Finance- Chapter 3 and 4

EBITDA stands for earnings before interest, taxes, debt and assets.

False

Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's.

False

Companies typically provide four basic financial statements: the fixed income statement, the current income statement, the balance sheet and the cash flow statement.

False

Which of the following statements is correct? a. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget and the statement of stockholders' equity. b. The balance sheet gives us a picture of the firms financial position at a point in time. c. The income statement gives us a picture of the firms financial position at a point in time. d. The statement of cash flows tells us how much cash the firm must pay out in interest during the year. e. 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. The balance sheet gives us a picture of the firms financial position at a point in time.

Which of the following statements is correct? a. Assets other than cash are expected to produce cash over time and the amounts of cash they eventually produce should be exactly the same as the amounts at which the assets are carried on the books. b. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firms future earnings and dividends and the riskiness of those cash flows. c. The annual report is an internal document prepared by a firms managers solely for the use of its creditors/lenders. d. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget and statement of stockholders equity. e. Prior to the Enron scandal in the early 2000s, companies would put verbal information in their annual reports, along with the financial statements. That verbal information was often misleading so today annual reports can contain only quantitative information--audited financial statements.

B. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firms future earnings and dividends and the riskiness of those cash flows.

Considered alone, which of the following would increase a company's current ratio? a. An increase in net fixed assets. b. An increase in accrued liabilities. c. An increase in notes payable. d. An increase in accounts receivable. e. An increase in accounts payable.

D. An increase in accounts receivable.

A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid.

False

A firm's ROE is equal to 9% and its ROA is equal to 6%. The firm finances only with short-term debt, long-term debt, and common equity, so assets equal total invested capital. The firm's total debt to total capital ratio must be 50%.

False

An increase in accounts receivable represents an increase in net cash provided by operating activities because receivables will produce cash when they are collected.

False

Because the U.S. tax system is a progressive tax system, a taxpayer's marginal and average tax rates are the same.

False

Firms A and B have the same current ratio, 0.75, the same amount of sales, and the same amount of current liabilities. However, Firm A has a higher inventory turnover ratio than B. Therefore, we can conclude that A's quick ratio must be smaller than B's.

False

Free cash flow is the amount of cash that if withdrawn would harm the firms ability to operate and to produce future cash flows.

False

High current and quick ratios always indicate that the firm is managing its liquidity position well.

False

If a firm is reporting its income in accordance with GAAP, then its net income as reported on the income statement should be equal to its free cash flow.

False

If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline.

False

If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant.

False

In general, if investors regard a company as being relatively risky and/or having relatively poor growth prospects, then it will have relatively high P/E and M/B ratios.

False

In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock.

False

It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

False

Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid out to stockholders as dividends. If the firm has sufficient retained earnings, it can purchase assets and pay for them with cash from retained earnings.

False

One problem with ratio analysis is that relationships can be manipulated. For example, we know that if our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.

False

One problem with ratio analysis is that relationships can sometimes be manipulated. For example, if our current ratio is greater than 1.5, then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to INCREASE.

False

Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin.

False

Other things held constant, the higher a firm's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)], the higher its TIE ratio will be.

False

Other things held constant, the more debt a firm uses, the lower its operating margin will be.

False

Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed, two firms with the same EBIT must have the same ROA.

False

Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.

False

Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a margin of 8% for Firm B. Firm A's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is 70% versus one of 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A's higher profit margin.

False

The amount shown on the December 31, 2015 balance sheet as "retained earnings" is equal to the firms net income for 2015 minus any dividends it paid.

False

The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.

False

The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision.

False

The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that represent increases or decreases to cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt.

False

The more conservative a firm's management is, the higher its total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is likely to be.

False

The next-to-last line on the income statement shows the firms earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line".

False

The operating margin measures operating income per dollar of assets.

False

The return on common equity (ROE) is generally regarded as being less significant, from a stockholder's viewpoint, than the return on total assets (ROA).

False

a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change.

False

Assume that two firms are both following GAAP. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors.

False (Depends on the type of depreciation the firm decides to use; straight line or accelerated)

Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firms taxes.

False.

Consider the following balance sheet for Games Inc. Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000.

False.

The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement measures the firms financial position at a point in time.

False.

Free cash flow (FCF) is essentially the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations.

True

If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio would increase.

True

If a firm's ROE is equal to 9% and its ROA is equal to 6%, its equity multiplier must be 1.5.

True

If a firm's fixed assets turnover ratio is significantly higher than its industry average, this could indicate that it uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets.

True

If we were describing the income statement and the balance sheet, it would be correct to say that the income statement is more like a video while the balance sheet is more like a snapshot.

True

Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use estimates of a firm's liquidity position.

True

An increase in accounts payable represents an increase in net cash provided by operating activities just like borrowing money from a bank. An increase in accounts payable has an effect similar to taking out a new bank loan. However, these two items show up in different sections of the statement of cash flows to reflect the difference between operating and financing activities.

True

Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could be higher or lower than the amounts at which the assets are carried on the books.

True

Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.

True

Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of examining changes in a firm's performance over time.

True

EBIT stands for earnings before interest and taxes, and it is often called "operating income."

True

In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and changes in net operating working capital.

True

Interest paid by a corporation is a tax deduction for the paying corporation but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations.

True

Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, no debt and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow money, use the funds to buy back stock, and raise the equity multiplier to 2.0. The size of the firm (assets) would not change. She thinks that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would probably be a good move, as it would increase the ROE from 7.5% to 13.5%.

True

Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects.

True

On the balance sheet, total assets must always equal the sum of total liabilities and equity.

True

Other things held constant, the more debt a firm uses, the lower its profit margin will be.

True

Other things held constant, the more debt a firm uses, the lower its return on total assets will be.

True

Profitability ratios show the combined effects of liquidity, asset management, and debt management on a firm's operating results.

True

Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength.

True

Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used the same or similar accounting methods.

True

Suppose Firms A and B have the same amount of assets, total assets are equal to total invested capital, pay the same interest rate on their debt, have the same basic earning power (BEP), finance with only debt and common equity, and have the same tax rate. However, Firm A has a higher debt to capital ratio. If BEP is greater than the interest rate on debt, Firm A will have a higher ROE as a result of its higher debt ratio.

True

Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required to achieve its target TIE ratio.

True

The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed.

True

The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

True

The alternative minimum tax (AMT) was created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions.

True

The annual report contains four basic financial statements: the income statement, the balance sheet, the cash flow statement and statement of stockholders' equity.

True

The current and quick ratios help us measure a firm's liquidity. The current ratio measures the relationship of the firm's current assets to its current liabilities, while the quick ratio measures the firm's ability to pay off short-term obligations without relying on the sale of inventories

True

The days sales outstanding tells us how long it takes, on average, to collect after a sale is made. The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time.

True

The income statement shows the difference between a firms income and its costs--i.e., its profits--during a specified period of time. However, not all reported income comes in the form of cash, and reported costs likewise may not be consistent with cash outlays. Therefore, there may be a substantial difference between a firms reported profits and its actual cash flow for the same period.

True

The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.

True

The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets.

True

The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher M/B ratios as being less risky and/or more likely to enjoy higher growth in the future.

True

The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In general, investors regard companies with higher P/E ratios as being less risky and/or more likely to enjoy higher growth in the future.

True

The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends and the riskiness of those cash flows.

True

The profit margin measures net income per dollar of sales.

True

The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of the stockholders' claim against the firms existing assets. Put another way, retained earnings are stockholders' reinvested earnings.

True

The return on invested capital (ROIC) differs from the return on assets (ROA). First, ROIC is based on total invested capital rather than total assets. Second, the numerator of the ROIC is after-tax operating income rather than net income.

True

The return on invested capital measures the total return that a company has provided for its investors.

True

The statement of cash flows has four main sections, one each for operating, investing and financing activities and one that shows a summary of the cash and cash equivalents at the end of the year.

True

The time dimension is important in financial statement analysis. The balance sheet shows the firms financial position at a given point in time, the income statement shows results over a period of time and the statement of cash flows reflects specific changes in accounts over that period of time.

True

The times-interest-earned ratio measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs.

True

The value of any asset is the present value of the cash flows, the asset is expected to provide. The cash flows a business is able to provide to its investors is its free cash flow. This is the reasons that FCF is so important in finance.

True

To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue in the net income calculation.

True

Two metrics that are used to measure a company's financial performance are net income and cash flow. Accountants emphasize net income as calculated in accordance with GAAP. Fiance people generally put at least as much weight on cash flows as they do on net income.

True

Typically, the statement of stockholders' equity starts with total stockholders' equity at the beginning of the year, adds net income, subtracts dividends paid, and ends up with total stockholders' equity at the end of the year. Over time, a profitable company will have earnings in excess of the dividends it pays out, and will result in a substantial amount of retained earnings shown on the balance sheet.

True

Net operating working capital is equal to current assets minus the difference between current liabilities and notes payable. This definition assumes that the firm has no "excess" cash.

True.

Wu Systems has the following balance sheet. How much net operating working capital does the firm have? Cash $ 100 Accounts payable $ 200 Accounts receivable 650 Accruals 135 Inventory 550 Notes payable 565 Current assets $ 1,300 Current liabilities $ 900 Net fixed assets $ 1,000 Long-term debt 600 Common equity 300 Retained earnings 500 Total assets $ 2,300 Total liab. & equity $ 2,300 a. $965 b. $1,177 c. $772 d. $1,033 e. $1,042

a. $965 Cash $100 Accounts payable $200 Accounts receivable 650 Accruals 135 Inventory 550 Notes payable 565 Current assets $1,300 Current liabilities $ 900 Net fixed assets 1,000 Long-term debt 600 Common equity 300 Retained earnings 500 Total assets $ 2,300 Total liab. & equity $2,300 Net operating working capital = Current assets (Current liabilities - Notes payable) NOWC = $1,300.00 - $335.00 NOWC = $965

Walter Industries' current ratio is 0.5. Considered alone, which of the following actions would increase the company's current ratio? a. Borrow using short-term notes payable and use the cash to increase inventories. b. Use cash to reduce accruals. c. Use cash to reduce accounts payable. d. Use cash to reduce short-term notes payable. e. Use cash to reduce long-term bonds outstanding.

a. Borrow using short-term notes payable and use the cash to increase inventories.

Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both firms finance using only debt and common equity and total assets equal total invested capital. Both companies have positive net incomes. Company HD has a higher total debt to total capital ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT? a. Company HD pays less in taxes. b. Company HD has a lower equity multiplier. c. Company HD has a higher ROA. d. Company HD has a higher times-interest-earned (TIE) ratio. e. Company HD has more net income.

a. Company HD pays less in taxes.

Which of the following statements is CORRECT? a. Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations. b. After-tax operating income is calculated as EBIT(1 - T) + Depreciation. c. Two firms with identical sales and operating costs but with different amounts of debt and tax rates will have different operating incomes by definition. d. If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow. e. Retained earnings as reported on the balance sheet represent cash and, therefore, are available to distribute to stockholders as dividends or any other required cash payments to creditors and suppliers.

a. Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations.

You observe that a firm's ROE is above the industry average, but both its profit margin and equity multiplier are below the industry average. Which of the following statements is CORRECT? a. Its total assets turnover must be above the industry average. b. Its return on assets must equal the industry average. c. Its TIE ratio must be below the industry average. d. Its total assets turnover must be below the industry average. e. Its total assets turnover must equal the industry average.

a. Its total assets turnover must be above the industry average.

Amram Company's current ratio is 2.0. Considered alone, which of the following actions would lower the current ratio? a. Borrow using short-term notes payable and use the proceeds to reduce accruals. b. Borrow using short-term notes payable and use the proceeds to reduce long-term debt. c. Use cash to reduce accruals. d. Use cash to reduce short-term notes payable. e. Use cash to reduce accounts payable.

b. Borrow using short-term notes payable and use the proceeds to reduce long-term debt.

A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio? a. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable. b. Issue new common stock and use the proceeds to increase inventories. c. Speed up the collection of receivables and use the cash generated to increase inventories. d. Use some of its cash to purchase additional inventories. e. Issue new common stock and use the proceeds to acquire additional fixed assets.

a. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.

Which of the following statements is CORRECT? a. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity and total assets equal total invested capital. Under these conditions, the ROE will increase. b. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity and total assets equal total invested capital. Without additional information, we cannot tell what will happen to the ROE. c. The DuPont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE. d. Other things held constant, an increase in the total debt to total capital ratio will result in an increase in the profit margin. e. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity and total assets equal total invested capital. Under these conditions, the ROE will decrease.

a. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. The firm finances using only debt and common equity and total assets equal total invested capital. Under these conditions, the ROE will increase.

Which of the following factors could explain why Michigan Energy's cash balance increased even though it had a negative cash flow last year? a. The company sold a new issue of bonds. b. The company made a large investment in new plant and equipment. c. The company paid a large dividend. d. The company had high depreciation expenses. e. The company repurchased 20% of its common stock.

a. The company sold a new issue of bonds.

Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company's total assets or operating income. Which of the following effects would occur as a result of this action? a. The company's current ratio increased. b. The company's times interest earned ratio decreased. c. The company's basic earning power ratio increased. d. The company's equity multiplier increased. e. The company's total debt to total capital ratio increased.

a. The company's current ratio increased.

If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., "grading" the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant. a. The division's basic earning power ratio is above the average of other firms in its industry. b. The division's total assets turnover ratio is below the average for other firms in its industry. c. The division's total debt to total capital ratio is above the average for other firms in the industry. d. The division's inventory turnover is 6×, whereas the average for its competitors is 8×. e. The division's DSO (days' sales outstanding) is 40 days, whereas the average for its competitors is 30 days.

a. The division's basic earning power ratio is above the average of other firms in its industry.

Which of the following statements is CORRECT? a. Since depreciation increases the firm's net cash provided by operating activities, the more depreciation a company has, the larger its retained earnings will be, other things held constant. b. A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments. c. Common equity includes common stock and retained earnings, less accumulated depreciation. d. The retained earnings account as reported on the balance sheet shows the amount of cash that is available for paying dividends. e. If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.

b. A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.

Which of the following statements is CORRECT? a. The use of debt financing will tend to lower the basic earning power ratio, other things held constant. b. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. c. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE. d. The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because interest is paid with post-tax dollars, so the firm's ability to pay current interest is affected by taxes. e. All else equal, increasing the total debt to total capital ratio will increase the ROA.

b. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.

Which of the following statements is CORRECT? a. Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing." b. Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing." c. Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase fixed assets is an example of "window dressing." d. Using some of the firm's cash to reduce long-term debt is an example of "window dressing." e. "Window dressing" is any action that does not improve a firm's fundamental long-run position and thus increases its intrinsic value.

b. Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."

A loss incurred by a corporation a. Must be carried forward unless the company has had 2 loss years in a row. b. Can be carried back 2 years, then carried forward up to 20 years following the loss. c. Can be carried back 5 years and forward 3 years. d. Cannot be used to reduce taxes in other years except with special permission from the IRS. e. Can be carried back 3 years or forward 10 years, whichever is more advantageous to the firm.

b. Can be carried back 2 years, then carried forward up to 20 years following the loss.

Which of the following statements is most correct? a. Corporations are allowed to exclude 70% of their interest income from corporate taxes. b. Corporations are allowed to exclude 70% of their dividend income from corporate taxes. c. Individuals pay taxes on only 30% of the income realized from municipal bonds. d. Individuals are allowed to exclude 70% of their interest income from their taxes. e. Individuals are allowed to exclude 70% of their dividend income from their taxes.

b. Corporations are allowed to exclude 70% of their dividend income from corporate taxes.

Which of the following statements is CORRECT? a. Other things held constant, the more debt a firm uses, the higher its operating margin will be. b. Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage. c. Other things held constant, the more debt a firm uses, the higher its profit margin will be. d. Other things held constant, the higher a firm's total debt to total capital ratio, the higher its TIE ratio will be. e. Debt management ratios show the extent to which a firm's managers are attempting to reduce risk through the use of financial leverage. The higher the total debt to total capital ratio, the lower the risk.

b. Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.

Which of the following statements is CORRECT? a. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be equal. b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same. c. If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price/earnings ratio. d. If Firm X's P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and/or be expected to grow at a faster rate. e. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same.

b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.

Which of the following statements is CORRECT? a. An increase in accounts receivable is added to net income in the operating activities section because if accounts receivable increase, then when they are collected cash will come into the firm. b. In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and the change in net operating working capital. Free cash flow is the amount of cash that could be withdrawn without harming the firm's ability to operate and to produce future cash flows. c. The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that add to or subtract from cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt. d. The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line." e. Most rapidly growing companies have positive free cash flows because cash flows from existing operations will exceed fixed assets and working capital needed to support the growth.

b. In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and the change in net operating working capital. Free cash flow is the amount of cash that could be withdrawn without harming the firm's ability to operate and to produce future cash flows.

A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger? a. Increase accounts receivable while holding sales constant. b. Increase EBIT while holding sales and assets constant. c. Increase accounts payable while holding sales constant. d. Increase notes payable while holding sales constant. e. Increase inventories while holding sales constant.

b. Increase EBIT while holding sales and assets constant.

Which of the following statements is CORRECT? a. Most rapidly growing companies have positive free cash flows because cash flows from existing operations generally exceed fixed asset purchases and changes to net operating working capital. b. Changes in working capital have no effect on free cash flow. c. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T) + Depreciation - Capital expenditures required to sustain operations - Required changes in net operating working capital. d. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T) + Capital expenditures. e. Managers should be less concerned with free cash flow than with accounting net income. Accounting net income is the "bottom line" and represents how much the firm can distribute to all its investors--both creditors and stockholders.

c. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T) + Depreciation - Capital expenditures required to sustain operations - Required changes in net operating working capital.

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 paid to an individual is counted as income for federal tax purposes and taxed at the individual's regular tax rate, which in 2015 could go up to 39.6%, but qualified dividends received were taxed at a maximum rate of 15% for individuals earning less than $411,500 and married taxpayers filing jointly earning less than $464,850. c. The maximum federal tax rate on corporate income in 2015 was 50%. d. 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. e. The maximum federal tax rate on personal income in 2015 was 50%.

b. Interest paid to an individual is counted as income for federal tax purposes and taxed at the individual's regular tax rate, which in 2015 could go up to 39.6%, but qualified dividends received were taxed at a maximum rate of 15% for individuals earning less than $411,500 and married taxpayers filing jointly earning less than $464,850.

The Nantell 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 method for tax and stockholder reporting purposes. a. Nantell's taxable income will be lower. b. Nantell's operating income (EBIT) will increase. c. Nantell's cash position will improve (increase). d. Nantell's reported net income for the year will be lower. e. Nantell's tax liability for the year will be lower.

b. Nantell's operating income (EBIT) will increase.

Which of the following statements is CORRECT? a. Actions that increase reported net income will always increase cash flow. b. One way to increase EVA is to generate the same level of operating income but with less total invested capital. c. One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free. d. One way to increase EVA is to achieve the same level of operating income but with more total invested capital obtained at a higher cost of capital. e. If a firm reports positive net income, its EVA must also be positive.

b. One way to increase EVA is to generate the same level of operating income but with less total invested capital.

Which of the following statements is CORRECT? a. Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's. b. Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required to achieve its target TIE ratio. c. Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed, two firms with the same EBIT must have the same ROA. d. Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios. e. Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, no debt and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow funds using long-term debt, use the funds to buy back stock, and raise the equity multiplier to 2.0. The size of the firm (assets) would not change. She thinks that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would probably not be a good move, as it would decrease the ROE from 7.5% to 6.5%.

b. Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required to achieve its target TIE ratio.

Which of the following statements is CORRECT? a. Other things held constant, the less debt a firm uses, the lower its return on total assets will be. b. The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes. c. The return on common equity (ROE) is generally regarded as being less significant, from a stockholder's viewpoint, than the return on total assets (ROA). d. The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In general, investors regard companies with higher P/E ratios as being more risky and/or less likely to enjoy higher future growth. e. Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a margin of 8% for Firm B. Firm A's total debt to total capital ratio is 70% versus 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A's higher profit margin.

b. The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

Analysts who follow Howe Industries recently noted that, relative to the previous year, the company's net cash provided from operations increased, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation? a. The company cut its dividend. b. The company made large investments in fixed assets. c. The company sold a division and received cash in return. d. The company issued new common stock. e. The company issued new long-term debt.

b. The company made large investments in fixed assets.

46. Below is the common equity section (in millions) of Timeless Technology's last two year-end balance sheets: 2015 2014 Common stock 2,000 1,000 Retained earnings 2,000 2,340 Total common equity $4,000 $3,340 The firm has never paid a dividend to its common stockholders. Which of the following statements is CORRECT? a. The company's net income in 2015 was higher than in 2014. b. The firm issued common stock in 2015. c. The market price of the firm's stock doubled in 2015. d. The firm had positive net income in both 2014 and 2015, but its net income in 2015 was lower than it was in 2014. e. The company has more equity than debt on its balance sheet.

b. The firm issued common stock in 2015.

For managerial purposes, i.e., making decisions regarding the firm's operations, the standard financial statements as prepared by accountants under generally accepted accounting principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm's operations. Related to these modifications, which of the following statements is CORRECT? a. The standard statements make adjustments to reflect the effects of inflation on asset values, and these adjustments are normally carried into any adjustment that managers make to the standard statements. b. The standard statements focus on accounting income for the entire corporation, not cash flows, and the two can be quite different during any given accounting period. However, the firm's value is based on its future cash flows. After all, future cash flows tells us how much the firm can distribute to its investors. c. The standard statements provide useful information on the firm's individual operating units, but management needs more information on the firm's overall operations than the standard statements provide. d. The standard statements focus on cash flows, but managers should be less concerned with cash flows than with accounting income as defined by GAAP. e. The best feature of standard statements is that, if they are prepared under GAAP, the data are always consistent from firm to firm. Thus, under GAAP, there is no room for accountants to "adjust" the results to make earnings look better.

b. The standard statements focus on accounting income for the entire corporation, not cash flows, and the two can be quite different during any given accounting period. However, the firm's value is based on its future cash flows. After all, future cash flows tells us how much the firm can distribute to its investors.

Safeco's current assets total to $20 million versus $10 million of current liabilities, while Risco's current assets are $10 million versus $20 million of current liabilities. Both firms would like to "window dress" their end-of-year financial statements, and to do so they tentatively plan to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts. Which of the statements below best describes the results of these transactions? a. The transactions would improve Safeco's financial strength as measured by its current ratio but lower Risco's current ratio. b. The transactions would lower Safeco's financial strength as measured by its current ratio but raise Risco's current ratio. c. The transactions would have no effect on the firm' financial strength as measured by their current ratios. d. The transactions would lower both firm' financial strength as measured by their current ratios. e. The transactions would improve both firms' financial strength as measured by their current ratios.

b. The transactions would lower Safeco's financial strength as measured by its current ratio but raise Risco's current ratio.

Which of the following statements is CORRECT? a. The current cash flow from existing assets is highly relevant to investors. However, since the value of the firm depends primarily upon its growth opportunities, accounting net income projections from those opportunities are the only relevant future flows with which investors are concerned. b. Two metrics that are used to measure a company's financial performance are net income and free cash flow. Accountants tend to emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on free cash flows as they do on net income. c. To estimate the net cash provided by operations, depreciation must be subtracted from net income because it is a non-cash charge that has been added to revenue. d. Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to discourage the use of debt financing by corporations. e. If Congress changed depreciation allowances so that companies had to report higher depreciation levels for tax purposes in 2015, this would lower their free cash flows for 2015.

b. Two metrics that are used to measure a company's financial performance are net income and free cash flow. Accountants tend to emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on free cash flows as they do on net income.

Vasudevan Inc. recently reported operating income of $4.80 million, depreciation of $1.20 million, and had a tax rate of 40%. The firm's expenditures on fixed assets and net operating working capital totaled $0.6 million. How much was its free cash flow, in millions? a. $3.17 b. $2.68 c. $3.48 d. $3.38 e. $4.28

c. $3.48 FCF = EBIT(1 - T) + Deprec - (Capex + NOWC) EBIT $4.80 Tax rate 40% Depreciation $1.20 Capex + NOWC $0.60 FCF = $3.48

Brown Office Supplies recently reported $19,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's earnings before taxes (EBT)? a. $10,378 b. $10,201 c. $8,870 d. $9,580 e. $8,515

c. $8,870 Bonds $9,000.00 Interest rate 7.00% Sales $19,500 Operating costs excluding depr'n $8,250.00 Depreciation $1,750.00 Operating income (EBIT) $9,500.00 Interest charges -$630.00 EBT = Taxable income $8,870

Which of the following statements is most correct? a. Retained earnings, as reported on the balance sheet, represents the amount of cash a company has available to pay out as dividends to shareholders. b. 70% of the interest received by corporations is excluded from taxable income. c. 70% of the dividends received by corporations is excluded from taxable income. d. Because taxes on long-term capital gains are not paid until the gain is realized, investors must pay the top individual tax rate on that gain. e. The corporate tax system favors equity financing, as dividends paid are deductible from corporate taxes.

c. 70% of the dividends received by corporations is excluded from taxable income.

Which of the following items is NOT normally considered to be a current asset? a. Accounts receivable. b. Inventory. c. Bonds. d. Cash. e. Short-term, highly-liquid, marketable securities.

c. Bonds

Which of the following statements is CORRECT? a. A reduction in inventories would have no effect on the current ratio. b. An increase in inventories would have no effect on the current ratio. c. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase. d. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE. e. If a firm increases its sales while holding its inventories constant, then, other things held constant, its fixed assets turnover ratio will decline.

c. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.

Which of the following statements is CORRECT? a. Typically, a firm's DPS should exceed its EPS. b. Typically, a firm's net income should exceed its EBIT. c. If a firm is more profitable than average, we would normally expect to see its stock price exceed its book value per share. d. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation. e. The more depreciation a firm has in a given year, the higher its EPS, other things held constant.

c. If a firm is more profitable than average, we would normally expect to see its stock price exceed its book value per share.

Which of the following statements is CORRECT? a. If one firm has a higher total debt to total capital ratio than another, we can be certain that the firm with the higher total debt to total capital ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses. b. A firm's use of debt will have no effect on its profit margin. c. If two firms differ only in their use of debt—i.e., they have identical assets, identical total invested capital, sales, operating costs, interest rates on their debt, and tax rates—but one firm has a higher total debt to total capital ratio, the firm that uses more debt will have a lower profit margin on sales and a lower return on assets. d. The total debt to total capital ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable. e. If two firms differ only in their use of debt—i.e., they have identical assets, identical total invested capital, operating costs, and tax rates—but one firm has a higher total debt to total capital ratio, the firm that uses more debt will have a higher operating margin and return on assets.

c. If two firms differ only in their use of debt—i.e., they have identical assets, identical total invested capital, sales, operating costs, interest rates on their debt, and tax rates—but one firm has a higher total debt to total capital ratio, the firm that uses more debt will have a lower profit margin on sales and a lower return on assets.

Which of the following statements is CORRECT? a. In the statement of cash flows, a decrease in accounts receivable is subtracted from net income in the operating activities section. b. Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity. c. In the statement of cash flows, a decrease in accounts payable is subtracted from net income in the operating activities section. d. In the statement of cash flows, depreciation is subtracted from net income in the operating activities section. e. In the statement of cash flows, a decrease in inventories is subtracted from net income in the operating activities section.

c. In the statement of cash flows, a decrease in accounts payable is subtracted from net income in the operating activities section.

If a bank loan officer were considering a company's loan request, which of the following statements would you consider to be CORRECT? a. The lower the company's inventory turnover ratio, other things held constant, the lower the interest rate the bank would charge the firm. b. Other things held constant, the higher the days sales outstanding ratio, the lower the interest rate the bank would charge. c. Other things held constant, the lower the total debt to total capital ratio, the lower the interest rate the bank would charge. d. The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge. e. Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.

c. Other things held constant, the lower the total debt to total capital ratio, the lower the interest rate the bank would charge.

Which of the following statements is CORRECT? a. The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus, the federal government receives no tax revenue from these businesses, even though they report high accounting profits. b. All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code. c. Small corporations that qualify under the Tax Code can elect not to pay corporate taxes, but then each stockholder must report his or her pro rata shares of the firm's income as personal income and pay taxes on that income. d. 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 corporation's income and stockholders were taxed again on this income when it was paid to them as dividends. e. All corporations other than non-profits are subject to corporate income taxes, which are 15% for the lowest amounts of income and 38% for the highest income amounts.

c. Small corporations that qualify under the Tax Code can elect not to pay corporate taxes, but then each stockholder must report his or her pro rata shares of the firm's income as personal income and pay taxes on that income.

Which of the following statements is CORRECT? a. In general, if investors regard a company as being relatively risky and/or having relatively poor growth prospects, then it will have relatively high P/E and M/B ratios. b. The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects. c. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed. d. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher M/B ratios as being more risky and/or less likely to enjoy higher future growth. e. It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

c. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed.

Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet? a. The company repurchases common stock. b. The company pays a dividend. c. The company issues new common stock. d. The company gives customers more time to pay their bills. e. The company purchases a new piece of equipment.

c. The company issues new common stock.

62. Last year, Delip Industries had (1) negative cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation? a. The company had a sharp increase in its inventories. b. The company had a sharp increase in its accrued liabilities. c. The company sold a new issue of common stock. d. The company made a large capital investment early in the year. e. The company had a sharp increase in depreciation expenses.

c. The company sold a new issue of common stock.

A start-up firm is making an initial investment in new plant and equipment. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is considering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law, which of the following would occur in the year following the change? a. The firm's operating income (EBIT) would increase. b. The firm's taxable income would increase. c. The firm's cash flow would increase. d. The firm's tax payments would increase. e. The firm's reported net income would increase.

c. The firm's cash flow would increase.

Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant? a. The TIE declines. b. The DSO increases. c. The quick ratio increases. d. The current ratio declines. e. The total assets turnover decreases.

c. The quick ratio increases.

Taggart Technologies is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Taggart pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue? a. The ROA will decline. b. Taxable income will decline. c. The tax bill will increase. d. Net income will decrease. e. The times-interest-earned ratio will decrease.

c. The tax bill will increase.

Bauer Software's current balance sheet shows total common equity of $5,125,000. The company has 430,000 shares of stock outstanding, and they sell at a price of $27.50 per share. By how much do the firm's market and book values per share differ? (Round your intermediate and final answer to two decimal places.) a. $12.31 b. $17.61 c. $17.30 d. $15.58 e. $15.11

d. $15.58 Shares outstanding 430,000 Price per share $27.50 Total book common equity $5,125,000 Book value per share = Total book equity/Number of shares $11.92 Difference between book and market values $15.58

Rao Construction recently reported $18.00 million of sales, $12.60 million of operating costs other than depreciation, and $3.00 million of depreciation. It had $8.50 million of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. What was Rao's operating income, or EBIT, in millions? a. $2.78 b. $2.88 c. $1.90 d. 0$2.40 e. $2.11

d. 0$2.40 Sales $18.00 Operating costs excluding depreciation 12.60 Depreciation 3.00 Operating income (EBIT) $2.40 Note that operating income is before interest and taxes.

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, and assume that the same depreciation method is used for tax and stockholder reporting purposes. a. Companies' after-tax operating profits would decline. b. Companies' physical stocks of fixed assets would increase. c. Companies' cash flows would increase. d. Companies' cash positions would decline. e. Companies' reported net incomes would decline.

d. Companies' cash flows would increase.

Companies HD and LD are both profitable, and they have the same total assets (TA), total invested capital, sales (S), return on assets (ROA), and profit margin (PM). Both firms finance using only debt and common equity. However, Company HD has the higher total debt to total capital ratio. Which of the following statements is CORRECT? a. Company HD has a lower total assets turnover than Company LD. b. Company HD has a lower equity multiplier than Company LD. c. Company HD has a higher fixed assets turnover than Company LD. d. Company HD has a higher ROE than Company LD. e. Company HD has a lower operating income (EBIT) than Company LD.

d. Company HD has a higher ROE than Company LD.

. Which of the following items cannot be found on a firm's balance sheet under current liabilities? a. Accounts payable. b. Short-term notes payable to the bank. c. Accrued wages. d. Cost of goods sold. e. Accrued payroll taxes.

d. Cost of goods sold.

HD Corp and LD Corp have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. Both firms finance using only debt and common equity and total assets equal total invested capital. However, HD uses more debt than LD. Which of the following statements is CORRECT? a. Without more information, we cannot tell if HD or LD would have a higher or lower net income. b. HD would have the lower equity multiplier for use in the DuPont equation. c. HD would have to pay more in income taxes. d. HD would have the lower net income as shown on the income statement. e. HD would have the higher operating margin.

d. HD would have the lower net income as shown on the income statement.

A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio? a. Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment. b. Use cash to repurchase some of the company's own stock. c. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year. d. Issue new stock, then use some of the proceeds to purchase additional inventory and hold the remainder as cash. e. Use cash to increase inventory holdings.

d. Issue new stock, then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

Which of the following statements is CORRECT? a. The more depreciation a firm reports, the higher its tax bill, other things held constant. b. People sometimes talk about the firm's cash flow, which is shown as the lowest entry on the income statement, hence it is often called "the bottom line." c. Depreciation reduces a firm's cash balance, so an increase in depreciation would normally lead to a reduction in the firm's cash flow. d. Operating income is derived from the firm's regular core business. Operating income is calculated as Revenues less Operating costs. Operating costs do not include interest or taxes. e. Depreciation is not a cash charge, so it does not have an effect on a firm's reported profits.

d. Operating income is derived from the firms regular core business. Operating income is calculated as Revenues less Operating costs. Operating costs do not include interest or taxes.

Last year Besset Company's operations provided a negative cash flow, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company's financial statements were prepared under generally accepted accounting principles (GAAP)? a. The company repurchased some of its common stock. b. The company dramatically increased its capital expenditures. c. The company retired a large amount of its long-term debt. d. The company sold some of its fixed assets. e. The company had high depreciation expenses.

d. The company sold some of its fixed assets.

Austin Financial recently announced that its net income increased sharply from the previous year, yet its net cash provided from operations declined. Which of the following could explain this performance? a. The company's dividend payment to common stockholders declined. b. The company's expenditures on fixed assets declined. c. The company's cost of goods sold increased. d. The company's depreciation expense declined. e. The company's interest expense increased.

d. The company's depreciation expense declined.

The CFO of Daves Industries plans to have the company issue $300 million of new common stock and use the proceeds to pay off some of its outstanding bonds that carry a 7% interest rate. 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's taxable income would fall. b. The company's interest expense would remain constant. c. The company would have less common equity than before. d. The company's net income would increase. e. The company would have to pay less taxes.

d. The company's net income would increase.

Assume that Besley Golf Equipment commenced operations on January 1, 2015, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes. The company planned to depreciate its fixed assets over 15 years, but in December 2015 management realized that the assets would last for only 10 years. The firm's accountants plan to report the 2015 financial statements based on this new information. How would the new depreciation assumption affect the company's financial statements? a. The firm's reported net fixed assets would increase. b. The firm's EBIT would increase. c. The firm's reported 2015 earnings per share would increase. d. The firm's cash position in 2015 and 2016 would increase. e. The provision will increase the company's tax payments.

d. The firm's cash position in 2015 and 2016 would increase.

Which of the following statements is CORRECT? a. Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm either sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors. b. Assets other than cash are expected to produce cash over time, and the amount of cash they eventually produce must be the same as the amounts at which the assets are carried on the books. c. The income statement shows the difference between a firm's income and its costs--i.e., its profits--during a specified period of time. However, all reported income comes in the form of cash, and reported costs likewise are consistent with cash outlays. Therefore, there will not be a substantial difference between a firm's reported profits and its actual cash flow for the same period. d. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows. e. EPS stands for earnings per share, while DPS stands for dividends per share. We would normally expect to see DPS exceed EPS.

d. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.

Prezas Company's balance sheet showed total current assets of $3,000, all of which were required in operations. Its current liabilities consisted of $975 of accounts payable, $600 of 6% short-term notes payable to the bank, and $250 of accrued wages and taxes. What was its net operating working capital? a. $1,935 b. $1,438 c. $1,651 d. $1,544 e. $1,775

e. $1,775 NOWC = Current assets (Current liabilities Notes payable) NOWC = $3,000 ($1,825 $600) NOWC = $1,775

Brown Fashions Inc.'s December 31, 2015 balance sheet showed total common equity of $4,050,000 and 225,000 shares of stock outstanding. During 2015, the firm had $450,000 of net income, and it paid out $100,000 as dividends. What was the book value per share at 12/31/15, assuming no common stock was either issued or retired during 2015? (Round your final answer to two decimal places.) a. $24.44 b. $17.01 c. $24.25 d. $20.73 e. $19.56

e. $19.56 12/31/14 common equity $4,050,000 2014 net income $450,000 2014 dividends $100,000 2014 addition to retained earnings $350,000 12/31/14 common equity $4,400,000 Shares outstanding 225,000 12/31/14 BVPS $19.56

Over the years, O'Brien Corporation's stockholders have provided $20,000,000 of capital, when they purchased new issues of stock and allowed management to retain some of the firm's earnings. The firm now has 1,000,000 shares of common stock outstanding, and it sells at a price of $43.50 per share. How much value has O'Brien's management added to stockholder wealth over the years, i.e., what is O'Brien's MVA? a. $21,150,000 b. $28,200,000 c. $25,850,000 d. $29,375,000 e. $23,500,000

e. $23,500,000 Total book value of equity $20,000,000 Stock price per share $43.50 Shares outstanding 1,000,000 Market value of equity Stock price Number of shares $43,500,000 MVA Market value of equity Book value of equity $23,500,000

Emery Mining Inc. recently reported $130,000 of sales, $75,500 of operating costs other than depreciation, and $10,200 of depreciation. The company had $16,500 of outstanding bonds that carry a 7.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net income? The firm uses the same depreciation expense for tax and stockholder reporting purposes. (Round your intermediate and final answers to two decimal places.) a. $22,413.95 b. $29,138.14 c. $28,577.79 d. $24,935.52 e. $28,017.44

e. $28,017.44 Bonds $16,500 Interest rate 7.25% Tax rate 35% Sales $130,000 Operating costs excluding depr'n $75,500 Depreciation $10,200 Operating income (EBIT) $44,300 Interest charges -$1,196.25 Taxable income $43,103.75 Taxes -$15,086.31 Net income $28,017.44

Which of the following statements is CORRECT? a. The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio. b. If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE. c. An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio. d. An increase in the DSO, other things held constant, could be expected to increase the ROE. e. An increase in a firm's total debt to total capital ratio, with no changes in its sales or operating costs, could be expected to lower its profit margin.

e. An increase in a firm's total debt to total capital ratio, with no changes in its sales or operating costs, could be expected to lower its profit margin.

Companies E and P each reported the same earnings per share (EPS), but Company E's stock trades at a higher price. Which of the following statements is CORRECT? a. Company E probably has fewer growth opportunities. b. Company E is probably judged by investors to be riskier. c. Company E must have a higher market-to-book ratio. d. Company E must pay a lower dividend. e. Company E trades at a higher P/E ratio.

e. Company E trades at a higher P/E ratio.

Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Both firms finance using only debt and common equity and total assets equal total invested capital. Company HD has a higher total debt to total capital ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT? a. Company HD has a lower equity multiplier. b. Company HD has more net income. c. Company HD pays more in taxes. d. Company HD has a lower ROE. e. Company HD has a lower times-interest-earned (TIE) ratio.

e. Company HD has a lower times-interest-earned (TIE) ratio.

On its 12/31/15 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT? a. If the company lost money in 2015, it must have paid dividends. b. The company must have had zero net income in 2015. c. The company must have paid out half of its 2015 earnings as dividends. d. The company must have paid no dividends in 2015. e. Dividends could have been paid in 2015, but they would have had to equal the earnings for the year.

e. Dividends could have been paid in 2015, but they would have had to equal the earnings for the year.

Which of the following statements is CORRECT? a. MVA stands for market value added, and it is defined as follows: MVA = (Shares outstanding)(Stock price) + Book value of common equity. b. The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses. c. MVA gives us an idea about how much value a firm's management has added during the last year. d. EVA gives us an idea about how much value a firm's management has added over the firm's life. e. EVA stands for economic value added, and it is defined as follows: EVA = NOPAT - (Total invested capital)(AT cost of capital %)

e. EVA stands for economic value added, and it is defined as follows: EVA = NOPAT - (Total invested capital)(AT cost of capital %)

Which of the following statements is CORRECT? a. Dividends paid reduce the net income that is reported on a company's income statement. b. If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet. c. If a company issues new long-term bonds to purchase fixed assets during the current year, this will increase both its reported current assets and current liabilities at the end of the year. d. Accounts receivable are reported as a current liability on the balance sheet. e. If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance.

e. If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance.

Which of the following statements is CORRECT? a. If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average, and was increasing and trending still higher, this would be interpreted as a sign of strength. b. A high average DSO indicates that none of its customers are paying on time. In addition, it makes no sense to evaluate the firm's DSO with the firm's credit terms. c. There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things. d. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio. e. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.

e. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.

Companies HD and LD have the same total assets, sales, operating costs, and tax rates, and they pay the same interest rate on their debt. Both firms finance using only debt and common equity and total assets equal total invested capital. However, company HD has a higher total debt to total capital ratio. Which of the following statements is CORRECT? a. Given this information, LD must have the higher ROE. b. Company LD has a higher basic earning power ratio (BEP). c. Company HD has a higher basic earning power ratio (BEP). d. If the interest rate the companies pay on their debt is more than their basic earning power (BEP), then Company HD will have the higher ROE. e. If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company HD will have the higher ROE.

e. If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company HD will have the higher ROE.

Assume that Congress recently passed a provision that will enable Bev's Beverages Inc. (BBI) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or the tax rate. Prior to the new provision, BBI's net income was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BBI's financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes. a. The provision will reduce the company's cash flow. b. The provision will increase the company's tax payments. c. The provision will increase the firm's operating income (EBIT). d. The provision will increase the company's net income. e. Net fixed assets on the balance sheet will decrease.

e. Net fixed assets on the balance sheet will decrease.

Which of the following statements is correct? a. The balance sheet for a given year is designed to give us an idea of what happened to the firm during that year. b. The balance sheet for a given year tells us how much money the company earned during that year. c. The difference between the total assets reported on the balance sheet and the liabilities reported on this statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in accordance with GAAP. d. If a company's statements were prepared in accordance with GAAP, the market value of the stock equals the book value of the stock as reported on the balance sheet. e. The assets section of a typical company's balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last.

e. The assets section of a typical company's balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last.

Which of the following would indicate an improvement in a company's financial position, holding other things constant? a. The inventory and total assets turnover ratios both decline. b. The total debt to total capital ratio increases. c. The profit margin declines. d. The times-interest-earned ratio declines. e. The current and quick ratios both increase.

e. The current and quick ratios both increase.

Which of the following statements is CORRECT? a. A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid. b. In general, it's better to have a low inventory turnover ratio than a high one, as a low one indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock. c. If a firm's fixed assets turnover ratio is significantly lower than its industry average, this could indicate that it uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets. d. The more conservative a firm's management is, the higher its total debt to total capital ratio is likely to be. e. The days sales outstanding ratio tells us how long it takes, on average, to collect after a sale is made. The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time.

e. The days sales outstanding ratio tells us how long it takes, on average, to collect after a sale is made. The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time.

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

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

Which of the following statements is CORRECT? a. If a firm has high current and quick ratios, this always indicate that the firm is managing its liquidity position well. b. If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline. c. If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio would decline. d. If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change. e. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets.

e. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets.

Which of the following statements is CORRECT? a. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets. b. The statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit. c. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital. d. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock. e. The statement of cash flows shows how much the firm's cash--the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)--increased or decreased during a given year.

e. The statement of cash flows shows how much the firm's cash--the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)--increased or decreased during a given year.