Financial Statement Analysis:

True or False $($Questions $1-5)$

Creditors of a business are more concerned with the future cash flows of a business than the future

return on equity.

True False

Evaluating risk of long$-$term creditors $($e$.$g$.$ bondholders$)$ involves more detail than evaluating the risk

of equity holders.

True False

Stockholders are the residual claimants of a company.

True False

A company issues a $$100,000,9\%$ bond and receives $$99,000($ignoring transaction costs$).$ This

implies that the effective interest rate is less than $9\%.$

True False

If a company increases the amount of debt it has, all other things being equal, the risk to the

shareholders increases.

True False

Multiple Choice $($Questions $6-10)$

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 Chapter Three $-$ Exercises

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

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.

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.

A defined benefit pension 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 The purchase of treasury stock $($commonly called stock buybacks$)$ is being done with increasing

frequency in lieu of dividend payments.

Required:

a$.$ Explain why stock buybacks are similar to dividends from the company's viewpoint.

b$.$ Explain why managers might prefer the purchase of treasury shares to the payment of

dividends.

c$.$ Explain why investors might prefer that firms use excess cash to purchase treasury shares rather

than pay dividends.