Corporate Finance: Core Principles & Apps, 5e (Ross)
Chapter 2 Financial Statements and Cash Flow
1) A current asset is best defined as
A) the market value of all assets currently owned by the firm.
B) an asset the firm expects to purchase within the next year.
C) the amount of cash on hand the firm currently shows on its balance sheet.
D) cash and other assets owned by the firm that should convert to cash within the next year.
E) the value of fixed assets the firm expects to sell within the next year.
2) The long-term debts of a firm are liabilities
A) owed to the firm’s stockholders.
B) that do not come due for at least 12 months.
C) owed to the firm’s suppliers.
D) that come due within the next 12 months.
E) the firm expects to incur within the next 12 months.
3) A(n) ________ asset is one that can be quickly converted into cash without significant loss in
value.
A) tangible
B) fixed
C) intangible
D) liquid
E) long-term
4) Current assets include
A) inventory and accounts receivable.
B) accounts payable and cash.
C) cash and intangible assets.
D) inventory and accounts payable.
E) buildings and equipment.
5) An example of a current liability is
A) a loan secured by a mortgage and payable in 8 months.
B) any loan payable to a bank.
C) all accounts due from customers within the next year.
D) a note payable in full in 18 months.
E) an account due from a customer that is past due.
6) Which one of the following accounts is generally the most liquid?
A) Patent
B) Building
C) Accounts receivable
D) Equipment
E) Inventory
7) Which one of the following statements concerning liquidity is correct?
A) Fixed assets are more liquid than current assets.
B) Balance sheet accounts are listed in order of decreasing liquidity.
C) Liquid assets tend to be highly profitable.
D) The less liquidity a firm has, the lower the probability the firm will encounter financial
difficulties.
E) Trademarks and patents are highly liquid.
8) Liquidity is
A) a measure of the use of debt in a firm’s capital structure.
B) equal to current assets minus current liabilities.
C) equal to the market value of a firm’s total assets minus its current liabilities.
D) generally associated with intangible assets.
E) valuable to a firm even though liquid assets tend to be less profitable to own.
9) Book value is
A) based on historical cost.
B) equivalent to market value for firms with fixed assets.
C) more of a financial than an accounting valuation.
D) the amount a willing buyer will pay for an asset.
E) adjusted to market value whenever the market value exceeds the stated book value.
10) When making financial decisions related to assets, you should
A) place primary emphasis on historical costs.
B) place more emphasis on book values than on market values.
C) rely primarily on the value of assets as shown on the balance sheet.
D) always consider market values.
E) only consider market values if they are less than book values.
11) Which one of these, all else held constant, will increase the value of stockholders’ equity?
A) Decrease in accounts receivable
B) Increase in long-term debt
C) Decrease in retained earnings
D) Increase in accounts payable
E) Increase in fixed assets
12) Which one of these statements is correct?
A) Long-term debt is the residual difference between assets and liabilities.
B) Net income that is not paid out in dividends decreases retained earnings.
C) Long-term debt requires a payout of cash within a stated time period.
D) Stockholders’ equity is stated at market value on the balance sheet.
E) Stockholders’ equity increases as the liquidity of a firm increases.
13) The carrying value or book value of assets
A) is always the best measure of a company’s value to an investor.
B) represents an average market value over time.
C) is always higher than the replacement cost of the assets.
D) is determined under GAAP and is based on the cost of the assets.
E) is determined under GAAP and is based on the current market value of the assets.
14) Stockholders’ equity is equal to
A) net working capital plus long-term liabilities.
B) current assets plus fixed assets minus long-term liabilities.
C) total assets plus total liabilities.
D) current assets minus total liabilities plus fixed assets.
E) net working capital plus total fixed assets.
15) The income statement
A) measures a firm’s performance as of a specific date.
B) determines the aftertax income of a firm.
C) excludes deferred taxes.
D) includes dividends as an expense.
E) determines the value of a firm to its stockholders.
16) As seen on an income statement,
A) interest is deducted from income and increases the total taxes incurred.
B) depreciation reduces both the pretax income and the net income.
C) depreciation is shown as an expense but does not affect the taxes payable.
D) the tax rate is applied to the earnings before interest and taxes when the firm has both
depreciation and interest expenses.
E) both dividends and interest expense reduce corporate income taxes.
17) Depreciation
A) reduces both the net fixed assets and the costs of a firm.
B) decreases net fixed assets, net income, and operating cash flows.
C) is a noncash expense that decreases the selling, general, and administrative expenses.
D) is a noncash expense that reduces the pretax income.
E) increases the net fixed assets as shown on the balance sheet.
18) Noncash items refer to
A) the credit sales of a firm.
B) the accounts payable of a firm.
C) all accounts on the balance sheet other than cash on hand.
D) the costs incurred for the purchase of intangible fixed assets.
E) expenses charged against revenues that do not directly affect cash flow.
19) Assume both current and deferred taxes are positive values. Given this, deferred taxes will
A) reduce the current tax expense and thus increase net income.
B) increase expenses and increase operating cash flows.
C) increase expenses and lower operating cash flows.
D) reduce net income but not affect the operating cash flows.
E) reduce both net income and operating cash flows.
20) Which one of these will increase earnings per share?
A) Decreasing deferred taxes
B) Increasing depreciation expense
C) Lowering the operating income
D) Increasing the average corporate tax rate
E) Increasing the addition to retained earnings by reducing dividends paid
21) Revenue is recorded on an income statement when
A) payment for a sale has been received in full.
B) an order for goods is placed.
C) an exchange of goods or services has occurred and the earnings process is completed.
D) an order for goods or services is placed and an initial payment is received.
E) goods are placed in inventory and ready for future delivery.
22) Expenses are recorded on an income statement based on
A) their payment dates.
B) the date the expenses are expected.
C) the matching principle.
D) their invoice dates.
E) the average time principle.
23) Earnings per share is computed as
A) net income divided by total stockholders’ equity.
B) EBIT divided by total stockholders’ equity.
C) pretax income minus current taxes divided by total shares outstanding.
D) the addition to retained earnings divided by total shares outstanding.
E) net income divided by total shares outstanding.
24) Which one of these is both a product cost and a fixed cost in the short run?
A) Monthly electric bill for manufacturing facility
B) Salary for company CEO
C) Overtime pay for production employees
D) Sales commission paid based on monthly sales
E) Monthly lease payment for production equipment
25) Your ________ tax rate is the percentage of the next taxable dollar of income you earn that is
payable as a tax.
A) deductible
B) residual
C) marginal
D) average
E) total
26) Your ________ tax rate measures the total taxes you pay divided by your total taxable income.
A) average
B) marginal
C) total
D) deductible
E) residual
27) When you are making a financial decision, the most relevant tax rate is the ________ rate.
A) average
B) fixed
C) marginal
D) total
E) variable
28) ________ refers to the difference between a firm’s current assets and its current liabilities.
A) Operating cash flow
B) Capital spending
C) Net working capital
D) Cash flow from assets
E) Cash flow to creditors
29) A firm starts its year with positive net working capital. During the year, the firm acquires more
short-term debt than it does short-term assets. This means that
A) the ending net working capital might be positive, negative, or equal to zero.
B) both accounts receivable and inventory decreased during the year.
C) the beginning current assets were less than the beginning current liabilities.
D) accounts payable increased and inventory decreased during the year.
E) the ending net working capital will be negative.
30) ________ is calculated by adding back noncash expenses to earnings before interest and taxes,
subtracting taxes, and adjusting for any changes in total assets or current liabilities that affect cash
flows.
A) Distributable cash flow
B) Capital spending
C) Cash flow from assets
D) Cash flow from investing activities
E) Cash flow to creditors
31) ________ refers to a firm’s interest payments minus any net new borrowing.
A) Operating cash flow
B) Distributable cash flow
C) Net working capital
D) Cash flow to stockholders
E) Cash flow to creditors
32) ________ refers to a firm’s dividend payments minus any net new equity raised.
A) Operating cash flow
B) Capital spending
C) Net working capital
D) Cash flow to stockholders
E) Cash flow from creditors
33) Al’s has a positive net income and a marginal tax rate of 34 percent. Given this, an increase in
which one of the following will cause the operating cash flow to increase?
A) Fixed assets
B) Taxes
C) Net working capital
D) Cost of goods sold
E) Depreciation
34) The cash flow to creditors increases when
A) cash is used to reduce accounts payable.
B) new shares of stock are sold for cash.
C) interest is paid on outstanding debt.
D) an asset is sold for cash.
E) a long-term debt is incurred.
35) Cash flow to stockholders must be positive when
A) the net sale of common stock exceeds the amount of dividends paid.
B) no income is distributed but new shares of stock are sold.
C) both the cash flow to assets and the cash flow to creditors are negative.
D) both the cash flow to assets and the cash flow to creditors are positive.
E) the dividends paid exceed the net new equity raised.
36) What is the formula for computing operating cash flow?
A) EBIT + Depreciation − Current taxes
B) EBIT + Depreciation − Interest expense − Current taxes
C) EBIT + NWC − Depreciation
D) EBIT − Depreciation + Current taxes
E) EBIT − Change in NWC + Depreciation − Current taxes
37) Capital spending is equal to
A) the net purchases and sales of fixed assets.
B) total cash flow to stockholders less interest and dividends paid.
C) net income plus depreciation.
D) the net change in total assets.
E) the change in current assets minus the change in current liabilities.
38) Cash flow to stockholders is best defined as
A) the total dividends paid.
B) the cash flow from assets plus the cash flow to creditors.
C) cash dividends plus repurchases of equity minus new equity financing.
D) repurchases of equity less cash dividends paid plus new equity sold.
E) the net change in common stock and capital surplus.
39) Free cash flow is
A) equal to net income.
B) equal to net income plus taxes.
C) a term used to describe an increase in net working capital.
D) cash that is available to distribute to creditors and equity holders.
E) another term for operating cash flow.
40) The cash flow of a firm, also referred to as cash flow from assets, must be equal to the cash
flow to
A) debt holders minus the cash flow to equity holders.
B) equity holders plus the cash flow to debt holders.
C) the government plus the cash flow to equity holders.
D) equity holders minus the cash flow to debt holders.
E) the government, the debt holders, and the equity holders.
41) Which one of these is handled differently in calculating cash flows for accounting versus
financial purposes?
A) Change in net working capital
B) Depreciation expense
C) Interest expense
D) Deferred taxes
E) Dividends paid
42) ________ refers to the cash flow resulting from a firm’s ongoing, normal business activities.
A) Cash flow from assets
B) Net working capital
C) Capital spending
D) Cash flow from operating activities
E) Cash flow from investing activities
43) ________ refers to the changes in net fixed assets.
A) Cash flow from assets
B) Net working capital
C) Cash flow from investing activities
D) Cash flow from operating activities
E) Cash flow to creditors
44) A change in which one of these accounts will appear as an investing activity in an accounting
statement of cash flows?
A) Accounts payable
B) Inventory
C) Interest expense
D) Fixed assets
E) Sales
45) A change in which one of these accounts is treated as a cash flow from operating activities in
an accounting statement of cash flows?
A) Long-term debt
B) Inventory
C) Dividends
D) Fixed assets
E) Depreciation
46) The cash flow from operating activities decreases when
A) fixed assets are sold.
B) interest expense increases.
C) dividends increase.
D) depreciation increases.
E) accounts receivables decrease.
47) A firm has total equity of $2,011, net working capital of $175, long-term debt of $890, and
current liabilities of $420. What is the amount of the net fixed assets?
A) $2,325
B) $2,974
C) $2,726
D) $3,075
E) $2,825
48) A firm has $480 in inventory, $1,860 in fixed assets, $520 in accounts receivables, $190 in net
working capital, and $120 in cash. What is the amount of the current liabilities?
A) $550
B) $770
C) $820
D) $760
E) $930
49) Brad’s Company has equipment with a book value of $1,380 that could be sold today at a 20
percent discount. Its inventory is valued at $360 and could be sold to a competitor for 90 percent of
that value. The firm has $45 in cash and customers owe them $240, of which 97 percent is
collectible. What is the accounting value of its liquid assets?
A) $601.80
B) $350.00
C) $2,025.00
D) $645.00
E) $1,705.80
50) Martha’s Enterprises spent $3,300 to purchase equipment 2 years ago. This equipment is
currently valued at $2,357 on today’s balance sheet but could actually be sold for $2,750. Net
working capital is $860 and long-term debt is $1,650. Assuming this equipment is the firm’s only
fixed asset, what is the book value of shareholders’ equity?
A) $1,960
B) $1,800
C) $1,567
D) $2,510
E) $1,633
51) A firm has beginning retained earnings of $4,200 and ending retained earnings of $4,150.
What is the amount of dividends paid if the firm earned a net income of $1,950?
A) $1,500
B) $1,950
C) $1,900
D) $2,000
E) $2,100
52) MLM Enterprises has net income of $984, interest expense of $146, sales of $6,320, addition
to retained earnings of $495, selling and general expenses of $1,210, and depreciation of $1,140.
What is the amount of dividends paid if the tax rate is 34 percent?
A) $1,479
B) $1,162
C) $489
D) $507
E) $783
53) Assume sales are $1,100, cost of goods sold is $510, depreciation expense is $80, interest paid
is $40, selling and general expenses are $230, dividends paid is $45, and the tax rate is 34 percent.
What is the addition to retained earnings?
A) $203.40
B) $113.40
C) $166.20
D) $109.60
E) $158.40
54) Lester’s has $33,600 in sales, $17,200 in cost of goods sold, $2,300 in depreciation, $980 in
interest expense, and $5,800 in selling, general, and administrative expenses. The firm owes no
taxes for this year. What is the amount of the period costs that are included in the operating cash
flow?
A) $25,300
B) $3,280
C) $23,980
D) $23,000
E) $5,800