Question 1
Which of the following items is NOT included in current assets?
Answer
Accounts receivable.
Inventory.
Bonds.
Cash.
Short-term, highly liquid, marketable securities.
2 points
Question 2
Which of the following factors could explain why Dellva Energy had a negative net cash flow
last year, even though the cash on its balance sheet increased?
Answer
The company sold a new issue of bonds.
The company made a large investment in new plant and equipment.
The company paid a large dividend.
The company had high amortization expenses.
The company repurchased 20% of its common stock.
2 points
Question 3
Aubey Aircraft recently announced that its net income increased sharply from the previous year,
yet its net cash flow from operations declined. Which of the following could explain this
performance?
Answer
The company’s operating income declined.
The company’s expenditures on fixed assets declined.
The company’s cost of goods sold increased.
The company’s depreciation and amortization expenses declined.
The company’s interest expense increased.
2 points
Question 4
Which of the following statements is CORRECT?
Answer
Since depreciation is a source of funds, the more depreciation a company has, the larger its
retained earnings will be, other things held constant.
A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash
to make required payments.
Common equity includes common stock and retained earnings, less accumulated depreciation.
The retained earnings account as shown on the balance sheet shows the amount of cash that is
available for paying dividends.
If a firm reports a loss on its income statement, then the retained earnings account as shown on
the balance sheet will be negative.
2 points
Question 5
Analysts who follow Howe Industries recently noted that, relative to the previous year, the
company’s operating net cash flow increased, yet cash as reported on the balance sheet
decreased. Which of the following factors could explain this situation?
Answer
The company cut its dividend.
The company made a large investment in a profitable new plant.
The company sold a division and received cash in return.
The company issued new common stock.
The company issued new long-term debt.
2 points
Question 6
Which of the following statements is CORRECT?
Answer
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.
Interest paid to an individual is counted as income for tax purposes and taxed at the individual’s
regular tax rate, which in 2008 could go up to 35%, but dividends received were taxed at a
maximum rate of 15%.
The maximum federal tax rate on corporate income in 2008 was 50%.
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.
The maximum federal tax rate on personal income in 2008 was 50%.
2 points
Question 7
Below are the 2008 and 2009 year-end balance sheets for Wolken Enterprises:
Assets: 2009 2008
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
Wolken has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year noncallable, long-term debt in 2008. As of the end of 2009, none of the principal on this debt had
been repaid. Assume that the company’s sales in 2008 and 2009 were the same. Which of the
following statements must be CORRECT?
Answer
Wolken increased its short-term bank debt in 2009.
Wolken issued long-term debt in 2009.
Wolken issued new common stock in 2009.
Wolken repurchased some common stock in 2009.
Wolken had negative net income in 2009.
2 points
Question 8
Which of the following statements is CORRECT?
Answer
One way to increase EVA is to achieve the same level of operating income but with more
investor-supplied capital.
If a firm reports positive net income, its EVA must also be positive.
One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital
is free.
One way to increase EVA is to generate the same level of operating income but with less
investor-supplied capital.
Actions that increase reported net income will always increase net cash flow.
2 points
Question 9
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.
Answer
Companies’ net operating profits after taxes (NOPAT) would decline.
Companies’ physical stocks of fixed assets would increase.
Companies’ net cash flows would increase.
Companies’ cash positions would decline.
Companies’ reported net incomes would decline.
2 points
Question 10
Which of the following statements is CORRECT?
Answer
In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.
Dividends do not show up in the statement of cash flows because dividends are considered to be
a financing activity, not an operating activity.
In the statement of cash flows, a decrease in accounts payable is reported as a use of cash.
In the statement of cash flows, depreciation charges are reported as a use of cash.
In the statement of cash flows, a decrease in inventories is reported as a use
of cash.
2 points
Question 11
Which of the following statements is CORRECT?
Answer
Operating cash flow (OCF) is defined as follows:
(1-T) - Depreciation and Amortization.
Changes in working capital have no effect on free cash flow.
Free cash flow (FCF) is defined as follows:
(1 - T)
+ Depreciation and Amortization
- Capital expenditures required to sustain operations
- Required changes in net operating working capital.
Free cash flow (FCF) is defined as follows:
(1-T)+ Depreciation and Amortization + Capital expenditures.
Operating cash flow is the same as free cash flow (FCF).
2 points
Question 12
For managerial purposes, i.e., making decisions regarding the firm's operations, the standard
financial statements as prepared by accountants under Generally Accepted Accounting Principles
(GAAP) are often modified and used to create alternative data and metrics that provide a
somewhat different picture of a firm's operations. Related to these modifications, which of the
following statements is CORRECT?
Answer
The standard statements make adjustments to reflect the effects of inflation on asset values, and
these adjustments are normally carried into any adjustment that managers make to the standard
statements.
The standard statements focus on accounting income for the entire corporation, not cash flows,
and the two can be quite different during any given accounting period. However, for valuation
purposes we need to discount cash flows, not accounting income. Moreover, since many firms
have a number of separate divisions, and since division managers should be compensated on
their divisions’ performance, not that of the entire firm, information that focuses on the divisions
is needed. These factors have led to the development of information that is focused on cash flows
and the operations of individual units.
The standard statements provide useful information on the firm’s individual operating units, but
management needs more information on the firm’s overall operations than the standard
statements provide.
The standard statements focus on cash flows, but managers are less concerned with cash flows
than with accounting income as defined by GAAP.
The best feature of standard statements is that, if they are prepared under GAAP, the data are
always consistent from firm to firm. Thus, under GAAP, there is no room for accountants to
“adjust” the results to make earnings look better.
2 points
Question 13
Other things held constant, which of the following actions would increase the amount of cash on
a company’s balance sheet?
Answer
The company repurchases common stock.
The company pays a dividend.
The company issues new common stock.
The company gives customers more time to pay their bills.
The company purchases a new piece of equipment.
2 points
Question 14
A security analyst obtained the following information from Prestopino Products’ financial
statements:
− Retained earnings at the end of 2009 were $700,000, but retained earnings at the end of 2010
had declined to $320,000.
− The company does not pay dividends.
– The company’s depreciation expense is its only non-cash expense; it has no amortization
charges.
– The company has no non-cash revenues.
–The company’s net cash flow (NCF) for 2010 was $150,000.
On the basis of this information, which of the following statements is CORRECT?
Answer
Prestopino had negative net income in 2010.
Prestopino’s depreciation expense in 2010 was less than $150,000.
Prestopino had positive net income in 2010, but its income was less than its 2009 income.
Prestopino's NCF in 2010 must be higher than its NCF in 2009.
Prestopino’s cash on the balance sheet at the end of 2010 must be lower than the cash it had on
the balance sheet at the end of 2009.
2 points
Question 15
Which of the following statements is CORRECT?
Answer
The balance sheet for a given year, say 2008, is designed to give us an idea of what happened to
the firm during that year.
The balance sheet for a given year, say 2008, tells us how much money the company earned
during that year.
The difference between the total assets reported on the balance sheet and the debts reported on
this statement tells us the current market value of the stockholders' equity, assuming the
statements are prepared in accordance with generally accepted accounting principles (GAAP).
For most companies, the market value of the stock equals the book value of the stock as reported
on the balance sheet.
A typical industrial company’s balance sheet lists the firm's assets that will be converted to cash
first, and then goes on down to list the firm's longest lived assets last.
2 points
Question 16
Which of the following statements is CORRECT?
Answer
A reduction in inventories held would have no effect on the current ratio.
An increase in inventories would have no effect on the current ratio.
If a firm increases its sales while holding its inventories constant, then, other things held
constant, its inventory turnover ratio will increase.
A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
If a firm increases its sales while holding its inventories constant, then, other things held
constant, its inventory turnover ratio will decrease.
2 points
Question 17
A firm wants to strengthen its financial position. Which of the following actions would increase
its quick ratio?
Answer
Offer price reductions along with generous credit terms that would (1) enable the firm to sell
some of its excess inventory and (2)lead to an increase in accounts receivable.
Issue new common stock and use the proceeds to increase inventories.
Speed up the collection of receivables and use the cash generated to increase inventories.
Use some of its cash to purchase additional inventories.
Issue new common stock and use the proceeds to acquire additional fixed assets.
2 points
Question 18
HD Corp. and LD Corp. have identical assets, sales, interest rates paid on their debt, tax rates,
and EBIT. However, HD uses more debt than LD. Which of the following statements is
CORRECT?
Answer
Without more information, we cannot tell if HD or LD would have a higher or lower net income.
HD would have the lower equity multiplier for use in the Du Pont equation.
HD would have to pay more in income taxes.
HD would have the lower net income as shown on the income statement.
HD would have the higher net income as shown on the income statement.
2 points
Question 19
Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and
basic earning power. Both companies have positive net incomes. Company HD has a higher debt
ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?
Answer
Company HD pays less in taxes.
Company HD has a lower equity multiplier.
Company HD has a higher ROA.
Company HD has a higher times interest earned (TIE) ratio.
Company HD has more net income.
2 points
Question 20
Considered alone, which of the following would increase a company’s current ratio?
Answer
An increase in net fixed assets.
An increase in accrued liabilities.
An increase in notes payable.
An increase in accounts receivable.
An increase in accounts payable.
2 points
Question 21
Companies E and P each reported the same earnings per share (EPS), but Company E’s stock
trades at a higher price. Which of the following statements is CORRECT?
Answer
Company E probably has fewer growth opportunities.
Company E is probably judged by investors to be riskier.
Company E must have a higher market-to-book ratio.
Company E must pay a lower dividend.
Company E trades at a higher P/E ratio.
2 points
Question 22
Which of the following statements is CORRECT?
Answer
Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit
margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Under these
conditions, the ROE will increase.
Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit
margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Without
additional information, we cannot tell what will happen to the ROE.
The modified Du Pont equation provides information about how operations affect the ROE, but
the equation does not include the effects of debt on the ROE.
Other things held constant, an increase in the debt ratio will result in an increase in the profit
margin on sales.
Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit
margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. Under
these conditions, the ROE will decrease.
2 points
Question 23
Amram Company’s current ratio is 1.9. Considered alone, which of the following actions would
reduce the company’s current ratio?
Answer
Borrow using short-term notes payable and use the proceeds to reduce accruals.
Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
Use cash to reduce accruals.
Use cash to reduce short-term notes payable.
Use cash to reduce accounts payable.
2 points
Question 24
If a bank loan officer were considering a company’s request for a loan, which of the following
statements would you consider to be CORRECT?
Answer
The lower the company’s EBITDA coverage ratio, other things held constant, the lower the
interest rate the bank would charge the firm.
Other things held constant, the higher the debt ratio, the lower the interest rate the bank would
charge the firm.
Other things held constant, the lower the debt ratio, the lower the interest rate the bank would
charge the firm.
The lower the company’s TIE ratio, other things held constant, the lower the interest rate the
bank would charge the firm.
Other things held constant, the lower the current ratio, the lower the interest rate the bank would
charge the firm.
2 points
Question 25
Which of the following statements is CORRECT?
Answer
The use of debt financing will tend to lower the basic earning power ratio, other things held
constant.
A firm that employs financial leverage will have a higher equity multiplier than an otherwise
identical firm that has no debt in its capital structure.
If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the
way they are financed, the firm with less debt will generally have the higher expected ROE.
Holding bonds is better than holding stock for investors because income from bonds is taxed on a
more favorable basis than income from stock.
All else equal, increasing the debt ratio will increase the ROA.
2 points
Question 26
Which of the following statements is CORRECT?
Answer
If a security analyst saw that a firm’s days’ sales outstanding (DSO) was higher than the industry
average and was also increasing and trending still higher, this would be interpreted as a sign of
strength.
If a firm increases its sales while holding its accounts receivable constant, then, other things held
constant, its days’ sales outstanding (DSO) will increase.
There is no relationship between the days’ sales outstanding (DSO) and the average collection
period (ACP). These ratios measure entirely different things.
A reduction in accounts receivable would have no effect on the current ratio, but it would lead to
an increase in the quick ratio.
If a firm increases its sales while holding its accounts receivable constant, then, other things held
constant, its days’ sales outstanding will decline.
2 points
Question 27
Which of the following statements is CORRECT?
Answer
If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held
constant, this suggests that the board of directors should fire the president.
If a firm has the highest market/book ratio of any firm in its industry, then, other things held
constant, this suggests that the board of directors should fire the president.
Other things held constant, the higher a firm’s expected future growth rate, the lower its P/E ratio
is likely to be.
The higher the market/book ratio, then, other things held constant, the higher one would expect
to find the Market Value Added (MVA).
If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors
expect this situation to continue, then its market/book ratio and MVA are both likely to be below
average.
2 points
Question 28
If the CEO of a large, diversified, firm were filling out a fitness report on a division manager
(i.e., “grading” the manager), which of the following situations would be likely to cause the
manager to receive a better grade? In all cases, assume that other things are held constant.
Answer
The division’s basic earning power ratio is above the average of other firms in its industry.
The division’s total assets turnover ratio is below the average for other firms in its industry.
The division’s debt ratio is above the average for other firms in the industry.
The division’s inventory turnover is 6, whereas the average for its competitors is 8.
The division’s DSO (days’ sales outstanding) is 40, whereas the average for its competitors is 30.
2 points
Question 29
Which of the following statements is CORRECT?
Answer
If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be the
same.
If Firms X and Y have the same net income, number of shares outstanding, and price per share,
then their P/E ratios must also be the same.
If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the
same price earnings ratio.
If Firm X’s P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and also to be
expected to grow at a faster rate.
If Firms X and Y have the same net income, number of shares outstanding, and price per share,
then their market-to-book ratios must also be the same.
2 points
Question 30
Other things held constant, which of the following alternatives would increase
a company’s cash flow for the current year?
Answer
Increase the number of years over which fixed assets are depreciated for tax purposes.
Pay down the accounts payables.
Reduce the days’ sales outstanding (DSO) without affecting sales or operating costs.
Pay workers more frequently to decrease the accrued wages balance.
Reduce the inventory turnover ratio without affecting sales or operating costs.
2 points