Answer Choices:
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.
Answer: b. One way to increase EVA is to generate the same level of operating income but with less total invested capital.
Question: Which of the following items is NOT normally considered to be a current asset?
Answer Choices:
a. Accounts receivable.
b. Inventory.
c. Bonds.
d. Cash.
e. Short-term, highly-liquid, marketable securities.
Answer: c. Bonds.
Question: Which of the following statements is CORRECT?
Answer Choices:
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.
Answer: c. If a firm is more profitable than average, we would normally expect to see its stock price exceed its book value per share.
Question: 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.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
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 2014, this would lower their free cash flows for 2014.
Answer: 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.
Question: 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?
Answer Choices:
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.
Answer: c. The company sold a new issue of common stock.
Question: 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.
Answer Choices:
a. True
b. False
Answer: b. False
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?
Answer Choices:
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. The firm’s cash flow would increase.
Question: The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of the stockholders’ claims against the firm’s existing assets. Put another way retained earnings are stockholders’ reinvested earnings.
Answer Choices:
a. True
b. False
Answer: a. True
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.
Answer Choices:
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. Net fixed assets on the balance sheet will decrease.
Question: A loss incurred by a corporation
Answer Choices:
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.
Answer: b. Can be carried back 2 years, then carried forward up to 20 years following the loss.
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 Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
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.
Answer: 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.
Question: The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement measures the firm’s financial position at a point in time.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
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 firm’s financial position at a point in time.
c. The income statement gives us a picture of the firm’s 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.
Answer: b. The balance sheet gives us a picture of the firm’s financial position at a point in time.
Question: Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm’s taxes.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
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.”
Answer: 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.”
Question: Which of the following statements is CORRECT?
Answer Choices:
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.
Answer: b. A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.