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Exam 2: Financial Statements, Cash Flow, and Taxes

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Question 31

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On its 2019 balance sheet, Barngrover Books showed $510 million of retained earnings, and exactly that same amount was shown the following year in 2020.Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

A) Dividends could have been paid in 2020, but they would have had to equal the earnings for the year.
B) If the company lost money in 2020, they must have paid dividends.
C) The company must have had zero net income in 2020.
D) The company must have paid out half of its earnings as dividends.
E) The company must have paid no dividends in 2020.

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

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Question 32

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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.

A) True
B) False

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Question 33

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The interest and dividends paid by a corporation are considered to be deductible operating expenses, hence they decrease the firm's tax liability.

Companies generate income from their "regular" operations and from other sources like interest earned on the securities they hold, which is called non-operating income.Lindley Textiles recently reported $12,500 of sales, $7,250 of operating costs other than depreciation, and $1,000 of depreciation.The company had no amortization charges and no non-operating income.It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was 25%.How much was Lindley's operating income, or EBIT?

NNR Inc.'s balance sheet showed total current assets of $1,875,000 plus $4,225,000 of net fixed assets.All of these assets were required in operations.The firm's current liabilities consisted of $475,000 of accounts payable, $375,000 of 6% short-term notes payable to the bank, and $150,000 of accrued wages and taxes.Its remaining capital consisted of long-term debt and common equity.What was NNR's total investor-provided operating capital?

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.

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.

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

Rao Corporation has the following balance sheet.How much net operating working capital does the firm have? $\begin{array}{llll}\text { Cash } & \$ 10& \text { Accounts payable } & \$ 20 \\\text { Short-term investments } && \text { Accruals } & 20 \\\text { Accounts receivable } & 50& \text { Notes payable } & 50 \\\text { Inventory } & 40& \text { Current liabilities } & \$ 90\\\text { Current assets } & \$ 130& \text { Long-term debt } & 0 \\\text { Net fixed assets } & 100 &\text { Common equity } & 30\\&& \text { Retaned earnings } & 50 \\\text { Total assets } & \$ 230& \text { Total liab. \& equity } & \$ 230\end{array}$

Which of the following statements is CORRECT?

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

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?

Analysts following Armstrong Products recently noted that the company's net cash flow from operations increased over the prior year, yet cash as reported on the balance sheet decreased.Which of the following factors could explain this situation?

Swinnerton Clothing Company's balance sheet showed total current assets of $2,250, all of which were required in operations.Its current liabilities consisted of $575 of accounts payable, $300 of 6% short-term notes payable to the bank, and $145 of accrued wages and taxes.What was its net operating working capital that was financed by investors?

For managerial purposes, i.e., making decisions regarding the firm's operations, the standard financial statements as prepared by accountants under Generally Accepted Accounting Principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm's operations.Related to these modifications, which of the following statements is CORRECT?

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.

EP Enterprises has the following income statement.How much net operating profit after taxes (NOPAT) does the firm have? $\begin{array}{lr}\text { Sales } & \$ 1,800.00 \\\text { Costs } & 1,400.00 \\\text { Depreciation } & 250.00 \\\text { EBIT } & \$ 150.00 \\\text { Interest expense } & 70.00 \\\text { EBT } & \$ 80.00 \\\text { Taxes (25\%) } & 20.00 \\\text { Net income } & \$ 60.00\end{array}$

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.Retained earnings are kept in cash or near cash accounts and, thus, these cash accounts, when added together, will always be equal to the firm's total retained earnings.

Lucy's Music Emporium purchased $50 million in fixed assets in January and their accountant told them that they would have to depreciate the assets over 20 years (they use the same depreciation calculations for shareholder reporting and income tax purposes) .In December they learned that their accountant did not have a college degree and fired him.They hired a new accountant with a college degree and she told them that they could depreciate the assets over 15 years.How would the new depreciation assumption affect the company's financial statements relative to the old assumption?

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. $\begin{array}{lcc}\text { Cash } & \$ 50,000& \text { Accounts payable } & \$ 100,000 \\\text { Inventory } & 200,000& \text { Accruals } & 100,000\\\text { Accounts receivable } & 250,000& \mathrm{Total} \mathrm{CL} & \$ 200,000\\\text { Total CA } & \$ 500,000& \text { Debt } & 200,000 \\\text { Net fixed assets } & \$ 900,000& \text { Common stock } & 200,000 \\&& \text { Retained eamings } & 800,000\\\text { Total assets }&\$1,400,000&\text { Total L \& E }&\$1,400,000\end{array}$