1. Which of the following statements is correct?
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 2013, this would lower their free cash flows for 2013.
2. Which of the following statements is correct?
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.
3. Which of the following statements is correct?
A. Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of “window dressing.” Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of “window dressing.”
B. Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of “window dressing.”
C. Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase fixed assets is an example of “window dressing.”
D. Using some of the firm’s cash to reduce long-term debt is an example of “window dressing.”
E. “Window dressing” is any action that does not improve a firm’s fundamental long-run position and thus increases its intrinsic value.
4. Which of the following statements is correct?
A. The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
B. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.
C. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE.
D. The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because interest is paid with post-tax dollars, so the firm’s ability to pay current interest is affected by taxes.
E. All else equal, increasing the total debt to total capital ratio will increase the ROA.