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Evaluating The Financial Performance Literature Questions
100 Multiple choice questions
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) A firm’s capital structure refers to the firm’s: A) combination of cash and cash equivalents. B) combination of accounts appearing on the left side of its balance sheet. C) mixture of various types of production equipment. D) proportions of financing from current and long-term debt and equity. E) investment selections for its excess cash reserves.
2) Short-term finance deals with: A) acquiring and selling fixed assets. B) the timing of cash flows. C) financing long-term projects. D) issuing additional shares of common stock. E) capital budgeting.
3) As seen on an income statement: A) depreciation is shown as an expense but does not affect the tax expense. B) interest is deducted from income and increases the total taxes incurred. C) the tax rate is applied to the earnings before interest and taxes when the firm has
both depreciation and interest expenses. D) interest expense is added to earnings before interest and taxes to compute pretax
income. E) depreciation reduces both the pretax income and the net income.
4) According to the Generally Accepted Accounting Principles, costs are: A) matched with revenues. B) expensed as management desires. C) recorded as incurred. D) matched with production levels. E) recorded when paid.
5) Under generally accepted accounting principles (GAAP), a firm’s assets are reported at: A) liquidation value less accumulated depreciation. B) market value less accumulated depreciation. C) historical cost less accumulated depreciation. D) market value. E) liquidation value.
6) According to generally accepted accounting principles (GAAP), revenue is recognized as income when:
7) Projected future financial statements are called: A) plug statements. B) comparative statements. C) aggregated statements. D) pro forma statements. E) reconciled statements.
8) Which statement expresses all accounts as a percentage of total assets? A) common-size balance sheet B) statement of cash flows C) common-size income statement D) pro forma income statement E) pro forma balance sheet
9) Ratios that measure a firm’s financial leverage are known as ________ ratios. A) profitability B) asset management C) long-term solvency D) market value E) short-term solvency
10) The debt-equity ratio is measured as: A) total debt divided by total equity. B) long-term debt divided by total equity. C) total assets minus total debt, divided by total equity. D) total equity divided by long-term debt. E) total equity divided by total debt.
11) The measure of net income returned from every dollar invested in total assets is the: A) return on equity. B) return on assets. C) asset turnover. D) profit margin. E) earnings before interest and taxes.
12) The market-to-book ratio is measured as the: A) market price per share divided by the net income per share. B) market price per share divided by the dividends per share. C) market value per share divided by the book value per share. D) net income per share divided by the market price per share. E) market price per share divided by the par value per share.
13) An increase in which one of the following accounts increases a firm’s current ratio without affecting its quick ratio?
14) A banker considering loaning money to a firm for ten years would most likely prefer the firm have a debt ratio of _______ and a times interest earned ratio of _______.
15) If a firm produces a return on assets of 15 percent and also a return on equity of 15 percent, then the firm:
16) Turner’s Inc. has a price-earnings ratio of 16. Alfred’s Co. has a price-earnings ratio of 19. Thus, you can state with certainty that one share of stock in Alfred’s:
stock. C) has a higher market price than one share of stock in Turner’s. D) earns a greater profit per share than does one share of Turner’s stock. E) has a higher market price per dollar of earnings than does one share of Turner’s.
17) The most effective method of directly evaluating the financial performance of a firm is to compare the financial ratios of the firm to:
firm. C) the average ratios of all firms within the same country over a period of time. D) the firm’s ratios from prior time periods and to the ratios of firms with similar
operations. E) those of other firms located in the same geographic area that are similarly sized.
18) Enterprise value is based on the: A) book value of debt plus the market value of equity. B) market value of equity plus the book value of total debt minus cash. C) market value of interest bearing debt plus the market value of equity minus cash. D) book values of debt and assets, other than cash. E) book values of debt and equity less cash.
19) The equity multiplier measures: A) management efficiency. B) financial leverage. C) returns to stockholders. D) asset use efficiency. E) operating efficiency.
20) The return on equity can be calculated as: A) Profit margin × ROA × Total asset turnover. B) Profit margin × ROA. C) ROA × Debt-equity ratio. D) ROA × Equity multiplier. E) ROA × (Net income / Total assets).
What is the current ratio for 2015? A) 2.06 B) .95 C) .98 D) 1.98 E) 1.95
22) An annuity stream of cash flow payments is a set of: A) increasing cash flows occurring at set intervals of time that go on forever. B) equal cash flows occurring each time period forever. C) either equal or varying cash flows occurring at set intervals of time for a fixed
period. D) arbitrary cash flows occurring each time period for no more than 10 years. E) equal cash flows occurring each time period over a fixed length of time.
23) The interest rate charged per period multiplied by the number of periods per year is called the _____ rate.
24) You are considering two projects with the following cash flows:
Assuming both projects have the same initial cost, you know that: A) both projects have equal net present values at any discount rate. B) Project B has a higher net present value than Project A. C) Project A is more valuable than Project B given a positive discount rate. D) there are no conditions under which the projects can have equal values. E) both projects offer the same rate of return.
25) You would be making a wise decision if you chose to: A) base decisions regarding investments on effective rates and base decisions
regarding loans on annual percentage rates. B) ignore the effective rates and concentrate on the annual percentage rates for all
transactions. C) accept the loan with the lower effective annual rate rather than the loan with the
lower annual percentage rate. D) invest in an account paying 6 percent, compounded quarterly, rather than an
account paying 6 percent, compounded monthly. E) assume all loans and investments are based on simple interest.
26) The net present value of a project is equal to the: A) present value of the future cash flows minus the initial cost. B) sum of the project’s anticipated cash flows. C) present value of the future cash flows. D) future value of the future cash flows minus the present value of the initial cost. E) future value of the future cash flows minus the initial cost.
27) Olivia is willing to pay $185 a month for four years for a car payment. If the interest rate is 4.9 percent, compounded monthly, and she has a cash down payment of $2,500, what price car can she afford to purchase?
28) You borrow $12,600 to buy a car. The terms of the loan call for monthly payments for five years at an interest rate of 4.65 percent, compounded monthly. What is the amount of each payment?
29) Luis has a management contract which grants him a lump sum payment of $20 million be paid upon the completion of his first five years of service. The company wants to set aside an equal amount of funds each year to cover this anticipated cash outflow. The company can earn 4.5 percent on these funds. How much must the company set aside each year for this purpose?
30) Stu can purchase a one-bedroom house near his college today for $110,000, including the cost of some minor repairs. He expects to be able to resell it in four years for $150,000 if he just puts a little effort into cleaning up the property. At a discount rate of 6.5 percent, what is the expected net present value of this purchase opportunity?
31) The difference between the present value of an investment’s future cashes flows and its initial cost is the:
32) The length of time required for a project’s discounted cash flows to equal the initial cost of the project is called the:
33) The discount rate that makes the net present value of an investment exactly equal to zero is called the:
34) A situation in which accepting one investment prevents the acceptance of another investment is called the:
35) The present value of an investment’s future cashes flows divided by the initial cost of the investment is called the:
36) All else constant, the net present value of a typical investment project increases when: A) the initial cost of a project increases. B) the discount rate increases. C) all cash inflows occur during the last year instead of periodically throughout a
project’s life. D) each cash inflow is delayed by one year. E) the rate of return decreases.
37) The primary reason that company projects with positive net present values are considered acceptable is that:
38) One characteristic of the payback method of project analysis is the: A) standardized cutoff point for cash flow consideration. B) discounting of all cash flows. C) use of variable discount rates. D) consideration of the risk level of each project. E) bias towards liquidity.
39) Project A is opening a bakery at 10 Center Street. Project B is opening a specialty coffee shop at the same address. Both projects have unconventional cash flows, that is, both projects have positive and negative cash flows that occur following the initial investment. When trying to decide which project to accept, given sufficient funding to accept either, you should rely most heavily on the _____ method of analysis.
40) If a firm is more concerned about the quick return of its initial investment than it is about the amount of value created, then the firm is most apt to evaluate a capital project using the _____ method of analysis.
41) Accepting a positive net present value (NPV) project: A) means the present value of the expected cash flows is equal to the project’s cost. B) guarantees all cash flow assumptions will be realized. C) indicates the project will pay back within the required period of time. D) ignores the inherent risks within the project. E) is expected to increase the stockholders’ value by the amount of the NPV.
42) The net present value method of capital budgeting analysis does all of the following except:
43) The payback method of analysis: A) applies an industry-standard recoupment period. B) discounts cash flows. C) always uses all project cash flows. D) has a timing bias. E) ignores the initial cost.
44) The payback method: A) applies mainly to projects where the actual results will be known relatively soon. B) generally results in decisions that conflict with the decision suggested by NPV
analysis. C) is a more sophisticated method of analysis than the profitability index. D) is the most frequently used method of capital budgeting analysis. E) considers the time value of money.
45) A mutually exclusive project is a project whose: A) NPV is always negative. B) acceptance or rejection has no effect on other projects. C) cash flow pattern exhibits more than one sign change. D) acceptance or rejection affects other projects. E) IRR is always negative.
46) Which one of the following statements is true? A) You must know the discount rate to compute the NPV but you can compute the
IRR without having a discount rate. B) Discounted payback is a better method than payback and is more frequently used
in practice. C) Financing projects can only ever have one IRR. D) Payback uses the same discount rate as that applied in the NPV calculation. E) You must have a discount rate to compute, NPV, IRR, PI, and discounted
47) What is the net present value of a project with an initial cost of $36,900 and cash inflows of $13,400, $21,600, and $10,000 for Years 1 to 3, respectively? The discount rate is 13 percent.
48) What is the net present value of a project that has an initial cash outflow of $7,670 and cash inflows of $1,280 in Year 1, $6,980 in Year 3, and $2,750 in Year 4? The discount rate is 12.5 percent.
49) Wilson’s Market is considering two mutually exclusive projects that will not be repeated. The required rate of return is 13.9 percent for Project A and 12.5 percent for Project B. Project A has an initial cost of $54,500, and should produce cash inflows of $16,400, $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $69,400, and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. Which project, or projects, if either, should be accepted and why?
50) Bernstein’s proposed project has an initial cost of $128,600 and cash flows of $64,500, $98,300, and −$15,500 for Years 1 to 3 respectively. If all negative cash flows are moved to Time 0 at a discount rate of 10 percent, what is the modified internal rate of return?
51) Blue Bird Café is considering a project with an initial cost of $46,800, and cash flows of $8,500, $25,000, $19,000, and −$4,500 for Years 1 to 4, respectively. How many internal rates of return do you expect this project to have?
52) It will cost $3,000 to acquire a small ice cream cart. Cart sales are expected to be $1,400 a year for three years. After the three years, the cart is expected to be worthless as that is the expected remaining life of the cooling system. What is the payback period of the ice cream cart?
53) A project has an initial cost of $2,250. The cash inflows are $0, $500, $900, and $700 for Years 1 to 4, respectively. What is the payback period?
54) Homer is considering a project with cash inflows of $950 a year for Years 1 to 4, respectively. The project has a required discount rate of 11 percent and an initial cost of $2,100. What is the discounted payback period?
55) Ginny is considering an investment costing $55,000 that has cash flows of $35,000 in Year 2, $36,000 in Year 3, and −$5,000 in Year 4. Ginny requires a rate of return of 8 percent and has a required discounted payback period of three years. Based on the discounted payback method should she make this investment? All things considered; do you agree with this decision? Why or why not?
NPV is negative and the final cash outflow is ignored by payback C) yes; because the NPV is positive and the project pays back on a discounted basis
within the assigned time period D) no; although the project earns more than 8 percent, there is no situation were the
project can pay back on a discounted basis within three years E) yes; but only because the discounted payback requirement is met
56) Consider an investment with an initial cost of $20,000 that expected to last for 5 years. The expected cash flows in Years 1 and 2 are $5,000 each, in Years 3 and 4 are $5,500 each, and the Year 5 cash flow is $1,000. Assume each annual cash flow is spread evenly over its respective year. What is the payback period?
57) The changes in a firm’s future cash flows that are a direct consequence of accepting a project are called _____ cash flows.
58) A cost that has already been paid, or the liability to pay has already been incurred, is a(n):
59) The most valuable investment given up if an alternative investment is chosen is a(n): A) salvage value expense. B) net working capital expense. C) opportunity cost. D) erosion cost. E) sunk cost.
60) A decrease in a firm’s current cash flows resulting from the implementation of a new project is referred to as:
61) The depreciation method currently allowed under U.S. tax law governing the accelerated write-off of property under various lifetime classifications is called _____ depreciation.
62) The cash flow tax savings generated as a result of a firm’s tax-deductible depreciation expense is called the:
63) The cash flow from a project is computed as the: A) sum of the sunk costs, opportunity costs, and erosion costs of the project. B) net income generated by the project, plus the annual depreciation expense. C) net operating cash flow generated by the project, less any sunk costs and erosion
costs. D) sum of the incremental operating cash flow, capital spending, and net working
capital cash flows incurred by the project. E) sum of the incremental operating cash flow and aftertax salvage value of the
64) Interest rates or rates of return on investments that have been adjusted for the effects of inflation are called _____ rates.
65) Sunk costs include any cost that: A) will be incurred if a project is accepted. B) will change if a project is undertaken. C) will occur if a project is accepted and once incurred, cannot be recouped. D) has previously been incurred and cannot be changed. E) will be paid to a third party and cannot be refunded for any reason whatsoever.
66) You spent $500 last week fixing the transmission in your car. Now, the brakes are acting up and you are trying to decide whether to fix them or trade the car in for a newer model. In analyzing the brake situation, the $500 you spent fixing the transmission is a(n) _____ cost.
67) Erosion can be explained as the: A) additional income generated from the sales of a newly added product. B) loss of revenue due to customer theft. C) loss of revenue due to employee theft. D) loss of current sales due to a new project being implemented. E) loss of cash due to the expenses required to fix a parking lot after a heavy rain
68) Which one of the following should be excluded from the analysis of a project? A) sunk costs B) incremental fixed costs C) incremental variable costs D) erosion costs E) opportunity costs
69) All of the following are anticipated effects of a proposed project. Which of these should be considered when computing the cash flow for the final year of a project?
70) Changes in the net working capital: A) only affect the initial cash flows of a project. B) affect the initial and the final cash flows of a project but not the cash flows of the
middle years. C) can affect the cash flows of a project every year of the project’s life. D) are included in project analysis only if they represent cash outflows. E) are generally excluded from project analysis due to their irrelevance to the total
71) The net working capital of a firm will decrease if there is: A) a decrease in accounts receivable. B) a decrease in fixed assets. C) a decrease in accounts payable. D) an increase in inventory. E) an increase in the firm’s checking account balance.
72) Net working capital: A) is the only expenditure where at least a partial recovery can be made at the end of
a project. B) can be ignored in project analysis because any expenditure is normally recouped
by the end of the project. C) is frequently affected by the additional sales generated by a new project. D) requirements generally, but not always, create a cash inflow at the beginning of a
project. E) expenditures commonly occur at the end of a project.
73) The book value of an asset is primarily used to compute the: A) amount of cash received from the sale of an asset. B) amount of tax due on the sale of an asset. C) change in depreciation needed to reflect the market value of the asset. D) amount of tax saved annually due to the depreciation expense. E) annual depreciation tax shield.
74) The salvage value of an asset creates an aftertax cash flow in an amount equal to the: A) sales price of the asset. B) sales price plus the tax due based on the sales price minus the book value. C) sales price minus the book value. D) sales price plus the tax due based on the book value minus the sales price. E) sales price minus the tax due based on the sales price minus the book value.
75) A project’s operating cash flow will increase when the: A) interest expense is lowered. B) sales projections are lowered. C) net working capital requirement increases. D) depreciation expense increases. E) earnings before interest and taxes decreases.
76) Assume a firm has no interest expense or extraordinary items. Given this, the operating cash flow can be computed as:
77) Tax shield refers to a reduction in taxes created by: A) a reduction in sales. B) a project’s incremental expenses. C) opportunity costs. D) an increase in interest expense. E) noncash expenses.
78) Marshalls purchased a corner lot five years ago at a cost of $498,000 and then spent $63,500 on grading and drainage so the lot could be used for storing outdoor inventory. The lot was recently appraised at $610,000. The company now wants to build a new retail store on the site. The building cost is estimated at $1.1 million. What amount should be used as the initial cash flow for this building project?
79) The Boat Works currently produces boat sails and is considering expanding its operations to include awnings. The expansion would require the use of land the firm purchased three years ago at a cost of $197,000 that is currently valued at $209,500. The expansion could use some equipment that is currently sitting idle if $7,500 of modifications were made to it. The equipment originally cost $387,500 five years ago, has a current book value of $132,700, and a current market value of $139,000. Other capital purchases costing $520,000 will also be required. What is the value of the opportunity costs that should be included in the initial cash flow for the expansion project?
80) Foamsoft sells customized boat shoes. Currently, it sells 16,850 pairs of shoes annually at an average price of $79 a pair. It is considering adding a lower-priced line of shoes which sell for $49 a pair. Foamsoft estimates it can sell 5,000 pairs of the lower-priced shoes but will sell 1,250 less pairs of the higher-priced shoes by doing so. What is the estimated value of the erosion cost that should be charged to the lower-priced shoe project?
81) Sue purchased a house for $89,000, spent $56,000 upgrading it, and currently had it appraised at $212,900. The house is being rented to a family for $1,200 a month, the maintenance expenses average $200 a month, and the property taxes are $4,800 a year. If she sells the house she will incur $20,000 in expenses. She is considering converting the house into professional office space. What opportunity cost, if any, should she assign to this property if she has been renting it for the past two years?
82) Ernie’s Electrical is evaluating a project which will increase sales by $50,000 and costs by $30,000. The project will cost $150,000 and will be depreciated straight-line to a zero-book value over the 10-year life of the project. The applicable tax rate is 34 percent. What is the operating cash flow for this project?
83) Kurt’s Cabinets is looking at a project that will require $80,000 in fixed assets and another $20,000 in net working capital. The project is expected to produce sales of $110,000 with associated costs of $70,000. The project has a 4-year life. The company uses straight-line depreciation to a zero book value over the life of the project. The tax rate is 35 percent. What is the operating cash flow for this project?
84) A project will produce an operating cash flow of $7,300 a year for three years. The initial investment for fixed assets will be $11,600, which will be depreciated straight-line to zero over the asset’s 4-year life. The project will require an initial $500 in net working capital plus an additional $500 every year with all net working capital levels restored to their original levels when the project ends. The fixed assets can be sold for an estimated $2,500 at the end of the project, the tax rate is 34 percent, and the required rate of return is 12 percent. What is the net present value of the project?
85) Tool Makers manufactures equipment for use by other firms. The initial cost of one customized machine is $850,000 with an annual operating cost of $10,000, and a life of 3 years. The machine will be replaced at the end of its life. What is the equivalent annual cost of this machine if the required rate of return is 15 percent and we ignore taxes?
86) Kay’s Nautique is considering a project which will require additional inventory of $128,000 and will also increase accounts payable by $45,000. Accounts receivable are currently $80,000 and are expected to increase by 10 percent if this project is accepted. What is the initial project cash flow needed for net working capital?
87) Wheels and More needs to maintain 8 percent of its sales in net working capital. The firm is considering a 5-year project which will increase sales from their current level of $110,000 to $146,000, $152,000, $158,000, $164,000, and $155,000 for Years 1 to 5 of the project, respectively. What amount should be included in the project analysis for net working capital for Year 3 of the project?
88) Tech Enterprises is considering a new project that will require $325,000 for fixed assets, $160,000 for inventory, and $35,000 for accounts receivable. Short-term debt is expected to increase by $100,000. The project has a 5-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 25 percent of their original cost and the net working capital will return to its original level. The project is expected to generate annual sales of $554,000 and costs of $430,000. The tax rate is 35 percent and the required rate of return is 15 percent. What is the net present value of this project?
89) The Down Towner is considering a 4-year project that will require $164,800 for fixed assets and $42,400 for net working capital. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for $37,500 and the net working capital will return to its original level. The project is expected to generate annual sales of $195,000 and costs of $117,500. The tax rate is 35 percent and the required rate of return is 13 percent. What is the project’s net present value?
90) In working on a bid project you have determined that $245,000 of fixed assets will be required and that they will be depreciated straight-line to zero over the 5-year life of the project. You have also determined that the discount rate should be 14.5 percent and the tax rate will be 35 percent. In addition, the annual cash costs will be $68,500. After considering all of the project’s cash flows you have determined that the required operating cash flow is $68,700. What is the amount of annual sales revenue that is required?
91) Which one of these is a correct definition? A) Current liabilities are debts that must be repaid in 18 months or less. B) Net working capital equals current assets plus current liabilities. C) Current assets are assets with short lives, such as inventory. D) Tangible assets are fixed assets such as patents. E) Long-term debt is defined as a residual claim on a firm’s assets.
92) The corporate controller is generally responsible for which one of these functions? A) cash management B) tax reporting C) capital expenditures D) financial planning E) credit management
93) The corporate treasurer oversees which one of these areas? A) financial accounting B) information systems C) cost accounting D) financial planning E) tax reporting
94) Which one of these is a cash outflow from a corporation? A) sale of common stock B) sale of an asset C) profit retained by the firm D) dividend payment E) issuance of debt
95) Which one of these statements is correct? A) When selecting one of two projects, managers should only consider the total cash
flow from each. B) All overseas operations present the same amount of risk. C) Accountants record sales and expenses after the related cash flows occur. D) The value of an investment by a firm depends on the size, the timing, and the risk
of the investment’s cash flows. E) Most investors prefer greater risk over less risk.
96) An investment is acceptable if the payback period: A) is equal to or greater than some pre-specified period of time. B) is negative. C) is less than some pre-specified period of time. D) is equal to, and only if it is equal to, the investment’s life. E) exceeds the life of the investment.
97) The discounted payback rule states that you should accept an investment project if its discounted payback period:
98) If a project has a net present value equal to zero, then: A) the initial cost of the project exceeds the present value of the project’s subsequent
cash flows. B) the discount rate exceeds the internal rate of return. C) the internal rate of return exceeds the discount rate. D) the project produces cash inflows that exceed the minimum required inflows. E) any delay in receiving the projected cash inflows will cause the project’s NPV to
99) Net present value: A) is more useful than the internal rate of return when comparing different sized
projects. B) is not as widely used in practice as payback and discounted payback. C) cannot be used when deciding between two mutually exclusive projects. D) ignores the risk of a project. E) is rarely used by small firms according to the Graham and Harvey survey.
100) Payback is frequently used to analyze independent projects because: A) it produces better decisions than those made using either NPV or IRR. B) it considers the time value of money. C) it is the most desirable of all the available analytical methods from a financial
perspective. D) it is easy and quick to calculate. E) all relevant cash flows are included in the analysis.
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