Test Bank For Financial Management Theory Practice 14th Edition by Eugene F Brigham Michael C Ehrhardt Sample

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Test Bank for Financial Management Theory Practice 14th

Edition by Eugene F Brigham Michael C Ehrhardt Sample
Math 1 (‫)سيوسلا ةانق ةعماج‬
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Test Bank for Financial Management: Theory & Practice 14th Edition
Brigham Ehrhardt
Complete Download: https://testbankarea.com/download/test-bank-financial-management-
theory-practice-14th-edition-brigham-ehrhardt/
Solutions manual for Fundamentals of Financial Management 14th Edition Brigham
Complete Download: https://testbankarea.com/download/solutions-manual-fundamentals-
financial-management-14th-edition-brigham-houston/
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
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: Annual report
KEYWORDS: Bloom’s: Knowledge
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
POINTS: 1
DIFFICULTY: EASY
TOPICS: Annual report
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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
POINTS: 1
DIFFICULTY: EASY
TOPICS: Financial statements
4. On the balance sheet, total assets must always equal the sum of total liabilities and equity.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 3-2 The Balance Sheet
LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet
United States - OH - DISC.FOFM.BRIG.16.06 - Finance function
TOPICS: Balance sheet
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
POINTS: 1
DIFFICULTY: EASY
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

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b. False
ANSWER: False
POINTS: 1
DIFFICULTY: EASY
NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
7. The income statement shows the difference between a firm's income and its costs--i.e., its profits--during 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
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
POINTS: 1
DIFFICULTY: EASY
9. EBIT stands for earnings before interest and taxes, and it is often called "operating income."
a. True
b. False

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ANSWER: True
POINTS: 1
DIFFICULTY: EASY
10. EBITDA stands for earnings before interest, taxes, debt, and assets.
a. True
b. False
ANSWER: False
POINTS: 1
DIFFICULTY: EASY
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 $ 50,000 Accounts payable $ 100,000

Inventory 200,000 Accruals 100,000
Accounts receivable 250,000 Total CL $ 200,000
Total CA $ 500,000 Long-term debt 200,000
Net fixed assets $ 900,000 Common stock 200,000
Retained earnings 800,000
Total assets $1,400,000 Total L & E $1,400,000
a. True
b. False
ANSWER: False
RATIONALE: 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
TOPICS: Retained earnings

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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
TOPICS: Stockholders' equity statement
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
TOPICS: Free cash flow
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

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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
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
TOPICS: Income taxes
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
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.

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a. True
b. False
ANSWER: False
POINTS: 1
DIFFICULTY: EASY
REFERENCES: Comprehensive
LEARNING OBJECTIVES: FOFM.BRIG.16.03.00 - Comprehensive
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
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
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
TOPICS: Net operating working capital
21. The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the

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company paid. Therefore, the dividends are frequently called "the bottom line."
a. True
b. False
ANSWER: False
POINTS: 1
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
REFERENCES: 3-4 Statement of Cash Flows
LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows
TOPICS: Statement of cash flows
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
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.

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a. True
b. False
ANSWER: False
POINTS: 1
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
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

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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
TOPICS: Cash flow and net income
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
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
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

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operating working capital.

a. True
b. False
ANSWER: True
POINTS: 1
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
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 tax-
deductible 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
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

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ANSWER: True
POINTS: 1
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
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
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

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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
OTHER: Multiple Choice: Conceptual

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

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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
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

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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
TOPICS: Current assets
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
TOPICS: Current liabilities

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.

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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
44. Below are the 2013 and 2014 year-end balance sheets for Tran Enterprises:
Assets: 2014 2013

Cash $ 200,000 $ 170,000
Accounts receivable 864,000 700,000
Inventories 2,000,000 1,400,000
Total current assets $3,064,000 $2,270,000
Net fixed assets 6,000,000 5,600,000
Total assets $9,064,000 $7,870,000
Liabilities and equity:

Accounts payable $1,400,000 $1,090,000
Notes payable to bank 1,600,000 1,800,000
Total current liabilities $3,000,000 $2,890,000
Long-term debt 2,400,000 2,400,000
Common stock 3,000,000 2,000,000
Retained earnings 664,000 580,000
Total common equity $3,664,000 $2,580,000
Total liabilities and equity $9,064,000 $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

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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
46. Below is the common equity section (in millions) of Timeless Technology's last two year-end balance sheets:
2014 2013
Common stock $2,000 $1,000
Retained earnings 2,000 2,340
Total common equity $4,000 $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

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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
TOPICS: EPS, DPS, BVPS, and stock price

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
TOPICS: Depreciation, EBIT, and CF
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.

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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
TOPICS: Cash flow
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
TOPICS: Cash flow
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.
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

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TOPICS: Cash flow and net income

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 short-
term liquid securities (or cash equivalents), increased or decreased during a given year.
ANSWER: e
POINTS: 1

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.
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

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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

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.
e. If a firm reports positive net income, its EVA must also be positive.
ANSWER: b
RATIONALE: Statement b is true, because the EVA equation: EVA = EBIT(1 − T) − (After-tax cost of
capital %) (Investor-supplied operating capital) implies that lowering the operating capital, all
else equal, lowers capital costs and thus increases EVA.
POINTS: 1
REFERENCES: 3-8 MVA and EVA
LEARNING OBJECTIVES: FOFM.BRIG.16.03.08 - MVA and EVA

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TOPICS: EVA, cash flow, and NI

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
RATIONALE: Statement e gives the correct equation for EVA. The other statements are false.
POINTS: 1
TOPICS: MVA and EVA
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
RATIONALE: Statement a is false, corporations cannot exclude interest income from corporate 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: 1

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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
TOPICS: Carry-back, carry-forward

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

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.

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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
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
RATIONALE: Statement a is false, because retained earnings represent the cumulative accrued value to
shareholders that a firm has amassed. Statement b is false, because interest income does
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: 1
TOPICS: Tax concepts

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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
TOPICS: Cash flow and FCF
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
TOPICS: Changes in depreciation
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.

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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
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
66. Assume that Besley Golf Equipment commenced operations on January 1, 2014, 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 2014 management realized that the assets would last for only 10 years. The
firm's accountants plan to report the 2014 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 2014 earnings per share would increase.
d. The firm's cash position in 2014 and 2015 would increase.
e. The provision will increase the company's tax payments.

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ANSWER: d
POINTS: 1
67. 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 cash flow would increase.
d. The firm's tax payments would increase.
e. The firm's reported net income would increase.
ANSWER: c
POINTS: 1

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 to purchase fixed assets during the current year, this will increase
both its reported current assets and 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.
ANSWER: e
POINTS: 1

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69. 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?
a. The standard statements make adjustments to reflect the effects of inflation on asset values, and these
adjustments are normally carried into any adjustment that managers make to the standard statements.
b. The standard statements focus on accounting income for the entire corporation, not cash flows, and the two
can be quite different during any given accounting period. However, the firm's value is based on its future cash
flows. After all, future cash flows tells us how much the firm can distribute to its investors.
c. The standard statements provide useful information on the firm's individual operating units, but management
needs more information on the firm's overall operations than the standard statements provide.
d. The standard statements focus on cash flows, but managers should be less concerned with cash flows than with
accounting income as defined by GAAP.
e. The best feature of standard statements is that, if they are prepared under GAAP, the data are always
consistent from firm to firm. Thus, under GAAP, there is no room for accountants to "adjust" the results to
make earnings look better.
ANSWER: b
POINTS: 1

a. Since depreciation increases the firm's net cash provided by operating activities, 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 reported 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.
ANSWER: b
POINTS: 1

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71. Last year Besset Company's operations provided a negative cash flow, yet the cash shown on its balance sheet
increased. Which of the following statements could explain the increase in cash, assuming the company's financial
statements were prepared under generally accepted accounting principles (GAAP)?
a. The company repurchased some of its common stock.
b. The company dramatically increased its capital expenditures.
c. The company retired a large amount of its long-term debt.
d. The company sold some of its fixed assets.
e. The company had high depreciation expenses.
ANSWER: d
POINTS: 1
DIFFICULTY: CHALLENGING
TOPICS: Cash flow
72. The CFO of Daves Industries plans to have the company issue $300 million of new common stock and use the
proceeds to pay off some of its outstanding bonds that carry a 7% interest rate. Assume that the company, which does not
pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant.
Which of the following would occur?
a. The company's taxable income would fall.
b. The company's interest expense would remain constant.
c. The company would have less common equity than before.
d. The company's net income would increase.
e. The company would have to pay less taxes.
ANSWER: d
POINTS: 1
TOPICS: Changes in leverage

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a. 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 either 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.
b. Assets other than cash are expected to produce cash over time, and the amount of cash they eventually produce
must be the same as the amounts at which the assets are carried on the books.
c. The income statement shows the difference between a firm's income and its costs (i.e., its profits) during a
specified period of time. However, all reported income comes in the form of cash, and reported costs likewise
are consistent with cash outlays. Therefore, there will not be a substantial difference between a firm's reported
profits and its actual cash flow for the same period.
d. 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.
e. EPS stands for earnings per share, while DPS stands for dividends per share. We would normally expect to see
DPS exceed EPS.
ANSWER: d
POINTS: 1

a. An increase in accounts receivable is added to net income in the operating activities section because if
accounts receivable increase, then when they are collected cash will come into the firm.
b. 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 the change
in net operating working capital. Free cash flow is the amount of cash that could be withdrawn without
harming the firm's ability to operate and to produce future cash flows.
c. 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 add to or subtract from 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.
d. 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."
e. Most rapidly growing companies have positive free cash flows because cash flows from existing operations
will exceed fixed assets and working capital needed to support the growth.
ANSWER: b
POINTS: 1

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a. 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.
b. After-tax operating income is calculated as EBIT(1 − T) + Depreciation.
c. Two firms with identical sales and operating costs but with different amounts of debt and tax rates will have
different operating incomes by definition.
d. 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.
e. Retained earnings as reported on the balance sheet represent cash and, therefore, are available to distribute to
stockholders as dividends or any other required cash payments to creditors and suppliers.
ANSWER: a
POINTS: 1

a. The current cash flow from existing assets is highly relevant to investors. However, since the value of the firm
depends primarily upon its growth opportunities, accounting net income projections from those opportunities
are the only relevant future flows with which investors are concerned.
b. Two metrics that are used to measure a company's financial performance are net income and free cash flow.
Accountants tend to emphasize net income as calculated in accordance with generally accepted accounting
principles. Finance people generally put at least as much weight on free cash flows as they do on net income.
c. To estimate the net cash provided by operations, depreciation must be subtracted from net income because it is
a non-cash charge that has been added to revenue.
d. 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 discourage the use of debt financing by
corporations.
e. If Congress changed depreciation allowances so that companies had to report higher depreciation levels for tax
purposes in 2014, this would lower their free cash flows for 2014.
ANSWER: b
POINTS: 1

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TOPICS: Cash flow and taxes

Multiple Choice: Problems
A good bit of relatively simple arithmetic is involved in some of these problems, and although the calculations are simple,
it will take students some time to set up the problem and do the arithmetic. We allow for this when assigning problems for
a timed test.
Also, students must use a number of definitions to answer some of the questions. To avoid excessive memorization, we
provide students with a list of formulas and definitions for use on exams. Problems with * in the topic line are
nonalgorithmic.
77. Bauer Software's current balance sheet shows total common equity of $5,125,000. The company has 530,000 shares of
stock outstanding, and they sell at a price of $27.50 per share. By how much do the firm's market and book values per
share differ?
a. $17.83
b. $18.72
c. $19.66
d. $20.64
e. $21.67
ANSWER: a
RATIONALE:
Shares outstanding 530,000
Price per share $27.50
Total book common equity $5,125,000
Book value per share = Total book equity/Number of shares $9.67
Difference between book and market values $17.83
POINTS: 1
DIFFICULTY: EASY
KEYWORDS: Bloom's: Evaluation
OTHER: Multiple Choice: Problem
78. Brown Fashions Inc.'s December 31, 2014, balance sheet showed total common equity of $4,050,000 and 200,000
shares of stock outstanding. During 2014, the firm had $450,000 of net income, and it paid out $100,000 as dividends.
What was the book value per share at 12/31/14, assuming no common stock was either issued or retired during 2014?
a. $20.90
b. $22.00
c. $23.10
d. $24.26
e. $25.47
ANSWER: b

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RATIONALE: 12/31/14 common equity $4,050,000

2014 net income $ 450,000
2014 dividends $ 100,000
2014 addition to retained earnings $ 350,000
12/31/14 common equity $4,400,000
Shares outstanding 200,000
12/31/14 BVPS $22.00
POINTS: 1
DIFFICULTY: EASY
KEYWORDS: Bloom’s: Analysis
79. Prezas Company's balance sheet showed total current assets of $4,250, all of which were required in operations. Its
current liabilities consisted of $975 of accounts payable, $600 of 6% short-term notes payable to the bank, and $250 of
accrued wages and taxes. What was its net operating working capital?
a. $2,874
b. $3,025
c. $3,176
d. $3,335
e. $3,502
ANSWER: b
RATIONALE: NOWC = Current assets − (Current liabilities − Notes payable)
NOWC = $4,250 − ($1,825 − $600)
NOWC = $3,025
POINTS: 1
DIFFICULTY: EASY
80. Rao Construction recently reported $20.50 million of sales, $12.60 million of operating costs other than depreciation,
and $3.00 million of depreciation. It had $8.50 million of bonds outstanding that carry a 7.0% interest rate, and its federal-
plus-state income tax rate was 40%. What was Rao's operating income, or EBIT, in millions?
a. $3.21
b. $3.57
c. $3.97
d. $4.41

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e. $4.90
ANSWER: e
RATIONALE: Sales $20.50
Operating costs excluding depreciation 12.60
Depreciation 3.00
Operating income (EBIT) $ 4.90
Note that operating income is before interest and taxes.
POINTS: 1
DIFFICULTY: EASY
81. Brown Office Supplies recently reported $15,500 of sales, $8,250 of operating costs other than depreciation, and
$1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income
tax rate was 40%. How much was the firm's earnings before taxes (EBT)?
a. $4,627
b. $4,870
c. $5,114
d. $5,369
e. $5,638
ANSWER: b
RATIONALE: Bonds $ 9,000.00
Interest rate 7.00%
Sales $15,500.00
Operating costs excluding depreciation 8,250.00
Depreciation 1,750.00
Operating income (EBIT) $ 5,500.00
Interest charges −630.00
EBT = Taxable income $ 4,870
POINTS: 1
DIFFICULTY: EASY
82. Vasudevan Inc. recently reported operating income of $2.75 million, depreciation of $1.20 million, and had a tax rate
of 40%. The firm's expenditures on fixed assets and net operating working capital totaled $0.6 million. How much was its
free cash flow, in millions?

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a. $1.93
b. $2.03
c. $2.14
d. $2.25
e. $2.36
ANSWER: d
RATIONALE: FCF = EBIT(1 − T) + Deprec. − (Capex + ΔNOWC)
EBIT $2.75
Tax rate 40%
Depreciation $1.20
Capex + ΔNOWC $0.60
FCF = $2.25
POINTS: 1
DIFFICULTY: EASY
83. 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?
a. $18,500,000
b. $18,870,000
c. $19,247,400
d. $19,632,348
e. $20,024,995
ANSWER: a
RATIONALE: Total book value of equity
Stock price per share
Shares outstanding
Market value of equity = Stock price × Number of shares
MVA = Market value of equity − Book value of equity
POINTS: 1
DIFFICULTY: EASY
LEARNING OBJECTI FOFM.BRIG.16.03.08 - MVA and EVA
VES:
NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills
DS:
TOPICS: MVA

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84. Wu Systems has the following balance sheet. How much net operating working capital does the firm have?
Cash $ 100 Accounts payable $ 200

Accounts receivable 650Accruals 350
Inventory 550Notes payable 350
Current assets $1,300 Current liabilities $ 900
Net fixed assets 1,000Long-term debt 600
Common equity 300
_____ Retained earnings 500
Total assets $2,300 Total liab. & equity $2,300
a. $675
b. $750
c. $825
ANSWER: b
RATIONALE: Cash $ 100 Accounts payable $ 200
Accounts receivable 650Accruals 350
Inventory 550Notes payable 350
Current assets $1,300Current liabilities $ 900
Net fixed assets 1,000Long-term debt 600
Common equity 300
_____ Retained earnings 500
Total assets $2,300 Total liab. & equity $2,300
Net operating working capital = Current assets − (Current liabilities − Notes payable)
NOWC = $1,300.00 − $550 NOWC = $750
POINTS: 1
85. 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.
a. $35,167.33
b. $37,018.24
c. $38,966.57
d. $41,017.44
e. $43,068.31
ANSWER: d
RATIONALE: Bonds $ 16,500

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Interest rate 7.25%

Tax rate 35%
Sales $ 150,000
Operating costs excluding depreciation 75,500
Depreciation 10,200
Operating income (EBIT) $64,300.00
Interest charges −1,196.25
Taxable income $63,103.75
Taxes −22,086.31
Net income $41,017.44
POINTS: 1
86. Last year Almazan Software reported $10.50 million of sales, $6.25 million of operating costs other than depreciation,
and $1.30 million of depreciation. The company had $5.00 million of bonds that carry a 6.5% interest rate, and its federal-
plus-state income tax rate was 35%. This year's data are expected to remain unchanged except for one item, depreciation,
which is expected to increase by $0.70 million. By how much will net income change as a result of the change in
depreciation? The company uses the same depreciation calculations for tax and stockholder reporting purposes.
a. −$0.432
b. −$0.455
c. −$0.478
d. −$0.502
e. −$0.527
ANSWER: b
RATIONALE: This problem can be worked very easily: just multiply the increase in depreciation by (1 − T)
to get the decrease in net income:
Change in depreciation $0.700

Tax rate 0.350
Reduction in net income $0.455
We can also get the answer a longer way, which explains things more clearly:
Old New Change

Bonds $ 5.000 $ 5.000 $0.000
Interest rate 0.065 0.065 0.000
Tax rate 0.350 0.350 0.000
Sales $10.500 $10.500 $0.000
Operating costs excluding depreciation $ 6.250 $ 6.250 $0.000
Depreciation $ 1.300 $ 2.000 $0.700
Operating income (EBIT) $ 2.950 $ 2.250 −$0.700
Interest charges $ 0.325 $ 0.325 $0.000
Taxable income $ 2.625 $ 1.925 −$0.700
Taxes $ 0.919 $ 0.674 −$0.245
Net income $ 1.706 $ 1.251 −$0.455
POINTS: 1

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87. On 12/31/14, Hite Industries reported retained earnings of $525,000 on its balance sheet, and it reported that it had
$135,000 of net income during the year. On its previous balance sheet, at 12/31/13, the company had reported $445,000 of
retained earnings. No shares were repurchased during 2014. How much in dividends did the firm pay during 2014?
a. $49,638
b. $52,250
c. $55,000
d. $57,750
e. $60,638
ANSWER: c
RATIONALE: 12/31/14 RE $525,000
12/31/13 RE 445,000
Change in RE $ 80,000
Net income for 2014 $135,000
Dividends = Net income − Change in RE $ 55,000
POINTS: 1
TOPICS: Statement of stockholders' equity
88. During 2014, Bascom Bakery paid out $33,525 of common dividends. It ended the year with $197,500 of retained
earnings versus the prior year's retained earnings of $159,600. How much net income did the firm earn during the year?
a. $71,425
b. $74,996
c. $78,746
d. $82,683
e. $86,818
ANSWER: a
RATIONALE: Net income = The change in retained earnings plus the dividends paid:
Current RE $197,500
Previous RE = Current RE − increment 159,600
Change in RE $ 37,900
Plus dividends paid 33,525

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= Net income $ 71,425

POINTS: 1
TOPICS: Statement of stockholders' equity
89. C. F. Lee Inc. has the following income statement. How much after-tax operating income does the firm have?
Sales $2,850.00
Costs 1,850.00
Depreciation 192.00
EBIT $ 808.00
Interest expense 285.00
EBT $ 523.00
Taxes (35%) 183.05
Net income $ 339.95
a. $427.78
b. $450.29
c. $473.99
d. $498.94
e. $525.20
ANSWER: e
RATIONALE: Sales $2,850.00
Costs 1,850.00
Depreciation 192.00
EBIT $ 808.00
Interest expense 285.00
EBT $ 523.00
Taxes: rate = 35% 183.05
Net income $ 339.95
EBIT $808.00
Tax rate 35%
EBIT(1 − T) = $525.20
POINTS: 1
TOPICS: After-tax operating income

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90. Kwok Enterprises has the following income statement. How much after-tax operating income does the firm have?
Sales $2,250
Costs 1,400
Depreciation 250
EBIT $ 600
Interest expense 70
EBT $ 530
Taxes (40%) 212
Net income $ 318
a. $325
b. $342
c. $360
d. $378
e. $397
ANSWER: c
RATIONALE: Sales $2,250
Costs 1,400
Depreciation 250
EBIT $ 600
Interest expense 70
EBT $ 530
Taxes: rate = 40% 212
Net income $ 318
EBIT $600.00
Tax rate 40%
EBIT(1 − T) = $360
POINTS: 1
TOPICS: After-tax operating income
91. Hartzell Inc. had the following data for 2013, in millions: Net income = $600; after-tax operating income [EBIT(1 −
T)] = $700; and Total assets = $2,000. Information for 2014 is as follows: Net income = $825; after-tax operating income
[EBIT(1 − T)] = $925; and Total assets = $2,500. How much free cash flow did the firm generate during 2014?
a. $383
b. $425
c. $468
d. $514
e. $566
ANSWER: b

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RATIONALE: EBIT(1 − T) 2013 2014 Change = Net invest. in FA + NOWC

Total assets $2,000 $2,500 $500
2014 FCF = EBIT(1 − T) − Net investment in FA + NOWC

2014 FCF = $925 − $500
2014 FCF = $425
POINTS: 1
92. 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?
a. $1,873
b. $1,972
c. $2,076
d. $2,185
e. $2,300
ANSWER: e
RATIONALE: Bonds $ 3,500.00
Interest rate 6.25%
Tax rate 35.00%
Sales $10,750.00
Depreciation 1,250.00
Operating income (EBIT) $ 4,000.00
Capex + ΔNOWC = $ 1,550.00

Tax rate = 35%
FCF = EBIT(1 − T) + Deprec. − (Capex + ΔNOWC)

FCF = $2,600 + $1,250 − $1,550 Free cash flow = $2,300
POINTS: 1

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93. Houston Pumps recently reported $185,250 of sales, $140,500 of operating costs other than depreciation, and $9,250
of depreciation. The company had $35,250 of outstanding bonds that carry a 6.75% interest rate, and its federal-plus-state
income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm was
required to spend $15,250 to buy new fixed assets and to invest $6,850 in net operating working capital. What was the
firm's free cash flow?
a. $10,225
b. $10,736
c. $11,273
d. $11,837
e. $12,429
ANSWER: a
RATIONALE: Tax rate 35%
Required addition to net operating working capital $6,850
Required capital expenditures (fixed assets) $15,250
Sales $185,250
Operating costs excluding depreciation 140,500
Depreciation 9,250
Operating income (EBIT) $ 35,500
FCF = EBIT(1 − T) + Deprec. − Capex − ΔNOWC

FCF = $23,075.00 + $9,250 − $15,250 − $6,850
FCF = $10,225
POINTS: 1
94. Hayes Corporation has $300 million of common equity, with 6 million shares of common stock outstanding. If Hayes'
Market Value Added (MVA) is $162 million, what is the company's stock price?
a. $66.02
b. $69.49
c. $73.15
d. $77.00
e. $80.85
ANSWER: d
RATIONALE: Total book value of equity $300,000,000
Shares outstanding 6,000,000
Market Value Added $162,000,000
Market value of equity = Stock price × Number of shares − Total BV of Equity

$162,000,000 = Stock price × 6,000,000 − $300,000,000
Stock price = $77.00

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POINTS: 1
TOPICS: MVA
95. Byrd Lumber has 2 million shares of common stock outstanding that sell for $17 a share. If the company has $40
million of common equity on its balance sheet, what is the company's Market Value Added (MVA)?
a. −$5,415,000
b. −$5,700,000
c. −$6,000,000
d. −$6,300,000
e. −$6,615,000
ANSWER: c
RATIONALE: Total book value of equity $40,000,000
Stock price per share $17.00
Shares outstanding 2,000,000
Market value of equity = Stock price × Number of shares $34,000,000

= Market value of equity − Book value of
MVA −$6,000,000
equity
POINTS: 1
TOPICS: MVA
96. Scranton Shipyards has $20 million in total invested operating capital, and its WACC is 10%. Scranton has the
following income statement:
Sales $10.0 million

Operating costs 6.0 million
Operating income (EBIT) $ 4.0 million
Interest expense 2.0 million
Earnings before taxes (EBT) $ 2.0 million
Taxes (40%) 0.8 million
Net income $ 1.2 million
What is Scranton's EVA?
a. $400,000
b. $420,000
c. $441,000

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d. $463,050
e. $486,203
ANSWER: a
RATIONALE: EBIT $4,000,000
Tax rate 40.00%
WACC 10.00%
Total invested capital $20,000,000
EVA = EBIT(1 − T) − (WACC × Total invested capital)

EVA = $2,400,000 − $2,000,000
EVA = $400,000
POINTS: 1
TOPICS: EVA
97. Casey Motors recently reported the following information:
∙ Net income = $600,000.

∙ Tax rate = 40%.
∙ Interest expense = $200,000.
∙ Total invested operating capital employed = $9 million.
∙ After-tax cost of capital = 10%.
What is the company's EVA?
a. −$171,000
b. −$180,000
c. −$189,000
d. −$198,450
e. −$208,373
ANSWER: b
RATIONALE: Net income $600,000
Interest expense $20,000
Total invested operating capital $9,000,000
Tax rate 40%
After-tax cost of capital 10%
EBT = Net income/(1 − T)

EBT = $1,000,000
EBIT = EBT + Interest

EBIT = $1,200,000

EVA = $720,000 − $900,000
EVA = −$180,000
POINTS: 1

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TOPICS: EVA
98. Your corporation has the following cash flows:
Operating income $250,000

Interest received $ 10,000
Interest paid $ 45,000
Dividends received $ 20,000
Dividends paid $ 50,000
If the applicable income tax rate is 40% (federal and state combined), and if 70% of dividends received are exempt from
taxes, what is the corporation's tax liability?
a. $ 83,980
b. $ 88,400
c. $ 92,820
d. $ 97,461
e. $102,334
ANSWER: b
RATIONALE: Operating income $250,000
Interest received $ 10,000
Interest paid $ 45,000
Dividends received $ 20,000
Dividend exclusion % 70%
Dividends paid $ 50,000
Tax rate (T) 40%
Taxable income = Oper. income + Interest received − Interest paid + Taxable dividends
received
Taxable income = Oper. income + Interest received − Interest paid + Div. received(1 − Div.
exclusion %)
Taxable income = $221,000
Taxes paid = Taxable income × Tax rate

Taxes paid = $88,400
POINTS: 1
TOPICS: Corporate taxes
99. Your corporation has a marginal tax rate of 35% and has purchased preferred stock in another company. The before-

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tax dividend yield on the preferred stock is 12%. What is the company's after-tax return on the preferred, assuming a 70%
dividend exclusion?
a. 10.20%
b. 10.74%
c. 11.28%
d. 11.84%
e. 12.43%
ANSWER: b
RATIONALE: Preferred dividend rate 12.00%
Tax rate 35%
After-tax dividend yield = Preferred dividend rate[1 − (1 − Div. exclusion %)(T)]

After-tax dividend yield = 10.74%
POINTS: 1
TOPICS: After-tax returns
100. 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?
a. 7.02%
b. 7.39%
c. 7.76%
d. 8.15%
e. 8.56%
ANSWER: b
Tax rate 40%
If a company buys preferred stock in another company, 70% of the dividends are excluded
from taxes. Therefore, the after-tax return will be:

POINTS: 1

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101. 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?
a. 6.90%
b. 7.26%
c. 7.64%
d. 8.02%
e. 8.42%
ANSWER: c
Tax rate 15%

POINTS: 1
102. Van Dyke Corporation has a corporate tax rate equal to 30%. The company recently purchased preferred stock in
another company. The preferred stock has an 8% before-tax yield. What is Van Dyke's after-tax yield on the preferred
stock?
a. 6.57%
b. 6.92%
c. 7.28%
d. 7.64%
e. 8.03%
ANSWER: c
Tax rate 30%

POINTS: 1

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103. Granville Co. recently purchased several shares of Kalvaria Electronics' preferred stock. The preferred stock has a
before-tax yield of 8.6%. If the company's tax rate is 40%, what is Granville Co.'s after-tax yield on the preferred stock?
a. 6.49%
b. 6.83%
c. 7.19%
d. 7.57%
e. 7.95%
ANSWER: d
Tax rate 40%

POINTS: 1
104. Appalachian Airlines began operating in 2010. The company lost money the first year but has been profitable ever
since. The company's taxable income (EBT) for its first five years is listed below. Each year the company's corporate tax
rate has been 40%.
Year Taxable Income

2010 −$4,000,000
2011 $1,000,000
2012 $2,000,000
2013 $3,000,000
2014 $5,000,000
Assume that the company has taken full advantage of the Tax Code's carry-back, carry-forward provisions and that the
current provisions were applicable in 2010. How much did the company pay in taxes in 2013?
a. $ 688,500
b. $ 765,000

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c. $ 800,000
d. $ 930,000
e. $1,023,000
ANSWER: c
EBT After Unused
Carry-Forward Forward Carryable
Year Taxable Income Used Applied Amount
2010 −$4,000,000 $0 $0 $4,000,000
2011 $1,000,000 $1,000,000 $0 $3,000,000
2012 $2,000,000 $2,000,000 $0 $1,000,000
2013 $3,000,000 $1,000,000 $2,000,000 $0
2014 $5,000,000 $0 $5,000,000 $0
2013 Tax liability = EBT × Tax rate

2013 Tax liability = $800,000
POINTS: 1
105. Garner Grocers began operations in 2011. Garner has reported the following levels of taxable income (EBT) over the
past several years. The corporate tax rate was 34% each year. Assume that the company has taken full advantage of the
Tax Code's carry-back, carry-forward provisions, and assume that the current provisions were applicable in 2011. What is
the amount of taxes the company paid in 2014?
Year Taxable Income

2011 −$3,200,000
2012 $ 200,000
2013 $ 500,000
2014 $2,800,000
a. $ 92,055
b. $ 96,900
c. $102,000
d. $107,100
e. $112,455
ANSWER: c
EBT After Unused
Year Income Used Applied Amount
2011 −$3,200,000 $0 $ 0 $3,200,000
2012 $ 200,000 $ 200,000 $ 0 $3,000,000
2013 $ 500,000 $ 500,000 $ 0 $2,500,000
2014 $2,800,000 $2,500,000 $300,000 $0

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POINTS: 1
106. A corporation recently purchased some preferred stock that has a before-tax yield of 7%. The company has a tax rate
of 38%. What is the after-tax return on the preferred stock?
a. 5.32%
b. 5.60%
c. 5.89%
d. 6.20%
e. 6.51%
ANSWER: d
Tax rate 38%

POINTS: 1
107. A corporate bond currently yields 8.5%. Municipal bonds with the same risk, maturity, and liquidity currently yield
5.5%. At what tax rate would investors be indifferent between the two bonds?
a. 35.29%
b. 37.06%
c. 38.91%
d. 40.86%
e. 42.90%
ANSWER: a
RATIONALE: Bond yield 8.50%
Municipal bond yield 5.50%

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Municipal yield = After-tax bond yield

5.50% = 8.50% × (1 − T)
0.6471 = (1 − T)
T = 35.29%
POINTS: 1
108. A 7-year municipal bond yields 4.8%. Your marginal tax rate (including state and federal taxes) is 27%. What
interest rate on a 7-year corporate bond of equal risk would provide you with the same after-tax return?
a. 5.64%
b. 5.93%
c. 6.25%
d. 6.58%
e. 6.90%
ANSWER: d
RATIONALE: Municipal bond yield 4.80%
Tax rate 27.00%

4.80% = BT yield × (1 − T)
4.80% = BT yield × 73.00%
BT yield = 6.58%
POINTS: 1
109. A bond issued by the State of Pennsylvania provides a 9% yield. What yield on a Synthetic Chemical Company bond
would cause the two bonds to provide the same after-tax rate of return to an investor in the 35% tax bracket?
a. 13.85%
b. 14.54%
c. 15.27%
d. 16.03%
e. 16.83%

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ANSWER: a
RATIONALE: Municipal bond yield 9.00%
Tax rate 35.00%

9.00% = BT yield × (1 − T)
9.00% = BT yield × 65.00%
BT yield = 13.85%
POINTS: 1
110. Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds
and U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. If Treasury bonds yield 6%,
and Carter's marginal income tax rate is 40%, what yield on the Chicago municipal bonds would make Carter's treasurer
indifferent between the two?
a. 3.42%
b. 3.60%
c. 3.78%
d. 3.97%
e. 4.17%
ANSWER: b
RATIONALE: Treasury bond yield 6.00%
Tax rate 40.00%
Remember that municipal bonds are tax exempt, so their BT yield = AT yield.
Municipal yield = AT bond yield

Municipal yield = BT bond yield × (1 − T)
Municipal yield = 3.60%
POINTS: 1
111. A 5-year corporate bond yields 9%. A 5-year municipal bond of equal risk yields 6.5%. Assume that the state tax rate
is zero. At what federal tax rate are you indifferent between the two bonds?

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a. 27.78%
b. 29.17%
c. 30.63%
d. 32.16%
e. 33.76%
ANSWER: a
RATIONALE: BT Bond yield 9.00%
Municipal bond yield 6.50%

6.50% = 9.00% × (1 − T)
0.7222 = (1 − T)
T = 27.78%
POINTS: 1
112. 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.
a. −$383.84; $206.68
b. −$404.04; $217.56
c. −$425.30; $229.01
d. −$447.69; $241.06
e. −$471.25; $253.75
ANSWER: e
RATIONALE: This problem can be worked very easily--just multiply the increase in depreciation by (1 − T)
to get the decrease in net income, and then subtract this value from the change in
depreciation to get the change in free cash flow:
Change in depreciation $725

Tax rate 35.00%
Reduction in net income = Change in Deprec. (1 − Tax rate) −$471.25
Increase in free cash flow = Change in Deprec. − Reduction in NI $253.75
We can also get the answer the long way, which explains things in more detail:
Old New Change

Bonds $ 3,500 $ 3,500 $ 0.00

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Interest rate 6.50% 6.50% 0.00

Tax rate 35% 35% 0.00
Capex + NOWC $ 2,000 $ 2,000 $ 0.00
Sales $11,250 $11,250 $ 0.00

Operating costs excluding depreciation $ 4,500 $ 4,500 $ 0.00
Depreciation $ 1,250 $ 1,975 $725.00
Operating income (EBIT) $ 5,500 $ 4,775 −$725.00
Interest charges $ 228 $ 228 $ 0.00
Taxable income $ 5,273 $ 4,548 −$725.00
Taxes $ 1,845 $ 1,592 −$253.75
Net income $ 3,427 $ 2,956 −$471.25
Free cash flow = EBIT(1 − T) +
Deprec − [Capex + ΔNOWC] $ 2,825 $ 3,079 $253.75
Check on FCF: ΔFCF = Change in depreciation × Tax rate $253.75
We like this problem because it illustrates that an increase in depreciation will decrease the
firm's net income yet increase its free cash flow, and cash is king.
POINTS: 1
TOPICS: Net income vs. FCF
113. Watson Oil recently reported (in millions) $8,250 of sales, $5,750 of operating costs other than depreciation, and
$650 of depreciation. The company had $3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-
state income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm
was required to make $1,250 of capital expenditures on new fixed assets and to invest $300 in net operating working
capital. By how much did the firm's net income exceed its free cash flow?
a. $718
b. $756
c. $796
d. $836
e. $878
ANSWER: c
RATIONALE: Bonds $3,200
Interest rate 5%
Tax rate 35%
Required capital expenditures (fixed assets) $1,250
Required addition to net operating working capital $300
Sales $8,250.00
Depreciation 650.00
Operating income (EBIT) $1,850.00
Interest charges 160.00
Taxable income (EBT) $1,690.00
Taxes 591.50
Net income $1,098.50

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FCF = EBIT(1 − T) + Deprec. − Capex − ΔNOWC

FCF = $1,202.50 + $650 − $1,250 − -$300 = $302.50
Difference between net income and FCF = $796.00
POINTS: 1
TOPICS: Net income vs. FCF
114. For 2014, Bargain Basement Stores reported $11,500 of sales and $5,000 of operating costs (including depreciation).
The company has $20,500 of total invested capital, the weighted average cost of that capital (the WACC) was 10%, and
the federal-plus-state income tax rate was 40%. What was the firm's Economic Value Added (EVA), i.e., how much value
did management add to stockholders' wealth during 2014?
a. $1,670
b. $1,758
c. $1,850
d. $1,943
e. $2,040
ANSWER: c
RATIONALE: WACC 10.00%
Total invested capital $20,500
Sales $11,500
Operating costs including depreciation $5,000
Tax rate 40%
EBIT = Sales − Operating costs

EBIT = $6,500

EVA = $3,900 − $2,050
EVA = $1,850
POINTS: 1
TOPICS: EVA
115. Allen Corporation can (1) build a new plant that should generate a before-tax return of 11%, or (2) invest the same
funds in the preferred stock of Florida Power & Light (FPL), which should provide Allen with a before-tax return of 9%,
all in the form of dividends. Assume that Allen's marginal tax rate is 25%, and that 70% of dividends received are
excluded from taxable income. If the plant project is divisible into small increments, and if the two investments are

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equally risky, what combination of these two possibilities will maximize Allen's effective return on the money invested?
a. All in the plant project.
b. All in FPL preferred stock.
c. 60% in the project; 40% in FPL.
d. 60% in FPL; 40% in the project.
e. 50% in each.
ANSWER: b
RATIONALE: BT project return 11.00%
BT preferred return 9.00%
Tax rate 25.00%
Dividend exclusion % 70.00%
After-tax return on project = BT project return × (1 − T)

After-tax return on project = 8.25% After-tax return on pref. = BT pref. return[1 − (1 − Div.
exclusion %)(T)]
After-tax return on pref. = 8.33%
POINTS: 1
TOPICS: After-tax returns–nonalgorithmic
116. 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%
ANSWER: b
RATIONALE: BT bond yield 11.00%
BT municipal bond yield 8.00%
BT preferred yield 9.00%
Tax rate 40.00%
Since municipal bonds are exempt from federal taxes, its BT return = AT return
AT municipal bond yield = 8.00%
AT bond yield = BT bond yield × (1 − T)

AT bond yield = 6.60%
AT preferred yield = BT pref. return[1 − (1 − Div. exclusion %)(T)]

AT preferred yield = 7.92%

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Highest AT yield = 8.00%

POINTS: 1
117. A corporation can earn 7.5% if it invests in municipal bonds. The corporation can also earn 8.5% (before-tax) by
investing in preferred stock. Assume that the two investments have equal risk. What is the break-even corporate tax rate
that makes the corporation indifferent between the two investments?
a. 35.39%
b. 37.25%
c. 39.22%
d. 41.18%
e. 43.24%
ANSWER: c
RATIONALE: BT Preferred stock yield 8.50%
Municipal yield 7.50%
Municipal yield = After-tax preferred yield

7.50% = BT pref. return × [1 − (1 − Div. exclusion %)(T)]
7.50% = 8.50% × [1 − 30.00% × (T)]
88.24% = [1 − 30.00% × (T)]
T = 39.22%
POINTS: 1
KEYWORDS: Bloom's: Analysis
118. Mantle Corporation is considering two equally risky investments:
∙ A $5,000 investment in preferred stock that yields 7%.

∙ A $5,000 investment in a corporate bond that yields 10%.
What is the break-even corporate tax rate that makes the company indifferent between the two investments?
a. 34.27%
b. 36.08%

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c. 37.97%
d. 39.87%
e. 41.87%
ANSWER: c
RATIONALE: BT Preferred stock yield 7.00%
BT bond yield 10.00%
AT bond yield = After-tax preferred yield
BT bond yield × (1 − T) = BT pref. return × [1 − (1 − Div. exclusion %)(T)]

10.00% × (1 − T) = 7.00% × [1 − 30.00% × (T)]
3.00% = 7.900%(T)
T = 37.97%
POINTS: 1
119. West Corporation has $50,000 that it plans to invest in marketable securities. The corporation is choosing between
the following three equally risky securities: Alachua County tax-free municipal bonds yielding 8.5%; Exxon Mobil bonds
yielding 10.5%; and GM preferred stock with a dividend yield of 9.25%. West's corporate tax rate is 35%. What is the
after-tax return on the best investment alternative? (Assume the company chooses on the basis of after-tax returns.)
a. 8.500%
b. 8.925%
c. 9.371%
d. 9.840%
e. 10.332%
ANSWER: a
RATIONALE: BT municipal bond yield 8.50%
Tax rate 35.00%

AT preferred yield = BT pref. return[1 − (1 − Div exclusion%)(T)]


POINTS: 1

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120. Arvo Corporation is trying to choose between three alternative investments. The three securities that the company is
considering are as follows:
∙ Tax-free municipal bonds with a return of 8.8%.

∙ Wooli Corporation bonds with a return of 11.75%.
∙ CFI Corp. preferred stock with a return of 9.8%.
The company's tax rate is 25%. What is the after-tax return on the best investment alternative?
a. 7.383%
b. 7.772%
c. 8.181%
d. 8.612%
e. 9.065%
ANSWER: e
RATIONALE: BT municipal bond yield 8.80%
Tax rate 25.00%

AT preferred yield = BT pref. return[1 − (1 − Div. exclusion %)(T)]


POINTS: 1
121. Collins Co. began operations in 2011. The company lost money the first two years, but has been profitable ever

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since. The company's taxable income (EBT) for its first four years is summarized below:
Year EBT
2011 −$3,000,000
2012 −$5,200,000
2013 $4,200,000
2014 $8,300,000
The corporate tax rate has remained at 34%. Assume that the company has taken full advantage of the Tax Code's carry-
back, carry-forward provisions, and assume that the current provisions were applicable in 2011. What is Collins' tax
liability for 2014?
a. $1,069,848
b. $1,188,720
c. $1,320,800
d. $1,462,000
e. $1,617,200
ANSWER: d
EBT After Unused
Taxable Carry-Forward Forward Carryable
2011 −$3,000,000 $0 $0 $3,000,000
2012 −$5,200,000 $0 $0 $8,200,000
2013 $4,200,000 $4,200,000 $0 $4,000,000
2014 $8,300,000 $4,000,000 $4,300,000 $0

2014 Tax liability = $1,462,000
POINTS: 1
122. Salinger Software was founded in 2011. The company lost money each of its first three years, but was able to turn a
profit in 2014. Salinger's operating income (EBIT) for its first four years of operations is reported below.
Year EBIT
2011 −$ 50,000,000
2012 −$150,000,000
2013 −$100,000,000
2014 $700,000,000
The company has no debt, so operating income equals earnings before taxes. The corporate tax rate has remained constant
at 35%. Assume that the company took full advantage of the carry-back, carry-forward provisions in the Tax Code, and
assume that the current provisions were applicable in 2011. How much tax did the company pay in 2014?
a. $114,030,875
b. $120,032,500
c. $126,350,000

lOMoARcPSD|14337717
d. $133,000,000
e. $140,000,000
ANSWER: e
EBT After Unused
Year Taxable Income Used Applied Amount
2011 −$ 50,000,000 $0 $0 $ 50,000,000
2012 −$150,000,000 $0 $0 $200,000,000
2013 −$100,000,000 $0 $0 $300,000,000
2014 $700,000,000 $300,000,000 $400,000,000 $0

2014 Tax liability = $140,000,000
POINTS: 1
123. Bradshaw Beverages began operations in 2010. The table below contains the company's taxable income during each
year of its operations. Notice that the company lost money in each of its first three years. The corporate tax rate has been
40% each year.
Year Taxable Income

2010 −$ 700,000
2011 −$ 500,000
2012 −$ 200,000
2013 $ 800,000
2014 $1,000,000
Assume that the company has taken full advantage of the Tax Code's carry-back, carry-forward provisions, and assume
that the current provisions were applicable in 2010. How much did the company pay in taxes during 2014?
a. $160,000
b. $168,000
c. $176,400
d. $185,220
e. $194,481
ANSWER: a
EBT After Unused
2010 −$ 700,000 $0 $0 $ 700,000
2011 −$ 500,000 $0 $0 $1,200,000
2012 −$ 200,000 $0 $0 $1,400,000
2013 $ 800,000 $800,000 $0 $ 600,000
2014 $1,000,000 $600,000 $400,000 $0

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POINTS: 1
124. Uniontown Books began operating in 2010. The company lost money its first three years of operations, but has had
an operating profit during the past two years. The company's operating income (EBIT) for its first five years was as
follows:
Year EBIT
2010 −$3,600,000
2011 −$2,000,000
2012 −$1,000,000
2013 $1,200,000
2014 $7,000,000
The company has no debt, and therefore, pays no interest expense. Its corporate tax rate has remained at 34% during this
5-year period. What was Uniontown's tax liability for 2014? (Assume that the company has taken full advantage of the
carry-back and carry-forward provisions, and assume that the current provisions were applicable in 2010.)
a. $466,412
b. $490,960
c. $516,800
d. $544,000
e. $571,200
ANSWER: d
EBT After Unused
2010 −$3,600,000 $0 $0 $3,600,000
2011 −$2,000,000 $0 $0 $5,600,000
2012 −$1,000,000 $0 $0 $6,600,000
2013 $1,200,000 $1,200,000 $0 $5,400,000
2014 $7,000,000 $5,400,000 $1,600,000 $0

POINTS: 1

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125. Mays Industries was established in 2009. Since its inception, the company has generated the following levels of
taxable income (EBT):
Year Taxable Income

2009 $ 50,000
2010 $ 40,000
2011 $ 30,000
2012 $ 20,000
2013 −$100,000
2014 $ 60,000
Assume that each year the company has faced a 40% income tax rate. Also, assume that the company has taken full
advantage of the Tax Code's carry-back, carry-forward provisions, and assume that the current provisions were applicable
in 2008. What is the company's tax liability for 2014?
a. $4,000
b. $4,200
c. $4,410
d. $4,631
e. $4,862
ANSWER: a
EBT After Unused
2009 $ 50,000 $0 $50,000 $0
2010 $ 40,000 $0 $40,000 $0
2011 $ 30,000 $0 $30,000 $0
2012 $ 20,000 $0 $20,000 $0
2013 −$100,000 $0 $0 $100,000
2014 $ 60,000 $100,000 $10,000 $0

POINTS: 1
126. Moose Industries faces the following tax schedule:
Tax on Base Percentage on

Taxable Income of Bracket Excess above Base

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Up to $50,000 $0 15%
$50,000−$75,000 7,500 25
$75,000−$100,000 13,750 34
$100,000−$335,000 22,250 39
$335,000−$10,000,000 113,900 34
$10,000,000−$15,000,000 3,400,000 35
$15,000,000−$18,333,333 5,150,000 38
Over $18,333,333 6,416,667 35
Last year the company realized $10,000,000 in operating income (EBIT). Its annual interest expense is $1,500,000. What
was the company's net income for the year?
a. $4,809,874
b. $5,063,025
c. $5,329,500
d. $5,610,000
e. $5,890,500
ANSWER: d
RATIONALE: Operating income $10,000,000
Interest expense $1,500,000
Taxable income = Operating income − Interest expense

Taxable income = $10,000,000 − $1,500,000
Taxable income = $8,500,000
Taxable Tax on Base % on

Income of Bracket Excess above Base
$0 $0 15%
$50,000 7,500 25%
$75,000 13,750 34%
$100,000 22,250 39%
$335,000 113,900 34%
$10,000,000 3,400,000 35%
$15,000,000 5,150,000 38%
$18,333,333 6,416,667 35%
Tax on base = $113,900

Tax on excess base = $2,776,100
Tax liability = $2,890,000
Net income = Taxable income − Taxes
Net income = $5,610,000
POINTS: 1
TOPICS: Net income
127. Corporations face the following tax schedule:


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Up to $50,000 $0 15%
$50,000−$75,000 7,500 25
$75,000−$100,000 13,750 34
$100,000−$335,000 22,250 39
$335,000−$10,000,000 113,900 34
$10,000,000−$15,000,000 3,400,000 35
$15,000,000−$18,333,333 5,150,000 38
Over $18,333,333 6,416,667 35
Company Z has $80,000 of taxable income from its operations, $5,000 of interest income, and $30,000 of dividend
income from preferred stock it holds in other corporations. What is Company Z's tax liability?
a. $17,328
b. $18,240
c. $19,200
d. $20,210
e. $21,221
ANSWER: d
RATIONALE: Taxable income $80,000
Interest income $ 5,000
Dividend income $30,000
Total taxable income = Taxable income + Interest income + Taxable dividend income
Total taxable income = Taxable income + Interest income + Dividend income (1 − Dividend
exclusion %)
Total taxable income = $94,000

$0 $0 15%
$50,000 7,500 25%
$75,000 13,750 34%
$100,000 22,250 39%
$335,000 113,900 34%
$10,000,000 3,400,000 35%
$15,000,000 5,150,000 38%
$18,333,333 6,416,667 35%

Tax on excess base = $6,460
Tax liability = $20,210
POINTS: 1
128. Lintner Beverage Corp. reported the following information from their financial statements:
Operating income (EBIT) = $20,000,000


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Interest payments on long-term debt = $1,750,000

Dividend income = $1,000,000
Calculate Lintner's total tax liability using the corporate tax schedule below:

$0−$50,000 $0 15%
$50,000−$75,000 7,500 25
$75,000−$100,000 13,750 34
$100,000−$335,000 22,250 39
$335,000−$10,000,000 113,900 34
$10,000,000−$15,000,000 3,400,000 35
$15,000,000−$18,333,333 5,150,000 38
Over $18,333,333 6,416,667 35
a. $6,167,875
b. $6,492,500
c. $6,817,125
d. $7,157,982
e. $7,515,881
ANSWER: b
RATIONALE: Operating income $20,000,000
Interest payments $ 1,750,000
Dividend income $ 1,000,000
Taxable income = Operating income − Interest payments + Taxable dividend income

Taxable income = Operating income − Interest payments + Dividend income × (1 − Dividend
exclusion %)
Taxable income = $18,550,000

$0 $0 15%
$50,000 7,500 25%
$75,000 13,750 34%
$100,000 22,250 39%
$335,000 113,900 34%
$10,000,000 3,400,000 35%
$15,000,000 5,150,000 38%
$18,333,333 6,416,667 35%
Tax on base = $6,416,667

Tax liability = $6,492,500
POINTS: 1

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129. Last year, Martyn Company had $500,000 in taxable income from its operations, $50,000 in interest income, and
$100,000 in dividend income. Using the corporate tax rate table given below, what was the company's tax liability for the
year?

$0−$50,000 $0 15%
$50,000−$75,000 7,500 25
$75,000−$100,000 13,750 34
$100,000−$335,000 22,250 39
$335,000−$10,000,000 113,900 34
$10,000,000−$15,000,000 3,400,000 35
$15,000,000−$18,333,333 5,150,000 38
Over $18,333,333 6,416,667 35
a. $177,973
b. $187,340
c. $197,200
d. $207,060
e. $217,413
ANSWER: c
Dividend income $100,000
Taxable income = Operating income + Interest income + Taxable dividend income

Taxable income = Operating income + Interest income + Dividend income × (1 − Dividend
exclusion %)
Taxable income = $580,000

$0 $0 15%
$50,000 7,500 25%
$75,000 13,750 34%
$100,000 22,250 39%
$335,000 113,900 34%
$10,000,000 3,400,000 35%
$15,000,000 5,150,000 38%
$18,333,333 6,416,667 35%

POINTS: 1

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130. Griffey Communications recently realized $125,000 in operating income. The company had interest income of
$25,000 and realized $70,000 in dividend income. The company's interest expense was $40,000.

Up to $50,000 $0 15%
$50,000−$75,000 7,500 25
$75,000−$100,000 13,750 34
$100,000−$335,000 22,250 39
$335,000−$10,000,000 113,900 34
$10,000,000−$15,000,000 3,400,000 35
$15,000,000−$18,333,333 5,150,000 38
Over $18,333,333 6,416,667 35
Using the corporate tax schedule above, what is Griffey's tax liability?
a. $29,442
b. $30,992
c. $32,623
d. $34,340
e. $36,057
ANSWER: d
Interest expense $ 40,000
Dividend income $ 70,000
Taxable income = Operating income − Interest expense + Interest income + Taxable dividend
income
Taxable income = Operating income − Interest expense + Interest income + Div. income (1 −
Div. exclusion %)
Total taxable income = $131,000

$0 $0 15%
$50,000 7,500 25%
$75,000 13,750 34%
$100,000 22,250 39%
$335,000 113,900 34%
$10,000,000 3,400,000 35%
$15,000,000 5,150,000 38%
$18,333,333 6,416,667 35%

POINTS: 1

lOMoARcPSD|14337717

Test Bank For Financial Management Theory Practice 14th Edition by Eugene F Brigham Michael C Ehrhardt Sample

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Test Bank for Financial Management Theory Practice 14th

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CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES

Multiple Choice: True/False

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Cash $ 50,000 Accounts payable $ 100,000

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KEYWORDS: Bloom's: Comprehension

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operating working capital.

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Multiple Choice: Conceptual

37. Which of the following statements is CORRECT?

38. Which of the following statements is CORRECT?

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LEARNING OBJECTIVES: FOFM.BRIG.16.03.01 - Financial Statements and Reports

39. Which of the following statements is CORRECT?

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OTHER: Multiple Choice: Conceptual

43. Which of the following statements is CORRECT?

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Assets: 2014 2013

Liabilities and equity:

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TOPICS: Balance sheet

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OTHER: Multiple Choice: Conceptual

47. Which of the following statements is CORRECT?

48. Which of the following statements is CORRECT?

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c. The company paid a large dividend.

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LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows

52. Which of the following statements is CORRECT?

53. Which of the following statements is CORRECT?

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United States - OH - DISC.FOFM.BRIG.16.06 - Finance function

54. Which of the following statements is CORRECT?

c. Free cash flow (FCF) is defined as follows:

d. Free cash flow (FCF) is defined as follows:

55. Which of the following statements is CORRECT?

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56. Which of the following statements is CORRECT?

57. Which of the following statements is most correct?

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58. A loss incurred by a corporation

59. Which of the following statements is CORRECT?

60. Which of the following statements is CORRECT?

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