Chapter 2 Financial Statements, Taxes, and Cash Flow

True/False

1. Suppose Mery, Inc. just received a patent on a new anti-cholesterol drug. This patent is considered an
intangible fixed asset.

Ans: True Level: Basic Subject: Fixed Assets Type: Concepts

2. There is a tradeoff between the advantages of liquidity and forgone potential profits.

Ans: True Level: Basic Subject: Liquidity Type: Concepts

3. According to generally accepted accounting principles (GAAP), assets are generally shown on financial
statements at the higher of current market value or historical cost.

Ans: False Level: Basic Subject: Accounting Principles Type: Concepts

4. If a firm's cash flow to stockholders is negative, then total dividends must have exceeded the value of net
new equity sold by the firm during the year.

Ans: False Level: Intermediate Subject: Cash Flows Type: Concepts

5. A firm's marginal tax rate may differ from its average tax rate. However, it is the average tax rate that is
relevant for financial decision-making purposes.

Ans: False Level: Basic Subject: Tax Rates Type: Concepts

Multiple Choice

6. The financial statement showing a firm's accounting value on a particular date is the:
A) Income statement.
B) Balance sheet.
C) Statement of cash flows.
D) Tax reconciliation statement.
E) Shareholders' equity sheet.

Ans: B Level: Basic Subject: Balance Sheet Type: Definitions

7. A current asset is:

A) An item currently owned by the firm.
B) An item that the firm expects to own within the next year.
C) An item currently owned by the firm that will convert to cash within the next 12 months.
D) The amount of cash on hand the firm currently shows on its balance sheet.
E) The market value of all the items currently owned by the firm.

Ans: C Level: Basic Subject: Current Assets Type: Definitions

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

8. ____________ normally must be paid by a firm within 12 months.

A) Long-term bank loans
B) Current liabilities
C) Bonds
D) Marketable securities
E) Accounts receivable

Ans: B Level: Basic Subject: Current Liabilities Type: Definitions

9. The long-term debts of a firm are:

A) Liabilities that come due within the next 12 months.
B) Liabilities that do not come due for at least 12 months.
C) Liabilities owed to the firm's suppliers.
D) Liabilities owed to the firm's shareholders.
E) Liabilities the firm expects to incur within the next 12 months.

Ans: B Level: Basic Subject: Long-Term Debt Type: Definitions

10. Net working capital is defined as:

A) Total liabilities minus shareholders' equity.
B) Current liabilities minus shareholders' equity.
C) Fixed assets minus shareholders' equity.
D) Total assets minus total liabilities.
E) Current assets minus current liabilities.

Ans: E Level: Basic Subject: Net Working Capital Type: Definitions

11. ____________ 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

Ans: C Level: Basic Subject: Net Working Capital Type: Definitions

12. A(n) _________ asset is one which can be quickly converted into cash without significant loss in value.
A) current
B) fixed
C) intangible
D) liquid
E) long-term

Ans: D Level: Basic Subject: Liquid Assets Type: Definitions

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

13. Financial leverage refers to:

A) The proportion of debt used in a firm's capital structure.
B) The ratio of retained earnings to shareholders' equity.
C) The ratio of paid-in surplus to shareholders' equity.
D) The ratio of cost-of-goods-sold to total sales.
E) The amount of receivables present in the firm's asset structure.

Ans: A Level: Basic Subject: Financial Leverage Type: Definitions

14. The common set of standards and procedures by which audited financial statements are prepared is known
as:
A) The matching principle.
B) The cash flow identity.
C) Generally Accepted Accounting Principles (GAAP).
D) The Freedom of Information Act (FOIA) .
E) The 1993 Omnibus Budget Reconciliation Act.

Ans: C Level: Basic Subject: GAAP Type: Definitions

15. The financial statement summarizing a firm's performance over a period of time is the:
A) Income statement.
B) Balance sheet.
C) Statement of cash flows.
D) Tax reconciliation statement.
E) Shareholders' equity sheet.

Ans: A Level: Basic Subject: Income Statement Type: Definitions

16. Earnings per share is equal to:

A) Net income divided by the total number of shares outstanding.
B) Net income divided by the par value of common stock.
C) Gross income multiplied by the par value of common stock.
D) Operating income divided by the par value of common stock.
E) Net income divided by total stockholders' equity.

Ans: A Level: Basic Subject: Earnings Per Share Type: Definitions

17. Dividends per share is equal to:

A) Dividends paid divided by the par value of common stock.
B) Dividends paid divided by the total number of shares outstanding.
C) Dividends paid divided by total stockholders' equity.
D) Dividends paid multiplied by the par value of common stock.
E) Dividends paid multiplied by the total number of shares outstanding.

Ans: B Level: Basic Subject: Dividends Per Share Type: Definitions

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

18. Non-cash items

A) The credit sales of a firm.
B) The accounts payable of a firm.
C) Expenses incurred for the purchase of intangible fixed assets.
D) Expenses charged against revenues that do not directly affect cash flow.
E) All accounts on the balance sheet other than cash on hand.

Ans: D Level: Intermediate Subject: Non-cash Items Type: Definitions

19. ________________ refers to the cash flow that results from the firm's ongoing, normal business activities.
A) Operating cash flow
B) Capital spending
C) Net working capital
D) Cash flow from assets
E) Cash flow to creditors

Ans: A Level: Basic Subject: Operating Cash Flow Type: Definitions

20. _____________ refers to the net spending of the firm on fixed asset purchases.
A) Operating cash flow
B) Capital spending
C) Net working capital
D) Cash flow from assets
E) Cash flow to creditors

Ans: B Level: Basic Subject: Capital Spending Type: Definitions

21. ____________ refers to the net total cash flow of the firm accruing to its creditors and stockholders.
A) Operating cash flow
B) Capital spending
C) Net working capital
D) Cash flow from assets
E) Cash flow to creditors

Ans: D Level: Basic Subject: Cash Flow From Assets Type: Definitions

22. Cash flow from assets is also known as the firm's ______________.
A) capital structure
B) equity structure
C) hidden cash flow
D) free cash flow
E) historical cash flow

Ans: D Level: Basic Subject: Free Cash Flow Type: Definitions

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

23. ______________ refers to the firm's interest payments less any net new borrowing.
A) Operating cash flow
B) Capital spending
C) Net working capital
D) Cash flow from assets
E) Cash flow to creditors

Ans: E Level: Basic Subject: Cash Flow To Creditors Type: Definitions

24. ___________ refers to the firm's dividend payments less any net new equity raised.
A) Operating cash flow
B) Capital spending
C) Net working capital
D) Cash flow from assets
E) Cash flow to stockholders

Ans: E Level: Basic Subject: Cash Flow To Stockholders Type: Definitions

25. Your __________ tax rate is the amount of tax payable on the next dollar you earn.
A) deductible
B) residual
C) total
D) average
E) marginal

Ans: E Level: Basic Subject: Marginal Tax Rates Type: Definitions

26. Your ________ tax rate measures the total taxes you pay divided by your taxable income.
A) deductible
B) residual
C) total
D) average
E) marginal

Ans: D Level: Basic Subject: Average Tax Rates Type: Definitions

27. The ___________ tax rate is the rate that applies if one more dollar of income is earned and the
___________ tax rate is the total tax bill divided by taxable income.
A) marginal; flat
B) marginal; average
C) flat; marginal
D) flat; average
E) average; marginal

Ans: B Level: Basic Subject: Tax Rates Type: Definitions

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

28. A current asset:

A) Has a life of less than one year.
B) Includes accounts payable.
C) Is an illiquid asset.
D) Is included in the income statement.
E) Is part of shareholders' equity.

Ans: A Level: Basic Subject: Assets Type: Definitions

29. Current assets minus current liabilities is referred to as:

A) Tangible assets.
B) Net working capital.
C) Net income.
D) Net assets.
E) Net book value.

Ans: B Level: Basic Subject: Net Working Capital Type: Definitions

30. The balance sheet:

A) Reflects the income and expenses incurred year-to-date.
B) Reflects the income and expenses for the current month only.
C) Reflects the financial status of the firm as of a particular date.
D) Reflects the cash flows of a firm over a period of time.
E) Reflects the current market value of the firm.

Ans: C Level: Basic Subject: Balance Sheet Type: Definitions

31. Which of the following statements is true?

A) Liabilities equal assets plus shareholders' equity.
B) Shareholders' equity equals assets plus liabilities.
C) Shareholders' equity equals liabilities minus assets.
D) Assets equal liabilities plus shareholders' equity.
E) Assets equal liabilities minus shareholders' equity.

Ans: D Level: Basic Subject: Balance Sheet Type: Definitions

32. Which one of the following is an example of an intangible asset?

A) Accounts receivable
B) Inventory
C) Accounts payable
D) Furniture
E) Patent

Ans: E Level: Basic Subject: Balance Sheet Type: Definitions

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

33. The ease and speed with which an asset can be converted into cash is called:
A) Liquidity.
B) Marketability.
C) Convertibility.
D) Transferability.
E) Liability.

Ans: A Level: Basic Subject: Liquidity Type: Definitions

34. The cost of an asset less the depreciation to date is referred to as the net _____ value.
A) Liquid
B) Book
C) Market
D) Cash
E) Financial

Ans: B Level: Basic Subject: Book Value Type: Definitions

35. Which one of the following is a non-cash item?

A) Down payment on a building
B) Rent expense
C) Depreciation of equipment
D) Payroll tax expense
E) Company provided health insurance

Ans: C Level: Basic Subject: Non-Cash Item Type: Definitions

36. The cash generated from a firm's normal business activities is called:
A) Financing cash flow.
B) Net income.
C) Gross profit.
D) Operating cash flow.
E) Free cash flow.

Ans: D Level: Basic Subject: Operating Cash Flow Type: Definitions

37. The use of debt in a firm's capital structure is called:

A) Liquidity.
B) Equity financing.
C) Free cash flow.
D) Net working capital.
E) Financial leverage.

Ans: E Level: Basic Subject: Financial Leverage Type: Definitions

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

38. The balance sheet identity states that:

A) Current assets + Fixed assets = Total assets
B) Assets = Liabilities + Shareholders' equity
C) Current liabilities + Long-term debt = Total liabilities
D) Common stock + Retained earnings = Shareholders' equity
E) Cash flow = Market value – Book value

Ans: B Level: Basic Subject: Balance Sheet Identity Type: Concepts

39. Balance sheet assets __________________.

I. are always equal to total liabilities minus shareholders' equity
II. represent items acquired with the use of the firm's assumed liabilities and equity
III. are listed in order of increasing liquidity
A) I only
B) II only
C) III only
D) I and III only
E) II and III only

Ans: B Level: Basic Subject: Balance Sheet Type: Concepts

40. Assets are listed on the balance sheet in

A) order of importance to the firm
B) order of increasing size
C) order of decreasing liquidity
D) no particular order
E) order of preference in bankruptcy

Ans: C Level: Basic Subject: Balance Sheet Type: Concepts

41. Which of the following is NOT typically characterized as a current asset?

A) Inventory
B) Cash on hand
C) Patents
D) Accounts receivable
E) Marketable securities

Ans: C Level: Basic Subject: Current Assets Type: Concepts

42. Intangible assets ________.

A) are generally considered very liquid
B) are classified on the balance sheet just before accounts receivable
C) include such things as patents
D) include any item that exists physically
E) are generally very valuable

Ans: C Level: Basic Subject: Intangible Assets Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

43. A firm with negative net working capital ____________________.

A) is technically bankrupt
B) has no cash on hand
C) needs to sell some of its inventory to correct the problem
D) has more current liabilities than current assets
E) most likely will not run short of cash over the next six months

Ans: D Level: Basic Subject: Net Working Capital Type: Concepts

44. Accounts payable are a component of:

A) Net working capital.
B) Current assets.
C) Long-term debt.
D) Fixed assets.
E) Shareholders' equity.

Ans: A Level: Basic Subject: Net Working Capital Type: Concepts

45. Which of the following assets would most likely be considered the least liquid?
A) A share of common stock in Nortel
B) A bond issued by Corel
C) A share of preferred stock in GM of Canada
D) A Lethbridge, Alberta municipal bond
E) A Canadian Treasury bill

Ans: D Level: Intermediate Subject: Liquid Assets Type: Concepts

46. Which of the following financial statement items is generally considered the most liquid?
A) Inventory
B) Net fixed assets
C) Long-term debt
D) Patents and trademarks
E) Accounts receivable

Ans: E Level: Basic Subject: Liquid Assets Type: Concepts

47. Which of the following assets is generally considered to be the least liquid?
A) Plant and equipment
B) Inventory
C) Goodwill
D) Cash
E) Accounts receivable

Ans: C Level: Basic Subject: Liquidity Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

48. Which of the following is generally true regarding liquidity as it relates to the firm?
A) Liquidity is detrimental to a firm because it allows the firm to pay its bills more easily, thereby
avoiding financial distress
B) Liquidity is valuable to a firm because liquid assets can be sold quickly without much loss in value
C) Liquidity is valuable to a firm because a firm can borrow money using its liquid assets, such as a
warehouse, as collateral
D) Assets are generally listed on a firm's balance sheet in the order of increasing liquidity
E) Liquid assets generally earn a large return, especially in comparison to illiquid assets

Ans: B Level: Intermediate Subject: Liquidity Type: Concepts

49. Which of the following are characteristics of a liquid asset?

I. Can be converted into cash quickly
II. Can be converted into cash with little or no loss in value
III. Generally earn low returns
A) I and II only
B) II and III only
C) III only
D) I and III only
E) I, II, and III

Ans: E Level: Basic Subject: Liquidity Type: Concepts

50. Which of the following statements about liquidity is true?

A) If a firm has a high degree of liquidity, it also faces a high degree of financial distress
B) At times, too little liquidity can result in lower profits for a firm since there is often a trade-off
between liquidity and profitability
C) You can get an accurate picture of the liquidity of a firm by looking at its current assets
D) Accounts receivable are generally considered to be more liquid than inventory
E) An asset is liquid if it can be sold quickly regardless of price

Ans: D Level: Intermediate Subject: Liquidity Type: Concepts

51. An increase in the financial leverage of a firm as a result of an increase in outstanding debt __________ the
potential reward to stockholders while ___________ the risk of financial distress or bankruptcy.
A) decreases; decreasing
B) increases; decreasing
C) increases; increasing
D) decreases; increasing
E) does not affect; increasing

Ans: C Level: Basic Subject: Financial Leverage Type: Concepts

52. Which of the following would decrease the financial leverage of a firm?
A) Total assets increase and the debt-to-equity ratio remains constant.
B) Total debt increases and total assets remain constant.
C) Net new equity is sold and existing bonds are paid off.
D) Net new bonds are sold and outstanding common stock is repurchased.
E) Net new bonds are sold and short-term notes payable are paid off.

Ans: C Level: Intermediate Subject: Financial Leverage Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

53. Which of the following accurately describes the relation between book and market value?
A) Financial managers should rely on book values, and not market values, when making decisions for
the firm, because the firm's tax liability is based on book values.
B) Financial managers should rely on market values, and not book values, when making decisions for
the firm, because the firm's tax liability is based on market values.
C) Book value is an accounting summary of value and is inferior to market value as a source of current
information regarding the true value of the firm.
D) The market value of current assets is often difficult to determine, and thus of little value to the
decision making process of financial managers.
E) Market value always exceeds book value.

Ans: C Level: Intermediate Subject: Market Value vs. Book Value Type: Concepts

54. As an investor how would you determine the total market value of a publicly traded corporation such as
General Motors?
I. The values of debt and equity as they appear on the most recent financial statements
II. The value of debt as it appears on the most recent financial statements plus the current market value
of GM's common stock
III. The current market value of GM's stock plus the market value of GM's debt
A) I only
B) II only
C) III only
D) I and II only
E) II and III only

Ans: C Level: Intermediate Subject: Market Value Type: Concepts

55. Under GAAP, balance sheet assets are ________________________.

A) carried on the books at historic cost
B) only carried on the books if they are relatively liquid
C) carried on the books at market value
D) listed in order of increasing relative liquidity
E) carried at the larger of historic cost and market value

Ans: A Level: Basic Subject: GAAP Type: Concepts

56. For which of the following balance sheet items will the book value and market value most likely be closest
at the time the balance sheet is prepared?
A) Net fixed assets
B) Common stock
C) Accounts receivable
D) Long-term debt
E) Retained earnings

Ans: C Level: Intermediate Subject: Market Value vs. Book Value Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

57. Which of the following is/are true regarding the balance sheet and income statement?
I. The income statement reflects a summary of activity that occurs over some period of time while the
balance sheet is a snapshot taken at a single point in time.
II. Both represent a summary of activity that occurs over some time period.
III. The two statements, taken together, give an accurate estimate of the firm's cash flows and market
value.
A) I only
B) II only
C) III only
D) I and III only
E) II and III only

Ans: A Level: Basic Subject: Accounting Statements Type: Concepts

58. An income statement _____________________.

A) measures performance as a snapshot on a specific date
B) prepared according to GAAP, will show revenue when it accrues
C) excludes accrued taxes payable
D) includes expenses only when they are ultimately paid off in cash
E) is an accurate representation of a firm's net cash flows

Ans: B Level: Intermediate Subject: Income Statement Type: Concepts

59. Which of the following is a true statement?

A) Accounting income is generally equal to firm cash flow.
B) Accounting statements are usually prepared to match the timing of income and expenses.
C) The balance sheet equity account represents the market value of the firm to shareholders.
D) The balance sheet tells investors exactly what the firm is worth.
E) Assets are usually listed on the balance sheet at market value.

Ans: B Level: Intermediate Subject: Matching Principle Type: Concepts

60. Which of the following represents a use of the matching principle in accounting?
I. The cost of purchasing an item on account is recorded when the payable is paid.
II. Revenues from a credit sale are recorded when the receivable is received.
III. The production costs of inventory are recorded along with the revenue from the sale on the date the
sale is made.
A) I only
B) II only
C) III only
D) I and III only
E) II and III only

Ans: C Level: Intermediate Subject: Matching Principle Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

61. On January 1, 1996 Slowpay Company makes a verbal commitment to buy a $150,000 piece of equipment.
On January 5 the contract is signeD) A $1,000 down payment is paid on January 5 and the machine is
delivered on January 10. The balance owed is due on February 15, but Slowpay waits until March 10 to
pay. When will the firm that sold the equipment to Slowpay recognize the sale as income under GAAP
rules?
A) On January 1, when the commitment is made
B) On January 5 when the contract is signed
C) On January 10, when Slowpay takes possession
D) On February 15, when the payment is due
E) On March 10, when payment is received

Ans: B Level: Challenge Subject: GAAP and Sales Type: Concepts

62. Which of the following income statement accounts is a non-cash item?

A) Wages and salaries
B) Interest expense
C) Cost of goods sold
D) Depreciation
E) Income taxes

Ans: D Level: Basic Subject: Noncash Items Type: Concepts

63. Which of the following is probably considered a fixed cost, at least in the short run?
A) The cost of raw materials
B) The cost of direct labour expenses
C) The company president's salary
D) The cost of utilities
E) The commissions paid to the sales force

Ans: C Level: Basic Subject: Variable Costs Type: Concepts

64. Cash flow from assets is equal to which of the following?

A) Cash flow to creditors – cash flow to shareholders
B) Cash flow to shareholders + cash flow to creditors
C) Cash flow to creditors + cash flow to the government
D) Cash flow to shareholders – net new borrowing
E) Cash flow to shareholders + operating cash flow

Ans: B Level: Basic Subject: Cash Flow Equation Type: Concepts

65. Which of the following is NOT a component of cash flow from assets?
I. Net new borrowings
II. Operating cash flow
III. Additions to net working capital
A) I only
B) II only
C) II and III only
D) I and III only
E) III only

Ans: A Level: Basic Subject: Cash Flow From Assets Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

66. Suppose you have the 2003 income statement for a firm, along with the 12/31/2002 and 12/31/2003 balance
sheets. How would you calculate net capital spending?
A) Ending net fixed assets (2003) minus beginning net fixed assets (2002) plus 2003 depreciation
B) Beginning net fixed assets (2002) minus ending net fixed assets (2003) plus 2003 depreciation
C) Beginning net fixed assets (2002) plus ending net fixed assets (2003) minus 2003 depreciation
D) Ending net fixed assets (2003) minus beginning net fixed assets (2002) plus 2003 taxes paid
E) Ending net fixed assets (2003) plus beginning net fixed assets (2002) minus 2003 taxes paid

Ans: A Level: Intermediate Subject: Net Capital Spending Type: Concepts

67. Net capital spending is equal to ________.

A) the change in net working capital
B) the change in net fixed assets minus depreciation
C) net income plus depreciation
D) total cash flow to stockholders' less interest and dividends paid
E) operating cash flow minus cash flow from assets minus additions to net working capital

Ans: E Level: Basic Subject: Net Capital Spending Type: Concepts

68. Operating cash flow is calculated as:

A) EBIT + depreciation – taxes
B) EBIT + depreciation + taxes
C) EBIT – depreciation – taxes
D) EBIT – depreciation + taxes
E) None of the above

Ans: A Level: Basic Subject: Operating Cash Flow Type: Concepts

69. An increase in which of the following results in an increase in operating cash flow, all else equal?
I. Interest expense
II. Depreciation
III. Taxes
A) II only
B) III only
C) I and II only
D) II and III only
E) I, II, and III

Ans: A Level: Basic Subject: Operating Cash Flow Type: Concepts

70. An increase in which of the following will cause operating cash flow to decrease, all else the same?
I. Interest expense
II. Depreciation
III. Taxes paid
A) I and II only
B) II and III only
C) I only
D) II only
E) III only

Ans: E Level: Basic Subject: Operating Cash Flow Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

71. Suppose you have the beginning and ending year balance sheets for a firm, along with the year's income
statement. Changes in net working capital (NWC) would be calculated as:
A) Ending NWC plus depreciation minus beginning NWC.
B) Ending NWC minus depreciation minus beginning NWC.
C) Ending NWC plus taxes paid plus beginning NWC.
D) Ending NWC minus beginning NWC.
E) Ending NWC plus beginning NWC.

Ans: D Level: Basic Subject: Net Working Capital Changes Type: Concepts

72. Which of the following does NOT directly appear in either of the two definitions of cash flow from assets?
A) Addition to retained earnings
B) Net capital spending
C) Changes in net working capital
D) Operating cash flow
E) Cash flow to stockholders

Ans: A Level: Basic Subject: Cash Flow From Assets Type: Concepts

73. If operating cash flow is negative, then __________________.

A) the firm is bankrupt
B) the firm can pay no dividends
C) cash flow to bondholders must be negative
D) cash flow to stockholders must be positive
E) cash flow from assets may be positive

Ans: E Level: Intermediate Subject: Cash Flow From Assets Type: Concepts

74. In 2003, Sensicon Company experienced negative cash flow from assets. It must be the case that:
A) The company is in financial distress.
B) Cash flow to creditors and cash flow to shareholders are both negative.
C) Sensicon's interest payments were greater than its dividend payments.
D) Sensicon's dividend payments were greater than its interest payments.
E) Operating cash flow was less than the combination of additions to net working capital and net new
capital expenditures.

Ans: E Level: Intermediate Subject: Cash Flow From Assets Type: Concepts

75. What is the proper measure of cash flow to creditors in a given year?
A) Interest paid
B) Operating cash flow minus net new borrowing
C) Interest paid plus changes in long-term debt
D) Interest paid plus net new borrowing minus additions to net fixed assets
E) Interest paid minus net new borrowing

Ans: E Level: Basic Subject: Cash Flow To Creditors Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

76. Which of the following is a component of cash flow to creditors?

I. Interest paid
II. Net new borrowing
III. Dividends paid
A) I only
B) II only
C) I and II only
D) I and III only
E) II and III only

Ans: C Level: Basic Subject: Cash Flows to Creditors Type: Concepts

77. The net new equity raised by a firm during a given year can be calculated as:
A) New equity sales minus equity repurchases plus retained earnings.
B) New equity sales minus equity repurchases plus retained earnings minus dividends paid.
C) New equity sales minus equity repurchases.
D) New equity sales plus retained earnings.
E) New equity sales minus dividends paid.

Ans: C Level: Basic Subject: Net New Equity Type: Concepts

78. Net new equity is equal to _____________.

A) the dollar value of equity sales minus any equity repurchases
B) the dollar value of equity sales plus retained earnings
C) the dollar value of equity sales plus retained earnings minus dividends paid
D) the dollar value of equity sales plus retained earnings plus dividends paid
E) the dollar value of equity sales plus dividends paid

Ans: A Level: Basic Subject: Net New Equity Type: Concepts

79. XYZ Company had net income of $40 million in 2003. The firm paid no dividends. If there were no
further changes to the stockholders' equity accounts, then ____________ by $40 million.
A) common stock must have increased
B) retained earnings must have increased
C) total shareholders' equity must have decreased
D) common stock must have decreased
E) the market value of the firm's stock must have decreased

Ans: B Level: Basic Subject: Retained Earnings Type: Concepts

80. Cash flow to stockholders is equal to _____________.

A) net income
B) dividends paid
C) net new equity
D) dividends paid minus net new equity
E) dividends paid minus interest paid

Ans: D Level: Basic Subject: Cash Flow To Stockholders Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

81. Which of the following is a component of cash flow to stockholders?

I. Net new equity raised
II. New common stock sold
III. Dividends paid
A) I only
B) I and III only
C) II and III only
D) I and II only
E) I, II, and III

Ans: E Level: Basic Subject: Cash Flows to Stockholders Type: Concepts

82. Cash flow to stockholders is

A) equal to total cash flow from assets minus cash flow to creditors
B) equal to sales of equity plus cash dividends paid
C) equal to operating cash flow minus additions to net working capital minus net capital spending
D) equal to cash dividends minus repurchases of equity plus new equity sold
E) usually greater than cash flow to creditors

Ans: A Level: Basic Subject: Cash Flow To Stockholders Type: Concepts

83. Which of the following statements is false?

A) While marginal and average tax rates often differ, it is the average tax rate that is relevant for most
financial decisions.
B) The book value of an asset on the balance sheet can be very different from its market value.
C) Net income as calculated from the income statement is not the net cash flow of the firm.
D) Non-cash items are expenses charged against revenues that do not directly affect cash flow.
E) The cash flow identity states that all net cash flows earned by the firm are distributed in whole to its
creditors and shareholders.

Ans: A Level: Basic Subject: Tax Rates Type: Concepts

84. When evaluating project cash flows in a financial decision, __________.

A) taxes can generally be ignored since they are a non-cash expense
B) the financial manager should compute and use the marginal tax rate
C) the marginal tax rate and average tax rate are of equal importance
D) the financial manager should use the tax rate that is equal to the total tax liability divided by total
taxable income
E) taxes are irrelevant unless income for the firm is greater than zero

Ans: B Level: Intermediate Subject: Taxes Type: Concepts

85. Suppose a firm has a negative UCC balance; they

A) can claim the amount as a tax deductible expense
B) must add the amount (as a positive number) to their taxable income
C) should sell off all items in the asset pool
D) can calculate CCA for the year using the negative balance
E) should use the negative amount as a future tax loss

Ans: B Level: Intermediate Subject: UCC Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

86. Cash flow from assets represents the cash:

A) Generated solely from a firm's daily sales.
B) Generated solely from the sale of company assets.
C) Currently held in the bank.
D) Available to pay for current asset purchases.
E) Available to distribute to creditors and stockholders.

Ans: E Level: Basic Subject: Cash Flow From Assets Type: Concepts

87. If the market value of an asset exceeds the book value of that asset, then the sale of the asset will:
A) Generate taxable income.
B) Result in a capital loss.
C) Cause a cash outflow for the firm.
D) Cause net profits to decline.
E) Cause operating cash flows to decrease.

Ans: A Level: Intermediate Subject: Market Vs. Book Value Type: Concepts

88. Which one of the following will decrease net working capital?
A) An increase in accounts receivable
B) An increase in accounts payable
C) A sale of a fixed asset for cash
D) A sale of inventory at a profit
E) A decrease in accounts payable

Ans: B Level: Intermediate Subject: Net Working Capital Type: Concepts

89. Which one of the following will increase net working capital?
A) A decrease in cash
B) An increase in accounts payable
C) An increase in depreciation
D) A profitable sale of inventory
E) The write-off of a bad debt

Ans: D Level: Intermediate Subject: Net Working Capital Type: Concepts

90. Which one of the following will increase shareholders' equity, all else held constant?
A) A purchase of equipment on account
B) The collection of an accounts receivable
C) A sale of inventory at a profit
D) A payment on a loan
E) The declaration of a stock dividend

Ans: C Level: Intermediate Subject: Balance Sheet Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

91. Which of the following statements concerning a balance sheet is (are) correct?
I. Assets equal liabilities minus shareholders' equity.
II. Current assets can be converted into cash within twelve months.
III. A patent is an example of an intangible asset.
IV. Retained earnings is classified as long-term debt.
A) I and II only
B) I and III only
C) II and III only
D) II and IV only
E) III and IV only

Ans: C Level: Intermediate Subject: Balance Sheet Type: Concepts

92. Which one of the following assets is generally considered the most liquid?
A) Equipment
B) Inventory
C) Building
D) Accounts receivable
E) Land

Ans: D Level: Basic Subject: Liquidity Type: Concepts

93. Which one of the following will cause net income to decrease for the following year?
A) The accumulation of more long-term debt by a firm
B) An increase in the amount of dividends paid per share
C) A reduction in tax rates
D) An increase in profit margins
E) A reduction in depreciation expense

Ans: A Level: Challenge Subject: Net Income Type: Concepts

94. Net income is allocated to which two items?

A) Shareholders' equity and cash
B) Common stock and dividends
C) Taxes and dividends
D) Paid-in surplus and cash
E) Retained earnings and dividends

Ans: E Level: Intermediate Subject: Net Income Type: Concepts

95. Which one of the following will increase earnings per share, all else held constant?
A) A decrease in the number of shares outstanding
B) An increase in wages paid to employees
C) A decrease in sales of the firm
D) An increase in marginal tax rates
E) An increase in depreciation expense

Ans: A Level: Intermediate Subject: Earnings Per Share Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

96. A firm has a calendar tax year. On January 10, the firm purchased depreciable equipment for cash. This
purchase will create:
A) A current cash outflow and an equal decrease in current net income.
B) A current cash outflow and a lesser decrease in current net income.
C) A decrease in net income by an amount equal to the decrease in net assets.
D) No change in net income for the current year.
E) An increase in the total taxes of the firm over a period of years.

Ans: B Level: Challenge Subject: Non-Cash Expenses Type: Concepts

97. Which of the following are included in cash flow from assets?
I. The payment of a dividend
II. A payment of a bill from a supplier
III. The payment of taxes
IV. Receipt of a payment from a customer
A) I and II only
B) I and III only
C) II and IV only
D) I, II, and III only
E) II, III, and IV only

Ans: E Level: Intermediate Subject: Cash Flow From Assets Type: Concepts

98. Which of the following will increase the amount of the cash flow to creditors?
A) A new long-term loan
B) The early payment of an accounts payable
C) An early payoff of a long-term loan
D) A decrease in the rate of interest charged on a loan
E) The payment of a cash dividend

Ans: C Level: Intermediate Subject: Cash Flow To Creditors Type: Concepts

99. Which one of the following situations will cause cash flow to creditors to be negative?
A) When there are no new loans and the interest paid exceeds the principal repaid on a loan
B) When the amount of a new loan exceeds both the interest and principal payments made
C) When the amount of the loan paid off exceeds both the amount of a new loan plus the interest paid
D) When the rate of interest on all outstanding loans is decreased
E) When there are no new loans and the current loan is paid off in full

Ans: B Level: Intermediate Subject: Cash Flow To Creditors Type: Concepts

100. Net income differs from operating cash flow due to the handling of:
A) Dividends and interest expense.
B) Interest expense and depreciation.
C) Depreciation and dividends.
D) Dividends, interest expense, and depreciation.
E) Dividends and interest expense.

Ans: B Level: Intermediate Subject: Operating Cash Flow Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

101. Operating cash flow is equal to earnings before interest and taxes:
A) Minus depreciation minus taxes.
B) Minus depreciation plus taxes.
C) Minus interest plus taxes.
D) Plus depreciation minus taxes.
E) Plus interest minus taxes.

Ans: D Level: Basic Subject: Operating Cash Flow Type: Concepts

102. The repurchase of outstanding stock by a corporation causes ________ for the firm, all else constant.
A) An immediate cash inflow
B) A decrease in the cash flow to stockholders
C) A decrease in both earnings per share and dividends per share
D) A decrease in dividends per share
E) Both a cash outflow and an increase in earnings per share

Ans: E Level: Intermediate Subject: Cash Flow To Stockholders Type: Concepts

103. Cash flow to stockholders is computed as:

A) Interest paid minus net new debt.
B) Dividends paid minus net new debt.
C) Dividends paid plus net new equity.
D) Cash flow from assets minus cash flow to creditors.
E) Cash flow to creditors minus cash flow from assets.

Ans: D Level: Basic Subject: Cash Flow To Stockholders Type: Concepts

104. Which one of the following will cause cash flow to stockholders to increase, all else constant?
A) A secondary common stock offering
B) A decrease in dividends per share
C) An increase in cash flow to creditors given no change in cash flow from assets
D) A decrease in cash flow from assets given no change in cash flow to creditors
E) A decrease in cash flow to creditors given an increase in cash flow from assets

Ans: E Level: Intermediate Subject: Cash Flow To Stockholders Type: Concepts

105. A negative cash flow to stockholders means:

A) Cash flow from assets must also be negative.
B) Cash flow to creditors must also be negative.
C) The firm repurchased a significant number of outstanding shares.
D) Stockholders were a source of cash for the period.
E) The firm is bankrupt.

Ans: D Level: Intermediate Subject: Cash Flow To Stockholders Type: Concepts

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

106. Which of the following will increase cash flow from assets?
I. The sale of inventory at cost
II. The sale of machinery and equipment at book value
III. The purchase of inventory on credit
IV. An increase in accounts receivable due to a profitable sale
A) I only
B) III only
C) IV only
D) I and II only
E) III and IV only

Ans: C Level: Intermediate Subject: Cash Flow From Assets Type: Concepts

107. Which of the following accounts is (are) included in cash flow from assets?
I. Rent expense
II. Interest expense
III. Accounts receivable
IV. Equipment
A) I and II only
B) III and IV only
C) I, II, and III only
D) I, III, and IV only
E) I, II, III, and IV

Ans: D Level: Intermediate Subject: Cash Flow From Assets Type: Concepts

108. If current assets = $95, net fixed assets = $250, long-term debt = $40, and owners' equity = $200, what is
the value of current liabilities if it is the only other item on the balance sheet?
A) –$50
B) $50
C) $105
D) $145
E) $545

Ans: C Level: Basic Subject: Balance Sheet Identity Type: Problems

109. At year-end 2002, Jordan Company's balance sheet showed current assets = $800, fixed assets = $1,500,
intangible assets = $300, current liabilities = $600, and long-term liabilities = $1,400. What is the value of
the shareholders' equity account?
A) $300
B) $500
C) $600
D) $900
E) $1,100

Ans: C Level: Basic Subject: Balance Sheet Identity Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

110. During 2003, Spend-it Corporation reported net income of $200 and paid a $40 stock dividend. Spend-it's
December 31, 2002 balance sheet reported the following items: common stock = $220, capital surplus =
$180, retained earnings = $300. What is the value of the retained earnings account for the December 31,
2003 balance sheet?
A) $160
B) $340
C) $360
D) $460
E) $540

Ans: D Level: Intermediate Subject: Balance Sheet Identity Type: Problems

111. Based on the following information, calculate stockholders' equity: cash = $30; total current liabilities =
$80; accounts receivable = $30; inventory = $90; net fixed assets = $220; accounts payable = $20; longterm
debt = $50.
A) $170
B) $190
C) $220
D) $240
E) $290

Ans: D Level: Intermediate Subject: Balance Sheet Identity Type: Problems

112. ABC Corporation reported retained earnings of $400 on its year-end 2002 balance sheet. During 2003, the
company reported a loss of $40 in net income, and it paid out a dividend of $60. What will retained
earnings be for ABC's 2003 year-end balance sheet?
A) $220
B) $300
C) $320
D) $380
E) $420

Ans: B Level: Intermediate Subject: Retained Earnings Type: Problems

113. If total assets = $550, fixed assets = $375, current liabilities = $140, equity = $265, long-term debt = $145,
and current assets is the only remaining item on the balance sheet, what is the value of net working capital?
A) –$265
B) $35
C) $190
D) $230
E) $265

Ans: B Level: Intermediate Subject: Net Working Capital Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

114. Given the following balance sheet data, calculate net working capital: cash = $110, accounts receivable =
$410, inventory = $350, net fixed assets = $1,000, accounts payable = $60, short-term debt = $375, and
long-term debt = $510.
A) –$590
B) $0
C) $100
D) $435
E) $535

Ans: D Level: Intermediate Subject: Net Working Capital Type: Problems

115. Given the following income statement data, calculate net income: sales = $135, cost of goods sold = $40,
miscellaneous expenses = $35, depreciation = $20, interest expense = $20, tax rate = 34%.
A) $13.20
B) $19.80
C) $20.00
D) $23.10
E) $42.90

Ans: A Level: Intermediate Subject: Income Statement Type: Problems

116. RDJ Manufacturing had 300 million shares of stock outstanding at the end of 2003. During 2003, the
company reported net income of $600 million, retained earnings of $900 million, and $240 million in
dividends paid. What is RDJ's earnings per share?
A) $0.50
B) $0.67
C) $0.80
D) $1.25
E) $2.00

Ans: E Level: Intermediate Subject: Earnings Per Share Type: Problems

117. Given the following income statement data, calculate operating cash flow: net sales = $16,500, cost of
goods sold = $10,350, operating expenses = $3,118, depreciation = $1,120, interest expense = $900, tax
rate = 34%.
A) $667. 92
B) $1,912. 00
C) $2,201. 12
D) $2,381. 92
E) $2,687. 92

Ans: E Level: Intermediate Subject: Operating Cash Flow Type: Problems

118. If net income = $46,750, depreciation expense = $20,000, interest expense = $10,000, and the tax rate =
15%, what is operating cash flow?
A) $21,250
B) $72,250
C) $76,750
D) $85,250
E) $93,350

Ans: C Level: Intermediate Subject: Operating Cash Flow Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

119. Swell, Inc. had net fixed assets of $6.5 million on December 31, 2002 and $11 million on December 31,
2003. If Swell's depreciation expense for 2003 was $750,000, what was the firm's 2003 capital spending?
A) $3.75 million
B) $4.25 million
C) $4.50 million
D) $5.25 million
E) $6.75 million

Ans: D Level: Intermediate Subject: Net Capital Spending Type: Problems

120. If cash flow from operations is $938, net capital spending is –$211, and net working capital declines by
$73, what is cash flow from assets?
A) $654
B) $800
C) $954
D) $1,076
E) $1,222

Ans: E Level: Intermediate Subject: Cash Flow From Assets Type: Problems

121. Given the following information from More Money, Inc. 's 2003 financial statements, calculate cash flow
from assets: operating cash flow = $284,500, net fixed assets declined by $8,000, depreciation expense =
$13,000, and net working capital increased by $1,500.
A) $262,000
B) $278,000
C) $281,000
D) $288,000
E) $301,000

Ans: B Level: Intermediate Subject: Cash Flow From Assets Type: Problems

122. During 2003, a firm paid $25,000 in interest expense and its long-term debt decreased from $350,000 to
$250,000. What is the 2003 cash flow to creditors?
A) –$75,000
B) –$25,000
C) $25,000
D) $75,000
E) $125,000

Ans: E Level: Intermediate Subject: Cash Flow To Creditors Type: Problems

123. Suppose that a firm paid dividends of $300 and interest of $640. In addition, the firm raised cash by selling
new debt of $400 and new equity of $950. What is the firm's cash flow to creditors?
A) –$1,040
B) –$240
C) $240
D) $890
E) $1,040

Ans: C Level: Intermediate Subject: Cash Flow To Creditors Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

124. Brandy's Candies paid $23 million in dividends during 2002, while also making net common stock
repurchases of $27 million. What was the cash flow to stockholders for 2002?
A) –$4 million
B) $4 million
C) $23 million
D) $27 million
E) $50 million

Ans: E Level: Intermediate Subject: Cash Flow To Stockholders Type: Problems

125. Suppose a firm's net income is $950, dividends paid total $300, and new equity sales over the same period
amount to $350. If the initial value of equity was $7,100, what is the cash flow to shareholders?
A) –$650
B) –$50
C) $50
D) $650
E) $8,100

Ans: B Level: Intermediate Subject: Cash Flow To Stockholders Type: Problems

126. Suppose that a firm paid dividends of $300 and interest of $640. In addition, the firm raised cash by selling
new debt of $400 and new equity of $950. What is the firm's cash flow to stockholders?
A) –$1,250
B) –$650
C) $650
D) $890
E) $1,250

Ans: B Level: Intermediate Subject: Cash Flow To Stockholders Type: Problems

127. At the start of the year, Gershon, Inc. had total shareholders' equity = $12,000. If net income during the
year was a $200 loss, dividends paid = $400, and $1,000 was raised from the sale of new stock, what is the
end of year value for total shareholders' equity?
A) $10,060
B) $11,800
C) $12,400
D) $12,800
E) $13,200

Ans: C Level: Intermediate Subject: Calculating Shareholders' Equity Type: Problems

128. Ice Corporation has purchased a Class 10 piece of equipment for a cost of $50,000 with a CCA rate of 30%.
Under the half year rule, the UCC amount used to calculate the first year CCA is
A) $50,000
B) $15,000
C) $25,000
D) $35,000
E) $42,500

Ans: C Level: Basic Subject: UCC Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

129. A firm has recently purchased Class 10 equipment for $100,000 with a CCA rate of 30%. Under the half-
year rule, what is the amount of depreciation that the firm can claim as a tax-deductible expense in the
second year?
A) $30,000
B) $15,000
C) $42,000
D) $25,500
E) $45,000

Ans: D Level: Basic Subject: UCC Type: Problems

Use the following to answer questions 130-131:

Taxable income Tax rate

$0 – $ 50,000 15%
$50,001 – $ 75,000 25%
$75,001 – $100,000 34%

130. If Systemic Corporation reports taxable income of $77,000, then the _______________.
A) average tax rate is 18.7%
B) average tax rate is 34.0%
C) marginal tax rate is 15.0%
D) marginal tax rate is 25.0%
E) marginal tax rate is 39.0%

Ans: A Level: Intermediate Subject: Tax Rates Type: Problems

131. Celeste Video, Inc. reports 2003 taxable income of $200,000. How large is this firm's tax bill?
A) $48,750
B) $61,250
C) $67,000
D) $78,000
E) $91,125

Ans: B Level: Intermediate Subject: Tax Expense Calculations Type: Problems

Use the following to answer questions 132-135:

Taxable income 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%
$18,333,334 and above_35%

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

132. If a company has taxable income = $250,000, what is the average tax rate?
A) 32.3%
B) 34.0%
C) 36.8%
D) 39.6%
E) 42.0%

Ans: A Level: Intermediate Subject: Average Tax Rates Type: Problems

133. If a firm has taxable income = $74,000, how much will it pay in taxes?
A) $10,050
B) $11,750
C) $13,500
D) $16,750
E) $18,500

Ans: C Level: Intermediate Subject: Tax Expense Calculations Type: Problems

134. If a firm has taxable income of $17.5 million and a total tax bill of $6.1 million, its marginal tax rate is
_______.
A) 15%
B) 25%
C) 34%
D) 38%
E) 39%

Ans: D Level: Basic Subject: Marginal Tax Rates Type: Problems

135. If a firm has taxable income of $17.5 million and a total tax bill of $6.1 million, its average tax rate is
_______.
A) 15.0%
B) 25.9%
C) 34.9%
D) 38.2%
E) 42.2%

Ans: C Level: Intermediate Subject: Average Tax Rates Type: Problems

Use the following to answer questions 136-143:

Kuipers, Inc.
2003 Income Statement
($ in millions)

Net sales $1,384

Less: Cost of goods sold 605
Less: Depreciation 180
Earnings before interest and taxes 599
Less: Interest paid 80
Taxable income 519
Less: Taxes 156
Net income $363

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

Addition to retained earnings $254

Dividends paid 109
Total assets_$2,446_$2,660__Total liabilities_$2,446_$2,660

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

Kuipers, Inc.
12/31/02 and 12/31/03 Balance Sheet
($ in millions)
2002 2003 2002 2003
Cash $ 100 $ 121 Accounts payable $ 400 $ 350
Accounts rec. 350 425 Notes payable 390 370
Inventory 440 410 Total $ 790 $ 720
Total $ 890 $ 956 Long-term debt 500 550
Net fixed assets 1,556 1,704 Owner's equity
Common stock 600 580
Retained earnings 556 810
Total 1,156 1,390

Total assets $2,446 $2,660 Total liabilities $2,446 $2,660

136. What is the firm's operating cash flow for 2003 ($ in millions)?
A) $359
B) $441
C) $543
D) $589
E) $623

Ans: E Level: Challenge Subject: Operating Cash Flow Type: Problems

137. What is the firm's net capital spending for 2003 ($ in millions)?
A) –$32
B) $32
C) $148
D) $328
E) $447

Ans: D Level: Challenge Subject: Net Capital Spending Type: Problems

138. What is the firm's change in net working capital for 2003 ($ in millions)?
A) –$40
B) $4
C) $94
D) $136
E) $205

Ans: D Level: Challenge Subject: Net Working Capital Type: Problems

139. What is the firm's cash flow from assets for 2003 ($ in millions)?
A) $21
B) $159
C) $197
D) $431
E) $1,087

Ans: B Level: Challenge Subject: Cash Flow From Assets Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

140. What is the firm's cash flow to creditors for 2003 ($ in millions)?
A) $30
B) $47
C) $100
D) $130
E) $146

Ans: A Level: Challenge Subject: Cash Flow To Creditors Type: Problems

141. What is the firm's cash flow to stockholders for 2003 ($ in millions)?
A) $89
B) $129
C) $188
D) $363
E) $383

Ans: B Level: Challenge Subject: Cash Flow To Stockholders Type: Problems

142. If the firm has 180 million shares of stock outstanding, what is the firm's 2003 earnings per share?
A) $0.50
B) $0.61
C) $1.41
D) $1.83
E) $2.02

Ans: E Level: Challenge Subject: Earnings Per Share Type: Problems

143. If the firm has 180 million shares of stock outstanding, what is the firm's 2003 dividends per share?
A) $0.50
B) $0.61
C) $1.41
D) $1.83
E) $2.02

Ans: B Level: Challenge Subject: Dividends Per Share Type: Problems

Use the following to answer questions 144-152:

2002 2003
Sales $2,900 $3,300
COGS 2,030 2,310
Interest 410 420
Dividends 56 79
Depreciation 290 330
Cash 250 150
Receivables 242 412
Current liabilities 900 1,100
Inventory 1,015 900
Long-term debt 3,200 3,100
Net fixed assets 6,000 5,700
Tax rate 34% 34%
Tax rate_34%_34%

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

144. What is earnings before interest and taxes for 2003?

A) $112
B) $158
C) $580
D) $660
E) $780

Ans: D Level: Challenge Subject: Earnings Before Interest & Taxes Type: Problems

145. What is net income for 2003?

A) $112
B) $158
C) $580
D) $660
E) $780

Ans: B Level: Challenge Subject: Net Income Type: Problems

146. What is operating cash flow for 2003?

A) $248
B) $662
C) $908
D) $1,072
E) $1,375

Ans: C Level: Challenge Subject: Operating Cash Flow Type: Problems

147. What is net working capital for 2003?

A) $362
B) $473
C) $519
D) $607
E) $1,060

Ans: A Level: Challenge Subject: Net Working Capital Type: Problems

148. What is cash flow to stockholders for 2003?

A) $79
B) $189
C) $445
D) $524
E) $547

Ans: E Level: Challenge Subject: Cash Flow To Stockholders Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

149. What is cash flow to creditors for 2003?

A) $100
B) $320
C) $420
D) $520
E) $720

Ans: D Level: Challenge Subject: Cash Flow To Creditors Type: Problems

150. What is net capital spending for 2003?

A) –$10
B) $30
C) $300
D) $530
E) $630

Ans: B Level: Challenge Subject: Net Capital Spending Type: Problems

151. What is the change in net working capital during 2003?

A) –$245
B) –$125
C) $362
D) $607
E) $904

Ans: A Level: Challenge Subject: Net Working Capital Changes Type: Problems

152. What is cash flow from assets for 2003?

A) $428
B) $540
C) $633
D) $923
E) $1,067

Ans: E Level: Challenge Subject: Cash Flow From Assets Type: Problems

153. A firm has current assets of $400, shareholders' equity of $700, current liabilities of $300, and net fixed
assets of $600. What is the amount of long-term debt?
A) $0
B) $100
C) $200
D) $300
E) $400

Ans: A Level: Basic Subject: Balance Sheet Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

154. A new firm issued $500 in common stock. At the end of the first year, the firm had total assets of $1100 and
total debt of $400. What was the amount of net income for the first year, assuming the firm paid no
dividends?
A) -$200 (a loss)
B) $200
C) $700
D) $1200
E) Can not be determined from the information provided

Ans: B Level: Intermediate Subject: Balance Sheet Type: Problems

Use the following to answer questions 155-163:

RST, Inc.
2003 Income Statement

Net sales $8,769

Cost of goods sold $6,128
Depreciation $1,364
Earnings before interest and taxes $1,277
Interest paid $730
Taxable income $547
Taxes $186
Net income $361
Dividends paid $?
Addition to retained earnings $?

RST, Inc.
Balance Sheets as of December 31, 2002 and 2003

2002 2003 2002 2003

Cash $1,423 $965 Accounts payable $1,007 $2,251
Accounts rec. $2,196 $2,894 Notes payable $2,100 $1,850
Inventory $1,543 $1,650 Total $3,107 $4,101
Total $5,162 $5,509 Long-term debt $8,670 $7,280
Net fixed assets $21,300 $22,758 Common stock $7,200 $9,200
Retained earnings $7,485 $7,686
Total assets $26,462 $28,267 Total liabilities $26,462 $28,267
and Owner's equity

155. If there are 100 shares of stock outstanding, what is the amount of the dividends paid per share?
A) $1.48
B) $1.60
C) $1.86
D) $2.01
E) $3.61

Ans: B Level: Intermediate Subject: Dividends Per Share Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

156. If there are 250 shares of stock outstanding, what is the amount of the earnings per share?
A) $0.64
B) $0.80
C) $1.21
D) $1.44
E) $2.19

Ans: D Level: Basic Subject: Earnings Per Share Type: Problems

157. What is the amount of non-cash items for 2003?

A) $186
B) $201
C) $730
D) $1,364
E) $2,094

Ans: D Level: Basic Subject: Non-Cash Items Type: Problems

158. What is the net working capital for 2003?

A) $643
B) $1,408
C) $2,055
D) $3,115
E) $5,509

Ans: B Level: Basic Subject: Net Working Capital Type: Problems

159. What is the average tax rate for 2003?

A) 19%
B) 25%
C) 34%
D) 39%
E) can not be determined from the information provided

Ans: C Level: Basic Subject: Average Tax Rate Type: Problems

160. What is the operating cash flow for the year 2003?
A) $361
B) $995
C) $1,725
D) $1,911
E) $2,455

Ans: E Level: Intermediate Subject: Operating Cash Flow Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

161. What is the cash flow to creditors for 2003?

A) -$1,075
B) -$660
C) -$264
D) $1,126
E) $2,120

Ans: E Level: Intermediate Subject: Cash Flow To Creditors Type: Problems

162. What is the cash flow to stockholders for 2003?

A) -$2,160
B) -$1,840
C) $1,840
D) $2,160
E) $2,320

Ans: B Level: Challenge Subject: Cash Flow To Stockholders Type: Problems

163. What is the change in net working capital for 2003?

A) -$647
B) -$347
C) $347
D) $647
E) $994

Ans: A Level: Intermediate Subject: Change In Net Working Capital Type: Problems

Use the following to answer questions 164-170:

KLM, Inc.
2003 Income Statement

Net sales $3,685

Cost of goods sold $3,180
Depreciation $104
Earnings before interest and taxes $401
Interest paid $25
Taxable income $376
Taxes $128
Net income $248
Dividends paid $60
Addition to retained earnings $188

KLM Corporation
Balance Sheets as of December 31, 2002 and 2003

2002 2003 2002 2003

Cash $520 $601 Accounts payable $621 $704
Accounts rec. $235 $219 Notes payable $333 $272
Inventory $964 $799 Current liabilities $954 $976
Current assets $1,719 $1,619 Long-term debt $350 $60
Net fixed assets $890 $930 Common stock $800 $820
Retained earnings $505 $693
Total assets $2,609 $2,549 Total liabilities and Owner's equity $2,609 $2,549

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

164. What is the change in net working capital for 2003?

A) -$643
B) -$122
C) $122
D) $643
E) $765

Ans: B Level: Intermediate Subject: Change In Net Working Capital Type: Problems

165. What is the net capital spending for 2003?

A) -$144
B) -$64
C) $64
D) $144
E) $208

Ans: D Level: Intermediate Subject: Net Capital Spending Type: Problems

166. What is the cash flow from assets for 2003?

A) $111
B) $355
C) $1,307
D) $2,259
E) $2,503

Ans: B Level: Intermediate Subject: Cash Flow From Assets Type: Problems

167. What is the ending net working capital for 2003?

A) -$60
B) $40
C) $60
D) $643
E) $765

Ans: D Level: Intermediate Subject: Net Working Capital Type: Problems

168. What is the net new equity for 2003?

A) -$40
B) -$20
C) $20
D) $40
E) $60

Ans: C Level: Intermediate Subject: Net New Equity Type: Problems

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

169. What is the operating cash flow for 2003?

A) $169
B) $272
C) $377
D) $425
E) $480

Ans: C Level: Intermediate Subject: Operating Cash Flow Type: Problems

170. What is the cash flow to stockholders for 2003?

A) $40
B) $60
C) $80
D) $148
E) $268

Ans: A Level: Intermediate Subject: Cash Flow To Stockholders Type: Problems

Use the following to answer questions 171-174:

OPQ, Inc.
2003 Income Statement

Net sales $8,953

Cost of goods sold $5,865
Depreciation $?
EBIT $?
Interest paid $675
Earnings before taxes $?
Taxes $400
Net income $705
Dividends paid $?
Addition to retained earnings $450

OPQ, Inc.
Balance Sheets as of December 31, 2002 and 2003

2002 2003 2002 2003

Cash $725 $1,135 Accounts payable $859 $1,031
Accounts rec. $2,330 $? Notes payable $? $4,020
Inventory $3,240 $5,202 Current liabilities $? $?
Current assets $? $? Long-term debt $9,250 $9,750
Net fixed assets $? $9,211 Common stock $250 $?
Retained earnings $? $2,797
Total assets $16,083 $17,848 Total liab. & equity $? $?

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

171. What is the operating cash flow for 2003?

A) $872
B) $2,013
C) $2,413
D) $2,688
E) $2,813

Ans: D Level: Challenge Subject: Operating Cash Flow Type: Problems

172. The net working capital at the end of 2002 is ______ and ______ at the end of 2003.
A) -$2,955; -$1,113
B) $2,059; $3,586
C) $5,436; $1,286
D) $5,436; $7,606
E) $2,059; $8,637

Ans: B Level: Challenge Subject: Net Working Capital Type: Problems

173. The cash flow to creditors for 2003 is ______ while the cash flow to stockholders for 2003 is _____.
A) -$640; $705
B) -$175; $255
C) $175; $255
D) $175; $450
E) $640; $450

Ans: C Level: Challenge Subject: Cash Flow To Creditors And Stockholders Type: Problems

174. Alpha, Inc. earned $95,000 in net income in 2002 and paid $20,548.50 in taxes. Alpha, Inc. earned $95,001
in net income in 2003 and paid $20,548.84 in taxes. What is the marginal tax rate for Alpha, Inc.?
A) 15%
B) 25%
C) 34%
D) 35%
E) 38%

Ans: C Level: Intermediate Subject: Marginal Tax Rate Type: Problems

Use the following to answer questions 175-176:

Taxable income 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%

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

175. The marginal tax rate on an income of $239,650 is:

A) 15%
B) 25%
C) 34%
D) 39%
E) 34%

Ans: D Level: Basic Subject: Marginal Tax Rate Type: Problems

176. The total tax on an income of $289,600 is:

A) $89,544
B) $96,194
C) $112,944
D) $113,900
E) $128,544

Ans: B Level: Intermediate Subject: Income Tax Type: Problems

177. All-Rite sold $133,500 in used equipment in 2003 and replaced it with $212,000 of new equipment.
Depreciation for 2003 and $12,500. What is the net capital spending for 2003?
A) $66,000
B) $78,500
C) $91,000
D) $199,500
E) $212,000

Ans: C Level: Intermediate Subject: Net Capital Spending Type: Problems

178. Jack's Shoes has net income of $19,600 in 2003 and owes $8,650 in taxes for the year. The company repaid
$4,200 in loan principal and $650 in loan interest during the year. No new funds were borrowed. The
depreciation expense is $420. What is the operating cash flow for the year?
A) $10,720
B) $19,370
C) $20,670
D) $28,670
E) $29,320

Ans: C Level: Challenge Subject: Operating Cash Flow Type: Problems

Essay

179. What is a liquid asset and why is it necessary for a firm to maintain a reasonable level of liquid assets?
Ans: Liquid assets are those that can be sold quickly with little or no loss in value. A firm that has
sufficient liquidity will be less likely to experience financial distress.

Level: Basic Subject: Liquid Assets Type: Essays

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

180. Discuss the difference between book values and market values on the balance sheet and explain which is
more important to the financial manager and why.
Ans: The accounts on the balance sheet are generally carried at historical cost, not market values.
Although the book value of current assets and current liabilities may closely approximate market
values, the same cannot be said for the rest of the balance sheet accounts. Ultimately, the financial
manager should focus on the firm's stock price, which is a market value measure. Hence, market
values are more meaningful than book values.

Level: Basic Subject: Book Value & Market Value Type: Essays

181. Explain why the income statement is not a good representation of cash flow.
Ans: Most income statements contain some non-cash items, so these must be accounted for when
calculating cash flows. More importantly, however, since GAAP is used to create income
statements, revenues and expenses are booked when they accrue, not when their corresponding cash
flows occur.

Level: Basic Subject: Cash Flow & Acct Statements Type: Essays

182. Why is interest expense excluded from the operating cash flow calculation?
Ans: Operating cash flow is designed to represent the cash flow a firm generates from its day-to-day
operating activities. Interest expense arises out of a financing choice and thus should rightfully be
considered as a cash flow to creditors.

Level: Intermediate Subject: Operating Cash Flow Type: Essays

183. Note that in all of our cash flow computations to determine cash flow from assets, we never include the
addition to retained earnings. Why not? Is this an oversight?
Ans: The addition to retained earnings is not a cash flow. It is simply an accounting entry that reconciles
the balance sheet. Any additions to retained earnings will show up as cash flow changes in other
balance sheet accounts.

Level: Intermediate Subject: Addition To Retained Earnings Type: Essays

184. Note that we added depreciation back to operating cash flow and to additions to fixed assets. Why add it
back twice, isn't this double-counting?
Ans: In both cases, depreciation is added back because it was previously subtracted when obtaining
ending balances of net income and fixed assets. And, since depreciation is a non-cash expense, we
need to add it back in both instances, so there is no double counting.

Level: Challenge Subject: Depreciation & Cash Flow Type: Essays

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 Chapter 2 Financial Statements, Taxes, and Cash Flow

185. Sometimes when businesses are critically delinquent on their tax liabilities, the tax authority comes in and
literally seizes the business by chasing all of the employees out of the building and changing the locks.
What does this tell you about the importance of taxes relative to our discussion of cash flow? Why might a
business owner want to avoid such an occurrence?
Ans: Taxes must be paid in cash, and in this case, they are one of the most important components of cash
flow. The reputation of a business can undergo irreparable harm if word gets out that the tax
authorities have confiscated the business, even if only for a couple of hours until the business owner
can come up with the money to clear up the tax problem. But, the bottom line is, if the owner can't
come up with the cash, the tax authority has effectively put them out of business.

Level: Challenge Subject: Tax Liabilities & Cash Flow Type: Essays

186. Interpret, in words, what cash flow from assets represents by discussing operating cash flow, changes in net
working capital, and additions to fixed assets.
Ans: Operating cash flow is the cash flow a firm generates from its day-to-day operations. In other words,
it is the cash inflow generated as a result of putting the firm's assets to work. Changes in net
working capital and fixed assets represent investments a firm makes in these assets. That is, a firm
typically takes some of the cash flow it generates from using assets and reinvests it in new assets.
Cash flow from assets, then, is the cash flow a firm generates by employing its assets, net of any
acquisitions.

Level: Challenge Subject: Cash Flow From Assets Type: Essays

187. When the half-year rule was introduced, do you think firms looked favourably or unfavourably upon the
change?
Ans: Firms who purchased assets in January could now use only one-half of its original cost to calculate
depreciation for the year, compared to the full cost that could have been used under the old system.
Also, firms who could previously claim the original cost for a whole year, even thought they had
only purchased and put in use the asset in December, had a reduction in the amount they could claim.
Therefore, all firms claim a smaller amount of depreciation in the first year so that their taxes
increase and usable cash flows decreasE) Therefore, firms would not be in favour of the change.

Level: Challenge Subject: Half-Year (50%) Rule Type: Essays

188. Discuss the differences between net income and cash flow from operations. Which measure is more
relevant to a corporate treasurer and why?
Ans: Non-cash items, such as depreciation, reduce net income but do not affect cash flows. Interest
expense is a cost of financing and not an operating expense; therefore it reduces net income but does
not affect cash flow from operations. Cash flows are more relevant to the corporate treasurer since
his/her focus is on the cash management of a firm and not the accounting management.

Level: Intermediate Subject: Accounting Income vs. Cash Flow Type: Essays

189. Explain why cash flow from assets must be positive over the long-term if a firm is to remain financially
solvent.
Ans: Cash flow from assets must be positive over the long-term as a firm must be able to financially
support its own operations. In the short-term, firms can borrow money and issue new securities in
order to finance a negative cash flow from assets. However, if a firm does not show that it is
financially viable after a period of time, the firm will no longer be able to raise funds in the capital
markets.

Level: Intermediate Subject: Cash Flow Type: Essays

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