Deck 7: Accounting for Financial Management

Question 1

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 encourage the use of debt financing by corporations.

Answer 1

True

Question 2

Net operating working capital is equal to the operating current assets minus the operating current liabilities.

Answer 2

True

Question 3

If the tax laws stated that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, it would probably encourage com¬panies to use more debt financing than they presently do, other things held constant.

Answer 3

False

Question 4

Total net operating capital is equal to net fixed assets.

Question 5

On its 2008 balance sheet, Sherman Books showed a balance of retained earnings equal to $510 million. On its 2009 balance sheet, the balance of retained earnings was also equal to $510 million. Which of the following statements is most correct?

A) The company must have had net income equal to zero in 2009.
B) The company did not pay a dividend in 2009.
C) If the company's net income in 2009 was $200 million, dividends paid must have also equaled $200 million.
D) If the company lost money in 2009, they must have paid a dividend.
E) None of the statements above is correct.

Question 6

Last year Aldrin Co. had negative net cash flow, yet its cash on the balance sheet increased. What could explain these events?

A) Aldrin issued long-term debt.
B) Aldrin repurchased some of its common stock.
C) Aldrin sold some of its assets.
D) Statements a and b are correct.
E) Statements a and c are correct.

Question 7

The annual report contains four basic financial statements: the income statement; balance sheet; statement of cash flows; and statement of retained earnings.

Question 8

On the balance sheet, total assets must always equal total liabilities. The amount remaining is what is used to finance the firm and includes equity and long-term debt.

Question 9

Retained earnings is the cash that has been generated by the firm through its operations which has not been paid out to stockholders as dividends. Retained earnings are kept in cash or near cash accounts and thus, these cash accounts, when added together, will always be equal to the total retained earnings of the firm.

Question 10

In order to accurately estimate cash flow from operations, depreciation must be added back to net income. The reason for this is that even though depreciation is deducted from revenue it is really a non-cash charge.

Question 11

Non-cash assets are expected to produce cash over time but the amount of cash they eventually produce could be higher or lower than the values at which the assets are carried on the books.

Question 12

The key importance of annual report information is that it is used by investors when they form their expectations about the firm's future earnings and dividends and the riskiness of those cash flows.

Question 13

Net operating profit after taxes (NOPAT) is the amount of profit a company would have from its operations if it had no interest income or interest expense.

Question 14

The retained earnings account on the balance sheet does not represent cash and in fact, represents a claim against the existing assets of the firm. This implies that retained earnings are in fact the reinvested earnings of stockholders.

Question 15

The time dimension is important in financial statement analysis. While the balance sheet and income statements represent the firm's financial position at a point in time, the statement of cash flows reports changes that were made to the firm's accounts over a period of time.

Question 16

In accounting, emphasis is placed on determining net income. In finance, the primary emphasis is also on net income because that is what investors use to value the firm. However, a secondary consideration is cash flow because that's what is used to run the business.

Question 17

The balance sheet is a financial statement measuring the flow of funds into and out of various accounts over time while the income statement measures the progress of the firm at a point in time.

Question 18

The income statement measures the flow of funds into (i.e., revenue) and out of (i.e., expenses) the firm over a certain time period. It is always based on accounting data.

Question 19

Interest and dividends paid by a corporation are considered to be deductible operating expenses, hence they decrease the firm's tax liability.

Question 20

The fact that a percentage of the interest income received by a corporation is excluded from taxable income has encouraged firms to use more debt financing relative to equity financing.

Question 21

The CFO of Mulroney Brothers has suggested that the company should issue $300 million worth of common stock and use the proceeds to reduce some of the company's outstanding debt. Assume that the company adopts this policy, and that total assets and operating income (EBIT) remain the same. The company's tax rate will also remain the same. Which of the following will occur:

A) The company's net income will increase.
B) The company's taxable income will fall.
C) The company will pay less in taxes.
D) All of the answers above are correct.
E) Answers b and c are correct.

Question 22

A loss incurred by a corporation

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.

Question 23

Holmes Aircraft recently announced an increase in its net income, yet its net cash flow declined relative to last year. Which of the following could explain this performance?

A) The company's interest expense increased.
B) The company's depreciation expense declined.
C) The company's operating income declined.
D) All of the statements above are correct.
E) None of the statements above is correct.

Question 24

Which of the following statements is most correct?

A) Indexing tax brackets reduces the extent of "bracket creep."
B) Bonds issued by a municipality such as the city of Miami would carry a lower interest rate than bonds with the same risk and maturity issued by a private corporation such as Florida Power & Light.
C) Our federal tax laws tend to encourage corporations to finance with debt rather than with equity securities.
D) Our federal tax laws encourage the managers of corporations with surplus cash to invest it in stocks rather than in bonds. However, other factors may offset tax considerations.
E) All of the statements above are true.

Question 25

Which of the following best describes free cash flow?

A) Free cash flow is the amount of cash flow available for distribution to all investors after all necessary investments in operating capital have been made.
B) Free cash flow is the amount of cash flow available for distribution to shareholders after all necessary investments in operating capital have been made.
C) Free cash flow is the net change in the cash account on the balance sheet.
D) Free cash flow is equal to net income plus depreciation.
E) Free cash flow is equal to the cash flow from non-taxable transactions.

Question 26

Which of the following statements is most correct?

A) Retained earnings, as reported on the balance sheet, represents the amount of cash a company has available to pay out as dividends to shareholders.
B) 70 percent of the interest received by corporations is excluded from taxable income.
C) 70 percent of the dividends received by corporations is excluded from taxable income.
D) None of the answers above is correct.
E) Answers a and c are correct.

Question 27

Assume that a company currently depreciates its fixed assets over 7 years. Which of the following would occur if a tax law change forced the company to depreciate its fixed assets over 10 years instead?

A) The company's tax payment would increase.
B) The company's cash position would increase.
C) The company's net income would increase.
D) Answers a and c are correct.
E) Answers b and c are correct.

Question 28

Which of the following statements is most correct?

A) Corporations are allowed to exclude 70 percent of their interest income from corporate taxes.
B) Corporations are allowed to exclude 70 percent of their dividend income from corporate taxes.
C) Individuals pay taxes on only 30 percent of the income realized from municipal bonds.
D) Answers a and b are correct.
E) None of the answers above is correct.

Question 29

Which of the following are likely to occur if Congress passes legislation which forces Carter Manufacturing to depreciate their equipment over a longer time period:

A) The company's physical stock of assets would increase.
B) The company's reported net income would decline.
C) The company's cash position would decline.
D) All of the answers above are correct.
E) Answers b and c are correct.

Question 30

Allen Corporation can (1) build a new plant which should generate a before-tax return of 11 percent, or (2) invest the same funds in the preferred stock of Florida Power & Light (FPL), which should provide Allen with a before-tax return of 9 percent, all in the form of dividends. Assume that Allen's marginal tax rate is 25 percent, and that 70 percent of dividends received are excluded from taxable income. If the plant project is divisible into small increments, and if the two investments are equally risky, what combination of these two possibilities will maximize Allen's effective return on the money invested?

A) All in the plant project.
B) All in FPL preferred stock.
C) 60% in the project; 40% in FPL.
D) 60% in FPL; 40% in the project.
E) 50% in each.

Question 31

Which of the following statements is most correct?

A) 70 percent of a corporation's interest income is excluded from corporate income taxes.
B) 70 percent of a corporation's dividend income is excluded from corporate income taxes.
C) A municipal bond will generally trade at a higher yield than a corporate bond of equal risk.
D) All of the answers above are correct.
E) Answers b and c are correct.

Question 32

Which of the following statements is most correct?

A) Actions which increase net income will always increase net cash flow.
B) One way to increase EVA is to maintain the same operating income with less capital.
C) One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free.
D) Answers a and b are correct.
E) Answers a and c are correct.

Question 33

Harmeling Enterprises experienced a decline in net operating profit after taxes (NOPAT). Which of the following definitely cannot help explain this decline?

A) Sales revenues decreased.
B) Costs of goods sold increased.
C) Depreciation increased.
D) Interest expense increased.
E) Taxes increased.

Question 34

Solo Company has been depreciating its fixed assets over 15 years. It is now clear that these assets will only last a total of 10 years. Solo's accountants have encouraged the firm to revise its annual depreciation to reflect this new information. Which of the following would occur as a result of this change?

A) The company's earnings per share would decrease.
B) The company's cash position would increase.
C) The company's EBIT would increase.
D) Both a and b are correct.
E) All of the answers above are correct.

Question 35

Which of the following would not cause an increase in net operating working capital?

A) Inventory increases.
B) Accounts receivable increases.
C) Short-term investments increase.
D) Accounts payables decrease.
E) Accruals decrease.

Question 36

Which of the following statements is most correct?

A) Cash flows and accounting profit are not at all related since no common elements are used in the calculation of either individual measure.
B) Accounting profits are more important than free cash flow.
C) High inflation can seriously distort firms' balance sheets, and since inflation also affects depreciation and inventory costs, profits can also be affected.
D) When an action is taken at one point in time, but its full effects cannot be accurately measured until later, this has the potential to affect the firm's financial statements. However, as long as the firm keeps the same standard accounting period this timing problem can be avoided.
E) None of the statements above is correct.

Question 37

A firm has notes payable of $1,546,000, long-term debt of $13,000,000, and total interest expense of $1,300,000. If the firm pays 8 percent interest on its long-term debt, what rate of interest does it pay on its notes payable?

A) 8.2%
B) 13.1%
C) 16.8%
D) 18.0%
E) 15.3%

Question 38

A start-up firm is making an initial investment in new plant and equipment. Currently equipment is depreciated on a straight line basis over 10 years. Assume that Congress is considering legislation which will allow the corporation to depreciate the equipment over 7 years. If the legislation becomes law, and the firm implements the 7-year depreciation basis, which of the following will occur?

A) The firm's tax payments will increase.
B) The firm's net income will increase.
C) The firm's taxable income will increase.
D) The firm's net cash flow will increase.
E) The firm's operating income (EBIT) will increase.

Question 39

Kramer Corporation recently announced that its net income was lower than last year. However, analysts estimate that the company's net cash flow increased. What factors could explain this discrepancy?

A) The company's depreciation expense increased.
B) The company's interest expense declined.
C) The company had an increase in its noncash revenues.
D) Answers a and b are correct.
E) Answers b and c are correct.

Question 40

Last year, Blanda Brothers had positive net cash flow, yet cash on the balance sheet decreased. Which of the following could explain the company's financial performance?

A) The company issued new common stock.
B) The company issued new long-term debt.
C) The company sold off some of its assets.
D) The company purchased a lot of new fixed assets.
E) The company eliminated its dividend.

Question 41

A corporation recently purchased some preferred stock that has a before-tax yield of 7 percent. The company has a tax rate of 40 percent. What is the after-tax yield on the preferred stock?

A) 4.20%
B) 5.04%
C) 5.65%
D) 6.16%
E) 7.00%

Question 42

Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds and U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. If Treasury bonds yield 6 percent, and Carter's marginal income tax rate is 40 percent, what yield on the Chicago municipal bonds would make Carter's treasurer indifferent between the two?

A) 2.40%
B) 3.60%
C) 4.50%
D) 5.25%
E) 6.00%

Question 43

Byrd Lumber has 2 million shares of stock outstanding. On the balance sheet the company has $40 million worth of common equity. The company's stock price is $15 a share. What is the company's Market Value Added (MVA)?

A) ($80 million)
B) ($20 million)
C) ($10 million)
D) $20 million
E) $80 million

Question 44

Garfield Industries is expanding its operations throughout the Southeast United States. Garfield anticipates that the expansion will increase sales by $1,000,000, and increase the costs of goods sold by $700,000. Depreciation expenses will rise by $50,000 and interest expense will increase by $150,000. The company's tax rate will remain at 40 percent. If the company's forecast is correct, how much will net income increase or decrease, as a result of the expansion?

A) No change.
B) $40,000 increase.
C) $60,000 increase.
D) $100,000 increase.
E) $180,000 increase.

Question 45

A 5-year corporate bond yields 9 percent. A 5-year municipal bond of equal risk yields 6.5 percent. Assume that the state tax rate is zero. At what federal tax rate are you indifferent between the two bonds?

A) 27.78%
B) 38.46%
C) 41.22%
D) 54.33%
E) 72.22%

Question 46

Bates Motors has the following information for the previous year: Net income = $200; Net operating profit after taxes (NOPAT) = $300; Total assets = $1,000; and Total net operating capital = $800. The information for the current year is: Net income = $500; Net operating profit after taxes (NOPAT) = $400; Total assets = $1,300; and Total net operating capital = $900. What is the free cash flow for the current year?

A) $100
B) $200
C) $300
D) $400
E) $500

Question 47

Strother Inc. has the following information for the previous year: Net income = $400; Net operating profit after taxes (NOPAT) = $600; Total assets = $2,000; and Total net operating capital = $1800. The information for the current year is: Net income = $900; Net operating profit after taxes (NOPAT) = $800; Total assets = $2,300; and Total net operating capital = $2200. What is the free cash flow for the current year?

A) $300
B) $400
C) $500
D) $600
E) $700

Question 48

Spencer Inc. has the following information for the current year: Net income = $600; Net operating profit after taxes (NOPAT) = $500; Total assets = $4,000; Short-term investments = $500; Stockholders equity = $2,000; Debt = $1,000; and Total net operating capital = $2500. If Spencer's cost of capital is 10%, what is its Economic value added (EVA)?

A) $250
B) $300
C) $350
D) $375
E) $400

Question 49

A seven-year municipal bond yields 4.8 percent. Your marginal tax rate (including state and federal taxes) is 28 percent. What interest rate on a seven-year corporate bond of equal risk would provide you with the same after-tax return?

A) 3.46%
B) 4.80%
C) 6.14%
D) 6.67%
E) 17.14%

Question 50

Giglio Inc. has the following information for the previous year: Net income = $400; Net operating profit after taxes (NOPAT) = $500; Total assets = $2,000; and Total operating capital = $1700. The information for the current year is: Net income = $800; Net operating profit after taxes (NOPAT) = $700; Total assets = $2,300; and Total operating capital = $2100. What is the free cash flow for the current year?

A) $300
B) $400
C) $500
D) $600
E) $700

Question 51

A corporate bond currently yields 8.5 percent. Municipal bonds with the same risk, maturity, and liquidity currently yield 5.5 percent. At what tax rate would investors be indifferent between the two bonds?

A) 35.29%
B) 40.00%
C) 24.67%
D) 64.71%
E) 30.04%

Question 52

Tibbs Inc. has the following information for the current year: Net income = $300; Net operating profit after taxes (NOPAT) = $400; Total assets = $2,900; Short-term investments = $200; Stockholders equity = $1,800; Debt = $700; and Total net operating capital = $2300. What is the Return on invested capital (ROIC) for the current year?

A) 13.0%
B) 13.8%
C) 16.0%
D) 17.4%
E) 22.2%

Question 53

A corporation with a marginal tax rate of 35 percent would receive what after-tax dividend yield on a 12 percent coupon rate preferred stock bought at par, assuming a 70 percent dividend exclusion?

A) 11.03%
B) 10.74%
C) 6.48%
D) 7.31%
E) 5.52%

Question 54

Spencer Inc. has the following information for the current year: Net income = $600; Net operating profit after taxes (NOPAT) = $500; Total assets = $4,000; Short-term investments = $500; Stockholders equity = $2,000; Debt = $1,000; and Total net operating capital = $2500. What is the Return on invested capital (ROIC) for the current year?

A) 15.0%
B) 20.0%
C) 24.0%
D) 25.0%
E) 30.0%

Question 55

Sanguillen Corp. showed retained earnings of $400,000 on its balance sheet last year. This year, the company's earnings per share (EPS) were $3.00 and its dividends paid per share (DPS) were $1.00. The company has 200,000 shares of stock outstanding. What is the level of retained earnings on the company's balance sheet this year?

A) $400,000
B) $500,000
C) $600,000
D) $700,000
E) $800,000

Question 56

A corporation can earn 7.5 percent if it invests in municipal bonds. The corporation can also earn 8.5 percent (before-tax) by investing in preferred stock. Assume that the two investments have equal risk. What is the break-even corporate tax rate which makes the corporation indifferent between the two investments?

A) 17.65%
B) 24.88%
C) 39.22%
D) 44.15%
E) 49.33%

Question 57

Hayes Corporation has $300 million worth of common equity on its balance sheet, and 6 million shares of stock outstanding. The company's Market Value Added (MVA) is $162 million. What is the company's stock price?

A) $ 23
B) $ 32
C) $ 50
D) $ 77
E) $138

Question 58

New Mexico Lumber recently reported that its earnings per share were $3.00. The company has 400,000 shares of stock outstanding. The company's interest expense was $500,000. The corporate tax rate is 40 percent. What was the company's operating income (EBIT)?

A) $ 980,000
B) $1,220,000
C) $2,000,000
D) $2,500,000
E) $3,500,000

Question 59

Edge Brothers recently reported net income of $385,000. The tax rate is 40 percent. The company's interest expense was $200,000. What would have been the company's net income if they would have been able to double their operating income (EBIT), assuming that the company's tax rate and interest expense remain unchanged?

A) $ 770,000
B) $ 890,000
C) $ 920,000
D) $1,100,000
E) $1,275,000

Question 60

New Hampshire Services reported $2.3 million of retained earnings on its balance sheet last year. This year, the company lost money--its net income was -$500,000 (negative $500,000). Despite the loss, the company still paid a $1.00 per share dividend this year. The company's earnings per share for this year were -$2.50 (negative $2.50). What was the level of retained earnings on the company's balance sheet this year?

A) $1.2 million
B) $1.6 million
C) $1.8 million
D) $2.6 million
E) $2.8 million

Question 61

A bond issued by the State of Pennsylvania provides a 9 percent yield. What yield on a Synthetic Chemical Company bond would cause the two bonds to provide the same after-tax rate of return to an investor in the 36 percent tax bracket?

A) 14.06%
B) 17.50%
C) 7.00%
D) 12.50%
E) 9.00%

Question 62

Mantle Corporation is considering two equally risky investments: (1)(2)What is the break-even corporate tax rate which makes the company indifferent between the two investments?

A) 33.17%
B) 34.00%
C) 37.97%
D) 42.15%
E) 42.86%

Question 63

Solarcell Corporation has $20,000 which it plans to invest in marketable securities. It is choosing between AT&T bonds which yield 11 percent, State of Florida muni bonds which yield 8 percent, and AT&T preferred stock with a dividend yield of 9 percent. Solarcell's corporate tax rate is 40 percent, and 70 percent of the preferred stock dividends it receives are tax exempt. Assuming that the investments are equally risky and that Solarcell chooses strictly on the basis of after-tax returns, which security should be selected? Answer by giving the after-tax rate of return on the highest yielding security.

A) 8.46%
B) 8.00%
C) 7.92%
D) 9.00%
E) 9.16%

Question 64

West Corporation has $50,000 which it plans to invest in marketable securities. The corporation is choosing between the following three equally risky securities: Alachua County tax-free municipal bonds yielding 6 percent; Exxon bonds yielding 9.5 percent; GM preferred stock with a dividend yield of 9 percent. West's corporate tax rate is 35 percent. What is the after-tax return on the best investment alternative? (Assume the company chooses on the basis of after-tax returns.)

A) 8.06%
B) 7.13%
C) 6.18%
D) 6.55%
E) 6.00%

Question 65

Arvo Corporation is trying to choose between three alternative investments. The three securities that the company is considering are as follows: (1)(2)(3)The company's tax rate is 28 percent. What is the after-tax return on the best investment alternative?

A) 7.00%
B) 7.20%
C) 6.48%
D) 9.00%
E) 8.24%

Question 66

A municipal bond issued by the City of Gainesville provides a 7.6 percent after-tax return. For an individual investor in the 31 percent tax bracket, (1) what return on a corporate bond and (2) what return on a preferred stock would produce the same after-tax return to the investor as the municipal bond?

A) 8.28% and 10.25%, respectively.
B) 11.01% and 11.01%, respectively.
C) 11.01% and 8.38%, respectively.
D) 24.52% and 11.01%, respectively.
E) 24.52% and 9.58%, respectively.

Question 67

Casey Motors recently reported the following information: • Net income = $600,000.
• Tax rate = 40%.
• Interest expense = $200,000.
• Operating capital = $9 million.
• After-tax cost of capital = 10%.
What is the company's EVA?

A) ($300,000)
B) ($180,000)
C) $ 0
D) $200,000
E) $400,000