FIN 221 Chapter 3 Intro Exercises

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. a. Companies' cash positions would decline. b. Companies' net operating profits after taxes (NOPAT) would decline. c. Companies' physical stocks of fixed assets would increase. d. Companies' net cash flows would increase. e. Companies' reported net incomes would decline.

a. Companies' cash positions would decline

On its 2004 balance sheet, Sherman Books showed $510 million of retained earnings, and exactly the same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT? a. Dividends could have been paid in 2005, but they would have had to equal the earning for the year. b. If the company lost money in 2005, they must have paid dividends. c. The company must have had zero net income in 2005. d. The company must have paid no dividends in 2005. e. The company must have paid out half of its earnings as dividends.

a. Dividends could have been paid in 2005, but they would have had to equal the earning for the year.

What liabilities are subtracted from current assets to find net operating working capital?

- Non-interest bearing current liabilities - Accounts payable & Accruals (accrued taxes & wages) - NOT notes payable because interest bearing

Which of the following statements accurately describes the balance sheet? Check all that apply. -Shows operating performance over a period of time -Uses "current" to mean an account with an expected life of less than a year -Shows operating performance on a specific date -Allows the book value and market value of equity to be different

-Shows operating performance over a period of time -Uses "current" to mean an account with an expected life of less than a year -Allows the book value and market value of equity to be different -Shows asset, liability, and equity account values on a specific date

A 5-year corporate bond yields 9%. A 5-year municipal bond of equal risk yields 6.5%. Assume that the state tax rate is zero. At what federal tax rate are you indifferent between the two bonds?

27.78%

Lovell Co. purchased preferred stock in another company. The preferred stock's before-tax yield was 8.4%. The corporate tax rate is 40%. What is the after-tax return on the preferred stock, assuming a 70% dividend exclusion?

7.39%

Which of the following is NOT tax deductible for a corporation? - Dividends paid - Interest Paid -Depreciation - All of the above

Dividends Paid

What does the statement of cash flows measure?

How the company's cash account changed over a period of time

Which of the following sources of investment income has the highest marginal tax rate for an individual? - Interest from a savings account - Dividends - Long-term capital gains - Interest from a municipal bond

Interest from a savings account

What does net operating profit after taxes plus depreciation measure?

Operating Cash Flow

Which of the following is true about an income statement? - The income statement is a snapshot of a company's financial position - The income statement shows how a company's retained earnings changed over a given period of time - The income statement is reported on an accrual basis - The income statement accurately represents all cash inflows and outflows for a given period of time

The income statement is reported on an accrual basis

Which of the following statements is CORRECT? a. 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. Four key financial statements are the balance sheet, the income statement, the statement of cash flows, and the statement of retained earnings. c. The balance sheet gives us a picture of the firm's financial situation over a period of time. d. The income statement gives us a snapshot of what is happening at a point in time. e. The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits.

b. Four key financial statements are the balance sheet, the income statement, the statement of cash flows, and the statement of retained earnings.

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 earned by an individual is counted as income for tax purposes and taxed at the individual's regular tax rate, which in 2005 could go up to 35%, but dividends received are taxed at a maximum rate of 15%. c. The maximum federal tax rate on personal income in 2005 was 50%. d. The maximum federal tax rate on corporate income in 2005 was 50%. e. 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.

b. Interest earned by an individual is counted as income for tax purposes and taxed at the individual's regular tax rate, which in 2005 could go up to 35%, but dividends received are taxed at a maximum rate of 15%.

Which of the following statements is CORRECT? a. The balance sheet for a given year, say 2005, tells us how much money the company earned during that year. b. The difference between the total assets reported on the balance sheet and the debts reported on the statement tells us the current market value of the stockholders equity, assuming the statements are prepared in accordance with generally accepted accounting principles (GAAP). c. For most companies, the market value of the stock differs from the book value of the stock as reported on the balance sheet. d. A typical industrial company's balance sheet lists the firm's longest lived assets first, then goes on down to the assets that will be converted to cash. e. The balance sheet for a given year, say 2005, is designed to give us an idea of what happened to the firm during that year.

c. For most companies, the market value of the stock differs from the book value of the stock as reported on the balance sheet.

Which of the following statements is CORRECT? a. All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income. b. 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 income and stockholders were taxed again on the income when it was paid to them as dividends. c. Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm's income as personal income and pay taxes on that income. d. All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code. e. The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus, the federal government gets no tax revenue from these businesses.

c. Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm's income as personal income and pay taxes on that income.

The Campbell Corporation just purchased an expensive piece of equipment. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation for tax and stockholder reporting purposes. a. Campbell's cash position will improve (increase). b. Campbell's reported net income after taxes for the year will be lower. c. Campbell's taxable income will be lower. d. Campbell's net fixed assets as shown on the balance sheet will be higher at the end of the year. e. Campbell's tax liability for the year will be lower.

d. Campbell's net fixed assets as shown on the balance sheet will be higher at the end of the year.

Which of the following statements is CORRECT? a. The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow standardized procedures as specified by the Securities and Exchange Commission (SEC). b. If a firm follows generally accepted accounting principles (GAAP), then its reported net income will be identical to its reported net cash flow. c. The focal point of the income statement is the cash account, because it cannot be manipulated by "accounting tricks." d. The income statement for a given year, say 2005, is designed to give us an idea of how much the firm earned during that year. e. The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP)

d. The income statement for a given year, say 2005, is designed to give us an idea of how much the firm earned during that year.