Chaper 2

The more debt a firm has, the greater its:

degree of financial leverage

Net capital spending is equal to the change in net fixed assets plus

depreciation

Cash flow refers to _____.

the difference between the number of dollars that came in and the number that went out

shareholders equity (also called common equity or owners equity)

the difference between the total value of the assets current and fixed and the total value of the liabilities current and long term

From the income statement, the corporation had a net income of $724 million for the year. Total dividends were $106 million. There were 400 million shares outstanding. How much is the earnings per share?

$1.81 Earnings per share=Net income/Total shares outstanding =$724/400 = $1.81 per share

You are analyzing the Statement of Cash flows for Coffey Corporation. You have the following information: Beginning Cash: Ending Cash: $285 Net cash increase: $102 Calculate the Beginning Cash.

$183

Long-term liabilities represent obligations of the firm lasting more than

1 year

Current assets are defined as assets that can be turned into cash within ______ months.

12

According to the current U.S. corporate tax code, the corporate tax rate in effect for 2021 is ______ percent.

21

U.S. corporations pay tax at a rate of _________ percent.

21

What does shareholders' equity represent?

A residual claim against the firm's total assets

What is depreciation?

A systematic expensing of an asset based on the asset's estimated life

An income statement prepared using GAAP will show revenue when it is:

Accrued

Balence Sheet Equation

Assets = liabilities + stockholders equity

Which of the following is the balance sheet equation? Stockholders' equity equals assets plus liabilities Assets equal liabilities plus stockholders' equity. Liabilities equal assets plus stockholders' equity. Assets equal stockholders' equity minus liabilities.

Assets equal liabilities plus stockholders' equity.

The size of a company's tax bill is determined by the tax _______.

Code

True or false: With the passage of the Tax Cuts and Jobs Act of 2017, corporate tax rates went up.

False

When considering Net Working Capital, a project will generally need all of the following, except: Some cash on hand to pay any expenses that arise. An initial investment in inventories and accounts receivables. Some financing in the form of accounts payable. A balance that represents the investment in net working capital. Only long-term assets to get the project started.

Only long-term assets to get the project started.

income statement equation

Revenues - Expenses = Income

The first thing reported on an income statement would usually be:

Revenues.

Which one of the following items is a source of cash from financing activities in the statement of cash flows? Sale of common stock Negative net income Dividends paid Common stock repurchase

Sale of common stock

The Statement of Cash Flows has all of the following categories, except: Operating Financing Standard Investment

Standard

Which one of the following activities would increase the firm's cash balance? Inventories are increased. The firm increases its accounts payable. The company pays a cash dividend to common and preferred stockholders. The company acquires another firm outside its current market.

The firm increases its accounts payable.

Which one of the following activities would decrease the firm's cash balance? Inventories are decreased. The firm increases its accounts payable. The firm sells more on credit, increasing its accounts receivable. The company sells one of its divisions.

The firm sells more on credit, increasing its accounts receivable.

financial leverage

The use of debt in the firm's capital structure

How is the average income tax rate computed?

Total tax bill/Total taxable income

Which of these questions can be answered by reviewing a firm's balance sheet? What is the total amount of assets the firm owns? How much of the firm's net income was paid out in dividends? How much net income has the firm earned this period? How much debt is used to finance the firm?

What is the total amount of assets the firm owns? How much debt is used to finance the firm?

According to GAAP, when is income reported?

When it is earned or accrued

Balance Sheet

a convenient means of organizing and summarizing what a firm owns (its assets), what a firm owes (its liabilities), and the difference between the two the firm's equity at a given point in time

Net capital spending is negative when ______.

a firm sold off more assets than it purchased

A balance sheet reflects a firm's:

accounting value on a specific date

Which one of these is considered to be the most liquid? accounts receivable inventory equipment and machines land

accounts receivable

Net income refers to income earned ______.

after interest and taxes

In the long run, costs may be considered as ______.

all variable

The short run is ______.

an imprecise period of time

asset

anything of value that is owned. are classified as either current or fixed.

A company's ______ tax rate is its tax bill divided by its total taxable income, and its ______ tax rate is the tax rate it pays on the next dollar of income.

average; marginal

On the balance sheet, assets are listed at their ______ value.

book

The short run is a period when there are ______ costs.

both fixed and variable

Noncash items do not affect _____.

cash flow

In finance, the value of a firm depends on its ability to generate_______

cash flows

operating cash flow

cash generated from a firm's normal business activities -expenses associated with the firm's financing of its assets are not included because they are not operating expenses

Which of the following is an example of a noncash item on an income statement? costs retained earnings dividends depreciation

depreciation

___________ paid minus net new equity raised equals cash flow to stockholders.

dividends

cash flow to stockholders

dividends paid - net new equity raised

Cash flow to stockholders equals ____.

dividends paid minus net new equity raised

When a firm smooths earnings to please investors, it is called _______.

earnings management

liquidity really has two dimensions:

ease of conversion, versus loss of value

True or false: Current assets plus current liabilities equals net working capital.

false

Which of the following is not a component of cash flow from assets? financing expenses capital spending change in net working capital operating cash flow

financing expenses

in the short run, all business costs are _________________. They must be paid no matter what.

fixed -for example: property taxes

Depreciation is the accountant's estimate of the cost of ______ used in the production process matched with the benefits produced from owning it.

fixed assets equipment

Marginal tax rates are the most important tax rates because:

incremental cash flows are taxed at marginal tax rates. financial decisions are usually based on new cash flows.

Cash flow to creditors equals:

interest paid - net new borrowing

cash flow to creditors

interest paid - net new borrowing

Period costs are the costs that are allocated to a specific ______

interval of time

Which of the following is a current asset? equipment inventory accrued expense accounts payable

inventory

net capital spending

is money spent on fixed assets less money received from the sale of fixed assets ending net fixed assets - beginning net fixed assets + depreciation

fixed asset

is one that has a relatively long life can either be tangible such as a truck or a computer or intangible such as a trademark or patent

Current assets are classified as relatively ______; these assets can be converted to cash within the next 12 months.

liquid

current assets are relatively _____________ and include cash and those assets that we expect to convert to cash over the next 12 months

liquid

three particularly important things to keep in mind when examining a balance sheet:

liquidity, debt versus equity, and market value versus book value

For financial decision-making purposes, the most important tax rate is the ______ tax rate.

marginal

in a healthy firm ____________ is usually positive.

networking capital

a primary reason that accounting income differs from cash flow is that an income statement contains

non-cash items

net income often is expressed

on a per share basis and called earnings per share (EPS)

cash flow from assets involves 3 components:

operating cash flow, capital spending, and change in net working capital

The cash flow that results from the firm's day-to-day activities of producing and selling is called:

operating cash flow.

Earnings management is a controversial practice in which corporations ______ or ______ their earnings to "smooth out" dips and surges and keep investors calm.

overstate; understate

A positive operating cash flow indicates that the firm is generating enough cash to:

pay everyday cash outflows.

the way costs are reported on the income statement is not a good guide as to which costs are which because

practice accountants tend to classify costs as either product cost or period costs

In practice, accountants tend to classify costs as either ______ costs or ______ costs.

product; period

Liquidity has two dimensions which are the ability to:

quickly convert assets into cash without significant loss in value.

liquidity

refers to the speed and ease with which an asset can be converted to cash

Fixed assets are ______________________ these consist of tangible things such as buildings and equipment that don't convert to cash at all in normal business activity. They are of course used in the business to generate cash.

relatively illiquid

a highly liquid asset is one that can be quickly sold without

significant loss of value

Physical assets are termed ______________ assets.

tangible

Operating cash flow _________.

tells us whether or not a firm's cash inflows from its operations are sufficient to cover its everyday cash outflows is a sign of trouble if negative over a long period of time

True or false: Free cash flow is also known as cash flow from assets.

true

True or false: Interest paid minus net new borrowing equals cash flow to creditors.

true

True or false: Long-term liabilities are not due in the current year (from the date of the balance sheet).

true

True or false: Operating cash flow does not include depreciation or interest.

true

true or false. Earnings per share can be calculated as Net Income/Total shares outstanding.

true

true or false. The Income Statement measures performance over some period of time.

true

cash flow

the difference between cash coming in and cash going out of a business

marginal tax rate

the extra tax you would pay if you earned one more dollar

after the passage of the Tax Cuts and Jobs Act of 2017, the federal corporate tax rate in the United states became

a flat 21% -however, tax rates on other forms of business as such as proprietorships, partnerships, and LLCs did not become flat

Intangible assets, such as trademarks, have no physical existence but can be very valuable. Like tangible fixed assets, they won't ordinarily convert to cash and are _______________.

generally illiquid

general rule (the recognition principle)

is to recognize revenue when the earnings process is virtually complete and the value of an exchange of goods or services is known or can be reliably determined -in practice, this principle usually means that revenue is recognized at the time of sale, which need not be the same as the time of collection

Ending net fixed assets minus beginning net fixed assets _________ depreciation equals net investment in fixed assets.

plus

Net capital spending is equal to ending net fixed assets minus beginning net fixed assets ______.

plus depreciation

average tax rate

tax bill divided by your taxable income; the percentage of your income that goes to pay taxes

The market value of an item is:

the cash value you'd get if you sold it

net working capital

the difference between a firm's current assets and its current liabilities

Can net capital spending be negative?

yes, this would happen if the firm sold off more assets than it purchased. The net here refers to purchases of fixed assets net of any sales of fixed assets.

illiquid assets

asset that cannot be quickly converted to cash without a substantial price reduction

The cash flow identity states that cash flows from ______ should equal cash flows to creditors and equity investors.

assets

Liquidity refers to the ease of changing _____.

assets to cash

Tax rates for proprietorships, partnerships, and LLCs ______ with the passage of the Tax Cuts and Jobs Act of 2017.

changed

Product costs are usually shown on the income statement under the heading of ______.

cost of goods sold

The cash flow identity states that cash flow from assets equals cash flows to ______.

creditors and stockholders

Assets can be categorized as:

current and fixed assets tangible and intangible assets

For current assets, market value and book value might be somewhat similar because

current assets are bought and converted into cash over a relatively short span of time

networking capital is positive when

current assets exceed current liabilities -based on the definitions of current assets and current liabilities, this means that the cash that will become available over the next 12 months, exceeds the cash that must be paid over that same period

earnings management

deliberate actions taken by management to meet earnings objectives -corporations frequently like to show investors that they have steadily growing earnings. To do this they might take steps to overstate or understate earnings at various times. It is a controversial practice

operating cash flow is important number because

it tells us on a very basic level, whether or not a firm's cash inflows from its business operations are sufficient to cover its everyday cash outflows. For this reason, a negative operating cash flow is often a sign of trouble.

The ___________ tax rate is relevant for financial decision making. The reason is that any new cash flows will be taxed at that _______________ rate because financial decisions usually involve new cash flows or changes in existing ones. This rate will tell us the _______________ effect on our tax bill.

marginal, marginal, marginal

income statement

measures performance over some period of time, usually a quarter or a year

The balance sheet identity shows that stockholders' equity equals assets ______ liabilities.

minus

Cash flow refers to _____

the difference between the number of dollars that came in and the number that went out

the more debt a firm has as a percentage of assets..

the greater is its degree of leverage

Accounts receivable represent amounts not yet collected from customers on sales already made and is probably ____________________ of the current assets at least for many businesses

the least liquid

it is often useful to think of the future as having two distinct parts:

the short run and the long run -These are not precise time periods. The distinction has to do with whether costs are fixed or variable

market value

the true value of any asset, which is the amount of cash we would get if we actually sold it

in accounting, the revenues associated with an asset would generally occur over some length of time. So the accountant seeks

to match the expense of purchasing the asset with the benefits produced from owning it.

What is the purpose of the income statement?

to measure performance over a set period of time

is the value of the firm's assets is equal

to the sum of its liabilities and shareholders equity

Financial leverage refers to a firm's ______.

use of debt in its capital structure

in the long run, all business costs are _________________. Given sufficient time, assets can be sold and debts can be paid.

variable

______ changes as the output of the firm changes.

variable cost

any asset can be converted to cash quickly if

we cut the price enough

Costs that do not change in the short run arise because of ________

fixed commitments

For current assets, market value and book value might be different because

for fixed assets it would be purely a coincidence if the actual market value of an asset (what the asset could be sold for) would equal to its book value. -For example, a railroad might own enormous tracts of land purchased a century or more ago. What the railroad paid for that land could be hundreds or thousands of times less than what it is worth today. The balance sheet would nonetheless show the historical cost. There are exceptions to this practice.

True or false: Ending net fixed assets plus beginning net fixed assets minus depreciation equals net investment in fixed assets.

false

ture or false. Net working capital represents current assets plus current liabilities.

false

Which of the following are classified as fixed assets on the balance sheet? trademark equipment cash buildings

equipment, buildings

A debt that is not do the coming year is classified as

a long term liability

period costs

are incurred during a particular time period and might be reported as selling general and administrative expenses -some of these costs may be fixed and others may be variable.

Net working capital will be negative when current assets ______ current liabilities.

are less than

Rank the ease (from easiest to hardest) of turning the following assets into cash. accounts receivable cash equivalents inventory plant and equipment

cash equivalents accounts receivable inventory plant and equipment

free cash flow

cash flow from assets -refers to cash that the firm is free to distribute to creditors and stockholders because it is not needed for working capital or fixed asset investments

Cash Flow Identity

cash flow from assets = cash flow to creditors + cash flow to stockholders

Cash flow from assets equals:

cash flow to creditors + cash flow to stockholders

Which of the following are components of cash flow from assets? net new equity change in net working capital operating cash flow net new borrowing capital spending

change in net working capital operating cash flow capital spending

A _________ __________ is one that has a life of less than one year, meaning they must be paid within the year.

current liability

assets are normally listed on the balance sheet in order of

decreasing liquidity, meaning that the most liquid assets are listed first

The purpose of a(n) ______ is to measure performance over a set period of time.

income statement

The price at which willing buyers and sellers would trade is called ______ value.

market

The last item (or "bottom line") on the income statement is typically the

net income

Costs incurred during a particular time period that might be reported as selling, general, and administrative expenses are also known as

period costs

If everything else is the same, when depreciation appears in the income statement, one can estimate that

the cash flow from operations exceeds the net income.

Shareholders' equity equals ______.

total assets - total liabilities

Free cash flow is better described as ______

total distributable cash flow

Which of the following are classified as fixed assets on the balance sheet? cash trademark equipment buildings

trademark equipment buildings

Financial leverage refers to a firm's

use of debt in its capital structure

According to GAAP, when is revenue recognized on an income statement? when the value of an exchange of goods or services is known or reliably determined after the related expenses are paid in full when the earnings process is virtually completed only when cash has been received for the sale

when the value of an exchange of goods or services is known or reliably determined when the earnings process is virtually completed

If the cash flow from operations exceeds the total investing and financing cash flows, the cash balance in the statement of cash flows

will increase.

the depreciation deduction is another application of the

matching principle

current asset

has a life of less than one year this means that the asset will normally convert to cash within 12 months

Under GAAP, assets are generally carried on a firm's balance sheet at ___________

historical cost book value

product costs

include raw materials, direct labor expense, and manufacturing overhead. -these are reported on the income statement as costs of goods sold but they include both fixed and variable costs