Taxation study guide

Question: High current and quick ratios always indicate that the firm is managing its liquidity position well. a. True b. False

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Answer: B – False

Question: If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline. a. True b. False

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Answer: B – False

Question: If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio would increase. a. True b. False

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Answer: A – True

Question: If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change. a. True b. False

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Answer: False

Question: The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets. a. True b. False

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Answer: True

Question: A decline in a firm’s inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid. a. True b. False

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Answer: False

Question: In general, it’s better to have a low inventory turnover ratio than a high one, as a low ratio indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock. a. True b. False

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Answer: False

Question: The days sales outstanding tells us how long it takes, on average, to collect after a sale is made. The DSO can be compared with the firm’s credit terms to get an idea of whether customers are paying on time. a. True b. False

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Answer: True

Question: If a firm’s fixed assets turnover ratio is significantly higher than its industry average, this could indicate that it uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets. a. True b. False

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Answer: True

Question: Debt management ratios show the extent to which a firm’s managers are attempting to magnify returns on owners’ capital through the use of financial leverage.

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Answer: A – True

Question: The more conservative a firm’s management is, the higher its total debt to total capital ratio (measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)) is likely to be.

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Answer: B – False

Question: Other things held constant, the higher a firm’s total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + common equity)], the higher its TIE ratio will be.

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Answer: B – False

Question: If expectations for long-term inflation rose, but the slope of the SML remained constant, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. Therefore, the percentage point increase in the cost of equity would be greater than the increase in the interest rate on long-term debt. a. True b. False

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Answer: B – False

Question: If investors’ aversion to risk rose, causing the slope of the SML to increase, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. Other things held constant. a. True b. False

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Answer: A – True

Question: A 100% stock dividend and a 2:1 stock split should, at least conceptually, have the same effect on the firm’s stock price. a. True b. False

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Answer: True

Question: A “reverse split” reduces the number of shares outstanding. a. True b. False

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Answer: True

Question: The announcement of an increase in the cash dividend should, according to MM, lead to an increase in the price of the firm’s stock, other things held constant.

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Answer: B – False

Question: The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to an increase in dividend payout ratios.

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Answer: B – False

Question: The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, if the tax rate on dividends is high relative to that on capital gains, then individuals with low taxable incomes should favor stocks with low payouts and high-income individuals should favor high-payout companies.

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Answer: A – True