Question: a. A firm invests in a project

> What are the five steps used in NPV analysis?

> Explain why it is difficult to value a young, rapidly growing company?

> Given that many new businesses fail in the first few years after they are established, how should an entrepreneur think about the risk of failure associated with a new business? From what you have learned in this chapter, what can an entrepreneur do to i

> Fled Flightstone Mining’s management does not like to pay cash dividends due to the volatility of the company’s cash flows. Fled management has found, however, that when it does not pay dividends, its stock price becomes too high for individual investors

> Some people argue that a high tax rate on dividends creates incentives for managers to go about their business without credibly convincing investors that the firm is doing well, even when it is. Discuss why this may be true?

> You have just read a press release in which a firm claims that it will be able to generate a higher level of cash flows for its investors going forward. Justify the choice of a dividend payout that could credibly convey that information to the market?

> You have accumulated stock in a firm that does not pay cash dividends. You have read that, according to Modigliani and Miller, you can create a “homemade” dividend should you require cash. Discuss why this choice may not be very good for the value of you

> You are the CEO of a firm that appears to be the target of a hostile takeover attempt. Thibeaux Piques has been accumulating the shares of your stock and now holds a substantial percentage of the outstanding shares. You would like to purchase the shares

> Discuss why the dividend payment process is so much simpler for private companies than for public companies?

> You find that you are the only investor in a particular stock who is subject to a 15 percent tax rate on dividends (all other investors are subject to a 5 percent tax rate on dividends). Is there greater value to you in holding the stock beyond the ex-di

> Lintner found that firms are reluctant to make dividend changes that might have to be reversed. Discuss the rationale for that behavior?

> What is the NPV of a project?

> Suppose that you live in a country where it takes 10 days to settle a stock purchase. By how many days will the ex-dividend date precede the record date?

> Discuss under what circumstances you might be able to use a model that assumes constant growth in dividends to calculate the current cost of equity capital for a firm?

> Ten years ago, the Edson Water Company issued preferred stock at a price equal to the par value of $100. If the dividend yield on that issue was 12 percent, explain why the firm’s current cost of preferred capital is not likely to equal 12 percent?

> Maltese Falcone, Inc., has not checked its weighted average cost of capital for four years. Firm management claims that since Maltese has not had to raise capital for new projects in four years, they should not have to worry about their current weighted

> Describe why it is not usually appropriate to use the coupon rate on a firm’s bonds to estimate the pretax cost of debt for the firm?

> Your firm will have a fixed interest expense for the next 10 years. You recently found out that the marginal income tax rate for the firm will change from 30 percent to 40 percent next year. Describe how the change will affect the cash flow available to

> Your friend has recently told you that the federal government effectively subsidizes the use of debt financing (vs. equity financing) for corporations. Do you agree with that statement? Explain?

> With respect to the level of risk and the required return for a firm’s portfolio of projects, discuss how the market and a firm’s management can have inconsistent information and expectations?

> Which is easier to calculate directly, the expected rate of return on the assets of a firm or the expected rate of return on the firm’s debt and equity? Assume that you are an outsider to the firm?

> Your boss just finished computing your firm’s weighted average cost of capital. He is relieved because he says that he can now use that cost of capital to evaluate all projects that the firm is considering for the next four years. Evaluate that statement

> What are the differences between capital projects that are independent, mutually exclusive, and contingent?

> Explain why the required rate of return on a firm’s assets must be equal to the weighted average cost of capital associated with its liabilities and equity?

> How does the pretax operating cash flow for a project differ from the economic profit for that project?

> The economics break-even calculation assumes that the number of units sold is the same each year during the life of the project. It is possible for the NPV of a project to be negative if unit sakes are not the same each year and the average unit sales ar

> What is the fundamental difference between a sensitivity analysis and a scenario analysis?

> Is it possible to have a crossover point where the accounting break-even point is the same for two alternatives - that is, above the break-even point for a low-fixed-cost alternative but below the break-even point for a high-fixed-cost alternative? Expla

> Describe how the pretax operating cash flow break-even point is related to the economic break-even point?

> Explain how EBITDA differs from incremental after-tax free cash flows (FCF) and discuss the types of businesses for which this difference would be especially small or large?

> Discuss the interpretation of the degree of accounting operating leverage and degree of pretax cash flow operating leverage?

> You own a firm with a single new product that is about to be introduced to the public for the first time. Your marketing analysis suggests that the annual demand for this product could be anywhere between 500,000 units and 5,000,000 units. Given such a w

> What is the advantage of using a simulation analysis instead of a scenario analysis to assess the risk of a project?

> Why are capital investments considered the most important decisions made by a firm’s management?

> You are involved in the planning process for a firm that is expected to have a large increase in sales next year. Which type of firm would benefit the most from that sales increase: a firm with low fixed costs and high variable costs or a firm with high

> Explain the difference between marginal and average tax rates, and identify which of these rates is used in capital budgeting and why?

> How is the MACRS depreciation method under IRS rules different from the straight-line depreciation allowed under GAAP rules? What is the implication on incremental after-tax free cash flows from firms’ investments?

> High-End Fashions, Inc., bought a production line of ankle-length skirts last year at a cost of $500,000. This year, however, miniskirts are in and ankle-length skirts are completely out of fashion. High-End has the option to rebuild the production line

> QualityLiving Trust is a real estate investment company that builds and remodels apartment buildings in northern California. It is currently considering remodeling a few idle buildings that it owns in San Jose into luxury apartment buildings. The company

> MusicHeaven, Inc., is a producer of media players which currently have either 20 gigabytes or 30 gigabytes of storage. Now the company is considering launching a new production line making mini media players with 5 gigabytes of storage. Analysts forecast

> Suppose that FRA Corporation already has divisions in both Dallas and Houston. FRA is now considering setting up a third division in Austin. This expansion will require that one senior manager from Dallas and one from Houston relocate to Austin. Ignore r

> You are providing financial advice to a shrimp farmer who will be harvesting his last crop of farm-raised shrimp. His current shrimp crop is very young and will, therefore, grow and become more valuable as their weight increases. Describe how you would d

> What is the opportunity cost of using an existing asset? Give an example of the opportunity cost of using the excess capacity of a machine?

> When two mutually exclusive projects have different lives, how can an analyst determine which is better? What is the underlying assumption in this method?

> Describe the process of capital rationing?

> Do you agree or disagree with the following statement given the discussion in this chapter? We can calculate future cash flows precisely and obtain an exact value for the NPV of an investment?

> Under what circumstances might the IRR and NPV approaches produce conflicting results?

> What are the strengths and weaknesses of the accounting rate of return approach?

> Identify the weaknesses of the payback period method?

> In the context of capital budgeting, what is “capital rationing”?

> a. Sykes, Inc. management is considering two projects: a plant expansion and a new computer system for the firm’s production department. Classify these projects as independent, mutually exclusive, or contingent projects and explain your reasoning. b. A c

> Elkridge Construction Company has an overall (composite) cost of capital of 12 percent. This cost of capital reflects the cost of capital for an Elkridge Construction project with average risk. However, the firm takes on projects of various risk levels.

> Explain why the cost of capital is referred to as the “hurdle” rate in capital budgeting?

> The profitability index is a tool for measuring a project’s benefits relative to its costs. How might this help to eliminate bias in project selection?

> What is the cost of capital?

> What is the general formula used to calculate the price of a share of a stock? What does it mean?

> Select the best answer for each of the following questions. Explain the reasons for your selection. a. Which of the following is not a financial statement assertion made by management? (1) Existence of recorded assets and liabilities. (2) Completeness of

> For each definition (or portion of a definition) in the first column, select the term that most closely applies. Each term may be used only once or not at all. Partial (or Complete) Definition Term a. A federal securities statute covering registrat

> Items (a) through ( f ) relate to what a plaintiff who purchased securities must prove in a civil liability suit against a CPA. For each item, determine whether it must be proved assuming application of the following acts: 1. Only applies to Section 11 o

> Match the important cases listed below with the appropriate legal precedent or implication. Case: a. Hochfelder v. Ernst b. Escott v. BarChris Construction Corp. c. Credit Alliance v. Arthur Andersen & Co. d. Ultramares v. Touche & Co. e. Rosenblum v. A

> Assume that in a particular audit the CPAs were negligent but not grossly negligent. Indicate whether they would be “liable” or “not liable” for the following losses proximately caused by their negligence and determine that liability under the various th

> Dandy Container Corporation engaged the accounting firm of Adams and Adams to audit financial statements to be used in connection with an interstate public offering of securities. The audit was completed, and an unqualified opinion was expressed on the f

> Gloria and Deloria, CPAs, have recently started their public accounting firm and intend to provide attestation and a variety of consulting services for their clients, which are all nonpublic. Both Ms. Gloria and Mr. Deloria have particular expertise in d

> The firm of Schilling & Co., CPAs, has offices in Chicago and Green Bay, Wisconsin. Gillington Company, which has 1 million shares of outstanding stock, is audited by the Chicago office of Schilling; Welco, of the Chicago office, is the partner in charge

> The firm of Bell & Greer, CPAs, has been asked to perform attest services for Trek Corporation (a nonpublic company) for the year ended December 31, Year 5. Bell & Greer has two offices: one in Los Angeles and the other in Newport Beach. Trek Corporation

> Describe briefly the function of the GAO.

> The cost of an audit might be significantly reduced if the auditors relied upon a representation letter from the client instead of observing the physical counting of inventory. Would this use of a representation letter be an acceptable means of reducing

> James Daleiden, CPA, is interested in expanding his practice through acquisition of new clients. For each of the following independent cases, indicate whether Daleiden would violate the AICPA Code of Professional Conduct by engaging in the suggested prac

> The firm of Harwood & Toole, CPAs, has been the auditor and tax return preparer for Tucker, Inc., a nonpublic company, for several years. In the current year, the management of Tucker discharged Harwood & Toole from the audit and tax engagement because o

> The firm of McGraw and West, CPAs, has two offices, one in Phoenix and one in San Diego. The firm has audited the Cameron Corporation out of its Phoenix office for the past five years. For each of the following independent cases, which occurred during th

> Donald Westerman is president of Westerman Corporation, a nonpublic manufacturer of kitchen cabinets. He has been approached by Darlene Zabish, a partner with Zabish and Co., CPAs, who suggests that her firm can design a payroll system for Westerman that

> The firm of Wilson and Wiener (WW), CPAs, has had requests from a number of clients and prospective clients to perform various types of services. Please reply as to whether the appropriate independence rules (AICPA and/or PCAOB) allow the following engag

> Select the best answer for each of the following. Explain the reasons for your selection. a. Which of the following is not a covered member for an attest engagement under the Independence Rule of the AICPA Code of Professional Conduct? (1) An individual

> For each term in the first column, select the partial (or complete) definition or illustration. Each partial (or complete) definition or illustration may be used only once. Term Partial (or Complete) Definition or Illustration a. A report providing

> State whether each of the following is or is not a principle (or a portion of a principle) underlying an audit conducted in accordance with generally accepted auditing standards. Principles Yes (Y) or No (N) 1. The purpose of an audit Is to provide

> Match each the following statements with the appropriate type of auditors’ report (each auditors’ report may be used once, more than once, or not at all): A. Adverse. D. Disclaimer. Q. Qualified. S. Standard unmodified

> State whether you agree (A) or disagree (D) with each of the following statements concerning the auditors’ unqualified report of a public company. Agree (A) or Disagree (D) Statement a. The report should begln with "CPA's Report"

> What are the major purposes of obtaining representation letters from audit clients?

> Spacecraft, Inc., is a large corporation that is audited regularly by a public accounting firm but also maintains an internal auditing staff. Explain briefly how the relationship of the public accounting firm to Spacecraft differs from the relationship o

> Casa Royale, Inc., a public company, retains Ying and Company CPA to audit its financial statements and internal control. Howard Smythe, the partner in charge of the audit, drafted the following unqualified report: Respond as to the accuracy of the fo

> Select the best answer for each of the following items and give reasons for your choice. a. Which of the following organizations can revoke the right of an individual to practice as a CPA? (1) The Public Company Accounting Oversight Board. (2) The Americ

> For the purposes of this problem, assume the existence of five types of auditors: CPA, GAO, IRS, bank examiner, and internal auditor. Also assume that the work of these various auditors can be grouped into five classifications: audits of financial statem

> Susan Harris is a new assistant auditor with the public accounting firm of Sparks, Watts, and Wilcox, CPAs. On her third audit assignment, Harris examined the documentation underlying 60 disbursements as a test of controls over purchasing, receiving, vou

> Wanda Young, doing business as Wanda Young Fashions, engaged the CPA partnership of Scott & Green to audit her financial statements. During the audit, Scott & Green discovered certain irregularities that would have indicated to a reasonably prudent audit

> The public accounting firm of Hanson and Brown was expanding very rapidly. Consequently, it hired several staff assistants, including James Small. Subsequently, the partners of the firm became dissatisfied with Small’s production and warned him that they

> Jensen, Inc., filed suit against a public accounting firm, alleging that the auditors’ negligence\ was responsible for failure to disclose a large defalcation that had been in process for several years. The public accounting firm responded that it may ha

> Glover, Inc., engaged Herd & Irwin, CPAs, to assist in the installation of a new computerized production system. Because the firm did not have experienced staff available for the engagement, Herd & Irwin assigned several newly hired staff assistants with

> What would you accept as satisfactory documentary evidence in support of entries in the following? a. Sales journal. b. Sales returns journal. c. Voucher or invoice register. d. Payroll journal. e. Check register.

> Provide at least four examples of specialists whose findings might provide appropriate evidence for the independent auditors.

> Auditors are required on every engagement to obtain a representation letter from the client. Required: a. What are the objectives of the client’s representation letter? b. Who should prepare and sign the client’s representation letter? c. When should th

> Is an independent status possible or desirable for internal auditors as compared with the independence of a public accounting firm? Explain.

> When analytical procedures disclose unexpected changes in financial relationships relative to prior years, the auditors consider the possible reasons for the changes. Give several possible reasons for the following significant changes in relationships: a

> Analytical procedures are extremely useful throughout the audit. Required: a. Explain how analytical procedures are useful in (1) The risk assessment stage of the audit. (2) The substantive procedures stage of the audit. (3) Near the end of the audit. b

> Comment on the reliability of each of the following examples of audit evidence. Arrange your answer in the form of a separate paragraph for each item. Explain fully the reasoning employed in judging the reliability of each item. a. Copies of client’s sal

> In an audit of financial statements, the auditors gather various types of audit evidence. List seven major types of evidence and provide a procedural example of each.

> Marion Watson & Co., CPAs, is planning its audit procedures for its tests of the valuation of inventories of East Coast Manufacturing Co. The auditors on the engagement have assessed inherent risk and control risk for valuation of inventories at 100 perc

> Financial statements contain a number of assertions about account balances, classes of transactions, and disclosures. a. Identify who makes these assertions. b. List and describe each of the assertions regarding each financial statement component.

> At 12 o’clock, when the plant whistle sounded, George Jones, an assistant auditor, had been working on his laptop computer. Jones stopped work immediately, but not wanting to waste a lot of time, he simply closed his laptop. He then departed for lunch. T

> Working papers should contain facts and nothing but facts,” said student A. “Not at all,” replied student B. “The audit working papers also may include expressions of opinion. Facts are not always available to settle all issues.” “In my opinion,” said st

> Use of data analytics is likely to increase the use of sampling and eliminate the audit of all items in a population.” Comment on the accuracy of this quotation.