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Chapter 06: Accounting for Financial Management
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Page 1
True / False
1. The annual report contains four basic financial statements: the income statement, balance sheet, statement of cash
flows, and statement of stockholders' equity.
a.
True
b.
False
ANSWER:
True
2. The primary reason the annual report is important in finance is that it is used by investors when they form expectations
about the firm's future earnings and dividends, and the riskiness of those cash flows.
a.
True
b.
False
ANSWER:
True
3. Consider the balance sheet of Wilkes Industries as shown below. Because Wilkes has $800,000 of retained earnings,
the company would be able to pay cash to buy an asset with a cost of $200,000.
Cash
$ 50,000
Accounts payable
$ 100,000
Inventory
200,000
Accruals
100,000
Accounts receivable
250,000
Total CL
$ 200,000
Chapter 06: Accounting for Financial Management
Total CA
$ 500,000
Debt
200,000
Net fixed assets
$ 900,000
Common stock
200,000
_________
Retained earnings
800,000
Total assets
$1,400,000
Total L & E
$1,400,000
a.
True
b.
False
ANSWER:
False
4. On the balance sheet, total assets must always equal total liabilities and equity.
a.
True
b.
False
ANSWER:
True
5. Assets other than cash 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 these assets are carried on the books.
a.
True
b.
False
ANSWER:
True
6. The income statement shows the difference between a firm's income and its costs⎯i.e., its profits⎯during a specified
period of time. However, not all reported income comes in the form or cash, and reported costs likewise may not correctly
reflect cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash
flow for the same period.
a.
True
b.
False
ANSWER:
True
7. The balance sheet is a financial statement that measures the flow of funds into and out of various accounts over time,
while the income statement measures the firm's financial position at a point in time.
a.
True
b.
False
ANSWER:
False
8. Net operating working capital is equal to operating current assets minus operating current liabilities.
a.
True
b.
False
ANSWER:
True
9. Total net operating capital is equal to net fixed assets.
a.
True
b.
False
ANSWER:
False
10. 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
ANSWER:
True
11. 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
ANSWER:
False
12. The fact that 70% 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
ANSWER:
False
13. 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.
a.
True
b.
False
ANSWER:
False
14. 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
ANSWER:
False
15. 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
ANSWER:
True
16. Its retained earnings is the actual cash that the firm has generated through operations less the cash that has 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 firm's total retained earnings.
a.
True
b.
False
ANSWER:
False
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17. The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of stockholders'
claims against the firm's existing assets. This implies that retained earnings are in fact stockholders' reinvested earnings.
a.
True
b.
False
ANSWER:
True
18. In accounting, emphasis is placed on determining net income in accordance with generally accepted accounting
principles. In finance, the primary emphasis is also on net income because that is what investors use to value the firm.
However, a secondary financial consideration is cash flow, because cash is needed to operate the business.
a.
True
b.
False
ANSWER:
False
19. To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash
charge that has been deducted from revenue.
a.
True
b.
False
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ANSWER:
True
20. The time dimension is important in financial statement analysis. The balance sheet shows the firm's financial position
at a given point in time, the income statement shows results over a period of time, and the statement of cash flows reflects
changes in the firm's accounts over that period of time.
a.
True
b.
False
Multiple Choice
21. Which of the following statements is CORRECT?
a.
The statement of cash needs tells us how much cash the firm will require during some future period, generally
a month or a year.
b.
The four most important financial statements provided in the annual report are the balance sheet, income
statement, cash budget, and the statement of stockholders' equity.
c.
The balance sheet gives us a picture of the firm's financial position at a point in time.
d.
The income statement gives us a picture of the firm's financial position at a point in time.
e.
The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits.
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ANSWER:
c
22. Which of the following statements is CORRECT?
a.
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.
b.
The balance sheet for a given year is designed to give us an idea of what happened to the firm during that year.
c.
The balance sheet for a given year tells us how much money the company earned during that year.
d.
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).
e.
For most companies, the market value of the stock equals the book value of the stock as reported on the
balance sheet.
ANSWER:
a
23. Other things held constant, which of the following actions would increase the amount of cash on a company's balance
sheet?
a.
The company purchases a new piece of equipment.
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b.
The company repurchases common stock.
c.
The company pays a dividend.
d.
The company issues new common stock.
e.
The company gives customers more time to pay their bills.
ANSWER:
d
24. Which of the following items is NOT included in current assets?
a.
Short-term, highly liquid, marketable securities.
b.
Accounts receivable.
c.
Inventory.
d.
Bonds.
e.
Cash.
ANSWER:
d
25. Which of the following items cannot be found on a firm's balance sheet under current liabilities?
a.
Accrued payroll taxes.
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b.
Accounts payable.
c.
Short-term notes payable to the bank.
d.
Accrued wages.
e.
Cost of goods sold.
ANSWER:
e
26. Below are the year-end balance sheets for Wolken Enterprises:
Assets:
2015
2014
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 non-callable, long-term debt
in 2014. As of the end of 2015, none of the principal on this debt had been repaid. Assume that the company's sales in
2014 and 2015 were the same. Which of the following statements must be CORRECT?
a.
Wolken increased its short-term bank debt in 2015.
b.
Wolken issued long-term debt in 2015.
c.
Wolken issued new common stock in 2015.
d.
Wolken repurchased some common stock in 2015.
e.
Wolken had negative net income in 2015.
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ANSWER:
c
27. On its 2014 balance sheet, Barngrover Books showed $510 million of retained earnings, and exactly that same amount
was shown the following year in 2015. Assuming that no earnings restatements were issued, which of the following
statements is CORRECT?
a.
Dividends could have been paid in 2015, but they would have had to equal the earnings for the year.
b.
If the company lost money in 2015, they must have paid dividends.
c.
The company must have had zero net income in 2015.
d.
The company must have paid out half of its earnings as dividends.
e.
The company must have paid no dividends in 2015.
ANSWER:
a
28. Below is the common equity section (in millions) of Fethe Industries' last two year-end balance sheets:
2015
2014
Common stock
$2,000
$1,000
Retained earnings
2,000
2,340
Chapter 06: Accounting for Financial Management
Total common equity
$4,000
$3,340
The company has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?
a.
The company's net income in 2014 was higher than in 2015.
b.
The company issued common stock in 2015.
c.
The market price of the company's stock doubled in 2015.
d.
The company had positive net income in both 2014 and 2015, but the company's net income in 2014 was
lower than it was in 2015.
e.
The company has more equity than debt on its balance sheet.
ANSWER:
b
29. Tucker Electronic System's current balance sheet shows total common equity of $3,125,000. The company has
125,000 shares of stock outstanding, and they sell at a price of $52.50 per share. By how much do the firm's market and
book values per share differ?
a.
$27.50
b.
$28.88
c.
$30.32
d.
$31.83
e.
$33.43
ANSWER:
a
30. Hunter Manufacturing Inc.'s December 31, 2014 balance sheet showed total common equity of $2,050,000 and
100,000 shares of stock outstanding. During 2015, Hunter had $250,000 of net income, and it paid out $100,000 as
dividends. What was the book value per share at 12/31/2015, assuming that Hunter neither issued nor retired any common
stock during 2015?
a.
$20.90
b.
$22.00
c.
$23.10
d.
$24.26
e.
$25.47
ANSWER:
b
31. Which of the following statements is CORRECT?
a.
The income statement for a given year is designed to give us an idea of how much the firm earned during that
year.
b.
The focal point of the income statement is the cash account, because that account cannot be manipulated by
"accounting tricks."
c.
The reported income of two otherwise identical firms cannot be manipulated by different accounting
procedures provided the firms follow Generally Accepted Accounting Principles (GAAP).
d.
The reported income of two otherwise identical firms must be identical if the firms are publicly owned,
provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC).
e.
If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be
identical to its reported net cash flow.
ANSWER:
a
32. Which of the following statements is CORRECT?
a.
The more depreciation a firm has in a given year, the higher its EPS, other things held constant.
b.
Typically, a firm's DPS should exceed its EPS.
c.
Typically, a firm's EBIT should exceed its EBITDA.
d.
If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed
its book value per share.
e.
If a firm is more profitable than most other firms, we would normally expect to see its book value per share
exceed its stock price, especially after several years of high inflation.
ANSWER:
d
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33. Companies generate income from their "regular" operations and from other sources like interest earned on the
securities they hold, which is called non-operating income. Lindley Textiles recently reported $12,500 of sales, $7,250 of
operating costs other than depreciation, and $1,000 of depreciation. The company had no amortization charges and no
non-operating income. It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income
tax rate was 40%. How much was Lindley's operating income, or EBIT?
a.
$3,462
b.
$3,644
c.
$3,836
d.
$4,038
e.
$4,250
ANSWER:
e
34. Frederickson Office Supplies recently reported $12,500 of sales, $7,250 of operating costs other than depreciation, and
$1,250 of depreciation. The company had no amortization charges and no non-operating income. It had $8,000 of bonds
outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's
taxable income, or earnings before taxes (EBT)?
a.
$3,230.00
Chapter 06: Accounting for Financial Management
b.
$3,400.00
c.
$3,570.00
d.
$3,748.50
e.
$3,935.93
ANSWER:
b
35. Meric Mining Inc. recently reported $15,000 of sales, $7,500 of operating costs other than depreciation, and $1,200 of
depreciation. The company had no amortization charges, it had outstanding $6,500 of bonds that carry a 6.25% interest
rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net income after taxes? Meric uses the
same depreciation expense for tax and stockholder reporting purposes.
a.
$3,284.55
b.
$3,457.42
c.
$3,639.39
d.
$3,830.94
e.
$4,022.48
ANSWER:
d
36. Last year Tiemann Technologies reported $10,500 of sales, $6,250 of operating costs other than depreciation, and
$1,300 of depreciation. The company had no amortization charges, it had $5,000 of bonds that carry a 6.5% interest rate,
and its federal-plus-state income tax rate was 35%. This year's data are expected to remain unchanged except for one item,
depreciation, which is expected to increase by $750. By how much will net after-tax income change as a result of the
change in depreciation? The company uses the same depreciation calculations for tax and stockholder reporting purposes.
a.
−463.13
b.
−487.50
c.
−511.88
d.
−537.47
e.
−564.34
ANSWER:
b
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37. 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?
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.
ANSWER:
b
