ECO 550 MIDTERM PART 1 LATEST (TWO VERSIONS POSTED) - 92475

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  • From: Economics, Microeconomics
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VERSION 1 Question 1 Which of the following statements is CORRECT? Answer While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. A security whose value is derived from the price of some other "underlying" asset is called a liquid security. Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks. Money markets are markets for common stocks and long-term debt. The NYSE operates as an auction market, whereas the Nasdaq is a dealer market. Question 2 Which of the following statements is CORRECT? Answer If expected inflation increases, interest rates are likely to increase. If individuals in general increase the percentage of their income that they save, interest rates are likely to increase. If companies have fewer good investment opportunities, interest rates are likely to increase. Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities. Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills Question 3 Which of the following statements is CORRECT? Answer The New York Stock Exchange is an auction market with a physical location. Capital market transactions involve only the purchase and sale of equity securities, i.e., common stocks. If an investor sells shares of stock through a broker, then this would be a primary market transaction. Consumer automobile loans are evidenced by legal documents called "promissory notes," and these individual notes are traded in the money market. While the distinctions are blurring as investment banks are today buying commercial banks, and vice versa, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. Question 4 Which of the following statements is CORRECT? Answer Capital market instruments include both long-term debt and common stocks. An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift. The NYSE does not exist as a physical location; rather, it represents a loose collection of dealers who trade stocks electronically. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors. Question 5 Which of the following statements is CORRECT? Answer If Apple issues additional shares of common stock through an investment banker, this would be a secondary market transaction. If you purchased 100 shares of Apple stock from your sister-in-law, this would be an example of a primary market transaction. The IPO market is a subset of the secondary market. Only institutions, and not individuals, can participate in derivatives market transactions. As they are generally defined, money market transactions involve debt securities with maturities of less than one year. Question 6 Which of the following statements is CORRECT? Answer One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability. It is generally easier to transfer one's ownership interest in a partnership than in a corporation. One of the advantages of the corporate form of organization is that it avoids double taxation. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., "one person, one vote." Corporations of all types are subject to the corporate income tax Question 7 Money markets are markets for Answer Foreign stocks. Consumer automobile loans. U.S. stocks. Short-term debt securities. Long-term bonds. Question 8 Which of the following statements is CORRECT? Answer One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt. Sole proprietorships are subject to more regulations than corporations. In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner. Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones. Corporations of all types are subject to the corporate income tax. Question 9 Which of the following statements is CORRECT? Answer The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses. MVA gives us an idea about how much value a firm's management has added during the last year. MVA stands for market value added, and it is defined as follows: MVA = (Shares outstanding)(Stock price) + Book value of common equity. EVA stands for economic value added, and it is defined as follows: EVA = EBIT(1 - T) - (Investor-supplied op. capital) x (A - T cost of capital). EVA gives us an idea about how much value a firm's management has added over the firm's life. Question 10 Which of the following statements is CORRECT? Answer If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative. Since depreciation is a source of funds, the more depreciation a company has, the larger its retained earnings will be, other things held constant. A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments. Common equity includes common stock and retained earnings, less accumulated depreciation. The retained earnings account as shown on the balance sheet shows the amount of cash that is available for paying dividends. Question 11 Analysts following Armstrong Products recently noted that the company's operating net cash flow increased over the prior year, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation? Answer The company issued new long-term debt. The company cut its dividend. The company made a large investment in a profitable new plant. The company sold a division and received cash in return. The company issued new common stock. Question 12 Which of the following items cannot be found on a firm's balance sheet under current liabilities? Answer Accrued payroll taxes. Accounts payable. Short-term notes payable to the bank. Accrued wages. Cost of goods sold. Question 13 Which of the following statements is CORRECT? Answer A typical industrial company's balance sheet lists the firm's assets that will be converted to cash first, and then goes on down to list the firm's longest lived assets last. The balance sheet for a given year, say 2012, is designed to give us an idea of what happened to the firm during that year. The balance sheet for a given year, say 2012, tells us how much money the company earned during that year. The difference between the total assets reported on the balance sheet and the debts reported on this statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in accordance with generally accepted accounting principles (GAAP). For most companies, the market value of the stock equals the book value of the stock as reported on the balance sheet. Question 14 Which of the following statements is CORRECT? Answer The statement of cash flows shows how much the firm's cash?the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)?increased or decreased during a given year. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets. The statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock. Question 15 Which of the following statements is CORRECT? Answer Net cash flow (NCF) is defined as follows: NCF = Net income - Depreciation and Amortization. Changes in working capital have no effect on free cash flow. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T) + Depreciation and Amortization - Capital expenditures required to sustain operations - Required changes in net operating working capital. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T)+ Depreciation and Amortization + Capital expenditures. Net cash flow is the same as free cash flow (FCF). Question 16 DeYoung Devices Inc., a new high-tech instrumentation firm, is building and equipping a new manufacturing facility. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is considering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law, which of the following would occur in the year following the change? Answer The firm's reported net income would increase. The firm's operating income (EBIT) would increase. The firm's taxable income would increase. The firm's net cash flow would increase. The firm's tax payments would increase. Question 17 Which of the following statements is CORRECT? Answer All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income. The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus, the federal government receives no tax revenue from these businesses. All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code. Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm's income as personal income and pay taxes on that income. Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes. Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the income and stockholders were taxed again on the income when it was paid to them as dividends Question 18 Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant? Answer The total assets turnover decreases. The TIE declines. The DSO increases. The EBITDA coverage ratio increases. The current and quick ratios both decline. Question 19 If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT? Answer Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm. The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm. Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm. Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm. The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm. Question 20 Which of the following would indicate an improvement in a company's financial position, holding other things constant? Answer The current and quick ratios both increase. The inventory and total assets turnover ratios both decline. The debt ratio increases. The profit margin declines. The EBITDA coverage ratio declines. Question 21 Which of the following statements is CORRECT? Answer If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president. If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president. Other things held constant, the higher a firm's expected future growth rate, the lower its P/E ratio is likely to be. The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA). If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average. Question 22 Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company Heidee has the higher debt ratio. Which of the following statements is CORRECT? Answer Company Heidee has a lower operating income (EBIT) than Company LD. Company Heidee has a lower total assets turnover than Company Leaudy. Company Heidee has a lower equity multiplier than Company Leaudy. Company Heidee has a higher fixed assets turnover than Company Leaudy. Company Heidee has a higher ROE than Company Leaudy. Question 23 Considered alone, which of the following would increase a company's current ratio? Answer An increase in accounts payable. An increase in net fixed assets. An increase in accrued liabilities. An increase in notes payable. An increase in accounts receivable. Question 24 You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT? Answer Its total assets turnover must equal the industry average. Its total assets turnover must be above the industry average. Its return on assets must equal the industry average. Its TIE ratio must be below the industry average. Its total assets turnover must be below the industry average Question 25 If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., "grading" the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant. Answer The division's DSO (days' sales outstanding) is 40, whereas the average for its competitors is 30. The division's basic earning power ratio is above the average of other firms in its industry. The division's total assets turnover ratio is below the average for other firms in its industry. The division's debt ratio is above the average for other firms in the industry. The division's inventory turnover is 6, whereas the average for its competitors is 8. VERSION 2 1. Money markets are markets for Answer Foreign stocks. Consumer automobile loans. U.S. stocks. Short-term debt securities. Long-term bonds. 2. Which of the following is a primary market transaction? Answer You sell 200 shares of Johnson & Johnson stock on the NYSE through your broker. Johnson & Johnson issues 2,000,000 shares of new stock and sells them to the public through an investment banker. You buy 200 shares of Johnson & Johnson stock from your younger brother. You just give him cash and he gives you the stock?the trade is not made through a broker. One financial institution buys 200,000 shares of Johnson & Johnson stock from another institution. An investment banker arranges the transaction. You invest $10,000 in a mutual fund, which then uses the money to buy $10,000 of Johnson & Johnson shares on the NYSE. 3. Which of the following statements is CORRECT? Answer If Apple issues additional shares of common stock through an investment banker, this would be a secondary market transaction. If you purchased 100 shares of Apple stock from your sister-in-law, this would be an example of a primary market transaction. The IPO market is a subset of the secondary market. Only institutions, and not individuals, can participate in derivatives market transactions. As they are generally defined, money market transactions involve debt securities with maturities of less than one year. 4. Which of the following statements is CORRECT? Answer It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship. Corporate shareholders are exposed to unlimited liability. Corporations generally face fewer regulations than sole proprietorships. Corporate shareholders are exposed to unlimited liability, and this factor may be compounded by the tax disadvantages of incorporation. Shareholders in a regular corporation (not an S corporation) pay higher taxes than owners of an otherwise identical proprietorship. 5. Which of the following statements is CORRECT? Answer It is generally more expensive to form a proprietorship than a corporation because, with a proprietorship, extensive legal documents are required. Corporations face fewer regulations than sole proprietorships. One disadvantage of operating a business as a sole proprietorship is that the firm is subject to double taxation, at both the firm level and the owner level. One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership. If a regular partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business. 6. Which of the following statements is CORRECT? Answer While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. A security whose value is derived from the price of some other "underlying" asset is called a liquid security. Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks. Money markets are markets for common stocks and long-term debt. The NYSE operates as an auction market, whereas the Nasdaq is a dealer market. 7. Which of the following statements is CORRECT? Answer If expected inflation increases, interest rates are likely to increase. If individuals in general increase the percentage of their income that they save, interest rates are likely to increase. If companies have fewer good investment opportunities, interest rates are likely to increase. Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities. Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills. 8. Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a regular corporation. Which of the following statements is CORRECT? Answer Assuming Cheers is profitable, less of its income will be subject to federal income taxes. Cheers will now be subject to fewer regulations. Cheers' shareholders (the ex-partners) will now be exposed to less liability. Cheers' investors will be exposed to less liability, but they will find it more difficult to transfer their ownership. Cheers will find it more difficult to raise additional capital. 9. Which of the following statements is CORRECT? Answer Net cash flow (NCF) is defined as follows: NCF = Net income - Depreciation and Amortization. Changes in working capital have no effect on free cash flow. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T) + Depreciation and Amortization - Capital expenditures required to sustain operations - Required changes in net operating working capital. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T)+ Depreciation and Amortization + Capital expenditures. Net cash flow is the same as free cash flow (FCF). 10. Which of the following statements is CORRECT? Answer The statement of cash flows shows how much the firm's cash?the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)?increased or decreased during a given year. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets. The statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock. 11. Analysts following Armstrong Products recently noted that the company's operating net cash flow increased over the prior year, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation? Answer The company issued new long-term debt. The company cut its dividend. The company made a large investment in a profitable new plant. The company sold a division and received cash in return. The company issued new common stock. 12. Which of the following statements is CORRECT? Answer The income statement for a given year, say 2012, is designed to give us an idea of how much the firm earned during that year. The focal point of the income statement is the cash account, because that account cannot be manipulated by "accounting tricks." The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP). The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC). If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be identical to its reported net cash flow. 13. Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined. Which of the following could explain this performance? Answer The company's operating income declined. The company's expenditures on fixed assets declined. The company's cost of goods sold increased. The company's depreciation and amortization expenses declined. The company's interest expense increased. 14. Which of the following statements is CORRECT? Answer A typical industrial company's balance sheet lists the firm's assets that will be converted to cash first, and then goes on down to list the firm's longest lived assets last. The balance sheet for a given year, say 2012, is designed to give us an idea of what happened to the firm during that year. The balance sheet for a given year, say 2012, tells us how much money the company earned during that year. The difference between the total assets reported on the balance sheet and the debts reported on this statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in accordance with generally accepted accounting principles (GAAP). For most companies, the market value of the stock equals the book value of the stock as reported on the balance sheet. 15. Danielle's Sushi Shop last year had (1) a negative net cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation? Answer The company had a sharp increase in its depreciation and amortization expenses. The company had a sharp increase in its inventories. The company had a sharp increase in its accrued liabilities. The company sold a new issue of common stock. The company made a large capital investment early in the year. 16. Which of the following statements is CORRECT? Answer The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses. MVA gives us an idea about how much value a firm's management has added during the last year. MVA stands for market value added, and it is defined as follows: MVA = (Shares outstanding)(Stock price) + Book value of common equity. EVA stands for economic value added, and it is defined as follows: EVA = EBIT(1 - T) - (Investor-supplied op. capital) x (A - T cost of capital). EVA gives us an idea about how much value a firm's management has added over the firm's life. 17. Assume that Congress recently passed a provision that will enable Barton's Rare Books (BRB) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or tax rate. Prior to the new provision, BRB's net income after taxes was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BRB's financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes. Answer Net fixed assets on the balance sheet will decrease. The provision will reduce the company's net cash flow. The provision will increase the company's tax payments. Net fixed assets on the balance sheet will increase. The provision will increase the company's net income. 18. Which of the following statements is CORRECT? Answer If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease. A reduction in inventories held would have no effect on the current ratio. An increase in inventories would have no effect on the current ratio. If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE. 19. If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., "grading" the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant. Answer The division's DSO (days' sales outstanding) is 40, whereas the average for its competitors is 30. The division's basic earning power ratio is above the average of other firms in its industry. The division's total assets turnover ratio is below the average for other firms in its industry. The division's debt ratio is above the average for other firms in the industry. The division's inventory turnover is 6, whereas the average for its competitors is 8. 20. Companies A and C each reported the same earnings per share (EPS), but Company A's stock trades at a higher price. Which of the following statements is CORRECT? Answer Company A trades at a higher P/E ratio. Company A probably has fewer growth opportunities. Company A is probably judged by investors to be riskier. Company A must have a higher market-to-book ratio. Company A must pay a lower dividend. 21. Which of the following would indicate an improvement in a company's financial position, holding other things constant? Answer The current and quick ratios both increase. The inventory and total assets turnover ratios both decline. The debt ratio increases. The profit margin declines. The EBITDA coverage ratio declines. 22. Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000. What was its total assets turnover ratio (TATO)? Answer 2.03 2.13 2.25 2.36 2.48 23. Which of the following statements is CORRECT? Answer If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president. If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president. Other things held constant, the higher a firm's expected future growth rate, the lower its P/E ratio is likely to be. The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA). If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average. 24. A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio? Answer Use cash to increase inventory holdings. Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment. Use cash to repurchase some of the company's own stock. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year. Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash. 25. Considered alone, which of the following would increase a company's current ratio? Answer An increase in accounts payable. An increase in net fixed assets. An increase in accrued liabilities. An increase in notes payable. An increase in accounts receivable.
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