Fundamentals of Financial Management 12th Edition Brigham Test Bank PDF

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Test bank for chapter no. 2 of Financial Management by Brigham...

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FINANCIAL STATEMENTS, CASH CHAPTER 3 FLOW, AND TAXES

(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)

This chapter has a lot of definitions. They are important, but we don't like to make students memorize too many of them early in the course. We let our students use a formula sheet that includes the key definitions. Also, note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in multiple-choice questions. Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject lines. Multiple Choice: True/False (3-1) Annual report 1

.

F K

Answer: a

EASY

The annual report contains four basic financial statements: the income statement, the balance sheet, the cash flow statement, and statement of stockholders' equity. a. True b. False

(3-1) Annual report 2

.

F K

Answer: a

EASY

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

(3-1) Financial statements 3

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F K

Answer: b

EASY

Companies typically provide four basic financial statements: the fixed income statement, the current income statement, the balance sheet, and the cash flow statement. a. True b. False

(3-2) Balance sheet 4

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F K M

Answer: a

EASY

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

Chapter 3: Financial Statements

True/False

Page 33

(3-2) Balance sheet 5

.

F K M

Answer: a

EASY

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 amounts at which the assets are carried on the books. a. True b. False

(3-2) Balance sheet 6

.

C K M

Answer: b

EASY

The amount shown on the December 31, 2009 balance sheet as "retained earnings" is equal to the firm's net income for 2009 minus any dividends it paid. a. True b. False

(3-3) Income statement 7

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C K M

Answer: a

EASY

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 of cash, and reported costs likewise may not be consistent with 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

(3-3) Income statement 8

.

C K M

Answer: a

EASY

If we were describing the income statement and the balance sheet, it would be correct to say that the income statement is more like a video while the balance sheet is more like a snapshot. a. True b. False

(3-3) Income statement 9

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F K

Answer: a

EASY

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

(3-3) Income statement 10

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F K

Answer: b

EASY

EBITDA stands for earnings before interest, taxes, debt, and assets. a. True b. False

Page 34

True/False

Chapter 3: Financial Statements

(3-5) Retained earnings 11

.

C K M

Answer: b

EASY

Consider the following balance sheet, for Games Inc. Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000. Cash Inventory Accounts receivable Total CA Net fixed assets

$

Total assets

$1,400,000

$ $

50,000 200,000 250,000 500,000 900,000

Accounts payable Accruals Total CL Debt Common stock Retained earnings Total L & E

$

100,000 100,000 $ 200,000 200,000 200,000 800,000 $1,400,000

a. True b. False (3-5) Stockholders' equity stmt. 12

C K M

Answer: a

EASY

Typically, the statement of stockholders' equity starts with retained earnings at the beginning of the year, adds net income, subtracts dividends paid, and ends up with retained earnings at the end of the year. Over time, a profitable company will have earnings in excess of the dividends it pays out, and the series of annual retained earnings will result in a substantial amount of retained earnings as shown on the balance sheet. a. True b. False

(3-6) Free cash flow 13

.

F K

Answer: a

EASY

Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations. a. True b. False

(3-6) Free cash flow 14

.

F K

Answer: a

EASY

The value of any asset is the present value of the cash flows the asset is expected to provide. The cash flows a business is able to provide to its investors is its free cash flow. This is the reason that FCF is so important in finance. a. True b. False

(3-6) Free cash flow 15

.

C K M

Answer: b

EASY

If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow.

Chapter 3: Financial Statements

True/False

Page 35

a. True b. False

Page 36

True/False

Chapter 3: Financial Statements

(3-7) Income taxes 16

.

F K

Answer: b

EASY

The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision. a. True b. False

(3-7) Income taxes 17

.

F K

Answer: b

EASY

Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes. a. True b. False

(Comp.) Financial statements 18

.

F K M

Answer: b

EASY

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. True b. False

(3-2) Retained earnings 19

.

C K M

Answer: b

MEDIUM

Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm either sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors. a. True b. False

(3-2) Net working capital 20

.

F K

Answer: a

MEDIUM

Net working capital is equal to current assets minus accounts payable and accruals. a. True b. False

(3-3) Income statement 21

.

F K M

Answer: b

MEDIUM

The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line." a. True b. False

Chapter 3: Financial Statements

True/False

Page 37

(3-4) Statement of cash flows 22

.

F K

Answer: a

MEDIUM

The statement of cash flows has four main sections, one each for operating, investing, and financing activities, and one that shows a summary of the cash and cash equivalents at the end of the year. a. True b. False

(3-4) Statement of cash flows 23

.

C K M

Answer: a

MEDIUM

An increase in accounts payable represents an increase in net cash provided by operating activities just like borrowing money from a bank. An increase in accounts payable has an effect similar to taking out a new bank loan. However, these two items show up in different sections of the statement of cash flows. a. True b. False

(3-4) Statement of cash flows 24

.

C K M

Answer: b

MEDIUM

An increase in accounts receivable represents an increase in net cash provided by operating activities because receivables will produce cash when they are collected. a. True b. False

(3-4) Statement of cash flows 25

.

C K M

Answer: b

MEDIUM

The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that represent increases or decreases to cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt. a. True b. False

(3-4) Statement of cash flows 26

.

C K M

Answer: a

MEDIUM

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

(3-4) Cash flow and net income 27

.

F K

Answer: a

MEDIUM

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.

Page 38

True/False

Chapter 3: Financial Statements

Finance people generally put at least as much weight on cash flows as they do on net income. a. True b. False (3-5) Retained earnings 28

.

F K

Answer: b

MEDIUM

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. If the firm has sufficient retained earnings, it can purchase assets and pay for them with cash from retained earnings. a. True b. False

(3-5) Retained earnings 29

.

F K

Answer: a

MEDIUM

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. a. True b. False

(3-6) Free cash flow 30

.

F K

Answer: a

MEDIUM

In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and changes in net working capital. a. True b. False

(3-6) Free cash flow 31

.

F K

Answer: b

MEDIUM

Free cash flow is the amount of cash that if withdrawn would harm the firm's ability to operate and to produce future cash flows. a. True b. False

(3-7) Income taxes 32

.

C K M

Answer: b

MEDIUM

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

(3-7) Income taxes

Chapter 3: Financial Statements

C K M

True/False

Answer: a

MEDIUM

Page 39

33

.

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

Page 40

True/False

Chapter 3: Financial Statements

(3-7) Income taxes 34

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F K

Answer: b

MEDIUM

Because the U.S. tax system is a progressive tax system, a taxpayer's marginal and average tax rates are the same. a. True b. False

(3-7) Income taxes 35

.

F K

Answer: a

MEDIUM

The alternative minimum tax (AMT) was created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions. a. True b. False

(Comp.) Financial statements 36

.

F K

Answer: a

MEDIUM

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 specific changes in accounts over that period of time. a. True b. False

Multiple Choice: Conceptual (3-1) Financial statements 37

.

F K

Answer: b

EASY

Which of the following statements is CORRECT? a. 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. b. The balance sheet gives us a picture of the firm’s financial position at a point in time. c. The income statement gives us a picture of the firm’s financial position at a point in time. d. The statement of cash flows tells us how much cash the firm must pay out in interest during the year. e. The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.

Chapter 3: Financial Statements

Conceptual M/C

Page 41

(3-1) Financial statements 38

.

F K

Answer: b

EASY

Which of the following statements is CORRECT? a. Assets other than cash are expected to produce cash over time, and the amounts of cash they eventually produce should be exactly the same as the amounts at which the assets are carried on the books. b. 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. c. The annual report is an internal document prepared by a firm's managers solely for the use of its creditors/lenders. d. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and statement of stockholders' equity. e. Prior to the Enron scandal in the early 2000s, companies would put verbal information in their annual reports, along with the financial statements. That verbal information was often misleading, so today annual reports can contain only quantitative information--audited financial statements.

(3-2) Balance sheet 39

.

C K M

Answer: e

EASY

Which of the following statements is CORRECT? 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.

(3-2) Balance sheet 40

.

C K M

Answer: c

EASY

Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet? a. b. c. d. e.

Page 42

The The The The The

company company company company company

repurchases common stock. pays a dividend. issues new common stock. gives customers more time to pay their bills. purchases a new piece of equipment.

Conceptual M/C

Chapter 3: Financial Statements

(3-2) Current assets 41

.

Answer: d

EASY

Accounts payable. Short-term notes payable to the bank. Accrued wages. Cost of goods sold. Accrued payroll taxes.

(3-3) Income statement .

C K M

Which of the following items cannot be found on a firm’s balance sheet under current liabilities? a. b. c. d. e.

43

EASY

Accounts receivable. Inventory. Bonds. Cash. Short-term, highly-liquid, marketable securities.

(3-2) Current liabilities .

Answer: c

Which of the following items is NOT normally considered to be a current asset? a. b. c. d. e.

42

C K M

C K M

Answer: e

EASY

Which of the following statements is CORRECT? a. The focal point of the income statement is the cash account, because that account cannot be manipulated by “accounting tricks.” b. The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow generally accepted accounting principles (GAAP). c. 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). d. If a firm follows generally accepted accounting principles (GAAP), then its reported net income will be identical to its reported cash flow. e. The income statement for a given year, say 2008, is designed to give us an idea of how much the firm earned during that year.

(3-7) Income taxes 44

.

F K

Answer: b

EASY/MEDIUM

Which of the following statements is most correct? a. Corporations are allowed to exclude 70% of their interest income from corporate taxes. b. Corporations are allowed to exclude 70% of their dividend income from corpor...