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Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 2 Introduction to Financial Statement Analysis
2.1 Firms' Disclosure of Financial Information
1) In the United States, publicly traded companies can choose whether or not they wish to
release periodic inancial statements.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Financial statements are optional accounting reports issued periodically by a irm which
present information on the past performance of the irm, a summary of the irm's assets
and the inancing of those assets, and a prediction of the irm's future performance.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3) International Financial Reporting Standards are taking root throughout the world.
However, it is unlikely that the U.S. will report according to IFRS before the second half of
the twenty-irst century.
AACSB Objective: Analytic Skills
Author: JP
Question Status: New
4) What is the main reason that it is necessary for public companies to follow the rules and
format set out in the Generally Accepted Accounting Principles (GAAP) when creating
inancial statements?
A) It ensures that the market value of assets and debt are reported accurately.
B) It ensures that information on the performance of public companies is reported on cash-
basis accounting.
C) It ensures that important budgetary information is not omitted.
D) It makes it easier to compare the inancial results of diferent irms.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
5) Which of the following best describes why a irm produces inancial statements?
A) to use as a tool when planning future investments within a irm
B) to increase the intrinsic value of a irm
C) to provide a means for interested outside parties such as creditors to obtain information
about a irm, with an overview of the short- and long-term inancial condition of a business
D) to show the daily activities a irm has undertaken in the previous inancial year, and
1
what activities are planned for the near future
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
6) The exchanges in which of the following countries or regions do NOT accept the
International Financial Reporting Standards set out by the International Accounting
Standards Board?
A) Germany
B) France
C) United States
D) United Kingdom
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
7) Which of the following is NOT one of the inancial statements that must be produced by
a public company?
A) the balance sheet
B) the income statement
C) the statement of cash lows
D) the statement of activities
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2
8) U.S. public companies are required to ile their annual inancial statements with the U.S.
Securities and Exchange Commission on which form?
A) 10-A
B) 10-K
C) 10-Q
D) 10-SEC
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
9) Which of the following is NOT a inancial statement that every public company is
required to produce?
A) income statement
B) statement of sources and uses of cash
C) balance sheet
D) statement of stockholders' equity
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
10) The third party who checks annual inancial statements to ensure that they are
prepared according to Generally Accepted Accounting Principles (GAAP) and veriies that
the information reported is reliable is the ________.
A) NYSE Enforcement Board
B) Accounting Standards Board
C) Securities and Exchange Commission (SEC)
D) auditor
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
3
11) What is the role of an auditor in inancial statement analysis?
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
12) What are the four inancial statements that all public companies must produce?
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
2.2 The Balance Sheet
1) The balance sheet shows the assets, liabilities, and stockholders' equity of a irm over a
given length of time.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Stockholders' equity is the diference between a irm's assets and liabilities, as shown on
the balance sheet.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
4
3) Which of the following amounts would be included on the right side of a balance sheet?
A) the value of government bonds held by the company
B) the cash held by the company
C) the amount of deferred tax liability held by the company
D) the amount of money owed to the company by customers who have not yet paid for
goods and services they have received
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
4) Which of the following best describes why the left and right sides of a balance sheet are
equal?
A) In a properly run business, the value of liabilities will not exceed the assets held by the
company.
B) By deinition, the assets plus the liabilities will be the same as the stockholders' equity.
C) The assets must equal liabilities plus stockholders' equity because stockholders' equity
is the diference between the assets and the liabilities.
D) By accounting convention, the assets of a company must be equal to the liabilities of
that company.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
5) A company that produces drugs is preparing a balance sheet. Which of the following
would be most likely to be considered a long-term asset on this balance sheet?
A) commercial paper held by the company
B) the inventory of chemicals used to produce the drugs made by the company
C) a patent for a drug held by the company
D) the cash reserves of the company
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
5
6) A delivery company is creating a balance sheet. Which of the following would most likely
be considered a short-term liability on this balance sheet?
A) the depreciation over the last year in the value of the vehicles owned by the company
B) revenue received for the delivery of items that have not yet been delivered
C) a loan which must paid back in two years
D) prepaid rent on the oices occupied by the company
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
7) A small company has current assets of $112,000 and current liabilities of $117,000.
Which of the following statements about that company is most likely to be true?
A) Since net working capital is negative, the company will not have enough funds to meet
its obligations.
B) Since net working capital is high, the company will likely have little diiculty meeting its
obligations.
C) Since net working capital is very high, the company will have ample money to invest
after it meets its obligations.
D) Since net working capital is nearly zero, the company is well run and will have little
diiculty attracting investors.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
8) What is the main problem in using a balance sheet to provide an accurate assessment of
the value of a company's equity?
A) Valuable assets such as the company's reputation, the quality of its work force, and the
strength of its management are not captured on the balance sheet.
B) The balance sheet does not accurately represent the book value of assets held by the
company.
C) The equity shown on the balance sheet does not relect the market capitalization of the
company.
D) Knowing at a single point in time what assets a irm possesses and the liabilities a irm
owes does not give any indication of what those assets can produce in the future.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
6
9) The major components of stockholders' equity are ________.
A) cash, common stock, and paid-in surplus
B) common stock, paid-in surplus, and net income
C) common stock, paid-in surplus, and retained earnings
D) common stock, liabilities, and retained earnings
AACSB Objective: Analytic Skills
Author: JP
Question Status: Revised
10) Balance Sheet
Assets Liabilities
Current Assets Current Liabilities
Cash 46 Accounts payable 39
Accounts receivable 23 Notes payable/short-term debt 5
Inventories 20
Total current assets 89 Total current liabilities 44
Long-Term Assets Long-Term Liabilities
Net property, plant,
and equipment 121 Long-term debt 133
Total long-term assets 121 Total long-term liabilities 133
Total Liabilities 177
Stockholders' Equity 33
Total Assets 210 Total Liabilities and 210
Stockholders' Equity
The above diagram shows a balance sheet for a certain company. All quantities shown are
in millions of dollars. What is the company's net working capital?
A) $133 million
B) $2 million
C) $89 million
D) $45 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
7
11) Balance Sheet
Assets Liabilities
Current Assets Current Liabilities
Cash 49 Accounts payable 38
Accounts receivable 21 Notes payable/short-term debt 5
Inventories 18
Total current assets 88 Total current liabilities 43
Long-Term Assets Long-Term Liabilities
Net property, plant,
and equipment 122 Long-term debt 134
Total long-term assets 122 Total long-term liabilities 134
Total Liabilities 177
Stockholders' Equity 33
Total Assets 210 Total Liabilities and 210
Stockholders' Equity
The above diagram shows a balance sheet for a certain company. If the company pays back
all of its accounts payable today using cash, what will its net working capital be?
A) $131 million
B) $6 million
C) $88 million
D) $45 million
AACSB Objective: Analytic Skills
Author: JP
Question Status: Revised
8
12) Balance Sheet
Assets Liabilities
Current Assets Current Liabilities
Cash 54 Accounts payable 42
Accounts receivable 20 Notes payable/short-term debt 6
Inventories 16
Total current assets 90 Total current liabilities 48
Long-Term Assets Long-Term Liabilities
Net property, plant,
and equipment 120 Long-term debt 129
Total long-term assets 120 Total long-term liabilities 129
Total Liabilities 177
Stockholders' Equity 33
Total Assets 210 Total Liabilities and 210
Stockholders' Equity
The above diagram shows a balance sheet for a certain company. If the company buys new
property, plant and equipment today using its entire cash balance, what will its net working
capital be?
A) -$12 million
B) $12 million
C) -$24 million
D) $24 million
AACSB Objective: Analytic Skills
Author: JP
Question Status: Revised
9
13) Balance Sheet
Assets Liabilities
Current Assets Current Liabilities
Cash 48 Accounts payable 35
Accounts receivable 25 Notes payable/short-term debt 5
Inventories 16
Total current assets 89 Total current liabilities 40
Long-Term Assets Long-Term Liabilities
Net property, plant,
and equipment 121 Long-term debt 137
Total long-term assets 121 Total long-term liabilities 137
Total Liabilities 177
Stockholders' Equity 33
Total Assets 210 Total Liabilities and 210
Stockholders' Equity
The above diagram shows a balance sheet for a certain company. All quantities shown are
in millions of dollars. How would the balance sheet change if the company's long-term
assets were judged to depreciate at an extra $5 million per year?
A) Net property, plant, and equipment would rise to $126 million, and total assets and
stockholders' equity would be adjusted accordingly.
B) Net property, plant, and equipment would fall to $116 million, and total assets and
stockholders' equity would be adjusted accordingly.
C) Long-term liabilities would rise to $131 million, and total liabilities and stockholders'
equity would be adjusted accordingly.
D) Long-term liabilities would fall to $111 million, and total liabilities and stockholders'
equity would be adjusted accordingly.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
10
