Chapter 2 Smartbook
Dexter's has operating income of $82,000 and a 30 percent tax rate and is all-equity financed. Brown's has operating income of $82,000, a 30 percent tax rate, and has $5,000 in interest expense since it is partially debt-financed. What is the difference in the income available for asset funders between these two firms?
$1,500 Reason: Asset funders includes both bondholders and stockholders so the difference = Tax savings on interest = 0.30($5,000) = $1,500
Assume net income is $32, cash dividends paid are $20, and the ending retained earnings balance is $44. What is the change in retained earnings for the period?
$12 Reason: Change in retained earnings = Net income - Cash dividends paid = $32 - $20 = $12
Kettles, Inc., paid $50,000 in preferred dividends and $100,000 in common dividends this year. There are 25,000 shares of preferred stock and 40,000 shares of common stock outstanding. What is the amount of the dividends per share (DPS)?
$2.50 Reason: Dividends per share = Common stock dividends/Number of shares of common stock outstanding = $100,000/40,000 = $2.50
Buster's owns a machine which cost $110,000 initially. The latest financial statement shows depreciation expense of $22,000 and accumulated depreciation of $77,000. What is the book value of the firm's net plant and equipment?
$33,000 Reason: $110,000 - $77,000 = $33,000
A firm has an operating cash flow of $600, a net change in gross fixed assets of $100, and a change in net operating working capital of $50. What is the firm's free cash flow (FCF)?
$450 Reason: IOC = Change in gross fixed assets + Change in net operating working capital. FCF = OCF - IOC = $600 - ($100 + $50) = $450.
Delta's has operating income of $128,000 and a 35 percent tax rate and is all-equity financed. Sigma's has operating income of $128,000, a 35 percent tax rate, and has $15,000 in interest expense since it is partially debt-financed. What is the difference in the income available for asset funders between these two firms?
$5,250 Reason: Asset funders includes both bondholders and stockholders so the difference = Tax savings on interest = 0.35($15,000) = $5,250
A firm has EBIT of $600, depreciation of $200, and a tax rate of 34 percent. What is the operating cash flow?
$596 Reason: OCF = EBIT(1 - Tax rate) + Depreciation = $600(1 - 0.34) + $200 = $596
A firm has sales of $8,900, depreciation of $200, cost of goods sold of $3,700, other operating expenses of $4,200, and interest of $600. What is the firm's EBIT?
$800 Reason: EBIT = Sales - Cost of goods sold - Depreciation - Other operating expenses = $8,900 - $3,700 -$200 -$4,200= $800
Which of these accounts are long-term debts? Select all that apply.
- 15-year mortgage - 10-year bonds
Which of these statements is correct concerning the structure of a statement of cash flows? Select all that apply.
- An increase in accounts payable is an addition to the cash flows from operating activities. - A decrease in fixed assets is an addition to the cash flows from investing activities.
Which of these assets have useful lives exceeding one year and are classified as fixed assets? Select all that apply.
- Building - Machinery - Land
Which of these is (are) a source of cash? Select all that apply.
- Decrease in inventory - Increase in long-term debt
Which of these characteristics apply to the definition of preferred stock? Select all that apply.
- Fixed periodic payments - Ownership interest in the firm
Which of these are cash flows from financing activities? Select all that apply.
- Increase in common stock - Preferred stock dividend - Decrease in long-term debt
Which of these are added or subtracted from net income to compute the net cash flows from operating activities? Select all that apply.
- Increase in inventory - Decrease in accrued wages and taxes - Depreciation
Which of these are additions to the cash flows from financing activities? Select all that apply.
- Increase in long-term debt - Increase in common stock
Which of these statements regarding the federal taxation of interest income earned by a corporation is(are) correct? Select all that apply.
- Interest earned on a corporate bond is taxable. - Interest earned on a bond issued by a city is tax-exempt.
Which of these accounts are included in net working capital? Select all that apply.
- Inventory - Notes payable
The statement of cash flows separates cash flows into which of the following categories?
- Net change in cash and marketable securities - Cash flow from investing activities. - Cash flow from financing activities. - Cash flow from operating activities.
Rank these assets in order of liquidity with the most liquid asset listed first.
1. Cash 2. Accounts receivable 3. Inventory 4. Plant and equipment
Which one of these accounts is a long-term debt?
5-year bonds
Which one of these is a current liability?
6-month note payable
Which one of these statements correctly applies to a balance sheet?
A balance sheet shows what a firm owns, what it owes, and what it is worth.
Which of these is a requirement of the Sarbanes-Oxley Act of 2002?
A corporate board's audit committee must have considerable experience with GAAP.
A current asset is an asset that does which one of the following?
A current asset provides liquidity and a low rate of return.
A change in financial leverage does which one of the following?
A decrease in financial leverage decreases the risks faced by the firm.
How is the fixed nature of an asset determined?
A fixed nature of an asset is determined by its useful life.
Which of these actions fits the definition of earnings management?
A major sale to a customer was purposely delayed one day so it would be recorded in a later accounting period.
What is the definition of a marketable security?
A marketable security is a short-term, low-rate investment security.
What is the definition of a statement of cash flows?
A statement of cash flows is a financial statement that shows the firm's cash flows over a period of time.
Which one of these is the best definition of a statement of cash flows?
A statement of cash flows summarizes the sources and uses of cash by type of cash flow.
Which one of these assets is considered to be the most liquid?
Accounts receivable
Which one of these is a current asset?
Accounts receivable
Which one of these accounts is a noncash expense?
Amortization Reason: Depreciation is the expensing of a tangible asset. Amortization is the expensing of an intangible asset. Both depreciation and amortization are noncash expenses.
An income statement is best defined by which one of these statements?
An income statement reflects the total revenues that a firm earns over a period of time and the total expenses incurred to generate those sales.
Which of one of these statements best illustrates the definition of a marginal tax rate?
Antonio will pay $0.28 more in taxes if his taxable income increases by $1, or 28 percent.
What is the balance sheet identity formula?
Assets = Liabilities + Equity
Which one of these formulas best defines an average tax rate?
Average tax rate = Tax liability/Taxable income
Which one of these is a subtraction from the cash flows from financing activities?
Buying back common stock
A statement of cash flows for the year ending December 31, 2012 shows a net change in cash and marketable securities of $20. How can this $20 change be defined?
Cash and marketable securities were $20 more on December 31, 2012 than they were on December 31, 2011.
A statement of retained earnings showed a beginning retained earnings balance of $24 and an ending balance of $22. Net income was positive. What do you know given this information?
Cash dividends paid exceeded net income.
Which one of these is the definition of cash flows from investing activities?
Cash flow from investing activities is defined as the cash flows associated with the purchase or sale of fixed or other long-term assets.
What is the definition of cash flows from operations?
Cash flow from operations is defined as the cash flows that are the direct result of the production and sale of the firm's products.
Interest payments on long-term debt are found in what section of the Statement of Cash Flows?
Cash flows from operating activities
The Sarbanes-Oxley Act of 2002 requires senior management of a firm to do which one of these?
Certify the financial statements are accurate and representative of the firm's earnings
Which one of these formulas will correctly compute dividends per share (DPS)?
DPS = Common stock dividends paid/Number of shares of common stock outstanding
Cash flows from financing activities are defined as the cash flows resulting from which one of the following?
Debt and equity financing transactions
Which one of these best explains how debt financing affects the income available to a firm's asset funders?
Debt increases the income available to asset funders by an amount equal to the interest on the debt times the tax rate.
Which one of these is classified as a cash flow from operating activities?
Decrease in accounts payable
Which one of these is an addition to the cash flows from operating activities?
Decrease in accounts receivable
Which one of these is a subtraction from the cash flows from operating activities?
Decrease in accrued wages and taxes
Which one of these is a cash flow from a financing activity?
Decrease in loans payable
Which one of these is an addition to the cash flows from investing activities?
Decrease in other long-term assets
Which one of these accounts is a noncash expense?
Depreciation
Which one of these formulas is a correct computation of EBIT?
EBIT = Gross profits - Depreciation - Other operating expenses
Which one of these correctly defines EBIT?
EBIT is the earnings a firm generates prior to paying interest to its creditors or income taxes to the government.
What is the definition of EBT?
EBT is the taxable income of a firm.
Which one of these statements is a correct interpretation of an income statement?
Earnings per share = Net income available to common stockholders / Total shares of common stock outstanding
Which one of these correctly defines the balance sheet identity?
Equity = Assets - Liabilities
Which one of these statements related to the recording of financial statement items based on GAAP is (are) correct?
Expenses related to the production of a product are recorded on the income statement when that product is sold, not when the expenses are paid.
True or false: All interest payments and dividends are deducted from operating income when the firm calculates taxable income.
False Reason: Only the allowable portion of interest and no dividends are deducted
True or false: The cash flows directly resulting from a firm's sales and production activities are classified as cash flows from investing activities.
False Reason: The cash flows directly resulting from a firm's sales and production activities are classified as cash flows from operations.
Explain why following GAAP to record sales on an income statement may differ from the cash flows generated by those sales.
GAAP requires the revenue from a sale be recorded at the time of sale, which may not coincide with the cash flow from the sale.
Gross profit is equal to net sales minus cost of goods sold. How else can gross profit be defined?
Gross profit = EBIT + Other operating expenses + Depreciation
Which one of the following is a use of cash?
Increase in a fixed asset
Which one of these is a subtraction from the cash flows from investing activities?
Increase in a fixed asset
Which one of these is a cash flow from an investing activity?
Increase/decrease in fixed assets
What is the definition of net income?
Net income is the aftertax profit or loss earned over a specified period of time.
How is net plant and equipment calculated?
Net plant and equipment is equal to gross plant and equipment less accumulated depreciation
What is the definition of net working capital?
Net working capital is the difference between a firm's current assets and current liabilities.
Current liabilities are debts of a firm that must be paid within what time frame?
One year
Long-term debt is defined as the obligations of the firm that are due after what period of time?
One year
Earnings management is the process of controlling which of these for a firm?
Profits Reason: Earnings management is the process of controlling a firm's earnings, or profits.
What does a balance sheet do?
Reports a firm's assets, liabilities, and equity at a particular point in time
Which one of the following best illustrates a highly liquid asset?
Sale of a $100 asset by tomorrow at a price of $100.
Which party has a residual claim to a firm's cash flows?
Stockholders
What is the definition of an average tax rate?
The average tax rate is the percentage of each dollar of taxable income that the firm pays in taxes.
A firm has a negative free cash flow and a negative operating cash flow. What does this indicate?
The firm is experiencing operating or managerial problems.
A statement of cash flows reflects a net cash flow from operating activities of -$89 million, a net cash flow from investing activities of $42 million, and a net cash flow from financing activities of $28 million. What can you determine from this information?
The firm sold long-term assets, issued securities, and reduced its cash holdings in order to finance its operations.
Which one of these correctly defines the net change in cash and marketable securities as it is used on the statement of cash flows?
The net change in cash and marketable securities is the sum of the cash flows from operations, investing activities, and financing activities.
The Keyser Corporation owns 1,000 shares of Mountain Top Industries. How are the dividends paid by Mountain Top to Keyser treated for federal tax purposes?
Thirty percent of the dividend income received is taxable, the other seventy percent is tax-exempt.
Which one of these formulas correctly defines retained earnings?
Total net earnings for all years - Total dividends paid for all years
Which one of these is an intangible long-term asset?
Trademark
True or false: Cash flows that result from debt and equity financing transactions are cash flows from financing activities.
True Reason: Cash flows from financing activities are defined as cash flows that result from debt and equity financing transactions.
True or false: A decrease in a long-term asset account balance is a cash flow from investing activity.
True Reason: Changes in fixed and other long-term assets are cash flows from investing activities.
True or false: Net working capital is a measure of a firm's ability to pay its bills for the next year.
True Reason: Net working capital compares the amount of assets a firm has that can be converted into cash within one year to the amount of debts the firm must pay within the year.
True or false: The cash flows that result from debt and equity financing transactions are cash flows from financing activities.
True Reason: The statement is true. The cash flows that result from debt and equity financing transactions are financing activities.
A firm with positive operating cash flow but negative free cash flow may be
investing heavily in operating capital
Which of these assets are generally converted into cash within one year? Select all that apply.
- Accounts receivable - Inventory
Which of these accounts are current liabilities? Select all that apply.
- Accounts payable - Accrued wages - Notes payable
Which of these accounts are included in net working capital? Select all that apply.
- Accounts receivable - Accounts payable - Cash
Which of these are equity accounts? Select all that apply.
- Retained earnings - Common stock - Preferred stock
Which of these are fixed assets? Select all that apply.
- Sewing machines owned by a clothing manufacturer - Land owned by a retail outlet
What is the definition of an income statement?
An income statement reports total revenues and expenses over a specific period of time.
Book value per share (BVPS) is based on which one of the following?
BVPS is based on the equity of a firm that is attributable to the common shareholders.
How is the capital structure of a firm defined?
Capital structure is the amount of debt versus equity financing held on the balance sheet.
What is the definition of common stock and paid in surplus?
Common stock and paid in surplus represent the fundamental ownership claim in a public or private company.
What is the definition of EBIT?
EBIT is the earnings before interest and taxes.
Which one of these formulas correctly computes the value of EBT?
EBT = Net income + Taxes
Reason: How can EBT be defined?
EBT is earnings before taxes, also referred to as taxable income.
What is the definition of liabilities?
Liabilities are funds provided by lenders to a firm.
What is the definition of liquidity?
Liquidity is the ease of conversion of an asset into cash at a fair value.
What is the definition of long-term debt?
Long-term debt is defined as the obligations of the firm that are due in more than one year.
Which of these examples best defines a liquid asset?
Mia sold 100 shares of stock today at the going market price.
A firm has total assets of $439,000, current assets of $49,000, total equity of $283,000 and long-term debt of $107,000. How do you compute net working capital (NWC)?
NWC = $49,000 - ($439,000 - $107,000 - $283,000) Reason: Total liabilities and equity = Total assets = $439,000. Current liabilities = $439,000 - $107,000 - $283,000. Net working capital = $49,000 - ($439,000 - $107,000 - $283,000).
A firm has total assets of $358,000 and fixed assets of $220,000. Current liabilities are $77,000 and long-term debt is $289,000. How do you compute net working capital (NWC)?
NWC = ($358,000 - $220,000) - $77,000 Reason: Current assets = Total assets - Fixed assets. Net working capital = Current assets - Current liabilities.
A fixed asset is an asset that is defined as having a useful life in excess of which one of these time periods?
One year
Which relationship of liquidity is correct?
The liquidity of an asset is inversely related to the profitability of that asset.
What is the definition of a marginal tax rate?
The marginal tax rate is the amount of additional taxes a firm must pay out for every additional dollar of taxable income it earns.
True or false: Both common stock and paid in surplus represent a fundamental ownership claim in either a private or a public company.
True Reason: Both common stock and paid-in surplus represent the fundamental ownership claim in a public or private company.
Which of these reduce the taxable income of a corporation?
Interest expense
What is the basic reason why debt financing affects the income available to asset funders?
Interest is a tax-deductible expense.
The statement of retained earnings reconciles the dividends paid and the change in retained earnings to which one of these?
Net income
Which one of these formulas depicts the definition of the statement of retained earnings?
Net income = Dividends paid + Change in retained earnings
Dalton Bros. has 5,000 shares of common stock outstanding, earnings before taxes of $3,000, preferred dividends of $1,000, common dividends of $500, and taxes of $900. What is the earnings per share (EPS) amount?
$0.22 Reason: EPS = Income available to common stockholders/Total shares outstanding = ($3,000 - $900 - $1,000)/5,000 - $0.22
What is the definition of a current asset?
A current asset is an asset that can be converted into cash within one year.
Which one of these is not one of the four basic financial statements?
Statement of ratios
Stockholders' equity can be defined by which one of these formulas?
Stockholders' equity = Assets - Liabilities
Which of these definitions of stockholders' equity is correct?
Stockholders' equity is defined as the funds provided by the firm's preferred and common stock owners.
Which sentence best illustrates the definition of market value?
If the Cookie Palace sells its oven today, it could receive a price of $89,000.
Which type of depreciation offers the greatest tax deferral benefit in the early years of an asset's life?
MACRS depreciation
What is the definition of preferred stock?
Preferred stock is a hybrid security that has characteristics of both long-term debt and common stock.
True or false: An increase in the financial leverage of a firm reduces both the firm's profits and its losses.
False Reason: An increase in the financial leverage of a firm magnifies both the firm's profits and its losses. In other words, profits get larger but losses also get larger.
D.O. Co. has a total of $6,500 in total assets and $4,200 in fixed assets on its balance sheet. The fixed assets were just appraised at $4,700. The firm feels it can liquidate its current assets for 96 percent of their book value. What is the book and market value of the firm's assets?
The book value is $6,500 and the market value is $6,908. Reason: Book value = $6,500 Market value = 0.96($6,500 - $4,200) + $4,700 + $6,908
How is the book value of land defined?
The book value of land is its historical cost, or the amount paid for that land.
__________ holders have first claim to the cash flows of the firm.
Bond or Debt
A firm has net income of $2,200, depreciation of $500, taxes of $600, other operating expenses of $800, interest of $200, and sales of $5,900. What is the value of EBT?
$2,800 Reason: EBT = Net income + Taxes = $2,200 + $600 = $2,800
A firm has fixed assets of $28,000, long-term debt of $12,000, current liabilities of $4,000, current assets of $5,000 and equity of $17,000. What is the total of the assets side of the balance sheet of the firm?
$33,000
Which of these statements regarding the structure of an income statement is (are) correct? Select all that apply.
- EBT = Dividends paid + Addition to retained earnings + Taxes - EBIT= Gross profit - Depreciation - Other operating expenses - Gross profit = Net sales - Cost of goods sold
Which of these questions can be answered by monitoring a firm's balance sheets for last year and this year? Select all that apply.
- Is the firm more or less liquid than last year? - Did the firm issue additional shares of stock this year?
Which of these characteristics apply to a marketable security? Select all that apply.
- Provides a low rate of return - Convertible to cash within one year or less
Which one of these relationships regarding liquidity is correct?
As the liquidity of assets increases, both the firm's probability of financial distress and its profits on those assets decrease.
Balance sheets list assets in declining order of liquidity. Which of these orders best illustrates this?
Cash, accounts receivable, inventory, plant and equipment
Which one of these actions meets the definition of a liability?
Corner Bank loans $100,000 to the Corner Bakery for two years.
Which one of these reports the amount of money a firm owes its creditors within the next year?
Current liabilities
What is the definition of current liabilities?
Current liabilities are obligations of the firm that are due within one year.
How can financial leverage be defined?
Financial leverage is the degree to which a firm finances its total assets with debt securities.
How is financial leverage defined?
Financial leverage is the extent to which debt securities are used by a firm.
How is gross profit defined?
Gross profit = Net sales - Cost of goods sold
Which account is the least liquid of the current asset accounts?
Inventory
Which one of these questions can be answered by monitoring a firm's balance sheets?
Level of net working capital
Which one of these is the best explanation of the market value per share (MVPS)?
MVPS is the current price at which a share of common stock sells in the open market.
Which one of these defines net income?
Net income is the amount of profit a firm can either distribute as dividends or reinvest in the firm.
What is the definition of retained earnings?
Retained earnings is the cumulative earnings a firm has reinvested rather than paid out as dividends.
Which one of these comparisons fits the definition of capital structure?
The capital structure of a firm compares the total debt to the total equity.
How is the market value of an asset defined?
The market value of an asset is the amount the firm would receive if it sold the asset.
The operating profit is equal to earnings before interest and taxes.
True
Another name for the bottom line of an income statement is
net income
Which one of these is a current asset?
Cash
When computing book value per share (BVPS) which of these balance sheet values is used as the total book value?
Common stock + Paid in surplus + Retained earnings
Which one of these formulas will correctly compute the earnings per share (EPS)?
EPS = Net income available to common stockholders/Total shares of common stock outstanding
Which one of these terms is the price at which one share of common stock can currently be sold?
Market value per share
Which one of these statements correctly applies to straight-line depreciation?
Straight-line depreciation is commonly used when compiling financial statements.
Jed's balance sheet lists cash of $300, accounts receivable of $700, inventory of $1,200, and fixed assets of $2,800. The inventory can be sold for 95 percent of its costs while 98 percent of the receivables can be collected. The fixed assets can be sold for $2,700. What are the book and market values of the firm's assets?
The book value is $5,000 and the market value is $4,826. Reason: Book value = $300 + $700 + $1,200 + $2,800 = $5,000 Market value = $300 + (0.98 × $700) + (0.95 × $1,200) + $2,700 = $4,826
Which statement correctly defines the book value of a firm's assets as shown in the gross plant and equipment account?
The book value of a firm's assets in the gross plant and equipment account is the total amount the firm paid for those assets.
A financial statement provides an _______-based picture of a firm's financial condition.
accounting