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web.groovymark@gmail.com
- December 23, 2024
Question 01
A company reports the following: 1) decreasing profits, 2) declining operations cash flows, 3) low investment cash flows, and 4) negative financing cash flows. Which stage of the product life cycle is this company in?
a) Introduction
b) Growth
c) Maturity
d) Decline
Answer: d) Decline
Explanation: These factors are indicative of a company in the decline stage, where cash flows and profits are typically decreasing.
Question 02
Which transaction will increase the current ratio when it is already above 1.0?
a) Accruing wages earned but not yet paid
b) Prepaying the next six month’s rent
c) Using cash to pay down accounts payable
d) Purchasing inventory on account
Answer: c) Using cash to pay down accounts payable
Explanation: Paying down accounts payable reduces current liabilities, increasing the current ratio when it is already above 1.0.
Question 03
Which statement represents the effect of dilutive securities on basic earnings per share (EPS) calculations when computing diluted earnings per share?
a) Convertible debt is assumed to be dilutive on EPS as of the maturity date of the debt
b) When the strike price on a stock option is above market value, no dilutive effect occurs on EPS
c) The existence of dilutive securities will result in dilutive EPS being higher than basic EPS
d) When no dividends are declared, there is no dilutive effect on EPS from convertible preferred stock
Answer: b) When the strike price on a stock option is above market value, no dilutive effect occurs on EPS
Explanation: Dilution does not occur when the strike price of an option exceeds the market value, as the options are unlikely to be exercised.
Question 04
Which change, with other factors remaining equal, would result in an increase in the return on assets (ROA)?
a) An increase in property, plant, and equipment
b) An increase in non-controlling interest in earnings
c) An increase in advertising expense
d) An increase in the tax rate
Answer: b) An increase in non-controlling interest in earnings
Explanation: Increasing non-controlling interest in earnings would boost the overall profit, raising ROA, as it enhances profitability without affecting asset levels.
Question 05
Which is a correct statement regarding profitability measures?
a) If ROA (return on assets) is positive, then (RI) residual income will also be positive
b) ROCE (return on common equity) will exceed ROA (return on assets) whenever ROA exceeds the cost of capital provided by creditors and preferred shareholders
c) ROCE (return on common equity) eliminates the effect of financing costs by adding back the after-tax interest to net income
d) ROA (return on assets) and RI (residual income) will lead to the same performance ranking order for subunits of an organization
Answer: b) ROCE (return on common equity) will exceed ROA (return on assets) whenever ROA exceeds the cost of capital provided by creditors and preferred shareholders
Explanation: ROCE will be higher than ROA if the return on assets exceeds the cost of capital provided by creditors and preferred shareholders, making the firm profitable for equity holders.
Question 06
Which type of risk is classified as a firm-specific risk?
a) Labor wages and supply of labor
b) Dependence on one or a few suppliers
c) Shifts in consumer preference
d) Availability and price of raw materials
Answer: b) Dependence on one or a few suppliers
Explanation: Dependence on one or a few suppliers is specific to the company and is within its control. It can adjust supplier relationships to manage this risk.
Question 07
Which link does the extent to which market prices fully reflect the implications of accounting information depend on?
a) Firm accountants maintaining their independence of management manipulation
b) Accountants reporting accounting information as quickly as possible
c) Investors mapping accounting fundamentals into expectations of future earnings
d) Auditors’ thoroughness in examining the financial statements
Answer: c) Investors mapping accounting fundamentals into expectations of future earnings
Explanation: The degree to which market prices reflect accounting information depends largely on how investors use that information to form expectations about future earnings.
Question 08
Which statement regarding the economic attributes of a company is correct?
a) A product that is promoted to other businesses places a high value on advertising
b) When there is a high level of technological obsolescence a firm can carry high levels of debt financing
c) A company that is growing rapidly has a large need for outside capital financing from issuing stocks and bonds
d) When demand moves with economic cycles, production can be steady in the long term
Answer: c) A company that is growing rapidly has a large need for outside capital financing from issuing stocks and bonds
Explanation: Growing companies require significant external capital to support their expansion, which often comes from issuing stock or bonds.
Question 09
Which business activity is a firm most likely to see cash inflows when it is in the introductory stage of its life cycle?
a) Investing activities
b) Financing activities
c) Accrual activities
d) Operating activities
Answer: b) Financing activities
Explanation: In the introduction stage, cash inflows are primarily from financing activities as the firm raises capital to fund its initial operations.
Question 10
Which of the interrelated sequential steps in financial statement analysis should an investigator begin with?
a) Obtain all of the information available from a firm’s financial statements and assess the quality of that information
b) Examine the firm’s industry to identify economic features and competitive aspects
c) Use information from the financial statement to analyze the firm’s profitability, growth, and risk
d) Prepare forecasted financial statements and use them to determine the enterprise value of the firm
Answer: b) Examine the firm's industry to identify economic features and competitive aspects
Explanation: The first step in analyzing financial statements is to understand the broader industry and competitive environment in which the firm operates.
Question 11
Which category requires no adjustment between net income and cash flows from operations?
a) Purchase of equipment with a note payable
b) Stock-based compensation
c) Deferred tax expense
d) Equity method income
Answer: a) Purchase of equipment with a note payable
Explanation: Equipment purchased with a note payable affects neither cash flow nor net income directly, hence no adjustment is needed between net income and cash flows from operations.
Question 12
What is the impact of repurchasing shares on a company’s equity?
a) It increases equity
b) It decreases equity
c) It has no effect on equity
d) It increases liabilities
Answer: b) It decreases equity
Explanation: Share repurchases reduce the number of shares outstanding and decrease equity since the company is using its assets to buy back its own stock.
Question 13
How does a company treat depreciation when calculating free cash flows to the company?
a) It adds depreciation expense to earnings before interest and taxes on the income statement
b) It subtracts accumulated depreciation from the fixed assets section of the balance sheet since it is not a cash flow
c) It ignores depreciation expense on the income statement since it is not a cash flow
d) It adds accumulated depreciation to the asset section of the balance sheet to negate its effect
Answer: a) It adds depreciation expense to earnings before interest and taxes on the income statement
Explanation: Depreciation is a non-cash expense and is added back to net income when calculating free cash flow since it does not involve actual cash outflows.
Question 14
Which of the following is an example of an income-increasing accrual?
a) Recording the completion of work for which a firm has previously been paid
b) Increasing the value of a stock investment whose market price has risen
c) Reducing the use of supplies that a firm has previously paid for
d) Recording a warranty obligation
Answer: a) Recording the completion of work for which a firm has previously been paid
Explanation: Recognizing revenue for work that has been completed increases income through an accrual adjustment without cash necessarily being received at the time.
Question 15
Which accounting treatment would justify the presumption that MB and VB are equal?
a) Trading securities are recorded at fair value
b) Fixed assets are recorded at historical costs
c) Research and development costs are expensed on the income statement
d) Inventory is recorded at lower-of-cost-or-net-realizable-value
Answer: a) Trading securities are recorded at fair value
Explanation: Fair value accounting ensures that assets and liabilities are recorded at their market value, making the market-to-book and value-to-book ratios more aligned.
Question 16
A firm has current earnings of $235. The earnings are expected to grow (g) by 4% annually. The cost of equity capital (R(E)) is 13%. What is the value of the firm (rounded to the nearest dollar)?
a) $2,716
b) $2,824
c) $1,880
d) $2,611
Answer: a) $2,716
Explanation: The formula for valuing the firm is: Value = Current Earnings / (Cost of Equity - Growth Rate). Plugging in the values: $235 / (0.13 - 0.04) = $2,716.
Question 17
Which is a correct statement regarding leverage?
a) A firm with a higher financial leverage is riskier than a firm with a higher operating leverage
b) A firm with a higher operating leverage has proportionally more fixed costs than a firm with a lower operating leverage
c) Operating leverage is a multiplier on ROA (return on assets) to get a firm’s ROCE (return on common equity)
d) Financial leverage measures a firm’s pre-tax profit reaction to a change in sales revenue
Answer: b) A firm with a higher operating leverage has proportionally more fixed costs than a firm with a lower operating leverage
Explanation: Operating leverage refers to the proportion of fixed costs in a company's cost structure. A firm with higher operating leverage has a larger proportion of fixed costs.
Question 18
Which statement reflects a correct insight that comes from disaggregating return on common equity (ROCE) into various components?
a) ROCE will increase when there is more risk in the capital structure of the firm
b) Increasing average total assets, keeping all other factors equal, will increase the ROCE
c) Strong asset turnover and capital structure leverage can overcome a net loss, allowing ROCE to remain positive
d) Increasing sales revenues, keeping all other factors equal, will increase the ROCE
Answer: a) ROCE will increase when there is more risk in the capital structure of the firm
Explanation: ROCE increases as financial leverage increases, meaning the firm uses more debt to finance its assets, which amplifies returns to common equity holders when net income is positive.
Question 19
Which step in the financial forecasting process is last?
a) Projecting the statement of cash flows
b) Projecting the balance sheet
c) Projecting operating assets and liabilities
d) Projecting non-recurring gains and losses
Answer: a) Projecting the statement of cash flows
Explanation: Cash flow projections are derived from other forecasts, such as the income statement and balance sheet, and represent the final step in financial forecasting.
Question 20
How does the inclusion of working capital adjustments and other non-cash components of income adjustments in the statement of cash flows affect financial performance?
a) It reflects timing differences between income recognition and cash flow realization
b) It distorts financial performance by overstating cash flow
c) It has no impact on financial performance
d) It ensures all cash and non-cash activities are perfectly aligned
Answer: a) It reflects timing differences between income recognition and cash flow realization
Explanation: Non-cash adjustments and working capital changes affect cash flow timing but not the actual income reported, leading to temporary discrepancies between cash flow and income.
