WHICH OF THE FOLLOWING COULD EXPLAIN WHY A BUSINESS MIGHT CHOOSE TO OPERATE AS A CORPORATION RATHER THAN AS A SOLE PROPRIETORSHIP OR A PARTNERSHIP

13 Jun WHICH OF THE FOLLOWING COULD EXPLAIN WHY A BUSINESS MIGHT CHOOSE TO OPERATE AS A CORPORATION RATHER THAN AS A SOLE PROPRIETORSHIP OR A PARTNERSHIP

This exam consist of 25 multiple choice questions and covers the material in Chapters 1 through 3.

Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?
Answer

Corporations generally find it relatively difficult to raise large amounts of capital.

Less of a corporation’s income is generally subjected to taxes than would be true if the firm were a partnership.

Corporate shareholders escape liability for the firm’s debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.

Corporate investors are exposed to unlimited liability.

Corporations generally face relatively few regulations.
You recently sold 200 shares of Apple stock to your brother. The transfer was made through a broker, and the trade occurred on the NYSE. This is an example of:
Answer

A futures market transaction.

A primary market transaction.

A secondary market transaction.

A money market transaction.

An over-the-counter market transaction.

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
Which of the following statements is CORRECT?
Answer

In Europe and Asia hedge funds are legal, but they are not permitted to operate in the United States.

Hedge funds have more in common with commercial banks than with any other type of financial institution.

Hedge funds have more in common with investment banks than with any other type of financial institution.

In the United States hedge funds are legal, but in Europe and Asia they are not permitted to operate.

The justification for the “light” regulation of hedge funds is that only “sophisticated” investors with high net worths and high incomes are permitted to invest in these funds, and such investors supposedly can do the necessary “due diligence” on their own rather than have it done by the SEC or some other regulator.
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.

Which of the following is a primary market transaction?

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.

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.
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.
Which of the following statements is CORRECT?
Answer

If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year’s balance.

Dividends paid reduce the net income that is reported on a company’s income statement.

If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.

If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.

Accounts receivable are reported as a current liability on the balance sheet.
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.
Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet?
Answer

The company purchases a new piece of equipment.

The company repurchases common stock.

The company pays a dividend.

The company issues new common stock.

The company gives customers more time to pay their bills.

2 points
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.
Which of the following would be most likely to occur in the year after Congress, in an effort to increase tax revenue, passed legislation that forced companies to depreciate equipment over longer lives? Assume that sales, other operating costs, and tax rates are not affected, and assume that the same depreciation method is used for tax and stockholder reporting purposes.
Answer

Companies’ reported net incomes would decline.

Companies’ net operating profits after taxes (NOPAT) would decline.

Companies’ physical stocks of fixed assets would increase.

Companies’ net cash flows would increase.

Companies’ cash positions would decline.

Which of the following statements is CORRECT?
Answer

The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.

The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholders’ equity.

The balance sheet gives us a picture of the firm’s financial position at a point in time.

The income statement gives us a picture of the firm’s financial position at a point in time.

The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits.
The LeMond Corporation just purchased a new production line. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
Answer

LeMond’s tax liability for the year will be lower.

LeMond’s taxable income will be lower.

LeMond’s net fixed assets as shown on the balance sheet will be higher at the end of the year.

LeMond’s cash position will improve (increase).

LeMond’s reported net income after taxes for the year will be lower.
The LeMond Corporation just purchased a new production line. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
Answer

LeMond’s tax liability for the year will be lower.

LeMond’s taxable income will be lower.

LeMond’s net fixed assets as shown on the balance sheet will be higher at the end of the year.

LeMond’s cash position will improve (increase).

LeMond’s reported net income after taxes for the year will be lower.
Which of the following items is NOT included in current assets?
Answer

Short-term, highly liquid, marketable securities.

Accounts receivable.

Inventory.

Bonds.

Cash.

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.
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.
Which of the following statements is CORRECT?
Answer

“Window dressing” is any action that improves a firm’s fundamental, long-run position and thus increases its intrinsic value.

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.”

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.”

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 an example of “window dressing.”

Using some of the firm’s cash to reduce long-term debt is an example of “window dressing.”
cordelion Communications is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Cordelion pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?
Answer

The times interest earned ratio will decrease.

The ROA will decline.

Taxable income will decrease.

The tax bill will increase.

Net income will decrease.
2 points
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.
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.

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.

A firm’s new president wants to strengthen the company’s financial position. Which of the following actions would make it financially stronger?
Answer

Increase inventories while holding sales and cost of goods sold constant.

Increase accounts receivable while holding sales constant.

Increase EBIT while holding sales constant.

Increase accounts payable while holding sales constant.

Increase notes payable while holding sales constant.

2 points