Finance 420 Exam 1

Credit risk analysis relies primarily on quantitative inputs from the financial statements, as opposed to qualitative assessments. a. True b. False

False

Which of the industries would you expect to have the longest cash-to-cash cycle? a. Shipbuilding b. Restaurant c. Retail grocer d. Electric power distribution

Shipbuilding

Which of the following is the definition of a Level 2 fair value? a. "Level 2" inputs for estimating fair values include quoted prices for similar assets or liabilities in active or inactive markets, other observable information such as yield curves and price indexes, and other observable data such as market-based correlation estimates. b. "Level 2" inputs for estimating fair values include a firm's own assumptions about the fair value of an asset or a liability, such as using various data about future cash flows and discount rates to estimate present values. c. "Level 2" inputs for estimating fair values are based on inputs that are readily available via prices for identical assets or liabilities in actively traded markets, such as securities exchanges. d. None of these answer choices are correct

a. "Level 2" inputs for estimating fair values include quoted prices for similar assets or liabilities in active or inactive markets, other observable information such as yield curves and price indexes, and other observable data such as market-based correlation estimates.

A company reports a net loss of $773 million, cash flows from operating activities of $(124) million, cash flows from investing activities of $(1,416) million, and cash flows from financing activities of $3,744 million. What is your best estimate of the change in cash on the balance sheet during the year? a. $1,431 million b. $2,204 million c. $(897) million d. $(773) million

a. $1,431 million

Some companies use restricted stock in compensation plans. What is the effect at the date in which the restricted stock is granted? a. A journal entry is recorded, but the net effect of the journal entry is no change in shareholders' equity. b. A journal entry is recorded; the net effect of the journal entry is to increase shareholders' equity by the fair value of the stock. c. Income is reduced. d. There is no entry to record the grant.

a. A journal entry is recorded, but the net effect of the journal entry is no change in shareholders' equity.

Machinery is most likely valued using which basis? a. Adjusted historical cost b. Net realizable value c. Fair value d. Historical cos

a. Adjusted historical cost

When investors pay more than the face value of a note or bond payable, the debt was issued at which of the following? a. At a premium b. At a discount c. At par d. None of the answer choices are correct.

a. At a premium

Bryant Co. issued common stock two years ago for $10 per share, repurchased the shares in March of the current year for $12, and reissued the shares to market in April for $13. Which of the following is true with respect to the repurchase and reissue transactions? a. Bryant records no gains in current period income. b. Bryant records a $2 loss and a $1 gain on the two transactions. c. Bryant records a $1 gain in current period income. d. Bryant records a $3 gain in current period income.

a. Bryant records no gains in current period income.

Bianchi Inc. has ROA of 3.0% and ROCE of 11.2%. What must be true? a. Capital structure leverage is high. b. Profit margin for ROA is less than profit margin for ROCE. c. Total assets turnover is high. d. More information is required to know why ROA is less than ROCE.

a. Capital structure leverage is high.

Which of the following accurately describes the difference between basic and diluted EPS? a. Diluted EPS reflects EPS under an extreme scenario where all convertible securities are assumed to have been converted as of the beginning of the year. b. Preferred stock dividends reduce the numerator of the EPS calculation for diluted EPS, but not basic EPS. c. Diluted EPS is always less than basic EPS. d. Diluted EPS is not meaningful if a firm reports a net loss.

a. Diluted EPS reflects EPS under an extreme scenario where all convertible securities are assumed to have been converted as of the beginning of the year.

A company has accounts payable of $315,000 at the beginning of the year and $618,000 at the end of the year. Which of the following best describes the adjustment for accounts payable that would appear in the indirect statement of cash flows? a. The adjustment would be for $303,000, indicating a source of cash. b. The adjustment would be for $(303,000), indicating a use of cash. c. The adjustment would be for $303,000, indicating a use of cash. d. The adjustment would be for $(303,000), indicating a source of cash.

a. The adjustment would be for $303,000, indicating a source of cash.

Porter's five forces framework suggests analyzing competition within an industry by focusing on the following five forces: a. rivalry, threat of entrants, threat of substitutes, supplier power, and buyer power. b. demand, supply, government regulations, barriers to entry, and switching costs. c. demand, supply, manufacturing, marketing, investing, and financing. d. demand, supply, cyclicality, seasonality, and growth

a. rivalry, threat of entrants, threat of substitutes, supplier power, and buyer power.

Empirical results in Nichols and Wahlen's 2004 study showed that a. unexpected changes in earnings have a strong positive association with abnormal stock returns. b. the capital markets are inefficient with respect to earnings information because investors overreact to earnings surprises. c. analysts' forecasts of future earnings are optimistically biased. d. an investor could earn excess returns if the investor could predict accurately the sign of the change in working capital one year ahead

a. unexpected changes in earnings have a strong positive association with abnormal stock returns.

A local consulting firm performs services and extends credit. Occasionally, it has a cash shortage and transfers receivables on a "with recourse" basis to a local bank. Part of the agreement is that the firm can continue to use the receivables as collateral on other loans, an agreement that, under GAAP, requires that the arrangement be treated as a loan. Which of the following will occur? a. A recourse liability will be estimated and reported. b. A loan payable will be recorded on the firm's books. c. Receivables will be removed from the firm's books.

b. A loan payable will be recorded on the firm's books.

The text discussed three approaches for income recognition: Approach 1. Recognize changes in economic value on the balance sheet andincome statement when they are realized in a market transaction. Approach 2. Recognize changes in economic value on the balance sheet and income statement when they occur, even though they are not yet realized in a market transaction. Approach 3. Recognize changes in economic value on the balance sheet when the value changes occur over time, but delay recognition in net income until the value changes are realized in a market transaction. Include the delayed value change in "other comprehensive income" and shift it out of other comprehensive income and into net income when it is realized in the market transaction. Which of the approaches is the closest match to fair value accounting on the income statement? a. Approach 1 b. Approach 2 c. Approach 3 d. Approaches 1 and 3

b. Approach 2

Which of the following is not a benefit of the statement of cash flows? a. It reconciles the change in cash from the balance sheet. b. It focuses on cash flows, which are difficult for managers to manipulate. c. It highlights accruals as the difference between net income and operating cash flows. d. It is logically organized into three intuitive sections: operating, investing and financing

b. It focuses on cash flows, which are difficult for managers to manipulate.

The following are Item 1A risk disclosures by Tesla, Inc., a manufacturer of electric vehicles. Which of the following would be an example of a risk disclosure that might be applicable to any company? a. Our future growth is dependent upon consumers' willingness to adopt electric vehicles. b. We may fail to meet our publicly announced guidance or other expectations about our business, which would cause our stock price to decline. c. If our vehicles or vehicles that contain our powertrains fail to perform as expected, or if we suffer product recalls, our ability to develop, market, and sell our electric vehicles could be harmed. d. Our vehicles make use of lithium-ion battery cells, which have been observed to catch fire or vent smoke and flame, and such events have raised concerns, and future events may lead to additional concerns, about the batteries used in automotive applications.

b. We may fail to meet our publicly announced guidance or other expectations about our business, which would cause our stock price to decline.

Under current leasing rules, will a lessee report interest expense under operating and capital leases? a. Yes under both types of leases b. Yes for capital leases, no for operating leases c. No for capital leases, yes for operating leases d. No under both types of leases

b. Yes for capital leases, no for operating leases

For early-stage businesses, a. cash flows from financing activities tend to be close to zero. b. cash flows from financing activities tend to be positive. c. cash flows from financing activities tend to be negative. d. cash flows from financing activities depend on whether capital comes from banks versus equity investors.

b. cash flows from financing activities tend to be positive.

For very mature businesses, a. cash flows from operating activities tend to be negative, and cash flows from financing activities tend to be positive. b. cash flows from operating activities tend to be positive, and cash flows from financing activities tend to be negative. c. cash flows from operating and financing activities tend to be negative. d. cash flows from operating and financing activities tend to be positive

b. cash flows from operating activities tend to be positive, and cash flows from financing activities tend to be negative.

Percentage change financial statements are useful tools for a. left-handed analysts. b. highlighting relative growth rates in financial statement amounts from one period to the next. c. measuring profit margins. d. All of these answer choices are correct

b. highlighting relative growth rates in financial statement amounts from one period to the next.

On the statement of cash flows, operating activities a. involve cash outflows for investments in long-lived assets. b. include activities related to the production and delivery of goods or services. c. include noncash transactions such as the purchase of inventory with common stock. d. are the primary source of cash flows for early-stage enterprises.

b. include activities related to the production and delivery of goods or services.

An increase in the deferred tax asset valuation account a. decreases income tax expense. b. increases income tax expense. c. increases or decreases income tax expense, depending on the situation. d. has no effect on income tax expense

b. increases income tax expense.

As defined in the chapter, financial flexibility a. is the ability to delay payments to suppliers or accelerate collections from customers. b. is the ability of a firm to strategically use debt financing to increase returns to common shareholders on their investment in a firm. c. is the ability to refinance debt with common or preferred equity. d. is the ability to pay for goods and services through barter transactions.

b. is the ability of a firm to strategically use debt financing to increase returns to common shareholders on their investment in a firm.

A firm would likely have low financial flexibility if a. leverage is high. b. operating ROA is close to the net borrowing rate. c. cash and cash equivalents are low. d. operating ROA is above 10%

b. operating ROA is close to the net borrowing rate.

On the statement of cash flows, financing activities a. are the primary source of cash flows for mature businesses. b. summarize cash received or paid back to banks and shareholders. c. include cash flows generated from the investment of debt or equity capital in productive assets. d. capture cash inflows from the unplanned sale or liquidation of investments of idle cash

b. summarize cash received or paid back to banks and shareholders.

measures the covariability of a firm's return with the returns of a diversified portfolio of all shares traded on the market - the measure of systematic risk of the firm

beta

The text discussed three approaches for income recognition: Approach 1. Recognize changes in economic value on the balance sheet andincome statement when they are realized in a market transaction. Approach 2. Recognize changes in economic value on the balance sheet and income statement when they occur, even though they are not yet realized in a market transaction. Approach 3. Recognize changes in economic value on the balance sheet when the value changes occur over time, but delay recognition in net income until the value changes are realized in a market transaction. Include the delayed value change in "other comprehensive income" and shift it out of other comprehensive income and into net income when it is realized in the market transaction. Which of the approaches is the strongest on relevance while not ignoring the importance of representational faithfulness? a. Approach 1 b. Approach 2 c. Approach 3 d. Approaches 1 and 2

c. Approach 3

Removing management discretion in accounting choice is more likely to maximize a. representational faithfulness and relevance b. neither c. relevance d. representational faithfulness a. C b. B c. D d. A

c. D

Which of the following statements about the mixed attribute model is true? a. Relevance receives the primary emphasis. b. Representational faithfulness receives the primary emphasis. c. Obtaining an optimal mix of relevance and representational faithfulness is the primary objective. d. None of these statements are true.

c. Obtaining an optimal mix of relevance and representational faithfulness is the primary objective.

Some gains and losses from revaluation of certain assets and liabilities are treated as "other comprehensive income." Do these gains and losses affect current period net income, retained earnings, and shareholders' equity? a. Yes, all three are affected. b. Retained earnings and shareholders' equity are affected, but current period income is not. c. Of the three, only shareholders' equity is affected. d. No, none are affected.

c. Of the three, only shareholders' equity is affected.

GAAP and IFRS allow various treatments for revenue recognition. Which of the following correctly describes acceptable revenue recognition principles? a. Whenever cash is realized in a transaction with a customer (such as when a firm sells an asset to a customer) b. When value changes occur over time but are realized in a market transaction c. When the firm has completed all or substantially all of the revenue-generating processes by delivering goods or services to customers, and it is reasonable that it has generated an asset or satisfied a liability d. All of these answer choices are correct, depending on the circumstance.

c. When the firm has completed all or substantially all of the revenue-generating processes by delivering goods or services to customers, and it is reasonable that it has generated an asset or satisfied a liability

To be considered high quality, accounting information should a. be a fair and complete representation of the firm's economic performance, financial position, and risk. b. provide relevant information to forecast the firm's expected future earnings and cash flows. c. both be a fair and complete representation of the firm's economic performance, financial position, and risk; and provide relevant information to forecast the firm's expected future earnings and cash flows. d. None of these answer choices are correct.

c. both be a fair and complete representation of the firm's economic performance, financial position, and risk; and provide relevant information to forecast the firm's expected future earnings and cash flows.

Bankruptcy prediction a. is not relevant for firms reporting losses because such firms are already performing poorly. b. is not relevant for firms reporting profits because there is no risk of bankruptcy. c. is a combination of financial statement analysis and statistical modeling. d. is used by creditors to minimize losses from loans, but it is not useful to equity investors.

c. is a combination of financial statement analysis and statistical modeling.

A company overstates revenues by €1.2 million by overstating accounts receivable. The best characterization of the effect of this misstatement is a. overstated net income and overstated operating cash flows. b. overstated net income and understated operating cash flows. c. overstated net income and no effect on operating cash flows. d. no effect on the statement of cash flows.

c. overstated net income and no effect on operating cash flows.

The beta coefficient measuring systematic risk indicates the covariability of a firm's common stock return and a. cash flows from operations. b. long-term debt to total capital ratios. c. the market portfolio in excess of the risk-free rate. d. bottom-line accounting earnings.

c. the market portfolio in excess of the risk-free rate.

Total assets turnover can be better understood if a. you prepare common-size and percentage change financial statements. b. you adjust net income for unusual or nonrecurring items. c. you separately analyze receivables, inventory, and fixed assets turnovers. d. you prepare separate decomposition of ROA and ROCE.

c. you separately analyze receivables, inventory, and fixed assets turnovers.

contract that gives the owner the right, but not the obligation to buy a stock at a fixed price on or before a given date

call option

Which of the following is false regarding common-size analysis? a. Common-size analysis enables comparisons across firms and across time. b. On a common-size income statement, the net income line reflects the net profit margin. c. Common-size analysis is more useful when you understand a firm's economic environment and strategy. d. All numbers on the income statement and balance sheet are divided by total assets.

d. All numbers on the income statement and balance sheet are divided by total assets.

Large negative cash flows from operations a. can indicate a poorly run, unprofitable business. b. can reflect a business in the introduction phase, which is requiring large investments in working capital such as accounts receivable and inventory. c. cannot occur indefinitely. d. All of the answer choices are correct

d. All of the answer choices are correct

Which of the following are typical sources of risk disclosures required in Item 1A in U.S. filings with the SEC? a. Firm-specific risks b. Industry risks c. Domestic risks d. All of the answer choices are correct

d. All of the answer choices are correct

Which of the following are limitations of profitability analysis? a. Acquisitions can trigger noncomparability across time. b. Different business strategies make direct comparisons between firms challenging. c. Unusual and nonrecurring items included within profitability can obscure comparisons across time. d. All of the answer choices are limitations.

d. All of the answer choices are limitations.

An indirect statement of cash flows a. is more common than a direct method statement of cash flows. b. reports cash inflows and outflows within three different sections. c. can be useful in identifying significant estimates and choices made by managers under accrual accounting. d. All of these answer choices are correct

d. All of these answer choices are correct

Common-size financial statements are useful tools for a. analyzing profit margins. b. revealing relations between amounts for specific items in a financial statement and the relevant total for that statement. c. showing the proportion of debt and equity financing used to finance the total assets of the firm. d. All of these answer choices are correct

d. All of these answer choices are correct

Which of the following is not possible under the double entry accounting system? a. Increase an asset and increase a revenue. b. Decrease a liability and increase a revenue. c. Increase an expense and increase a liability. d. All of these answer choices are possible

d. All of these answer choices are possible

Which of the following is not an important factor in assessing a firm's credit risk? a. Cash flows b. Current debt levels c. Contingent claims d. All the answer choices are important.

d. All the answer choices are important.

The text discussed three approaches for income recognition: Approach 1. Recognize changes in economic value on the balance sheet and income statement when they are realized in a market transaction. Approach 2. Recognize changes in economic value on the balance sheet and income statement when they occur, even though they are not yet realized in a market transaction. Approach 3. Recognize changes in economic value on the balance sheet when the value changes occur over time, but delay recognition in net income until the value changes are realized in a market transaction. Include the delayed value change in "other comprehensive income" and shift it out of other comprehensive income and into net income when it is realized in the market transaction. Which of the approaches matches historical cost accounting on the income statement (not to be confused with the statement of comprehensive income)? a. Approach 1 b. Approach 2 c. Approach 3 d. Approaches 1 and 3

d. Approaches 1 and 3

Which financial statement reports elements that describe changes in assets and liabilities? a. balance sheet and income stmt b. balance sheet c. neither d. income statement a. C b. B c. A d. D

d. D

The text presents a six-step analysis and valuation framework. Place these steps in the most appropriate chronological order: A. Identify the strategies the firm pursues to gain and sustain a competitive advantage. B. Analyze the current profitability and risk of the firm. C. Value the firm. D. Identify the economic characteristics and competitive dynamics of the industry in which the firm participates. E. Assess the quality of the firm's financial statements and, if necessary, adjust them to more faithfully represent the underlying economics of the firm. F. Prepare forecasted financial statements. a. A, B, C, D, E, F b. A, D, B, E, C, F c. A, D, B, E, F, C d. D, A, E, B, F, C

d. D, A, E, B, F, C

Why does depreciation appear as a positive adjustment in the operating section of an indirect statement of cash flows? a. Depreciation expense needs to be included in the investing section. b. Long-lived assets are frequently financed with borrowings, which are a financing activity. c. A negative adjustment would reduce cash flows from operating activities. d. Depreciation expense reduces net income, the starting point of the statement of cash flows, but does not require a cash outflow

d. Depreciation expense reduces net income, the starting point of the statement of cash flows, but does not require a cash outflow

In reformatting balance sheets into operating, financing, and equity components, which of the following would be considered a financial asset? a. Inventory b. Accounts Receivable c. Prepaid assets d. Excess cash

d. Excess cash

Which of the following is an example of a permanent difference? a. Prepaid rent that is recognized as an asset for financial reporting but tax deductible when paid b. Depreciation recognized using straight-line for financial reporting but using an accelerated method for tax reporting c. Bad debt expense recognized for financial reporting, but only write-offs of bad debts are deductible for tax reporting d. Interest income from municipal bond investments recognized for financial reporting, but not taxable for tax reporting

d. Interest income from municipal bond investments recognized for financial reporting, but not taxable for tax reporting

A company reports a net loss of $773 million, cash flows from operating activities of $(124) million, cash flows from investing activities of $(1,416) million, and cash flows from financing activities of $3,744 million. This company is likely in what stage of the business life cycle? a. Decline b. Growth c. Maturity d. Introduction

d. Introduction

Which of the following two equity-related events reduce shareholders' equity? a. Both stock dividends and stock splits b. Stock dividends but not stock splits c. Stock splits but not stock dividends d. Neither stock dividends nor stock splits

d. Neither stock dividends nor stock splits

Some debt is convertible into common shares at a predetermined exchange rate. At the date of issue, how is convertible debt treated under IFRS and under U.S. GAAP? a. Equity under both IFRS and U.S. GAAP b. Debt under both IFRS and U.S. GAAP c. Debt under IFRS and part debt and part equity under U.S. GAAP d. Part debt and part equity under IFRS and debt under U.S. GAAP Hide Feedback

d. Part debt and part equity under IFRS and debt under U.S. GAAP

Which of the following best describes the relation between ROA and ROCE? a. ROA measures asset productivity, whereas ROCE measures profitability. b. ROA can be negatively affected by changing interest rates, whereas ROCE is immune from financing costs. c. ROA is susceptible to product life cycles, whereas ROCE is not. d. ROA measures the overall profitability of a firm, whereas ROCE measures the profitability of the firm after considering strategic use of nonequity financing.

d. ROA measures the overall profitability of a firm, whereas ROCE measures the profitability of the firm after considering strategic use of nonequity financing.

Financial accounting numbers are a function of several concepts that affect observed accounting numbers. Which of the following is not one of those concepts? a. Economics b. Measurement error c. Bias d. Relevance

d. Relevance

A company has accounts receivable of $4,200 at the beginning of the year and $5,000 at the end of the year. Which of the following best describes the adjustment for accounts receivable that would appear in the indirect statement of cash flows? a. The adjustment would be for $(800), indicating a source of cash. b. The adjustment would be for $800, indicating a use of cash. c. The adjustment would be for $800, indicating a source of cash. d. The adjustment would be for $(800), indicating a use of cash

d. The adjustment would be for $(800), indicating a use of cash

Complete the following statement correctly. Cash flow a. always equals income. b. always follows income. c. always precedes income. d. can arise from operating, investing, and financing activities

d. can arise from operating, investing, and financing activities

Present value is most likely to be used as a valuation basis for a. accounts receivable. b. property, plant, and equipment. c. inventory. d. long-term debt

d. long-term debt

On the statement of cash flows, investing activities a. include activities related to the production and delivery of goods or services. b. include bank borrowings only if those borrowings are collateralized by long-lived assets. c. would not include acquisitions or divestitures of businesses or business units. d. summarize cash outflows for the acquisition of long-lived assets, as well as cash inflows from the disposal of long-lived assets.

d. summarize cash outflows for the acquisition of long-lived assets, as well as cash inflows from the disposal of long-lived assets.

The accrual method of accounting can be best described as a. the recording of transactions and events so that debits equal credits. b. the method that equates assets with liabilities and owners' equity. c. the method that recognizes revenue when money is received. d. the method that aligns revenues and expenses with the appropriate period in which resources are generated and consumed

d. the method that aligns revenues and expenses with the appropriate period in which resources are generated and consumed

an asset that derives its price from an underlying asset like a stock

derivatives

- explicit outflows of cash - paid to shareholders from NI (reduces RE)

dividends

when you use your right to buy/sell the stock

exercising the option

what are the four areas of discussing risk

firm specific risk industry risk domestic risk international risk

contract where two parties agree on the price of an asset today to be delivered and paid for at some future date - legally binding on both parties

forward contracts

what do z scores < 1.81 indicate?

high probability of default (borrower unable to meet debt obligations)

termination of the business selling of all assets - try to get as much cash as possible

liquidation

type of hedge - appropriate for a participant who wants to reduce cash market risk associated with an increase in the cash position

long hedge

what do z scores > 3.00 indicate?

low probability of default (borrower unable to meet debt obligations)

- has a high priority, but still lower priority than debt - usually in the form of paid dividends

preferred stock

a contract that gives the owner the right, but not the obligation, to sell a stock at a fixed price on or before a given date

put option

keeping the business going - often issuing new securities to replace old - focus on reconstructing existing debt and asset growth model

reorganization

proportional reduction in number of shares

reverse stock split

type of hedge - applies to any participant who wants to reduce the risk of a decrease in cash position

short hedge

issue of additional shares to a firms stockholders with no payment made by investors

stock split

drives option value

variance