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Exam 2: Financial Statements, Cash Flow, and Taxes

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Question 1

Multiple Choice

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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?

A) The company's operating income declined.
B) The company's expenditures on fixed assets declined.
C) The company's cost of goods sold increased.
D) The company's depreciation and amortization expenses declined.
E) The company's interest expense increased.

F) D) and E)
G) B) and C)

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Question 2

Multiple Choice

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Which of the following statements is CORRECT?

A) Typically, a firm's DPS should exceed its EPS.
B) Typically, a firm's EBIT should exceed its EBITDA.
C) If a firm is more profitable than average (e.g., Google) , we would normally expect to see its stock price exceed its book value per share.
D) If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.
E) The more depreciation a firm has in a given year, the higher its EPS, other things held constant.

F) B) and D)
G) B) and C)

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C

Question 3

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Total net operating capital is equal to net fixed assets.

Wells Water Systems recently reported $8,250 of sales, $4,500 of operating costs other than depreciation, and $950 of depreciation. The company had no amortization charges, it had $3,250 of outstanding bonds that carry a 6.75% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to spend $750 to buy new fixed assets and to invest $250 in net operating working capital. How much free cash flow did Wells generate?

Which of the following items cannot be found on a firm's balance sheet under current liabilities?

On its 2010 balance sheet, Barngrover Books 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?

A start-up firm is making an initial investment in new plant and equipment. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is considering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law, which of the following would occur in the year following the change?

JBS Inc. recently reported net income of $4,750 and depreciation of $885. How much was its net cash flow, assuming it had no amortization expense and sold none of its fixed assets.

Consider the balance sheet of Wilkes Industries as shown below. Because Wilkes has $800,000 of retained earnings, the company would be able to pay cash to buy an asset with a cost of $200,000.

The CFO of Shalit Industries plans to have the company issue $300 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT) , and its tax rate all remain constant. Which of the following would occur?

Which of the following statements is CORRECT?

The annual report contains four basic financial statements: the income statement, balance sheet, statement of cash flows, and statement of stockholders' equity.

TSW Inc. had the following data for last year: Net income = $800; Net operating profit after taxes (NOPAT) = $700; Total assets = $3,000; and Total operating capital = $2,000. Information for the just-completed year is as follows: Net income = $1,000; Net operating profit after taxes (NOPAT) = $925; Total assets = $2,600; and Total operating capital = $2,500. How much free cash flow did the firm generate during the just-completed year?

Last year Roussakis Company's operations provided a negative net cash flow, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company's financial statements were prepared under generally accepted accounting principles?

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

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.

Which of the following factors could explain why Dellva Energy had a negative net cash flow last year, even though the cash on its balance sheet increased?

The current cash flow from existing assets is highly relevant to the investor. However, since the value of the firm depends primarily upon its growth opportunities, profit projections from those opportunities are the only relevant future flows with which investors are concerned.

Net operating profit after taxes (NOPAT) is the amount of net income a company would generate from its operations if it had no interest income or interest expense.

Which of the following statements is CORRECT?