Test Prep BUSINESS-ENVIRONMENT-AND-CONCEPTS Online Practice Questions and Exam Preparation

Test Prep BUSINESS-ENVIRONMENT-AND-CONCEPTS Online Questions & Answers

• Question 151:

  An example of an indirect cash flow effect would be:

  A. Cash committed at inception of the project.
  B. Increased payroll expenses due to the project.
  C. A depreciation tax shield.
  D. An increase in expected future operating cash flows.
  C. A depreciation tax shield.

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  Choice "c" is correct. A depreciation tax shield is one of the most common indirect cash flow effects.

  Choices "a", "b", and "d" are incorrect, as these are all directly related to the capital investment and have an immediate effect on the amount of cash available to the company. Thus, they are all direct cash flow effects.

• Question 152:

  Whatney Co. is considering the acquisition of a new, more efficient press. The cost of the press is $360,000, and the press has an estimated six-year life with zero salvage value. Whatney uses straightline depreciation for both financial reporting and income tax reporting purposes and has a 40 percent corporate income tax rate. In evaluating equipment acquisitions of this type, Whatney uses a goal of a four-year payback period. To meet Whatney's desired payback period, the press must produce a minimum annual before-tax, operating cash savings of:

  A. $90,000
  B. $110,000
  C. $114,000
  D. $150,000
  B. $110,000

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  Choice "b" is correct. $110,000 minimum annual before-tax operating cash savings.

  Step 1: Determine the after-tax annual cash savings. The question provides the cash outflow and the desired payback period (which is calculated using after-tax cash flows). The $90,000 annual after-tax cash flows is calculated as follows:

  

  Step 2: Determine the amount of the annual depreciation expense. Because the question asks for annual before-tax cash savings, we will need to convert the $90,000 after-tax cash savings we calculated in Step 1, above, to a before-tax amount. The depreciation tax shield plays a role in the after-tax cash flows, so the annual depreciation of $60,000 must be calculated, as follows:

  

  Step 3: Use algebra to determine the before-tax cash savings. Before-tax cash savings is equal to the after-tax cash savings plus the taxes paid. So:

  Let B = annual before-tax operating cash savings

  $90,000 after tax cash savings + [(B - $60,000 depreciation expense) (.40 tax rate)] = B $90,000 + [(B - $60,000) (.40)] = B $90,000 + [.40B - $24,000] = B $90,000 - $24,000 = .60B $66,000 = .60B $110,000 = B = annual before-tax operating cash savings

  

• Question 153:

  Which of the following statements is correct regarding the declaration of a stock dividend by a corporation having only one class of par value stock?

  A. A stock dividend is prohibited in such a corporation.
  B. A stock dividend increases a stockholder's proportionate share of corporate ownership.
  C. A stock dividend causes a decrease in the assets of the corporation.
  D. A stock dividend is a corporation's ratable distribution of additional shares of stock to its stockholders.
  D. A stock dividend is a corporation's ratable distribution of additional shares of stock to its stockholders.

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  Choice "d" is correct. Stock dividends are dividends in the corporation's own authorized but unissued shares given to existing shareholders on account of their shares. Choice "a" is incorrect. Despite the fact that a stock dividend in a

  corporation with only one class of par value stock does not change a shareholder's proportional ownership or affect capitalization of the corporation, nothing prohibits a corporation--even a corporation with only one class of par value stock-from declaring a stock dividend.

  Choice "b" is incorrect. With a stock dividend, when there is only one class of stock, each shareholder receives a proportionate amount of stock, resulting in each shareholder owning the same percentage of the corporation after the dividend

  is issued as he or she owned before the dividend was issued.

  Choice "c" is incorrect. When a stock dividend is issued in a corporation's own stock, no assets are distributed and the solvency of the corporation remains the same.

• Question 154:

  A depreciation tax shield is:

  A. An after-tax cash outflow.
  B. A reduction in income taxes.
  C. The expense caused by depreciation.
  D. Caused by the fact that depreciation does not affect cash flow.
  B. A reduction in income taxes.

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  Choice "b" is correct. Whenever depreciation protects income from taxation, it is known as a depreciation tax shield.

  Choice "a" is incorrect. A depreciation tax shield may result in after-tax cash inflow, but not outflow.

  Choice "c" is incorrect, per above.

  Choice "d" is incorrect. A depreciation tax shield is caused by the tax deductibility of the depreciation expense, not by the fact that depreciation does not affect cash flow.

• Question 155:

  Which one of the following statements about supply and demand is true?

  A. If supply increases and demand remains constant, equilibrium price will rise.
  B. If demand increases and supply increases, equilibrium quantity will fall.
  C. If demand increases and supply decreases, equilibrium price will increase.
  D. If demand increases and supply remains constant, equilibrium price will fall.
  C. If demand increases and supply decreases, equilibrium price will increase.

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  Choice "c" is correct. If quantity demanded for a product goes up, this drives price up. Additionally, if supply decreases, this will also drive prices up. Therefore, it is a certainty that price will be driven up, given an increase in demand and a

  decrease in supply.

  Choice "a" is incorrect. Increased supply will reduce (not increase) prices, assuming demand remains constant.

  Choice "b" is incorrect. Increased demand will increase price, and increased supply will reduce price.

  The net impact on price cannot be determined without more facts.

  Choice "d" is incorrect. Increased demand will increase (not reduce) price, assuming supply remains constant.

• Question 156:

  A company has two divisions. Division A has operating income of $500 and total assets of $1,000. Division B has operating income of $400 and total assets of $1,600. The required rate of return for the company is 10%. The company's residual income would be which of the following amounts?

  A. $0
  B. $260
  C. $640
  D. $900
  C. $640

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  Choice "c" is correct. Residual income is the difference between net income and the required return. The required return is net book value (total assets) times the hurdle rate (required rate of return). The calculations are as follows:

  

  Choice "a" is incorrect. Residual income would certainly not be $0 in this question because the operating income is greater than the required return for both Division A and Division B.

  Choice "b" is incorrect. The $260 is the total required return, not the total residual income.

  Choice "d" is incorrect. The $900 is the total operating income, not the total residual income.

• Question 157:

  When applying value chain analysis, a firm asks it accounting department to perform an analysis of the sources of profits and costs of activities that exist within the firm. The firm is performing which form of value chain analysis?

  A. Internal differentiation analysis.
  B. Internal costs analysis.
  C. Vertical linkage analysis.
  D. None of the above.
  B. Internal costs analysis.

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  Choice "b" is correct. Internal costs analysis includes analyzing the internal value-creating ability of a firm, so the sources of profit and costs of the internal activities of the firm must be analyzed. Choices "a", "c", and "d" are incorrect, per the above Explanation.

• Question 158:

  The capital structure of a firm includes bonds with a coupon rate of 12% and an effective interest rate is 14%. The corporate tax rate is 30%. What is the firm's net cost of debt?

  A. 8.4%
  B. 9.8%
  C. 12.0%
  D. 14.0%
  B. 9.8%

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  Choice "b" is correct. The net cost of debt is computed as the effective interest rate net of tax, or 14% x .70 = 9.8%. The question is trying to trick the candidate into using the coupon rate of 12% rather than the effective interest rate. The

  coupon rate is used only if it is the same as the effective interest rate and there are no flotation costs.

  Choice "a" is incorrect. The net cost of debt is computed as the effective interest rate net of tax, or 14% x .70 = 9.8%, not the coupon rate of 12% x .70 = 8.4%. Choice "c" is incorrect. The net cost of debt is computed as the effective interest

  rate net of tax, or 14% x .70 = 9.8%, not the coupon rate of 12% by itself. The cost of debt is computed on an after-tax basis and uses the effective interest rate instead of the coupon rate.

  Choice "d" is incorrect. The net cost of debt is computed as the effective interest rate net of tax, or 14% x .70 = 9.8%, not the effective interest rate of 14% by itself. The cost of debt is computed on an after-tax basis.

• Question 159:

  A project's net present value, ignoring income tax considerations, is normally affected by the:

  A. Proceeds from the sale of the asset to be replaced.
  B. Carrying amount of the asset to be replaced by the project.
  C. Amount of annual depreciation on the asset to be replaced.
  D. Amount of annual depreciation on fixed assets used directly on the project.
  A. Proceeds from the sale of the asset to be replaced.

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  Choice "a" is correct. A project's net present value is a function of current and future cash flows, including proceeds from the sale of the old asset. Choice "b" is incorrect. A project's net present value is a function of current and future cash

  flows. The carrying amount of the asset does not affect cash flows.

  Choice "c" is incorrect. A project's net present value is a function of current and future cash flows.

  Depreciation is a noncash item and does not affect cash flows.

  Choice "d" is incorrect. A project's net present value is a function of current and future cash flows.

  Depreciation is a noncash item and does not affect cash flows.

• Question 160:

  On February 1, Addison, Bradley, and Carter, physicians, formed ABC Medical Partnership. Dr. Bradley was placed in charge of the partnership's financial books and records. On April 1, Dr. Addison joined the City Hospital Medical

  Partnership, retaining the partnership interest in ABC. On May 1, ABC received a writ of attachment from the court attaching Dr. Carter's interest in ABC. The writ resulted from Dr. Carter's failure to pay a credit card bill. On June 1, Dr.

  Addison was adjudicated bankrupt. On July 1, Dr. Bradley was sued by the other partners of ABC for an accounting of ABC's revenues and expenses.

  Under the Revised Uniform Partnership Act, which of the preceding events resulted in the dissociation of a partner?

  A. Dr. Addison joining the City Hospital Medical Partnership.
  B. Dr. Carter's interest in the partnership being attached by the court.
  C. Dr. Addison being adjudicated bankrupt.
  D. Dr. Bradley being sued for an accounting by the other partners of ABC.
  C. Dr. Addison being adjudicated bankrupt.

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  Choice "c" is correct. The bankruptcy of a partner will result in the dissociation of a partner.

  Choice "a" is incorrect, because although joining the city hospital medical partnership could be construed as a breach of fiduciary duty owed to the other partners in ABC medical partnership, standing alone, it would not result in a dissociation.

  Choice "b" is incorrect. All that was attached was the partner's right to distributions, which does not cause dissociation.

  Choice "d" is incorrect, because although being sued might cause Dr. Bradley to resign, which would cause dissociation, standing alone, being sued by the other partners does not cause dissociation.