Q&A Hero

Q: Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument that the value of the firm is determined only by its basic earning power and its business risk. a. True b. False

Q: The bank reconciliation uncovered a transposition error in the books. This is an example of a a. preventive control b. detective control c. corrective control d. none of the above

Q: A physical inventory count is an example of a a. preventive control b. detective control c. corrective control d. Feed-forward control

Q: The announcement of an increase in the cash dividend should, according to MM, lead to an increase in the price of the firm's stock. a. True b. False

Q: If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a low payout ratio. a. True b. False

Q: A well-designed purchase order is an example of a a. preventive control b. detective control c. corrective control d. none of the above

Q: Which of the following is a preventive control? a. credit check before approving a sale on account b. bank reconciliation c. physical inventory count d. comparing the accounts receivable subsidiary ledger to the control account

Q: MM's dividend irrelevance theory says that while dividend policy does not affect a firm's value, it can affect the cost of capital. a. True b. False

Q: The dividend irrelevance theory, proposed by Miller and Modigliani, says that provided a firm pays at least some dividends, how much it pays does not affect either its cost of capital or its stock price. a. True b. False

Q: The most cost-effective type of internal control is a. preventive control b. accounting control c. detective control d. corrective control

Q: Which of the following is not a limitation of the internal control system? a. errors are made due to employee fatigue b. fraud occurs because of collusion between two employees c. the industry is inherently risky d. management instructs the bookkeeper to make fraudulent journal entries

Q: The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm's stock price. a. True b. False

Q: The following data apply to Elizabeth's Electrical Equipment:Value of operations $20,000Short-term investments $1,000Debt $6,000Number of shares 300The company plans on distributing $50 million by repurchasing stock. What will the intrinsic per share stock price be immediately after the repurchase?a. $47.50b. $50.00c. $52.50d. $55.13e. $57.88

Q: The concept of reasonable assurance suggests that a. the cost of an internal control should be less than the benefit it provides b. a well-designed system of internal controls will detect all fraudulent activity c. the objectives achieved by an internal control system vary depending on the data processing method d. the effectiveness of internal controls is a function of the industry environment

Q: Substantive testing techniques provide information about the accuracy and completeness of an application's processes.

Q: The following data apply to Garber Industries, Inc. (GII):Value of operations $1,000Short-term investments $100Debt $300Number of shares 100The company plans on distributing $50 million as dividend payments. What will the intrinsic per share stock price be immediately after the distribution?a. $6.32b. $6.65c. $7.00d. $7.35e. $7.72

Q: A strong internal control system will reduce the amount of substantive testing that must be performed.

Q: Which of the following statements is correct? a. Capital gains earned in a share repurchase are taxed less favorably than dividends; this explains why companies typically pay dividends and avoid share repurchases. b. Very often, a company's stock price will rise when it announces that it plans to commence a share repurchase program. Such an announcement could lead to a stock price decline, but this does not normally happen. c. Stock repurchases increase the number of outstanding shares. d. The clientele effect is the best explanation for why companies tend to vary their dividend payments from quarter to quarter. e. If a company has a 2-for-1 stock split, its stock price should roughly double.

Q: Which of the following statements is correct? a. If a company uses the residual dividend model to determine its dividend payments, dividends payout will tend to increase whenever its profitable investment opportunities increase. b. The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model. c. Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm's financial risk. d. A dollar paid out to repurchase stock is taxed at the same rate as a dollar paid out in dividends. Thus, both companies and investors are indifferent between distributing cash through dividends and stock repurchase programs. e. The tax code encourages companies to pay dividends rather than retain earnings.

Q: Audit risk is the probability that the auditor will render an unqualified opinion on financial statements that are materially misstated.

Q: Tests of controls determine whether the database contents fairly reflect the organization's transactions.

Q: Which of the following statements is correct? a. One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends. b. Empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend, and as a result share prices fall when dividend increases are announced. The reason is that investors interpret the increase as a signal that the firm has relatively few good investment opportunities. c. If a company wants to raise new equity capital rather steadily over time, a new stock dividend reinvestment plan would make sense. However, if the firm does not want or need new equity, then an open market purchase dividend reinvestment plan would probably make more sense. d. Dividend reinvestment plans have not caught on in most industries, and today about 99% of all companies with DRIPs are utilities. e. Under the tax laws as they existed in 2008, a dollar received for repurchased stock must be taxed at the same rate as a dollar received as dividends.

Q: External auditors can cooperate with and use evidence gathered by internal audit departments that are organizationally independent and that report to the Audit Committee of the Board of Directors.

Q: Which of the following statements is correct? a. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account. b. Stock repurchases can be used by a firm that wants to increase its debt ratio. c. Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities. d. One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding. e. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their ownership in the company.

Q: External auditing is an independent appraisal function established within an organization to examine and evaluate its activities as a service to the organization.

Q: Which of the following is NOT normally regarded as being a good reason to establish an ESOP? a. To enable the firm to borrow at a below-market interest rate. b. To make it easier to grant stock options to employees. c. To help prevent a hostile takeover. d. To help retain valued employees. e. To increase worker productivity.

Q: An IT auditor expresses an opinion on the fairness of the financial statements.

Q: ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers. a. True b. False

Q: Which of the following is NOT normally regarded as being a barrier to hostile takeovers? a. Targeted share repurchases. b. Shareholder rights provisions. c. Restricted voting rights. d. Poison pills. e. Abnormally high executive compensation.

Q: Advisory services is an emerging field that goes beyond the auditor's traditional attestation function.

Q: The CEO of D'Amico Motors has been granted some stock options that have provisions similar to most other executive stock options. If D'Amico's stock underperforms the market, these options will necessarily be worthless. a. True b. False

Q: Application controls apply to a wide range of exposures that threaten the integrity of all programs processed within the computer environment.

Q: Section 302 requires the management of public companies to assess and formally report on the effectiveness of their organization's internal controls.

Q: A poison pill is also known as a corporate restructuring. a. True b. False

Q: Two important issues in corporate governance are (1) the rules that cover the board's ability to fire the CEO and (2) the rules that cover the CEO's ability to remove members of the board. a. True b. False

Q: Section 404 requires that corporate management (including the CEO) certify their organization's internal controls on a quarterly and annual basis.

Q: Weber Interstate Paving Co. had $450 million of sales and $225 million of fixed assets last year, so its FA/Sales ratio was 50%. However, its fixed assets were used at only 65% of capacity. If the company had been able to sell off enough of its fixed assets at book value so that it was operating at full capacity, with sales held constant at $450 million, how much cash (in millions) would it have generated?a. $74.81b. $78.75c. $82.69d. $86.82e. $91.16

Q: The Sarbanes-Oxley Act requires the audit committee to hire and oversee the external auditors.

Q: Last year National Aeronautics had a FA/Sales ratio of 40%, comprised of $250 million of sales and $100 million of fixed assets. However, its fixed assets were used at only 75% of capacity. Now the company is developing its financial forecast for the coming year. As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full capacity. What target FA/Sales ratio should the company set?a. 28.5%b. 30.0%c. 31.5%d. 33.1%e. 34.7%

Q: While the Sarbanes-Oxley Act prohibits auditors from providing non-accounting services to their audit clients, they are not prohibited from performing such services for non-audit clients or privately held companies.

Q: A key modifying assumption in internal control is that the internal control system is the responsibility of management.

Q: North Construction had $850 million of sales last year, and it had $425 million of fixed assets that were used at only 60% of capacity. What is the maximum sales growth rate North could achieve before it had to increase its fixed assets?a. 54.30%b. 57.16%c. 60.17%d. 63.33%e. 66.67%

Q: Last year Baron Enterprises had $350 million of sales, and it had $270 million of fixed assets that were used at 65% of capacity last year. In millions, by how much could Baron's sales increase before it is required to increase its fixed assets?a. $170.09b. $179.04c. $188.46d. $197.88e. $207.78

Q: Preventive controls are passive techniques designed to reduce fraud.

Q: Segregation of duties is an example of an internal control procedure.

Q: The Besnier Company had $250 million of sales last year, and it had $75 million of fixed assets that were being operated at 80% of capacity. In millions, how large could sales have been if the company had operated at full capacity?a. $312.5b. $328.1c. $344.5d. $361.8e. $379.8

Q: The external auditor is responsible for establishing and maintaining the internal control system.

Q: Which of the following statements is CORRECT? a. When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow. b. Firms whose fixed assets are "lumpy" frequently have excess capacity, and this should be accounted for in the financial forecasting process. c. For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets. d. There are economies of scale in the use of many kinds of assets. When economies occur the ratios are likely to remain constant over time as the size of the firm increases. The Economic Ordering Quantity model for establishing inventory levels demonstrates this relationship. e. When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner.

Q: The same internal control objectives apply to manual and computer-based information systems.

Q: Which of the following statements is CORRECT? a. The first, and perhaps the most critical, step in forecasting financial requirements is to forecast future sales. b. Forecasted financial statements, as discussed in the text, are used primarily as a part of the managerial compensation program, where management's historical performance is evaluated. c. The capital intensity ratio gives us an idea of the physical condition of the firm's fixed assets. d. The AFN equation produces more accurate forecasts than the forecasted financial statement method, especially if fixed assets are lumpy, economies of scale exist, or if excess capacity exists. e. Perhaps the most important step when developing forecasted financial statements is to determine the breakdown of common equity between common stock and retained earnings.

Q: A qualified opinion on management's assessment of internal controls over the financial reporting system necessitates a qualified opinion on the financial statements?

Q: The AFN equation assumes that the ratios of assets and liabilities to sales remain constant over time. However, this assumption can be relaxed when we use the forecasted financial statement method. Three conditions where constant ratios cannot be assumed are economies of scale, lumpy assets, and excess capacity. a. True b. False

Q: Both the SEC and the PCAOB require management to use the COSO framework for assessing internal control adequacy.

Q: You have been asked to forecast the additional funds needed (AFN) for Houston, Hargrove, & Worthington (HHW), which is planning its operation for the coming year. The firm is operating at full capacity. Data for use in the forecast are shown below. However, the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 50%, which the firm's investment bankers have recommended. Based on the AFN equation, by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions.Last year's sales = S0 $300.0 Last year's accounts payable $50.0Sales growth rate = g 40% Last year's notes payable $15.0Last year's total assets = A0* $500.0 Last year's accruals $20.0Last year's profit margin = PM 20.0% Initial payout ratio 10.0%a. $31.9b. $33.6c. $35.3d. $37.0e. $38.9

Q: In your internship with Lewis, Lee, & Taylor Inc. you have been asked to forecast the firm's additional funds needed (AFN) for next year. The firm is operating at full capacity. Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year?Last year's sales = S0 $200,000 Last year's accounts payable $50,000Sales growth rate = g 40% Last year's notes payable $15,000Last year's total assets = A0* $135,000 Last year's accruals $20,000Last year's profit margin = PM 20.0% Target payout ratio 25.0%a. -$14,440b. -$15,200c. -$16,000d. -$16,800e. -$17,640

Q: Both the SEC and the PCAOB require management to use the COBIT framework for assessing internal control adequacy.

Q: Corporate management (including the CEO) must certify monthly and annually their organization's internal controls over financial reporting.

Q: Daniel Sawyer, the CEO of the Sawyer Group, is initiating planning for the company's operations next year, and he wants you to forecast the firm's additional funds needed (AFN). The firm is operating at full capacity. Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year? Dollars are in millions.Last year's sales = S0 $350 Last year's accounts payable $40Sales growth rate = g 30% Last year's notes payable $50Last year's total assets = A0* $500 Last year's accruals $30Last year's profit margin = PM 5% Target payout ratio 60%a. $102.8b. $108.2c. $113.9d. $119.9e. $125.9

Q: Which of the following statements is CORRECT? a. If a firm's assets are growing at a positive rate, but its retained earnings are not increasing, then it would be impossible for the firm's AFN to be negative. b. If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually decrease, then the firm's actual AFN must, mathematically, exceed the previously calculated AFN. c. Higher sales usually require higher asset levels, and this leads to what we call AFN. However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have a zero dividend payout ratio. d. Dividend policy does not affect the requirement for external funds based on the AFN equation. e. The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external funds. In other words, it is the growth rate at which the firm's AFN equals zero.

Q: Which of the following statements is CORRECT? a. The AFN equation for forecasting funds requirements requires only a forecast of the firm's balance sheet. Although a forecasted income statement may help clarify the results, income statement data are not essential because funds needed relate only to the balance sheet. b. Dividends are paid with cash taken from the accumulated retained earnings account, hence dividend policy does not affect the AFN forecast. c. A negative AFN indicates that retained earnings and spontaneous liabilities are far more than sufficient to finance the additional assets needed. d. If the ratios of assets to sales and spontaneous liabilities to sales do not remain constant, then the AFN equation will provide more accurate forecasts than the forecasted financial statements method. e. Any forecast of financial requirements involves determining how much money the firm will need, and this need is determined by adding together increases in assets and spontaneous liabilities and then subtracting operating income.

Q: Which of the following statements is CORRECT? a. Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no excess current assets. Based on the AFN equation, its AFN will be larger than if it had been operating with excess capacity in both fixed and current assets. b. If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth. c. Additional funds needed (AFN) are typically raised using a combination of notes payable, long-term debt, and common stock. Such funds are non-spontaneous in the sense that they require explicit financing decisions to obtain them. d. If a firm has a positive free cash flow, then it must have either a zero or a negative AFN. e. Since accounts payable and accrued liabilities must eventually be paid off, as these accounts increase, AFN as calculated by the AFN equation must also increase.

Q: A company expects sales to increase during the coming year, and it is using the AFN equation to forecast the additional capital that it must raise. Which of the following conditions would cause the AFN to increase? a. The company increases its dividend payout ratio. b. The company begins to pay employees monthly rather than weekly. c. The company's profit margin increases. d. The company decides to stop taking discounts on purchased materials. e. The company previously thought its fixed assets were being operated at full capacity, but now it learns that it actually has excess capacity.

Q: Spontaneous funds are generally defined as follows: a. A forecasting approach in which the forecasted percentage of sales for each item is held constant. b. Funds that a firm must raise externally through short-term or long-term borrowing and/or by selling new common or preferred stock. c. Funds that arise out of normal business operations from its suppliers, employees, and the government, and they include immediate increases in accounts payable, accrued wages, and accrued taxes. d. The amount of cash raised in a given year minus the amount of cash needed to finance the additional capital expenditures and working capital needed to support the firm's growth. e. Assets required per dollar of sales.

Q: The capital intensity ratio is generally defined as follows: a. The percentage of liabilities that increase spontaneously as a percentage of sales. b. The ratio of sales to current assets. c. The ratio of current assets to sales. d. The amount of assets required per dollar of sales, or A0*/S0. e. Sales divided by total assets, i.e., the total assets turnover ratio.

Q: The term "additional funds needed (AFN)" is generally defined as follows: a. Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations. b. The amount of assets required per dollar of sales. c. The amount of internally generated cash in a given year minus the amount of cash needed to acquire the new assets needed to support growth. d. A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant. e. Funds that are obtained automatically from routine business transactions.

Q: F. Marston, Inc. has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN)? a. A switch to a just-in-time inventory system and outsourcing production. b. The company reduces its dividend payout ratio. c. The company switches its materials purchases to a supplier that offers a longer credit period (with all other terms held equal). d. The company discovers that it has excess capacity in its fixed assets. e. A sharp increase in its forecasted sales.

Q: Which of the following assumptions is embodied in the AFN equation? a. Accounts payable and accruals are tied directly to sales. b. Common stock and long-term debt are tied directly to sales. c. Fixed assets, but not current assets, are tied directly to sales. d. Last year's total assets were not optimal for last year's sales. e. None of the firm's ratios will change.

Q: The minimum growth rate that a firm can achieve with no access to external capital is called the firm's sustainable growth rate. It can be calculated by using the AFN equation with AFN equal to zero and solving for g. a. True b. False

Q: If a firm's capital intensity ratio (A0*/S0) decreases as sales increase, use of the AFN formula is likely to understate the amount of additional funds required, other things held constant. a. True b. False

Q: Two firms with identical capital intensity ratios are generating the same amount of sales. However, Firm A is operating at full capacity, while Firm B is operating below capacity. If the two firms expect the same growth in sales during the next period, then Firm A is likely to need more additional funds than Firm B, other things held constant. a. True b. False

Q: Firms with high capital intensity ratios have found ways to lower this ratio permitting them to achieve a given level of growth with fewer assets and consequently less external capital. For example, just-in-time inventory systems, multiple shifts for labor, and outsourcing production are all feasible ways for firms to reduce their capital intensity ratios. a. True b. False

Q: Companies with relatively high assets-to-sales ratios require a relatively large amount of new assets for any given increase in sales; hence, they have a greater need for external financing. There are currently no alternatives for these types of firms to lower their asset requirements. a. True b. False

Q: A firm's profit margin is 5%, its debt/assets ratio is 56%, and its dividend payout ratio is 40%. If the firm is operating at less than full capacity, then sales could increase to some extent without the need for external funds, but if it is operating at full capacity with respect to all assets, including fixed assets, then any positive growth in sales will require some external financing. a. True b. False

Q: If a firm with a positive net worth is operating its fixed assets at full capacity, if its dividend payout ratio is 100%, and if it wants to hold all financial ratios constant, then for any positive growth rate in sales, it will require external financing. a. True b. False

Q: The capital intensity ratio is the amount of assets required per dollar of sales and it has a major impact on a firm's capital requirements. a. True b. False

Q: To determine the amount of additional funds needed (AFN), you may subtract the expected increase in liabilities, which represents a source of funds, from the sum of the expected increases in retained earnings and assets, both of which are uses of funds. a. True b. False

Q: If a firm wants to maintain its ratios at their existing levels, then if it has a positive sales growth rate of any amount, it will require some amount of external funding. a. True b. False

Q: A firm's AFN must come from external sources. Typical sources include short-term bank loans, long-term bonds, preferred stock, and common stock. a. True b. False

Q: A rapid build-up of inventories normally requires additional financing, unless the increase is matched by an equally large decrease in some other asset. a. True b. False

Q: As long as a firm does not pay out 100% of its earnings, the firm's annual profit that is retained in the business (i.e., the addition to retained earnings) is another source of funds for a firm's expansion. a. True b. False