Financial Management 3400 Chapter 2

Compute the net increase or decrease in cash flows if Star Corporation had $250,000 in net income, $30,000 in depreciation expense, a decrease of $20,000 in A/R and an increase in bonds payable of $50,000

$350,000 Change in cash flow = Net income + Depreciation + Decrease in A/R + Increase in bonds = $250,000 + $30,000 + $20,000 + $50,000 = $350,000.

Hoover Inc. has current assets of $350,000 and fixed assets of $650,000. Current liabilities are $100,000 and long-term liabilities are $250,000. There is $120,000 in preferred stock outstanding and the firm has issued 10,000 shares of common stock. Compute book value (net worth) per share

$53.00 Current Assets $350,000 Fixed Assets $650,000 Total Assets $1,000,000 Current Liabilities $100,000 Long Term Liabilities $250,000 Shareholders Equity = $650,000 Preferred Stock = $120,000 Common Stock = $530,000 $530,000/10,000 shares = $53.00

Assuming a tax rate of 40%, the after-tax cost of interest expense of $1,000,000 is

$600,000 After tax cost of interest = Interest × (1 - tax rate) = $1,000,000 × .60 = $600,000

Gerry Co. has a gross profit of $1,200,000 and $400,000 in depreciation expense. Selling and administrative expense is $250,000. Given that the tax rate is 40 percent, compute the cash flow for Gerry Co.

$730,000 Gross Profit $1,200,000 minus Selling & Admin $250,000 minus Depreciation $400,000 = Operating Profit $550,000 Taxes (40%) $220,000 Earnings After taxes $330,000 plus depreciation Expense $400,000 Cash flow $730,000

Which of the following would represent a use of funds and, indirectly, a reduction in cash balances?

An increase in inventories

The statement of cash flows does not include which of the following sections?

Cash flows from sales activities

Which factor(s) can cause an increase in the firm's P/E ratio

Falling earnings per share

A cash flow statement is correct if the net cash flow ties to the ending cash balance.

False

Accumulated depreciation should always be equal to the depreciation expense charged in the income statement.

False

Accumulated depreciation shows up in the income statement.

False

An increase in accounts payable represents a reduction in cash flows from operations.

False

An increase in accrued expenses results in a cash outflow on the statement of cash flows.

False

An increase in an asset represents a source of funds.

False

An increase in inventory represents a source of funds.

False

Assume that two companies both have Net Income of $100,000. The firm with the highest depreciation expense will have the highest cash flow, assuming all other adjustments are equal.

False

Balance sheet items are usually adjusted for inflation.

False

Book value per share is of greater concern to the financial manager than market value per share.

False

Book value per share is the most important measure of value for a stockholder.

False

Cash flow consists of illiquid cash equivalents which are difficult to convert to cash within 90 days.

False

Dividing Operating Profit by Shares Outstanding produces Earnings per Share.

False

For corporations with low taxable income (less than $100,000), the effective tax rate can be as much as 40%

False

It is not possible for a company with a high profit margin to have a low operating profit.

False

Marketable securities are temporary investments of excess cash and are valued at their original purchase price.

False

Preferred stock dividends are paid out before income taxes.

False

Retained earnings shown on the balance sheet represents available cash on hand generated from prior year's earnings but not paid out in dividends.

False

Sales minus cost of goods sold is equal to earnings before taxes.

False

Stockholders' equity is equal to liabilities plus assets.

False

The P/E ratio is strongly related to the past performance of the firm.

False

The income statement measures the increase in the assets of a firm over a period of time.

False

The investments account includes marketable securities.

False

The real value of a firm is the same from an economic and accounting perspective.

False

The use of depreciation is an attempt to allocate the past and future costs of an asset over its useful life.

False

Total assets of a firm are financed with liabilities and stockholders equity

False

Unlike sole proprietorships, corporations do not need to be concerned about individual tax rates in corporate decisions.

False

When a firm's earnings are falling more rapidly than its stock price, its P/E ratio will:

Go up

Which of the following would not be classified as a current asset?

Investments

Net worth is equal to stockholders' equity

Minus preferred stock

Increasing interest expense will have what effect on EBIT?

No effect

Which of the following factors do not influence the firm's P/E ratio?

Past earnings. Shares outstanding. Volatility in performance. None of these.

A $125,000 credit sale could be a part of a firm's cash flow from operations if paid off within the firm's fiscal year.

True

A decrease in bonds payable results in a cash outflow on the statement of cash flows.

True

Accounting income is based on verifiably completed transactions.

True

An increase in accounts receivable represents a reduction in cash flows from operations.

True

Assume that two companies both have Net Income of $100,000. The firm with the highest depreciation expense will have the highest cash flow, assuming all other adjustments are equal.

True

Book value is equal to net worth

True

Cash flow is equal to earnings before taxes minus depreciation.

True

Depreciation is an accounting entry and does not involve a cash expense.

True

Equity is a measure of the monetary contributions that have been made directly or indirectly on behalf of the owners of the company.

True

Federal corporate tax rates have changed four times since 1980.

True

Retained earnings represent the firm's cumulative earnings since inception, minus dividends and other adjustments.

True

Stockholders' equity is equal to assets minus liabilities.

True

Stockholders' equity minus preferred stock is the same thing as what is sometimes called net worth or book value.

True

The investments account represents a commitment of funds of at least one year or more.

True

The purchase of a new factory would reduce the cash flows from investing activities on the statement of cash flows.

True

The sale of a firm's securities is a source of funds, whereas the payment of dividends is a use of funds.

True

The sale of corporate bonds held by the firm as a long-term investment would increase cash flows from investing activities on the statement of cash flows.

True

The statement of cash flows helps measure how the changes in a balance sheet were financed between two time periods.

True

When a firm has a sharp drop off in earnings, its P/E ratio may be artificially high.

True

Which of the following would represent a source of funds and, indirectly, an increase in cash balances?

a reduction in accounts receivable

A statement of cash flows allows a financial analyst to determine

whether a cash dividend is affordable. how increases in asset accounts have been financed. whether long-term assets are being financed with long-term or short-term financing. all of these.

Allen Lumber Company had earnings after taxes of $750,000 in the year 2009 with 300,000 shares outstanding on December 31, 2009. On January 1, 2010, the firm issued 50,000 new shares. Because of the proceeds from these new shares and other operating improvements, 2010 earnings after taxes were 25 percent higher than in 2009. Earnings per share for the year 2010 were

$2.68

Farah Snack Co. has earnings after taxes of $150,000. Interest expense for the year was $20,000; preferred dividends paid were $20,000; and common dividends paid were $30,000. Taxes were $22,500. The firm has 100,000 shares of common stock outstanding. Earnings per share on the common stock was

$1.30 Earnings after taxes - Preferred stock dividends = Earnings available to common $150,000 - $20,000 = $130,000 EAC Earnings per share = Earnings available to common/number of shares outstanding $130,000/100,000 = $1.30

Assuming a tax rate of 30%, the after-tax cost of a $100,000 dividend payment is

$100,000 Dividends are not tax deductible.

Consider the following information for Ball Corp.: Selling & Admin expenses $40,000 Depreciation expense $70,000 Sales $350,000 Interest Expense $30,000 Cost of Goods Sold $110,000 Taxes $17,500 What is the Operating Profit for Ball Corp?

$130,000

A firm has $1,500,000 in its common stock account and $1,000,000 in its paid-in capital account. The firm issued 100,000 shares of common stock. What was the original issue price if only one stock issue has ever been sold?

$25

Density Farms, Inc. had sales of $750,000, cost of goods sold of $200,000, selling and administrative expense of $70,000, and operating profit of $150,000. What was the value of depreciation expense?

$330,000

Candy Company had sales of $320,000 and cost of goods sold of $112,000. What is the gross profit margin (ratio of gross profit to sales)?

65

Which of the following is an outflow of cash?

The payment of cash dividends

Which of the following is an inflow of cash?

The sale of the firms bonds

The firm's price-earnings (P/E) ratio is influenced by its

capital structure. earnings volatility. sales, profit margins, and earnings. all of these.

Free cash flow is equal to:

cash flow from operating activities minus capital expenditures, minus dividends.

An increase in investments in long-term securities will:

decrease cash flow from investing activities.

The P/E ratio is strongly related to the past performance of the firm

false

The major limitation of financial statements is

in their use of historical cost accounting.

Depreciation tends to

increase cash flow and decrease income.

A corporation can increase their earnings per share by

increasing Treasury stock

Which of the following would not be classified as a current asset? .

investments

In the last decade, free cash flow has been associated with special financial activities such as:

leveraged buyouts

Asset accounts on the balance sheet are listed in the order of:

liquidity

Free cash flow is equal to cash flow from operating activities

minus capital expenditures, minus dividends.

Earnings per share is

net income minus preferred dividends divided by number of shares outstanding