(Corporate Finance) Ch. 3 Financial Statements

An asset's liquidity is determined by how readily the asset can be converted to an appropriate amount of cash.

True

Assets can be either tangible or intangible. (T or F)

True

The difference between the market values of assets and liabilities is the market value of the shareholders' equity claim. (T or F)

True

True or false: In order to calculate cash produced by the business it is necessary to add back the depreciation charge.

True. Depreciation is a non-cash outlay, therefore, the cash deducted as an expense must be added back

The net value or book value of an asset is determined by subtracting the _____ from the asset's gross value.

accumulated depreciation

When a company pays more for an acquired business than what it is worth the difference is shown in an account entitled _____.

annually

Uses of funds raised by a company are known as _____.

assets

The financial statement that presents a snapshot of a company's assets and liabilities at a particular moment is known as the _____.

balance sheet

Intangible assets include:

brand names, patents, trademarks, copyrights, franchises, and goodwill

Free cash flow is equal to cash flow from operations minus

capital expenditures

Financial managers must track _______ inflows and outflows in order to pay interest to banks and dividends to shareholders.

cash

The process of deliberately inflating earnings based on the ambiguity of the revenue recognition principle is termed

channel stuffing

The purpose of depreciation is to allocate the original _____ of the asset over its life.

cost

The largest single expense of a merchandising firm, such as Home Depot, is called

cost of goods sold

Market values of assets and liabilities measure _______ value. Book values are based on ________ value.

current, original

A deduction in the value of a company's plant and equipment used up in producing goods is known as

depreciation

The annual decline in the book value of an asset is known as ______.

depreciation

Corporations can deduct their expenses to reduce taxable income, but they cannot deduct

dividends to shareholders

The rules governing the depreciation of asset values _____ reflect actual loss of market value.

do not

Market values of assets and liabilities generally

do not equal their book values.

Companies have used the ambiguity of the revenue recognition principle to deliberately inflate their

earnings

Fixed assets include:

equipment buildings

Interest on debt is not treated in the same manner as dividends because it is considered a business

expense

Longer lived assets are known as _____ assets.

fixed

Cash generated for investors after the firm pays for new capital investments is known as

free cash flow

When a company pays more for an acquired business than what it is worth the difference is shown in an account entitled _____.

goodwill

The _______ shows how profitable a firm has been over the course of the past year.

income statement

Managers may inflate earnings for the purpose of satisfying the

investors

Managers under pressure to perform are tempted to take advantage of the

leeway provided by GAAP

Sources of funds raised by a company are known as _____.

liabilities

If you are a single taxpayer and your income is greater than $9,526 and less than $38,700, you would pay _____ cents of tax on each extra dollar you earn.

12

Depreciation expense is used to: A) allocate historical cost over the life of an asset. B) allocate costs to all departments of the firm. C) determine when an asset is fully paid off. D) equate the historical cost and market values of an asset.

A) allocate historical cost over the life of an asset.

Assume a firm generates $2,000 in sales and has a $500 increase in accounts receivable during an accounting period. Based solely on this information, cash flow will increase by: A) $2,500. B) $1,500. C) $500. D) $2,000.

B) $1,500.

Assume a firm increases its revenue by $100 while increasing its cost of goods sold by $85. How much additional tax will the firm owe if its marginal tax rate is 21%? A) $13.75 B) $3.15 C) $25.00 D) $7.50

B) $3.15

Johnson's Nursery has net income of $42,500, depreciation expense of $1,800, interest expense of $900, taxes of $1,600, additions to net working capital of $2,300, and capital expenditures of $11,700. What is the amount of the free cash flow? A) $30,300 B) $31,200 C) $34,400 D) $28,700

B) $31,200

Who pays taxes on earnings distributed as dividends? A) Neither the issuing corporation nor the shareholder B) The shareholder receiving the dividend C) The issuing corporation D) Both the issuing corporation and the shareholder

D) Both the issuing corporation and the shareholder

Which of the following changes in working capital will result in an increase in cash flows? A) Decrease in other current liabilities B) Increase in accounts receivable C) Increase in inventories D) Increase in accounts payable

D) Increase in accounts payable

Which of the following values would most likely interest a shareholder? A) Retained earnings B) Book value of equity C) Net working capital D) Market value of equity

D) Market value of equity

Which one of the following will reduce the cash flow during an accounting period? A) Increase in accounts payable B) Reduction of inventory levels C) High depreciation expense D) Purchase of equipment

D) Purchase of equipment

Operating cash flow (OCF) is defined as: A) a firm's net profit over a specified period of time. B) the cash that is generated and added to retained earnings. C) the change in the net working capital over a stated period of time. D) the cash that a firm generates from its normal business activities

D) the cash that a firm generates from its normal business activities

Which of the following is treated as an annual expense on the income statement even though it is not an actual cash payment?

Depreciation

What is the term used to describe the situation in which original earnings are taxed as corporate income and again as dividend income?

Double taxation

The income statement resembles a snapshot of the firm at a specific time. (T or F)

False

True or false: depreciation is an out-of-pocket cash expense for a business.

False depreciation does not require a cash payment

Which of the following financial statements are public companies required to file with the SEC each quarter?

Income Statement Balance Sheet Statement of Cash Flows

Which of the following explain why a firm's cash flows differ from the net income?

The income statement spreads capital expenditure expenses over time. The income statement does not recognize capital expenditures as expenses in the year purchased. The income statement uses the accrual accounting method.

Maxwell Corporation had a net income of $40,000, interest of $4,000, depreciation of $5,000, additions to net working capital of $6,000, and capital expenditures of $20,000. Maxwell Corporation's free cash flow amounts to:

$23,000 Rationale: First calculate cash flow from operations = net income + interest + deprecation - additions to net working capital: $40,000 + $4,000 + $5,000 - $6,000 = $43,000. Next, calculate free cash flow by taking the cash flow from operations that you just calculated and subtracting the capital expenditures: $43,000 - $20,000 = $23,000

Lowe's current assets total $22,590 million and its current liabilities total $15,456 million. Lowe's net working capital is:

$7,134 million Net working capital equals current assets minus current liabilities = $22,590 million - $15,456 million = $7,134 million

22) Assume a single taxpayer is taxed at 10% on the first $9,525 of taxable income, 12% on the next $29,175 of income, and at 22% for the following $43,800 of income. What is the average tax rate for that individual if her taxable income is $42,000? [Hint: calculate the amount of tax first.] A) 16.13% B) 12.33% C) 16.67% D) 25%

B) 12.33%

Which one of these is correct? A) Taxable income must be a positive value. B) Net income is distributed either to dividends or retained earnings. C) Depreciation has no effect on taxes. D) Interest paid is a noncash item.

B) Net income is distributed either to dividends or retained earnings.

Which one of these would not be paid from free cash flow? A) Repayment of principal on a long-term debt B) New equipment purchase (i.e. capital expenditure) C) Cash dividends D) Repurchase of outstanding shares of common stock

B) New equipment purchase (i.e. capital expenditure)

Net working capital is a measure of a company's: A) shareholders' equity. B) estimated cash reservoir. C) short-term liabilities. D) goodwill

B) estimated cash reservoir.

5) A balance sheet portrays the value of a firm's assets and liabilities: A) only at the end of the calendar year. B) over an annual period. C) at any stated point in time. D) over any stated period of time

C) at any stated point in time.

Highly liquid assets: A) include all intangible assets. B) generally produce a high rate of return. C) can be sold quickly at close to full value. D) increase the probability a firm will face financial distress

C) can be sold quickly at close to full value.

Over the past year, a firm decreased its current assets and increased its current liabilities. As a result, the firm's net working capital: A) had to increase. B) was unaffected as the changes occurred in the firm's current accounts. C) had to decrease. D) remained constant

C) had to decrease.

The market value: A) of an asset is reflected in the balance sheet. B) of accounts receivable is generally higher than the book value of those receivables. C)of an asset tends to provide a better guide to the actual worth of that asset than does the book value. D) of an asset is lowered each year by the amount of depreciation expensed for that asset.

C) of an asset tends to provide a better guide to the actual worth of that asset than does the book value

Current period depreciation expense is listed: A) on neither the balance sheet nor the income statement; it is a noncash expense. B) on the left-hand side of balance sheet C) on the income statement. D) on the right-hand side of balance sheet

C) on the income statement.

The tax rate that an individual pays on each extra dollar of income is known as the

marginal tax rate

Shareholders are concerned with the (book or market) ____ value of their shares.

market

The price at which shareholders can sell their shares is known as the ________ value.

market

Managers who wish to keep their shareholders happy will focus on

market values

Liabilities represent

money owed by the company

Current assets minus current liabilities is known as

net current assets or net working capital.

Free cash flow is available for which of the following uses?

payment of debt payment of interest to investors payment of dividends

Earnings that a firm keeps and reinvests are referred to as:

retained earnings

The right-hand portion of a company's balance sheet shows

where the money to buy assets came from.