Chapter 3 Finance

49. 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.

a. The company sold a new issue of bonds.

37. Which of the following statements is CORRECT? a. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholders' equity. b. The balance sheet gives us a picture of the firm's financial position at a point in time. c. The income statement gives us a picture of the firm's financial position at a point in time. d. The statement of cash flows tells us how much cash the firm must pay out in interest during the year. e. The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.

b. The balance sheet gives us a picture of the firm's financial position at a point in time.

61. 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.

c. 70% of the dividends received by corporations is excluded from taxable income.

40. 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.

c. The company issues new common stock.

62. 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.

c. The company sold a new issue of common stock.

63. 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.

d. Companies' cash positions would decline.

42. 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.

d. Cost of goods sold.

51. 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.

d. The company's depreciation expense declined.

45. On its 12/31/14 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 2014, it must have paid dividends. b. The company must have had zero net income in 2014. c. The company must have paid out half of its 2014 earnings as dividends. d. The company must have paid no dividends in 2014. e. Dividends could have been paid in 2014, but they would have had to equal the earnings for the year.

e. Dividends could have been paid in 2014, but they would have had to equal the earnings for the year.

58. 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.

b. Can be carried back 2 years, then carried forward up to 20 years following the loss.

57. 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.

b. Corporations are allowed to exclude 70% of their dividend income from corporate taxes.

59. 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 2014 could go up to 39.6%, but qualified dividends received were taxed at a maximum tax rate of 15% for individuals earning less than $400,000 and married taxpayers filing jointly earning less than $450,000. c. The maximum federal tax rate on corporate income in 2014 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 2014 was 50%.

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 2014 could go up to 39.6%, but qualified dividends received were taxed at a maximum tax rate of 15% for individuals earning less than $400,000 and married taxpayers filing jointly earning less than $450,000.

55. 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 total invested 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 total invested capital obtained at a higher cost of capital. e. If a firm reports positive net income, its EVA must also be positive.

b. One way to increase EVA is to generate the same level of operating income but with less total invested capital.

50. 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

b. The company made large investments in fixed assets.

46. Below is the common equity section (in millions) of Timeless Technology's last two year-end balance sheets: 2014 2013 Common stock $2,000 $1,000 Retained earnings 2,000 2,340 Total common equity $4,000 $3,340 ​ The firm has never paid a dividend to its common stockholders. Which of the following statements is CORRECT? a. The company's net income in 2014 was higher than in 2013. b. The firm issued common stock in 2014. c. The market price of the firm's stock doubled in 2014. d. The firm had positive net income in both 2013 and 2014, but its net income in 2014 was lower than it was in 2013. e. The company has more equity than debt on its balance sheet.

b. The firm issued common stock in 2014.

38. Which of the following statements is CORRECT? a. Assets other than cash are expected to produce cash over time, and the amounts of cash they eventually produce should be exactly the same as the amounts at which the assets are carried on the books. b. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows. c. The annual report is an internal document prepared by a firm's managers solely for the use of its creditors/lenders. d. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and statement of stockholders' equity. e. Prior to the Enron scandal in the early 2000s, companies would put verbal information in their annual reports, along with the financial statements. That verbal information was often misleading, so today annual reports can contain only quantitative information: audited financial statements.

b. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.

41. Which of the following items is NOT normally considered to be a current asset? a. Accounts receivable. b. Inventory. c. Bonds. d. Cash. e. Short-term, highly-liquid, marketable securities.

c. Bonds.

54. 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.

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. ​

47. 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.

c. If a firm is more profitable than average, we would normally expect to see its stock price exceed its book value per share.

53. 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.

c. In the statement of cash flows, a decrease in accounts payable is subtracted from net income in the operating activities section.

60. 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.

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.

44. Below are the 2013 and 2014 year-end balance sheets for Tran Enterprises: Assets: 2014 2013 Cash $ 200,000 $ 170,000 Accounts receivable 864,000 700,000 Inventories 2,000,000 1,400,000 Total current assets $3,064,000 $2,270,000 Net fixed assets 6,000,000 5,600,000 Total assets $9,064,000 $7,870,000 Liabilities and equity: Accounts payable $1,400,000 $1,090,000 Notes payable to bank 1,600,000 1,800,000 Total current liabilities $3,000,000 $2,890,000 Long-term debt 2,400,000 2,400,000 Common stock 3,000,000 2,000,000 Retained earnings 664,000 580,000 Total common equity $3,664,000 $2,580,000 Total liabilities and equity $9,064,000 $7,870,000 ​ The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt in 2013. As of the end of 2014, none of the principal on this debt had been repaid. Assume that the company's sales in 2013 and 2014 were the same. Which of the following statements must be CORRECT? a. The firm increased its short-term bank debt in 2014. b. The firm issued long-term debt in 2014. c. The firm issued new common stock in 2014. d. The firm repurchased some common stock in 2014. e. The firm had negative net income in 2014.

c. The firm issued new common stock in 2014.

48. 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.

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.

56. 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: EVA = NOPAT − (Total invested capital)(AT cost of capital %)

e. EVA stands for economic value added, and it is defined as follows: EVA = NOPAT − (Total invested capital)(AT cost of capital %)

64. 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 the tax rate. Prior to the new provision, BBI's net income 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 cash flow. b. The provision will increase the company's tax payments. c. The provision will increase the firm's operating income (EBIT). d. The provision will increase the company's net income. e. Net fixed assets on the balance sheet will decrease.

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

39. Which of the following statements is CORRECT? a. The balance sheet for a given year is designed to give us an idea of what happened to the firm during that year. b. The balance sheet for a given year tells us how much money the company earned during that year. c. The difference between the total assets reported on the balance sheet and the liabilities reported on this statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in accordance with generally accepted accounting principles (GAAP). d. If a company's statements were prepared in accordance with generally accepted accounting principles (GAAP), the market value of the stock equals the book value of the stock as reported on the balance sheet. e. The assets section of a typical company's balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last.

e. The assets section of a typical company's balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last.

43. 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 is designed to give us an idea of how much the firm earned during that year.

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

52. 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.

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.