Solved by verified expert :[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 firm’s 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 firm’s management has added over the firm’s 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 individual’s 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, 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.
a.
The provision will reduce the
company’s net cash flow.
b.
The provision will increase the
company’s tax payments.
c.
Net fixed assets on the balance
sheet will increase.
d.
The provision will increase the
company’s 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.
Nantell’s taxable income will be
lower.
b.
Nantell’s net fixed assets as
shown on the balance sheet will be higher at the end of the year.
c.
Nantell’s cash position will
improve (increase).
d.
Nantell’s reported net income
after taxes for the year will be lower.
e.
Nantell’s 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 company’s financial statements?
a.
The firm’s reported net fixed
assets would increase.
b.
The firm’s 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 firm’s 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 firm’s operating income (EBIT)
would increase.
b.
The firm’s taxable income would
increase.
c.
The firm’s net cash flow would
increase.
d.
The firm’s tax payments would
increase.
e.
The firm’s 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 company’s 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.
