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CHAPTER 3 FINANCIAL STATEMENTS, CASH FLOW, AND TAXES True/False Easy: (3.1) Annual report Answer: a EASY . 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 (3.1) Annual report and expectations Answer: a EASY . 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 (3.2) Retained earnings versus cash Answer: b EASY . Consider the balance sheet of Wilkes Industries as shown below. Because Wilkes has $800,000 of retained earnings, the company would be able to pay cash to buy an asset with a cost of $200,000. 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 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 (3.2) Balance sheet Answer: a EASY . On the balance sheet, total assets must always equal total liabilities and equity. a. True b. False (3.2) Balance sheet: non-cash assets Answer: a EASY . 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 values at which these assets are carried on the books. a. True b. False (3.3) Income statement Answer: a EASY . 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 or cash, and reported costs likewise may not correctly reflect 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 (3.7) Net operating working capital Answer: a EASY . Net operating working capital is equal to operating current assets minus operating current liabilities. a. True b. False (3.7) Total net operating capital Answer: b EASY . Total net operating capital is equal to net fixed assets. a. True b. False (3.7) Net operating profit after taxes (NOPAT) Answer: a EASY . Net operating profit after taxes (NOPAT) is the amount of net income a company would generate from its operations if it had no interest income or interest expense. a. True b. False (3.9) Federal income taxes: interest income Answer: b EASY . The fact that 70% of the interest income received by a corporation is excluded from its taxable income encourages firms to use more debt financing than they would in the absence of this tax law provision. a. True b. False (3.9) Federal income taxes: interest expense Answer: b EASY . 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
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