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Exam 2: Financial Statements, Cash Flow, and Taxes

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Question 31

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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.

A) True
B) False

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Question 32

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Which of the following statements is CORRECT?

A) The maximum federal tax rate on personal income can exceed 50%.
B) Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity financing over debt financing, and this causes companies' debt ratios to be lower than they would be if interest and dividends were both deductible.
C) Interest paid to an individual is counted as income for tax purposes and taxed at the individual's regular tax rate, but dividends received are taxed at a maximum rate of 20%.
D) The maximum federal tax rate on corporate income is 50%.
E) Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by selling new common stock or by retaining earnings.The cost of debt capital is the interest paid on the debt, and the cost of the equity is the dividends paid on the stock.Both of these costs are deductible from income when calculating income for tax purposes.

F) D) and E)
G) A) and B)

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Question 33

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Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible.This treatment, other things held constant, tends to encourage the use of debt financing by corporations.

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 or cash, and reported costs likewise may not correctly reflect cash outlays.Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period.

Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?

If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant.

Meric Mining Inc.recently reported $15,000 of sales, $7,500 of operating costs other than depreciation, and $1,200 of depreciation.The company had no amortization charges, it had outstanding $6,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax rate was 25%.How much was the firm's net income after taxes? Meric uses the same depreciation expense for tax and stockholder reporting purposes.