TEST BANK CHAPTER 03 FINANCIAL STATEMENTS CASH FLOW AND TAXES

CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
This chapter has a lot of definitions. They are important, but we don't like to make students memorize too many of them
early in the course. We let our students use a formula sheet that includes the key definitions.
Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in
multiple-choice questions.
Multiple Choice: True/False
1. The annual report contains four basic financial statements: the income statement, the balance sheet, the cash flow
statement, and statement of stockholders' equity.
a. True
b. False
ANSWER: True
2. The primary reason the annual report is important in finance is that it is used by investors when they form expectations
about the firm's future earnings and dividends, and the riskiness of those cash flows.
a. True
b. False
ANSWER: True
3. Companies typically provide four basic financial statements: the fixed income statement, the current income statement,
the balance sheet, and the cash flow statement.
a. True
b. False
ANSWER: False
4. On the balance sheet, total assets must always equal the sum of total liabilities and equity.
a. True
b. False
ANSWER:
True
KEYWORDS: Bloom’s: Knowledge
5. Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could be
higher or lower than the amounts at which the assets are carried on the books.
a. True
b. False

ANSWER:
True
KEYWORDS: Bloom’s: Knowledge
6. The amount shown on the December 31, 2015, balance sheet as "retained earnings" is equal to the firm's net income for
2015 minus any dividends it paid.
a. True
b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-2 The Balance Sheet
Cengage Learning Testing, Powered by Cognero

Page 1


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Balance sheet
KEYWORDS:
Bloom’s: Knowledge

7. The income statement shows the difference between a firm's income and its costs--i.e., its profits­­during a specified
period of time. However, not all reported income comes in the form of cash, and reported costs likewise may not be
consistent with cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its
actual cash flow for the same period.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-3 The Income Statement
LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Income statement
KEYWORDS:
Bloom's: Comprehension
8. 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.
a. True
b. False
ANSWER: True
9. EBIT stands for earnings before interest and taxes, and it is often called "operating income."
a. True

b. False
ANSWER: True
10. EBITDA stands for earnings before interest, taxes, debt, and assets.
a. True
b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-3 The Income Statement
LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
Cengage Learning Testing, Powered by Cognero

Page 2


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
TOPICS:
KEYWORDS:

Income statement
Bloom’s: Knowledge

11. Consider the following balance sheet, for Games Inc. Because Games has $800,000 of retained earnings, we know that

the company would be able to pay cash to buy an asset with a cost of $200,000.
Cash
Inventory
Accounts receivable
Total CA
Net fixed assets

$

50,000
200,000
250,000
$ 500,000
$ 900,000

Total assets

$1,400,000

Accounts payable
Accruals
Total CL
Long-term debt
Common stock
Retained earnings
Total L & E

$ 100,000
100,000
$ 200,000

200,000
200,000
800,000
$1,400,000

a. True
b. False
ANSWER:
RATIONALE:

False
Note that the firm has only $50,000 of cash. It would have to either sell assets or borrow
$150,000 to pay cash for the new asset. That might not be possible.
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-5 Statement of Stockholders’ Equity
LEARNING OBJECTIVES: FOFM.BRIG.16.03.05 - Statement of Stockholders' Equity
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Retained earnings
KEYWORDS:
Bloom's: Comprehension
12. Typically, the statement of stockholders' equity starts with total stockholders' equity at the beginning of the year, adds
net income, subtracts dividends paid, and ends up with total stockholders' equity at the end of the year. Over time, a

profitable company will have earnings in excess of the dividends it pays out, and will result in a substantial amount of
retained earnings shown on the balance sheet.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-5 Statement of Stockholders’ Equity
LEARNING OBJECTIVES: FOFM.BRIG.16.03.05 - Statement of Stockholders' Equity
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Stockholders' equity statement
KEYWORDS:
Bloom's: Comprehension
Cengage Learning Testing, Powered by Cognero

Page 3


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
13. Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has
made the investments in current and fixed assets that are necessary to sustain ongoing operations.
a. True

b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-7 Free Cash Flow
LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Free cash flow
KEYWORDS:
Bloom’s: Knowledge
14. The value of any asset is the present value of the cash flows the asset is expected to provide. The cash flows a business
is able to provide to its investors is its free cash flow. This is the reason that FCF is so important in finance.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-7 Free Cash Flow
LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow

NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Free cash flow
KEYWORDS:
Bloom’s: Knowledge
15. If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as
reported on the income statement should be equal to its free cash flow.
a. True
b. False
ANSWER:
False
RATIONALE:
There is no reason to think that net income would be equal to FCF. For example, a company
that is not growing might report zero net income yet have high FCF because of depreciation.
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-7 Free Cash Flow
LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Free cash flow
KEYWORDS:

Bloom's: Comprehension
Cengage Learning Testing, Powered by Cognero

Page 4


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
16. 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.
a. True
b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-9 Income Taxes
LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Income taxes
KEYWORDS:
Bloom’s: Knowledge
17. Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's
taxes.
a. True

b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-9 Income Taxes
LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Income taxes
KEYWORDS:
Bloom’s: Knowledge
18. The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement
measures the firm's financial position at a point in time.
a. True
b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
Comprehensive
LEARNING OBJECTIVES: FOFM.BRIG.16.03.00 - Comprehensive

NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Financial statements
KEYWORDS:
Bloom’s: Knowledge
19. 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
Cengage Learning Testing, Powered by Cognero

Page 5


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
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.
a. True
b. False
ANSWER:
False
RATIONALE:
One firm might choose to use straight-line depreciation, the other an accelerated method, and
this would lead to differences in reported depreciation and therefore reported net fixed assets.
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:

3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Retained earnings
KEYWORDS:
Bloom's: Comprehension
20. Net operating working capital is equal to current assets minus the difference between current liabilities and notes
payable. This definition assumes that the firm has no "excess" cash.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Net operating working capital
KEYWORDS:
Bloom’s: Knowledge

21. The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the
company paid. Therefore, the dividends are frequently called "the bottom line."
a. True
b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-3 The Income Statement
LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Income statement
KEYWORDS:
Bloom’s: Knowledge
Cengage Learning Testing, Powered by Cognero

Page 6


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
22. The statement of cash flows has four main sections, one each for operating, investing, and financing activities, and one
that shows a summary of the cash and cash equivalents at the end of the year.
a. True

b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Statement of cash flows
KEYWORDS:
Bloom’s: Knowledge
23. An increase in accounts payable represents an increase in net cash provided by operating activities just like borrowing
money from a bank. An increase in accounts payable has an effect similar to taking out a new bank loan. However, these
two items show up in different sections of the statement of cash flows to reflect the difference between operating and
financing activities.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:

3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Statement of cash flows
KEYWORDS:
Bloom's: Comprehension
24. An increase in accounts receivable represents an increase in net cash provided by operating activities because
receivables will produce cash when they are collected.
a. True
b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Statement of cash flows
Cengage Learning Testing, Powered by Cognero

Page 7


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
KEYWORDS:

Bloom's: Comprehension

25. The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section
is "Net Income." Then, also in the first section, we show some items that represent increases or decreases to cash, and the
last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is
negative, the firm is almost certain to soon go bankrupt.
a. True
b. False
ANSWER:
False
RATIONALE:
Rapidly growing firms often require additions to inventory and receivables that are larger
than net income, with the deficit being made up by borrowings and/or the sale of new stock.
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows

United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Statement of cash flows
KEYWORDS:
Bloom's: Comprehension
26. 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 in the net income calculation.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Statement of cash flows
KEYWORDS:
Bloom’s: Knowledge
27. 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.
a. True

b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
Cengage Learning Testing, Powered by Cognero

Page 8


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
NATIONAL STANDARDS:
STATE STANDARDS:
TOPICS:
KEYWORDS:

United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
Cash flow and net income
Bloom’s: Knowledge

28. Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid
out to stockholders as dividends. If the firm has sufficient retained earnings, it can purchase assets and pay for them with
cash from retained earnings.
a. True

b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-5 Statement of Stockholders’ Equity
LEARNING OBJECTIVES: FOFM.BRIG.16.03.05 - Statement of Stockholders' Equity
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Retained earnings
KEYWORDS:
Bloom’s: Knowledge
29. The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of the
stockholders' claims against the firm's existing assets. Put another way retained earnings are stockholders' reinvested
earnings.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-5 Statement of Stockholders’ Equity

LEARNING OBJECTIVES: FOFM.BRIG.16.03.05 - Statement of Stockholders' Equity
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Retained earnings
KEYWORDS:
Bloom’s: Knowledge
30. In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is
calculated as after-tax operating income plus depreciation less the sum of capital expenditures and changes in net
operating working capital.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-7 Free Cash Flow
LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow
Cengage Learning Testing, Powered by Cognero

Page 9


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
NATIONAL STANDARDS:
STATE STANDARDS:

TOPICS:
KEYWORDS:

United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
Free cash flow
Bloom’s: Knowledge

31. Free cash flow is the amount of cash that if withdrawn would harm the firm's ability to operate and to produce future
cash flows.
a. True
b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-7 Free Cash Flow
LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Free cash flow
KEYWORDS:
Bloom’s: Knowledge
32. If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a taxdeductible expense, this would probably encourage companies to use more debt financing than they presently do, other
things held constant.

a. True
b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-9 Income Taxes
LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Income taxes
KEYWORDS:
Bloom's: Comprehension
33. 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.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:

3-9 Income Taxes
LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
Cengage Learning Testing, Powered by Cognero

Page 10


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
STATE STANDARDS:
TOPICS:
KEYWORDS:

United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
Income taxes
Bloom's: Comprehension

34. Because the U.S. tax system is a progressive tax system, a taxpayer's marginal and average tax rates are the same.
a. True
b. False
ANSWER:
False
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-9 Income Taxes
LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes

NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Income taxes
KEYWORDS:
Bloom’s: Knowledge
35. 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.
a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-9 Income Taxes
LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Income taxes
KEYWORDS:
Bloom’s: Knowledge
36. The time dimension is important in financial statement analysis. The balance sheet shows the firm's financial position
at a given point in time, the income statement shows results over a period of time, and the statement of cash flows reflects
specific changes in accounts over that period of time.

a. True
b. False
ANSWER:
True
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
Comprehensive
LEARNING OBJECTIVES: FOFM.BRIG.16.03.00 - Comprehensive
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Financial statements
Cengage Learning Testing, Powered by Cognero

Page 11


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
KEYWORDS:

Bloom’s: Knowledge

Multiple Choice: Conceptual
Please note that some of the answer choices, or answers that are very close, are used in different questions. This has
caused us no difficulties, but please take this into account when you make up exams.
37. Which of the following statements is CORRECT?

a. The four most important financial statements provided in the annual report are the balance sheet, income
statement, cash budget, and the statement of stockholders' equity.
b. The balance sheet gives us a picture of the firm's financial position at a point in time.
c. The income statement gives us a picture of the firm's financial position at a point in time.
d. The statement of cash flows tells us how much cash the firm must pay out in interest during the year.
e. The statement of cash needs tells us how much cash the firm will require during some future period, generally
a month or a year.
ANSWER:
b
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-1 Financial Statements and Reports
LEARNING OBJECTIVES: FOFM.BRIG.16.03.01 - Financial Statements and Reports
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Financial statements
KEYWORDS:
Bloom’s: Knowledge
OTHER:
Multiple Choice: Conceptual
38. Which of the following statements is CORRECT?
a. Assets other than cash are expected to produce cash over time, and the amounts of cash they eventually
produce should be exactly the same as the amounts at which the assets are carried on the books.
b. The primary reason the annual report is important in finance is that it is used by investors when they form
expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.

c. The annual report is an internal document prepared by a firm's managers solely for the use of its
creditors/lenders.
d. The four most important financial statements provided in the annual report are the balance sheet, income
statement, cash budget, and statement of stockholders' equity.
e. Prior to the Enron scandal in the early 2000s, companies would put verbal information in their annual reports,
along with the financial statements. That verbal information was often misleading, so today annual reports can
contain only quantitative information: audited financial statements.
ANSWER:
b
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-1 Financial Statements and Reports
LEARNING OBJECTIVES: FOFM.BRIG.16.03.01 - Financial Statements and Reports
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
Cengage Learning Testing, Powered by Cognero

Page 12


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
TOPICS:
KEYWORDS:
OTHER:

Financial statements

Bloom’s: Knowledge
Multiple Choice: Conceptual

39. Which of the following statements is CORRECT?
a. The balance sheet for a given year is designed to give us an idea of what happened to the firm during that year.
b. The balance sheet for a given year tells us how much money the company earned during that year.
c. The difference between the total assets reported on the balance sheet and the liabilities reported on this
statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in
accordance with generally accepted accounting principles (GAAP).
d. If a company's statements were prepared in accordance with generally accepted accounting principles
(GAAP), the market value of the stock equals the book value of the stock as reported on the balance sheet.
e. The assets section of a typical company's balance sheet begins with cash, then lists the assets in the order in
which they will probably be converted to cash, with the longest lived assets listed last.
ANSWER:
e
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Balance sheet
KEYWORDS:
Bloom's: Comprehension

OTHER:
Multiple Choice: Conceptual
40. 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.
ANSWER:
c
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Balance sheet
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
Cengage Learning Testing, Powered by Cognero

Page 13


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
41. Which of the following items is NOT normally considered to be a current asset?
a. Accounts receivable.
b. Inventory.
c. Bonds.
d. Cash.
e. Short-term, highly-liquid, marketable securities.
ANSWER:
c
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Current assets
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
42. Which of the following items cannot be found on a firm's balance sheet under current liabilities?

a. Accounts payable.
b. Short-term notes payable to the bank.
c. Accrued wages.
d. Cost of goods sold.
e. Accrued payroll taxes.
ANSWER:
d
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Current liabilities
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
43. Which of the following statements is CORRECT?
a. The focal point of the income statement is the cash account, because that account cannot be manipulated by
"accounting tricks."
b. The reported income of two otherwise identical firms cannot be manipulated by different accounting
procedures provided the firms follow generally accepted accounting principles (GAAP).
c. 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).
d. If a firm follows generally accepted accounting principles (GAAP), then its reported net income will be
identical to its reported cash flow.
Cengage Learning Testing, Powered by Cognero

Page 14


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
e. The income statement for a given year is designed to give us an idea of how much the firm earned during that
year.
ANSWER:
e
POINTS:
1
DIFFICULTY:
EASY
REFERENCES:
3-3 The Income Statement
LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Income statement
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual

44. Below are the 2013 and 2014 year-end balance sheets for Tran Enterprises:
Assets:
Cash
Accounts receivable
Inventories
Total current assets
Net fixed assets
Total assets

2014
$ 200,000
864,000
2,000,000
$3,064,000
6,000,000
$9,064,000

2013
$ 170,000
700,000
1,400,000
$2,270,000
5,600,000
$7,870,000

Liabilities and equity:
Accounts payable
Notes payable to bank
Total current liabilities
Long-term debt

Common stock
Retained earnings
Total common equity
Total liabilities and equity

$1,400,000
1,600,000
$3,000,000
2,400,000
3,000,000
664,000
$3,664,000
$9,064,000

$1,090,000
1,800,000
$2,890,000
2,400,000
2,000,000
580,000
$2,580,000
$7,870,000

The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt
in 2013. As of the end of 2014, none of the principal on this debt had been repaid. Assume that the company's sales in
2013 and 2014 were the same. Which of the following statements must be CORRECT?
a. The firm increased its short-term bank debt in 2014.
b. The firm issued long-term debt in 2014.
c. The firm issued new common stock in 2014.
d. The firm repurchased some common stock in 2014.

e. The firm had negative net income in 2014.
ANSWER:
c
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
Cengage Learning Testing, Powered by Cognero

Page 15


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
STATE STANDARDS:
TOPICS:
KEYWORDS:
OTHER:

United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
Balance sheet
Bloom's: Comprehension
Multiple Choice: Conceptual

45. On its 12/31/14 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?
a. If the company lost money in 2014, it must have paid dividends.
b. The company must have had zero net income in 2014.
c. The company must have paid out half of its 2014 earnings as dividends.
d. The company must have paid no dividends in 2014.
e. Dividends could have been paid in 2014, but they would have had to equal the earnings for the year.
ANSWER:
e
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Balance sheet
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
46. Below is the common equity section (in millions) of Timeless Technology's last two year-end balance sheets:
Common stock
Retained earnings
Total common equity

2014
$2,000
2,000
$4,000

2013
$1,000
2,340
$3,340

The firm has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?
a. The company's net income in 2014 was higher than in 2013.
b. The firm issued common stock in 2014.
c. The market price of the firm's stock doubled in 2014.
d. The firm had positive net income in both 2013 and 2014, but its net income in 2014 was lower than it was in
2013.
e. The company has more equity than debt on its balance sheet.
ANSWER:
b
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
Cengage Learning Testing, Powered by Cognero

Page 16

CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
STATE STANDARDS:
TOPICS:
KEYWORDS:
OTHER:

United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
Balance sheet
Bloom's: Comprehension
Multiple Choice: Conceptual

47. Which of the following statements is CORRECT?
a. Typically, a firm's DPS should exceed its EPS.
b. Typically, a firm's net income should exceed its EBIT.
c. If a firm is more profitable than average, 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.
ANSWER:
c
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-3 The Income Statement

LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
EPS, DPS, BVPS, and stock price
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
48. Which of the following statements is CORRECT?
a. The more depreciation a firm reports, the higher its tax bill, other things held constant.
b. People sometimes talk about the firm's cash flow, which is shown as the lowest entry on the income statement,
hence it is often called "the bottom line."
c. Depreciation reduces a firm's cash balance, so an increase in depreciation would normally lead to a reduction
in the firm's cash flow.
d. Operating income is derived from the firm's regular core business. Operating income is calculated as Revenues
less Operating costs. Operating costs do not include interest or taxes.
e. Depreciation is not a cash charge, so it does not have an effect on a firm's reported profits.
ANSWER:
d
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-3 The Income Statement
LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills

STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Depreciation, EBIT, and CF
KEYWORDS:
Bloom's: Comprehension
Cengage Learning Testing, Powered by Cognero

Page 17


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
OTHER:

Multiple Choice: Conceptual

49. Which of the following factors could explain why Michigan Energy's cash balance increased even though it had a
negative cash flow last year?
a. The company sold a new issue of bonds.
b. The company made a large investment in new plant and equipment.
c. The company paid a large dividend.
d. The company had high depreciation expenses.
e. The company repurchased 20% of its common stock.
ANSWER:
a
POINTS:
1
DIFFICULTY:
MODERATE

REFERENCES:
3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Cash flow
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
50. 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?
a. The company cut its dividend.
b. The company made large investments in fixed assets.
c. The company sold a division and received cash in return.
d. The company issued new common stock.
e. The company issued new long-term debt.
ANSWER:
b
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows

NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Cash flow
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
51. Austin Financial recently announced that its net income increased sharply from the previous year, yet its net cash
provided from operations declined. Which of the following could explain this performance?
a. The company's dividend payment to common stockholders declined.
b. The company's expenditures on fixed assets declined.
Cengage Learning Testing, Powered by Cognero

Page 18


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
c. The company's cost of goods sold increased.
d. The company's depreciation expense declined.
e. The company's interest expense increased.
ANSWER:
d
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:

3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Cash flow and net income
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
52. Which of the following statements is CORRECT?
a. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or
selling fixed assets.
b. The statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all banks
and brokerage houses where cash is on deposit.
c. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects
of changes in working capital.
d. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect
cash obtained by selling new common stock.
e. The statement of cash flows shows how much the firm's cash, the total of currency, bank deposits, and shortterm liquid securities (or cash equivalents), increased or decreased during a given year.
ANSWER:
e
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-4 Statement of Cash Flows

LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Statement of cash flows
KEYWORDS:
Bloom’s: Knowledge
OTHER:
Multiple Choice: Conceptual
53. Which of the following statements is CORRECT?
a. In the statement of cash flows, a decrease in accounts receivable is subtracted from net income in the operating
activities section.
b. Dividends do not show up in the statement of cash flows because dividends are considered to be a financing
activity, not an operating activity.
c. In the statement of cash flows, a decrease in accounts payable is subtracted from net income in the operating
activities section.
d. In the statement of cash flows, depreciation is subtracted from net income in the operating activities section.
Cengage Learning Testing, Powered by Cognero

Page 19


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
e. In the statement of cash flows, a decrease in inventories is subtracted from net income in the operating
activities section.
ANSWER:
c
POINTS:
1

DIFFICULTY:
MODERATE
REFERENCES:
3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Statement of cash flows
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
54. Which of the following statements is CORRECT?
a. Most rapidly growing companies have positive free cash flows because cash flows from existing operations
generally exceed fixed asset purchases and changes to net operating working capital.
b. Changes in working capital have no effect on free cash flow.
c. Free cash flow (FCF) is defined as follows:
FCF = EBIT(1 − T) + Depreciation
− Capital expenditures required to sustain operations
− Required changes in net operating working capital.
d. Free cash flow (FCF) is defined as follows:
FCF = EBIT(1 − T) + Capital expenditures.
e. Managers should be less concerned with free cash flow than with accounting net income. Accounting net income
is the "bottom line" and represents how much the firm can distribute to all its investors, both creditors and
stockholders.
ANSWER:
c

POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-7 Free Cash Flow
LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Free cash flow
KEYWORDS:
Bloom’s: Knowledge
OTHER:
Multiple Choice: Conceptual
55. Which of the following statements is CORRECT?
a. Actions that increase reported net income will always increase cash flow.
b. One way to increase EVA is to generate the same level of operating income but with less total invested capital.
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 achieve the same level of operating income but with more total invested capital
obtained at a higher cost of capital.
Cengage Learning Testing, Powered by Cognero

Page 20


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
e. If a firm reports positive net income, its EVA must also be positive.
ANSWER:

b
Statement b is true, because the EVA equation: EVA = EBIT(1 − T) − (After-tax cost of capital
RATIONALE:
%) (Investor-supplied operating capital) implies that lowering the operating capital, all else
equal, lowers capital costs and thus increases EVA.

POINTS:
DIFFICULTY:
REFERENCES:
LEARNING OBJECTIVES:
NATIONAL STANDARDS:
STATE STANDARDS:
TOPICS:
KEYWORDS:
OTHER:

1
MODERATE
3-8 MVA and EVA
FOFM.BRIG.16.03.08 - MVA and EVA
United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
EVA, cash flow, and NI
Bloom's: Comprehension
Multiple Choice: Conceptual

56. Which of the following statements is CORRECT?
a. MVA stands for market value added, and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity.
b. 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.
c. MVA gives us an idea about how much value a firm's management has added during the last year.
d. EVA gives us an idea about how much value a firm's management has added over the firm's life.
e. EVA stands for economic value added, and it is defined as follows:
EVA = NOPAT − (Total invested capital)(AT cost of capital %)
ANSWER:
e
Statement e gives the correct equation for EVA. The other statements are false.
RATIONALE:
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-8 MVA and EVA
LEARNING OBJECTIVES: FOFM.BRIG.16.03.08 - MVA and EVA
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
MVA and EVA
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
57. Which of the following statements is most correct?
a. Corporations are allowed to exclude 70% of their interest income from corporate taxes.
b. Corporations are allowed to exclude 70% of their dividend income from corporate taxes.
c. Individuals pay taxes on only 30% of the income realized from municipal bonds.

d. Individuals are allowed to exclude 70% of their interest income from their taxes.
e. Individuals are allowed to exclude 70% of their dividend income from their taxes.
ANSWER:
b
Statement a is false, corporations cannot exclude interest income from corporate taxes.
RATIONALE:
Cengage Learning Testing, Powered by Cognero

Page 21


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
Statement b is true, because the 70% exclusion rule gets around the issue of triple taxation.
Statements c, d, and e are false, because individuals pay no taxes on municipal bond income
and individuals cannot exclude 70% of their income from either interest or dividends.

POINTS:
DIFFICULTY:
REFERENCES:
LEARNING OBJECTIVES:
NATIONAL STANDARDS:
STATE STANDARDS:
TOPICS:
KEYWORDS:
OTHER:

1
MODERATE
3-9 Income Taxes
FOFM.BRIG.16.03.09 - Income taxes

United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
Income taxes
Bloom’s: Knowledge
Multiple Choice: Conceptual

58. A loss incurred by a corporation
a. Must be carried forward unless the company has had 2 loss years in a row.
b. Can be carried back 2 years, then carried forward up to 20 years following the loss.
c. Can be carried back 5 years and forward 3 years.
d. Cannot be used to reduce taxes in other years except with special permission from the IRS.
e. Can be carried back 3 years or forward 10 years, whichever is more advantageous to the firm.
ANSWER:
b
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
3-9 Income Taxes
LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Carry-back, carry-forward
KEYWORDS:
Bloom’s: Knowledge
OTHER:
Multiple Choice: Conceptual

59. 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 federal tax purposes and taxed at the individual's regular
tax rate, which in 2014 could go up to 39.6%, but qualified dividends received were taxed at a maximum tax
rate of 15% for individuals earning less than $400,000 and married taxpayers filing jointly earning less than
$450,000.
c. The maximum federal tax rate on corporate income in 2014 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 2014 was 50%.
ANSWER:
b
POINTS:
1
Cengage Learning Testing, Powered by Cognero

Page 22


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
DIFFICULTY:
REFERENCES:
LEARNING OBJECTIVES:
NATIONAL STANDARDS:
STATE STANDARDS:
TOPICS:

KEYWORDS:
OTHER:

MODERATE
3-9 Income Taxes
FOFM.BRIG.16.03.09 - Income taxes
United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
Income taxes
Bloom’s: Knowledge
Multiple Choice: Conceptual

60. Which of the following statements is CORRECT?
a. The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate
income taxes. Thus, the federal government receives no tax revenue from these businesses, even though they
report high accounting profits.
b. All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of
the Internal Revenue Code.
c. Small corporations that qualify under the Tax Code can elect not to pay corporate taxes, but then each
stockholder must report his or her pro rata shares of the firm's income as personal income and pay taxes on
that income.
d. Congress recently changed the tax laws to make dividend income received by individuals exempt from income
taxes. Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was
first taxed on the corporation's income and stockholders were taxed again on this income when it was paid to
them as dividends.
e. All corporations other than non-profits are subject to corporate income taxes, which are 15% for the lowest
amounts of income and 38% for the highest income amounts.
ANSWER:
c
POINTS:

1
DIFFICULTY:
MODERATE
REFERENCES:
3-9 Income Taxes
LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
TOPICS:
Income taxes
KEYWORDS:
Bloom’s: Knowledge
OTHER:
Multiple Choice: Conceptual
61. Which of the following statements is most correct?
a. Retained earnings, as reported on the balance sheet, represents the amount of cash a company has available to
pay out as dividends to shareholders.
b. 70% of the interest received by corporations is excluded from taxable income.
c. 70% of the dividends received by corporations is excluded from taxable income.
d. Because taxes on long-term capital gains are not paid until the gain is realized, investors must pay the top
individual tax rate on that gain.
e. The corporate tax system favors equity financing, as dividends paid are deductible from corporate taxes.
ANSWER:
c
Statement a is false, because retained earnings represent the cumulative accrued value to
RATIONALE:
shareholders that a firm has amassed. Statement b is false, because interest income does

Cengage Learning Testing, Powered by Cognero

Page 23


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
not benefit from tax exclusion. Statement c is true, because dividend income does benefit
from tax exclusion. Statement d is false, because long-term capital gains are taxed at the L-T
capital gains rate, which depends upon the investor's taxable income but is usually
significantly lower than personal tax rates. Statement e is false, because the tax deductibility
of interest paid shows the tax system favors debt financing.

POINTS:
DIFFICULTY:
REFERENCES:
LEARNING OBJECTIVES:
NATIONAL STANDARDS:
STATE STANDARDS:
TOPICS:
KEYWORDS:
OTHER:

1
MODERATE
3-9 Income Taxes
FOFM.BRIG.16.03.09 - Income taxes
United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
Tax concepts
Bloom’s: Knowledge
Multiple Choice: Conceptual

62. Last year, Delip Industries had (1) negative 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 depreciation expenses.
ANSWER:
c
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
Comprehensive
LEARNING OBJECTIVES: FOFM.BRIG.16.03.00 - Comprehensive
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Cash flow and FCF
KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
63. 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.
a. Companies' after-tax operating profits would decline.
b. Companies' physical stocks of fixed assets would increase.
c. Companies' cash flows would increase.
d. Companies' cash positions would decline.
e. Companies' reported net incomes would decline.
ANSWER:
d
POINTS:
1
DIFFICULTY:
MODERATE
Cengage Learning Testing, Powered by Cognero

Page 24


CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
REFERENCES:
LEARNING OBJECTIVES:
NATIONAL STANDARDS:
STATE STANDARDS:
TOPICS:
KEYWORDS:
OTHER:

Comprehensive
FOFM.BRIG.16.03.00 - Comprehensive
United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows

United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
Changes in depreciation
Bloom's: Comprehension
Multiple Choice: Conceptual

64. 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 the tax rate. Prior to the new
provision, BBI's net income 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 cash flow.
b. The provision will increase the company's tax payments.
c. The provision will increase the firm's operating income (EBIT).
d. The provision will increase the company's net income.
e. Net fixed assets on the balance sheet will decrease.
ANSWER:
e
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
Comprehensive
LEARNING OBJECTIVES: FOFM.BRIG.16.03.00 - Comprehensive
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
STATE STANDARDS:
United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS:
Changes in depreciation

KEYWORDS:
Bloom's: Comprehension
OTHER:
Multiple Choice: Conceptual
65. 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 operating income (EBIT) will increase.
c. Nantell's cash position will improve (increase).
d. Nantell's reported net income for the year will be lower.
e. Nantell's tax liability for the year will be lower.
ANSWER:
b
POINTS:
1
DIFFICULTY:
MODERATE
REFERENCES:
Comprehensive
Cengage Learning Testing, Powered by Cognero

Page 25