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1 Which of the following statements is CORRECT? The New York Stock Exchange is an auction market with a physical location. Capital market transactions involve only the purchase and sale of equity securities, i.e., common stocks. If an investor sells shares of stock through a broker, then this would be a primary market transaction. Consumer automobile loans are evidenced by legal documents called “promissory notes,” and these individual notes are traded in the money market. While the distinctions are blurring as investment banks are today buying commercial banks, and vice versa, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. 2 Which of the following statements is CORRECT? It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship. Corporate shareholders are exposed to unlimited liability. Corporations generally face fewer regulations than sole proprietorships. Corporate shareholders are exposed to unlimited liability, and this factor may be compounded by the tax disadvantages of incorporation. Shareholders in a regular corporation (not an S corporation) pay higher taxes than owners of an otherwise identical proprietorship. 3 Which of the following statements is CORRECT? While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. A security whose value is derived from the price of some other “underlying” asset is called a liquid security. Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks. Money markets are markets for common stocks and long-term debt. The NYSE operates as an auction market, whereas the Nasdaq is a dealer market. 4 Which of the following statements is CORRECT? Capital market instruments include both long-term debt and common stocks. An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift. The NYSE does not exist as a physical location; rather, it represents a loose collection of dealers who trade stocks electronically. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors. 5 Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership? Corporations generally find it relatively difficult to raise large amounts of capital. Less of a corporation’s income is generally subjected to taxes than would be true if the firm were a partnership. Corporate shareholders escape liability for the firm’s debts, but this factor may be offset by the tax disadvantages of the corporate form of organization. Corporate investors are exposed to unlimited liability. Corporations generally face relatively few regulations. 6 You recently sold 100 shares of your new company, XYZ Corporation, to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following statements best describes this transaction? This is an example of an exchange of physical assets. This is an example of a primary market transaction. This is an example of a direct transfer of capital. This is an example of a money market transaction. This is an example of a derivatives market transaction 7 Money markets are markets for Foreign stocks. Consumer automobile loans. U.S. stocks. Short-term debt securities. Long-term bonds. 8 Which of the following statements is CORRECT? If Apple issues additional shares of common stock through an investment banker, this would be a secondary market transaction. If you purchased 100 shares of Apple stock from your sister-in-law, this would be an example of a primary market transaction. The IPO market is a subset of the secondary market. Only institutions, and not individuals, can participate in derivatives market transactions. As they are generally defined, money market transactions involve debt securities with maturities of less than one year. 9 DeYoung Devices Inc., a new high-tech instrumentation firm, is building and equipping a new manufacturing facility. 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? The firm’s reported net income would increase. The firm’s operating income (EBIT) would increase. The firm’s taxable income would increase. The firm’s net cash flow would increase. The firm’s tax payments would increase. 10 Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash flow last year, even though the cash on its balance sheet increased? The company repurchased 20% of its common stock. The company sold a new issue of bonds. The company made a large investment in new plant and equipment. The company paid a large dividend. The company had high amortization expenses. 11 Which of the following statements is CORRECT? 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. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets. 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. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital. 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. 12 Which of the following statements is CORRECT? One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital. If a firm reports positive net income, its EVA must also be positive. One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free. One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital. Actions that increase reported net income will always increase net cash flow. 13 The LeMond Corporation just purchased a new production line. 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. LeMond’s tax liability for the year will be lower. LeMond’s taxable income will be lower. LeMond’s net fixed assets as shown on the balance sheet will be higher at the end of the year. LeMond’s cash position will improve (increase). LeMond’s reported net income after taxes for the year will be lower. 14 Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet? The company purchases a new piece of equipment. The company repurchases common stock. The company pays a dividend. The company issues new common stock. The company gives customers more time to pay their bills. 15 Which of the following statements is CORRECT? All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income. 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. All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code. Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm’s income as personal income and pay taxes on that income. 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 income and stockholders were taxed again on the income when it was paid to them as dividends. 16 Which of the following statements is CORRECT? 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. MVA gives us an idea about how much value a firm’s management has added during the last year. MVA stands for market value added, and it is defined as follows: MVA = (Shares outstanding)(Stock price) + Book value of common equity. EVA stands for economic value added, and it is defined as follows: EVA = EBIT(1 – T) – (Investor-supplied op. capital) x (A – T cost of capital). EVA gives us an idea about how much value a firm’s management has added over the firm’s life. 17 Which of the following items cannot be found on a firm’s balance sheet under current liabilities? Accrued payroll taxes. Accounts payable. Short-term notes payable to the bank. Accrued wages. Cost of goods sold. 18 Which of the following statements is CORRECT? If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease. A reduction in inventories held would have no effect on the current ratio. An increase in inventories would have no effect on the current ratio. If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE. 19 Which of the following would, generally, indicate an improvement in a company’s financial position, holding other things constant? The total assets turnover decreases. The TIE declines. The DSO increases. The EBITDA coverage ratio increases. The current and quick ratios both decline. 20 Cordelion Communications is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Cordelion pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue? The times interest earned ratio will decrease. The ROA will decline. Taxable income will decrease. The tax bill will increase. Net income will decrease. 21 Which of the following would indicate an improvement in a company’s financial position, holding other things constant? The current and quick ratios both increase. The inventory and total assets turnover ratios both decline. The debt ratio increases. The profit margin declines. The EBITDA coverage ratio declines. 22 The Cavendish Company recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company’s total assets or operating income. Which of the following effects would occur as a result of this action? The company’s debt ratio increased. The company’s current ratio increased. The company’s times interest earned ratio decreased. The company’s basic earning power ratio increased. The company’s equity multiplier increased. 23 If a bank loan officer were considering a company’s request for a loan, which of the following statements would you consider to be CORRECT? Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm. The lower the company’s EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm. Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm. Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm. The lower the company’s TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm. 24 Arshadi Corp.’s sales last year were $52,000, and its total assets were $22,000. What was its total assets turnover ratio (TATO)? 2.03 2.13 2.25 2.36 2.48 25 Companies A and C each reported the same earnings per share (EPS), but Company A’s stock trades at a higher price. Which of the following statements is CORRECT? Company A trades at a higher P/E ratio. Company A probably has fewer growth opportunities. Company A is probably judged by investors to be riskier. Company A must have a higher market-to-book ratio. Company A must pay a lower dividend.
