TESTBANK FOR Corporate Finance, 3rd Edition

TESTBANK FOR Corporate Finance, 3rd Edition by Jonathan Berk and Peter DeMarzo Corporate Finance, 3e (Berk/DeMarzo) Chapter 1 The Corporation 1.1 The Four Types of Firms 1) A sole proprietorship is owned by: A) one person. B) two of more persons. C) shareholders. D) bankers. Answer: A Diff: 1 Section: 1.1 The Four Types of Firms Skill: Definition 2) Which of the following organization forms for a business does NOT avoid double taxation? A) Limited partnership B) "C" corporation C) "S" corporation D) Limited liability company Answer: B Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 3) Which of the following organization forms accounts for the most revenue? A) "S" corporation B) Limited partnership C) "C" corporation D) Limited liability company Answer: C Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 4) Which of the following organization forms accounts for the greatest number of firms? A) "S" corporation B) Limited partnership C) Sole proprietorship D) "C" corporation Answer: C Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 5) Which of the following is NOT an advantage of a sole proprietorship? A) Single taxation B) Ease of setup C) Limited liability D) No separation of ownership and control Answer: C Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 6) Which of the following statements regarding limited partnerships is TRUE? A) There is no limit on a limited partner's liability. B) A limited partner's liability is limited by the amount of their investment. C) A limited partner is not liable until all the assets of the general partners have been exhausted. D) A general partner's liability is limited by the amount of their investment. Answer: B Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 7) Which of the following is/are an advantage of incorporation? A) Access to capital markets B) Limited liability C) Unlimited life D) All of the above Answer: D Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 8) Which of the following statements is most correct? A) An advantage to incorporation is that it allows for less regulation of the business. B) An advantage of a corporation is that it is subject to double taxation. C) Unlike a partnership, a disadvantage of a corporation is that has limited liability. D) Corporations face more regulations when compared to partnerships. Answer: D Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 9) A limited liability company is essentially: A) a limited partnership without limited partners. B) a limited partnership without a general partner. C) just another name for a limited partnership. D) just another name for a corporation. Answer: B Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 10) The distinguishing feature of a corporation is that: A) their is no legal difference between the corporation and its owners. B) it is a legally defined, artificial being, separate from its owners. C) it spreads liability for its corporate obligations to all shareholders. D) provides limited liability only to small shareholders. Answer: B Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 11) Which of the following are subject to double taxation? A) Corporation B) Partnership C) Sole proprietorship D) A and B Answer: A Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 12) You own 100 shares of a "C" corporation. The corporation earns $5.00 per share before taxes. Once the corporation has paid any corporate taxes that are due, it will distribute the rest of its earnings to its shareholders in the form of a dividend. If the corporate tax rate is 40% and your personal tax rate on (both dividend and non-dividend) income is 30%, then how much money is left for you after all taxes have been paid? A) $210 B) $300 C) $350 D) $500 Answer: A Explanation: A) EPS × number of shares × (1 - Corporate Tax Rate) × (1 - Individual Tax Rate) $5.00 per share × 100 shares × (1 - .40) × (1 - .30) = $210 Diff: 2 Section: 1.1 The Four Types of Firms Skill: Analytical 13) You own 100 shares of a Sub Chapter "S" corporation. The corporation earns $5.00 per share before taxes. Once the corporation has paid any corporate taxes that are due, it will distribute the rest of its earnings to its shareholders in the form of a dividend. If the corporate tax rate is 40% and your personal tax rate on (both dividend and non-dividend) income is 30%, then how much money is left for you after all taxes have been paid? A) $210 B) $300 C) $350 D) $500 Answer: C Explanation: C) EPS × number of shares × (1 - Individual Tax Rate) $5.00 per share × 100 shares × (1 - .30) = $350 Diff: 2 Section: 1.1 The Four Types of Firms Skill: Analytical 14) You are a shareholder in a "C" corporation. This corporation earns $4 per share before taxes. After it has paid taxes, it will distribute the remainder of its earnings to you as a dividend. The dividend is income to you, so you will then pay taxes on these earnings. The corporate tax rate is 35% and your tax rate on dividend income is 15%. The effective tax rate on your share of the corporations earnings is closest to: A) 15% B) 35% C) 45% D) 50% Answer: C Explanation: C) First the corporation pays taxes. It earned $4 per share, but must pay $4 × .35 = $1.40 to the government in corporate taxes. That leaves $4.00 - $1.40 = $2.60 to distribute to the shareholders. However, the shareholder must pay $2.60 × .15 = $0.39 in income taxes on this amount, leaving only $2.21 to the shareholder after all taxes are paid. The total amount paid in taxes is $1.40 + 0.39 = $1.79. The effective tax rate is then $1.79 ÷ $4 = .4475 or 44.75% which is closest to 45%. Diff: 3 Section: 1.1 The Four Types of Firms Skill: Analytical 15) Explain the benefits of incorporation. Answer: 1. Limited liability 2. Unlimited life 3. Access to capital markets/availability of outside funding Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 16) Explain the difference between a sub-chapter "S" corporation and a sub-chapter "C" corporation. Answer: "C" Corporation "S" Corporation Publicly traded stock Privately traded stock Unlimited shareholders No more than 75 shareholders Double taxation Taxed like a partnership Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 1.2 Ownership Versus Control of Corporations 1) In a corporation, the ultimate decisions regarding business matters are made by: A) the Board of Directors. B) debt holders. C) shareholders. D) investors. Answer: A Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 2) The person charged with running the corporation by instituting the rules and policies set by the board of directors is called: A) the chief operating officer. B) the company president. C) the chief executive officer. D) the chief financial officer. Answer: C Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 3) The Principal-Agent Problem arises: A) because managers have little incentive to work in the interest of shareholders when this means working against their own self-interest. B) because of the separation of ownership and control in a corporation. C) Both A and B D) None of the above Answer: C Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 4) If shareholders are unhappy with a CEO's performance, they are most likely to: A) buy more shares in an effort to gain control of the firm. B) file a shareholder resolution. C) replace the CEO through a grassroots shareholder uprising. D) sell their shares. Answer: D Diff: 2 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 5) A ________ is when a rich individual or organization purchases a large fraction of the stock of a poorly performing firm and in doing so gets enough votes to replace the board of directors and the CEO. A) shareholder proposal B) leveraged buyout C) shareholder action D) hostile takeover Answer: D Diff: 2 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 6) Which of the following statements is FALSE? A) In bankruptcy, management is given the opportunity to reorganize the firm and renegotiate with debt holders. B) Because a corporation is a separate legal entity, when it fails to repay its debts, the people who lent to the firm, the debt holders are entitled to seize the assets of the corporation in compensation for the default. C) As long as the corporation can satisfy the claims of the debt holders, ownership remains in the hands of the equity holders. D) If the corporation fails to satisfy debt holders' claims, debt holders may lose control of the firm. Answer: D Explanation: D) If the corporation fails to satisfy debt holders' claims, debt holders may take control of the firm. Diff: 2 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 7) The most senior financial manager in a corporation is usually called: A) the chief executive officer. B) the chief financial officer. C) the chief operating officer. D) the chairman of the board. Answer: B Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 8) You overhear your manager saying that she plans to book an Ocean-view room on her upcoming trip to Miami for a meeting. You know that the interior rooms are much less expensive, but that your manager is traveling at the Company's expense. This use of additional funds comes about as a result of: A) an agency problem. B) an adverse selection problem. C) a moral hazard. D) a publicity problem. Answer: A Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 9) An agency problem can be alleviated by: A) requiring all firms to be sole proprietorships. B) compensating managers in such a way that acting in the best interest of shareholders is also in the best interest of managers. C) asking managers to take on more risk than they are comfortable taking. D) A and B. Answer: D Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 10) Do corporate decisions that increase the value of the firm's equity benefit society as a whole? A) Yes, as long as the value of the firm's equity increases, society is better off. B) Yes, as long as the increase in the value of the firm's equity does not come at the expense of others. C) No, any gain in the value of the firm's equity is always less than the cost to society. D) No, any gains in the value of the firm's equity are perfectly offset by societal costs. Answer: B Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 11) What strategies are available to shareholders to help ensure that managers are motivated to act in the interest of the shareholders rather than their own interest? Answer: 1. The threat of a hostile takeover 2. Shareholder initiatives 3. Performance based compensation Diff: 3 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 1.3 The Stock Market Use the table for the question(s) below. Consider the following two quotes for XYZ stock: November 11th November 18th Ask: 25.25 Ask: 26.00 Bid: 25.20 Bid: 25.93 1) How much would you have to pay to purchase 100 shares of XYZ stock on November 18th? A) $2520 B) $2525 C) $2593 D) $2600 Answer: D Explanation: D) 100 shares × $26.00 (ask price) = $2600 Diff: 1 Section: 1.3 The Stock Market Skill: Analytical 2) How much would you receive if you sold 200 shares of XYZ stock on November 11th? A) $5050 B) $5040 C) $5186 D) $5200 Answer: B Explanation: B) 200 shares × $25.20 (bid price) = $5040 Diff: 1 Section: 1.3 The Stock Market Skill: Analytical 3) The largest stock market in the world is: A) the London Stock Exchange. B) NASDAQ. C) the American Stock Exchange. D) the New York Stock Exchange. Answer: D Diff: 1 Section: 1.3 The Stock Market Skill: Definition 4) An investment is said to be liquid if the investment: A) has large day to day fluctuations in price. B) has a large bid-ask spread. C) can easily be converted into cash. D) is traded on a stock exchange. Answer: C Diff: 2 Section: 1.3 The Stock Market Skill: Definition 5) What type of company trades on an organized stock exchange? A) A limited liability company B) A private company C) An "S" corporation D) A public company Answer: D Diff: 1 Section: 1.3 The Stock Market Skill: Definition 6) Which of the following statements is FALSE? A) On Nasdaq, stocks can and do have multiple market makers who compete with each other. Each market maker must post bid and ask prices in the Nasdaq network where they can be viewed by all participants. B) Bid prices exceed ask prices. C) Because customers always buy at the ask and sell at the bid, the bid-ask spread is a transaction cost investors have to pay in order to trade. D) On the floor of the NYSE, market makers (known on the NYSE as specialists) match buyers and sellers. Answer: B Explanation: B) Ask prices exceed bid prices. Diff: 2 Section: 1.3 The Stock Market Skill: Conceptual 7) If you buy shares of Coca-Cola on the primary market: A) Coca-Cola receives the money because the company has issued new shares. B) you buy the shares from another investor who decided to sell the shares. C) you buy the shares from the New York Stock Exchange. D) you buy the shares from the Federal Reserve. Answer: A Diff: 1 Section: 1.3 The Stock Market Skill: Definition 8) If you buy shares of Coca-Cola on the secondary market: A) Coca-Cola receives the money because the company has issued new shares. B) you buy the shares from another investor who decided to sell the shares. C) you buy the shares from the New York Stock Exchange. D) you buy the shares from the Federal Reserve. Answer: B Diff: 1 Section: 1.3 The Stock Market Skill: Definition Use the table for the question(s) below. Consider the following two quotes for XYZ stock: November 11th November 18th Ask: 25.25 Ask: 26.00 Bid: 25.20 Bid: 25.93 9) What are your net proceeds if you purchased 2500 shares of XYZ stock on November 11th and then sold them a week later on November 18th? Answer: buy at ask price 11/11 = 2500 × $25.25 = $63,125 sell at bid price 11/18 = 2500 × $25.93 = $64,825 now subtract the price paid for the shares so net proceeds = 64,825 - 63,125 = $1700 Diff: 2 Section: 1.3 The Stock Market Skill: Analytical 10) Explain the main differences between the NYSE and NASDAQ stock markets. Answer: Key points: NYSE has physical location—NASDAQ is an electronic market. NYSE has one specialist in each stock and his role is to match buyers and sellers. NASDAQ has multiple market makers (dealers) in each stock who stand ready to trade on their own accounts. Diff: 2 Section: 1.3 The Stock Market Skill: Conceptual Corporate Finance, 3e (Berk/DeMarzo) Chapter 2 Introduction to Financial Statement Analysis 2.1 Firms' Disclosure of Financial Information 1) U.S. public companies are required to file their annual financial statements with the U.S. Securities and Exchange Commission on which form? A) 10-A B) 10-K C) 10-Q D) 10-SEC Answer: B Diff: 1 Section: 2.1 Firms' Disclosure of Financial Information Skill: Definition 2) Which of the following is NOT a financial statement that every public company is required to produce? A) Income Statement B) Statement of Sources and Uses of Cash C) Balance Sheet D) Statement of Stockholders' Equity Answer: B Diff: 2 Section: 2.1 Firms' Disclosure of Financial Information Skill: Conceptual 3) The third party who checks annual financial statements to ensure that they are prepared according to GAAP and verifies that the information reported is reliable is the: A) NYSE Enforcement Board. B) Accounting Standards Board. C) Securities and Exchange Commission (SEC). D) auditor. Answer: D Diff: 1 Section: 2.1 Firms' Disclosure of Financial Information Skill: Definition 4) What is the role of an auditor in financial statement analysis? Answer: Key points: 1. To ensure that the annual financial statements are prepared accurately. 2. To ensure that the annual financial statements are prepared according to GAAP. 3. To verify that the information used in preparing the annual financial statements is reliable. Diff: 2 Section: 2.1 Firms' Disclosure of Financial Information Skill: Conceptual 5) What are the four financial statements that all public companies must produce? Answer: 1. Balance Sheet 2. Income Statement 3. Statement of Cash Flows 4. Statement of Stockholder's Equity Diff: 2 Section: 2.1 Firms' Disclosure of Financial Information Skill: Conceptual 2.2 The Balance Sheet 1) Which of the following balance sheet equations is INCORRECT? A) Assets - Liabilities = Shareholders' Equity B) Assets = Liabilities + Shareholders' Equity C) Assets - Current Liabilities = Long Term Liabilities D) Assets - Current Liabilities = Long Term Liabilities + Shareholders' Equity Answer: C Diff: 2 Section: 2.2 The Balance Sheet Skill: Conceptual 2) Cash is a: A) long-term asset. B) current asset. C) current liability. D) long-term liability. Answer: B Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 3) Accounts payable is a: A) long-term liability. B) current asset. C) long-term asset. D) current liability. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 4) A 30 year mortgage loan is a: A) long-term liability. B) current liability. C) current asset. D) long-term asset. Answer: A Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 5) Which of the following statements regarding the balance sheet is INCORRECT? A) The balance sheet provides a snapshots of the firm's financial position at a given point in time. B) The balance sheet lists the firm's assets and liabilities. C) The balance sheet reports stockholders' equity on the right hand side. D) The balance sheet reports liabilities on the left hand side. Answer: D Diff: 2 Section: 2.2 The Balance Sheet Skill: Conceptual 6) Dustin's Donuts experienced a decrease in the value of the trademark of a company it acquired two years ago. This reduction in value results in: A) an impairment charge. B) depreciation expense. C) an operating expense. D) goodwill. Answer: A Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 7) Which of the following is an example of an intangible asset? A) Brand names and trademarks B) Patents C) Customer relationships D) All of the above are intangible assets. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 8) On the balance sheet, short-term debt appears: A) in the Stockholders' Equity section. B) in the Operating Expenses section. C) in the Current Assets section. D) in the Current Liabilities section. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 9) On the balance sheet, current maturities of long-term debt appears: A) in the Stockholders' Equity section. B) in the Operating Expenses section. C) in the Current Assets section. D) in the Current Liabilities section. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 10) The firm's assets and liabilities at a given point in time are reported on the firm's: A) income statement or statement of financial performance. B) income statement or statement of financial position. C) balance sheet or statement of financial performance. D) balance sheet or statement of financial position. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 11) The statement of financial position is also known as the: A) balance sheet. B) income statement. C) statement of cash flows. D) statement of stockholder's equity. Answer: A Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition Use the following information for ECE incorporated: Assets $200 million Shareholder Equity $100 million Sales $300 million Net Income $15 million Interest Expense $2 million 12) If ECE's stock is currently trading at $24.00 and ECE has 25 million shares outstanding, then ECE's market-to-book ratio is closest to: A) 0.24 B) 4 C) 6 D) 30 Answer: C Explanation: C) Market to Book = (MV Equity)/(BV Equity) = ($24 × 25 million)/100 million = 6.0 Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical Use the information for the question(s) below. In November 2009, Perrigo Co. (PRGO) had a share price of $39.20. They had 91.33 million shares outstanding, a market-to-book ratio of 3.76. In addition, PRGO had $845.01 million in outstanding debt, $163.82 million in net income, and cash of $257.09 million. 13) Perrigo's market capitalization is closest to: A) $952.16 million B) $3,580.14 million C) $4,168.06 million D) $4,425.15 million Answer: B Explanation: B) Market cap = price × shares outstanding = $39.2 × 91.33 million = $3,580.14 million Diff: 1 Section: 2.2 The Balance Sheet Skill: Analytical 14) Perrigo's book value of equity is closest to: A) $952.16 million B) $3,580.14 million C) $4,168.06 million D) $4,425.15 million Answer: A Explanation: A) Market to Book = (MV Equity)/(BV Equity) = ($39.2 × 91.33 million)/(BV Equity) = 3.76; BV Equity = $952.16 million. Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical 15) Perrigo's enterprise value is closest to: A) $952.16 million B) $3,580.14 million C) $4,168.06 million D) $4,425.15 million Answer: C Explanation: C) Enterprise Value = MV Equity + Debt - Cash = $39.2 × 91.33 +$845.01 - $257.09 = $4168.06 Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical Use the table for the question(s) below. Consider the following balance sheet: Luther Corporation Consolidated Balance Sheet December 31, 2009 and 2008 (in $ millions) Assets Liabilities and Stockholders' Equity Current Assets Current Liabilities Cash 63.6 58.5 Accounts payable 87.6 73.5 Accounts receivable 55.5 39.6 Notes payable/ short-term debt 10.5 9.6 Inventories 45.9 42.9 Current maturities of long-term debt 39.9 36.9 Other current assets 6.0 3.0 Other current liabilities 6.0 12.0 Total current assets 171.0 144.0 Total current liabilities 144.0 132.0 Long-Term Assets Long-Term Liabilities Land 66.6 62.1 Long-term debt 239.7 168.9 Buildings 109.5 91.5 Capital lease obligations --- --- Equipment 119.1 99.6 Total Debt 239.7 168.9 Less accumulated depreciation (56.1) (52.5) Deferred taxes 22.8 22.2 Net property, plant, and equipment 239.1 200.7 Other long-term liabilities --- --- Goodwill 60.0 -- Total long-term liabilities 262.5 191.1 Other long-term assets 63.0 42.0 Total liabilities 406.5 323.1 Total long-term assets 362.1 242.7 Stockholders' Equity 126.6 63.6 Total Assets 533.1 386.7 Total liabilities and Stockholders' Equity 533.1 386.7 16) What is Luther's net working capital in 2008? A) $12 million B) $27 million C) $39 million D) $63.6 million Answer: A Explanation: A) NWC = current assets - current liabilities = 144 - 132 = $12 million Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical 17) If in 2009 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share, then Luther's Market-to-book ratio would be closest to: A) 0.39 B) 0.76 C) 1.29 D) 2.57 Answer: C Explanation: C) MTB = market cap/book value of equity = (10.2 million × 16)/126.6 = 163.2/126.6 = 1.289 Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical 18) If in 2009 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share, then what is Luther's Enterprise Value? A) -$63.3 million B) $353.1 million C) $389.7 million D) $516.9 million Answer: C Explanation: C) Enterprise value = MVE + Debt - Cash = 10.2 × $16 + 290.1 - 63.6 = 389.7 Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical 19) If on December 31, 2008 Luther has 8 million shares outstanding trading at $15 per share, then what is Luther's market-to-book ratio? Answer: market-to-book = market value of equity/book value of equity market-to-book = 8 million × $15/$63.6 = 1.89 Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical 20) If on December 31, 2008 Luther has 8 million shares outstanding trading at $15 per share, then what is Luther's enterprise value? Answer: Enterprise value = Market value of equity + Debt - Cash market value of equity = 8 million × $15 = $120 million Debt = notes payable + current maturities of long-term debt + long-term debt Debt = 9.6 + 36.9 + 168.9 = 215.4 Cash = 58.5 So, enterprise value = $120 + 215.4 - 58.5 = $276.90 Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical 2.3 The Income Statement 1) Which of the following statements regarding the income statement is INCORRECT? A) The income statement shows the earnings and expenses at a given point in time. B) The income statement shows the flow of earnings and expenses generated by the firm between two dates. C) The last or "bottom" line of the income statement shows the firm's net income. D) The first line of an income statement lists the revenues from the sales of products or services. Answer: A Diff: 2 Section: 2.3 The Income Statement Skill: Conceptual 2) Gross profit is calculated as: A) Total sales - cost of sales - selling, general and administrative expenses - depreciation and amortization B) Total sales - cost of sales - selling, general and administrative expenses C) Total sales - cost of sales D) None of the above Answer: C Diff: 2 Section: 2.3 The Income Statement Skill: Conceptual 3) Which of the following is NOT an operating expense? A) Interest expense B) Depreciation and amortization C) Selling, general and administrative expenses D) Research and development Answer: A Diff: 2 Section: 2.3 The Income Statement Skill: Conceptual Use the information for the question(s) below. In November 2009, Perrigo Co. (PRGO) had a share price of $39.20. They had 91.33 million shares outstanding, a market-to-book ratio of 3.76. In addition, PRGO had $845.01 million in outstanding debt, $163.82 million in net income, and cash of $257.09 million. 4) Perrigo's earnings per share (EPS) is closest to: A) $0.19 B) $1.79 C) $2.81 D) $3.76 Answer: B Explanation: B) EPS = (Net Income)/(Shares Outstanding) = $163.82/91.33 = 1.7937 Diff: 2 Section: 2.3 The Income Statement Skill: Analytical 5) The firm's revenues and expenses over a period of time are reported on the firm's: A) income statement or statement of financial performance. B) income statement or statement of financial position. C) balance sheet or statement of financial performance. D) balance sheet or statement of financial position. Answer: A Diff: 1 Section: 2.3 The Income Statement Skill: Definition 6) The statement of financial performance is also known as the: A) balance sheet. B) income statement. C) statement of cash flows. D) statement of stockholder's equity. Answer: B Diff: 1 Section: 2.3 The Income Statement Skill: Definition Use the table for the question(s) below. Consider the following income statement and other information: Luther Corporation Consolidated Income Statement Year ended December 31 (in $ millions) Total sales 610.1 578.3 Cost of sales (500.2) (481.9) Gross profit 109.9 96.4 Selling, general, and administrative expenses (40.5) (39.0) Research and development (24.6) (22.8) Depreciation and amortization (3.6) (3.3) Operating income 41.2 31.3 Other income --- --- Earnings before interest and taxes (EBIT) 41.2 31.3 Interest income (expense) (25.1) (15.8) Pre-tax income 16.1 15.5 Taxes (5.5) (5.3) Net income 10.6 10.2 Price per share $16 $15 Shares outstanding (millions) 10.2 8.0 Stock options outstanding (millions) 0.3 0.2 Stockholders' Equity 126.6 63.6 Total Liabilities and Stockholders' Equity 533.1 386.7 7) For the year ending December 31, 2009 Luther's earnings per share are closest to: A) $0.96 B) $1.04 C) $1.28 D) $1.33 Answer: B Explanation: B) EPS = Net Income/Shares Outstanding = $10.6/10.2 = $1.04 Diff: 1 Section: 2.3 The Income Statement Skill: Analytical 8) Assuming that Luther has no convertible bonds outstanding, then for the year ending December 31, 2009 Luther's diluted earnings per share are closest to: A) $1.01 B) $1.04 C) $1.28 D) $1.33 Answer: A Explanation: A) Diluted EPS = Net Income/(shares outstanding + options contracts outstanding + shares possible from convertible bonds outstanding) = 10.6/(10.2 + 0.3 + 0.0) = $1.01 Diff: 2 Section: 2.3 The Income Statement Skill: Analytical 2.4 The Statement of Cash Flows 1) Which of the following is NOT a section on the cash flow statement? A) Income generating activities B) Investing activities C) Operating activities D) Financing activities Answer: A Diff: 1 Section: 2.4 The Statement of Cash Flows Skill: Conceptual 2) Which of the following statements regarding net income transferred to retained earnings is correct? A) Net income = net income transferred to retained earnings - dividends B) Net income transferred to retain earnings = net income + dividends C) Net income = net income transferred to retain earnings + dividends D) Net income transferred to retain earnings - net income = dividends Answer: C Diff: 2 Section: 2.4 The Statement of Cash Flows Skill: Conceptual 3) Which of the following is NOT a reason why cash flow may not equal net income? A) Amortization is added in when calculating net income. B) Changes in inventory will change cash flows but not income. C) Capital expenditures are not recorded on the income statement. D) Depreciation is deducted when calculating net income. Answer: A Diff: 1 Section: 2.4 The Statement of Cash Flows Skill: Conceptual 4) Which of the following adjustments to net income is NOT correct if you are trying to calculate cash flow from operating activities? A) Add increases in accounts payable B) Add back depreciation C) Add increases in accounts receivable D) Deduct increases in inventory Answer: C Diff: 2 Section: 2.4 The Statement of Cash Flows Skill: Conceptual 5) Which of the following adjustments is NOT correct if you are trying to calculate cash flow from financing activities? A) Add dividends paid B) Add any increase in long term borrowing C) Add any increase in short-term borrowing D) Add proceeds from the sale of stock Answer: A Diff: 2 Section: 2.4 The Statement of Cash Flows Skill: Conceptual Use the tables for the question(s) below. Consider the following financial information: Luther Corporation Consolidated Balance Sheet December 31, 2009 and 2008 (in $ millions) Assets Liabilities and Stockholders' Equity Current Assets Current Liabilities Cash 63.6 58.5 Accounts payable 87.6 73.5 Accounts receivable 55.5 39.6 Notes payable/ short-term debt 10.5 9.6 Inventories 45.9 42.9 Current maturities of long-term debt 39.9 36.9 Other current assets 6.0 3.0 Other current liabilities 6.0 12.0 Total current assets 171.0 144.0 Total current liabilities 144.0 132.0 Long-Term Assets Long-Term Liabilities Land 66.6 62.1 Long-term debt 239.7 168.9 Buildings 109.5 91.5 Capital lease obligations --- --- Equipment 119.1 99.6 Total Debt 239.7 168.9 Less accumulated depreciation (56.1) (52.5) Deferred taxes 22.8 22.2 Net property, plant, and equipment 239.1 200.7 Other long-term liabilities --- --- Goodwill 60.0 -- Total long-term liabilities 262.5 Other long-term assets 63.0 42.0 Total liabilities 406.5 323.1 Total long-term assets 362.1 242.7 Stockholders' Equity 126.6 63.6 Total Assets 533.1 386.7 Total liabilities and Stockholders' Equity 533.1 386.7 Luther Corporation Consolidated Income Statement Year ended December 31 (in $ millions) Total sales 610.1 578.3 Cost of sales (500.2) (481.9) Gross profit 109.9 96.4 Selling, general, and administrative expenses (40.5) (39.0) Research and development (24.6) (22.8) Depreciation and amortization (3.6) (3.3) Operating income 41.2 31.3 Other income --- --- Earnings before interest and taxes (EBIT) 41.2 31.3 Interest income (expense) (25.1) (15.8) Pre-tax income 16.1 15.5 Taxes (5.5) (5.3) Net income 10.6 10.2 Dividends Paid 5.1 5.0 Price per Share $16 $15 Shares outstanding (millions) 10.2 8.0 Stock options outstanding (millions) 0.3 0.2 Stockholders’ Equity 126.6 63.6 Total Liabilities and Stockholders’ Equity 533.1 386.7 6) For the year ending December 31, 2009 Luther's cash flow from operating activities is: Answer: Operating cash flow = NI + Depreciation - inc in AR + inc in AP - inc in INV Operating cash flow = 10.6 + 3.6 - (55.5 - 39.6) + (87.6 - 73.5) - (45.9 - 42.9) = 9.4 Diff: 3 Section: 2.4 The Statement of Cash Flows Skill: Analytical 7) For the year ending December 31, 2009 Luther's cash flow from financing activities is: Answer: Cash flow from financing: - dividends paid (5.1) + sale or (purchase) of stock 57.5* + increase in ST borrowing 3.9 + increase in LT borrowing 70.8 Cash flow from financing 127.1 NI transferred to RE(2006) = NI - Dividends paid = 10.6 - 5.1 = 5.5 sale of stock = Equity(2006) - NI transferred to RE(2006) - Equity(2005) = 126.6 - 5.5 - 63.6 = 57.5 increase in ST borrowing = chg in notes payable + chg in current portion of LT debt = (10.5 - 9.6) + (39.9 - 36.9) = 3.9 increase in LT borrowing = 239.7 - 168.9 = 70.8 Diff: 3 Section: 2.4 The Statement of Cash Flows Skill: Analytical 2.5 Other Financial Statement Information 1) In addition to the balance sheet, income statement, and the statement of cash flows, a firm's complete financial statements will include all of the following EXCEPT: A) Management discussion and analysis B) Notes to the financial statements C) Securities and Exchange Commission's (SEC) commentary D) Statement of stockholders' equity Answer: C Diff: 1 Section: 2.5 Other Financial Statement Information Skill: Conceptual 2) Off-balance sheet transactions are required to be disclosed: A) in the management discussion and analysis. B) in the auditor's report. C) in the Securities and Exchange Commission's commentary. D) in the statement of stockholders' equity. Answer: A Diff: 2 Section: 2.5 Other Financial Statement Information Skill: Conceptual 3) Details of acquisitions, spin-offs, leases, taxes, and risk management activities are given: A) in the management discussion and analysis. B) in the Securities and Exchange Commission's commentary. C) in the auditor's report. D) in the notes to the financial statements. Answer: D Diff: 2 Section: 2.5 Other Financial Statement Information Skill: Conceptual 2.6 Financial Statement Analysis Use the information for the question(s) below. In November 2009, Perrigo Co. (PRGO) had a share price of $39.20. They had 91.33 million shares outstanding, a market-to-book ratio of 3.76. In addition, PRGO had $845.01 million in outstanding debt, $163.82 million in net income, and cash of $257.09 million. 1) Perrigo's market debt to equity ratio is closest to: A) 0.24 B) 0.50 C) 0.75 D) 0.89 Answer: A Explanation: A) Market Debt to Equity Ratio = Debt/(MV Equity) = $845.01/($39.2 × 91.33) = 0.236 Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 2) Perrigo's debt to equity ratio is closest to: A) 0.24 B) 0.50 C) 0.75 D) 0.89 Answer: D Explanation: D) Debt to Equity Ratio = Debt/(BV Equity) = $845.01/(($39.2 × 91.33)/3.76) = 0.887 Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical Use the table for the question(s) below. Consider the following balance sheet: Luther Corporation Consolidated Balance Sheet December 31, 2009 and 2008 (in $ millions) Assets Liabilities and Stockholders' Equity Current Assets Current Liabilities Cash 63.6 58.5 Accounts payable 87.6 73.5 Accounts receivable 55.5 39.6 Notes payable/ short-term debt 10.5 9.6 Inventories 45.9 42.9 Current maturities of long-term debt 39.9 36.9 Other current assets 6.0 3.0 Other current liabilities 6.0 12.0 Total current assets 171.0 144.0 Total current liabilities 144.0 132.0 Long-Term Assets Long-Term Liabilities Land 66.6 62.1 Long-term debt 239.7 168.9 Buildings 109.5 91.5 Capital lease obligations --- --- Equipment 119.1 99.6 Total Debt 239.7 168.9 Less accumulated depreciation (56.1) (52.5) Deferred taxes 22.8 22.2 Net property, plant, and equipment 239.1 200.7 Other long-term liabilities --- --- Goodwill 60.0 -- Total long-term liabilities 262.5 191.1 Other long-term assets 63.0 42.0 Total liabilities 406.5 323.1 Total long-term assets 362.1 242.7 Stockholders' Equity 126.6 63.6 Total Assets 533.1 386.7 Total liabilities and Stockholders' Equity 533.1 386.7 3) When using the book value of equity, the debt to equity ratio for Luther in 2009 is closest to: A) 0.43 B) 2.29 C) 2.98 D) 3.57 Answer: B Explanation: B) D/E = Total Debt/Total Equity Total Debt = (notes payable (10.5) + current maturities of long-term debt (39.9) + long-term debt (239.7) = 290.1 million Total Equity = 126.6, so D/E = 290.1/126.6 = 2.29 Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 4) If in 2009 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share, then using the market value of equity, the debt to equity ratio for Luther in 2009 is closest to: A) 1.47 B) 1.78 C) 2.31 D) 4.07 Answer: B Explanation: B) D/E = Total Debt/Total Equity Total Debt = (notes payable (10.5) + current maturities of long-term debt (39.9) + long-term debt (239.7) = 290.1 million Total Equity = 10.2 × $16 = 163.2, so D/E = 290.1/163.2 = 1.78 Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 5) Luther's current ratio for 2009 is closest to: A) 0.84 B) 0.92 C) 1.09 D) 1.19 Answer: D Explanation: D) current ratio = current assets/current liabilities = 171/144 = 1.19 Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 6) Luther's quick ratio for 2008 is closest to: A) 0.77 B) 0.87 C) 1.15 D) 1.30 Answer: A Explanation: A) quick ratio = (current assets - inventory)/current liabilities quick ratio = (144.0 - 42.9)/132 = 0.77 Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 7) The change in Luther's quick ratio from 2008 to 2009 is closest to: A) a decrease of .10 B) an increase of .10 C) a decrease of .15 D) an increase of .15 Answer: B Explanation: B) quick ratio in 2009 = (171.0 - 45.9)/144 = .87 quick rat io 2008 = (144.0 - 42.9)/132 = .77 so the quick ratio increased by .87 - .77 = .10 Diff: 3 Section: 2.6 Financial Statement Analysis Skill: Analytical Use the following information for ECE incorporated: Assets $200 million Shareholder Equity $100 million Sales $300 million Net Income $15 million Interest Expense $2 million 8) IECE's Return on Assets (ROA) is: A) 5.0% B) 8.5% C) 7.5% D) 15.0% Answer: B Explanation: B) ROA = (Net Income + Interest Expense)/Assets = ($15 million+2 million)/$200 million = 0.085 = 8.5% Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical Use the information for the question(s) below. In November 2009, Perrigo Co. (PRGO) had a share price of $39.20. They had 91.33 million shares outstanding, a market-to-book ratio of 3.76. In addition, PRGO had $845.01 million in outstanding debt, $163.82 million in net income, and cash of $257.09 million. 9) Perrigo's price-earnings ratio (P/E) is closest to: A) 15.96 B) 21.85 C) 29.77 D) 35.64 Answer: B Explanation: B) price-earnings ratio (P/E) = (M V Equity)/(Net Income) = ($39.2 × 91.33)/$163.82 = 21.85408 Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical Use the table for the question(s) below. Consider the following income statement and other information: Luther Corporation Consolidated Income Statement Year ended December 31 (in $ millions) Total sales 610.1 578.3 Cost of sales (500.2) (481.9) Gross profit 109.9 96.4 Selling, general, and administrative expenses (40.5) (39.0) Research and development (24.6) (22.8) Depreciation and amortization (3.6) (3.3) Operating income 41.2 31.3 Other income --- --- Earnings before interest and taxes (EBIT) 41.2 31.3 Interest income (expense) (25.1) (15.8) Pre-tax income 16.1 15.5 Taxes (5.5) (5.3) Net income 10.6 10.2 Price per share $16 $15 Shares outstanding (millions) 10.2 8.0 Stock options outstanding (millions) 0.3 0.2 Stockholders' Equity 126.6 63.6 Total Liabilities and Stockholders' Equity 533.1 386.7 10) Luther's Operating Margin for the year ending December 31, 2008 is closest to: A) 0.5% B) 0.7% C) 5.4% D) 6.8% Answer: C Explanation: C) Operating Margin = Operating Income/Sales OM = 31.3/578.3 = .054 or 5.4% Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 11) Luther's Net Profit Margin for the year ending December 31, 2008 is closest to: A) 1.8% B) 2.7% C) 5.4% D) 16.7% Answer: A Explanation: A) Net Profit Margin = Net Income/Total Sales = 10.2/578.3 = .018 or 1.8% Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 12) Luther's earnings before interest, taxes, depreciation, and amortization (EBITDA) for the year ending December 31, 2009 is closest to: A) 19.7 million B) 37.6 million C) 41.2 million D) 44.8 million Answer: D Explanation: D) EBITDA = EBIT + Depreciation & Amortization = 41.2 + 3.6 = $ 44.8 million Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 13) Luther's return on equity (ROE) for the year ending December 31, 2009 is closest to: A) 2.0% B) 6.5% C) 8.4% D) 12.7% Answer: C Explanation: C) ROE = Net income/shareholders' equity = 10.6/126.6 = .084 or 8.4% Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 14) Luther's return on assets (ROA) for the year ending December 31, 2009 is closest to: A) 1.6% B) 6.7% C) 2.3% D) 2.6% Answer: B Explanation: B) ROA = (Net income + Interest Expense)/total assets. This is a little tricky in that total assets aren't given in the problem. The student must remember the basic balance sheet equation A = L + SE. Total Liabilities and Shareholders' Equity is given and this is the same as total assets. So ROA = (10.6+25.1/533.1 = 0.067 or 6.7% Diff: 3 Section: 2.6 Financial Statement Analysis Skill: Analytical 15) Luther's price - earnings ratio (P/E) for the year ending December 31, 2009 is closest to: A) 7.9 B) 10.1 C) 15.4 D) 16.0 Answer: C Explanation: C) P/E = Price/EPS or Market Cap/Earnings = (10.2 × $16)/$10.6 = 15.4 Diff: 3 Section: 2.6 Financial Statement Analysis Skill: Analytical 16) Calculate Luther's return of equity (ROE), return of assets (ROA), and price-to-earnings ratio (P/E) for the year ending December 31, 2008. Answer: ROE = NI/shareholder equity = 10.2/63.6 = .160 or 16.0% ROA = NI/total assets Here total assets are not given, but we know that Total Assets = Total Liabilities + Shareholder Equity, so ROA = 10.2/386.7 = .026 or 2.6% P/E = price/EPS or Market Cap/NI = (8.0 × $15)/$10.2 = 11.8 Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical Use the following information for ECE incorporated: Assets $200 million Shareholder Equity $100 million Sales $300 million Net Income $15 million Interest Expense $2 million 17) If ECE's return on assets (ROA) is 12%, then ECE's net income is: A) $6 million B) $12 million C) $22 million D) $36 million Answer: C Explanation: C) ROA = (Net Income + Interest Expense)/Assets = ($ X million + 2 million)/$200 million = 0.12; X = $22 million Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical Use the table for the question(s) below. Consider the following income statement and other information: Luther Corporation Consolidated Income Statement Year ended December 31 (in $ millions) Total sales 610.1 578.3 Cost of sales (500.2) (481.9) Gross profit 109.9 96.4 Selling, general, and administrative expenses (40.5) (39.0) Research and development (24.6) (22.8) Depreciation and amortization (3.6) (3.3) Operating income 41.2 31.3 Other income --- --- Earnings before interest and taxes (EBIT) 41.2 31.3 Interest income (expense) (25.1) (15.8) Pre-tax income 16.1 15.5 Taxes (5.5) (5.3) Net income 10.6 10.2 Price per share $16 $15 Shares outstanding (millions) 10.2 8.0 Stock options outstanding (millions) 0.3 0.2 Stockholders' Equity 126.6 63.6 Total Liabilities and Stockholders' Equity 533.1 386.7 18) If Luther's accounts receivable were $55.5 million in 2009, then calculate Luther's accounts receivable days for 2009. Answer: Accounts receivable days = = = 33.2 days Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 19) Luther's EBIT coverage ratio for the year ending December 31, 2008 is closest to: A) 1.64 B) 1.78 C) 1.98 D) 2.19 Answer: A Explanation: A) EBIT Coverage ratio = EBIT/(Interest Expense) = 41.2/25.1 = 1.6414 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 20) Luther's EBIT coverage ratio for the year ending December 31, 2009 is closest to: A) 1.64 B) 1.78 C) 1.98 D) 2.19 Answer: C Explanation: C) EBIT Coverage ratio = EBIT/(Interest Expense) = 31.3/15.8 = 1.981 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 21) Wyatt Oil has a net profit margin of 4.0%, a total asset turnover of 2.2, total assets of $525 million, and a book value of equity of $220 million. Wyatt Oil's current return-on-equity (ROE) is closest to: A) 8.8% B) 9.5% C) 21.0% D) 22.8% Answer: C Explanation: C) ROE = net profit margin × total asset turnover × leverage ROE = 0.04 × 2.2 × (525/220) = 0.21 = 21% Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical Use the table for the question(s) below. Consider the following income statement and other information: Luther Corporation Consolidated Income Statement Year ended December 31 (in $ millions) Total sales 610.1 578.3 Cost of sales (500.2) (481.9) Gross profit 109.9 96.4 Selling, general, and administrative expenses (40.5) (39.0) Research and development (24.6) (22.8) Depreciation and amortization (3.6) (3.3) Operating income 41.2 31.3 Other income --- --- Earnings before interest and taxes (EBIT) 41.2 31.3 Interest income (expense) (25.1) (15.8) Pre-tax income 16.1 15.5 Taxes (5.5) (5.3) Net income 10.6 10.2 Price per share $16 $15 Shares outstanding (millions) 10.2 8.0 Stock options outstanding (millions) 0.3 0.2 Stockholders' Equity 126.6 63.6 Total Liabilities and Stockholders' Equity 533.1 386.7 22) Luther's EBITDA coverage ratio for the year ending December 31, 2009 is closest to: A) 1.64 B) 1.78 C) 1.98 D) 2.19 Answer: B Explanation: B) EBITDA Coverage ratio = (EBIT + Dep & Amort)/(Interest Expense) = (41.2 + 3.6)/25.1 = 1.7849 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 23) Wyatt Oil has a net profit margin of 4.0%, a total asset turnover of 2.2, total assets of $525 million, and a book value of equity of $220 million. Wyatt Oil's current return-on-assets (ROA) is closest to: A) 8.8% B) 9.5% C) 21.0% D) 22.8% Answer: A Explanation: A) ROA = net profit margin × total asset turnover = 0.04 × 2.2 = 0.088 = 8.8% Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical Use the information for the question(s) below. In November 2009, Perrigo Co. (PRGO) had a share price of $39.20. They had 91.33 million shares outstanding, a market-to-book ratio of 3.76. In addition, PRGO had $845.01 million in outstanding debt, $163.82 million in net income, and cash of $257.09 million. 24) Perrigo's return on equity (ROE) is closest to: A) 4.6% B) 9.1% C) 17.2% D) 27% Answer: C Explanation: C) ROE = (Net Income)/(B V Equity) = $163.82/(($39.20 × 91.33)/3.76) = 0.172 = 17.2% Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical Use the following information for ECE incorporated: Assets $200 million Shareholder Equity $100 million Sales $300 million Net Income $15 million Interest Expense $2 million 25) If ECE reported $15 million in net income, then ECE's Return on Equity (ROE) is: A) 5.0% B) 7.5% C) 10.0% D) 15.0% Answer: D Explanation: D) ROE = (Net Income)/(Shareholder Equity) = $15 million /$100 million = 0.15 = 15% Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 26) If ECE's return on assets (ROA) is 12%, then ECE's return on equity (ROE) is: A) 10% B) 12% C) 18% D) 22% Answer: D Explanation: D) ROA = (Net Income + Interest Expense)/Assets = ($X million+2 million)/$200 million = 0.12; X = $22 million; ROE = (Net Income)/(Shareholder Equity) = $22 million/$100 million = 0.22 = 24% Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 27) If ECE's net profit margin is 8%, then ECE's return on equity (ROE) is: A) 10% B) 12% C) 24% D) 30% Answer: C Explanation: C) net profit margin = (Net Income)/Sales = $X million/$300 million = 0.08; X = $24 million; ROE = (Net Income)/(Shareholder Equity) = $24 million/$100 million = 0.24 = 24% Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Analytical 28) The firm's asset turnover measures: A) the value of assets held per dollar of shareholder equity. B) the return the firm has earned on its past investments. C) the firm's ability to sell a product for more than the cost of producing it. D) how efficiently the firm is utilizing its assets to generate sales. Answer: D Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Definition 29) If Firm A and Firm B are in the same industry and use the same production method, and Firm A's asset turnover is higher than that of Firm B, then all else equal we can conclude: A) Firm A is more efficient than Firm B. B) Firm A has a lower dollar amount of assets than Firm B. C) Firm A has higher sales than Firm B. D) Firm A has a lower ROE than Firm B. Answer: A Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Definition 30) The firm's equity multiplier measures: A) the value of assets held per dollar of shareholder equity. B) the return the firm has earned on its past investments. C) the firm's ability to sell a product for more than the cost of producing it. D) how efficiently the firm is utilizing its assets to generate sales. Answer: A Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Definition 31) If Alex Corporation takes out a bank loan to purchase a machine used in production and everything else stays the same, its equity multiplier will ________, and its ROE will ________. A) increase; increase B) decrease; decrease C) increase; decrease D) decrease; increase Answer: A Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Conceptual 32) The DuPont Identity expresses the firm's ROE in terms of: A) profitability, asset efficiency, and leverage. B) valuation, leverage, and interest coverage. C) profitability, margins, and valuation. D) equity, assets, and liabilities. Answer: A Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Definition 33) Suppose Novak Company experienced a reduction in its ROE over the last year. This fall could be attributed to: A) an increase in net profit margin. B) a decrease in asset turnover. C) an increase in leverage. D) a decrease in Equity. Answer: B Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Definition 34) If Moon Corporation has an increase in sales, which of the following would result in no change in its EBIT margin? A) A proportional increase in its net income B) A proportional decrease in its EBIT C) A proportional increase in its EBIT D) An increase in its operating expenses Answer: C Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Definition 35) If Moon Corporation's gross margin declined, which of the following is TRUE? A) Its cost of goods sold increased. B) Its cost of goods sold as a percent of sales increased. C) Its sales increased. D) Its net profit margin was unaffected by the decline. Answer: B Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Definition 36) The inventory days ratio measures: A) the average length of time it takes a company to sell its inventory. B) the average length of time it takes the company's suppliers to deliver its inventory. C) the level of sales required to keep a company's average inventory on the books. D) the percentage change in inventory over the past year. Answer: A Diff: 2 Section: 2.6 Financial Statement Analysis Skill: Definition 37) If Moon Corporation has depreciation or amortization expense, which of the following is TRUE? A) Its EBITDA /Interest Coverage ratio will be greater than its EBIT/Interest Coverage ratio. B) Its EBITDA /Interest Coverage ratio will be less than its EBIT/Interest Coverage ratio. C) Its EBITDA /Interest Coverage ratio will be equal to its EBIT/Interest Coverage ratio. D) Not enough information to answer the question. Answer: A Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Definition Use the table for the question(s) below. Consider the following balance sheet: Luther Corporation Consolidated Balance Sheet December 31, 2009 and 2008 (in $ millions) Assets Liabilities and Stockholders' Equity Current Assets Current Liabilities Cash 63.6 58.5 Accounts payable 87.6 73.5 Accounts receivable 55.5 39.6 Notes payable/ short-term debt 10.5 9.6 Inventories 45.9 42.9 Current maturities of long-term debt 39.9 36.9 Other current assets 6.0 3.0 Other current liabilities 6.0 12.0 Total current assets 171.0 144.0 Total current liabilities 144.0 132.0 Long-Term Assets Long-Term Liabilities Land 66.6 62.1 Long-term debt 239.7 168.9 Buildings 109.5 91.5 Capital lease obligations --- --- Equipment 119.1 99.6 Total Debt 239.7 168.9 Less accumulated depreciation (56.1) (52.5) Deferred taxes 22.8 22.2 Net property, plant, and equipment 239.1 200.7 Other long-term liabilities --- --- Goodwill 60.0 -- Total long-term liabilities 262.5 191.1 Other long-term assets 63.0 42.0 Total liabilities 406.5 323.1 Total long-term assets 362.1 242.7 Stockholders' Equity 126.6 63.6 Total Assets 533.1 386.7 Total liabilities and Stockholders' Equity 533.1 386.7 38) Luther Corporation's cash ratio for 2009 is closest to: A) 1.19 B) 10.6 C) 0.44 D) 0.41 Answer: C Explanation: C) Cash Ratio = cash/current liabilities = 63.6/144 = 0.44 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 39) Luther Corporation's total sales for 2009 were $610.1, and gross profit was $109.0. Inventory days for 2009 is closest to: A) 27.5 B) 33.4 C) 153.7 D) 10.9 Answer: B Explanation: B) Inventory Days = Inventory/Average Daily Cost of Sales Average Daily Cost of Sales = (Sales - gross profit)/365 Inventory Days = 45.9/((610.1-109)/365) = 33.4 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 40) Luther Corporation's total sales for 2009 were $610.1, and gross profit was $109.0. Accounts payable days for 2009 is closest to: A) 27.5 B) 5.71 C) 52.4 D) 63.8 Answer: D Explanation: D) Accounts Payable Days = Accounts Payable/Average Daily Cost of Sales Average Daily Cost of Sales = (Sales - gross profit)/365 Accounts Payable Days = 87.6/((610.1-109)/365) = 63.8 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 41) Luther Corporation's stock price is $39 per share and the company has 20 million shares outstanding. Its book value Debt -Equity Ratio for 2009 is closest to: A) 2.29 B) 0.31 C) 1.89 D) 0.37 Answer: A Explanation: A) Debt-Equity Ratio = Total Debt/Book (or Market) Value of Equity = (10.5 + 39.9 + 239.7)/126.6 = 2.29 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 42) Luther Corporation's stock price is $39 per share and the company has 20 million shares outstanding. Its Market value Debt-Equity Ratio for 2009 is closest to: A) 2.29 B) 0.37 C) 1.89 D) 0.31 Answer: B Explanation: B) Debt-Equity Ratio = Total Debt/Book (or Market) Value of Equity = (10.5 + 39.9 + 239.7)/(39*20) = 0.37 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 43) Luther Corporation's stock price is $39 per share and the company has 20 million shares outstanding. Its Debt -Capital Ratio for 2009 is closest to: A) 0.696 B) 0.37 C) 1.89 D) 0.654 Answer: A Explanation: A) Debt-Capital Ratio = Total Debt/Total Equity + Total Debt = (10.5 + 39.9 + 239.7)/(126.6 + 10.5 + 39.9 + 239.7) = 0.696 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 44) Luther Corporation's stock price is $39 per share and the company has 20 million shares outstanding. Its excess cash in 2009 is $23.4. Its Debt-to-Enterprise Value Ratio in 2009 is closest to: A) 0.696 B) 0.37 C) 0.255 D) 0.654 Answer: C Explanation: C) Net Debt = 10.5 + 39.9 + 239.7 - 23.4 = 266.7 Debt-to-Enterprise Value = Net Debt/Market value of equity + Net debt = 266.7/(39 * 20 + 266.7) = 0.255 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 45) Luther Corporation's stock price is $39 per share and the company has 20 million shares outstanding. Its excess cash in 2009 is $23.4. If EBIT is 41.2 and tax rate is 35%, its Return on Invested Capital in 2009 is closest to: A) 0.104 B) 0.064 C) 0.038 D) 0.068 Answer: D Explanation: D) Net Debt = 10.5 + 39.9 + 239.7 - 23.4 = 266.7 Return on Invested Capital = EBIT(1-t)/Book value of equity + Net debt = 41.2(1-0.35)/(126.6 + 266.7) = 0.068 Diff: 1 Section: 2.6 Financial Statement Analysis Skill: Analytical 2.7 Financial Reporting in Practice 1) The Sarbanes-Oxley Act (SOX) was passed by Congress in 2002, in response to: A) financial scandals, including WorldCom and Enron. B) financial scandals, including Bernie Madoff and AIG. C) financial scandals, including General Motors and Chrysler. D) the Troubled Asset Relief Program (TARP). Answer: A Diff: 1 Section: 2.7 Financial Reporting in Practice Skill: Definition 2) The Sarbanes-Oxley Act (SOX) stiffened penalties for providing false information by: A) requiring the CEO and CFO to return bonuses or profits from the sale of stock that are later shown to be due to misstated financial reports. B) imposing large compliance costs on small companies. C) requiring auditing firms to have long-standing relationships with their clients and receive lucrative auditing and consulting fees from them. D) putting strict limits on the amount of non-audit fees (consulting or otherwise) that an accounting firm can earn from a firm that it audits. Answer: A Diff: 1 Section: 2.7 Financial Reporting in Practice Skill: Definition 3) The Sarbanes-Oxley Act (SOX) overhauled incentives and the independence in the auditing process by: A) requiring the CEO and CFO to return bonuses or profits from the sale of stock that are later shown to be due to misstated financial reports. B) imposing large compliance costs on small companies. C) requiring auditing firms to have long-standing relationships with their clients and receive lucrative auditing and consulting fees from them. D) putting strict limits on the amount of non-audit fees (consulting or otherwise) that an accounting firm can earn from a firm that it audits. Answer: D Diff: 1 Section: 2.7 Financial Reporting in Practice Skill: Definition 4) The Sarbanes-Oxley Act (SOX) forced companies to validate their internal financial control processes by: A) putting strict limits on the amount of non-audit fees (consulting or otherwise) that an accounting firm can earn from a firm that it audits. B) requiring the CEO and CFO to return bonuses or profits from the sale of stock that are later shown to be due to misstated financial reports. C) requiring auditing firms to have long-standing relationships with their clients and receive lucrative auditing and consulting fees from them. D) requiring senior management and the boards of public companies to validate and certify the process through which funds are allocated and controlled. Answer: D Diff: 1 Section: 2.7 Financial Reporting in Practice Skill: Definition 5) The Dodd-Frank Wall Street Reform and Consumer Protection Act does the following: A) Exempts firms with less than $75 million in publicly traded shares from some provisions of SOX. B) Requires the SEC to study ways to reduce the cost of SOX for firms with less than $250 million in publicly traded shares. C) Strengthens whistle-blower provisions of SOX. D) All of the above. Answer: D Diff: 1 Section: 2.7 Financial Reporting in Practice Skill: Definition Corporate Finance, 3e (Berk/DeMarzo) Chapter 3 Financial Decision Making and the Law of One Price 3.1 Valuing Decisions 1) Due to a pre-existing contract, Recycle America Inc. has the opportunity to acquire 10,000 pounds of scrap aluminum and 2,500 pounds of scrap lead for $10,750. If the current market price for scrap aluminum is $0.83 per pound and the current market price for lead is $1.06 per pound, then the added benefit (cost) to you if you acquire this metal is: A) ($200) B) $200 C) ($1,925) D) $1,925 Answer: B Explanation: B) Added Benefit = 10,000 × $0.83 + 2,500 × $1.06 - $10,750 = $200 Diff: 1 Section: 3.1 Valuing Decisions Skill: Analytical 2) Which of the following statements regarding the valuing of costs and benefits is NOT correct? A) The first step in evaluating a project is to identify its costs and benefits. B) In the absence of competitive markets, we can use one-sided prices to determine exact cash values. C) Competitive market prices allow us to calculate the value of a decision without worrying about the tastes or opinions of the decision maker. D) Because competitive markets exist for most commodities and financial assets, we can use them to determine cash values and evaluate decisions in most situations. Answer: B Diff: 2 Section: 3.1 Valuing Decisions Skill: Conceptual 3) Recycle America Inc. has the opportunity to trade 8,000 pounds of plastic pellets made from recycled soda bottles for 5,000 pounds of aluminum cans. If the current market price of scrap aluminum is $0.83 per pound and the current market price for plastic pellets is $0.57 per pound, then the added benefit (cost) of making this trade is: A) ($410) B) $410 C) ($780) D) $780 Answer: A Explanation: A) Added Benefit = 5,000 × $0.83 - 8,000 × $0.57 = -$410 Diff: 1 Section: 3.1 Valuing Decisions Skill: Analytical Use the information for the question(s) below. Alaska North Slope Crude Oil (ANS) $71.75/Bbl West Texas Intermediate Crude Oil (WTI) $73.06/Bbl As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one barrel of Alaska North Slope (ANS) crude oil. Because of its lower sulfur content, you can produce $77 worth of unleaded gasoline from one barrel of West Texas Intermediate (WTI) crude. 4) Another oil refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS) crude oil for 10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you currently have 10,000 Bbls of WTI crude, the added benefit (cost) to you if you take the trade is closest to: A) ($1,400) B) $1,400 C) ($3,908) D) $3,908 Answer: B Explanation: B) Total Benefits No trade and refine WTI crude (base case) 10,000 Bbls × $77 of gasoline/Bbl = $770,000 Trade WTI for ANS crude 10,150 Bbls × $76 of gasoline/Bbl = $771,400 Added Benefits = Total Benefits - Base Case Trade WTI for ANS crude = $771,400 - $770,000 = $1,400 Diff: 2 Section: 3.1 Valuing Decisions Skill: Analytical 5) Assuming you currently have 10,000 Bbls of WTI crude, the added benefit (cost) to you if you were to sell the 10,000 Bbls of WTI crude and use the proceeds to purchase and refine ANS crude is closest to: A) ($1,400) B) $1,400 C) ($3,908) D) $3,908 Answer: D Explanation: D) Total Benefits No trade and refine WTI crude (base case) 10,000 Bbls × $77 of gasoline/Bbl = $770,000 Sell WTI and use proceeds to buy ANS 10,000 Bbls WTI × $73.06/Bbl = $730,600 Buy ANS crude $730,600/$71.75/Bbl ANS = 10,182.57 or approx 10,183 Bbls ANS 10,183 Bbls × $76 of gasoline/Bbl = $773,908 Added Benefits = Total Benefits - Base Case Sell WTI and use proceeds to buy ANS = $773,908 - $77