Chapter 4 Cash Flow and Financial Planning: Principles of Managerial Finance, 14e, Global Edition (Gitman/Zutter)

Download as doc, pdf, or txt
Download as doc, pdf, or txt
You are on page 1of 80

Principles of Managerial Finance, 14e, Global Edition (Gitman/Zutter)

Chapter 4 Cash Flow and Financial Planning

4.1 Understand tax depreciation procedures and the effect of depreciation on the firm's cash
flows.

1) Depreciation deductions, like any other business expenses, reduce the income that a firm
reports on its income statement.
Answer: TRUE
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

2) Non-cash charges are expenses that involve an actual outlay of cash during the period but are
not deducted on the income statement.
Answer: FALSE
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

3) Under the basic MACRS procedures, the depreciable value of an asset is its full cost,
including outlays for installation.
Answer: TRUE
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

4) Business firms are permitted to systematically charge a portion of the market value of fixed
assets as depreciation against annual revenues.
Answer: FALSE
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

1
© Pearson Education Limited, 2015.
5) Given a financial manager's preference for faster receipt of cash flows, a longer depreciable
life is preferred to a shorter one.
Answer: FALSE
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

6) For tax purposes, using MACRS recovery periods, assets in the first four property classes are
depreciated by the double-declining balance method using the half-year convention and
switching to straight line when advantageous.
Answer: TRUE
Diff: 1
Topic: Depreciation Methods
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

7) The MACRS depreciation method requires use of the half-year convention. Assets are
assumed to be acquired in the middle of the year and only one-half of the first year's depreciation
is recovered in the first year.
Answer: TRUE
Diff: 1
Topic: Depreciation Methods
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

8) Allocation of the historic costs of fixed assets against the annual revenue they generate is
called ________.
A) arbitraging
B) securitization
C) depreciation
D) amortization
Answer: C
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

2
© Pearson Education Limited, 2015.
9) The Modified Accelerated Cost Recovery System (MACRS) is a depreciation method used for
________ purposes.
A) tax
B) financial reporting
C) budget
D) cost accounting
Answer: A
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

10) A corporation ________.


A) must use the straight-line depreciation method for tax purposes and double declining
depreciation method financial reporting purposes
B) can use straight-line depreciation method for tax purposes and MACRS depreciation method
financial reporting purposes
C) can use different depreciation methods for tax and financial reporting purposes
D) must use different depreciation method for tax purposes, but strictly mandated depreciation
methods for financial reporting purposes
Answer: C
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

11) The depreciable value of an asset, under MACRS, is the ________.


A) current cost
B) current cost minus salvage value
C) the original cost plus installation
D) the original cost plus installation costs, minus salvage value
Answer: C
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

3
© Pearson Education Limited, 2015.
MACRS RATE
Recovery year 3 years 5 years 7 years 10 years
1 33% 20% 14% 10%
2 45 32 25 18
3 15 19 18 14
4 7 12 12 12
5 12 9 9
6 5 9 8
7 9 7
8 4 6
9 6
10 6
11 4

12) Under MACRS, an asset which originally cost $10,000 is being depreciated using a 5-year
normal recovery period. What is the depreciation expense in year 3?
A) $1,900
B) $1,200
C) $1,500
D) $2,100
Answer: A
Diff: 2
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

13) Under MACRS, an asset which originally cost $100,000 is being depreciated using a 10-year
normal recovery period. The depreciation expense in year 5 is ________.
A) $10,000
B) $12,000
C) $21,000
D) $ 9,000
Answer: D
Diff: 2
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

4
© Pearson Education Limited, 2015.
14) Under MACRS, an asset which originally cost $100,000 is being depreciated using a 10-year
normal recovery period. The depreciation expense in year 11 is ________.
A) $3,000
B) $4,000
C) $0
D) $6,000
Answer: B
Diff: 2
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

15) Given a financial manager's preference for faster receipt of cash flows, ________.
A) a longer depreciable life is preferred to a shorter one
B) a shorter depreciable life is preferred to a longer one
C) the manager is not concerned with depreciable life, because depreciation is a noncash expense
D) the manager is not concerned with depreciable life, because once purchased, depreciation is
considered a sunk cost
Answer: B
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

16) In general, ________.


A) a longer depreciable life is preferred, because it will result in a faster receipt of cash flows
B) a shorter depreciable life is preferred, because it will result in a faster receipt of cash flows
C) a shorter depreciable life is preferred, because management can then purchase new assets, as
the old assets are written off
D) a longer depreciable life is preferred, because management can postpone purchasing new
assets, since the old assets still have a useful life
Answer: B
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

5
© Pearson Education Limited, 2015.
17) The depreciable value of an asset, under MACRS, is ________.
A) the full cost excluding installation costs
B) the full cost minus salvage value
C) the full cost including installation costs
D) the full cost including installation costs adjusted for the salvage value
Answer: C
Diff: 1
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

MACRS RATE
Recovery year 3 years 5 years 7 years 10 years
1 33% 20% 14% 10%
2 45 32 25 18
3 15 19 18 14
4 7 12 12 12
5 12 9 9
6 5 9 8
7 9 7
8 4 6
9 6
10 6
11 4

18) Under MACRS, an asset which originally cost $100,000, incurred installation costs of
$10,000, and has an estimated salvage value of $25,000, is being depreciated using a 5-year
normal recovery period. What is the depreciation expense in year 1?
A) $15,000
B) $12,750
C) $11,250
D) $22,000
Answer: D
Diff: 2
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

6
© Pearson Education Limited, 2015.
19) Darling Paper Container, Inc. purchased several machines at a total cost of $300,000. The
installation cost for this equipment was $25,000. The firm plans to depreciate the equipment
using the MACRS 5-year normal recovery period. Prepare a depreciation schedule showing the
depreciation expense for each year.
Answer: Depreciation Schedule

Diff: 2
Topic: Depreciation
Learning Obj.: LG 1
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

4.2 Discuss the firm's statement of cash flows, operating cash flow, and free cash flow.

1) In the statement of cash flows, the cash flows from financing activities result from debt and
equity financing transactions; including incurrence and repayment of debt, cash inflow from the
sale of stock, and cash outflows to repurchase stock or pay cash dividends.
Answer: TRUE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

2) Free cash flow (FCF) is the cash flow a firm generates from its normal operations; calculated
as EBIT minus taxes plus depreciation.
Answer: FALSE
Diff: 1
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

7
© Pearson Education Limited, 2015.
3) A firm's operating cash flow (OCF) is the cash flow it generates from its normal operations:
producing and selling its output of goods or services.
Answer: TRUE
Diff: 1
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

4) The net fixed asset investment (NFAI) is defined as the change in net fixed assets plus
depreciation.
Answer: TRUE
Diff: 1
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

5) The net current asset investment (NCAI) is defined as the change in current assets minus the
change in sum of the accounts payable and accruals.
Answer: TRUE
Diff: 1
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

6) A firm's free cash flow (FCF) represents the amount of cash flow available to investors
(stockholders and bondholders) after the firm has met all operating needs and after having paid
for net fixed asset investments and net current asset investments.
Answer: TRUE
Diff: 1
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

8
© Pearson Education Limited, 2015.
7) A firm's free cash flow (FCF) equals the sum of operating cash flows, financing cash flows,
and investing cash flows.
Answer: FALSE
Diff: 1
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

8) Operating cash flow (OCF) is equal to a firm's net operating profits after taxes minus all non-
cash charges.
Answer: FALSE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

9) In the statement of cash flows, cash flows from operating activities are cash flows directly
related to purchase and sale of fixed assets.
Answer: FALSE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

10) Depreciation is considered to be an outflow of cash.


Answer: FALSE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

9
© Pearson Education Limited, 2015.
11) The statement of cash flows allows the financial manager and other interested parties to
analyze a firm's past and possibly future profitability.
Answer: FALSE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

12) To assess whether any developments have occurred that are contrary to a company's financial
policies, the financial manager should pay special attention to both the major categories of cash
flow and the individual items of cash inflow and outflow.
Answer: TRUE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

13) It would be correct to define operating cash flow (OCF) as net operating profit after taxes
plus depreciation.
Answer: TRUE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

14) Operating cash flow (OCF) is calculated by deducting depreciation from net operating profit
after taxes.
Answer: FALSE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

10
© Pearson Education Limited, 2015.
15) Net operating profit after taxes (NOPAT) represents a firm's earnings before interest and
after taxes.
Answer: TRUE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

16) Net operating profit after taxes (NOPAT) represents a firm's earnings after deducting both
interest and taxes.
Answer: FALSE
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

17) A firm's operating cash flow (OCF) is defined as ________.


A) gross profit minus operating expenses
B) gross profit minus depreciation
C) EBIT times one minus the tax rate plus depreciation
D) EBIT plus depreciation
Answer: C
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

18) Which of the following is an example of noncash charges?


A) depreciation
B) accruals
C) interest expense
D) dividends paid
Answer: A
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

11
© Pearson Education Limited, 2015.
19) Which of the following is a source of cash flows?
A) increase in marketable securities
B) increase in accounts payable
C) decrease in notes payable
D) repurchase of stock
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

20) ________ is a noncash charge.


A) Labor expense
B) Depreciation
C) Salaries
D) Rent
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

21) In the statement of cash flows, retained earnings are handled through the adjustment of
________.
A) "Revenue" and "Cost" accounts
B) "Current Assets" and "Current Liabilities" accounts
C) "Depreciation" and "Purchases" accounts
D) "Net Profits After Taxes" and "Dividends Paid" accounts
Answer: D
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

12
© Pearson Education Limited, 2015.
22) The cash flows from operating activities section of the statement of cash flows includes
________.
A) principal received
B) cost of raw materials
C) dividends paid
D) stock repurchases
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

23) The cash flows from operating activities section of the statement of cash flows includes
________.
A) labor expense
B) proceeds from the sale of fixed assets
C) principal paid
D) dividends paid
Answer: A
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

24) The cash flows from financing activities section of the statement of cash flows includes
________.
A) labour expense
B) cost of raw materials
C) purchase of long-term assets
D) dividends paid
Answer: D
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

13
© Pearson Education Limited, 2015.
25) The three categories of a firm's statement of cash flows are ________.
A) cash flow from operating activities, cash flow from investment activities, and cash flow from
noncash activities
B) cash flow from operating activities, cash flow from noncash activities, and cash flow from
financing activities
C) cash flow from equity activities, cash flow from investment activities, and cash flow from
financing activities
D) cash flow from operating activities, cash flow from investment activities, and cash flow from
financing activities
Answer: D
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

26) Which of the following is a cash inflow?


A) a decrease in accounts payable
B) a decrease in accounts receivable
C) an increase in dividend payment
D) a decrease in accrued liabilities
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

27) Which of the following is a cash outflow?


A) an increase in accounts payable
B) a decrease in notes receivable
C) an increase in accounts receivable
D) an increase in accrued liabilities
Answer: C
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

14
© Pearson Education Limited, 2015.
28) Which of the following line items of the statement of cash flows must be obtained from the
income statement ?
A) accruals in current liabilities
B) interest expenses
C) accounts receivable
D) cash dividends paid on both preferred and common stocks
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

29) Cash flows directly related to production and sale of a firm's products and services are called
________.
A) cash flow from operating activities
B) cash flow from investment activities
C) cash flow from financing activities
D) cash flow from equity activities
Answer: A
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

30) Cash flows associated with the purchase and sale of fixed assets and business interests are
called cash flow from ________.
A) operating activities
B) investment activities
C) financing activities
D) equity activities
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

15
© Pearson Education Limited, 2015.
31) Cash flows that result from debt and equity financing transactions, including incurrence and
repayment of debt, cash inflows from the sale of stock, and cash outflows to pay cash dividends
or repurchase stock are called cash flow from ________.
A) operating activities
B) investment activities
C) financing activities
D) miscellaneous activities
Answer: C
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

16
© Pearson Education Limited, 2015.
Table 4.1

True Sandpaper Co.


Balance Sheets
For the Years Ended 2014 and 2015

32) The largest single source of funds for the firm in 2015 is ________. (See Table 4.1)
A) an increase in net profits after taxes
B) an increase in notes payable
C) an increase in long-term debt
D) an increase in inventory
Answer: C
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

17
© Pearson Education Limited, 2015.
33) Common stock dividends paid in 2015 amounted to ________. (See Table 4.1)
A) $100
B) $50
C) $600
D) $150
Answer: B
Diff: 2
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

34) The firm may have increased long-term debts to finance ________. (See Table 4.1)
A) an increase in net fixed assets
B) an increase in current assets
C) accounts receivable payments
D) an increase in dividends
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

35) The firm ________ fixed assets worth ________. (See Table 4.1)
A) purchased; $0
B) purchased; $200
C) sold; $0
D) sold; $200
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

18
© Pearson Education Limited, 2015.
36) The firm's cash flow from operating activities is ________. (See Table 4.1)
A) $50
B) $350
C) $150
D) $200
Answer: A
Diff: 2
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

37) The depreciation expense for 2015 is ________. (See Table 4.1)
A) $0
B) $200
C) $50
D) $1,000
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

38) A corporation sold a fixed asset for $100,000. This is ________.


A) an investment cash flow and a source of funds
B) an operating cash flow and a source of funds
C) an operating cash flow and a use of funds
D) an investment cash flow and a use of funds
Answer: A
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

19
© Pearson Education Limited, 2015.
39) A corporation raises $500,000 in long-term debt to acquire additional plant capacity. This is
considered as ________.
A) an investment cash flow
B) a financing cash flow
C) a financing cash flow and investment cash flow, respectively
D) a financing cash flow and operating cash flow, respectively
Answer: C
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

40) Which of the following is a cash flow from financing activities?


A) purchase of a long-term asset
B) decrease in accounts payable
C) increase in accounts payable
D) repurchasing stock
Answer: D
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

41) Which of the following represents a cash flow from operating activities?
A) dividends paid
B) increase or decrease in current liabilities
C) increase or decrease in fixed assets
D) repurchasing stock
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

20
© Pearson Education Limited, 2015.
42) For the year ended December 31, 2014, a corporation had cash flow from operating activities
of -$10,000, cash flow from investment activities of $4,000, and cash flow from financing
activities of $9,000. The statement of cash flows would show a ________.
A) net decrease of $3,000 in cash and marketable securities
B) net decrease of $5,000 in cash and marketable securities
C) net increase of $3,000 in cash and marketable securities
D) net increase of $5,000 in cash and marketable securities
Answer: C
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

43) For the year ended December 31, 2014, a corporation had cash flow from operating activities
of $20,000, cash flow from investment activities of -$15,000, and cash flow from financing
activities of -$10,000. The statement of cash flows would show a ________.
A) net increase of $5,000 in cash and marketable securities
B) net decrease of $5,000 in cash and marketable securities
C) net decrease of $15,000 in cash and marketable securities
D) net increase of $25,000 in cash and marketable securities
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

44) For the year ended December 31, 2014, a corporation had cash flow from operating activities
of $12,000, cash flow from investment activities of - $10,000, and cash flow from financing
activities of $4,000. The statement of cash flows would show a ________.
A) net decrease of $18,000 in cash and marketable securities
B) net decrease of $6,000 in cash and marketable securities
C) net increase of $6,000 in cash and marketable securities
D) net increase of $2,000 in cash and marketable securities
Answer: C
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

21
© Pearson Education Limited, 2015.
45) A firm has just ended the calendar year making a sale in the amount of $200,000 of
merchandise purchased during the year at a total cost of $150,500. Although the firm paid in full
for the merchandise during the year, it has yet to collect at year end from the customer. One
possible problem this firm may face is ________.
A) low profitability
B) insolvency
C) inability to receive credit
D) high leverage
Answer: B
Diff: 1
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

46) Calculate net operating profit after taxes (NOPAT) if a firm has sales of $1,000,000,
operating profit (EBIT) of $100,000, interest expense of $50,000, and a tax rate of 30%.
A) $35,000
B) $700,000
C) $70,000
D) $45,000
Answer: C
Diff: 2
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

47) Calculate a firm's free cash flow if it has net operating profit after taxes of $60,000,
depreciation expense of $10,000, net fixed asset investment requirement of $40,000, a net
current asset requirement of $30,000 and a tax rate of 30%.
A) $0
B) $30,000
C) -$30,000
D) $60,000
Answer: A
Diff: 2
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

22
© Pearson Education Limited, 2015.
48) NICO Corporation had net fixed assets of $2,000,000 at the end of 2015 and $1,800,000 at
the end of 2014. In addition, the firm had a depreciation expense of $200,000 during 2015 and
$180,000 during 2014. Using this information, NICO's net fixed asset investment for 2015 was
________.
A) $20,000
B) $0
C) $380,000
D) $400,000
Answer: D
Diff: 2
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

49) NICO Corporation had net current assets of $2,000,000 at the end of 2015 and $1,800,000 at
the end of 2014. In addition, NICO had net spontaneous current liabilities of $1,000,000 in 2015
and $1,500,000 in 2014. Using this information, NICO's net current asset investment for 2014
was ________.
A) $700,000
B) -$300,000
C) $300,000
D) -$700,000
Answer: B
Diff: 2
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

50) During 2015, NICO Corporation had EBIT of $100,000, a change in net fixed assets of
$400,000, an increase in net current assets of $100,000, an increase in spontaneous current
liabilities of $400,000, a depreciation expense of $50,000, and a tax rate of 30%. Based on this
information, NICO's free cash flow is ________.
A) -$630,000
B) -$50,000
C) $650,000
D) -$30,000
Answer: D
Diff: 2
Topic: Free Cash Flow
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills
23
© Pearson Education Limited, 2015.
51) Given the financial data for New Electronic World, Inc. (NEW), compute the following
measures of cash flows for the NEW for the year ended December 31, 2015.
(a) Operating cash flow
(b) Free cash flow

For the year ended December 31,

Answer:
(a) OCF = EBIT - Taxes + Depreciation
OCF = $30,000 - $8,000 + $3,000 = $25,000
(b) FCF = OCF - Net fixed asset investment (NFAI) - Net current asset investment (NCAI)
NFAI = Change in net fixed assets + Depreciation
= ($24,000 -$ 22,000) + 3,000 = $5,000
NCAI = Change in current assets - change in (Accounts payable + Accruals)
= ($99,000 - $87,000) - ($32,000 - $26,000)
= $6,000
FCF = $35,000 - $5,000 - $6,000 = $14,000
Diff: 2
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

24
© Pearson Education Limited, 2015.
52) Identify each expense or revenue as a cash flow from operating activities (O), a cash flow
from investment activities (I), or a cash flow from financing activities (F).
Administrative expenses
Rent payment
Interest on a note payable
Sale of equipment
Dividend payment
Stock repurchase
Sale of finished goods
Labor expense
Sale of a bond issue
Repayment of a long-term debt
Selling expenses
Depreciation expense
Sale of common stock
Purchase of fixed assets
Answer:

Diff: 2
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

25
© Pearson Education Limited, 2015.
53) Calculate the change in the key balance sheet accounts between 2014 and 2015 and classify
each as a source (S), a use (U), or neither (N), and indicate which type of cash flow it is: an
operating cash flow (O), and investment cash flow (I) or a financing cash flow (F).
ABC Corp.
Balance Sheet Changes and Classification
of Key Accounts between 2014 and 2015

Answer: ABC Corp.


Balance Sheet Changes and Classification
of Key Accounts between 2014 and 2015

Diff: 2
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

26
© Pearson Education Limited, 2015.
Table 4.2

Magna Fax, Inc.


Balance Sheet
For the Years Ended December 31, 2014 and 2015

27
© Pearson Education Limited, 2015.
54) The credit manager at First National Bank has just received the income statement and
balance sheet for Magna Fax, Inc. for the year ended December 31,2015. (See Table 4.2.) The
bank requires the firm to report its earnings performance and financial position quarterly as a
condition of a loan agreement. The bank's credit manager must prepare two key financial
statements based on the information sent by Magna Fax, Inc. This will be passed on to the
commercial loan officer assigned to this account, so that he may review the financial condition of
the firm.
(a) Prepare a statement of retained earnings for the year ended December 31, 2015.
(b) Prepare a summary of cash inflows and cash outflows for the year ended December 31, 2015.
(c) Prepare a statement of cash flows for the year ended December 31, 2015, organized by cash
flow from operating activities, cash flow from investment activities, and cash flow from
financing activities.

Answer:
(a)
Magna Fax, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2015

(b)
Magna Fax, Inc.
Statement of Cash Flows
For the Year Ended December 31, 2015

28
© Pearson Education Limited, 2015.
(c)
Magna Fax, Inc.
Statement of Cash Flows
For the Year Ended December 31, 2015

Diff: 2
Topic: Developing the Statement of Cash Flows
Learning Obj.: LG 2
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

4.3 Understand the financial planning process, including long-term (strategic) financial plans
and short-term (operating) financial plans.

1) Strategic financial plans are planned long-term financial actions and the anticipated financial
impact of those actions.
Answer: TRUE
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

29
© Pearson Education Limited, 2015.
2) A financial planning process begins with short-term, or operating, plans and budgets that in
turn guide the formulation of long-term, or strategic, financial plans.
Answer: FALSE
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

3) Operating financial plans are planned short-term financial actions and the anticipated financial
impact of those actions.
Answer: TRUE
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

4) Generally, firms that are subject to high degrees of operating uncertainty, relatively short
production cycles, or both, tend to use shorter planning horizons.
Answer: TRUE
Diff: 1
Topic: Long-Term (Strategic) Financial Plans
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

5) The sales forecast and various forms of operating and financial data are the key outputs of the
short-run (operating) financial planning.
Answer: FALSE
Diff: 1
Topic: Short-Term (Operating) Financial Plans
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

30
© Pearson Education Limited, 2015.
6) The financial planning process begins with ________ financial plans that in turn guide the
formation of ________ plans and budgets.
A) short-term; long-term
B) short-term; short-term
C) long-term; long-term
D) long-term; short-term
Answer: D
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

7) Short-term financial plans and long-term financial plans generally cover periods ranging from
________ years and ________ years, respectively.
A) one to two; two to ten
B) five to ten; ten to twenty
C) zero to one; five to ten
D) one to ten; ten to fifteen
Answer: A
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

8) The key aspects of a financial planning process are ________.


A) cash planning and investment planning
B) operations planning and investment planning
C) investment planning and profit planning
D) cash planning and profit planning
Answer: D
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

31
© Pearson Education Limited, 2015.
9) Pro forma financial statements are used for ________.
A) cash budgeting
B) preparing financial statements
C) profit planning
D) auditing
Answer: C
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

10) Which of the following would be the least likely to utilize a cash budget?
A) top management
B) middle management
C) public investors
D) lenders
Answer: C
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

11) The primary purpose in preparing pro forma financial statements is ________.
A) for cash planning
B) to ensure the ability to pay dividends
C) to reduce risk
D) for profit planning
Answer: D
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-02
Question Status: Revised
AACSB Tag: Analytic Skills

32
© Pearson Education Limited, 2015.
12) ________ consider proposed fixed-asset outlays, research and development activities,
marketing and product development actions, capital structure, and major sources of financing.
A) Short-term financial plans
B) Long-term financial plans
C) Pro forma statements
D) Cash budgeting
Answer: B
Diff: 1
Topic: Financial Planning Process
Learning Obj.: LG 3
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

13) ________ generally reflect(s) the anticipated financial impact of planned long-term actions.
A) A cash budget
B) Strategic financial plans
C) Operating financial plans
D) A pro forma income statement
Answer: B
Diff: 1
Topic: Long-Term (Strategic) Financial Plans
Learning Obj.: LG 3
Learning Outcome: F-02
Question Status: Previous Edition
AACSB Tag: Analytic Skills

14) In general, firms that are subject to a high degree of ________, relatively short production
cycles, or both, tend to use shorter planning horizons.
A) profitability
B) financial certainty
C) operating uncertainty
D) financial planning
Answer: C
Diff: 1
Topic: Long-Term (Strategic) Financial Plans
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

33
© Pearson Education Limited, 2015.
15) The key outputs of the short-term financial planning process are the ________.
A) cash budget, pro forma income statement, and pro forma balance sheet
B) sales forecast and capital assets journal
C) sales forecast and schedule of changes in working capital
D) income statement, balance sheet, and source and use statement
Answer: A
Diff: 1
Topic: Short-Term (Operating) Financial Plans
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

16) Key inputs to short-term financial planning are ________.


A) cash flow statements and income statement
B) pro forma financial statements
C) sales forecasts, and operating and financial data
D) leverage analysis and pro forma income statement
Answer: C
Diff: 1
Topic: Short-Term (Operating) Financial Plans
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

17) Once sales are forecasted, ________ must be generated to estimate required raw materials.
A) a production plan
B) a cash budget
C) an operating budget
D) a pro forma statement
Answer: A
Diff: 1
Topic: Short-Term (Operating) Financial Plans
Learning Obj.: LG 3
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

34
© Pearson Education Limited, 2015.
4.4 Discuss the cash-planning process and the preparation, evaluation, and use of the cash
budget.

1) The more seasonal and uncertain a firm's cash flows, the greater the number of intervals and
the shorter time intervals.
Answer: TRUE
Diff: 1
Topic: Cash Planning: Cash Budgets
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

2) An internal sales forecast is based on the relationships that can be observed between a firm's
sales and certain key economic indicators such as the gross domestic product, new housing starts,
or disposable personal income.
Answer: FALSE
Diff: 1
Topic: The Sales Forecast
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

3) The ________ is a financial projection of a firm's short-term cash surpluses or shortages.


A) operating financial plan
B) cash budget
C) strategic financial journal
D) capital assets journal
Answer: B
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

35
© Pearson Education Limited, 2015.
4) The primary purpose in preparing a cash budget is ________.
A) to evaluate the intrinsic value of a financial assets
B) to estimate a firm's short-term cash requirements
C) for risk analysis
D) to estimate sales
Answer: B
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

5) Cash budget is a statement of a firm's planned inflows and outflows of cash that is used to
estimate its long-term cash requirement.
Answer: FALSE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

6) Cash planning involves the preparation of a firm's cash budget. Without adequate cash—
regardless of the level of profits—any firm could fail.
Answer: TRUE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

7) Cash budgets and pro forma statements are useful not only for internal financial planning but
also are routinely required by the Internal Revenue Service (IRS).
Answer: FALSE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

36
© Pearson Education Limited, 2015.
8) A cash budget gives the financial manager a clear view of the timing of a firm's expected
profitability over a given period.
Answer: FALSE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

9) Since depreciation and other noncash charges represent a scheduled write-off of an earlier
cash outflow, they should not be included in the cash budget.
Answer: TRUE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

10) In cash budgeting, the impact of depreciation is reflected in a reduction in tax payments.
Answer: TRUE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

11) In cash budgeting, other cash receipts are cash receipts expected to result from sources other
than sales.
Answer: TRUE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

37
© Pearson Education Limited, 2015.
12) A firm's net cash flow is the mathematical difference between the firm's beginning cash and
its cash disbursements in each period.
Answer: FALSE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

13) The excess cash balance is the amount available for investment by a firm if the desired
minimum cash balance is less than the period's ending cash.
Answer: TRUE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

14) The required total financing figures in the cash budget refer to the monthly changes in
borrowing.
Answer: FALSE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

15) If the net cash flow is less than the minimum cash balance, financing is required.
Answer: FALSE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

16) If the ending cash is greater than the minimum cash balance, excess cash exists.
Answer: TRUE
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills
38
© Pearson Education Limited, 2015.
17) Using simulations, a firm can determine the amount of financing needed to protect it
adequately against a cash shortage.
Answer: TRUE
Diff: 1
Topic: Coping with Uncertainty in the Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

18) As the typical cash budget shows cash flows only on a monthly basis, the information
provided by the cash budget is not necessarily adequate for ensuring solvency.
Answer: TRUE
Diff: 1
Topic: Cash Flow within the Month
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

19) As the typical cash budget shows cash flows on a monthly basis, the information provided by
the cash budget is adequate for ensuring solvency.
Answer: FALSE
Diff: 1
Topic: Cash Flow within the Month
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

20) An external sales forecast is based on ________.


A) the relationships between a firm's sales and certain key economic indicators such as GDP and
consumer confidence
B) a buildup, or consensus of sales forecasts through a firm's own sales channels
C) the prediction of a firm's sales over a given period through the analysis of the sales trends of
its competitors.
D) developing the pro forma income statement to forecast sales and then express the various
income statement items as percentage of projected sales
Answer: A
Diff: 1
Topic: The Sales Forecast
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: New
AACSB Tag: Analytic Skills

39
© Pearson Education Limited, 2015.
21) An internal forecast is based on ________.
A) a buildup, or consensus, of sales forecasts through a firm's own sales channels, adjusted for
additional factors such as production capabilities
B) the relationships between a firm's sales and certain economic indicators
C) the prediction of a firm's sales over a given period through surveys sent to financial analysts
D) developing the pro forma income statement to forecast sales and then express the various
income statement items as percentage of projected sales
Answer: A
Diff: 1
Topic: The Sales Forecast
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: New
AACSB Tag: Analytic Skills

22) A firm's final sales forecast is usually a function of ________.


A) its net income
B) the salesperson's estimates of demand
C) internal and external factors in combination
D) its accounts receivable
Answer: C
Diff: 1
Topic: The Sales Forecast
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

23) The key input to the short-term financial planning process is ________.
A) the audit report
B) the pro forma balance sheet
C) the sales forecast
D) the pro forma income statement
Answer: C
Diff: 1
Topic: The Sales Forecast
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

40
© Pearson Education Limited, 2015.
24) A firm has projected sales in May, June, and July of $100, $200, and $300, respectively. The
firm makes 20 percent of sales for cash and collects the balance one month following the sale.
The firm's total cash receipts in July is ________.
A) $220
B) $200
C) $180
D) $140
Answer: A
Diff: 2
Topic: The Sales Forecast
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

25) In preparing a cash budget, the ________ seasonal and uncertain a firm's cash flows, the
________ the number of budgeting intervals it should use.
A) more; greater
B) more; fewer
C) less; greater
D) less; fewer
Answer: A
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

26) The key input to any cash budget is ________.


A) the sales forecast
B) the production plan
C) the pro forma balance sheet
D) the current tax laws
Answer: A
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

41
© Pearson Education Limited, 2015.
27) Of the following components of a cash budget, generally the easiest to estimate would be the
________.
A) cash sales
B) cash receipts
C) cash disbursements
D) month-to-month short-term borrowing
Answer: C
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

28) Cash disbursements include ________.


A) amortization expense
B) rent payments
C) depreciation expense
D) depletion
Answer: B
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

29) A projected excess cash balance for the month may be ________.
A) financed with short-term securities
B) financed with long-term securities
C) invested in marketable securities
D) invested in long-term securities
Answer: C
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

42
© Pearson Education Limited, 2015.
30) If a firm expects short-term cash surpluses, it can plan ________.
A) long-term investments
B) short-term borrowing
C) short-term investments
D) leverage decisions
Answer: C
Diff: 1
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

31) A firm has actual sales in November of $1,000 and projected sales in December and January
of $3,000 and $4,000, respectively. The firm makes 10 percent of its sales for cash, collects 40
percent of its sales one month following the sale, and collects the balance two months following
the sale. The firm's total cash receipts in November is ________.
A) $1,000
B) $100
C) $700
D) $400
Answer: B
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

32) A firm has actual sales in November of $1,000 and projected sales in December and January
of $3,000 and $4,000, respectively. The firm makes 10 percent of its sales for cash, collects 40
percent of its sales one month following the sale, and collects the balance two months following
the sale. The firm's total expected cash receipts in January is ________.
A) $700
B) $2,100
C) $1,900
D) $300
Answer: B
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

43
© Pearson Education Limited, 2015.
33) In April, a firm had an ending cash balance of $35,000. In May, the firm had total cash
receipts of $40,000 and total cash disbursements of $50,000. The minimum cash balance
required by the firm is $25,000. At the end of May, the firm had ________.
A) an excess cash balance of $25,000
B) an excess cash balance of $0
C) required financing of $10,000
D) required financing of $25,000
Answer: B
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

34) In October, a firm had an ending cash balance of $35,000. In November, the firm had a net
cash flow of $40,000. The minimum cash balance required by the firm is $25,000. At the end of
November, the firm had ________.
A) an excess cash balance of $50,000
B) an excess cash balance of $75,000
C) required total financing of $15,000
D) required total financing of $5,000
Answer: A
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

35) In the month of August, a firm had total cash receipts of $10,000, total cash disbursements of
$8,000, depreciation expense of $1,000, a minimum cash balance of $3,000, and a beginning
cash balance of $500. The ending cash balance for August totals ________.
A) $1,500
B) $5,500
C) $2,500
D) $3,500
Answer: C
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

44
© Pearson Education Limited, 2015.
36) In the month of August, a firm had total cash receipts of $10,000, total cash disbursements of
$8,000, depreciation expense of $1,000, a minimum cash balance of $3,000, and a beginning
cash balance of $500. At the end of August, the firm ________.
A) required total financing of $500
B) had an excess cash balance of $5,500
C) had an excess cash balance of $500
D) required total financing of $2,500
Answer: A
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

37) Which of the following represents a way of coping with uncertainty in a cash budget?
A) careful estimation of cash budgets outputs
B) developing a pro forma income statement to forecast sales and then express the various
income statement items as percentage of projected sales
C) always using the prior year's data for estimates of the future
D) using scenario analysis, or "what if" approach, to analyze cash flows under a variety of
circumstances
Answer: D
Diff: 1
Topic: Coping with Uncertainty in the Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

38) One way a firm can reduce the amount of cash it needs in any month is to ________.
A) slow down the payment of receivables
B) delay the payment of wages
C) accrue taxes
D) speed up payment of accounts payable
Answer: B
Diff: 1
Topic: Cash Flow within the Month
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

45
© Pearson Education Limited, 2015.
39) Gerry Jacobs, a financial analyst for Best Value Supermarkets, has prepared the following
sales and cash disbursement estimates for the period August through December of the current
year.

Ninety percent of sales are for cash, the remaining 10 percent are collected one month later. All
disbursements are on a cash basis. The firm wishes to maintain a minimum cash balance of $50.
The beginning cash balance in September is $25. Prepare a cash budget for the months of
October, November, and December, noting any needed financing or excess cash available.
Answer:

Best Value Supermarkets should arrange for a line of credit for at least $235 during the four
month period.
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

46
© Pearson Education Limited, 2015.
40) Terrel Manufacturing expects stable sales through the summer months of June, July, and
August of $500,000 per month. The firm will make purchases of $350,000 per month during
these months. Wages and salaries are estimated at $60,000 per month plus 7 percent of sales. The
firm must make a principal and interest payment on an outstanding loan in June of $100,000. The
firm plans a purchase of a fixed asset costing $75,000 in July. The second quarter tax payment of
$20,000 is also due in June. All sales are for cash.
(a) Construct a cash budget for June, July, and August, assuming the firm has a
beginning cash balance of $100,000 in June.
(b) The sales projections may not be accurate due to the lack of experience by a
newly-hired sales manager. If the sales manager believes the most optimistic
and pessimistic estimates of sales are $600,000 and $400,000, respectively, what
are the monthly net cash flows and required financing or excess cash balances?
Answer:

47
© Pearson Education Limited, 2015.
If the most pessimistic sales figure ($400,000) materializes, the financial manager should expect
a financing requirement of $209,000 and should arrange for a line of credit to cover the firm's
cash deficit. However, if the most optimistic estimate materializes, the financial manager will
need to arrange for investing a total of $349,000 over the three month period.
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

48
© Pearson Education Limited, 2015.
41) In the preparation of a quarterly cash budget, the following revenue and cost information
have been compiled. Prepare and evaluate a cash budget for the months of October, November,
and December based on the information shown below.

∙ The firm collects 60 percent of sales for cash and 40 percent of its sales one month later.
∙ Interest income of $50,000 on marketable securities will be received in December.
∙ The firm pays cash for 40 percent of its purchases.
∙ The firm pays for 60 percent of its purchases the following month.
∙ Salaries and wages amount to 15 percent of the preceding month's sales.
∙ Sales commissions amount to 2 percent of the preceding month's sales.
∙ Lease payments of $100,000 must be made each month.
∙ A principal and interest payment on an outstanding loan is due in December of $150,000.
∙ The firm pays dividends of $50,000 at the end of the quarter.
∙ Fixed assets costing $600,000 will be purchased in December.
∙ Depreciation expense each month of $45,000.
∙ The firm has a beginning cash balance in October of $100,000 and maintains a minimum
cash balance of $200,000.

49
© Pearson Education Limited, 2015.
Answer:

The firm has excess cash during the three month period and can invest the excess cash in
marketable securities.
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

50
© Pearson Education Limited, 2015.
42) Harry's House of Hamburgers (HHH) wants to prepare a cash budget for months of
September through December. Using the following information, prepare the cash budget
schedule and interpret the results.
∙ Sales were $50,000 in June and $60,000 in July. Sales have been forecasted to be $65,000,
$72,000, $63,000, $59,000, and $56,000 for months of August, September, October, November,
and December, respectively. In the past, 10 percent of sales were on cash basis, and the
collection were 50 percent in the first month, 30 percent in the second month, and 10 percent in
the third month following the sales.
∙ Every four months (three times a year) $500 of dividends from investments are expected.
The first dividend payment was received in January.
∙ Purchases are 60 percent of sales, 15 percent of which are paid in cash, 65 percent are paid
one month later, and the rest is paid two months after purchase.
∙ $8,000 dividends are paid twice a year (in March and September).
∙ The monthly rent is $2,000.
∙ Taxes are $6,500 payable in December.
∙ A new hamburger press will be purchased in October for $2,300.
∙ $1,500 interest will be paid in November.
∙ $1,000 loan payments are paid every month.
∙ Wages and salaries are $1,000 plus 5 percent of sales in each month.
∙ August's ending cash balance is $3,000.
∙ HHH would like to maintain a minimum cash balance of $10,000.

51
© Pearson Education Limited, 2015.
Answer: Cash Budget

No financing required. The company may invest the excess cash in marketable securities.
Diff: 2
Topic: Preparing The Cash Budget
Learning Obj.: LG 4
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

52
© Pearson Education Limited, 2015.
4.5 Explain the simplified procedures used to prepare and evaluate the pro forma income
statement and the pro forma balance sheet.

1) Development of pro forma financial statements helps a financial manager to project the
amount of external financing required to support a given level of sales as well as overall financial
performance of the firm in the coming year.
Answer: TRUE
Diff: 1
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

2) Since the percentage-of-sales method assumes that all the form's costs and expenses are
variable, it tends to understate profits when sales are increasing and overstate profits when sales
are decreasing.
Answer: TRUE
Diff: 1
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

3) In the development of pro forma statements, a firm that requires external funds means that its
projected level of cash is in excess of its needs and that funds would therefore be available for
repaying debt, repurchasing stock, or increasing the dividend to stockholders.
Answer: FALSE
Diff: 1
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

53
© Pearson Education Limited, 2015.
4) The primary purpose in preparing pro forma financial statements is ________.
A) for cash planning
B) to ensure the ability to pay dividends
C) for risk analysis
D) for profit planning
Answer: D
Diff: 1
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

5) ________ are projected financial statements.


A) Pro forma statements
B) Statements of retained earnings
C) Cash budgets
D) Cash flow statements
Answer: A
Diff: 1
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

6) The key inputs for preparing pro forma income statements using the simplified approaches are
the ________.
A) sales forecast for the preceding year and financial statements for the coming year
B) sales forecast for the coming year and the cash budget for the preceding year
C) sales forecast for the coming year and financial statements for the preceding year
D) cash budget for the coming year and sales forecast for the preceding year
Answer: C
Diff: 1
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

54
© Pearson Education Limited, 2015.
7) In the next planning period, a firm plans to change its policy of all cash sales and initiate a
credit policy requiring payment within 30 days. The statements that will be directly affected
immediately are the ________.
A) pro forma income statement, balance sheet, and cash budget
B) pro forma balance sheet and cash budget
C) cash budget and statement of retained earnings
D) pro forma income statement and pro forma balance sheet
Answer: B
Diff: 1
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

8) A firm plans to retire outstanding bonds in the next planning period. Which of the following
gets affected?
A) pro forma income statement and pro forma balance sheet
B) previous year income statement and previous year balance sheet
C) previous year income statement and statement of retained earnings
D) pro forma income statement and proxy statement
Answer: A
Diff: 1
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

9) A firm plans to depreciate a five year asset in the next planning period. The statements that
will be directly affected are the ________.
A) pro forma income statement, pro forma balance sheet, and cash budget
B) pro forma balance sheet, cash budget, and statement of retained earnings
C) cash budget and pro forma balance sheet
D) pro forma income statement and pro forma balance sheet
Answer: D
Diff: 1
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

55
© Pearson Education Limited, 2015.
10) In a period of rising sales, utilizing past cost and expense ratios (percent-of-sales method)
when preparing pro forma financial statements will tend to ________.
A) overstate costs and overstate profits
B) overstate costs and understate profits
C) understate costs and overstate profits
D) understate costs and understate profits
Answer: B
Diff: 1
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

11) The percentage-of-sales method of preparing pro forma income statements assumes that
________.
A) sales are fixed
B) all costs inversely vary with sales
C) all costs are independent
D) all costs are variable
Answer: D
Diff: 1
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

12) The percent-of-sales method of developing a pro forma income statement forecasts sales and
other line items as a ________.
A) percentage of projected sales
B) percentage of average sales over a period
C) percentage of projected total assets
D) percentage of average total assets over a period
Answer: A
Diff: 1
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

56
© Pearson Education Limited, 2015.
13) The best way to adjust for the presence of fixed costs when using the simplified approach for
pro forma income statement preparation is ________.
A) to proportionately vary the fixed costs with the change in sales
B) to adjust for projected fixed-asset outlays
C) to disproportionately vary the costs with the change in sales
D) to break the firm's historical costs into fixed and variable components
Answer: D
Diff: 1
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

14) The percent-of-sales method to prepare a pro forma income statement assumes a firm has no
fixed costs. Therefore, the use of the past cost and expense ratios generally tends to ________
profits when sales are increasing.
A) accurately predict
B) overstate
C) understate
D) have no effect on
Answer: C
Diff: 1
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

15) For firms with high fixed costs, the percent-of-sales approach for preparing a pro forma
income statement tends to ________.
A) overestimate profits when sales are increasing
B) underestimate profits when sales are increasing
C) underestimate profits when assets are increasing
D) overestimate profits when assets are increasing
Answer: B
Diff: 1
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

57
© Pearson Education Limited, 2015.
16) In a period of rising sales utilizing past cost and expense ratios (percent-of-sales method),
when preparing pro forma financial statements and planning financing, will tend to ________.
A) understate retained earnings and understate the additional financing needed
B) overstate retained earnings and overstate the additional financing needed
C) understate retained earnings and overstate the financing needed
D) overstate retained earnings and understate the financing needed
Answer: C
Diff: 1
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

17) Under the judgmental approach for developing a pro forma balance sheet, the "plug" figure
required to bring the statement into balance may be called the ________.
A) cash balance
B) retained earnings
C) external financing required
D) accounts receivable
Answer: C
Diff: 1
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

18) The ________ method of developing a pro forma balance sheet estimates values of certain
balance sheet accounts while external financing is used as a balancing, or plug, figure.
A) percent-of-sales
B) accrual
C) judgmental
D) cash
Answer: C
Diff: 1
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

58
© Pearson Education Limited, 2015.
19) A firm has prepared the coming year's pro forma balance sheet resulting in a plug figure in a
preliminary statement—called the external financing required—of $230,000. The firm should
prepare to ________.
A) repurchase common stock totaling $230,000
B) arrange for a loan of $230,000
C) do nothing; the balance sheet balances
D) invest in marketable securities totaling $230,000
Answer: B
Diff: 1
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

20) A firm has prepared the coming year's pro forma balance sheet resulting in a plug figure in a
preliminary statement—called the external financing required—of negative $250,000. The firm
may prepare to ________.
A) sell common stock totaling $250,000
B) arrange for a loan of $250,000
C) do nothing; the balance sheet balances
D) invest in marketable securities totaling $250,000
Answer: D
Diff: 1
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

59
© Pearson Education Limited, 2015.
Table 4.3

The financial analyst for Sportif, Inc. has compiled sales and disbursement estimates for the
coming months of January through May. Historically, 75 percent of sales are for cash with the
remaining 25 percent collected in the following month. The ending cash balance in January is
$3,000.

21) The total cash receipts for April are ________. (See Table 4.3)
A) $5,000
B) $7,500
C) $9,250
D) $10,000
Answer: D
Diff: 2
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

22) The net cash flow for February is ________. (See Table 4.3)
A) -$1,250
B) -$1,000
C) $5,750
D) $750
Answer: A
Diff: 2
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

60
© Pearson Education Limited, 2015.
23) The firm has a negative net cash flow in the month(s) of ________. (See Table 4.3)
A) January, February, and March
B) February and March
C) January and February
D) February
Answer: C
Diff: 2
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Analytic Skills

24) The ending cash balance for March is ________. (See Table 4.3)
A) $250
B) $6,750
C) $2,500
D) $500
Answer: B
Diff: 2
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

25) The ending cash balance for February is ________. (See Table 4.3)
A) $750
B) $1,750
C) $2,500
D) -$1,000
Answer: B
Diff: 2
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

61
© Pearson Education Limited, 2015.
26) At the end of May, the firm has an ending cash balance of ________. (See Table 4.3)
A) $9,000
B) $16,750
C) $14,250
D) $12,000
Answer: B
Diff: 2
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

27) The firm has a total financing requirement of ________ for the period from February through
May. (See Table 4.3)
A) $ 0
B) $1,750
C) $1,250
D) $ 750
Answer: A
Diff: 2
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

28) If a pro forma balance sheet dated at the end of May was prepared from the information
presented, the marketable securities would total ________. (See Table 4.3)
A) $9,000
B) $9,500
C) $12,000
D) $16,750
Answer: D
Diff: 2
Topic: Profit Planning: Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

62
© Pearson Education Limited, 2015.
Table 4.4

Use the percent-of-sales method to prepare a pro forma income statement for the year ended
December 31, 2015, for Hennesaw Lumber, Inc.

Hennesaw Lumber, Inc. estimates that its sales in 2000 will be $4,500,000. Interest expense is to
remain unchanged at $105,000 and the firm plans to pay cash dividends of $150,000 during
2015. Hennesaw Lumber, Inc.'s income statement for the year ended December 31, 2014 is
shown below. From your preparation of the pro forma income statement, answer the following
multiple choice questions.

29) The pro forma net profits after taxes for 2015 are ________. (See Table 4.4)
A) $202,500
B) $207,000
C) $52,500
D) $57,000
Answer: B
Diff: 2
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

63
© Pearson Education Limited, 2015.
30) The pro forma cost of goods sold for 2015 is ________. (See Table 4.4)
A) $3,500,000
B) $3,750,000
C) $3,825,000
D) $4,000,000
Answer: C
Diff: 2
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

31) The pro forma operating expenses for 2015 are ________. (See Table 4.4)
A) $150,000
B) $200,000
C) $210,000
D) $225,000
Answer: D
Diff: 2
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

32) The pro forma accumulated retained earnings account on the balance sheet is projected to be
________. (See Table 4.4)
A) $62,500
B) $52,500
C) $57,000
D) $67,000
Answer: C
Diff: 2
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

64
© Pearson Education Limited, 2015.
Table 4.5

A financial manager at General Talc Mines has gathered the financial data essential to prepare a
pro forma balance sheet for cash and profit planning purposes for the coming year ended
December 31, 2015. Using the percent-of-sales method and the following financial data, prepare
the pro forma balance sheet in order to answer the following multiple choice questions.
(a) The firm estimates sales of $1,000,000.
(b) The firm maintains a cash balance of $25,000.
(c) Accounts receivable represents 15 percent of sales.
(d) Inventory represents 35 percent of sales.
(e) A new piece of mining equipment costing $150,000 will be purchased in 2010.
Total depreciation for 2010 will be $75,000.
(f) Accounts payable represents 10 percent of sales.
(g) There will be no change in notes payable, accruals, and common stock.
(h) The firm plans to retire a long term note of $100,000.
(i) Dividends of $45,000 will be paid in 2015.
(j) The firm predicts a 4 percent net profit margin.

Balance Sheet
General Talc Mines
December 31, 2014

65
© Pearson Education Limited, 2015.
33) The pro forma total current assets amount is ________. (See Table 4.5)
A) $470,900
B) $500,000
C) $525,000
D) $575,000
Answer: C
Diff: 2
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

34) The pro forma net fixed assets amount is ________. (See Table 4.5)
A) $500,000
B) $575,000
C) $600,000
D) $650,000
Answer: B
Diff: 2
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

35) The pro forma current liabilities amount is ________. (See Table 4.5)
A) $400,000
B) $450,000
C) $475,000
D) $500,000
Answer: D
Diff: 2
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

66
© Pearson Education Limited, 2015.
36) The pro forma total liabilities amount is ________. (See Table 4.5)
A) $500,000
B) $550,000
C) $700,000
D) $650,000
Answer: B
Diff: 2
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

37) The pro forma accumulated retained earnings amount is ________. (See Table 4.5)
A) $90,000
B) $175,000
C) $140,000
D) $130,000
Answer: D
Diff: 2
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

38) The external financing required in 2015 will be ________. (See Table 4.5)
A) $230,000
B) $240,000
C) $0
D) $195,000
Answer: B
Diff: 2
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

67
© Pearson Education Limited, 2015.
39) General Talc Mines may prepare to ________. (See Table 4.5)
A) arrange for a loan equal to the external funds requirement
B) eliminate the dividend to cover the needed financing
C) cancel the retirement of the long term note to cover the needed financing
D) repurchase common stock equal to the external funds requirement
Answer: A
Diff: 1
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

40) The external funds requirement results primarily from ________. (See Table 4.5)
A) the payment of dividends
B) the retirement of debt and purchase of new fixed assets
C) low profit margin
D) high cost of sales
Answer: B
Diff: 1
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

41) If General Talc Mines cannot raise the external financing required through traditional credit
channels, the firm may ________. (See Table 4.5)
A) increase sales
B) purchase additional fixed assets to raise productivity
C) sell common stock
D) factor accounts receivable
Answer: C
Diff: 1
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

68
© Pearson Education Limited, 2015.
42) Income Statement
Huddleston Manufacturing Company
For the Year Ended December 31, 2015

Huddleston Manufacturing estimates its sales in 2016 will be $3 million. Interest expense is
expected to remain unchanged at $70,000, and the firm plans to pay cash dividends of $140,000
during 2016. Use the percent-of-sales method to prepare a pro forma income statement for the
year ended December 31, 2016, based on the 2015 income statement shown above.
Answer: Pro Forma Income Statement
Huddleston Manufacturing Company
For the Year Ended December 31, 2016

Diff: 2
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

43) Calculate the amount of accounts receivable assuming that a pro forma balance sheet dated at
the end of May was prepared from the information presented. (See Table 4.3)
Answer: $2,500.
Diff: 2
Topic: Preparing The Pro Forma Balance Sheet
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills
69
© Pearson Education Limited, 2015.
Table 4.6

Income Statement
Ace Manufacturing, Inc.
For the Year Ended December 31, 2015

44) Ace Manufacturing, Inc., is preparing pro forma financial statements for 2016. The firm
utilized the percent-of-sales method to estimate costs for the next year. Sales in 2015 were $2
million and are expected to increase to $2.4 million in 2016. The firm has a 40 percent tax rate.
(a) Given the 2015 income statement in Table 4.6, estimate net profit and retained earnings
for 2016.
(b) If $200,000 of the cost of goods sold and $40,000 of selling expense are fixed costs; and
the interest expense and dividends are not expected to change, what is he dollar effect on net
income and retained earnings? What is the significance of this effect?
Answer:
(a)
Pro forma income statement: December 31, 2016

70
© Pearson Education Limited, 2015.
(b)

Net profit after tax is understated by $38,400 and retained earnings by $58,400, using the
percent-of-sales method. In planning the addition of assets (current or fixed) and the financing of
those assets, the straight percent-of-sales method understates net profit and retained earnings.
This, therefore, overstates additional financing needed to add those assets. The judgmental
approach allows the firm to obtain a more accurate estimate of the line of credit or long-term
financing that will be necessary in the next planning period.
Diff: 2
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

71
© Pearson Education Limited, 2015.
Table 4.7

The income statement and balance sheet for the ZZZ Mattress Co. for the year ended December
31, 2015 follow.

Balance Sheet
ZZZ Mattress Company
December 31, 2015

72
© Pearson Education Limited, 2015.
45) The ZZZ Mattress Co. has been requested by the 1st National Bank, a major creditor, to
prepare a pro forma balance sheet for the year ending, December 31, 2016. Using the percent-of-
sales method and the following financial data, prepare the pro forma income statement and
balance sheet and discuss the resulting external financing required. (See Table 4.7)
∙ 2016 sales are estimated at $330,000.
∙ Accounts receivable represent 20 percent of sales.
∙ A minimum cash balance of $1,650 is maintained.
∙ Inventory represents 32 percent of sales.
∙ Fixed-asset outlays in 2006 are $20,000. Total depreciation expense for 2016 will be
$15,000.
∙ Accounts payable represents 15 percent of sales.
∙ Notes payable and accruals will remain the same.
∙ No long-term debt will be retired in 2016.
∙ No common stock will be repurchased in 2016.
∙ The firm will pay dividends equal to 50 percent of its earnings after taxes.
Answer:

73
© Pearson Education Limited, 2015.
Balance Sheet
ZZZ Mattress Company
December 31, 2016

A 10 percent growth rate in sales cannot be supported by the firm's internally generated funds. A
larger line of credit or a request for a long-term loan for the additional $8,390 is necessary to
finance operations.
Diff: 2
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Reflective Thinking Skills

74
© Pearson Education Limited, 2015.
Table 4.8

Balance Sheet
Wirl Wind Company

75
© Pearson Education Limited, 2015.
46) The Wirl-Wind Company of America is trying to plan for the next year. Using the current
income statement and balance sheet given in Table 4.8, and the additional information provided,
prepare the company's pro forma statements.
∙ Sales are projected to increase by 15 percent.
∙ Total of $75,000 in dividend will be paid.
∙ A minimum cash balance of $650,000 is desired.
∙ A new asset for $50,000 will be purchased.
∙ Depreciation expense for next year is $50,000.
∙ Marketable securities will remain the same.
∙ Accounts receivable, inventory, accounts payable, notes payable, and accruals will increase
by 15 percent.
∙ $30,000 new issue of bond will be sold.
∙ No new stock will be issued.
Answer:

76
© Pearson Education Limited, 2015.
The Wirl Wind Company of America will have an excess cash of $156,474 which can be used to
pay debt.
Diff: 2
Topic: Preparing The Pro Forma Income Statement
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Previous Edition
AACSB Tag: Reflective Thinking Skills

77
© Pearson Education Limited, 2015.
4.6 Evaluate the simplified approaches to pro forma financial statement preparation and the
common uses of pro forma statements.

1) One basic weakness of the simplified pro forma approaches lies in the assumption that certain
variables, such as cash, accounts receivable, and inventories, can be forced to take on certain
"desired" values.
Answer: TRUE
Diff: 1
Topic: Evaluation of Pro Forma Statements
Learning Obj.: LG 6
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

2) One basic weakness of the simplified pro forma approaches lies in the assumption that the
firm's past financial condition is an accurate indicator of its future.
Answer: TRUE
Diff: 1
Topic: Evaluation of Pro Forma Statements
Learning Obj.: LG 6
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

3) A weakness of the percent-of-sales method of preparing a pro forma income statement is


________.
A) that it forecasts income and then expresses the various income statement items as percentages
of projected income.
B) the assumption that the firm faces linear total revenue and total operating cost functions
C) the assumption that the firm's past financial condition is an accurate predictor of its future
D) the difficulty faced in calculation and preparation of such statements
Answer: C
Diff: 1
Topic: Evaluation of Pro Forma Statements
Learning Obj.: LG 6
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

78
© Pearson Education Limited, 2015.
4) Utilizing past cost and expense ratios (percent-of-sales method) when preparing pro forma
financial statements will tend to ________.
A) understate profits when sales are decreasing
B) understate profits when sales are increasing
C) overstate profits when sales are increasing
D) neither understate nor overstate profits
Answer: B
Diff: 1
Topic: Evaluation of Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

5) Utilizing past cost and expense ratios (percent-of-sales method) when preparing pro forma
financial statements will tend to ________.
A) understate profits when sales are decreasing and overstate profits when sales are increasing
B) understate profits, no matter what the change in sales, as long as fixed costs are present
C) understate profits when sales are increasing and overstate profits when sales are decreasing
D) overstate profits, no matter what the change in sales, as long as fixed costs are present
Answer: C
Diff: 1
Topic: Evaluation of Pro Forma Statements
Learning Obj.: LG 5
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

6) The weakness of the judgmental approach to preparing a pro forma balance sheet is ________.
A) the assumption that the values of certain accounts can be forced to take on desired levels
B) the assumption that the firm faces linear total revenue and total operating cost functions
C) the assumption that the firm's past financial condition is an accurate predictor of its future
D) ease of calculation and preparation
Answer: A
Diff: 1
Topic: Evaluation of Pro Forma Statements
Learning Obj.: LG 6
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

79
© Pearson Education Limited, 2015.
7) If transportation costs were a huge portion of a firm's expenses and the firm expected gas
prices to increase greatly in the next year, then in preparing its pro forma income statement the
firm should ________.
A) use the percentage of transportation costs from last year's sales
B) decrease the percentage of transportation costs from the percentage of last year's sales
C) increase the percentage of transportation costs from the percentage of last year's sales
D) double the percentage of transportation costs from the percentage of last year's sales
Answer: C
Diff: 1
Topic: Evaluation of Pro Forma Statements
Learning Obj.: LG 6
Learning Outcome: F-25
Question Status: Revised
AACSB Tag: Analytic Skills

80
© Pearson Education Limited, 2015.

You might also like