Question

Which of the following statements is CORRECT?

Dividends are always paid by a corporation.

EBIT has already been taxed.

One way of using the excess cash is to pay the shareholders a dividend. Another way might be a firm buying its own stock back.

If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.

For profit firms write large checks for depreciation expense.

Analysts who follow Howe Industries recently noted that, relative to the previous year, the company’s net cash provided from operations increased, yet cash as reported on the balance sheet decreased.Which of the following factors could explain this situation?

The company cut its dividend.

The company made large investments in fixed assets.

The company sold a division and received cash in return.

The company issued new common stock.

The company issued new long-term debt.

The Nantell Corporation just purchased an expensive piece of equipment.Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years.Other things held constant, which of the following will occur as a result of this Congressional action?Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.

Nantell’s taxable income will be lower.

Nantell’s operating income (EBIT) will increase.

Nantell’s cash position will improve (increase).

Nantell’s reported net income for the year will be lower.

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

4).      Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?

a.   The periodic rate of interest is 2% and the effective rate of interest is 4%.

b.   The periodic rate of interest is 8% and the effective rate of interest is greater than 8%.

c.   The periodic rate of interest is 4% and the effective rate of interest is less than 8%.

d.   The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.

e.   The periodic rate of interest is 8% and the effective rate of interest is also 8%.

Answer 1

1.

Dividends are always paid by a corporation. FALSE. Dividends are not always PAID in cash, there can be other schemes by a corporation for dividend distribution like Dividend reinvestment plan etc.

EBIT has already been taxed. FALSE. EBIT is Earnings before interest and taxes i.e. taxes have not yet been deducted.

One way of using the excess cash is to pay the shareholders a dividend. Another way might be a firm buying its own stock back. TRUE

If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation. FALSE. In such case, we would normally expect to see its stock price exceed its book value per share.

For profit firms write large checks for depreciation expense. FALSE.

2.

The company cut its dividend. No. It will result in increase in Cash from financing activities.

The company made large investments in fixed assets. Yes. It will decrease the cash flows from investing activities.

The company sold a division and received cash in return. No. It will result in increase in Cash from investing activities.

The company issued new common stock. No. It will result in increase in Cash from financing activities

The company issued new long-term debt. No. It will result in increase in Cash from financing activities

3.

Nantell’s taxable income will be lower. No. Decrease in depreciation amount will increase the net taxable income.

Nantell’s operating income (EBIT) will increase. Yes. Decrease in depreciation will increase the operating income.

Nantell’s cash position will improve (increase). No. Depreciation is a non-cash activity, it will not effect the cash. Also due to increase in taxable income, the net tax paid will increase, thus decreasing the cash position, not increasing it.

Nantell’s reported net income for the year will be lower. No. Decrease in depreciation amount will increase the net income.

Nantell’s tax liability for the year will be lower. No. Decrease in depreciation amount will increase the net taxable income, thereby increasing the tax liability on net taxable income.

4.

Periodic interest rate = nominal rate of interest/number of compounding periods = 8%/4 = 2%

Effective interest rate = [1+(nominal rate of interest/ number of compounding periods)]^{^number of compounding periods} - 1 = [1+(0.08/4)]^{^4} - 1 = 1.0824 - 1 = 0.0824 or 8.24%

Thus, the correct answer is d. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.