Financial Management 543 Part 1

QUESTION 1

Which of the following statements is CORRECT?

                       

One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.

                       

It is generally easier to transfer one's ownership interest in a partnership than in a corporation.

                       

One of the advantages of the corporate form of organization is that it avoids double taxation.

                       

One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., "one person, one vote."

                       

Corporations of all types are subject to the corporate income tax.

 

QUESTION 2

Which of the following statements is CORRECT?

                       

The New York Stock Exchange is an auction market with a physical location.

                       

Capital market transactions involve only the purchase and sale of equity securities, i.e., common stocks.

                       

If an investor sells shares of stock through a broker, then this would be a primary market transaction.

                       

Consumer automobile loans are evidenced by legal documents called "promissory notes," and these individual notes are traded in the money market.

                       

While the distinctions are blurring as investment banks are today buying commercial banks, and vice versa, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties

 

QUESTION 3

Which of the following statements is CORRECT?

                       

One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt.

                       

Sole proprietorships are subject to more regulations than corporations.

                       

In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner.

                       

Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones.

                       

Corporations of all types are subject to the corporate income tax.

 

QUESTION 4

Which of the following statements is CORRECT?

                       

In Europe and Asia hedge funds are legal, but they are not permitted to operate in the United States.

                       

Hedge funds have more in common with commercial banks than with any other type of financial institution.

                       

Hedge funds have more in common with investment banks than with any other type of financial institution.

                       

In the United States hedge funds are legal, but in Europe and Asia they are not permitted to operate.

                       

The justification for the "light" regulation of hedge funds is that only "sophisticated" investors with high net worths and high incomes are permitted to invest in these funds, and such investors supposedly can do the necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.

 

QUESTION 5

You recently sold 100 shares of your new company, XYZ Corporation, to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following statements best describes this transaction?

                       

This is an example of an exchange of physical assets.

                       

This is an example of a primary market transaction.

                       

This is an example of a direct transfer of capital.

                       

This is an example of a money market transaction.

 

This is an example of a derivatives market transaction

 

QUESTION 6

Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a regular corporation. Which of the following statements is CORRECT?

                       

Assuming Cheers is profitable, less of its income will be subject to federal income taxes.

                       

Cheers will now be subject to fewer regulations.

                       

Cheers' shareholders (the ex-partners) will now be exposed to less liability.

                       

Cheers' investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.

                       

Cheers will find it more difficult to raise additional capital

 

QUESTION 7

Which of the following statements is CORRECT?

                       

Capital market instruments include both long-term debt and common stocks.

                       

An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift.

                       

The NYSE does not exist as a physical location; rather, it represents a loose collection of dealers who trade stocks electronically.

                       

If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction.

                       

While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors.

 

QUESTION 8

Which of the following statements is CORRECT?

                       

If expected inflation increases, interest rates are likely to increase.

                       

If individuals in general increase the percentage of their income that they save, interest rates are likely to increase.

                       

If companies have fewer good investment opportunities, interest rates are likely to increase.

                       

Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.

                       

Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.

 

QUESTION 9

Lucy's Music Emporium opened its doors on January 1, 2012, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes. The company planned to depreciate its fixed assets over 20 years, but in December 2012 management realized that the assets would last for only 15 years. The firm's accountants plan to report the 2012 financial statements based on this new information. How would the new depreciation assumption affect the company's financial statements?

                       

The firm's net liabilities would increase.

                       

The firm's reported net fixed assets would increase.

                       

The firm's EBIT would increase.

                       

The firm's reported 2012 earnings per share would increase.

                       

The firm's cash position in 2012 and 2013 would increase.

 

 

QUESTION 10

The LeMond Corporation just purchased a new production line. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.

                       

LeMond's tax liability for the year will be lower.

                       

LeMond's taxable income will be lower.

                       

LeMond's net fixed assets as shown on the balance sheet will be higher at the end of the year.

                       

LeMond's cash position will improve (increase).

                       

LeMond's reported net income after taxes for the year will be lower.

 

QUESTION 11

Which of the following statements is CORRECT?

                       

If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance.

                       

Dividends paid reduce the net income that is reported on a company's income statement.

                       

If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.

                       

If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.

                       

Accounts receivable are reported as a current liability on the balance sheet.

 

 

QUESTION 12

Analysts following Armstrong Products recently noted that the company's operating net cash flow increased over the prior year, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation?

                       

The company issued new long-term debt.

                       

The company cut its dividend.

                       

The company made a large investment in a profitable new plant.

                       

The company sold a division and received cash in return.

                       

The company issued new common stock.

 

QUESTION 13

Which of the following statements is CORRECT?

                       

The maximum federal tax rate on personal income in 2010 was 50%.

                       

Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity financing over debt financing, and this causes companies' debt ratios to be lower than they would be if interest and dividends were both deductible.

                       

Interest paid to an individual is counted as income for tax purposes and taxed at the individual's regular tax rate, which in 2010 could go up to 35%, but dividends received were taxed at a maximum rate of 15%.

                       

The maximum federal tax rate on corporate income in 2010 was 50%.

                       

Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by selling new common stock or by retaining earnings. The cost of debt capital is the interest paid on the debt, and the cost of the equity is the dividends paid on the stock. Both of these costs are deductible from income when calculating income for tax purposes.

 

QUESTION 14

Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined. Which of the following could explain this performance?

                       

The company's operating income declined.

                       

The company's expenditures on fixed assets declined.

                       

The company's cost of goods sold increased.

                       

The company's depreciation and amortization expenses declined.

                       

The company's interest expense increased

 

QUESTION 15

Which of the following would be most likely to occur in the year after Congress, in an effort to increase tax revenue, passed legislation that forced companies to depreciate equipment over longer lives? Assume that sales, other operating costs, and tax rates are not affected, and assume that the same depreciation method is used for tax and stockholder reporting purposes.

                       

Companies' reported net incomes would decline.

                       

Companies' net operating profits after taxes (NOPAT) would decline.

                       

Companies' physical stocks of fixed assets would increase.

                       

Companies' net cash flows would increase.

                       

Companies' cash positions would decline.

 

QUESTION 16

Which of the following statements is CORRECT?

                       

The income statement for a given year, say 2012, is designed to give us an idea of how much the firm earned during that year.

                       

The focal point of the income statement is the cash account, because that account cannot be manipulated by "accounting tricks."

                       

The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP).

                       

The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC).

                       

If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be identical to its reported net cash flow.

 

QUESTION 17

Which of the following items is NOT included in current assets?

                       

Short-term, highly liquid, marketable securities.

                       

Accounts receivable.

                       

Inventory.

                       

Bonds.

                       

Cash.

 

 

QUESTION 18

If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?

                       

Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.

                       

The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.

                       

Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.

                       

Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.

                       

The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.

 

QUESTION 19

Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant?

                       

The total assets turnover decreases.

                       

The TIE declines.

                       

The DSO increases.

                       

The EBITDA coverage ratio increases.

                       

The current and quick ratios both decline

 

QUESTION 20

Cordelion Communications is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Cordelion pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?

                       

The times interest earned ratio will decrease.

                       

The ROA will decline.

                       

Taxable income will decrease.

                       

The tax bill will increase.

                       

Net income will decrease.

 

QUESTION 21

Which of the following would indicate an improvement in a company's financial position, holding other things constant?

                       

The current and quick ratios both increase.

                       

The inventory and total assets turnover ratios both decline.

                       

The debt ratio increases.

                       

The profit margin declines.

                       

The EBITDA coverage ratio declines.

 

 

QUESTION 22

Companies A and C each reported the same earnings per share (EPS), but Company A's stock trades at a higher price. Which of the following statements is CORRECT?

                       

Company A trades at a higher P/E ratio.

                       

Company A probably has fewer growth opportunities.

                       

Company A is probably judged by investors to be riskier.

                       

Company A must have a higher market-to-book ratio.

                       

Company A must pay a lower dividend.

QUESTION 23

You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT?

                       

Its total assets turnover must equal the industry average.

                       

Its total assets turnover must be above the industry average.

                       

Its return on assets must equal the industry average.

                       

Its TIE ratio must be below the industry average.

                       

Its total assets turnover must be below the industry average.

 

 

QUESTION 24

 

Which of the following statements is CORRECT?

                       

If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.

                       

A reduction in inventories held would have no effect on the current ratio.

                       

An increase in inventories would have no effect on the current ratio.

                       

If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.

                       

A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.

 

 

QUESTION 25

Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company Heidee has the higher debt ratio. Which of the following statements is CORRECT?

                       

Company Heidee has a lower operating income (EBIT) than Company LD.

                       

Company Heidee has a lower total assets turnover than Company Leaudy.

                       

Company Heidee has a lower equity multiplier than Company Leaudy.

                       

Company Heidee has a higher fixed assets turnover than Company Leaudy.

                       

Company Heidee has a higher ROE than Company Leaudy.

 

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