Answer Options:
a. True
b. False
Answer: a
Question: 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 generally accepted accounting principles. Finance people generally put at least as much weight on cash flows as they do on net income.
Answer Options:
a. True
b. False
Answer: a
Question: 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 2014 could go up to 39.6%, but qualified dividends received were taxed at a maximum tax rate of 15% for individuals earning less than $400,000 and married taxpayers filing jointly earning less than $450,000. c. The maximum federal tax rate on corporate income in 2014 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 2014 was 50%.
Answer: b
Question: 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.
Answer Options:
a. True
b. False
Answer: a
Question: 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 2014 could go up to 39.6%, but qualified dividends received were taxed at a maximum tax rate of 15% for individuals earning less than $400,000 and married taxpayers filing jointly earning less than $450,000. c. The maximum federal tax rate on corporate income in 2014 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 2014 was 50%.
Answer: b
Question: 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.
Answer Options:
a. True
b. False
Answer: a
Question: 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.
Answer: c
Question: 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.
Answer: b
Question: 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 %)
Answer: e
Question: 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.
Answer: c
Question: 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.
Answer: c
Question: 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.
Answer Options:
a. True
b. False
Answer: a
Question: 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.
Answer Options:
a. True
b. False
Answer: a
Question: Free cash flow is the amount of cash that if withdrawn would harm the firm’s ability to operate and to produce future cash flows.
Answer Options:
a. True
b. False
Answer: b
Question: 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.
Answer: c
Question: Which of the following statements is CORRECT? a. Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the United States. b. Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia. c. Hedge funds have more in common with investment banks than with any other type of financial institution. d. Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only “sophisticated investors” (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and these investors supposedly can do any necessary “due diligence” on their own rather than have it done by the SEC or some other regulator. e. Hedge funds have more in common with commercial banks than with any other type of financial institution.
Answer: d
Question: Because the U.S. tax system is a progressive tax system, a taxpayer’s marginal and average tax rates are the same.
Answer Options:
a. True
b. False
Answer: b
Question: 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.”
Answer Options:
a. True
b. False
Answer: b
Question: 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.
Answer Options:
a. True
b. False
Answer: b
Question: Assume that Congress recently passed a provision that will enable Beb’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.
Answer: e
Question: 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.
Answer Options:
a. True
b. False
Answer: a
Question: 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.
Answer: e