Series 79 Unit 2: Company Comparisons
ABC Corporation raised capital through an offering of equity securities. Which component of the balance sheet has changed as a result? A) Current liabilities B) Fixed assets C) Long-term liabilities D) Current assets
A When equity securities are issued, cash (a current asset) and net worth increases. Fixed assets and liabilities remain unchanged as a result of the offering.
Due to changes in market rates, a corporation is able to purchase some of its outstanding 20-year bonds at a discount. Which of the following is correct? - Working capital is increased. - Working capital is reduced. - Net worth is increased. - Net worth is reduced. A) II and IV B) II and III C) I and III D) I and IV
B
Debts that will come due more than one year after the date on the balance sheet are known as A) deferred charges. B) fixed (or long-term) liabilities. C) accounts payable. D) current liabilities.
B Debts that will come due more than one year after the date of the balance sheet are known as fixed (or long-term) liabilities. Current liabilities are debts that may come due within one year from the date on the balance sheet.
A corporation must have stockholder approval to A) repurchase 100,000 shares of stock for its treasury. B) issue convertible bonds. C) declare a 15% stock dividend. D) declare a cash dividend.
B Stockholders are entitled to vote on the issuance of additional securities that would dilute shareholders' equity (a shareholder's proportionate interest). Conversion of the bonds would cause more shares to be outstanding, thus reducing the proportionate interest of current stockholders. Decisions that are made by the board of directors that do not require a stockholder vote include the repurchase of stock for its treasury, declaration of a stock dividend, and declaration of a cash dividend.
A company's working capital equals its A) current liabilities minus its current assets. B) current assets minus its current liabilities. C) cash flow minus its retained earnings. D) fixed assets minus its fixed liabilities.
B Working capital is a measure of how well a company can meet its current obligations. It is the amount that is left free and clear if all current debts are paid off. Working capital is calculated by subtracting current liabilities from current assets.
Under Regulation S-X, financial statements included in registrations must be prepared and "attested" by auditors who A) agree in writing to follow the standards of Sarbanes-Oxley. B) meet minimum experience standards. C) are qualified and independent of their client's interests. D) are certified by the SEC.
C Auditors must meet qualification standards of their profession, and they must work independently of the client's interest in these engagements. They may not have conflicts of interest, such as consulting assignments with attest clients.
XYZ company has been experiencing increased earnings while not issuing any new shares. In the light of constant dividend payments, the company's balance sheet would reflect which of the following? A) Decreased retained earnings B) Decreased net worth C) Increased shareholders' equity D) Decreased net working capital
C If earnings increase, retained earnings also increase. If the increased retained earnings are not paid out as dividends, shareholders' equity increases.
Net worth is equal to A) liabilities minus assets. B) liabilities minus income. C) assets minus liabilities. D) income minus liabilities.
C The balance sheet offers a "snapshot" view of a firm's resources and obligations based on the firm's most recent reporting date. The basic balance sheet equation is: assets − liabilities = net worth.
If a debenture were convertible, future conversion would affect which of the following balance sheet items? - The total assets - The total liabilities - The working capital - The shareholders' equity A) III and IV B) I and II C) II and IV D) II and III
C When the debenture is converted to common shares, the shareholders' equity will increase by the transfer of liabilities to equity. Conversion eliminates the bond debt, which would decrease total liabilities.
A review of ABC, Inc.'s income statement shows their net income for the period was $1,450,000, interest expense was $250,000, and tax expense was $860,000. What is ABC's interest coverage ratio? A) 5.8 B) 2.8 C) 3.4 D) 10.2
D A firm's interest coverage ratio is calculated by dividing its EBIT by interest expense. ABC, Inc.'s interest coverage ratio is, therefore, ($1,450,000 + $860,000 + $250,000) / $250,000 = 10.2.
"Below the line" items on an income statement include all the following except A) income (loss) from discontinued operations. B) extraordinary items. C) adjustments for previous misstatements. D) infrequent items.
D Misstatement adjustments, discontinued operations, and extraordinary items are all entered "below the line" or after net income. Items that occur infrequently, but are not unusual, are not extraordinary and are reported "above the line."
During the prior 12-month period, MNO Holdings had an average of 5,250,000 common shares outstanding. According to it income statement, the company had gross sales of $120,000,000 and a net income of $32,000,000. What is MNO's EPS? A) $6.10 B) $22.86 C) $16.76 D) $3.20
A Earnings per share (EPS) is calculated by dividing the net income by the number of shares outstanding. In this case MNO's earnings per share is $32,000,000 ÷ 5,250,000 = $6.10.
A profitable company distributes 70% of its earnings in the form of cash dividends. What is the effect on the balance sheet of the 30% earnings not distributed? A) An increase to retained earnings B) An increase to capital surplus C) A decrease to capital surplus D) A decrease to retained earnings
A Retained earnings are created by undistributed company profits. Capital surplus comes from original investors purchasing stock at a price in excess of stated or par value.
Which of the following best describe the balance sheet formula? - Assets minus liabilities equals net worth - Sales minus expenses equals operating income - Liabilities plus equity equals assets - Dividends plus retained earnings equals net income A) II and IV B) I and III C) I and IV D) II and III
B A balance sheet basically lists what is owned (assets) and what is owed (liabilities). The difference between these two is the net worth or equity. Sales, expenses, and dividends are all found on the income statement.
A review of The XYZ Group's financial statements for the period 20X1 shows $5,500,000 in assets, $3,400,000 in liabilities, total sales of $14,000,000, and net income of $1,240,000. What is XYZ's return on assets? A) 36.47% B) 22.55% C) 24.29% D) 39.29%
B Return on assets is computed by dividing the firm's net income by total assets. XYZ's return on assets is, therefore, $1,240,000 / $5,500,000 = 0.2255.
Which of the following is not a source of cash reported on the statement of cash flows? A) Cash flows from investing B) Cash flows from accounting changes C) Cash flows from financing D) Cash flows from operations
B The statement of cash flows reported by U.S. companies does not contain an entry entitled "cash flows from accounting changes."
Your customer wants to know what portion of earnings one of the companies held in her portfolio has available to pay interest expense on bonds the company currently has outstanding. You would be able to find this information A) by contacting the IRS. B) on a firm's income statement by subtracting preferred dividends from EBIT. C) on the firm's income statement indicated as earnings before interest and taxes (EBIT). D) on the firm's most recent balance sheet.
C EBIT is the amount of money a company has retained before paying taxes and interest on outstanding debt issues. This can be found by looking at the income statement for the company.
All of the following are affected by the issuance of a bond except A) working capital. B) assets. C) shareholders' equity. D) total liabilities.
C On the issuance of a bond, cash is received (thus increasing current assets) and long-term debt increases (increasing total liabilities). Because there is no corresponding increase in current liabilities, working capital will increase; it would have no effect on shareholders' equity.
The issuance of a debenture by a company would have an immediate effect on which of the following balance sheet items? - Total assets - Total liabilities - Working capital - Shareholders' equity A) II, III, and IV B) I, II, and IV C) I, III, and IV D) I, II, and III
D
Which of the following statements about balance sheets are true? - Balance sheets provide a snapshot of a company's financial position on a given date. - Balance sheets represent the relationship between a company's assets, liabilities, and stockholders' equity. - Balance sheets provide a record of a company's earnings over a given period. - Balance sheets itemize changes in cash. A) I and III B) III and IV C) II and III D) I and II
D A balance sheet shows a company's assets, liabilities, and stockholders' equity on a specific date. The financial statement that reflects a company's operating activities and earnings over a period of time is the income statement.
A company's changing from straight-line to accelerated depreciation will increase income in the early years. decrease income in the early years. increase income in the later years. decrease income in the later years. A) I and III B) I and IV C) II and IV D) II and III
D Accelerated depreciation increases charged expenses during the early years of equipment life but decreases charged expenses during the later years.
All of the following are true of stockholders' equity except A) that it consists of stock issued, capital surplus, and retained earnings. B) that it is reflected in the book value of the stock. C) that it is also called net worth. D) that it is carried as an asset on the balance sheet.
D Stockholders' equity or net worth (total assets less liabilities) is what a stockholder is entitled to should a company liquidate.
Included in the working capital computation of a corporation are all of the following except A) cash on hand. B) accounts payable. C) investments in marketable securities. D) convertible bonds outstanding.
D The working capital of a corporation is equal to its current assets minus its current liabilities (a current liability is payable within 12 months). Because all bonds—convertible or not—issued by the corporation are long-term liabilities, they are not included in the working capital computation. Marketable securities and cash are current assets, and accounts payable are current liabilities—all of which are included in the calculation of working capital.
Long term debt to capital ratio
Long-term debt-to-capital ratio is long-term debt ÷ (long-term debt + equity). Long-term debt is found by subtracting short-term debt (current assets - working capital) from total liabilities. After determining long-term debt, the only variable left to find is equity. Equity is found by dividing total liabilities by the debt-to-equity ratio.
Which of the following equations correctly shows the relationship between the items on a company's balance sheet? A) Assets = liabilities + stockholders' equity B) Assets = liabilities − net worth C) Assets + liabilities = net worth D) Assets = stockholders' equity − liabilities
A
When a company issues additional bonds, which of the following is true? A) Leverage is decreased. B) Leverage is increased. C) It cannot be determined by only knowing that additional bonds have been issued. D) Leverage is not affected when debt securities are issued.
B Leverage is the use of someone else's money at a fixed cost to benefit the common shareholders. Issuing additional bonds increases the company's debt (money borrowed from someone else), and therefore, increases leverage for shareholders.
Which of the following may be affected when a company buys machinery for cash? - Shareholders' equity - Current assets - Total liabilities - Working capital A) I and III B) II and IV C) II and III D) I and IV
B The purchase of machinery for cash will reduce current assets and working capital.
Stock of which of the following companies trades on equity? A) Drug manufacturer B) Public utility C) Steel manufacturer D) Car manufacturer
B Trading on equity relates to a highly leveraged company. Utility companies are normally highly leveraged.
During the last 12 months, MNO Holdings has had an average of 5,250,000 common shares outstanding. According to its income statement, it has had gross sales of $120,000,000 and a net income of $32,000,000. What is MNO's EPS? A) $3.20 B) $16.76 C) $6.10 D) $22.86
C
The board of ABC has voted to pay a $0.32 dividend to holders of its common stock. These dividends will be paid from A) operating income. B) debt service. C) retained earnings. D) new stock issues.
C
The issuance of a debenture by a company would have an immediate effect on which of the following balance sheet items? The total assets The total liabilities The working capital The shareholders' equity A) I, III, and IV B) II, III, and IV C) I, II, and III D) I, II, and IV
C
Components of a company's net worth would include all of these except A) inventory. B) goodwill. C) operating income. D) fixed assets.
C Net worth is all of the company's assets minus its liabilities as found on the balance sheet. Operating income is found on the income statement and is neither an asset nor a liability.
If the assets of a company did not change, but stockholders' equity declined, it follows that A) retained earnings increased. B) liabilities declined. C) capital surplus decreased. D) liabilities increased.
D Stockholders' equity is assets minus liabilities. If assets stay the same, then an increase in liabilities will cause a decline in equity.
Which of the following is not a source of cash reported on the statement of cash flows? A) Cash flows from financing B) Cash flows from operations C) Cash flows from investing D) Cash flows from accounting changes
D The statement of cash flows reported by U.S. companies does not contain an entry entitled "cash flows from accounting changes."
Included in the working capital computation of a corporation are all of the following except A) cash. B) marketable securities of other companies. C) accounts receivable. D) convertible bonds it has issued.
D The working capital of a corporation is equal to its current assets minus its current liabilities (a current liability is payable within 12 months). Because all bonds, convertible or not, issued by the corporation are long-term liabilities, they are not included in the working capital computation. Accounts receivable, marketable securities, and cash are short-term assets included in the calculation of working capital.
If during a given year a company has net income of $1 million and pays out dividends of $800,000, its retained earnings will A) increase by $200,000. B) decrease by $1 million. C) decrease by $200,000. D) increase by $1 million.
A Retained earnings represent the net income a company has retained and not paid out in dividends. If a company has net income of $1 million and pays out only $800,000 in dividends, its retained earnings will increase by $200,000.
ABC Corporation's earnings remained steady while its shares outstanding increased by 5%. How does this impact ABC's earnings per share (EPS)? A) EPS has increased B) EPS has decreased C) Not enough information to answer the question D) EPS has stayed the same
B
Which of the following is not affected by the issuance of a bond? A) Working capital B) Shareholders' equity C) Total liabilities D) Assets
B
Which of the following statements is true? A) The stockholder's equity includes preferred stock, common stock, additional paid-in capital, retained earnings, and capital surplus. B) All of these. C) LIFO results in a lower net income during an inflationary period. D) FIFO assumes the first goods into inventory are the first goods sold.
B First in, first out (FIFO) assumes the first goods into inventory are the first goods sold. Last in, first out (LIFO) assumes the last goods into inventory are the first goods sold. The stockholder's equity/net worth would include preferred stock, common stock, additional paid-in capital, retained earnings, and capital surplus.
All of the following appear on a corporation's balance sheet as fixed assets except A) real estate. B) Inventory. C) furniture. D) computer equipment.
B Inventory is considered a current asset, not a fixed asset, because the company expects to convert its inventory into cash within a short period of time. The other choices are fixed assets and cannot be liquidated easily.
All of the following ratios are measures of the liquidity of a corporation except A) current ratio. B) debt-to-equity ratio. C) quick ratio. D) acid-test ratio.
B Liquidity ratios measure a firm's ability to meet its current financial obligations and include the current ratio and acid-test (quick) ratio. However, the debt-to-equity ratio is a capitalization ratio and measures the amount of leverage compared to equity in a company's overall capital structure.
If a company successfully gets its 7% debenture holders to exchange their 7% debentures for 7% preferred stock, what is the effect on EPS? A) Increase B) Decrease C) Not enough information D) No effect
B The 7% payment is moved from a pretax deduction to an after-tax payment. This increases the amount of taxable income, thereby increasing the company's tax liability. The 7% payment remains the same. With an increased tax burden and everything else remaining the same, the EPS will decrease.
Which of the following may be affected when a company buys machinery for cash? - Shareholders' equity - Current assets - Total liabilities - Working capital A) II and III B) I and IV C) II and IV D) I and III
C The purchase of machinery for cash will reduce current assets and working capital.
Profits that are not distributed to shareholders are called A) capital surplus. B) dividends. C) retained earnings. D) interest.
C When a corporation's board of directors determines how much of the net income to distribute as a dividend, the balance is retained by the company as retained earnings, sometimes called earned surplus.
If an investor wanted to verify a company's working capital, she would do so by reviewing its A) cash flow statement. B) footnotes. C) balance sheet. D) income statement.
C Working capital, current assets minus current liabilities, is determined from numbers found on the balance sheet.
How to calculate the Current Ratio?
Current ratios are calculated by dividing current assets by current liabilities. Company M's current liabilities are found by subtracting its working capital (current assets - current liabilities) from its current assets. Therefore, Company M's current ratio is $5,400,000 / ($5,400,000 - $2,000,000) = 1.59.
MNO Group's income statement shows that during the review period its total sales were $14,500,000, cost of goods sold were $7,500,000, and net income was $2,690,000. What is MNO's net margin for the review period? A) 18.55% B) 35.87% C) 15.42% D) 38.43%
A A firm's net margin is found by dividing net income by total sales. Therefore, MNO Group's net margin is $2,690,000 / 14,500,000 = 18.55%.
Working capital is A) current assets minus current liabilities. B) current assets minus inventory. C) total assets minus total liabilities. D) only the cash and equivalents.
A Current means cash or assets that would be exchanged for cash in the ordinary course of business in the current year. In the case of liabilities, current means maturing or falling due within the current year. The net of current assets less the current liabilities implies the company has cash availability of the remainder with which to work.
Which of the following is defined as profits after taxes and interest paid, less preferred dividends, divided by the number of shares of outstanding common stock? A) Earnings per share (EPS) B) Cash flow per share C) Book value per share D) Price-earnings (P/E)
A Dividing net income after taxes, interest, and payment of preferred dividends by the number of common shares outstanding determines earnings per share (EPS).
Which items change when a company pays a cash dividend? - Working capital - Total assets - Total liabilities - Shareholders' equity A) II and III B) I, II, and III C) I and IV D) II, III, and IV
A When a dividend is paid, total assets are decreased, as are total liabilities. The liabilities were increased at declaration time and are now decreased to reflect the payout. The two accounts affected would be decrease cash and decrease dividend payable.
Which of the following best describe the balance sheet formula? Assets minus liabilities equals net worth Sales minus expenses equals operating income Liabilities plus equity equals assets Dividends plus retained earnings equals net income A) I and IV B) I and III C) II and III D) II and IV
B A balance sheet basically lists what is owned (assets) and what is owed (liabilities). The difference between these two is the net worth or equity. Sales, expenses, and dividends are all found on the income statement.
The difference between current assets and current liabilities is called A) quick assets. B) working capital. C) net worth. D) cash flow.
B Working capital (or net working capital) is, by definition, the difference between current assets and current liabilities.
Refer to Exhibit 10. The company with the lowest long-term debt-to-capital ratio is A) Company P. B) Company O. C) Company N. D) Company M.
C Long-term debt-to-capital ratio is long-term debt ÷ (long-term debt + equity). Long-term debt is found by subtracting short-term debt (current assets - working capital) from total liabilities. After determining long-term debt, the only variable left to find is equity. Equity is found by dividing total liabilities by the debt-to-equity ratio.
A review of The XYZ Group's financial statements for the period 2019 shows $25,500,000 in assets, $13,400,000 in liabilities, total sales of $24,000,000, and net income of $5,240,000. What is XYZ's return on assets? A) 36.47% B) 24.29% C) 20.55% D) 39.29%
C Return on assets is computed by dividing the firm's net income ($5,240,000) by total assets ($25,500,000). XYZ's return on assets is, therefore, $5,240,000 / $25,500,000 = 0.2055.
Which of the following capital structures would be considered the most highly leveraged? A) Common stock only B) Equal values of common stock and bonds C) A large value of common stock and a small value of bonds D) A large value of bonds and a small value of common stock
D Leverage is using other people's money to enhance equity value. In this case, borrowing at a fixed rate of payment enhances cash flow, giving the company extra money to invest in its operations. Just as individuals, a company has to be careful not to borrow more than it can afford.
Which of the following is the most stringent test of liquidity? A) Assets / current liabilities B) (Cash + marketable securities) / current liabilities C) Current assets / current liabilities D) (Current assets - inventory) / current liabilities
B Of the answers given, the cash assets ratio is the most stringent because it excludes inventories and accounts receivable.
Current assets on a corporate balance sheet would include - accounts payable. - accrued wages. - cash. - inventory. A) II and IV B) I and II C) III and IV D) I and III
C Cash is the most obvious current asset. The general definition of a current asset is one that is expected to be turned into cash within the year. One would certainly hope that to be true of inventory. Accounts payable and accrued wages are liabilities, obligations that must be paid on a current basis.
A company has filed for an IPO at $20 par value. The IPO is priced at $30 per share. Where on the balance sheet is the extra $10 recorded? A) Retained earnings B) Distributed dividends C) Excess par value D) Capital surplus
D Capital surplus is the amount of premium paid by shareholders above par value.
A review of LMQ Corporation's financial statements reveals that they have $20,000,000 in assets, $17,000,000 in total liabilities, and 13,500,000 shares outstanding. What is LMQ Corporation's debt-to-equity ratio? A) 1.70 B) 4.00 C) 2.41 D) 5.66
D LMQ Corporation's debt-to-equity ratio is calculated by dividing total debt (liabilities) by total equity (assets - liabilities). Shares outstanding do not affect a firm's debt-to-equity ratio. LMQ's debt-to-equity ratio is 17,000,000 / (20,000,000 - 17,000,000) = 5.66.
Liquidity ratios measure the solvency of a firm or the firm's ability to meet short-term financial obligations. Which of the following is a liquidity ratio? A) Net income divided by average total equity B) Current assets divided by current liabilities C) Gross profit divided by net sales D) Dividend divided by earnings per share
B Current assets divided by current liabilities is the current ratio, a ratio that measures the liquidity of a firm. Gross profit divided by net sales is a profitability ratio that measures the gross profitability of the firm's business operations, not its liquidity. Net income divided by average total equity is the return on stockholders' equity, which measures the efficiency of common shareholders' investment or equity in the firm. Dividend amount divided by earnings per share is the dividend payout ratio, which measures how much of a company's earnings are distributed to common stockholders.
Which of the following balance sheet items is not a current liability? A) Accounts payable B) Mortgages C) Accrued taxes D) Long-term debt amount that is due within one year
B Short-term or current liabilities are those entries on a balance sheet that are due in one year or less. Accounts payable, accrued taxes, and that portion of long-term debt due within the year are all current liabilities. Mortgages are generally long-term liabilities, although that portion of a mortgage that is due within the year would be classified on the balance sheet as a current liability.
All of the following ratios are measures of the liquidity of a corporation except A) acid test ratio. B) quick ratio. C) debt/equity ratio. D) current ratio.
C Liquidity ratios measure a firm's ability to meet its current financial obligations and include the current ratio and acid test (quick) ratio. However, the debt/equity ratio is a capitalization ratio and measures the amount of leverage compared to equity in a company's overall capital structure.
A highly leveraged company has the smallest percentage of its total capitalization in A) long-term debt. B) short-term debt. C) preferred stock. D) common stock.
D Common stock, which represents ownership, would account for the smallest amount of capitalization of a highly leveraged company. Highly leveraged companies have the largest amount of their capitalization in debt instruments. Preferred stock, although an equity, is more like a debt instrument because of the stated dividend rate.
Which of the following describes additional paid-in capital? A) The difference between the total dollar amount received from the issuance of common stock and the stock's aggregate par value B) Also called earned surplus C) Total of all residual claims that stockholders have against the corporation's assets D) Total of all earnings since a corporation was formed, less dividends
A Additional paid-in capital is the difference between the dollar amount received from the sale of stock and the stock's aggregate par value. Earned surplus is another name for retained earnings.
Balance sheets contain A) the amount of cash and cash equivalents expended during the first half of the fiscal year as opposed to the second half. B) no reference to the accounting methods used to construct the balance sheet. C) gross revenues for the year. D) the net worth of the firm as of the date of the balance sheet.
D The balance sheet provides a snapshot of the financial condition of the firm on that date. It does not provide information on the flow of expenses, revenues, and cash during the reporting period because they would appear on the income statement.
When a company issues additional preferred stock and bonds, which of the following will be the net result? A) Leverage is decreased. B) Leverage is increased. C) Leverage is not affected because one issue is equity, the other is debt, and the net effect on leverage is zero. D) It is impossible to tell without the specific amounts of equity and debt issued.
B Leverage is the use of someone else's money at a fixed cost to benefit the common shareholders. Both preferred stock and bonds are fixed-rate issues. Therefore, issuing more preferred stock or bonds increases the leverage of the common stockholders.
Additional paid-in capital is described as A) total of all earnings since a corporation was formed, less dividends. B) total of all residual claims that stockholders have against the corporation's assets. C) the difference between the total dollar amount received from the issuance of stock and the stock's aggregate par value. D) earned surplus
C Additional paid-in capital is the difference between the dollar amount received from the sale of stock and the stock's aggregate par value. Earned surplus is another name for retained earnings.
In analyzing the ability of a company to meet its debt obligations, but not wanting to chance that certain accounting decisions or practices will cloud the picture, one measure that you might look at is the firm's A) net worth found on the firm's balance sheet. B) price-to-earnings (P/E) ratio. C) earnings before interest and taxes (EBIT) as calculated from the firm's income statement. D) cash flow from financing activities.
C EBIT, calculated from the firm's income statement, is a metric that measures the ability of a company to meet scheduled interest payments. Cash flow from financing activities reflects money raised by the company by issuing debt and equity securities. Net worth is useful for determining payback of principal but not semiannual interest.
A corporation has a net income of $5.2 million after taxes. If 4 million shares of common stock are outstanding, the earnings per share is A) $1.78. B) $5.20. C) $0.80. D) $1.30.
D Earnings per share equals net income (less preferred dividends) divided by the number of common shares outstanding. In this case, $5.2 million divided by 4 million equals an EPS of $1.30.
SSS Corporation's total assets amount to $780,000, of which $260,000 represents current assets. Total liabilities equal $370,000, of which $200,000 is considered long-term or other liabilities. What is the equity of SSS Corporation's shareholders? A) $170,000 B) $410,000 C) $980,000 D) $1,150,000
B Total assets minus total liabilities equals shareholders' equity ($780,000 - $370,000 = $410,000).
On a balance sheet, dividends payable would fall under the category of A) stockholders' equity. B) fixed liabilities. C) assets. D) current liabilities.
D Dividends payable are dividends that have been declared but have not yet paid out. They are a type of current liability—that is, an obligation that will come due within one year from the date on the balance sheet.
The type of financial statement that shows a record of a company's operating activities and earnings over a stated period of time is A) a retained earnings statement. B) a balance sheet. C) a cash flow statement. D) an income statement.
D An income statement reflects a company's operating activities and earnings over a stated period of time. A balance sheet, on the other hand, provides a snapshot on a given date. A retained earnings statement shows how much of its earnings a company has retained for future growth, while a cash flow statement reflects where the company's cash flow came from and where it went.
The amount paid in excess of par value on the sale of common shares by an issuer is reflected in which of the following accounts on the corporate financial records? A) In the retained earnings B) In the paid-in surplus C) In the earned surplus D) In the capital stock
B Paid-in surplus, or capital surplus, is the excess over par value that investors pay for stock on its original issue. Generally, par value on common stock is a matter of record for accounting purposes.
Refer to Exhibit 11. PDQ's effective tax rate is A) 4.0%. B) 9.3%. C) 10.2%. D) 14.2%.
B The effective tax rate of a company is its income tax expense divided by its taxable income (EBT). PDQ's tax expense is calculated by subtracting net income from its EBT (operating income less interest). Tax expense is therefore $12,300 - $430 - $10,770 = $1,100, and EBT is $11,870. Using this information, the effective tax rate equals $1,100 ÷ $11,870 = 9.3%.
Which of the following items would normally not be considered a current asset on a balance sheet? A) Inventories B) Cash C) Account receivables D) Land
D A current asset is an asset that is already cash or that, in the normal course of business, will become cash within one year from the date on the balance sheet. A fixed asset, such as land, is an asset that is used over a long period in the normal course of business and that is not intended for sale.
The total of the cash from operations, investing, and financing, as reported on the statement of cash flows, is A) an integral part of the footnotes to the balance sheet required by generally accepted accounting principles. B) reported as cash income on the income statement. C) the net change in the cash position of the firm for the reporting period. D) reported as a separate line item on the balance sheet.
C The total of the cash from operations, investing, and financing, as reported on the statement of cash flows, is the net change in the cash position of the firm for the reporting period. The sum total, or the net change in cash, is not reported on either the balance sheet or the income statement. It is the sum total of the entries on the statement of cash flows which is a separate financial statement.
Operating cash flow minus capital expenditures (CAPEX) is known as A) free cash flow (FCF). B) pre CAPEX cash flow. C) CAPEX cash flow. D) after CAPEX cash flow.
A By definition, FCF represents cash available to all potential providers of debt and equity financing.
Under what circumstances will a dilution of equity occur? A) Conversion of convertible bonds into common stocks B) Issue of mortgage bonds to replace debentures C) Stock dividend D) Stock split
A Dilution of equity occurs when stockholders experience a reduction in their percentage ownership of the company. If bonds are converted, more common shares are issued and the shareholder's equity is diluted. A stock dividend or stock split does not change a stockholder's percentage of ownership. Refunding debts has no effect on stockholders.
If DMF Corporation issues $10 million of convertible debentures at par, all of the following balance sheet items will be affected immediately except A) the net worth. B) the liabilities. C) the working capital. D) the assets.
A Net worth (equity in the company) remains unchanged. Assets and liabilities both increase, as does the working capital.
If XYZ common stock has a $4 dividend, a yield of 4.2%, and a PE ratio of 12, and it is trading at $96, its approximate earnings per share (EPS) is A) $8.00. B) $48.00. C) $50.40. D) $4.00.
A The stock's PE ratio is price to earnings per share (EPS). Dividing the stock's price by the PE will give the earnings per share ($96 / 12 = $8 EPS).
Balance sheets contain A) no reference to the accounting methods used to construct the balance sheet. B) gross revenues for the year. C) the net worth of the firm as of the date of the balance sheet. D) the amount of cash and cash equivalents expended during the first half of the fiscal year as opposed to the second half.
C The balance sheet provides a snapshot of the financial condition of the firm on that date. It does not provide information on the flow of expenses, revenues, and cash during the reporting period, as they would appear on the income statement. Among other references will be if inventory was calculated using first-in-first-out (FIFO) or last-in-first out (LIFO).
A noncontrolling interest can best be described as A) any interest requiring Form 144. B) interest in a company's shares controlled by its parent company. C) any interest that triggers a Form 13D filing. D) interest in a company's shares not controlled by its parent company.
D A noncontrolling interest (NCI) must be reported on the shareholder's balance sheet. If Alpha Company owns more than 50% of Beta Company, Alpha will consolidate Beta's financials with its own. NCI is recorded in the equity section of Alpha's balance sheet between liabilities and equity. Furthermore, that portion of income from the NCI must be identified on the P&L.
What is the balance sheet equation? A) Assets = liabilities + shareholders' equity B) Assets = shareholders' equity - liabilities C) Assets = net worth D) Assets = liabilities - shareholders' equity
A Total assets equal total liabilities plus total shareholders' equity.
All of the following ratios are measures of the liquidity of a corporation except A) debt-to-equity ratio. B) quick ratio. C) acid-test ratio. D) current ratio.
A Liquidity ratios measure a firm's ability to meet its current financial obligations and include the current ratio and acid-test (quick) ratio. However, the debt-to-equity ratio is a capitalization ratio and measures the amount of leverage, compared with equity, in a company's overall capital structure.
In a rising price environment, which of the following inventory valuation methods will result in the highest reported earnings? A) FIFO B) Straight line C) Average cost D) LIFO
A Using first in, first out (FIFO) means lower cost inventory is used first in determining the cost of goods sold. This has the effect of inflating earnings. Using last in, first out (LIFO) means higher cost inventory is used to determine the cost of goods sold. In a rising price environment, LIFO better matches cost with revenue.
Which of the following balance sheet entries may be affected when a company pays a cash dividend? - Shareholders' equity - Total assets - Total liabilities - Working capital A) I and IV B) II and III C) I and III D) II and IV
B When a company pays a cash dividend, the dividends payable (a current liability) and the cash account (current assets) are reduced by the same amount. Working capital is not affected because both current assets and current liabilities are reduced the by same amount. Shareholders' equity, or net worth, is also not affected when the dividend is paid. Net worth is reduced and liabilities are increased when a dividend is declared.
Net income A) reflects the operating profits of a firm only. B) must be paid out in dividends. C) represents the amount of money remaining after all expenses including taxes. D) is paid out in cash to stockholders in addition to any declared dividends.
C Net income is not a cash item that is paid out to stockholders. Dividends, both preferred and common, are generally cash distributions paid out from net income. Net income after taxes can reflect all sources of income in addition to the operating income generated by business activities. Net income also reflects investment income, as well as operating income. Net income may be paid out in the form of dividends; however, most firms retain a portion of net income in order to reinvest the funds in the business.
At the start of an accounting period, a company has retained earnings of $300 million. During the period, it reports net income of $50 million and declares dividends of $20 million. What are retained earnings at the end of the period? A) $370 million B) $300 million C) $330 million D) $350 million
C Retained earnings = beginning balance + net income = $300 million beginning balance + $50 million net income - $20 million dividends = $330 million.
In a rising price environment, which of the following inventory valuation methods will result in the highest reported earnings? A) Last in, first out (LIFO) B) Average cost C) Straight line D) First in, first out (FIFO)
D FIFO means lower cost inventory is used first in determining the cost of goods sold. This has the effect of inflating earnings. Using LIFO means higher cost inventory is used to determine the cost of goods sold. In a rising price environment, LIFO better matches cost with revenue.
Which of the following balance sheet entries may be affected when a company pays a cash dividend? - Shareholders' equity - Total assets - Total liabilities - Working capital A) II and III B) II and IV C) I and III D) I and IV
A When a company pays a cash dividend, the dividends payable (a current liability) and the cash account (current assets) are reduced by the same amount. Because liabilities and assets are each reduced by the same amount, working capital is not affected. Shareholders' equity—or net worth—is also not affected when the dividend is paid.
Which of the following are true of a minority interest, referred to as noncontrolling interest in a company? - It is found in the shareholder's equity section of the company's consolidated balance sheet. - It is not found on the company's consolidated balance sheet and must be disclosed in SEC filings. - The noncontrolling interest holder's share of income is subtracted from net income on the company's consolidated income statement. - The noncontrolling interest holder's share of income is not subtracted from net income on the company's consolidated income statement. A) I and IV B) I and III C) II and IV D) II and III
B Noncontrolling interest is the part of a subsidiary not controlled by the parent company. It is recorded in the shareholder's equity section of the balance sheet, and the percentage of the noncontrolling interest in the company is subtracted from the parent company's net income.
KPT, Inc., is preparing to report its net income for the past year. An increase in which of the following causes a decrease in the reported net income? - Tax rate - Cash dividend - Allowance for bad debts - Par value of common equity A) I and II B) I and IV C) I only D) I and III
D Higher taxes mean less net income. The allowance for bad debts is an expense item; increasing it lowers operating income. Dividends are paid out of retained earnings and have no effect on the net income the company reports. A change in the par value of common stock has no effect on any financial obligation or the income statement.
Which of the following would be considered an investing activity of a company that would be found on its cash flow statement? A) an increase in accounts receivable. B) an issuance of senior convertibles. C) an issuance of equity. D) a purchase of new equipment.
D The purchase of new equipment is a capital expenditure (cap ex) and is classified as an investing activity. Investing captures cash outflows or inflows from the purchase or sale of assets or equipment. An increase in accounts receivable, which is a use of cash, would be displayed under the operating activities section of the cash flow statement. The issuance of debt or equity is classified as a financing activity.
ABC Capital Advisers, LLC, is considering purchasing Best Manufacturing Co. (BMC) as a bolt-on acquisition to another company it already owns in its portfolio. It plans to contribute some equity with most of the purchase financed with debt. ABC has submitted an indication of interest pursuant to the auction process laid out by the target company's advisers. In the second round of the process, ABC decides to hire XYZ Investment Bank to complete additional due diligence. During this due diligence process, which of the following metrics regarding BMC would the bankers be least concerned with? A) Operating cash flow B) LTM EBITDA C) Gross profit margin D) Debt-to-capitalization ratio
D When a private equity firm purchases a company in an LBO, the target company will have an entirely new capitalization structure after the deal closes. Therefore, the company's current capital structure would not be relevant in the analysis. An equivalent analogy is when an individual purchases a house. The purchaser does not care if the seller owns 100% of the house or has a mortgage on the home.
A review of WRJ Corporation's financial statements reveals that they have $10,000,000 in assets, $7,000,000 in total liabilities, and 3,500,000 shares outstanding. What is WRJ Corporation's debt-to-equity ratio? A) 2.33 B) 0.41 C) 0.70 D) 2.00
A WRJ Corporation's debt-to-equity ratio is calculated by dividing total debt (liabilities) by total equity (assets - liabilities). Shares outstanding do not affect a firm's debt-to-equity ratio. WRJ's debt-to-equity ratio is 7,000,000 / (10,000,000 - 7,000,000) = 2.33
If a company issues $10 million in par value convertible debentures, all of the following balance sheet items will be affected except A) net worth. B) working capital. C) assets. D) liabilities.
A Net worth is not affected by the issuance of long-term debt because it does not represent ownership. Assets will be affected (increased) by the issuance of long-term bonds. Liabilities will be affected (increased) by the amount of the issuance. Working capital will also increase. How does the working capital increase if the net worth does not? Because this company now has $10 million more in cash, and the liability is the debenture that is included in long-term debt, not current liabilities.
An analyst comparing revenues with expenses is most likely analyzing A) cash flow. B) liquidity. C) capitalization. D) working capital.
A The analyst is most likely measuring the income statement for cash flow (money coming in against money going out). Working capital analysis would involve examining the balance sheet's current assets and current liability entries, not the income statement. Capitalization analysis involves examination of long-term debt and stock issues. Liquidity analysis involves examining current assets and liabilities from the balance sheet.
Which items would change if a company buys equipment for cash? The working capital The total assets The total liabilities The shareholders' equity A) I only B) III and IV C) IV only D) I and II
A The general balance sheet formula is assets equals liabilities plus shareholders' equity. A purchase of equipment for cash would affect working capital by reducing current assets. However, it would not affect total assets because it is an exchange of one asset (cash) for another asset of equal value (equipment). Because no loan was needed, it affects neither total liabilities nor equity.
The XYZ Corporation accesses the capital markets raising $200 million with two separate issues. It raised $100 million with a follow-on common stock offering, and another $100 million by issuing debentures maturing in 15 years. Which of the following measurements would be the least likely to be impacted by this capital raise? A) Liquidity ratios B) Inventory turnover ratio C) Leverage ratios D) Interest coverage ratio
B Leverage ratios should change, given there is more debt and equity. With $200 million of additional cash, at least in the short term, the firm's cash position should be higher increasing liquidity measurements. Additional debt creates additional interest expense. Although EBIT and EBITDA numbers will change because of the capital infusion, the coverage ratios should be impacted. The inventory turnover (CGS / avg. inventory) is not impacted by these two offerings.
