(Test Bank) Financial & Managerial Accounting For Decision Makers

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Test Bank

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© Cambridge Business Publishers, 2021 A-1 Financial & Managerial Accounting for Decision Makers, 4th Edition Appendix A Compound Interest and the Time-Value of Money True/False Topic: Compound interest 1. When interest is earned on interest in a savings account in a bank, this is called compound interest. Answer: True Rationale: As interest accumulates on an investment, both the original investment and the accumulated interest will earn a return in subsequent periods. Topic: Time value of money 2. A dollar received today is worth more than a dollar received two years ago. Answer: False Rationale: It is much better to receive money as soon as possible as it can be invested and will earn additional interest. Topic: Financial calculator 3. The interest rate on a financial calculator to be inputted using the I/Yr key means to enter the rate per period. Answer: True Rationale: I/Yr is the interest rate per period. Topic: Compounding 4. If an investment is made that pays 5% annual interest for a 3-year period with semiannual compounding, the number of periods is 6. Answer: True Rationale: There are 6 semiannual periods in three years: 3 years × 2 times per year = 6 periods of compounding. © Cambridge Business Publishers, 2021 Test Bank, Appendix A A-2 Topic: Installment loans 5. Installment loans require a series of equal payments that often vary in the time period between each payment. Answer: False Rationale: Installment notes have equal payments on a periodic basis, such that the time period between each payment must be the same. Topic: Bond valuation 6. There are two cash flows associated with bonds—a balloon payment and periodic interest payments. Answer: True Rationale: The balloon payment is the principal due when the bond matures. Interest payments are most often paid semiannually. © Cambridge Business Publishers, 2021 A-3 Financial & Managerial Accounting for Decision Makers, 4th Edition Multiple Choice Topic: Bond pricing (using a financial calculator or Excel) 1. TJ Services issued bonds with a face value of $5,000,000 and a coupon rate of 4% paid semiannually for 5 years. The market rate of interest is 3%. How much is the market value of the bonds? A. $4,308,336 B. $4,573,490 C. $5,228,985 D. $5,230,555 Answer: D Rationale: Interest payment = $5,000,000 × 4% × 1/2 = $100,000 N = 10 (5 *2) I/Y = 1.5 (3% / 2) PV = ? PMT = 100,000 FV = 5,000,000 PV = $5,230,555 Topic: Time value of money 2. Why is one dollar now worth more than one dollar in the future? A. The time value of money depreciates over long periods of time B. The amount to be received in the future is smaller than the amount to be paid off today C. The value of interest declines over time D. Funds can be invested in earning assets to yield a positive return Answer: D Rationale: Investing money received today generates interest so that the investor will have more accumulated funds compared to waiting to receive funds in the future. Topic: Future value (using a financial calculator or Excel) 3. If an investor invests $2,500,000 today at 4% interest compounded semiannually, how much will be in the bank account two years from the date invested? (Select the closest amount) A. $2,706,080 B. $2,924,646 C. $2,704,000 D. $2,601,000 Answer: A Rationale: N = 4 (2 * 2) I/Y = 2.0 (4% / 2) PV = 2,500,000 PMT = 0 FV = ? FV = $2,706,080 © Cambridge Business Publishers, 2021 Test Bank, Appendix A A-4 Topic: Bond pricing (using a financial calculator or Excel) 4. Seismic Industries issued bonds with a face value of $10,000,000 and a coupon rate of 4% paid semiannually for 5 years. The market rate of interest is 5%. How much is the market value of the bonds using a financial calculator? A. $ 7,683,480 B. $10,449,129 C. $ 9,562,397 D. $ 8,701,157 Answer: C Rationale: Interest payment = $10,000,000 × 4% × 1/2 = $200,000 N = 10 (5*2) I/Y = 2.5 (5%/2) PV = ? PMT = 200,000 FV = 10,000,000 PV = $9,562,397 Topic: Bond pricing (using a financial calculator or Excel) 5. Seismic Industries issued bonds with a face value of $10,000,000 and a coupon rate of 4% paid semiannually for 4 years. The market rate of interest is 5%. How much is the market value of the bonds? A. $8,207,466 B. $9,641,493 C. $8,936,215 D. $9,645,405 Answer: B Rationale: Interest payment = $10,000,000 × 4% × 1/2 = $200,000 N =8 (4* 2) I/Y = 2.5 (5% /2) PV = ? PMT = 200,000 FV = 10,000,000 PV = $9,641,493 Topic: Present value of a single amount 6. Which of the following determines the present value of a single cash payment? A. Future value × (1 + discount rate) B. Future value ÷ (1 + discount rate) C. Future value × (1 ‒ discount rate) D. Future value ÷ (1 ‒ discount rate) Answer: B Rationale: 1 plus the discount rate is divided into the future amount. © Cambridge Business Publishers, 2021 A-5 Financial & Managerial Accounting for Decision Makers, 4th Edition Topic: Present value of an investment (using a financial calculator or Excel) 7. Classy, Inc. wishes to accumulate $1,500,000 to be used to pay off a note at the end of 5 years. How much will Classy, Inc. invest today to accumulate the desired amount if the investment earns an annual rate of 6% compounded quarterly? (Select the closest amount) A. $ 830,514 B. $1,113,706 C. $1,116,141 D. $1,293,913 Answer: B Rationale: N =20 (5*4) I/Y = 1.5 (6%/4) PV = ? FV = 1,500,000 PV = $1,113,706 Topic: Future value of annuity (using a financial calculator or Excel) 8. Classy, Inc. wishes to accumulate $1,500,000 to be used to pay off a loan at the end of 3 years. How much will Classy, Inc. deposit each month for three years, beginning at the end of the first month, to accumulate the desired amount if the investment earns an annual rate of 6%, compounded monthly? (Select the closest amount) A. $ 15,652 B. $ 34,821 C. $115,020 D. $ 38,133 Answer: D Rationale: N = 36 (3*12) I/Y = 0.5 (6%/12) PMT = ? FV =1,500,000 PMT = $38,133 © Cambridge Business Publishers, 2021 Test Bank, Appendix A A-6 Exercises Topic: Present value of a sum (using a financial calculator or Excel) 1. Crawford Motor Company wants to accumulate $2,000,000 to pay off an equipment loan due in 6 years. How much should Crawford Motor Company deposit today if the bank pays 5% interest compounded annually? Answer: N = 6 I/ Y = 5 PV = ? PMT = 0 FV = 2,000,000 PV = $1,492,431 Topic: Present value of a sum (using a financial calculator or Excel) 2. Crawford Motor Company wants to accumulate $2,000,000 to pay off an equipment loan due in 6 years. How much should Crawford Motor Company deposit today if the bank pays 5% interest compounded semiannually? Answer: N = 12(6*2) I/Y = 2.5 (5%/2) PV = ? PMT = 0 FV = 2,000,000 PV = $1,487,112 Topic: Future value of an annuity (using a financial calculator or Excel) 3. Crawford Motor Company wants to accumulate $1,500,000 to pay off an equipment note due in 4 years. How much should Crawford Motor Company deposit each quarter beginning one quarter from today to accumulate the amount required if the bank pays 5% annual interest compounded quarterly? Answer: N = 16 (4 * 4) I/Y = 1.25 (5% /4) PV = 0 PMT = ? FV = 1,500,000 PMT = $85,270 Topic: Future value of an annuity (using a financial calculator or Excel) 4. Crawford Motor Company wants to accumulate $1,500,000 to pay off an equipment loan due in 3 years. How much should Crawford Motor Company deposit each month beginning one month from today in order to accumulate $1,500,000 if the bank pays 6% annual interest with monthly compounding? Answer: N = 36 (3 * 12) I/Y = 0.5 (6% / 12) PV = 0 PMT = ? FV = 1,500,000 PMT = $38,133 © Cambridge Business Publishers, 2021 A-7 Financial & Managerial Accounting for Decision Makers, 4th Edition Topic: Present value of a sum (using a financial calculator or Excel) 5. Magnum Co. needs to have $250 million accumulated to fund health insurance payments for its retirees. Will Magnum Co. have enough accumulated at the end of 4 years if it deposits $200 million today if compounding occurs semiannually with an annual rate of 6%? Answer: N = 8 (4*2) I/Y = 3 (6% /2) PV = 200,000,000 PMT = 0 FV = ? FV = $253,354,016 Yes, it will have over $253.3 million accumulated, which is enough to fund the health insurance. Topic: Installment note (using a financial calculator or Excel) 6. Magnum Co. borrowed $2,000,000 to buy equipment to be repaid as a installment note monthly over 4 years. How much will Magnum Co. pay each month if payments begin one month from now and the annual loan rate is 6% compounded monthly? Answer: N = 48(4 * 12) I/Y = 0.5 (6% /12) PV = 2,000,000 PMT = ? FV = 0 PMT = $46,970 Topic: Balloon note (using a financial calculator or Excel) 7. Magnum Co. borrowed $500,000,000 to buy equipment with the total principal and interest to be repaid as a balloon note at the end of 4 years. How much will Magnum Co. pay to liquidate the note at the maturity date if interest is 6% compounded quarterly? Answer: N = 16 (4 *4) I/Y =1.5 (6% /4) PV = 500,000,000 PMT = 0 FV = ? FV = $634,492,774 Topic: Present value of bonds (using a financial calculator or Excel) 8. Premier Investments recently issued bonds with a face value of $4,000,000 and a coupon rate of 4% for 5 years. The market rate of interest is 3% and the bonds pay interest semiannually. Compute the market value of the bond on the issue date. Answer: Interest payment = $4,000,000 × 4% × 1/2 = $80,000 N = 10 (5 *2) I/Y = 1.5 (3% /2) PV = ? PMT =80,000 FV = 4,000,000 PV = $4,184,444 © Cambridge Business Publishers, 2021 Test Bank, Appendix A A-8 Topic: Present value of notes (using a financial calculator or Excel) 9. Boyer Pharmaceuticals is a new drug company entering the market. It plans to issue notes with a face value of $10,000,000 and a coupon rate of 5% for 10 years. The market rate of interest is 4%. Compute the market value of the notes on the issue date if interest is paid semiannually. Answer: Interest payment = $10,000,000 × 5% × 1/2 = $250,000 N = 20 (10 * 2) I/Y = 2 (4% / 2) PV = ? PMT = 250,000 FV = 10,000,000 PV = $10,817,572 © Cambridge Business Publishers, 2021 A-9 Financial & Managerial Accounting for Decision Makers, 4th Edition Problems Topic: Bond pricing (using a financial calculator or Excel) 1. Mountaineer Services recently issued bonds with a face value of $15,000,000 and a coupon rate of 5% for 20 years. The market rate of interest is 4%. A. Compute the market value of the bonds if interest is paid annually. B. Computer the market value of the bonds if interest is paid semiannually. C. Explain the difference in the market value determined in parts A and B. Answer: A. Interest payment = $15,000,000 × 5% = $750,000 N = 20 I/Y = 4 PV = ? PMT = 750,000 FV = 15,000,000 PV = $17,038,549 B. Interest payment = $15,000,000 × 5% × 1/2 = $375,000 N = 40 (20 * 2) I/Y = 2 (4% / 2) PV = ? PMT = 375,000 FV = 15,000,000 PV = $17,051,661 C. The present value differs because interest is compounded more frequently with the semiannual payments providing a better return to the investor, so the investor is willing to pay $13,112 (= $17,051,661 - $17,038,549) more if the interest is compounded semiannually. Topic: Present value calculations (using a financial calculator or Excel) 2. An investment of $2,200,000 will return $500,000 per year for 5 years. Should the investment be undertaken if the market interest rate is 5% and interest is compounded annually? Answer: N = 5 I/Y = 5 PV = ? PMT = 500,000 FV = 0 PV = $2,164,738 No. Based on the financial aspects of the investment, it should not be undertaken as the present value of $2,164,738 is less than the required initial investment. © Cambridge Business Publishers, 2021 Test Bank, Appendix A A-10 Topic: Bond pricing (using a financial calculator or Excel) 3. Noodles and More Restaurants, Inc. plans to issue 10-year notes with a face value of $20,000,000 and a coupon rate of 4.5%. The market rate of interest is 4%. Interest payments will be made semiannually. A. Compute the market value of the notes. B. Assume the market rate remains at 4% after 4 years. How much cash will Noodles and More Restaurants, Inc. need to pay off the notes at this time? Answer: A. Interest payment = $20,000,000 × 4.5% × 1/2 = $450,000 N = 20 (10 * 2) I/Y = 2 (4% / 2) PV = ? PMT = 450,000 FV = 20,000,000 PV = $20,817,572 B. Interest payment = $20,000,000 × 4.5% × 1/2 = $450,000 N = 12 (6 * 2) I/Y = 2 (4% / 2) PV = ? PMT = 450,000 FV = 20,000,000 PV = $20,528,767 Topic: Present value (using a financial calculator or Excel) 4. Compute the present value for each of the following amounts. A. $100,000 received in 5 years if annual interest rate is: (1) 8% compounded annually or (2) 8% compounded semiannually B. $15,000 received at the end of each year for the next 6 years if the market rate of interest is 5% per year compounded annually Answer: A. (1) N = 5 I/Y = 8 PV = ? FV = 100,000 PV = $68,058 (2) N = 10 (5*2) I/Y = 4 (8% / 2) PV = ? FV = 100,000 PV = $67,556 B. N = 6 I/Y = 5 PV = ? PMT = 15,000 PV = $76,135 © Cambridge Business Publishers, 2021 A-11 Financial & Managerial Accounting for Decision Makers, 4th Edition Essay Topic: Present value 1. Why is one dollar now worth more than one dollar in the future? Answer: In periods of inflation, the purchasing power of a dollar declines over time. Consequently, a dollar in hand today is worth more than one to be received in the future. Even in the absence of inflation, funds can be invested in earning assets to yield a positive return. © Cambridge Business Publishers, 2021 1-1 Financial & Managerial Accounting for Decision Makers, 4th Edition Chapter 1 Introducing Financial Accounting Learning Objectives – Coverage by question True/False Multiple Choice Exercises Problems Essay Questions LO1 Identify the users of accounting information and discuss the costs and benefits of disclosure. (p. 4) 1, 2 1-3 1, 2 2, 5, 6 LO2 Describe a company's business activities and explain how these activities are represented by the accounting equation. (p. 7) 3-6 4, 5 3 1, 6 LO3 Introduce the four key financial statements including the balance sheet, income statement, statement of stockholders' equity, and statement of cash flows. (p. 11) 7-9 4, 6-11 4-11 1-5 LO4 Describe the institutions that regulate financial accounting and their role in establishing generally accepted accounting principles. (p. 17) 10-12 12, 19, 20 3, 4 LO5 Compute two key ratios that are commonly used to assess profitability and risk - return on equity and the debt-to-equity ratio. (p. 21) 13, 14 13-18 13, 14 LO6 Appendix 1A: Explain the conceptual framework for financial reporting. (p. 26) 15, 16 21, 22 12 3, 5 © Cambridge Business Publishers, 2021 Test Bank, Chapter 1 1-2 Chapter 1: Introducing Financial Accounting True/False Topic: Cost and benefits of disclosure LO: 1 1. One reason companies are motivated to disclose financial information to external decision makers is that it may lower financing and operating costs. Answer: True Rationale: For example, when a company applies for a loan, the bank uses the company’s financial statements to help determine the appropriate interest rate. Without this financial information, a company may have a higher cost of borrowing or not obtain the loan at all. Topic: Demand for accounting information LO: 1 2. Financial accounting is designed primarily for decision makers within the company. Answer: False Rationale: Financial accounting is designed primarily to provide information to decision makers outside of the company, while managerial accounting is designed primarily for decision makers within the company. Topic: Investing activities LO: 2 3. Investing activities are the acquiring and disposing of liabilities that a company needs in order to finance its operating activities. Answer: False Rationale: Investing activities are the acquiring and disposing of assets that a company needs for the production and sale of a company’s products and services. Topic: Accounting equation LO: 2 4. Assets must always equal liabilities plus stockholders’ equity. Answer: True Rationale: The accounting equation is Assets = Liabilities + Stockholders’ Equity. This relation must always stay in balance. © Cambridge Business Publishers, 2021 1-3 Financial & Managerial Accounting for Decision Makers, 4th Edition Topic: Financing activities LO: 2 5. Other than operating profit, there are three main sources of external financing. Answer: False Rationale: There are two main sources of financing: owner (also called shareholder or equity) financing and nonowner (also called creditor or lender) financing. Topic: Financing and investing activities LO: 2 6. Financing activities are defined as the acquiring and disposing of resources for the purpose of selling products and services. Answer: False Rationale: Financing activities are defined as methods a company uses to raise funds to pay for resources. Investing activities are defined as the acquiring and disposing of resources for the purpose of selling products and services. Topic: Statement of cash flows LO: 3 7. A statement of cash flows reports on cash flows for operating, investing and financing activities at a point in time. Answer: False Rationale: A statement of cash flows reports on cash flows for operating, investing, and financing activities over a period of time. Topic: Retained earnings LO: 3 8. Retained earnings are present on both the income statement and the statement of stockholders’ equity. Answer: False Rationale: Retained earnings are present in the statement of stockholders’ equity and the balance sheet. The income statement represents current period earnings. Topic: Balance sheet LO: 3 9. If a company reports retained earnings of $242.6 million on its balance sheet, it will also report $242.6 million in cash. Answer: False Rationale: The accounting equation requires total assets to equal total liabilities plus stockholders’ equity. That does not imply, however, that liability and equity accounts relate directly to specific assets. © Cambridge Business Publishers, 2021 Test Bank, Chapter 1 1-4 Topic: Regulation and Oversight LO: 4 10. The goal of the Sarbanes-Oxley Act of 2002 was to increase the level of confidence that external users have in the financial statements. Answer: True Rationale: In the wake of scandals, like those that took down Enron, the U.S. Congress passed the Sarbanes-Oxley Act to improve external user confidence in financial statement reporting. Topic: Global accounting perspective LO: 4 11. The International Accounting Standards Board (IASB) has legal authority to impose accounting standards on any country. Answer: False Rationale: The IASB works with standard setters within many countries, but does not have legal authority to impose IASB standards on any country. It was charged with creating International Financial Reporting Standards with the intention of unifying all public companies under one global set of reporting standards. Topic: IFRS LO: 4 12. Foreign companies using international accounting standards must reconcile their financial statements to American rules if they wish to sell securities in the U.S. Answer: False Rationale: The SEC adopted a rule in 2007 that allows foreign companies to stop reconciling to American rules. Topic: Financial statement analysis LO: 5 13. One key measure of profitability is the debt-to-equity ratio. Answer: False Rationale: Return on equity is a key profitability metric. The debt-to-equity ratio is a measure of long-term solvency when looking at credit risk. Topic: Credit risk analysis LO: 5 14. The greater the risk of any decision, the greater the expected return. Answer: True Rationale: The riskier an investment is, the greater the return demanded by investors.