Assignment | The primary reason the annual report is important in finance is that it is used by investors

CH3:
Part 1: True or False
1. The primary reason the annual report is important in finance is that it is used by investors when
they form expectations about the firm's future earnings and dividends, and the riskiness of those
cash flows.
True
2. The amount shown on the December 31, 2015 balance sheet as "retained earnings" is equal to the
firm's net income for 2015 minus any dividends it paid
False
3. The income statement shows the difference between a firm's income and its costs--i.e., its
profits--during a specified period of time. However, not all reported income comes in the form of
cash, and reported costs likewise may not be consistent with cash outlays. Therefore, there may
be a substantial difference between a firm's reported profits and its actual cash flow for the same
period.
True
4. In finance, we are generally more interested in cash flows than in accounting profits. Free cash
flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital
expenditures and changes in net operating working capital.
True
5. To estimate the cash flow from operations, depreciation must be added back to net income
because it is a non-cash charge that has been deducted from revenue in the net income
calculation.
True
Part 2: Multiple Choice Questions
1. Which of the following statements is CORRECT?
a
.
Assets other than cash are expected to produce cash over time, and the amounts of cash
they eventually produce should be exactly the same as the amounts at which the assets
are carried on the books.
b
.
The primary reason the annual report is important in finance is that it is used by investors
when they form expectations about the firm's future earnings and dividends, and the riskiness

of those cash flows.
c
.
The annual report is an internal document prepared by a firm's managers solely for the use of
its creditors/lenders.
d
.
The four most important financial statements provided in the annual report are the balance
sheet, income statement, cash budget, and statement of stockholders' equity.
Answer: a.
2. Other things held constant, which of the following actions would increase the amount of cash on
a company's balance sheet?
a
.
The company repurchases common stock.
b
.
The company pays a dividend.
c
.
The company issues new common stock.
d
.
The company gives customers more time to pay their
bills.
e
.
The company purchases a new piece of equipment.
Answer: c.
3. Which of the following items cannot be found on a firm’s balance sheet under current liabilities?
a
.
Accounts payable.
b
.
Short-term notes payable to the
bank.
c
.
Accrued wages.
d
.
Cost of goods sold.
e
.
Accrued payroll taxes.
Answer: d.
Part 3: Problems
Q1. The assets of Dallas & Associates consist entirely of current assets and
net plant and equipment. The firm has total assets of $2.5 million and net

plant and equipment equals $2 million. It has notes payable of $150,000,
long-term debt of $750,000, and total common equity of $1.5 million. The
firm does have accounts payable and accruals on its balance sheet. The firm
only finances with debt and common equity, so it has no preferred stock on
its balance sheet.
a. What is the company’s total debt? - $ 0.9 Million
b. What is the amount of total liabilities and equity that appears on the firm’s
balance
sheet? - $ 2.5 Million
c. What is the balance of current assets on the firm’s balance sheet? - $ 0.5 Million
d. What is the balance of current liabilities on the firm’s balance sheet? - $ 0.25
Million
e. What is the amount of accounts payable and accruals on its balance sheet? [Hint:
Consider this as a single line item on the firm’s balance sheet.] - $ 0.1 Million
f. What is the firm’s net working capital? - $ 0.4 Million
g. What is the firm’s net operating working capital? – (1 – 0.1) = $ 0.9 Million
Q2. Pearson Brothers recently reported an EBITDA of $7.5 million and net
income of $2.1 million. It had $2 million of interest expense, and its
corporate tax rate was 30%. What was its charge for depreciation and
amortization? Hint : Deprec. = EBITDA – EBIT EBIT = EBT +
Interest EBT = Net Income / ( 1- T ) Interest = EBIT – EBT
Depreciation = EBITDA – EBIT
= $7.5 – EBIT
EBIT = EBT + Interest
= EBT + 2
EBT = Net income/ (1-t) = $ 2.1/ (1-.3) = 3
Thus, EBIT = 3 +2
= 5
And, hence, depreciation = EBITDA – EBIT
= $ (7.5-5) Mn
= $ 2.5 Mn
Q3. Harper Industries has $900 million of common equity on its balance
sheet; its stock price is $80 per share; and its Market Value Added (MVA) is
$50 million. How many common shares are currently outstanding?