Chapter 02: Financial Statements, Cash Flow, and Taxes
41. 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’ reported net incomes would decline.
b. Companies’ net operating profits after taxes (NOPAT) would decline.
c. Companies’ physical stocks of fixed assets would increase.
d. Companies’ free cash flows would increase.
e. Companies’ cash positions would decline.
42. JBS Inc. recently reported net income of $4,750 and depreciation of $885. How much was its net cash provided (used)
by operations, assuming it had no amortization expense, added $200 to inventories, sold none of its fixed assets, and had a
$200 increase in accounts payable?
a. $4,831.31
b. $5,085.59
c. $5,353.25
d. $5,635.00
e. $5,916.75
Chapter 02: Financial Statements, Cash Flow, and Taxes
43. EP Enterprises has the following income statement. How much net operating profit after taxes (NOPAT) does the
firm have?
Sales $1,800.00
Costs 1,400.00
Depreciation 250.00
EBIT $ 150.00
Interest expense 70.00
EBT $ 80.00
Taxes (25%) 20.00
Net income $60.00
a. $101.53
b. $106.88
c. $112.50
d. $118.13
e. $124.03
44. Bae Inc. has the following income statement. How much net operating profit after taxes (NOPAT) does the firm have?
Sales $2,000.00
Costs 1,200.00
Depreciation 100.00
EBIT $ 700.00
Chapter 02: Financial Statements, Cash Flow, and Taxes
Interest expense 200.00
EBT $ 500.00
Taxes (25%) 125.00
Net income $375.00
a. $427.62
b. $450.12
c. $473.81
d. $498.75
e. $525.00
45. Total net operating capital is equal to net fixed assets.
a. True
b. False
Chapter 02: Financial Statements, Cash Flow, and Taxes
46. Net operating profit after taxes (NOPAT) is the amount of net income a company would generate from its operations
if it had no interest income or interest expense.
a. True
b. False
47. The current cash flow from existing assets is highly relevant to the investor. However, since the value of the firm
depends primarily upon its growth opportunities, profit projections from those opportunities are the only relevant future
flows with which investors are concerned.
a. True
b. False
48. 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?
Chapter 02: Financial Statements, Cash Flow, and Taxes
a. 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.
b. 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.
c. 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.
d. The standard statements focus on cash flows, but managers are less concerned with cash flows than with
accounting income as defined by GAAP.
e. 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.
49. Which of the following statements is CORRECT?
a. A shortcut to calculate free cash flow (FCF) is defined as follows:
FCF = Net income + Depreciation and Amortization.
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)
+ Depreciation and Amortization
− Capital expenditures required to sustain operations
− Required changes in net operating working capital.
d. Free cash flow (FCF) is defined as follows:
FCF = EBIT(1 − T)+ Depreciation and Amortization + Capital expenditures.
e. Net cash provided (used) by operations is the same as free cash flow (FCF).
Chapter 02: Financial Statements, Cash Flow, and Taxes
50. Danielle’s Sushi Shop last year had (1) a negative net 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 depreciation and amortization expenses.
b. The company had a sharp increase in its inventories.
c. The company had a sharp increase in its accrued liabilities.
d. The company sold a new issue of common stock.
e. The company made a large capital investment early in the year.
51. Swinnerton Clothing Company’s balance sheet showed total current assets of $2,250, all of which were required in
operations. Its current liabilities consisted of $575 of accounts payable, $300 of 6% short-term notes payable to the bank,
and $145 of accrued wages and taxes. What was its net operating working capital that was financed by investors?
a. $1,454
b. $1,530
c. $1,607
d. $1,687
e. $1,771
Chapter 02: Financial Statements, Cash Flow, and Taxes
52. NNR Inc.’s balance sheet showed total current assets of $1,875,000 plus $4,225,000 of net fixed assets. All of these
assets were required in operations. The firm’s current liabilities consisted of $475,000 of accounts payable, $375,000 of
6% short-term notes payable to the bank, and $150,000 of accrued wages and taxes. Its remaining capital consisted of
long-term debt and common equity. What was NNR’s total investor-provided operating capital?
a. $4,694,128
b. $4,941,188
c. $5,201,250
d. $5,475,000
e. $5,748,750
53. TSW Inc. had the following data for last year: Net income = $800; Net operating profit after taxes (NOPAT) = $700;
Total assets = $3,000; and Total operating capital = $2,000. Information for the just-completed year is as follows: Net
income = $1,000; Net operating profit after taxes (NOPAT) = $925; Total assets = $2,600; and Total operating capital =
$2,500. How much free cash flow did the firm generate during the just-completed year?
a. $383
Chapter 02: Financial Statements, Cash Flow, and Taxes
b. $425
c. $468
d. $514
e. $566
54. Rao Corporation has the following balance sheet. How much net operating working capital does the firm have?
Cash $ 10 Accounts payable $ 20
Short-term investments Accruals 20
Accounts receivable 50 Notes payable 50
Inventory 40 Current liabilities $ 90
Current assets $130 Long-term debt 0
Net fixed assets 100 Common equity 30
Retained earnings 50
Total assets $230 Total liab. & equity $230
a. $54.00
b. $60.00
c. $66.00
d. $72.60
e. $79.86
Chapter 02: Financial Statements, Cash Flow, and Taxes
55. Tibbs Inc. had the following data for the most recent year: Net income = $300; Net operating profit after taxes
(NOPAT) = $400; Total assets = $2,500; Short-term investments = $200; Stockholders’ equity = $1,800; Total debt =
$700; and Total operating capital = $2,300. What was its return on invested capital (ROIC)?
a. 14.91%
b. 15.70%
c. 16.52%
d. 17.39%
e. 18.26%
56. Zumbahlen Inc. has the following balance sheet. How much total operating capital does the firm have?
Cash $ 20.00 Accounts payable $ 30.00
Short-term investments 50.00 Accruals 50.00
Accounts receivable 20.00 Notes payable 30.00
Inventory 60.00 Current liabilities $110.00
Current assets $150.00 Long-term debt 70.00
Gross fixed assets $140.00 Common stock 30.00
Accumulated deprec. 40.00 Retained earnings 40.00
Net fixed assets $100.00 Total common equity $ 70.00
Total assets $250.00 Total liab. & equity $250.00
a. $114.00
b. $120.00
c. $126.00
d. $132.30
e. $138.92
Chapter 02: Financial Statements, Cash Flow, and Taxes
57. Wells Water Systems recently reported $8,250 of sales, $4,500 of operating costs other than depreciation, and $950 of
depreciation. The company had no amortization charges, it had $3,250 of outstanding bonds that carry a 6.75% interest
rate, and its federal-plus-state income tax rate was 25%. In order to sustain its operations and thus generate sales and cash
flows in the future, the firm was required to spend $750 to buy new fixed assets and to invest $250 in net operating
working capital. How much free cash flow did Wells generate?
a. $2,050.00
b. $2,152.50
c. $2,260.13
d. $2,373.13
e. $2,491.79
58. Last year, Michelson Manufacturing reported $10,250 of sales, $3,500 of operating costs other than depreciation, and
$1,250 of depreciation. The company had no amortization charges, it had $3,500 of bonds outstanding that carry a 6.5%
interest rate, and its federal-plus-state income tax rate was 25%. This year’s data are expected to remain unchanged except
Chapter 02: Financial Statements, Cash Flow, and Taxes
for one item, depreciation, which is expected to increase by $725. By how much will the depreciation change cause the
firm’s net after-tax income to change? Note that the company uses the same depreciation calculations for tax and
stockholder reporting purposes.
a. −$442.89
b. −$466.20
c. −$490.73
d. −$516.56
e. −$543.75
59. Bartling Energy Systems recently reported $9,250 of sales, $5,750 of operating costs other than depreciation, and
$700 of depreciation. The company had no amortization charges, it had $3,200 of outstanding bonds that carry a 5%
interest rate, and its federal-plus-state income tax rate was 25%. In order to sustain its operations and thus generate sales
and cash flows in the future, the firm was required to make $1,250 of capital expenditures on new fixed assets and to
invest $300 in net operating working capital. By how much did the firm’s net income exceed its free cash flow?
Chapter 02: Financial Statements, Cash Flow, and Taxes
a. $658.83
b. $693.50
c. $730.00
d. $766.50
e. $804.83
60. Which of the following statements is CORRECT?
a. The primary difference between EVA and accounting net income is that when net income is calculated, a
deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the
cost of the equity capital the firm uses.
b. MVA gives us an idea about how much value a firm’s management has added during the last year.
c. MVA stands for market value added, and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity.
d. EVA stands for economic value added, and it is defined as follows:
EVA = EBIT(1 − T) − (Investor-supplied op. capital) × (A − T cost of capital).
e. EVA gives us an idea about how much value a firm’s management has added over the firm’s life.
Chapter 02: Financial Statements, Cash Flow, and Taxes
61. Which of the following statements is CORRECT?
a. One way to increase EVA is to achieve the same level of operating income but with more investor-supplied
capital.
b. If a firm reports positive net income, its EVA must also be positive.
c. One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free.
d. One way to increase EVA is to generate the same level of operating income but with less investor-supplied
capital.
e. Actions that increase reported net income will always increase net cash flow from operations.
62. Over the years, Janjigian Corporation’s stockholders have provided $15,250 of capital, part when they purchased new
issues of stock and part when they allowed management to retain some of the firm’s earnings. The firm now has 1,000
shares of common stock outstanding, and it sells at a price of $42.00 per share. How much value has Janjigian’s
management added to stockholder wealth over the years, i.e., what is Janjigian’s MVA?
a. $21,788
b. $22,935
c. $24,142
d. $25,413
e. $26,750
Chapter 02: Financial Statements, Cash Flow, and Taxes
63. Barnes’ Brothers has the following data for the year ending 12/31/2015: Net income = $600; Net operating profit after
taxes (NOPAT) = $700; Total assets = $2,500; Short-term investments = $200; Stockholders’ equity = $1,800; Total debt
= $700; and Total operating capital = $2,100. Barnes’ weighted average cost of capital is 10%. What is its economic value
added (EVA)?
a. $399.11
b. $420.11
c. $442.23
d. $465.50
e. $490.00
64. HHH Inc. reported $12,500 of sales and $7,025 of operating costs (including depreciation). The company had $18,750
of investor-supplied operating assets (or capital), the weighted average cost of that capital (the WACC) was 9.5%, and the
Chapter 02: Financial Statements, Cash Flow, and Taxes
federal-plus-state income tax rate was 25%. What was HHH’s Economic Value Added (EVA), i.e., how much value did
management add to stockholders’ wealth during the year?
a. $2,098.31
b. $2,208.75
c. $2,325.00
d. $2,441.25
e. $2,563.31
65. The fact that 50% of the interest income received by a corporation is excluded from its taxable income encourages
firms to use more debt financing than they would in the absence of this tax law provision.
a. True
b. False
66. If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-
deductible expense, this would probably encourage companies to use more debt financing than they presently do, other
things held constant.
Chapter 02: Financial Statements, Cash Flow, and Taxes
a. True
b. False
67. The interest and dividends paid by a corporation are considered to be deductible operating expenses, hence they
decrease the firm’s tax liability.
a. True
b. False
68. 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.
a. True
b. False
Chapter 02: Financial Statements, Cash Flow, and Taxes
69. Which of the following statements is CORRECT?
a. All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the
lowest amounts of income and 35% for the highest amounts of income.
b. 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.
c. All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the
Internal Revenue Code.
d. Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must
report their pro rata shares of the firm’s income as personal income and pay taxes on that income.
e. 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 income and stockholders were taxed again on the income when it was paid to them as dividends.
70. Assume that Congress recently passed a provision that will enable Barton’s Rare Books (BRB) to double its
depreciation expense for the upcoming year but will have no effect on its sales revenue or tax rate. Prior to the new
provision, BRB’s net income after taxes was forecasted to be $4 million. Which of the following best describes the impact
of the new provision on BRB’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. Net fixed assets on the balance sheet will decrease.
b. The provision will reduce the company’s free cash flow.
c. The provision will increase the company’s tax payments.
d. Net fixed assets on the balance sheet will increase.
e. The provision will increase the company’s net income.
Chapter 02: Financial Statements, Cash Flow, and Taxes
71. The LeMond Corporation just purchased a new production line. Assume that the firm planned to depreciate the
equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to
depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will
occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and
stockholder reporting purposes.
a. LeMond’s tax liability for the year will be lower.
b. LeMond’s taxable income will be lower.
c. LeMond’s net fixed assets as shown on the balance sheet will be higher at the end of the year.
d. LeMond’s cash position will improve (increase).
e. LeMond’s reported net income after taxes for the year will be lower.
72. DeYoung Devices Inc., a new high-tech instrumentation firm, is building and equipping a new manufacturing facility.
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 reported net income would increase.
b. The firm’s operating income (EBIT) would increase.
c. The firm’s taxable income would increase.
d. The firm’s net cash flow provided (used) by operations would increase.
e. The firm’s tax payments would increase.
Chapter 02: Financial Statements, Cash Flow, and Taxes
73. Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new
common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not
pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant.
Which of the following would occur?
a. The company would have to pay less taxes.
b. The company’s taxable income would fall.
c. The company’s interest expense would remain constant.
d. The company would have less common equity than before.
e. The company’s net income would increase.
74. Which of the following statements is CORRECT?
a. The maximum federal tax rate on personal income can exceed 50%.
b. 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.
c. Interest paid to an individual is counted as income for tax purposes and taxed at the individual’s regular tax rate,
but dividends received are taxed at a maximum rate of 20%.
d. The maximum federal tax rate on corporate income is 50%.
e. 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.
Chapter 02: Financial Statements, Cash Flow, and Taxes
75. Edwards Electronics recently reported $11,250 of sales, $5,500 of operating costs other than depreciation, and
$1,250 of depreciation. The company had no amortization charges, it had $3,500 of bonds that carry a 6.25% interest
rate, and its federal-plus-state income tax rate was 25%. How much was its net operating profit after taxes (NOPAT)?
a. $2,748.96
b. $2,893.64
c. $3,045.94
d. $3,206.25
e. $3,375.00