Chap003 This Is A Quiz of Chapter 3 Fsa

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Chap003 - this is a quiz of chapter 3 FSA
Financial Management (Lahore School of Economics)
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Chapter 03 - Analyzing Financing Activities
Chapter 03
Analyzing Financing Activities
Multiple Choice Questions
1. The majority of financing for most companies comes from which of the following sources?
A. Owners and customers
B. Creditors and customers
C. Owners and managers
D. Creditors and owners
2. Which of the following would not be found listed as a liability on a company's balance
sheet?
A. Operating lease obligations
B. Capital lease obligations
C. Bonds payable
D. Taxes payable
3. Which of the following would be found listed as a liability on a company's balance sheet?
A. Operating lease obligations
B. Projected benefit obligation
C. Purchase Commitment obligation
D. Postretirement benefits other than pension obligation
4. Which of the following is not a criterion for defining a lease as a capital lease?
A. Ownership is transferred by the end of the lease agreement.
B. The lease contains an option to purchase the asset at a bargain price.
C. The present value of the lease payments at the beginning of the lease is 75% or more than
the value of the asset.
D. The lease term is at least 75% of the economic life of the asset.
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5. Which of the following is true concerning bond covenants?

A. Bond covenants are restrictions placed on bondholders to protect rights of equity holders.
B. Violation of a bond covenant requires that a company declares bankruptcy.
C. If a company violates a bond covenant, it means it has failed to make interest or principal
repayments on debt in a timely manner.
D. Bond covenants are legal restrictions placed in order to minimize the risk of default on
bonds.
6. Recording a long-term lease as an operating lease, as opposed to a capital lease, for a lessee
will cause the following ratios to be:
A. Option A
B. Option B
C. Option C
D. Option D
7. If a company leases equipment to other companies and records these leases as operating
leases rather than capital leases, its:
I. recorded liabilities will be lower.
II. recorded assets will be higher.
III. total cash flows will be higher.
IV. leverage ratios will be higher.
A. I and III
B. II and IV
C. I only
D. II, III and IV
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8. If a company that leases equipment from another company records these leases as operating
leases rather than capital leases, its:
I. recorded liabilities will be lower.
II. recorded assets will be higher.
III. total cash flows will be higher.
IV. leverage ratios will be higher.
A. I and III
B. II and IV
C. I only
D. II, III and IV
9. Which one of the following statements is false?

A. Short-term obligations may be classified as long term if the company intends to refinance
them on a long-term basis and can demonstrate the ability to do so.
B. Violation of a long-term debt covenant automatically means the company must reclassify
the debt as current.
C. Current liabilities are recorded at their maturity value, and not their present value.
D. If a bond is issued at a discount the effective interest rate is greater than the coupon rate.
10. When considering defined benefit pension plans, which of the following will not increase
the projected benefit obligation (PBO)?
A. A decrease in the discount rate.
B. An increase in estimated compensation growth.
C. An increase in expected average length of lives of employees.
D. A decrease in the expected rate of return on plan assets.
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11. With respect to pension liabilities, which of the following statements are true?
I. The projected benefit obligation (PBO) is always greater than or equal to the accumulated
benefit obligation (ABO).
II. The vested benefit obligation (VBO) is always as least as or as big as the accumulated
benefit obligation (ABO).
III. If the PBO is greater than the plan assets, the plan is said to be overfunded.
IV. If the weighted-average assumed discount rate is increased, the PBO will decrease.
A. I, III and IV
B. I and III
C. II and IV
D. I and IV
12. The difference between the accumulated benefit obligation (ABO) and the projected
benefit obligation (PBO) is:
A. the PBO considers non-vested obligations and the ABO does not.
B. the PBO takes into account the time value of money and the ABO does not.
C. the PBO takes into account future pay increases and the ABO does not.
D. the PBO takes into account mortality rates of employees and the ABO does not.
13. Hert Corporation acquired a capital lease that is carried on its books at a present value of
$100,000 (discounted at 12%). Its annual rental payment is $15,000. What is the amount of
interest expense from this lease?
A. Option A
B. Option B
C. Option C
D. Option D
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14. Which of the following might give rise to off-balance sheet financing?
I. Long-term operating leases
II. Sale of receivables without recourse
III. Through-put agreements
IV. Purchase commitments
A. I, II, III and IV
B. I, II and IV
C. II, III and IV
D. I, III and IV
15. Which of the following is an example of off-balance sheet financing?

A. Operating leases
B. Capital leases
C. Issuance of convertible bonds
D. Issuance of common stock
16. If a company engages in off-balance sheet financing, generally the effect is:
I. to cause assets to be understated.
II. to increase leverage ratios.
III. to increase cash flows.
IV. to cause liabilities to be understated.
B. I, III and IV
C. I and IV
D. IV only
17. Minority interest appears on the balance sheet of some companies. Minority interest:
A. is classified as a liability.
B. is classified as an equity.
C. arises when a company records investments using the equity method.
D. arises when a company owns controlling interest in another company, but less than 100%.
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18. A lessee must account for a lease as a capital lease if:

I. lease transfers ownership to lessee at the end of the lease.
II. lease contains option to purchase the asset at the end of the lease at a bargain price.
III. lease is longer than 20 years.
IV. present value of lease is greater than 10% of lessee's assets.
A. I and II
B. I, II and III
C. I, III and IV
D. I, II and IV
19. Dylan Corporation issues a zero-coupon bond with $100,000 face value, with a 5-year
maturity, and the market rate is 7%. Interest on corporate bonds is normally paid
semiannually. In the liability section of Dylan's balance sheet, the proceeds from selling the
zero-coupon immediately after issuance will be closest to:
A. $70,892.
B. $71,299.
C. $70,000.
D. $100,000.
20. Which of the following statements about stock dividends is true?

A. Stock dividends increase the number of shares outstanding.
B. Stock dividends are more valuable than stock splits.
C. Stock dividends are recorded as a reduction in cash.
D. Stock dividends are dividends given in the form of stock from another company.
21. Treasury stock is:

A. investments in government securities.
B. retained earnings that have been appropriated to make equity investments.
C. a company's own stock that it has repurchased.
D. assets held for safekeeping in company's vaults.
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Reling Company reports the following information as of 12/31/05
22. The book value per share of common stock is:

A. $12.20
B. $12.40
C. $15.25
D. $15.50
23. The book value per share of preferred stock is:

A. $ 22
B. $ 20
C. $ 11
D. $ 10
24. Which of the following statements concerning contingencies is correct?

I. Gain contingencies are recorded if they are probable and reasonably estimable.
II. Unredeemed frequent flyer mileage is an example of a loss contingency.
III. A loss contingency is a form of off-balance sheet financing.
IV. Loss contingencies are not recognized unless there is a greater than 95% chance they will
be realized.
B. II, III, and IV
C. II and III
D. II only
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25. Many of the postretirement health benefit plans offered by companies to their employees
are unfunded, while all of their pension plans have some degree of funding. Which of the
following statements is false?
A. There is no legal requirement to fund postretirement health benefits, but there are legal
requirements covering pension funding.
B. Contributions to pension plans are normally tax deductible, but contributions to
postretirement health plans are not tax deductible.
C. Funds contributed to a pension plan can be withdrawn at any time, but funds contributed to
a postretirement health plan cannot be withdrawn by law.
D. Taxes do not have to be paid on investment income earned by assets in pension plan, but
they do normally have to be paid on postretirement health plans.
26. One way for a company to increase its book value per share is to:
A. issue long-term debt.
B. retire long-term debt.
C. increase dividend payout ratio.
D. buy back shares at market prices below their book value.
27. A company's current ratio is 1.5. If the company uses cash to retire notes payable due
within one year, would this transaction increase or decrease the current ratio and return on
assets ratio?
A. Current Ratio: Increase; Return on Assets: Increase
B. Current Ratio: Increase; Return on Assets: Decrease
C. Current Ratio: Decrease; Return on Assets: Increase
D. Current Ratio: Decrease; Return on Assets: Decrease
28. An analyst should consider whether a company acquired assets through a capital lease or
an operating lease because a company may structure:
A. leases to be treated like capital leases to enhance its leverage ratios.
B. leases to be treated like capital leases to enhance its cash flow.
C. leases to be treated like operating leases to enhance its leverage ratios.
D. leases to be treated like operating leases to enhance its cash flow.
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29. Which of the following lease provisions would cause a lease to be classified as an
operating lease?
A. The lease contains a bargain purchase option.
B. The collectibility of lease payments by the lessor is unpredictable.
C. The term of the lease is more than 75 percent of the estimated economic life of the leased
property.
D. The present value of the minimum lease payments equals or exceeds 90 percent of the fair
value of the leased property.
30. On January 1, a company entered into a capital lease resulting in an obligation of $20,000
being recorded on the balance sheet. The lessor's implicit interest was 10 percent. At the end
of the first year of the lease, the cash flow from financing activities section of the lessee's
statement of cash flows showed a use of cash of $2,200 applicable to the lease. How much did
the company pay the lessor in the first year of the lease?
A. $2,000
B. $2,200
C. $4,200
D. $20,000
31. Which of the following is not a component of recognized OPEB cost?

A. Service cost
B. Amortization of prior service costs
C. Interest cost
D. Amortization of prior interest costs
32. Which of the following is reported in the equity section of the balance sheet?
A. Redeemable Preferred stock
B. Treasury stock
C. Investment in affiliates
D. Debentures
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33. Which of the following is not a component of pension expense?

A. Service cost
B. Interest cost
C. Actual return on plan assets
D. Expected return on plan assets
34. If a company increases its expected return on plan assets this year, the effect would be to:
I. increase plan assets.
II. decrease PBO.
III. decrease pension expense.
IV. decrease minimum liability.
A. I, II and IV
B. I and IV
C. III and IV
D. III only
Harms Inc. reported in its 2006 annual report the following information:
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35. Funded status at the end of 2006 was:

A. $15M.
B. $12M.
C. $10M.
D. $0M.
36. If Harms had decreased its compensation growth rate to 4.5% in 2006, the effect would
have been:
A. an increased ABO.
B. an increased PBO.
C. a decreased ABO.
D. a decreased PBO.
37. The estimated interest cost for 2007 is:

A. 7.95M.
B. 7.60M.
C. 7.36M.
D. 7.20M.
38. Synthetic leases may achieve all of the following benefits to the borrower except:
A. window dress the balance sheet.
B. increase cash flow.
C. reduce tax expense on the income statement.
D. increase net income.
39. The plan is said to be underfunded, if:

A. the pension obligation is more than the asset value.
B. the pension obligation is less than the asset value.
C. the pension obligation is equal to the asset value.
D. none of the above.
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40. Which of the following is not an actuarial assumption underlying the computation of the
pension obligation?
A. Employee turnover
B. Life expectancy
C. Interest rate
D. Service cost
41. Pension intensity can be measured by expressing the pension plan assets and the pension
obligation separately as:
A. a percentage of company's total liabilities.
B. a percentage of company's total assets.
C. a percentage of company's net income.
D. a percentage of company's shareholders' equity.
42. The net deferrals are included in the balance sheet as part of:
A. assets.
B. current liabilities.
C. shareholders' equity.
D. long-term liabilities.
True / False Questions
43. Current liabilities should always be expected to be liquidated within one year.
FALSE
44. A company will record a contingent gain if the gain is probable and reasonably estimable.
FALSE
45. Creditors of a business are more concerned with the future cash flows of a business than
the future return on equity.
TRUE
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46. Evaluating risk of long-term creditors (e.g. bondholders) involves more detail than
evaluating the risk of equity holders.
FALSE
47. Investing in equity is considered to be more risky than investing in bonds.

TRUE
48. Stockholders are the residual claimants of a company.

TRUE
49. A company issues a $100,000K 9% bond and receives $99,000K (ignoring transaction
costs). This implies that the effective interest rate is less than 9%.
FALSE
50. If the lease term is 75% or more of the economic life of the asset, the lease needs to be
classified as a capital lease.
TRUE
51. Operating leases can inflate both return on investment and asset turnover ratios.
TRUE
52. A convertible bond is an equity investment, which is convertible into bonds at the option
of the owner of the convertible bond.
FALSE
53. If a company increases the amount of debt it has, all other things being equal, the risk to
the shareholders increases.
TRUE
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54. A company which leases a piece of machinery (the lessee) will record it as a sales-type
lease if the lessor makes a profit on the lease.
FALSE
55. With a defined contribution plan the risk of pension fund performance rests with the
employees/retirees of the company, while with a defined benefit plan this risk rests with the
company.
TRUE
56. Many postretirement benefits other than pensions are not funded, in part because they are
not required to be funded by law, unlike pension plans.
TRUE
57. Three elements of pension expense for defined benefit plans are: service cost, interest cost
and actual return on plan assets.
FALSE
58. Pension accounting for defined benefit plans requires that retroactive adjustments to the
plan (prior service costs) be recognized immediately in full in the pension expense.
FALSE
59. If a company increases its expected rate of compensation increase for the purposes of
calculating its pension obligations, the accumulated benefit obligation and the projected
benefit obligation will both increase.
FALSE
60. If a company increases its discount rate for the purposes of calculating its pension
obligations, the accumulated benefit obligation and the projected benefit obligation will both
decrease.
TRUE
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61. One reason many companies do not fund their post-retirement obligations other than
pensions is because they are not required to do so by law.
TRUE
62. When analyzing post retirement benefits, one should evaluate the actuarial assumptions
and their effects on the financial statements.
TRUE
63. Actuarial gain or loss is the change in PBO that occurs when one or more actuarial
assumptions are revised in estimating PBO.
TRUE
64. Companies must report the economic pension cost in their financial statements.
FALSE
65. A decrease in the growth rate of the future compensation will cause an increase in pension
cost.
FALSE
66. For a company to report a contingent loss it should be either probable or reasonably
estimable.
FALSE
67. Funding of pension plans is required by GAAP.

FALSE
68. If a company issues new stock, this will always decrease book value per share.
FALSE
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69. The par value of common stock represents the price at which the company offered its
stock to investors when it made its initial public offering.
FALSE
70. An analyst should treat preferred stock on a firm's balance sheet as debt when calculating
leverage ratios if the preferred stock is convertible into common stock.
FALSE
71. Following recent SPE abuses, a new rule requiring a minimum of 3% external financing
was enacted.
FALSE
72. An SPE investor may secure its investment with a guarantee so that the SPE remains
unconsolidated.
FALSE
73. An increase in the pension obligation because of passage of time is referred to as the
interest cost.
TRUE
74. Companies report the funded status of pension plans as a separate line item on the balance
sheet.
FALSE
75. Pension risk arises to the extent to which plan assets have a different risk profile than the
pension obligation.
TRUE
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76. Unlike SFAS 158, SFAS 87 recognizes the funded status on the balance sheet.
FALSE
Essay Questions
77. Problem One: Leases
Compare the effects of operating leases as compared to capitalized leases, in the first year of a
lease, on the following items listed. Explain your answer.
1. EBIT
2. Net Income
3. Return on Assets (levered)
4. Cash flow from Operations

5. Current Ratio
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Problem One: Leases

1. EBIT
Operating leases deduct total rental expense in arriving at EBIT.
Capitalized leases deduct only depreciation expense in arriving at EBIT (the other deduction
is interest which is not included in EBIT).
Therefore, EBIT will be higher under capitalized leases.
2. Net Income
Operating leases deduct total rental expense in arriving at net income.
Capitalized leases deduct only depreciation expense and interest expense in arriving at NI.
In first year, depn + interest expense > rental expense, therefore, NI is lower for capitalized
lease.
3. ROA (levered)
Operating leases have higher NI (see 2) and lower assets (do not have to recognize assets they
are leasing on their balance sheet) than capitalized leases. Thus, ROA for operating lease is
higher than that for capitalized leases.
4. Cash flow from Operations
Operating leases: all rental expense is deducted in arriving at CFO.
Capitalized leases:
Capital Lease payments will affect CF from operating and financing activities.
Capital lease payments are treated the same way as financing. The amount paid on the
principle will show in CF from financing activities, while the interest option will be shown in
operating activities under "Interest paid".
Note: depreciation is not a factor (and is not a cash flow).
Thus, CFO is higher for capitalized leases.
5. Current Ratio
Current Assets are unaffected by either a capital or operating lease.
Current Liabilities are increased under a capital lease by the current portion of the lease
obligation.
Thus, Current ratio will be lower under a capital lease.
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78. Problem Two: Liabilities not recorded on balance sheet

You are considering purchasing a company - assets, liabilities, warts and all. You are aware
that sometimes liabilities do not always show up on the balance sheet. Give five examples of
liabilities that may not be explicitly recognized on the balance sheet, being sure to explain
why they are liabilities.
Problem Two: Liabilities not recorded on balance sheet

1. Sale of accounts receivable with recourse. This is when a company sells its receivables but
retains the risk of non-collection. This is more like a loan than a sale and as such it has
unrecorded liabilities (when the transaction meets certain regulations).
2. Many operating leases commit companies to long-term contracts that effectively result in
an obligation that is not recorded on the balance sheet.
3. Through-put or take-or-pay agreements. Company effectively gains use of productive
assets without recording them or associated debt on their balance sheet.
4. Creation of joint ventures recorded using equity method where debt does not show up on
the balance sheet of the company.
5. Product financing arrangements where company sells goods and agrees to repurchase at a
later date.
6. Not all contingent liabilities are recorded - much of this is subjective. An example would be
contingent liabilities arising from lawsuits or environmental damage.
7. Commitments such as purchase orders (even if evidenced by signed contracts) are not
completed transactions and are thus not recorded under normal circumstances.
8. Synthetic leases are treated as operating leases by the lessee without appearing on the
balance sheet, even though the lessee can realize the benefits of ownership for tax purposes.
9. A sale-leaseback may be structured to result in an operating lease without being recorded as
a liability.
10. Executory costs such as maintenance, taxes and insurance can be substantial, but there is
no liability recorded under both operating and capitalized leases.
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79. Problem Three: Book Value per share

The following information was taken from Wicom's financial statements as of December 31,
2006.
a. Calculate book value per share of common stock.

b. Assume that the company also had $1,000,000 worth of convertible bonds. The bonds are
convertible at one $1,000 bond into 150 shares of stock. There are also stock options to buy
120,000 shares at a price of $5 per share. The stock is currently trading at $30 per share.
Recalculate your answer to part a) taking into account dilutive effects of the above.
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Problem Three: Book Value per share
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80. Problem Four: Operating Leases

Retail Inc. has both operating and capital leases. Below is a portion of its lease footnote taken
from their 2006 financial statements.
a. Obtain a crude estimate of the remaining length of the operating and capital leases.
b. Estimate the interest rate implicit in the capital leases.
c. Compute the present value of the operating leases.
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Problem Four: Operating Leases
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81. Problem Five: The effect of leases on financial ratios

Some financial information about Retail Inc. and Store Inc. is given below:
You are asked to analyze these companies and specifically analyze the impact of the leases on
different financial ratios.
a. Compute the present value of the lease obligations for Retail Inc. using an annual interest
rate of 8%. You should assume all payments are made at the end of the year, and all payments
after year X6 are equal to the payment in year X6.
b. Compute the present value of the lease obligations for Stores Inc. using an annual interest
rate of 8%. You should assume all payments are made at the end of the year, and all payments
after year X6 are equal to the payment in year X6.Error! Hyperlink reference not valid.
c. Compute the total liabilities to asset ratio and the long-term debt to assets ratio for Retail
Inc. for the end of year X1.
d. Compute the total liabilities to asset ratio and the long-term debt to assets ratio for Stores
Inc for the end of year X1.
e. Repeat c and d and compute the total liabilities to asset ratio and the long-term debt to
assets ratio for both companies for the end of year X1 assuming the companies capitalize the
leases.
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Problem Five: The effect of leases on financial ratios

a. Retail Inc.
*Present value of an annuity of $542 million for 2.847 periods (= $1,543/$542), then
discounted back five periods.
b. Stores Inc.
*Present value of an annuity of $312 million for 2.795 periods (= $872/$312), then discounted
back five periods.
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82. Problem Six: Post-retirement Health Benefits

Warden Corp. has a postretirement health benefit plan for its employees. As of December 31,
2006, the accumulated postretirement benefit obligation (APBO) is $250M and the
postretirement health benefit cost for the year was $23M. The plan assets are $10M. Warden
chose to recognize its unfunded liability immediately. Walden also has a pension plan, which
is fully funded.
a. What reasons are there for the minimal funding of the postretirement health benefits plans
versus the full funding of the pension plan?
b. In 2006 Walden makes the following changes.
● Increases its expected rate of return on plan assets.
● Increases the expected compensation growth rate.
● Increases its discount rate.
Explain the effect of each of these on
i. economic cost as of the end of 2007.
ii. reported cost for 2007.
Problem Six: Postretirement Health Benefits
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83. Problem Seven: Pension Expense

Werter Inc. has a defined benefit pension plan. Information related to this plan as of the end of
2006 is as follows:
a. Estimate pension expense for 2006 assuming that the pension plan assumptions remain
unchanged from 2006, service cost is 10% of beginning of year PBO and that the prior service
costs and transition assets are being amortized over 20 years.
b. Calculate the liability to be recorded in the balance sheet at the end of fiscal 2006.
Problem Seven: Pension Expense

a. Estimated pension expense
*interest cost  PBO-Beginning of year x discount rate

= $5,350,000 x.08 = $428,000
**expected return on plan assets  plan assets–beginning of year x expected rate = $3,500,000
x .10 = $350,000
b. liability = PBO – plan assets = $5,350,000 – 3,500,000 = $1,850,000 (plan is underfunded)
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84. Problem Eight: Pensions

Pawn Company's 2006 Annual Report included the following information about its defined
benefit pension plan:
a. If Pawn had increased its discount rate to 10% in 2006 what would be the effect on the
accumulated benefit obligation, the projected benefit obligation, service cost and interest cost?
b. Estimate the interest cost for 2007 under the existing plan.
Problem Eight: Pensions

a. An increase in discount rate will decrease all the benefit obligations as expected future
payments are being discounted at higher rate. The service cost will also decrease in year 2007.
Interest cost will increase in year 2007. The net effect will normally be to decrease pension
cost overall in 2007.
(CFA Adapted)
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85. Problem Nine: Post-retirement Benefits other than pensions

Below is part of Harnischfeger's footnote on Postretirement Benefits other than Pensions from
its X6 Annual report.
a. What amount is Harnischfeger showing as a liability on their balance sheet with respect to
postretirement benefits other than pensions at the end of fiscal X6?
b. What amount is Harnischfeger showing as an expense on the income statement for the
fiscal year X6?
c. Why is Harnischfeger's accrued postretirement benefit liability greater than the APBO?
d. If Harnischfeger wanted to reduce its APBO how might they do it? Provide three ways.
Problem Nine: Post-retirement Benefits other than pensions

a. The total liability they are showing is $97,306K. $18,492K is recorded as a short-term
liability, and the balance $78,814K as a long-term liability.
b. Negative $7,454K. That is, it is showing as a credit on income statement.
c. There is a very large prior service credit of $20,653K that has not yet been recognized in
financial statements. Changes in the APBO are not immediately recognized but amortized
over time.
d. The following will decrease the APBO:
1. Increase discount rate used to calculate APBO.
2. Amend plan to decrease benefits offered.
3. Decrease assumed rate of health care increases.
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86. Problem Ten: Special Purpose Entities

What are the four important requirements when structuring a valid SPE? How were they
abused by Enron?
Problem Ten: Special Purpose Entities

1. The SPE must be capitalized with outside equity from independent third-party investors.
Enron often supplied the equity to the investors.
2. The investment must be at least 10% of total SPE capitalization. The requirement used to
be 3%, but even this threshold was not always met.
3. The investment must be at risk. Enron frequently protected investors from loss through
mechanisms such as repurchasing the SPE's assets at a higher price in a subsequent
accounting period. Had it not been for such guaranteed profits, it is doubtful that Enron would
have been able to find any investors for some of the deals.
4. Effective control of the SPE should be retained by an outside party. Enron's CFO served as
the managing partner for some of the SPEs.
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87. Problem Eleven: Synthetic Leases

Following is selected financial information for Universal Skyhook:
Skyhook installed a new giant forging machine on January 1, 2006. It was financed as a five-
year capitalized lease with year-end payments of $1,002 with an implied 8% interest rate.
After the lease period, the scrap value will just about cover the cost to remove the machine.
Skyhook had no tax expense in 2006 and uses straight-line depreciation for book and tax
purposes.
a. The company is examining financing alternatives for another machine and has received a
synthetic lease proposal from a bank. To better understand this structure, the CEO asks you
how the above 2006 numbers would have changed had Skyhook used a synthetic lease for the
forging machine.
b. How would you interpret your results and what would your recommendation be?
c. Would your recommendation change if Skyhook had a tax rate of 36% and used accelerated
depreciation for tax purposes?
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lOMoARcPSD|11010251
Problem Eleven: Synthetic Leases

a. A properly structured synthetic lease is treated as an operating lease for book purposes and
a capitalized lease for tax purposes. With the given facts, all that is necessary is to restate
from a capitalized lease to an operating lease.
b. Net income would have been $118 (9.8%) higher using the synthetic lease. Total debt as a
percentage of total assets declined from 55.6% to 45.5%. Although we do not have total assets
as of 1/1/06, which is necessary to calculate return on average total assets for the year, it is
clear that return on assets would have increased significantly. Similarly, return on equity
would improve. Liquidity measures such as current ratio also increase.
The synthetic lease clearly makes the company look better. Assuming that similar financing
choices at the same rates are available for the new machine and that Skyhook's projected
financials are similar to 2006, the synthetic lease would be preferable. An astute student might
note that investors have become wary of such deals, hence the company might want to
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lOMoARcPSD|11010251
consider the broader implications. Furthermore, there is no fundamental economic difference,

and a skilled analyst could restate back to a capitalized lease.
c. This is the usual situation with a synthetic lease. The company would be able to take the
higher deduction due to accelerated depreciation for tax purposes, thereby increasing its cash
flow in the early years and resulting in an economic benefit.
3-34

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Chap003 - this is a quiz of chapter 3 FSA

Financial Management (Lahore School of Economics)

Studocu is not sponsored or endorsed by any college or university

Chapter 03 - Analyzing Financing Activities

Multiple Choice Questions

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Chapter 03 - Analyzing Financing Activities

5. Which of the following is true concerning bond covenants?

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Chapter 03 - Analyzing Financing Activities

9. Which one of the following statements is false?

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Chapter 03 - Analyzing Financing Activities

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Chapter 03 - Analyzing Financing Activities

15. Which of the following is an example of off-balance sheet financing?

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Chapter 03 - Analyzing Financing Activities

18. A lessee must account for a lease as a capital lease if:

20. Which of the following statements about stock dividends is true?

21. Treasury stock is:

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Chapter 03 - Analyzing Financing Activities

Reling Company reports the following information as of 12/31/05

22. The book value per share of common stock is:

23. The book value per share of preferred stock is:

24. Which of the following statements concerning contingencies is correct?

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Chapter 03 - Analyzing Financing Activities

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Chapter 03 - Analyzing Financing Activities

31. Which of the following is not a component of recognized OPEB cost?

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Chapter 03 - Analyzing Financing Activities

33. Which of the following is not a component of pension expense?

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Chapter 03 - Analyzing Financing Activities

35. Funded status at the end of 2006 was:

37. The estimated interest cost for 2007 is:

39. The plan is said to be underfunded, if:

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Chapter 03 - Analyzing Financing Activities

True / False Questions

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Chapter 03 - Analyzing Financing Activities

47. Investing in equity is considered to be more risky than investing in bonds.

48. Stockholders are the residual claimants of a company.

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Chapter 03 - Analyzing Financing Activities

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Chapter 03 - Analyzing Financing Activities

67. Funding of pension plans is required by GAAP.

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Chapter 03 - Analyzing Financing Activities

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Chapter 03 - Analyzing Financing Activities

4. Cash flow from Operations

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