Financial Management (Chapter 1: Getting Started-Principles of Finance)

Financial Management (Chapter 1: Getting Started-Principles of Finance)
1.1 Finance: An Overview
1) Which of the following statements best represents what finance is about?

A) How political, social, and economic forces affect corporations
B) Maximizing profits
C) The study of how people and businesses make investment decisions and how to finance
those decisions
D) Reducing risk
2) From a financial point of view, a company that decides to develop new product is making
A) a financing decision.
B) an investment decision.
C) a capital structure decision.
D) a cash flow decision.
3) Working capital management refers to

A) long-term financing decisions.
B) the management of cash flows.
C) investing in product development.
D) capital structure.
4) Finance managers need to interact constantly with

A) marketing managers.
B) accounting staff.
C) management information systems staff.
D) all of the above.
5) The personal decision to obtain a college degree in business is primarily a(n) ________
decision.
A) social
B) investment
C) ethical
D) financing
6) The area of finance that deals with long-term investment decisions is known as
A) capital structure.
B) working capital management.
C) financial strategy.
D) capital budgeting.
7) Capital structure refers to the financing of long-term investments.

Answer: TRUE
8) Business financial decisions are fundamentally different from personal financial decisions.
Answer: FALSE
9) What are the three basic questions addressed by the study of investments?
Answer:
1. What investments should the firm undertake?
2. How should the firm fund these investments?
3. How can the firm best manage cash flows in its day-to-day operations?
1.2 Three Types of Business
1) Which of the following is NOT an advantage of the sole proprietorship?

A) Limited liability
B) No time limit imposed on its existence
C) No legal requirements for starting the business
D) None of the above
2) What is the chief disadvantage of the sole proprietorship as a form of business organization
when compared to the corporate form?
A) Sole proprietorships are subject to double taxation of profits.
B) The cost of formation.
C) Inadequate profit sharing.
D) Owners have unlimited liability.
3) Which of the following is NOT true for limited partnerships?

A) Limited partners can only manage the business.
B) One general partner must exist who has unlimited liability.
C) Only the name of general partners can appear in the name of the firm.
D) Limited partners may sell their interest in the company.
4) The true owners of the corporation are the

A) holders of debt issues of the firm.
B) preferred stockholders.
C) board of directors of the firm.
D) common stockholders.
5) In terms of organizational costs, which of the following sequences is generally correct,

moving from lowest to highest cost?
A) General partnership, sole proprietorship, limited partnership, corporation
B) Sole proprietorship, general partnership, limited partnership, corporation
C) Corporation, limited partnership, general partnership, sole proprietorship
D) Sole proprietorship, general partnership, corporation, limited partnership
6) Assume that you are starting a business. Further assume that the business is expected to
grow very quickly and a great deal of capital will be needed soon. What type of business
organization would you choose?
A) Corporation
B) General Partnership
C) Sole proprietorship
D) Limited partnership
7) Which one of the following categories of owners enjoys limited liability?

A) General partners in a limited partnership or limited liability company
B) Shareholders (common stock) of a corporation
C) Sole proprietors
D) Both A and B
8) Which of the following is a characteristic of a limited partnership?

A) It allows one or more partners to have limited liability.
B) It requires one or more of the partners to be a general partner to whom the privilege of limited
liability does not apply.
C) It prohibits the limited partners from participating in the management of the partnership.
D) All of the above.
9) Which of the following forms of organization blends elements of partnerships and

corporations?
A) D.B.A.'s
B) Sole proprietorships
C) Limited liability companies (LLC's)
D) General partnership
10) Which of the following types of business forms is least risky to investors?
A) Sole proprietorship
B) Limited partnership
C) General partnership
D) A public corporation
11) Which forms of organization are free of initial legal requirements?

B) General partnership
C) Corporation
D) Both A and B
12) For these types of organization, no distinction is made between business and personal
assets.
B) General partnership
C) Limited partnership
D) Both A and B
13) Which of the following is a significant disadvantage of a general partnership?

A) The cost of forming it is high.
B) Each partner is fully responsible for the liabilities incurred by the partnership.
C) There is a risk associated with the industry in which it operates.
D) Forming the business is very complex.
14) Which of the following forms of business organization is the dominant economic force in the
United States?
A) The sole proprietorship
B) The general partnership
C) The limited partnership
D) The joint venture
E) The corporation
15) A limited partner is liable

A) for only his or her own share of the partnership's debts.
B) for his or her own share of the partnership's debts and contingently liable for the other
partners shares.
C) only up to the amount invested by that partner.
D) for none of the partnership's debts.
16) A corporation is owned by

A) shareholders and partners.
B) the shareholders who hold the company's stock.
C) the Board of Directors.
D) its Chief Executive Officer.
17) The major sources of financing for corporations are

A) partners contributions.
B) exchanges between shareholders.
C) interest and dividends.
D) debt and equity.
18) The term stockholder is equivalent to

A) general partner.
B) creditor.
C) shareholder.
D) stakeholder.
19) The sole proprietorship is the same as the individual for liability purposes.
Answer: TRUE
20) In a general partnership, all partners have unlimited liability for the actions of any one
partner when that partner is conducting business for the firm.
Answer: TRUE
21) There is no legal distinction made between the assets of the business and the personal
assets of the owners in the limited partnership.
Answer: FALSE
22) The owners of a corporation are liable for the corporation's obligations up to the amount of
their investment.
Answer: TRUE
23) General partners have unrestricted transferability of ownership, while limited partners must
have the consent of all partners to transfer their ownership.
Answer: FALSE
24) Ultimate control in a corporation is vested in the board of directors.

Answer: FALSE
25) Owners must register and pay yearly fees to their State of residence when establishing a
sole proprietorship.
Answer: FALSE
26) Limited partners may actively manage the business.

Answer: FALSE
27) The life of a corporation is not dependent upon the status of the investors.
Answer: TRUE
28) A sole proprietorship is the most desirable business form in all circumstances.
Answer: FALSE
29) In a sole proprietorship, the owner is personally responsible without limitation for the
liabilities incurred.
Answer: TRUE
30) In a limited partnership, at least one general partner must remain in the association; the
privilege of limited liability still applies to this partner.
Answer: FALSE
31) In a general partnership, each partner is liable for the partnership's obligations only up to a
percentage of the obligation equal to that partner's percentage of ownership of the partnership.
Answer: FALSE
1.3 The Goal of the Financial Manager
1) Maximization of shareholder wealth as a goal is superior to accounting profit maximization

because
A) it considers the time value of the money.
B) following the shareholder wealth maximization goal will ensure high stock prices.
C) accounting profits are not the same as cash flows.
D) A and C.
2) Which of the following best describes the goal of the firm?

A) The maximization of the total market value of the firm's common stock
B) Profit maximization
C) Risk minimization
3) Profit maximization does not adequately describe the goal of the firm because
A) profit maximization does not require the consideration of risk.
B) profit maximization ignores the timing of a project's return.
C) maximization of dividend payout ratio is a better description of the goal of the firm.
D) A and B.
4) Which of the following goals of the firm is equivalent to the maximization of shareholder
wealth?
A) Profit maximization
B) Risk minimization
C) Maximization of the total market value of the firm's common stock
5) If managers are making decisions to maximize shareholder wealth, then they are primarily
concerned with making decisions that should
A) positively affect profits.
B) increase the market value of the firm's common stock.
C) either increase or have no effect on the value of the firm's common stock.
D) accomplish all of the above.
6) Profit maximization is not an adequate goal of the firm when making financial decisions
because
A) it does not necessarily reflect shareholder wealth maximization.
B) it ignores the risk inherent in different projects that will generate the profits.
C) it ignores the timing of a project's returns.
D) all of the above are correct.
7) Which of the following goals is in the best long-term interest of stockholders?

A) Profit maximization
B) Risk minimization
C) Maximizing of the market value of the existing shareholders' common stock
D) Maximizing sales revenues
8) If managers do not pursue the goal of maximizing shareholder wealth

A) they concentrate on more important matters like growing market share.
B) they can focus more on social responsibilities.
C) they are likely to lose their jobs.
D) they can focus more on long-term profitability.
9) What does the agency problem refer to?

A) The conflict that exists between the board of directors and the employees of the firm.
B) The problem associated with financial managers and Internal Revenue agents.
C) The conflict that exists between stockbrokers and investors.
D) The problem that results from potential conflicts of interest between the manager of a
business and the stockholders.
10) Managers of corporations need to act in an ethical manner

A) because ethics violations will be punished by the law.
B) because a business must be trusted by investors, customer and the public if it is to succeed.
C) because business managers must answer to a higher authority.
D) because ethical behavior is its own justification.
11) In regard to the agency problem, ________ are the principal owners of a corporation.
A) shareholders
B) managers
C) employees
D) suppliers
12) Serious ethical violations by corporations such as Enron led to the passage of
A) the Dodd-Frank Act.
B) the Insider Trading Act of 1988.
C) the Sarbanes-Oxley Act.
D) All of the above.
13) The goal of the firm should be the maximization of profit.

Answer: FALSE
14) One of the problems associated with profit maximization is that it ignores the timing of a
project's return.
Answer: TRUE
15) The goal of profit maximization is equivalent to the goal of maximization of share value.
Answer: FALSE
16) The goal of profit maximization ignores the timing of profit.

Answer: TRUE
17) The goal of maximize shareholder wealth inevitably conflicts with socially responsible
behavior on the part of corporation.
18) The Sarbane-Oxley Act addresses insider trading by members of Congress.

Answer: FALSE
19) A reputation for unethical behavior can negatively affect the value of a company's stock.
Answer: TRUE
20) The agency problem arises due to the separation of ownership and control in a corporation.
Answer: TRUE
21) Briefly discuss the incentives for financial managers to conduct their business in an ethical
manner.
Answer: Extreme ethical lapses such as those evident in the Madoff Ponzi scheme may also
break laws and result in fines or imprisonment. In less extreme cases, deceptive accounting
practices or sales techniques once exposed lead to a loss of trust. Because individuals and
firms are reluctant to do business with those they mistrust, a reputation for unethical behavior
over the long run leads to adversarial relations with business partners, a loss of customers, and
destruction of the firm's value.
1.4 The Four Basic Principles of Finance
1) Consider the following equally likely project outcomes:
Profit
X Y
Pessimistic prediction $ 0 $500
Expected outcome $ 500 $500
Optimistic prediction $1000 $500
A) Investors will prefer project X because it potentially offers a higher profit.

B) Investors will reject both projects because the profit is too low.
C) Investors will prefer project Y because the expected return is the same as for project X but
the outcome is certain.
D) Since Projects X and Y have the same expected outcomes of $500, investors will view them
as identical in value.
2) Consider the timing of the profits of the following certain investment projects:
Profit
L S
Year 1 $ 0 $ 3000
Year 2 $ 3000 $ 0
A) Project S is preferred to Project L.

B) Project L is preferred to Project S.
C) Projects S and L are equally desirable.
D) A goal of profit maximization would favor Project S only.
3) In finance, we assume that investors are generally

A) neutral to risk.
B) averse to risk.
C) fond of risk.
D) none of the above.
4) Consider cash flows for Projects X and Y such as:
Project X Project Y

Year 1 $3000 $ 0
Year 2 $ 0 $3000
A rational person would prefer receiving cash flows sooner because

A) the money can be reinvested.
B) the money is nice to have around.
C) the investor may be tired of a particular investment.
D) the investor is indifferent to either proposal.
5) Which of the following should be considered when assessing the financial impact of business
decisions?
A) The amount of projected earnings
B) The risk-return tradeoff
C) The timing of projected earnings; i.e., when they are expected to occur
D) All of the above
6) Which of the following is most likely to motivate executives to maximize shareholder wealth?
A) Tying bonuses to cost reductions and meeting budget goals
B) Offering them relatively high salaries
C) Tying annual bonuses to increases in annual profits
D) Compensating them with stock options that can only be exercised after five years
7) If one security has a greater risk than another security, how will investors respond?
A) They will require a lower rate of return for the investment that has greater risk.
B) They would be indifferent regarding their expectation of rates of return for either investment.
C) They will require a higher rate of return for the investment that has greater risk.
D) None of the above.
8) How could you compensate an investor for taking on a significant amount of risk?
A) Increase the expected rate of return
B) Raise more debt capital
C) Offer stock at a higher price
D) Increase sales
9) If an investor had a choice of receiving $1,000 today, or $1,000 in five years, which would the
average investor prefer?
A) $1,000 in five years because they are not good at saving money.
B) $1,000 today because it will be worth more than $1,000 received in five years.
C) $1,000 in five years because it will be worth more than $1,000 received today.
D) Investors would be indifferent to when they would receive the $1,000.
E) None of the above.
10) Why do investors prefer receiving cash sooner rather than later, according to finance
theory?
A) Incremental profits are greater than accounting profits.
B) Money received earlier can be reinvested and returns can be increased.
C) Tax considerations are important when investing.
D) Diversification leads to increased value.
11) Investors choose to invest in higher risk investments because these investments offer
higher
A) expected returns.
B) inflation.
C) actual returns.
D) future consumption.
12) Foregoing the earning potential of a dollar today is referred to as the

A) time value of money.
B) opportunity cost concept.
C) risk/return tradeoff.
D) creation of wealth.
13) In measuring value, the focus should be on

A) cash flow.
B) accounting profits.
C) time value of money.
D) earnings per share.
14) Which of the following is a characteristic of an efficient market?

A) Small number of individuals
B) Opportunities exist for investors to profit from publicly available information.
C) Security prices reflect fair value of the firm.
D) Immediate response occurs for new public information.
15) Which of the following factors is most important in investment decisions?

A) The change in earnings before taxes.
B) The change in gross sales revenue.
C) The change in net income.
D) The change in after-tax cash flow.
16) Investors prefer $1 today versus $1 in the future due to

A) time value of money.
B) response to incentives.
C) the need for immediate gratification.
D) A and B.
17) The price of Netflix stock dropped sharply after customers responded negatively to a
change in pricing policies. The change in stock price illustrates which principle?
A) Market prices reflect information.
B) Individuals respond to incentives.
C) Cash flows are the source of value.
D) The time-value of money.
18) For the risk-return principle implies that the more risky a given course of action, the higher
the expected return must be.
Answer: TRUE
19) The financial manager should examine available risk-return trade-offs and make his
decision based upon the greatest expected return.
Answer: FALSE
20) Only a few financial decisions involve some sort of risk-return tradeoff.
Answer: FALSE
21) In efficient markets, price adjustments to new information are gradual.

Answer: FALSE
22) Rewarding executives for increasing quarterly earnings will motivate them to act in the long-
term best interests of shareholders.
Answer: FALSE
23) In an efficient market, prices will quickly adjust to new information.

Answer: TRUE
24) Briefly discuss why financial decision makers must focus on incremental cash flows when
evaluating new projects.
Answer: Incremental cash flows describe the total cash effect on the company, looking at the
difference between total cash flow to the company with the cash flow, and without the cash flow.
The company can then value these cash flows and see if the company is worth more with the
project or without the project.
25) Discuss the risk/return tradeoff and how it relates to finance.

Answer: As people are risk averse, they need a higher return as the risk gets higher. This
means that investors will need a higher return on bonds that they do not consider to be as safe
as other bonds, and they will need a higher return on stock when the company in question's
stock seems to be riskier than the stock of other companies.
26) Why do you think many companies compensate executives with options based on long-term
increases in the value of the company's stock?
Answer: Tying executive compensation to long-term increases in the stock price makes sense
because they are supposed to be working to maximize shareholder wealth. Stock-based
compensation plans imply that decisions made to benefit shareholders will also benefit
themselves.
Financial Management (Chapter 3: Understanding Financial Statements,

Taxes, and Cash Flows)
3.1 An Overview of the Firm's Financial Statements
1) Which of the basic financial statements is best used to answer the question, "How profitable
is the business?"
A) Balance sheet
B) Statement of shareholder's equity
C) Income statement
D) Accounts receivable aging schedule
2) Who owns the retained earnings of a public firm?

A) The IRS
B) Common stockholders
C) Bondholders
D) Preferred stockholders
3) Which of the following represents an attempt to measure the earnings of the firm's operations
over a given time period?
A) Balance sheet
B) Cash flow statement
C) Income statement
4) Stock that is repurchased by the issuing company is called

A) paid in capital.
B) treasury stock.
C) retained capital.
D) par value stock.
5) Which of the basic financial statements is best used to answer the questions "What does the
company own and how is it financed?"
A) Balance sheet
C) Income statement
D) Cash flow statement
6) Which of the basic financial statements is best used to answer the questions "Where did the
company's money come from and how was it spent over the preceding year?"
A) Balance sheet
C) Income statement
7) Which of the basic financial statements is best used to answer questions about changes in
owner's equity that are not explained by the income statement?
A) Balance sheet
C) Income statement
8) The income statement shows a company's earnings since it has been in business.
Answer: FALSE
9) The balance includes information about the company's assets and liabilities.
Answer: TRUE
10) The cash flow statement shows amounts that the company has earned but for which it has
not yet received cash.
Answer: FALSE
11) The cash flow statement is an alternative term for the balance sheet.
Answer: FALSE
3.2 The Income Statement
1) On the income statement, sales revenue, minus cost of goods sold and operating expenses,
equals which of the following?
A) Net profit
B) Retained earnings
C) Net income available to preferred shareholders
D) EBIT
2) Which of the following streams of income is not affected by how a firm is financed (whether
with debt or equity)?
A) Net profit after tax but before dividends
B) Net working capital
C) Operating income
D) Income before tax
3) Which of the following is not included in computing EBT (earnings before taxes)?
A) Marketing expenses
B) Depreciation expense
C) Cost of goods sold
D) Dividends
4) Your firm has the following income statement items: sales of $50,250,000; income tax of
$1,744,000; operating expenses of $10,115,000; cost of goods sold of $35,025,000; and
interest expense of $750,000. What is the amount of the firm's EBIT?
A) $15,552,000
B) $58,000,000
C) $5,110,000
D) $4,630,000
interest expense of $750,000. What is the amount of the firm's gross profit?
A) $18,000,000
B) $15,225,000
C) $5,000,110
D) $6,632,000
interest expense of $750,000. What is the amount of the firm's income before tax?
A) $4,360,000
B) $750,000
C) $10,865,000
D) $25,115,000
$1,744,000; operating expenses of $8,750,000; cost of goods sold of $35,025,000; and interest
expense of $750,000. What is the amount of the firm's net income?
A) $255,223
B) $4,731,000
C) $2,616,000
D) $7,775,000
$1,880,000; operating expenses of $9,000,000; cost of goods sold of $36,000,000; and interest
expense of $800,000. Compute the firm's gross profit margin.
A) 13.5%
B) 8.3%
C) 30.8%
D) 69.2%
Table 1
Jones Company
Financial Information
March 1995 March 1996
Net income $1,500 $3,000
Accounts receivable 750 750
Accumulated depreciation 1,125 1,500
Common stock 4,500 5,250
Capital surplus 7,500 8,250
Retained earnings 1,500 2,250
Accounts payable 750 750
9) Based on the information given in Table 1, calculate the dividends paid in 1996.
A) $3,750
B) $3,000
C) $750
D) $2,250
Table 2
Bird Industries, Inc.
Balance Sheets
2011 2012
Cash $1,000 $?
Accounts receivable 5,000 6,000
Inventories 6,500 6,000
Land 10,000 12,000
Other fixed assets 8,000 9,000
Accumulated depreciation (1,000) (1,600)
Total assets $29,500 $?
Accounts payable $3,200 $ 6,800
Bonds 4,000 4,000
Total debt and equity $29,500 $?
Bird Industries, Inc.

Income Statement
Sales $84,000
Cost of goods sold 66,400
Gross profit $17,600
Operating expenses (13,000)
Depreciation (600)
EBIT $4,000
Interest expense (500)
EBT $3,500
Taxes (1,500)
Net Income $2,000
10) Based on the information contained in Table 2, what was the total amount of Bird Industries'
common stock dividend for 2012?
A) $800
B) $2,300
C) $2,000
D) Cannot be determined with available information
11) Based on the information contained in Table 2, what was Bird Industries' operating profit
margin for 22012?
A) 21%
B) 4.8%
C) 4.2%
D) 2.4%
Table 3
Snark Enterprises, Inc.
Balance Sheets
2011 2012
Cash $1,000 $?
Accounts receivable 8,000 9,000
Inventories 4,000 7,000
Land 10,000 10,000
Other fixed assets 5,000 5,500
Accumulated depreciation (1,600) (2,000)
Total assets $26,400 $?
Accounts payable $4,200 $ 7,000
Bonds 4,000 4,000
Total debt and equity $26,400 $?
Snark Enterprises, Inc.

Income Statement
Sales $44,900
Cost of goods sold (22,000)
Gross profit $12,900
Depreciation (400)
EBIT $2,500
Interest expense (500)
EBT $2,000
Taxes (1,000)
Net Income $1,000
12) Based on the information contained in Table 3, what was the total amount of Snark
Enterprise's common stock dividend for 2012?
A) $0
B) $400
C) $600
D) Cannot be determined with available information
13) Based on the information contained in Table 3, what is Snark Enterprise's gross profit
margin in 2012.
A) 5.6%
B) 4.5%
C) 29.7%
D) 2.2%
14) Which of the following best represents operating income?

A) Income after financing activities
B) Earnings before interest and taxes
C) Income from capital gains
D) Income from discontinued operations
15) Which of the following best represents the stream of income that is available to
stockholders?
A) Net profit after tax
B) Earnings before interest, taxes and dividends
C) Gross profit
D) Operating profit
16) Which of the following is NOT included in operating income?

A) Cost of goods sold
B) Sales
C) Taxes
D) Operating expenses
17) Using the information provided, calculate net income for 2013. Assume a tax rate of 35
percent.
Year 2013
Inventory $5,000
Revenues 200,000
Depreciation expense 5,000
Interest expense 10,000
Operating expenses 30,000
A) $35,750
B) $44,000
C) $50,000
D) $19,250
18) The practice of shifting income from good years to poor years in order to show a record of
steady growth is
A) known as earnings management and is considered unethical.
B) highly recommended but not required by GAAP.
C) a basic requirement of accrual accounting.
D) impossible if Generally Accepted Accounting Principles are followed.
19) Firms should compare their gross, operating and net profit margins to past years and other
companies in order to
A) evaluate the firm's performance.
B) identify expenses that seem to be out-of-line
C) better manage the reporting of the firm's earnings.
D) Both A and B.
20) The income statement represents a snapshot of account balances at one point in time.
Answer: FALSE
21) Generally Accepted Accounting Principles (GAAP) require companies to smooth earnings
by shifting some profits from good years to bad years.
Answer: FALSE
22) The income statement describes the financial performance of a firm over a fixed period such
as a quarter or a year.
Answer: TRUE
23) On an accrual basis income statement, revenues and expenses always match the firm's
cash flow.
Answer: FALSE
24) Corporate income statements are usually compiled on an accrual, rather than cash, basis.
Answer: TRUE
25) The company's gross profit margin is EBIT divided by net sales.
Answer: FALSE
Table 4
Financial Data for Dooley Sportswear, December 31, 2013
Inventory $206,250
Accumulated depreciation 442,500
Cash 180,000
Net sales (all credit) 1,500,000
Accounts receivable 225,000
Accounts payable 168,750
Prepaid insurance 80,000
Accrued wages 65,000
Federal income taxes 5,750
26) From the scrambled list of items presented in Table 4, prepare an income statement Dooley
Sportswear Company. Not all items from Table 4 will be used.
Answer: Dooley Sportswear Company Income Statement
for the Year Ending December 31, 2013
Net sales (all credit) $1,500,000
Gross profits 562,500
EBIT 525,000
Net operating income 37,500
Net income before taxes 32,500
Federal income taxes 5,750
Net income $26,750
3.3 Corporate Taxes
1) 2013 U.S. Corporate tax rates are shown below:
Taxable Income Marginal Tax Rate

$0-$50,000 15%
$50,001-$75,000 25%
$75,001-$100,000 34%
$100,001-$335,000 39%
$335,001-$10,000,000 34%
$10,000,001-$15,000,000 35%
$15,000,001-$18,333,333 38%
Over $18,333,333 35%
RJH Inc. has earnings before taxes of $100,000 in 2013. The company's tax expense will be
A) $22,250
B) $24,670
C) $25,000
D) $34,000
2) 2013 U.S. Corporate tax rates are shown below:

$0-$50,000 15%
$50,001-$75,000 25%
$75,001-$100,000 34%
$100,001-$335,000 39%
$335,001-$10,000,000 34%
$10,000,001-$15,000,000 35%
$15,000,001-$18,333,333 38%
Over $18,333,333 35%
Bouffard Co. has earnings before taxes of $100,000,000 in 2013. The company's tax expense
will be
A) $3,500,000
B) $36,500,000
C) $31,875,000
D) $35,000,000
3) A & K Co. expects to have earnings before taxes of $250,000 to $300,000. The company's
marginal tax rate is 39% and its average tax rate about 33%. For every additional dollar of
interest expense, A & K's taxes will
A) increase by 39 cents.
B) fall by 39 cents.
C) be unaffected.
D) fall by about 33 cents.
4) A & K Co. expects to have earnings before taxes of $250,000 to $300,000. The company's
marginal tax rate is 39% and its average tax rate about 33%. For every additional dollar A & K
pays out in common dividends, its income tax liability will
A) increase by 39 cents.
B) fall by 39 cents.
C) be unaffected.
D) fall by about 33 cents.
5) Tax tables are based on ________ tax rates.

A) marginal
B) average
C) implied
D) investment
6) The marginal tax rate would equal the average tax rate for firms with earnings less than
$50,000 or more than $18,333,333.
Answer: TRUE
7) The interest payments on corporate bonds are tax-deductible.

Answer: TRUE
8) A corporation's average tax rate will always be lower than or equal to its marginal tax rate.
Answer: TRUE
9) The highest marginal corporate tax rate is 35%.

Answer: FALSE
10) When analyzing the cash flows from a new project proposal, a company should always use
its marginal tax rate.
Answer: TRUE
11) Pearls, Inc. had sales in 2013 of $2.1 million. The common stockholders received $600,000
in cash dividends. Interest totaling $150,000 was paid on outstanding debts. Operating
expenses totaled $300,000, and cost of goods sold was $500,000. What is the tax liability of
Pearls, Inc.? 2013 U.S. Corporate tax rates are shown below:

$0-$50,000 15%
$50,001-$75,000 25%
$75,001-$100,000 34%
$100,001-$335,000 39%
$335,001-$10,000,000 34%
$10,000,001-$15,000,000 35%
$15,000,001-$18,333,333 38%
Over $18,333,333 35%
Answer: Pearls Taxable Income

Sales $2,100,000
Less:
Cost of goods sold $500,000
Earnings before interest & taxes $1,300,000
Taxable income 1,150,000
Total taxes owed $391,000
Taxes on operating earnings = (.15)(50,000) + (.25)(25,000) + (.34) 25,000) + (.39)(235,000) +.
(34)(735,000)= 7,500 + 6,250 + 8500 + 91,650+277,100 = $391,000 or
Because taxable income is over $335,000
taxes can be computed 1,150,000 × .34 =
$391,000
12) Goodwin Enterprises had a gross profit of $2,500,000 for the year. Operating expenses and
interest expense incurred in that same year were $595,000 and $362,000, respectively.
Goodwin had 200,000 shares of common stock and 180,000 shares of preferred stock
outstanding. Management declared a $2.50 dividend per share on the common and a $1.50
dividend per share on the preferred. Securities purchased at a cost of $37,500 in a previous
year were resold at a price of $50,500. Compute the taxable income and the resulting tax
liability for Goodwin Enterprises for the year.
Use the following tax rates:
Income Tax rate
$0-$50,000 15%
$50,001-$75,000 25%
$75,001-$100,000 34%
$100,001-$335,000 39%
over $335,001 34%
Answer:
Gross profit $2,500,000
Interest expense (362,000)
Income before tax $1,543,000
Add: Gain on sales 13,000
Taxable Income $1,556,000
Income Marginal Tax Rate Tax Liability

$50,000 × 15% $7,500
$25,000 × 25% $6,250
$25,000 × 34% $8,500
$235,000 × 39% $91,650
$1,221,000 × 34% $415,140
$1,556,000 $529,040
By design, the marginal and the average tax rates are the same, 34%, for corporate incomes
between $335,000 and $10,000,000.
3.4 The Balance Sheet
1) Which of the following is not a current asset?

A) Accounts payable
B) Marketable securities
C) Accounts receivable
D) Inventory
2) Net plant and equipment is

A) plant and equipment purchases less amount borrowed to finance purchases.
B) current year plant and equipment purchases less current year's depreciation expense.
C) gross plant and equipment less accumulated depreciation.
D) plant and equipment at current market valuations.
3) Your firm has the following balance sheet statement items: total current liabilities of $805,000;
total assets of $2,655,000; fixed and other assets of $1,770,000; and long-term debt of
$200,000. What is the amount of the firm's total current assets?
A) $885,000
B) $1,550,000
C) $600,000
D) $325,000
4) Your firm has the following balance sheet statement items: total current liabilities of $805,000;
total assets of $2,655,000; fixed and other assets of $1,770,000; and long-term debt of
$200,000. What is the amount of the firm's net working capital?
A) $25,000
B) $325,000
C) $770,000
D) $80,000
5) Which of the following best describes a balance sheet?

A) Reports cash receipts and cash disbursements for a specific accounting period
B) Reports investment activities for a specified accounting period
C) Reports revenues and expenses for a specific accounting period
D) Reports the amount and composition of assets and liabilities at a specified point in time
6) Which of the following would NOT be included as an asset on a corporate balance sheet?
A) Accounts receivable
B) Common stock
C) Inventory
D) Buildings
7) Which of the following would NOT be included as a liability in a corporate balance sheet?
A) Notes payable
B) Accounts payable
C) Bonds
D) Accumulated Depreciation
8) Which of the following would NOT be included as equity in a corporate balance sheet?
A) Cash
B) Paid in capital
C) Retained earnings
D) Common stock
9) Patriot Corporation purchased manufacturing equipment with an expected useful life of five
years. The purchase of the machinery would be shown as
A) an expense on the balance sheet.
B) an expense on the income statement.
C) an asset on the balance sheet.
D) both an expense and an asset.
10) When a company pays a dividend on common stock, it appears as

A) an expense on the income statement.
B) a reduction in the amount of retained earnings.
C) a current liability on the balance sheet.
D) dividend payments have no effect on the financial statements.
11) Grass Gadgets had sales of $30 million and net income of $2 million in 2008. Grass paid a
dividend of $1.5 million. Assuming that their beginning balance for retained earnings was $3
million, calculate their ending balance for retained earnings.
A) $2.5 million
B) $3 million
C) $3.5 million
D) $4 million
12) Total equity on the balance sheet increases as dividends paid increases.
Answer: FALSE
13) A balance sheet is a statement of the financial position of the firm on a given date, including
its asset holdings, liabilities, and equity.
Answer: TRUE
14) Under current accounting rules, plant and equipment appear on a company's balance sheet
valued at replacement value.
Answer: FALSE
15) When a corporation sells common stock to investors, the amount is added to revenue on the
income statement.
Answer: FALSE
16) An advantage of balance sheet numbers is that assets reflect current market values.
Answer: FALSE
17) A firm's balance sheet provides a representation of the current market value of the
company.
Answer: FALSE
18) Gross plant and equipment minus accumulated depreciation represents the fair market
value of a company's fixed assets.
Answer: FALSE
19) Balance sheet and other accounts for GPA are listed below in alphabetical order. Use these
accounts to construct GPA's balance sheet for 2013. All balance sheet accounts are shown,
but some accounts will not be used. All amounts are in millions of dollars.
Accounts payable $1900

Accounts receivable $661
Cash $1,000
Common stock $2,000
EBIT $1,968
Interest expense $8.00
Inventories $1,620
Long-term debt $890
Net plant & equipment $2,563
Other current assets $645
Other long-term assets $576
Retained earnings $2,080
Short-term debt $195
Taxes $778
Answer:
Balance Sheet: GPA
Inc. 2013
Cash $1,000Accounts payable $1,900
Accounts receivable 661Short-term debt 195
Inventories 1,620Total current liabilities $2,095
Other current assets 645Long-term debt 890
Total current assets $3,926Common stock 2,000
Net plant & equipment 2,563Retained earnings 2,080
Other long-term assets 576
Total assets $7,065Total liab. & equity $7,065
3.5 The Cash Flow Statement
1) Which of the following represents a source of cash?

A) A decrease in accounts payable
B) A decrease in accounts receivable
C) Payment of dividends
D) An increase in inventories
2) The change between a firm's beginning cash balance and ending cash balance would equal
A) cash flow from operations + cash flow from investing activities + cash flow from financing
activities.
B) the change in current assets minus the change in current liabilities.
C) net income plus new borrowing minus asset purchases.
D) total assets minus total liabilities minus total stockholders' equity.
3) Which of the following does NOT represent cash outflows to the firm?
A) Taxes
B) Interest payments
C) Dividends
D) Depreciation
4) The ratio of ________ to ________ is an indicator of the quality of a firm's earnings.

A) cash flow from operations, net income
B) liabilities, assets
C) dividends, interest expense
D) cash flow from operations, capital expenditures
5) Operating cash flow will increase with a decrease in

A) inventories.
B) current liabilities.
C) depreciation expense.
D) capital expenditures.
6) In a growing business, negative cash flow from investing activities is normal.
Answer: TRUE
7) Reducing a firm's debt will increase its cash flow.

Answer: FALSE
8) Beginning cash balance + cash flow from operations + cash flow from investing activities +
cash flow from financing activities = ending cash balance.
Answer: TRUE

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Financial Management (Chapter 1: Getting Started-Principles of Finance)

1.1 Finance: An Overview

1) Which of the following statements best represents what finance is about?

3) Working capital management refers to

4) Finance managers need to interact constantly with

7) Capital structure refers to the financing of long-term investments.

1.2 Three Types of Business

1) Which of the following is NOT an advantage of the sole proprietorship?

3) Which of the following is NOT true for limited partnerships?

4) The true owners of the corporation are the

5) In terms of organizational costs, which of the following sequences is generally correct,

7) Which one of the following categories of owners enjoys limited liability?

8) Which of the following is a characteristic of a limited partnership?

9) Which of the following forms of organization blends elements of partnerships and

11) Which forms of organization are free of initial legal requirements?

13) Which of the following is a significant disadvantage of a general partnership?

15) A limited partner is liable

16) A corporation is owned by

17) The major sources of financing for corporations are

18) The term stockholder is equivalent to

24) Ultimate control in a corporation is vested in the board of directors.

26) Limited partners may actively manage the business.

1.3 The Goal of the Financial Manager

1) Maximization of shareholder wealth as a goal is superior to accounting profit maximization

2) Which of the following best describes the goal of the firm?

7) Which of the following goals is in the best long-term interest of stockholders?

8) If managers do not pursue the goal of maximizing shareholder wealth

9) What does the agency problem refer to?

10) Managers of corporations need to act in an ethical manner

13) The goal of the firm should be the maximization of profit.

16) The goal of profit maximization ignores the timing of profit.

18) The Sarbane-Oxley Act addresses insider trading by members of Congress.

1.4 The Four Basic Principles of Finance

1) Consider the following equally likely project outcomes:

A) Investors will prefer project X because it potentially offers a higher profit.

A) Project S is preferred to Project L.

3) In finance, we assume that investors are generally

4) Consider cash flows for Projects X and Y such as:

Project X Project Y

A rational person would prefer receiving cash flows sooner because

12) Foregoing the earning potential of a dollar today is referred to as the

13) In measuring value, the focus should be on

14) Which of the following is a characteristic of an efficient market?

15) Which of the following factors is most important in investment decisions?

16) Investors prefer $1 today versus $1 in the future due to

21) In efficient markets, price adjustments to new information are gradual.

23) In an efficient market, prices will quickly adjust to new information.

25) Discuss the risk/return tradeoff and how it relates to finance.

Financial Management (Chapter 3: Understanding Financial Statements,

2) Who owns the retained earnings of a public firm?

4) Stock that is repurchased by the issuing company is called

3.2 The Income Statement

Bird Industries, Inc.

Snark Enterprises, Inc.

14) Which of the following best represents operating income?

16) Which of the following is NOT included in operating income?

3.3 Corporate Taxes

1) 2013 U.S. Corporate tax rates are shown below:

Taxable Income Marginal Tax Rate

4) The ratio of to is an indicator of the quality of a firm's earnings.