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CHAPTER 3 Financial Statements, Cash Flows, and Taxes (Difficulty: E = Easy, M = Medium, and T = Tough) True-False Easy: Annual report Answer: a Diff: E 1 . The annual report contains four basic financial statements: the income statement; balance sheet; statement of cash flows; and statement of retained earnings. a. True b. False Annual report and expectations Answer: a Diff: E 2 . The key importance of annual report information is that it is used by investors when they form their expectations about the firm's future earnings and dividends and the riskiness of those cash flows. a. True b. False Financial statements Answer: b Diff: E 3 . The balance sheet is a financial statement measuring the flow of funds into and out of various accounts over time while the income statement measures the progress of the firm at a point in time. a. True b. False Balance sheet Answer: b Diff: E 4 . On the balance sheet, total assets must always equal total liabilities. The amount remaining is what is used to finance the firm and includes equity and long-term debt. a. True b. False Income statement Answer: a Diff: E 5 . The income statement measures the flow of funds into (i.e., revenue) and out of (i.e., expenses) the firm over a certain time period. It is always based on accounting data. a. True b. False Chapter 3 Page 1
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Non-cash assets Answer: a Diff: E 6 . Non-cash assets are expected to produce cash over time but the amount of cash they eventually produce could be higher or lower than the values at which the assets are carried on the books. a. True b. False Interest income Answer: b Diff: E 7 . The fact that a percentage of the interest income received by a corporation is excluded from taxable income has encouraged firms to use more debt financing relative to equity financing. a. True b. False Interest expense Answer: b Diff: E 8 . If the tax laws stated that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, it would probably encourage companies to use more debt financing than they presently do, other things held constant. a. True b. False Interest expense and dividends Answer: b Diff: E 9 . Interest and dividends paid by a corporation are considered to be deductible operating expenses, hence they decrease the firm's tax liability. a. True b. False Net operating working capital Answer: a Diff: E 10 . Net operating working capital is equal to the operating current assets minus the operating current liabilities. a. True b. False Total net operating capital Answer: b Diff: E 11 . Total net operating capital is equal to net fixed assets. a. True b. False Chapter 3 - Page 2
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Net operating profit after taxes (NOPAT) Answer: a Diff: E 12 . Net operating profit after taxes (NOPAT) is the amount of profit a company would have from its operations if it had no interest income or interest expense. a. True
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