difficulty meeting its obligations. C) Since net working capital is very high, the company will have ample money to invest after it meets its obligations. D) Since net working capital is nearly zero, the company is well run and will have little difficulty attracting investors.

A) Since net working capital is negative, the company will not have enough funds to meet its obligations.

What is the main problem in using a balance sheet to provide an accurate assessment of the value of a companyʹs equity? A) Valuable assets such as the companyʹs reputation, the quality of its work force, and the strength of its management are not captured on the balance sheet. B) The balance sheet does not accurately represent the book value of assets held by the company. C) The equity shown on the balance sheet does not reflect the market capitalization of the company. D) Knowing at a single point in time what assets a firm possesses and the liabilities a firm owes does not give any indication of what those assets can produce in the future.

A) Valuable assets such as the companyʹs reputation, the quality of its work force, and the strength of its management are not captured on the balance sheet.

A company has a share price of $22.15 and 118 million shares outstanding. Its market-to-book ratio is 4.2, its book debt-equity ratio is 3.2, and it has cash of $800 million. How much would it cost to take over this business assuming you pay its enterprise value?

Answer: $3.8 billion Explanation: Market cap = $22.15 x 118 = $2.614 billion; book value of equity = $2.614/4.2 = 0/622 billion; debt = $0.622 x 3.2 = 1.991; enterprise value = $2.614 + $1.991 = $0.800 = $3.805

GenCorp. has a total debt of $140 million and stockholdersʹ equity of $50 million. It also has 26 million shares outstanding, with a market price of $4.00 per share. What is GenCorpʹs market debt-equity ratio?

Answer: 1.35 Explanation: 140/($4.00 x 26) = 1.35

U.S. public companies are required to file their annual financial statements with the U.S. Securities and Exchange Commission on which form? A) 10-A B) 10-K C) 10-Q D) 10-SEC

B) 10-K

Cash is a ________. A) long-term asset B) current asset C) current liability D) long-term liability

B) current asset

A delivery company is creating a balance sheet. Which of the following would most likely be considered a short-term liability on this balance sheet? A) the depreciation over the last year in the value of the vehicles owned by the company B) revenue received for the delivery of items that have not yet been delivered C) a loan which must paid back in two years D) prepaid rent on the offices occupied by the company

B) revenue received for the delivery of items that have not yet been delivered

9) Which of the following is NOT a financial statement that every public company is required to produce? A) income statement B) statement of sources and uses of cash C) balance sheet D) statement of stockholdersʹ equity

B) statement of sources and uses of cash

Which of the following balance sheet equations is INCORRECT? A) Assets - Liabilities = Shareholdersʹ equity B) Assets = Liabilities + Shareholdersʹ equity C) Assets - Current liabilities = Long-term liabilities D) Assets - Current liabilities = Long-term liabilities + Shareholdersʹ equity

C) Assets - Current liabilities = Long-term liabilities

Which of the following best describes why the left and right sides of a balance sheet are equal? A) In a properly run business, the value of liabilities will not exceed the assets held by the company. B) By definition, the assets plus the liabilities will be the same as the stockholdersʹ equity. C) The assets must equal liabilities plus stockholdersʹ equity because stockholdersʹ equity is the difference between the assets and the liabilities. D) By accounting convention, the assets of a company must be equal to the liabilities of that company.

C) The assets must equal liabilities plus stockholdersʹ equity because stockholdersʹ equity is the difference between the assets and the liabilities.

The exchanges in which of the following countries or regions do NOT accept the International Financial Reporting Standards set out by the International Accounting Standards Board? A) Germany B) France C) United States D) United Kingdom flip

C) United States

A company that produces drugs is preparing a balance sheet. Which of the following would be most likely to be considered a long-term asset on this balance sheet? A) commercial paper held by the company B) the inventory of chemicals used to produce the drugs made by the company C) a patent for a drug held by the company D) the cash reserves of the company

C) a patent for a drug held by the company

The major components of stockholdersʹ equity are ________. A) cash, common stock, and paid-in surplus B) common stock, paid-in surplus, and net income C) common stock, paid-in surplus, and retained earnings D) common stock, liabilities, and retained earnings

C) common stock, paid-in surplus, and retained earnings

Which of the following amounts would be included on the right side of a balance sheet? A) the value of government bonds held by the company B) the cash held by the company C) the amount of deferred tax liability held by the company D) the amount of money owed to the company by customers who have not yet paid for goods and services they have received

C) the amount of deferred tax liability held by the company

Which of the following best describes why a firm produces financial statements? A) to use as a tool when planning future investments within a firm B) to increase the intrinsic value of a firm C) to provide a means for interested outside parties such as creditors to obtain information about a firm, with an overview of the short- and long-term financial condition of a business D) to show the daily activities a firm has undertaken in the previous financial year, and what activities are planned for the near future

C) to provide a means for interested outside parties such as creditors to obtain information about a firm, with an overview of the short- and long-term financial condition of a business

What is the main reason that it is necessary for public companies to follow the rules and format set out in the Generally Accepted Accounting Principles (GAAP) when creating financial statements? A) It ensures that the market value of assets and debt are reported accurately. B) It ensures that information on the performance of public companies is reported on cash-basis accounting. C) It ensures that important budgetary information is not omitted. D) It makes it easier to compare the financial results of different firms.

D) It makes it easier to compare the financial results of different firms.

Which of the following statements regarding the balance sheet is INCORRECT? A) it provides a snapshot of a firm's financial position at a given point in time. B) The balance sheet lists a firm's assets and liabilities C) It reports stockholder's equity on the right-hand side. D) The balance sheet reports liabilities on the left hand side

D) The balance sheet reports liabilities on the left hand side

10) The third party who checks annual financial statements to ensure that they are prepared according to Generally Accepted Accounting Principles (GAAP) and verifies that the information reported is reliable is the ________. A) NYSE Enforcement Board B) Accounting Standards Board C) Securities and Exchange Commission (SEC) D) auditor

D) auditor

Which of the following is NOT one of the financial statements that must be produced by a public company? A) the balance sheet B) the income statement C) the statement of cash flows D) the statement of activities

D) the statement of activities

Financial statements are optional accounting reports issued periodically by a firm which present information on the past performance of the firm, a summary of the firmʹs assets and the financing of those assets, and a prediction of the firmʹs future performance. True or False

FALSE

In the United States, publicly traded companies can choose whether or not they wish to release periodic financial statements. True or False.

FALSE

International Financial Reporting Standards are taking root throughout the world. However, it is unlikely that the U.S. will report according to IFRS before the second half of the twenty -first century. True or False

FALSE

The balance sheet shows the assets, liabilities, and stockholdersʹ equity of a firm over a given length of time.

FALSE

A public company has a book value of $128 million. They have 20 million shares outstanding, with a market price of $4 per share. Which of the following statements is true regarding this company?

Investors believe the company's assets are not likely to be profitable since its market value is worth less than the book value

What is the role of an auditor in financial statement analysis?

Key points: 1. to ensure that the annual financial statements are prepared accurately 2. to ensure that the annual financial statements are prepared according to Generally Accepted Accounting Principles (GAAP) 3. to verify that the information used in preparing the annual financial statements is reliable

What will be the effect on the balance sheet if a firm buys a new processing plant through a new loan?

The assets side will increase under net property, plant and equipment with the net effect of the new processing plant, while the liabilities side will correspondingly show the new debt that was incurred in paying for the plant.

How does a firm select the date for preparation of its balance sheet?

The balance sheet is prepared on the fiscal closing date for the accounts of a firm that may or may not coincide with the calendar year-end of Dec. 31st.

Stockholdersʹ equity is the difference between a firmʹs assets and liabilities, as shown on the balance sheet. TRUE or FALSE

True

Which ratio would you use to measure the financial health of a firm by assessing that firm's leverage?

debt-equity or equity multiplier ratio

A 30-year mortgage loan is a . . .

long-term liability

in general, a successful firm will have a market-to-book ratio that is substantially greater than 1. True or False

true