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Exam 3: Financial Statements

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Question 61

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Which of the following statements is CORRECT?

A) An increase in accounts receivable is added to net income in the operating activities section because if accounts receivable increase, then when they are collected cash will come into the firm.
B) In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and net operating working capital. Free cash flow is the amount of cash that could be withdrawn without harming the firm's ability to operate and to produce future cash flows.
C) The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that add to or subtract from cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt.
D) The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line."
E) Most rapidly growing companies have positive free cash flows because cash flows from existing operations will exceed fixed assets and working capital needed to support the growth.

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Question 62

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Which of the following statements is CORRECT?

A) In the statement of cash flows, a decrease in accounts receivable is subtracted from net income in the operating activities section.
B) Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity.
C) In the statement of cash flows, a decrease in accounts payable is subtracted from net income in the operating activities section.
D) In the statement of cash flows, depreciation is subtracted from net income in the operating activities section.
E) In the statement of cash flows, a decrease in inventories is subtracted from net income in the operating activities section.

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Question 63

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Moose Industries faces the following tax schedule: Last year the company realized $10,000,000 in operating income (EBIT) . Its annual interest expense is $1,500,000. What was the company's net income for the year?

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

Allen Corporation can (1) build a new plant that should generate a before-tax return of 11%, or (2) invest the same funds in the preferred stock of Florida Power & Light (FPL) , which should provide Allen with a before-tax return of 9%, all in the form of dividends. Assume that Allen's marginal tax rate is 25%, and that 70% of dividends received are excluded from taxable income. If the plant project is divisible into small increments, and if the two investments are equally risky, what combination of these two possibilities will maximize Allen's effective return on the money invested?

Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds and U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. If Treasury bonds yield 6%, and Carter's marginal income tax rate is 40%, what yield on the Chicago municipal bonds would make Carter's treasurer indifferent between the two?

Corporations face the following tax schedule: Company Z has $80,000 of taxable income from its operations, $5,000 of interest income, and $30,000 of dividend income from preferred stock it holds in other corporations. What is Company Z's tax liability?

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

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

Consider the following balance sheet, for Games Inc. Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000.

Net operating working capital is equal to current assets minus the difference between current liabilities and notes payable.

Byrd Lumber has 2 million shares of common stock outstanding that sell for $17 a share. If the company has $40 million of common equity on its balance sheet, what is the company's Market Value Added (MVA) ?

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

For managerial purposes, i.e., making decisions regarding the firm's operations, the standard financial statements as prepared by accountants under generally accepted accounting principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm's operations. Related to these modifications, which of the following statements is CORRECT?

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

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

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

Assume that Congress recently passed a provision that will enable Bev's Beverages Inc. (BBI) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or the tax rate. Prior to the new provision, BBI's net income was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BBI's financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.

Your corporation has the following cash flows: If the applicable income tax rate is 40% (federal and state combined) , and if 70% of dividends received are exempt from taxes, what is the corporation's tax liability?

Which of the following statements is CORRECT?