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web.groovymark@gmail.com
- December 23, 2024
Question 21
What is the primary benefit of using market-based multiples to value a company?
a) Net income will be overstated
b) Shareholders’ equity will be understated
c) Assets will be understated
d) Debt/equity ratio will be overstated
Answer: a) Net income will be overstated
Explanation: Failure to record a contingent liability means that the associated expense is not recognized, leading to an overstatement of net income.
Question 22
A firm has sold some of its machinery and has taken a loss on the sale. How does the recognition of the loss in the investing section of the statement of cash flows govern financial efficiency?
a) The firm must report the sale when the sale of the asset differs from that of book values
b) The firm’s statement of cash flows is unaffected
c) The loss is added to financing activities as the cost of machinery
d) The loss is reported as part of the equity portion of the balance sheet
Answer: a) The firm must report the sale when the sale of the asset differs from that of book values
Explanation: When the sale of a long-lived asset results in a loss, it is recorded in the investing section and reflects any difference from the book value of the asset.
Question 23
What will happen to a company’s return on equity (ROE) if the company issues new shares of stock?
a) ROE will increase
b) ROE will decrease
c) ROE will remain unchanged
d) ROE will become zero
Answer: b) ROE will decrease
Explanation: Issuing new shares increases equity, which in turn lowers the return on equity if net income remains unchanged, as ROE is calculated as net income divided by equity.
Question 24
A company maintains $1,500,000 worth of inventory. A sudden increase in the demand for its product leads to higher prices, and the company earns a significant profit from this inventory. Which financial statement will reflect this gain?
a) Balance sheet
b) Income statement
c) Statement of retained earnings
d) Cash flow statement
Answer: b) Income statement
Explanation: The gain from increased demand and higher prices will be reflected in the income statement, which tracks revenue and profits.
Question 25
What will happen to a company’s return on equity (ROE) if the company issues new shares of stock?
a) ROE will increase
b) ROE will decrease
c) ROE will remain unchanged
d) ROE will become zero
Answer: b) ROE will decrease
Explanation: Issuing new shares increases equity, which in turn lowers the return on equity if net income remains unchanged, as ROE is calculated as net income divided by equity.
Question 26
How does a decrease in accounts receivable affect cash flow from operations?
a) It decreases cash flow
b) It increases cash flow
c) It has no effect on cash flow
d) It increases liabilities
Answer: b) It increases cash flow
Explanation: When accounts receivable decrease, it means the company has collected cash from customers, increasing cash flow from operations.
Question 27
A company’s stock price was recorded at $35 at the end of the trading day to use for the previous quarter’s book value per share. After two months, the stock price rose to $48 per share on news of a potential acquisition. How will an analyst interpret this rise in market value relative to intrinsic value?
a) The stock is overvalued
b) The stock is undervalued
c) The stock is accurately valued based on intrinsic measures
d) The stock is inaccurately reflective of intrinsic value until the acquisition is complete
Answer: d) The stock is inaccurately reflective of intrinsic value until the acquisition is complete
Explanation: The market value reflects investor speculation, but until the acquisition is finalized, the stock's intrinsic value may not align with the market price.
Question 28
Which type of earnings management involves making non-cash adjustments to financial statements within the bounds of GAAP to influence reported earnings?
a) Accrual-based earnings management
b) Real earnings management
c) Earnings manipulation
d) Creative accounting
Answer: a) Accrual-based earnings management
Explanation: Accrual-based earnings management involves adjusting accruals such as revenue recognition and expense deferrals within the bounds of GAAP to influence reported earnings without affecting actual cash flow.
Question 29
How is earnings before interest, taxes, depreciation, and amortization (EBITDA) similar to cash flow from operations?
a) They both exclude depreciation expenses
b) They both exclude interest payments
c) They both include cash paid for unsold inventory
d) Cash paid for wages is equal to wages expense
Answer: a) They both exclude depreciation expenses
Explanation: Both EBITDA and cash flow from operations exclude depreciation, a non-cash expense, though they differ in the treatment of interest and taxes.
Question 30
How does a company reduce its cost of capital?
a) By increasing its equity
b) By reducing its debt
c) By optimizing its debt-to-equity mix and reducing risk
d) By increasing its dividend payouts
Answer: c) By optimizing its debt-to-equity mix and reducing risk
Explanation: An optimal debt-to-equity mix, with minimal risk, can lower the company's cost of capital by reducing interest payments and required returns by equity holders.
Question 31
What effect does capitalizing an expense have on a company’s financial statements?
a) It increases current liabilities
b) It spreads the cost over time, reducing immediate expenses and increasing assets
c) It increases operating cash flows
d) It immediately reduces the company’s retained earnings
Answer: b) It spreads the cost over time, reducing immediate expenses and increasing assets
Explanation: Capitalizing an expense turns it into a long-term asset, spreading the cost over its useful life, which reduces immediate expense recognition.
Question 32
A company uses $50,000 from its retained earnings to repurchase stock. What impact does this transaction have on the company’s balance sheet?
a) It reduces shareholders’ equity
b) It increases shareholders’ equity
c) It decreases liabilities
d) It has no impact on the balance sheet
Answer: a) It reduces shareholders' equity
Explanation: Stock repurchases reduce the number of shares outstanding, thereby decreasing shareholders' equity.
Question 33
A law firm applies for a loan to expand business operations. Before the loan is approved, the lender conducts a detailed analysis of the firm’s liquidity and solvency. Why are the liquidity and solvency of the firm important for the lender to assess?
a) To determine if the firm has enough collateral
b) To determine the firm’s ability to pay off long-term and short-term debt
c) To evaluate the firm’s long-term profitability
d) To ensure the firm has a positive cash flow
Answer: b) To determine the firm's ability to pay off long-term and short-term debt
Explanation: Liquidity and solvency are crucial measures of a firm's ability to meet its debt obligations, which are essential for the lender's risk assessment.
Question 34
A company increases its operating leverage. How does this affect its return on assets (ROA)?
a) ROA will increase
b) ROA will decrease
c) ROA will remain unchanged
d) ROA will become zero
Answer: b) ROA will decrease
Explanation: Higher operating leverage means higher fixed costs relative to sales, which can lead to lower returns on assets if sales do not significantly increase to cover those costs.
Question 35
A company’s cost of equity capital is 12%. The company’s existing assets and operations generate a 12% return on common equity. The company is considering raising additional equity capital to invest in a new product that will generate a return of 9%. How does this investment affect the company’s residual income?
a) Residual income will increase
b) Residual income will decrease
c) Residual income will remain unchanged
d) Residual income will become negative
Answer: b) Residual income will decrease
Explanation: Residual income is the amount of income earned above the required return on equity. If the return on the new project is lower than the cost of equity, residual income will decrease.
Question 36
How does increasing leverage affect a company’s return on equity (ROE)?
a) It decreases ROE if the return on assets exceeds the cost of debt
b) It increases ROE if the return on assets exceeds the cost of debt
c) It has no effect on ROE
d) It decreases ROE if the company issues more equity
Answer: b) It increases ROE if the return on assets exceeds the cost of debt
Explanation: If the return on assets exceeds the cost of debt, leverage amplifies the returns to equity holders, thereby increasing ROE.
Question 37
What financial statement helps determine a company’s liquidity?
a) The balance sheet
b) The income statement
c) The cash flow statement
d) The retained earnings statement
Answer: a) The balance sheet
Explanation: The balance sheet provides information about a company’s current assets and liabilities, which are key indicators of its liquidity position.
Question 38
Which cash flow category reflects the purchase or sale of long-term assets such as property, plant, and equipment?
a) Cash flow from operating activities
b) Cash flow from investing activities
c) Cash flow from financing activities
d) Cash flow from retained earnings
Answer: b) Cash flow from investing activities
Explanation: Cash flows related to the purchase or sale of long-term assets, like property and equipment, are reported under investing activities.
Question 39
What is the impact of rising interest rates on bond prices?
a) Rising interest rates typically increase bond prices
b) Rising interest rates typically decrease bond prices
c) Rising interest rates have no effect on bond prices
d) Rising interest rates increase the return on existing bonds
Answer: b) Rising interest rates typically decrease bond prices
Explanation: As interest rates rise, the prices of existing bonds typically decrease because new bonds are issued at higher yields, making older bonds less attractive.
Question 40
A company experiences a loss on the sale of equipment. Where is this loss recorded on the statement of cash flows?
a) Operating activities
b) Investing activities
c) Financing activities
d) It is not recorded
Answer: b) Investing activities
Explanation: Gains and losses from the sale of long-term assets are reported under investing activities on the statement of cash flows.
