Question 1

EBITDA stands for earnings before interest, taxes, debt, and assets.

Accepted Answer

A) True 
 B)False

Question 2

The balance sheet 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.

Accepted Answer

A) True 
 B)False

Question 3

A 5-year corporate bond yields 9%. A 5-year municipal bond of equal risk yields 6.5%. Assume that the state tax rate is zero. At what federal tax rate are you indifferent between the two bonds?

Accepted Answer

A)  27.78% 
B)  29.17% 
C)  30.63% 
D)  32.16% 
E)  33.76%

Question 4

Your corporation has a marginal tax rate of 35% and has purchased preferred stock in another company. The before-tax dividend yield on the preferred stock is 12%. What is the company's after-tax return on the preferred, assuming a 70% dividend exclusion?

Accepted Answer

A)  10.20% 
B)  10.74% 
C)  11.28% 
D)  11.84% 
E)  12.43%

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A)  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. 
B)  The balance sheet for a given year, say 2008, tells us how much money the company earned during that year. 
C)  The difference between the total assets reported on the balance sheet and the liabilities 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). 
D)  If a company's statements were prepared in accordance with generally accepted accounting principles (GAAP), the market value of the stock equals the book value of the stock as reported on the balance sheet. 
E)  The assets section of a typical industrial company's balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last.

Question 6

Your corporation has the following cash flows: Operating income $250,000
Interest received $10,000
Interest paid $45,000
Dividends received $20,000
Dividends paid $50,000
If the applicable income tax rate is 40% (federal and state combined), and if 70% of dividends received are exempt from taxes, what is the corporation's tax liability?

Accepted Answer

A)  $83,980 
B)  $88,400 
C)  $92,820 
D)  $97,461 
E)  $102,334

Question 7

Van Dyke Corporation has a corporate tax rate equal to 30%. The company recently purchased preferred stock in another company. The preferred stock has an 8% before-tax yield. What is Van Dyke's after-tax yield on the preferred stock?

Accepted Answer

A)  6.57% 
B)  6.92% 
C)  7.28% 
D)  7.64% 
E)  8.03%

Question 8

A 7-year municipal bond yields 4.8%. Your marginal tax rate (including state and federal taxes) is 27%. What interest rate on a 7-year corporate bond of equal risk would provide you with the same after-tax return?

Accepted Answer

A)  5.64% 
B)  5.93% 
C)  6.25% 
D)  6.58% 
E)  6.90%

Question 9

Two metrics that are used to measure a company's financial performance are net income and cash flow. Accountants emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on cash flows as they do on net income.

Accepted Answer

A) True 
 B)False

Question 10

On its 12/31/08 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

Accepted Answer

A)  If the company lost money in 2008, it must have paid dividends. 
B)  The company must have had zero net income in 2008. 
C)  The company must have paid out half of its 2008 earnings as dividends. 
D)  The company must have paid no dividends in 2008. 
E)  Dividends could have been paid in 2008, but they would have had to equal the earnings for the year.

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A)  Since depreciation increases the firm's net cash provided by operating activities, the more depreciation a company has, the larger its retained earnings will be, other things held constant. 
B)  A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments. 
C)  Common equity includes common stock and retained earnings, less accumulated depreciation. 
D)  The retained earnings account as reported on the balance sheet shows the amount of cash that is available for paying dividends. 
E)  If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.

Question 12

A start-up firm is making an initial investment in new plant and equipment. 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?

Accepted Answer

A)  The firm's operating income (EBIT) would increase. 
B)  The firm's taxable income would increase. 
C)  The firm's cash flow would increase. 
D)  The firm's tax payments would increase. 
E)  The firm's reported net income would increase.

Question 13

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.

Accepted Answer

A) True 
 B)False

Question 14

Brown Office Supplies recently reported $15,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's earnings before taxes (EBT)?

Accepted Answer

A)  $4,627 
B)  $4,870 
C)  $5,114 
D)  $5,369 
E)  $5,638

Question 15

Wu Systems has the following balance sheet. How much net working capital does the firm have?

Accepted Answer

A)  $675 
B)  $750 
C)  $825 
D)  $908 
E)  $998

Question 16

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?

Accepted Answer

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, the firm's value is based on its future cash flows. After all, future cash flows tells us how much the firm can distribute to its investors. 
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 should be 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.

Question 17

The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of the stockholders' claim against the firm's existing assets. Put another way retained earnings are stockholders' reinvested earnings.

Accepted Answer

A) True 
 B)False

Question 18

EBIT stands for earnings before interest and taxes, and it is often called "operating income."

Accepted Answer

A) True 
 B)False

Question 19

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.

Accepted Answer

A) True 
 B)False

Question 20

On the balance sheet, total assets must always equal the sum of total liabilities plus equity.

Accepted Answer

A) True 
 B)False

Exam 3: Financial Statements, Cash Flow, and Taxes

EBITDA stands for earnings before interest, taxes, debt, and assets.

The balance sheet 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 5-year corporate bond yields 9%. A 5-year municipal bond of equal risk yields 6.5%. Assume that the state tax rate is zero. At what federal tax rate are you indifferent between the two bonds?

Your corporation has a marginal tax rate of 35% and has purchased preferred stock in another company. The before-tax dividend yield on the preferred stock is 12%. What is the company's after-tax return on the preferred, assuming a 70% dividend exclusion?

Which of the following statements is CORRECT?

Van Dyke Corporation has a corporate tax rate equal to 30%. The company recently purchased preferred stock in another company. The preferred stock has an 8% before-tax yield. What is Van Dyke's after-tax yield on the preferred stock?

A 7-year municipal bond yields 4.8%. Your marginal tax rate (including state and federal taxes) is 27%. What interest rate on a 7-year corporate bond of equal risk would provide you with the same after-tax return?

On its 12/31/08 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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.

Wu Systems has the following balance sheet. How much net working capital does the firm have?

The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of the stockholders' claim against the firm's existing assets. Put another way retained earnings are stockholders' reinvested earnings.

EBIT stands for earnings before interest and taxes, and it is often called "operating income."

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.

On the balance sheet, total assets must always equal the sum of total liabilities plus equity.