BEC 3

Question 1

Which of the following characteristics represent(s) an advantage of the internal rate of return technique over the accounting rate of return technique in evaluating a project?

Recognition of the project’s salvage value

Emphasis on cash flows

Recognition of the time value of money

Answer 1

2 and 3 only

BOTH ARR and IRR consider salvage value - ARR in computation of depreciation expense and IRR as a future cash flow.

Question 2

If income tax considerations are ignored, how is depreciation handled by the following capital budgeting techniques?

Answer 2

Accounting rate of return is included, internal rate of return and payback are excluded

Internal rate of return is a capital budgeting method which attempts to determine the internal return from a proposed project.

The internal rate of return is that rate which produces a zero net present value. With this in mind, depreciation is only relevant if it affects cash flows. So, if tax considerations are ignored, depreciation must be excluded in performing internal rate of return analysis.

Question 3

What type of covenant requires a corporation to maintain, at all times, some minimum level of working capital?

Answer 3

Affirmative consent

An affirmative consent is a covenant that requires a corporation to maintain, at all times, some minimum level of working capital

Question 4

Because an organization makes heavy use of client/server architecture, end users have much of its critical and sensitive information on their personal computers (PCs) and departmental file servers. The chief financial officer has asked the auditors for input for developing an end-user computing policy. The policy requires a long-range, end-user computing plan. Which of the following documents should most strongly influence the development of this plan?

Answer 4

The organization’s strategic operational plan.

Strategic goals outline how the organization will use information systems to create a competitive advantage, and the strategic operational plan is, therefore, one of the most important influences on the development of the end-user computing strategic plan.

Question 5

Change Control System

Answer 5

The process of requesting a change, reviewing the effectiveness of the change, approving the change, and implementing the change.

Question 6

To successfully implement systems reliability principles, a company must:

design and implement specific control procedures before developing and documenting a comprehensive set of control policies.

effectively communicate policies to all employees, customers, suppliers, and other authorized users.

design and employ all appropriate control procedures to implement the policies, regardless of cost.

monitor the system but do not take corrective action without internal audit’s review and approval.

Answer 6

effectively communicate policies to all employees, customers, suppliers, and other authorized users.

To successfully implement systems reliability principles, a company must:

• develop and document a comprehensive set of control policies BEFORE designing and implementing specific control procedures
• effectively communicate policies to all employees, customers, suppliers, and other authorized users. All users should be send regular, period reminders about security policies and be trained in how to comply with them.
• design and employ appropriate and cost-beneficial control procedures to implement the policies.
• monitor the system and take corrective action to maintain compliance with policies. Internal audit review and approval is NOT required prior to taking corrective action.

Question 7

Banks are required to process many transactions from paper documents (e.g., checks, deposit slips) during the course of an average business day. This requires a reliable, yet economical form of input. The most common source automation device used by banks is:

Answer 7

Magnetic ink character recognition.

Magnetic ink character recognition is most often used by banks to read the magnetic ink on checks and deposit slips.

Question 8

Five Core Risk Principles

Answer 8

1. Security - the system is protected against unauthorized physical and logical access to prevent or minimize the theft, improper use, alteration, destruction, or disclosure of data and software.
2. Availability: the system is available for operation and use as committed or agreed
3. Processing Integrity: System Processing is complete, accurate, timely, and authorized
4. Confidentiality - Information designated as confidential is protected as committed or agreed.
5. Privacy - Personal information is collected, used, retained, disclosed, and destroyed in conformity with the commitments in the entity’s privacy notice and with criteria set forth in GAAP.

Question 9

Modigliani and Miller Theorem

Answer 9

the market value of a company is calculated using its earning power and the risk of its underlying assets and is independent of the way it finances investments or distributes dividends.

In a world with taxes and bankruptcy costs, the maximum value of a firm would be the point where the marginal cost of debt is equal to the marginal cost of bankruptcy.

In a world with taxes, the cost of capital would be different for different financing sources.

Question 10

What is the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt

Answer 10

To reduce the interest rate on the bonds being sold.

Question 11

A ratio that examines the percentage change in earnings available to common stockholder that is associated with a given percentage change in earnings before interest and taxes is a measure of

Answer 11

a degree of financial leverage

Question 12

Capital Asset Pricing Model

Answer 12

Required rate of return for equity = risk-free rate + beta(LT average risk premium for the market - risk-free rate)

Question 13

A firm with a higher degree of operating leverage when compared to the industry average implies that

Answer 13

the firm’s profits are more sensitive to changes in sales volumes

Operating Leverage is calculated by dividing an entity’s contribution margin/ net operating income

Question 14

A company has the following financial information:

 Sales          $200,000
 Net income      100,000
 Depreciation     20,000
 Interest         10,000
 Taxes             5,000
What is the company's operating profit margin?

Answer 14

Operating
profit = Operating income = $100,000 + $10,000 + $5,000 = 57.5%
margin Sales $200,000

Question 15

In relation to financial leverage, if Carlisle Company did not have preferred stock, the degree of total leverage would

Answer 15

decrease in proportion to a decrease in financial leverage

Financial leverage increases when the proportion of fixed payment obligations from interest and preferred dividends increases relative to the “variable” payments to the common stockholders.

Question 16

Sylvan Corporation has the following capital structure.

Debenture bonds $10,000,000
Preferred equity 1,000,000
Common equity 39,000,000
The financial leverage of Sylvan Corporation would increase as a result of:

Answer 16

Financing its future investment with a higher percentage of bonds

Debt pays a fixed amount.

Question 17

An advantage of using FIFO instead of LIFO in a period of rising prices is that:

Answer 17

FIFO better approximates the actual physical flow of units through inventory

Many companies try to use older units in inventory first so as to reduce spoilage and obsolescence costs.

Question 18

Which inventory method matches the most current costs with revenue?

Answer 18

FIFO

Question 19

A disadvantage to the net present value method is that:

Answer 19

We must know the cost of capital

Normally the cost of capital is used as the discount rate, and a discount rate is necessary in order to determine the net present value of the future cash inflows. We use the cost of capital today (the discount rate does not change based on expected fluctuating interest rates.

Question 20

The Valuation approach that is similar to the economic substitution principle is the ________ approach.

Answer 20

cost

The cost approach seeks to find the cost to replace the asset with an asset of like function and capacity. This method is similar to the economic substitution principle. It is important to adjust the cost for obsolescence and deterioration.

Question 21

What corporate characteristics would favor debt financing versus equity financing?

Answer 21

A high tax rate

Businesses can deduct their interest payments on the debt instruments.

Equity dividends are not deductible.

Question 22

According to the pecking order theory, what will companies prefer to use first

Answer 22

Internal financing

The other types of financing, but they require more time and less flexibility.

They include:
outside financing, debt financing, and adjusting the dividend.

Question 23

A firm’s target or optimal capital structure is consistent with which one of the following?

Answer 23

Minimum weighted average cost of capital

Question 24

Which of the following is not a source of funds used to finance a company?

Short-term debt

Long-term debt

Common stock

Investment in bonds

Answer 24

Investment in bonds

Investment in bonds is an asset and the acquisition of such bonds is a use of funds, not a source.

The right side of the balance sheet represents the sources of funds used to finance a company.

Question 25

In general it is more expensive for a company to finance with equity capital than with debt capital because:

Answer 25

investors are exposed to greater risk with equity capital

Stockholders are the last to be paid, making their risk in the company greater. The greater degree of risk requires a greater reward.

Question 26

Capital Asset pricing

Answer 26

Evaluates the following four components,

• risk-free rate, stock’s beta coefficient,
• rate of return on the market portfolio
• and required rate of return on the company’s stock.

Question 27

The cost of debt most frequently is measured as

Answer 27

actual interest rate minus tax savings.

Question 28

Optimal Capitalization for an organization usually can be determined by the:

Answer 28

Lowest total (WACC)

Weighted-average cost of capital

Question 29

The benefits of debt financing over equity financing are likely to be highest in which of the following situations?

Answer 29

High marginal tax rates and few noninterest tax benefits

Interest on debt is tax deductible by a corporation, while dividends paid are not.

Question 30

What factor is inherent in a firm’s operations if it utilizes only equity financing?

Answer 30

Business Risk

Business risk is the uncertainty associated with the ability to forecast EBIT (earnings before interest and taxes) due to such things as sales variability and operating leverage. THis risk is inherest in equity financing.

Question 31

If Brewer Corporation’s bonds are currently yielding 8% in the marketplace, why would the firm’s cost of debt be lower?

Answer 31

Interest is deductible for tax purposes.

Question 32

A strength of the percentage of accounts receivable balance method is that:

Answer 32

Is may be an accurate predictor of future relationships

The assumption is that, as total credit sales increase, total uncollectible accounts will increase,

Question 33

A weakness of the percentage of accounts receivable balance method is that

Answer 33

A conditions change, historical relationships may no longer hold true.

When using a historical relationship to predict future events, the estimate may no longer be accurate as conditions change that affect the accounts involved.

Question 34

With the percentage-of-sales method of calculating the allowance for doubtful accounts, uncollectible amounts very in proportion to:

Answer 34

Total credit sales

The assumption is that, as total credit sales increase, total uncollectible accounts will increase. Management would not use total sales, as they will not be part of the accounts receivable balance.

Question 35

A strength in the percentage-of-sales method is that it:

Answer 35

Matches the bad debt expense during the month with the credit sales made during the month.

Question 36

Cost of capital

Answer 36

the cost of debt and various equity components in the firm’s capital structure.

Question 37

Interest cost and marginal tax rate are used to determine the

Answer 37

cost of debt

Question 38

Besides the amount of the dividend paid to common shareholders and the new common stock price, the cost of common equity takes into consideration the:

Answer 38

Rate of growth of the dividend.

The cost of common equity is calculated using the amount of the dividend, the new stock price, the rate of growth of the dividend, and the flotation or selling cost.

Question 39

Which of the following responses is not an advantage to a corporation that uses commercial paper market for short-term financing:

This market provides more funds at lower rates than other methods provide.

The borrower avoids the expense of maintaining a compensating balance with a commercial bank.

There are no restrictions as to the type of corporation that can enter into this market.

This market provides a broad distribution for borrowing.

Answer 39

There are no restrictions as to the type of corporation that can enter into this market.

FALSE - commercial paper is issed in denominations of $100000 or more and is almost always back by bank lines of credit. This limits the access to this market to large corporations only.

Question 40

Marketable securities are low-risk investments that can quickly be turned into cash. Which of the following is not a marketable security?

U.S. Treasury bills

Bank certificates of deposit

Stocks

Commercial paper

Answer 40

Stocks

Stocks are NOT low-risk investments and can fluctuate in value dramatically over a short period of time.

Question 41

Level of safety stock in inventory management depends on :

Answer 41

Level of uncertainty of the sales forecast

level of customer dissatisfaction for back orders

cost of running out of inventory

Question 42

Zero-balance account

Answer 42

focuses on cash disbursements

• a checking account that normally carries a zero balance.

Question 43

Cost of Capital is important because:

Answer 43

the rate of return on various possible investments is compared to the cost of capital.

Question 44

Payback reciprocal can be used to approximate a project’s:

Answer 44

internal rate of return if the cash flow pattern is relatively stable.

Payback reciprocal = 1/ packback period

Payback = Net cash invested/ Annual cash inflow

If the cash flow pattern is relatively stable, the payback reciprocal number serves as a good approximation of a present value of an annuity table factor.

Question 45

An in-exchange premise as used when making a fair value calculation assumes that the maximum value of the item(s) being valued would come from

Answer 45

using the item alone.

In-exchange: by itself

in-use: with the group it is with

Question 46

Beyond the identification of the subject of a valuation, it is important to determine the Premise of value beforeinitiation any work on the engagement.

Answer 46

An assumption regarding the most likely set of transactional circumstances that may be applicable to the subject of the valuation

Question 47

Which of the following methods should be used if capital rationing needs to be considered when comparing capital projects

Answer 47

Profitability index

The profitability index is the present values of the cash flows after the initial investment divided by the amount of that investment.