Midterm Practice Problems

Which of the following adjustments to net income is NOT correct if you are trying to calculate cash flow from operating activities? a. add back depreciation b. add increases in accounts payable c. add increases in accounts receivables d. deduct increases in inventory

C

Which of the following balance sheet equations is INCORRECT? A. Assets - Liabilities = Shareholders' Equity B. Assets = Liabilities + Shareholders' Equity C. Assets - Current Liabilities = Long Term Liabilities D. Assets - Current Liabilities = Long Term Liabilities + Shareholders' Equity

C

Which of the following statements is FALSE? A. Many projects use a resource that the company already owns. B. Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project. C. When evaluating a capital budgeting decision, we generally include interest expense. D. As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.

C

Which of the following statements regarding net income transferred to retained earnings is correct? a. net income = net income transferred to retained earnings - dividends b. net income transferred to retained earnings = net income + dividends c. net income = net income transferred to retained earnings + dividends d. net income transferred to retained earnings - net income = dividends

C

A $250,000 loan is to be amortized over 8 years, with annual end-of-year payments. Which of these statements is CORRECT? a. The proportion of interest versus principal repayment would be the same for each of the 8 payments. b. The annual payments would be larger if the interest rate were lower. c. If the loan were amortized over 10 years rather than 8 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 8-year amortization plan. d. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower. e. The last payment would have a higher proportion of interest than the first payment.

D

Glucose Scan Incorporated (GSI) currently sells its latest glucose monitor, the Glucoscan 3000, to diabetic patients for $129. GSI plans on lowering their price next year to $99 per unit. The cost of goods sold for each Glucoscan unit is $50, and GSI expects to sell 100,000 units over the next year. Suppose that if GSI drops the price on the Glucoscan 3000 immediately, it can increase sales over the next year by 30% to 130,000 units. The incremental impact of this price drop on the firm's EBIT is closest to: A. an increase of $2.4 million. B. a decline of $2.4 million. C. an increase of $1.5 million. D. a decline of $1.5 million.

D

Which of the following is (are) deducted from EBIT to determine net income? a. Earnings per share b. Interest expenses c. Corporate expenses D. Both B and C

D

If Alex Corporation takes out a bank loan to purchase a machine used in production and everything else stays the same, its equity multiplier will_ a. Increase; increase b. Decrease; decrease c. Increase; decrease d. Decrease; increase

A

Money that has been or will be paid regardless of the decision whether or not to proceed with the project is: A. a sunk cost. B. considered as part of the initial investment in the project. C. an opportunity cost. D. cannibalization.

A

The Sarbanes-Oxley Act (SOX) overhauled incentives and the independence of the auditing process by: A) putting strict limits on the amount of non-audit fees (consulting or otherwise) that an accounting firm can earn from a firm that it audits. B) imposing large compliance costs on small companies. C) requiring the CEO and CFO to return bonuses or profits from the sale of stock that are later shown to be due to misstated financial reports. D) requiring auditing firms to have long-standing relationships with their clients and receive lucrative auditing and consulting fees from them

A

Which of the following costs would you consider when making a capital budgeting decision? A. Opportunity cost B. Sunk cost C. Fixed overhead cost D. Interest expense

A

Which of the following includes other sources of income or expenses that arise from activities that are not a central part of a company's business? a. Earnings before interest and taxes (EBIT) b. Gross profit c. Operating income d. Operating expenses

A

Which of the following is NOT an operating expense? a. Interest expense b. Depreciation and amortization c. Selling, general and administrative expenses d. Research and development

A

Which of the following statements is FALSE? A. Project externalities are direct effects of the project that may increase or decrease the profits of the business activities of other firms. B. Incremental earnings are the amount by which the firm's earnings are expected to change as a result of the investment decision. C. The average selling price of a product and its cost of production will generally change over time. D. Any money that has already been spent is a sunk cost and therefore irrelevant in the capital budgeting process.

A

Which of the following statements is FALSE? A. Sunk cost fallacy is a term used to describe the tendency of people to ignore sunk costs in capital budgeting analysis. B. If securities are fairly priced, the net present value of a fixed set of cash flows is independent of how those cash flows are financed. C. The firm deducts a fraction of the investments in plant, property, and equipment each year as depreciation. D. A good rule to remember is that if our decision does not affect a cash flow then the cash flow should not affect our decision.

A

On the balance sheet, short-term debt appears: a. current assets b. current liabilities c. long term liabilities d. shareholder's equity

B

Which of the following statements is FALSE? A. Unlevered Net Income = (Revenue - Costs - Depreciation) × (1 - τc). B. To the extent that overhead costs are fixed and will be incurred in any case, they are incremental to the project and should be included in the capital budgeting analysis. C. The ultimate goal in capital budgeting is to determine the effect on the firm's cash flows of the decision to take a particular project.. D. Earnings are not cash flows.

B

Which of the following statements is FALSE? a. An inverted yield curve generally signals an expected decline in future interest rates. b. An inverted yield curve is often interpreted as a positive forecast for economic growth. c. All the formulas for computing present values of annuities and perpetuities are based upon discounting all of the cash flows at the same rate. d. The rate of growth of your purchasing power is determined by the real interest rate. e. A risk-free cash flow received in two years should be discounted at the two-year interest rate.

B

Which of the following statements is NOT CORREC1? a. When a corporation's shares are owned by a few individuals and are not traded on public markets, we say that the firm is "closely, or privately, held." b "Going public" establishes a firm's true intrinsic value, and it also insures that a highly liquid market will always exist for the firm's shares c. When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market. d. Publicly owned companies have shares owned by investors who are not associated with management, and public companies must register with and report to a regulatory agency such as the SEC. e. It is possible for a firm to go public and yet not raise any additional new capital at the time.

B

Zoe Dental Implements has gross property, plant and equipment totaling $1.4 million, depreciation expense this year of $200,000, and accumulated depreciation of $750,000. What is the book value of Zoe's property, plant and equipment? a. 550,000 b. 650,000 c. 750,000 d. 850,000

B

Which of the following statements is CORRECT? a. The financial manager's proper goal should be to attempt to maximize the firm's expected cash flows, since that will add the most to the individual shareholders' wealth. b. The financial manager should seek that combination of assets, liabilities, and capital that will generate the largest expected projected after-tax income over the relevant time horizon, generally the coming year. c. The riskiness inherent in a firm's earnings per share (EPS) depends on the characteristics of the projects the firm selects, and thus on the firm's assets. However, EPS is not affected by the manner in which those assets are financed. d. Potential agency problems can arise between managers and stockholders, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders. e. Large, publicly owned firms like IBM and GE are controlled by their management teams. Ownership is generally widely dispersed; hence managers have great freedom in how they run the firm. Managers may operate in stockholders' best interests, but they also may operate in their own personal best interests. As long as they stay within the law, there is no way to either force or motivate managers to act in the stockholders' best interests.

D

Which of the following statements is FALSE? A. A sunk cost is any unrecoverable cost for which the firm is already liable. B. The decision to continue or abandon a project should be based only on the incremental costs and benefits of the project going forward. C. A simple method often used to calculate depreciation is the straight-line method. D. Unlevered Net Income = EBIT × τc.

D

Which of the following statements is FALSE? A. Overhead expenses are associated with activities that are not directly attributable to a single business activity but instead affect many different areas of the corporation. B. Because value is lost when a resource is used by another project, we should include the opportunity cost as an incremental cost of the project. C. When computing the incremental earnings of an investment decision, we should include all changes between the firm's earnings with the project versus without the project. D. Sunk costs are incremental with respect to the current decision regarding the project and should be included in its analysis.

D

Which of the following statements is FALSE? a. U.S. Treasury securities are widely regarded to be risk-free because there is virtually no chance the government will default on these bonds. b. In general, if the interest rate is r and the tax rate is r, then for each $1 invested you will earn interest equal to r and owe taxes ofr x r on the interest. c. Investors may receive less than the stated interest rate if the borrowing company has financial difficulties and is unable to fully repay the loan. d. Taxes reduce the amount of interest the investor can keep, and we refer to this reduced amount as the tax effective interest rate.

D

Which of the following statements regarding the lLaw of One Price is INCORRECT? a. At any point in time, the price of two equivalent goods trading in different competitive markets will be the same. b. One useful consequence of the Law of One Price is that when evaluating costs and benefits to compute a net present value, we can use any competitive price to determine a cash value, without checking the price in all possible markets. c. If equivalent goods or securities trade simultaneously in different competitive markets, then they will trade for the same price in both markets. d. An important property of the Law of One Price is that it holds even in markets where arbitrage is not possible. e. The practice of buying and selling equivalent goods in different markets to take advantage of a price difference is known as arbitrage.

D

You are considering two equally risky annuities, each of which pays $15,000 per year for 20 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? a. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant. b. The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE. c. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD. d. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE. e. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD.

D

Heidee Corp. and Leaudy Corp. have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, Heidee uses more debt than Leaudy. Which of the following statements is CORRECT? a. Heidee would have the higher net income as shown on the income statement. b. Without more information, we cannot tell if Heidee or Leaudy would have a higher or lower net income. C. Heidee would have the lower equity multiplier for use in the DuPont equation. d. Heidee would have to pay more in income taxes. e. Heidee would have the lower net income as shown on the income statement.

E

Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur? a. The company would have to pay less taxes. b. The company's taxable income would fall. c. The company's interest expense would remain constant. d. The company would have less common equity than before. e. The company's net income would increase.

E