[i].
Which of the following statements is CORRECT?
a.
The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses.
b.
MVA gives us an idea about how much value a firms management has added during the last year.
c.
MVA stands for market value added, and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity.
d.
EVA stands for economic value added, and it is defined as follows:
EVA = EBIT(1-T) (Investor-supplied op. capital) x (A-T cost of capital).
e.
EVA gives us an idea about how much value a firms management has added over the firms life.
(2.10) Tax Rules Applicable to US Firms
[ii].
Which of the following statements is CORRECT?
a.
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.
b.
Interest paid to an individual is counted as income for tax purposes and taxed at the individuals regular tax rate, which in 2008 could go up to 35%, but dividends received were taxed at a maximum rate of 15%.
c.
The maximum federal tax rate on corporate income in 2008 was 50%.
d.
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.
e.
The maximum federal tax rate on personal income in 2008 was 50%.
(Comp: 2.6,2.7) NCF, FCF, and cash
[iii].
Last year, Tucker Technologies had (1) a negative net cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation?
a.
The company had a sharp increase in its inventories.
b.
The company had a sharp increase in its accrued liabilities.
c.
The company sold a new issue of common stock.
d.
The company made a large capital investment early in the year.
e.
The company had a sharp increase in its depreciation and amortization expenses.
(Comp: 2.2,2.3,2.6,2.9) Changes in depreciation
[iv].
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, BBIs net income after taxes was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BBIs financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
a.
The provision will reduce the companys net cash flow.
b.
The provision will increase the companys tax payments.
c.
Net fixed assets on the balance sheet will increase.
d.
The provision will increase the companys net income.
e.
Net fixed assets on the balance sheet will decrease.
(Comp: 2.2,2.3,2.6,2.9) Changes in depreciation
[v].
The Nantell Corporation just purchased an expensive piece of equipment. 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.
a.
Nantells taxable income will be lower.
b.
Nantells net fixed assets as shown on the balance sheet will be higher at the end of the year.
c.
Nantells cash position will improve (increase).
d.
Nantells reported net income after taxes for the year will be lower.
e.
Nantells tax liability for the year will be lower.
(Comp: 2.2,2.3,2.6) Changes in depreciation
[vi].
Assume that Pappas Company commenced operations on January 1, 2010, 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 15 years, but in December 2010 management realized that the assets would last for only 10 years. The firm’s accountants plan to report the 2010 financial statements based on this new information. How would the new depreciation assumption affect the companys financial statements?
a.
The firms reported net fixed assets would increase.
b.
The firms EBIT would increase.
c.
The firm’s reported 2010 earnings per share would increase.
d.
The firm’s cash position in 2010 and 2011 would increase.
e.
The firms net liabilities would increase.
(Comp: 2.2,2.3,2.9) Changes in depreciation
[vii].
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?
a.
The firms operating income (EBIT) would increase.
b.
The firms taxable income would increase.
c.
The firms net cash flow would increase.
d.
The firms tax payments would increase.
e.
The firms reported net income would increase.
(Comp: 2.1-2.3,2.6) Financial statements
[viii].
Which of the following statements is CORRECT?
a.
Dividends paid reduce the net income that is reported on a companys income statement.
b.
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.
c.
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.
d.
Accounts receivable are reported as a current liability on the balance sheet.
e.
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.
(Comp: 2.5,2.6,2.8) EVA, CF, and net income
[ix].
Which of the following statements is CORRECT?
a.
One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital.
b.
If a firm reports positive net income, its EVA must also be positive.
c.
One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free.
d.
One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital.
e.
Actions that increase reported net income will always increase net cash flow.
(Comp: 2.2,2.3,2.6) Retained earnings
[x].
Which of the following statements is CORRECT?
a.
Since depreciation is a source of funds, the more depreciation a company has, the larger its retained earnings will be, other things held constant.
b.
A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.
c.
Common equity includes common stock and retained earnings, less accumulated depreciation.
d.
The retained earnings account as shown on the balance sheet shows the amount of cash that is available for paying dividends.
e.
If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.
