Chapter 2A

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

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 one of these is a current asset?

Accounts receivable

Which of these assets are generally converted into cash within one year? Select all that apply.

Accounts receivable Inventory

What is the definition of an income statement?

An income statement reports total revenues and expenses over a specific period of time.

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.

Which one of these formulas best defines an average tax rate?

Average tax rate = Tax liability/Taxable income

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.

Which of these are equity accounts? Select all that apply.

Common stock Preferred stock Retained earnings

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 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 EBIT?

EBIT is the earnings before interest and taxes.

Which one of these formulas correctly computes the value of EBT?

EBT = Net income + Taxes

What is the definition of EBT?

EBT is the taxable income of a firm.

True or false: All interest payments and dividends are deducted from operating income when the firm calculates taxable income.

False

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.

How can financial leverage be defined?

Financial leverage is the degree to which a firm finances its total assets with debt securities.

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

How is gross profit defined?

Gross profit = Net sales - Cost of goods sold

Which of these statements regarding the structure of an income statement is (are) correct? Select all that apply.

Gross profit = Net sales - Cost of goods sold EBT = Dividends paid + Addition to retained earnings + Taxes EBIT= Gross profit - Depreciation - Other operating expenses

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.

What is the definition of net income?

Net income is the aftertax profit or loss earned over a specified period of time.

What is the definition of net working capital?

Net working capital is the difference between a firm's current assets and current liabilities.

Which of these characteristics apply to the definition of preferred stock? Select all that apply.

Ownership interest in the firm Fixed periodic payments

What is the definition of preferred stock?

Preferred stock is a hybrid security that has characteristics of both long-term debt and common stock.

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?

Reason: Total assets = Current assets + Fixed assets = $5,000 + $28,000 = $33,000

What does a balance sheet do?

Reports a firm's assets, liabilities, and equity at a particular point in time

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 the following best illustrates a highly liquid asset?

Sale of a $100 asset by tomorrow at a price of $100. (Reason: A highly liquid asset can be sold quickly at its fair market value. A sale by tomorrow for the full $100 is a better illustration of liquidity.)

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 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.

How is the book value of land defined?

The book value of land is its historical cost, or the amount paid for that land.

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.

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

The operating profit is equal to earnings before interest and taxes.

True

True or false: Both common stock and paid in surplus represent a fundamental ownership claim in either a private or a public company.

True

True or false: Net working capital is a measure of a firm's ability to pay its bills for the next year.

True

Which one of these reports the amount of money a firm owes its creditors within the next year?

current liabilities

Which of these reduce the taxable income of a corporation?

interest expense

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 bond issued by a city is tax-exempt. Interest earned on a corporate bond is taxable.

What is the basic reason why debt financing affects the income available to asset funders?

Interest is a tax-deductible expense.

What is the definition of liabilities?

Liabilities are funds provided by lenders to a firm.

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 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 of these assets have useful lives exceeding one year and are classified as fixed assets? Select all that apply.

Machinery Building Land

A financial statement provides an _______-based picture of a firm's financial condition.

accounting

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.

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 these accounts are included in net working capital? Select all that apply.

Cash Accounts receivable Accounts payable

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

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.

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?

Reason: EPS = Income available to common stockholders/Total shares outstanding = ($3,000 - $900 - $1,000)/5,000 - $0.22

What is the definition of current liabilities?

Current liabilities are obligations of the firm that are due within one year

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

How is net plant and equipment calculated?

Net plant and equipment is equal to gross plant and equipment less accumulated depreciation.

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?

Reason: $110,000 - $77,000 = $33,000

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?

Reason: Asset funders includes both bondholders and stockholders so the difference = Tax savings on interest = 0.30($5,000) = $1,500.

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?

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

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?

Reason: Book value = $6,500 Market value = 0.96($6,500 - $4,200) + $4,700 + $6,908

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?

Reason: EBT = Net income + Taxes = $2,200 + $600 = $2,800

Another name for the bottom line of an income statement is

net income