Fundamentals of Financial Management 14th Edition by Eugene F. Brigham – Test Bank
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Sample Test
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CHAPTER_03_FINANCIAL_STATEMENTS_CASH_FLOW_AND_TAXES This chapter has a lot of definitions. They are important, but
we don’t like to make students memorize too many of them early in the course.
We let our students use a formula sheet that includes the key definitions. Note that there is an overlap between the
T/F and multiple-choice questions, as some of the T/F statements are used in
multiple-choice questions. Multiple Choice: True/False |
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1. The annual report contains four
basic financial statements: the income statement, the balance sheet, the cash
flow statement, and statement of stockholders’ equity.
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2. The primary reason the annual
report is important in finance is that it is used by investors when they form
expectations about the firm’s future earnings and dividends, and the
riskiness of those cash flows.
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3. Companies typically provide
four basic financial statements: the fixed income statement, the current
income statement, the balance sheet, and the cash flow statement.
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4. On the balance sheet, total
assets must always equal the sum of total liabilities and equity.
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5. Assets other than cash are
expected to produce cash over time, but the amount of cash they eventually
produce could be higher or lower than the amounts at which the assets are
carried on the books.
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6. The amount shown on the
December 31, 2015, balance sheet as “retained earnings” is equal to the
firm’s net income for 2015 minus any dividends it paid.
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7. The income statement shows the
difference between a firm’s income and its costs–i.e., its profits–during a
specified period of time. However, not all reported income comes in the form
of cash, and reported costs likewise may not be consistent with cash outlays.
Therefore, there may be a substantial difference between a firm’s reported
profits and its actual cash flow for the same period.
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8. If we were describing the
income statement and the balance sheet, it would be correct to say that the
income statement is more like a video while the balance sheet is more like a
snapshot.
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9. EBIT stands for earnings before
interest and taxes, and it is often called “operating income.”
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10. EBITDA stands for earnings
before interest, taxes, debt, and assets.
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11. 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.
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12. Typically, the statement
of stockholders’ equity starts with total stockholders’
equity at the beginning of the year, adds net income, subtracts dividends
paid, and ends up with total stockholders’ equity at the end of the year.
Over time, a profitable company will have earnings in excess of the dividends
it pays out, and will result in a substantial amount of retained earnings
shown on the balance sheet.
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13. Free cash flow (FCF) is,
essentially, the cash flow that is available for interest and dividends after
the company has made the investments in current and fixed assets that are
necessary to sustain ongoing operations.
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14. 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.
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15. 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.
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16. The fact that 70% of the
interest income received by corporations is excluded from
its taxable income encourages firms to finance with more debt than they would
in the absence of this tax law provision.
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17. Both interest and
dividends paid by a corporation are deductible operating
expenses, hence they decrease the firm’s taxes.
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18. The balance sheet measures the
flow of funds into and out of various accounts over time, while the income
statement measures the firm’s financial position at a point in time.
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19. Assume that two firms are both
following generally accepted accounting principles. Both firms commenced
operations two years ago with $1 million of identical fixed assets, and
neither firm sold any of those assets or purchased any new fixed assets. The
two firms would be required to report the same amount of net fixed assets on
their balance sheets as those statements are presented to investors.
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20. Net operating working capital
is equal to current assets minus the difference between current liabilities
and notes payable. This definition assumes that the firm has no “excess”
cash.
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21. 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.”
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22. The statement of cash flows
has four main sections, one each for operating, investing, and financing
activities, and one that shows a summary of the cash and cash equivalents at
the end of the year.
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23. An increase in accounts
payable represents an increase in net cash provided by operating activities
just like borrowing money from a bank. An increase in accounts payable has an
effect similar to taking out a new bank loan. However, these two items show
up in different sections of the statement of cash flows to reflect the
difference between operating and financing activities.
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24. An increase in accounts
receivable represents an increase in net cash provided by operating
activities because receivables will produce cash when they are collected.
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25. The first major section of a
typical statement of cash flows is “Operating Activities,” and the first
entry in this section is “Net Income.” Then, also in the first section, we
show some items that represent increases or decreases to cash, and the last
entry is called “Net Cash Provided by Operating Activities.” This number can
be either positive or negative, but if it is negative, the firm is almost
certain to soon go bankrupt.
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26. To estimate the cash flow from
operations, depreciation must be added back to net income because it is a
non-cash charge that has been deducted from revenue in the net income
calculation.
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27. Two metrics that are used to
measure a company’s financial performance are net income and cash flow.
Accountants emphasize net income as calculated in accordance with generally
accepted accounting principles. Finance people generally put at least as much
weight on cash flows as they do on net income.
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28. Its retained earnings is the
actual cash that the firm has generated through operations less the cash that
has been paid out to stockholders as dividends. If the firm has sufficient
retained earnings, it can purchase assets and pay for them with cash from
retained earnings.
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29. The retained earnings account
on the balance sheet does not represent cash. Rather, it represents part of
the stockholders’ claims against the firm’s existing assets. Put another way
retained earnings are stockholders’ reinvested earnings.
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30. In finance, we are generally
more interested in cash flows than in accounting profits. Free cash flow
(FCF) is calculated as after-tax operating income plus depreciation less the
sum of capital expenditures and changes in net operating working capital.
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31. Free cash flow is the amount
of cash that if withdrawn would harm the firm’s ability to operate and to
produce future cash flows.
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32. If the tax laws were changed
so that $0.50 out of every $1.00 of interest paid by a
corporation was allowed as a tax-deductible expense, this would probably
encourage companies to use more debt financing than they presently do, other
things held constant.
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33. Interest paid by a corporation
is a tax deduction for the paying corporation, but dividends paid are not
deductible. This treatment, other things held constant, tends to encourage
the use of debt financing by corporations.
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34. Because the U.S. tax system is
a progressive tax system, a taxpayer’s marginal and average tax rates are the
same.
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35. The alternative minimum tax
(AMT) was created by Congress to make it more difficult for wealthy
individuals to avoid paying taxes through the use of various deductions.
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36. The time dimension is
important in financial statement analysis. The balance sheet shows the firm’s
financial position at a given point in time, the income statement shows
results over a period of time, and the statement of cash flows reflects specific changes in
accounts over that period of time.
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Multiple Choice: Conceptual Please note that some of the answer choices, or answers that
are very close, are used in different questions. This has caused us no
difficulties, but please take this into account when you make up exams. |
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37. Which of the following
statements is CORRECT?
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38. Which of the following
statements is CORRECT?
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39. Which of the following
statements is CORRECT?
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40. Other things held constant,
which of the following actions would increase the amount of
cash on a company’s balance sheet?
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41. Which of the following items
is NOT normally considered to be a current asset?
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42. Which of the following
items cannot be found on a firm’s balance sheet under
current liabilities?
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43. Which of the following
statements is CORRECT?
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44. Below are the 2013 and 2014
year-end balance sheets for Tran Enterprises:
The firm has never paid a dividend on its common stock, and it
issued $2,400,000 of 10-year, non-callable, long-term debt in 2013. As
of the end of 2014, none of the principal on this debt had been repaid.
Assume that the company’s sales in 2013 and 2014 were the same. Which of the
following statements must be CORRECT?
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45. On its 12/31/14 balance sheet,
Barnes Inc showed $510 million of retained earnings, and exactly that same
amount was shown the following year. Assuming that no earnings restatements
were issued, which of the following statements is CORRECT?
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46. Below is the common equity
section (in millions) of Timeless Technology’s last two year-end balance
sheets:
The firm has never paid a dividend to its common stockholders.
Which of the following statements is CORRECT?
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