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Exam 3: Financial Statements

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Question 41

Multiple Choice

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Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?

A) The company repurchases common stock.
B) The company pays a dividend.
C) The company issues new common stock.
D) The company gives customers more time to pay their bills.
E) The company purchases a new piece of equipment.

F) A) and B)
G) B) and C)

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Question 42

Multiple Choice

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Solarcell Corporation has $20,000 that it plans to invest in marketable securities. It is choosing between AT&T bonds that yield 11%, State of Florida municipal bonds that yield 8%, and AT&T preferred stock with a dividend yield of 9%. Solarcell's corporate tax rate is 40%, and 70% of the preferred stock dividends it receives are tax exempt. Assuming that the investments are equally risky and that Solarcell chooses strictly on the basis of after-tax returns, which security should be selected? Answer by giving the after-tax rate of return on the highest yielding security.

A) 7.80%
B) 8.00%
C) 8.20%
D) 8.41%
E) 8.62%

F) A) and B)
G) B) and E)

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Question 43

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Casey Motors recently reported the following information: • Net income = $600,000. • Tax rate = 40%. • Interest expense = $200,000. • Total investor-supplied operating capital employed = $9 million. • After-tax cost of capital = 10%. What is the company's EVA?

On its 12/31/12 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

Lovell Co. purchased preferred stock in another company. The preferred stock's before-tax yield was 8.4%. The corporate tax rate is 40%. What is the after-tax return on the preferred stock, assuming a 70% dividend exclusion?

Which of the following statements is CORRECT?

Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors.

Over the years, O'Brien Corporation's stockholders have provided $20,000,000 of capital, when they purchased new issues of stock and allowed management to retain some of the firm's earnings. The firm now has 1,000,000 shares of common stock outstanding, and it sells at a price of $38.50 per share. How much value has O'Brien's management added to stockholder wealth over the years, i.e., what is O'Brien's MVA?

If we were describing the income statement and the balance sheet, it would be correct to say that the income statement is more like a video while the balance sheet is more like a snapshot.

Emery Mining Inc. recently reported $150,000 of sales, $75,500 of operating costs other than depreciation, and $10,200 of depreciation. The company had $16,500 of outstanding bonds that carry a 7.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net income? The firm uses the same depreciation expense for tax and stockholder reporting purposes.

Which of the following statements is most correct?

A company with a 15% tax rate buys preferred stock in another company. The preferred stock has a before-tax yield of 8%. What is the preferred stock's after-tax return?

Last year, Stewart-Stern Inc. reported $11,250 of sales, $4,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had $3,500 of bonds outstanding that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 35%. During last year, the firm had expenditures on fixed assets and net operating working capital that totaled $2,000. These expenditures were necessary for it to sustain operations and generate future sales and cash flows. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $725. By how much will the depreciation change cause (1) the firm's net income and (2) its free cash flow to change? Note that the company uses the same depreciation for tax and stockholder reporting purposes.

To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue.

Analysts who follow Howe Industries recently noted that, relative to the previous year, the company's net cash provided from operations increased, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation?

Shrives Publishing recently reported $10,750 of sales, $5,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had $3,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax rate was 35%. During the year, the firm had expenditures on fixed assets and net operating working capital that totaled $1,550. These expenditures were necessary for it to sustain operations and generate future sales and cash flows. What was its free cash flow?

An increase in accounts receivable represents an increase in net cash provided by operating activities because receivables will produce cash when they are collected.

The alternative minimum tax (AMT) was created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions.

Two metrics that are used to measure a company's financial performance are net income and cash flow. Accountants emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on cash flows as they do on net income.

The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision.