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Question(s) / Instruction(s):

1.             Below are the 2007 and 2008 year-end balance sheets for Tran Enterprises:

 

Assets:                                                                                                2008                                                      2007        

Cash                                                                                                   $  200,000                                             $  170,000

Accounts receivable                                                                             864,000                                                 700,000

Inventories                                                                                        2,000,000                                             1,400,000

  Total current assets                                                                      $3,064,000                                           $2,270,000

Net fixed assets                                                                                6,000,000                                             5,600,000

Total assets                                                                                      $9,064,000                                           $7,870,000

 

Liabilities and equity:

Accounts payable                                                                           $1,400,000                                           $1,090,000

Notes payable                                                                                   1,600,000                                             1,800,000

  Total current liabilities                                                                 $3,000,000                                           $2,890,000

Long-term debt                                                                                 2,400,000                                             2,400,000

Common stock                                                                                 3,000,000                                             2,000,000

Retained earnings                                                                                 664,000                                                 580,000

  Total common equity                                                                  $3,664,000                                           $2,580,000

Total liabilities and equity                                                             $9,064,000                                           $7,870,000

 

The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt in 2007.  As of the end of 2008, none of the principal on this debt had been repaid.  Assume that the company’s sales in 2007 and 2008 were the same.  Which of the following statements must be CORRECT?

 

a.     The firm increased its short-term bank debt in 2008.

b.     The firm issued long-term debt in 2008.

c.     The firm issued new common stock in 2008.

d.     The firm repurchased some common stock in 2008.

e.     The firm had negative net income in 2008.

 

2.             On its 12/31/08 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year.  Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

 

a.     If the company lost money in 2008, it must have paid dividends.

b.     The company must have had zero net income in 2008.

c.     The company must have paid out half of its 2008 earnings as dividends.

d.     The company must have paid no dividends in 2008.

e.     Dividends could have been paid in 2008, but they would have had to equal the earnings for the year.

 

3.             Below is the common equity section (in millions) of Timeless Technology’s last two year-end balance sheets:

 

                                                                                                   2008                                      2007  

Common stock                                                                       $2,000                                   $1,000

Retained earnings                                                                    2,000                                      2,340

Total common equity                                                            $4,000                                   $3,340

 

The firm has never paid a dividend to its common stockholders.  Which of the following statements is CORRECT?

 

a.     The company’s net income in 2008 was higher than in 2007.

b.     The firm issued common stock in 2008. 

c.     The market price of the firm's stock doubled in 2008.

d.     The firm had positive net income in both 2007 and 2008, but its net income in 2008 was lower than it was in 2007.

e.     The company has more equity than debt on its balance sheet.

 

4.             Which of the following statements is CORRECT?

 

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 (e.g., Google), 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.

 

5.             Which of the following statements is CORRECT?

 

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.”

c.     Depreciation reduces a firm’s cash balance, so an increase in depreciation would normally lead to a reduction in the firm’s cash flow.

d.     Operating income is derived from the firm's regular core business.  Operating income is calculated as Revenues less Operating costs.  Operating costs do not include interest or taxes.

e.     Depreciation is not a cash charge, so it does not have an effect on a firm’s reported profits.

 

6.             Which of the following factors could explain why Michigan Energy's cash balance increased even though it had a negative cash flow last year?

 

a.     The company sold a new issue of bonds.

b.     The company made a large investment in new plant and equipment.

c.     The company paid a large dividend.

d.     The company had high depreciation expenses.

e.     The company repurchased 20% of its common stock.

 

7.             Analysts who follow Howe Industries recently noted that, relative to the previous year, the company’s net cash provided from operations increased, yet cash as reported on the balance sheet decreased.  Which of the following factors could explain this situation?

 

a.     The company cut its dividend.

b.     The company made large investments in fixed assets.

c.     The company sold a division and received cash in return.

d.     The company issued new common stock.

e.     The company issued new long-term debt.

 

8.             Austin Financial recently announced that its net income increased sharply from the previous year, yet its net cash provided from operations declined.  Which of the following could explain this performance?

 

a.     The company’s dividend payment to common stockholders declined.

b.     The company’s expenditures on fixed assets declined.

c.     The company’s cost of goods sold increased.

d.     The company’s depreciation expense declined.

e.     The company’s interest expense increased.

  

9.             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.

  

10.          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.

 

11.          Which of the following statements is CORRECT?

 

a.     Most rapidly growing companies have positive free cash flows because cash flows from existing operations generally exceed fixed asset purchases and changes to net working capital.

b.     Changes in working capital have no effect on free cash flow.

c.     Free cash flow (FCF) is defined as follows:

              FCF =    EBIT(1 - T)

                             

d.     Free cash flow (FCF) is defined as follows:

 FCF = EBIT(1 - T) + Capital expenditures.

 e.     Managers should be less concerned with free cash flow than with accounting net income.  Accounting net income is the "bottom line" and represents how much the firm can distribute to all its investors‑‑both creditors and stockholders.

 

12.          Which of the following statements is CORRECT?

 

a.     The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes.  Thus, the federal government receives no tax revenue from these businesses, even though they report high accounting profits.

b.     All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code.

c.     Small corporations that qualify under the Tax Code can elect not to pay corporate taxes, but then each stockholder must report his or her pro rata shares of the firm’s income as personal income and pay taxes on that income.

d.     Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes.  Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the corporation's income and stockholders were taxed again on this income when it was paid to them as dividends.

e.     All corporations other than non-profits are subject to corporate income taxes, which are 15% for the lowest amounts of income and 38% for the highest amounts.

 

13.          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?

 

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.

 

14.          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.

 

15.          Assume that Congress recently passed a provision that will enable Bev'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.

 

16.          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.

 

 

17.          Which of the following statements is CORRECT?

 

a.     Dividends paid reduce the net income that is reported on a company’s income statement.

b.     If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.

c.     If a company issues new long-term bonds to purchase fixed assets during the current year, this will increase both its reported current assets and current liabilities at the end of the year.

d.     Accounts receivable are reported as a current liability on the balance sheet.

e.     If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance.

 

18.          Which of the following statements is CORRECT?

 

a.     Since depreciation increases the firm's net cash provided by operating activities, the more depreciation a company has, the larger it

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