Test Bank for Investments
Which best describes how an investor makes money off debt? - answers not selling
Which best describes the role that government and business play in investments? -
answers they both receive capital
Since stocks can be traded online, which purpose is best served by markets? - answers
not markets regulate tr
Which can be traded in a commodities market? - answers oil
If a company pays dividends on a stock, does that mean that the stock has appreciated
in value? Why or why not? - answers No, the payment of dividends indicates that a
company has earned profits.
Which is true about investments and risk? - answers Every investment carries some
degree of risk.
Capital appreciation refers to - answers the increased value of a stock.
Which factors can affect a stock's price? Check all that apply. - answers 1,2,5
Bonds are considered to offer a guaranteed return, as they must be honored by law, but
which is still a potential risk that investors face? - answers not the issuer many not make
a profit
Which are common types of bonds that are currently issued? Check all that apply. -
answers not 1,2,3
1. Walk me through the 3 financial statements. - answers "The 3 major financial
statements are the Income Statement, Balance Sheet and Cash Flow Statement.
The Income Statement gives the company's revenue and expenses, and goes down to
Net Income, the final line on the statement.
The Balance Sheet shows the company's Assets - its resources - such as Cash,
Inventory and PP&E, as well as its Liabilities - such as Debt and Accounts Payable -
and Shareholders' Equity. Assets must equal Liabilities plus Shareholders' Equity.
The Cash Flow Statement begins with Net Income, adjusts for non-cash expenses and
working capital changes, and then lists cash flow from investing and financing activities;
at the end, you see the company's net change in cash."
,2. Can you give examples of major line items on each of the financial statements? -
answers Income Statement: Revenue; Cost of Goods Sold; SG&A (Selling, General &
Administrative Expenses); Operating Income; Pretax Income; Net Income.
Balance Sheet: Cash; Accounts Receivable; Inventory; Plants, Property & Equipment
(PP&E); Accounts Payable; Accrued Expenses; Debt; Shareholders' Equity.
Cash Flow Statement: Net Income; Depreciation & Amortization; Stock-Based
Compensation; Changes in Operating Assets & Liabilities; Cash Flow From Operations;
Capital Expenditures; Cash Flow From Investing; Sale/Purchase of Securities;
Dividends Issued; Cash Flow From Financing.
3. How do the 3 statements link together? - answers "To tie the statements together,
Net Income from the Income Statement flows into Shareholders' Equity on the Balance
Sheet, and into the top line of the Cash Flow Statement.
Changes to Balance Sheet items appear as working capital changes on the Cash Flow
Statement, and investing and financing activities affect Balance Sheet items such as
PP&E, Debt and Shareholders' Equity. The Cash and Shareholders' Equity items on the
Balance Sheet act as "plugs," with Cash flowing in from the final line on the Cash Flow
Statement."
4. If I were stranded on a desert island, only had 1 statement and I wanted to review the
overall health of a company - which statement would I use and why? - answers You
would use the Cash Flow Statement because it gives a true picture of how much cash
the company is actually generating, independent of all the non-cash expenses you
might have. And that's the #1 thing you care about when analyzing the overall financial
health of any business - its cash flow.
5. Let's say I could only look at 2 statements to assess a company's prospects - which 2
would I use and why? - answers You would pick the Income Statement and Balance
Sheet, because you can create the Cash Flow Statement from both of those (assuming,
of course that you have "before" and "after" versions of the Balance Sheet that
correspond to the same period the Income Statement is tracking).
6. Walk me through how Depreciation going up by $10 would affect the statements. -
answers Income Statement: Operating Income would decline by $10 and assuming a
40% tax rate, Net Income would go down by $6.
Cash Flow Statement: The Net Income at the top goes down by $6, but the $10
Depreciation is a non-cash expense that gets added back, so overall Cash Flow from
Operations goes up by $4. There are no changes elsewhere, so the overall Net Change
in Cash goes up by $4.
Balance Sheet: Plants, Property & Equipment goes down by $10 on the Assets side
because of the Depreciation, and Cash is up by $4 from the changes on the Cash Flow
Statement.
,Overall, Assets is down by $6. Since Net Income fell by $6 as well, Shareholders' Equity
on the Liabilities & Shareholders' Equity side is down by $6 and both sides of the
Balance Sheet balance.
Note: With this type of question I always recommend going in the order:
1. Income Statement 2. Cash Flow Statement 3. Balance Sheet
This is so you can check yourself at the end and make sure the Balance Sheet
balances.
Remember that an Asset going up decreases your Cash Flow, whereas a Liability going
up increases your Cash Flow.
7. If Depreciation is a non-cash expense, why does it affect the cash balance? -
answers Although Depreciation is a non-cash expense, it is tax-deductible. Since taxes
are a cash expense, Depreciation affects cash by reducing the amount of taxes you
pay.
8. Where does Depreciation usually show up on the Income Statement? - answers It
could be in a separate line item, or it could be embedded in Cost of Goods Sold or
Operating Expenses - every company does it differently. Note that the end result for
accounting questions is the same: Depreciation always reduces Pre-Tax Income.
9. What happens when Accrued Compensation goes up by $10? - answers For this
question, confirm that the accrued compensation is now being recognized as an
expense (as opposed to just changing non-accrued to accrued compensation).
Assuming that's the case, Operating Expenses on the Income Statement go up by $10,
Pre-Tax Income falls by $10, and Net Income falls by $6 (assuming a 40% tax rate).
On the Cash Flow Statement, Net Income is down by $6, and Accrued Compensation
will increase Cash Flow by $10, so overall Cash Flow from Operations is up by $4 and
the Net Change in Cash at the bottom is up by $4.
On the Balance Sheet, Cash is up by $4 as a result, so Assets are up by $4. On the
Liabilities & Equity side, Accrued Compensation is a liability so Liabilities are up by $10
and Retained Earnings are down by $6 due to the Net Income, so both sides balance.
10. What happens when Inventory goes up by $10, assuming you pay for it with cash? -
answers No changes to the Income Statement.
On the Cash Flow Statement, Inventory is an asset so that decreases your Cash Flow
from Operations - it goes down by $10, as does the Net Change in Cash at the bottom.
, On the Balance Sheet under Assets, Inventory is up by $10 but Cash is down by $10,
so the changes cancel out and Assets still equals Liabilities & Shareholders' Equity.
11. Why is the Income Statement not affected by changes in Inventory? - answers This
is a common interview mistake - incorrectly stating that Working Capital changes show
up on the Income Statement.
In the case of Inventory, the expense is only recorded when the goods associated with it
are sold - so if it's just sitting in a warehouse, it does not count as a Cost of Good Sold
or Operating Expense until the company manufactures it into a product and sells it.
12. Let's say Apple is buying $100 worth of new iPad factories with debt. How are all 3
statements affected at the start of "Year 1," before anything else happens? - answers At
the start of "Year 1," before anything else has happened, there would be no changes on
Apple's Income Statement (yet).
On the Cash Flow Statement, the additional investment in factories would show up
under Cash Flow from Investing as a net reduction in Cash Flow (so Cash Flow is down
by $100 so far). And the additional $100 worth of debt raised would show up as an
addition to Cash Flow, canceling out the investment activity. So the cash number stays
the same.
On the Balance Sheet, there is now an additional $100 worth of factories in the Plants,
Property & Equipment line, so PP&E is up by $100 and Assets is therefore up by $100.
On the other side, debt is up by $100 as well and so both sides balance.
13. Now let's go out 1 year, to the start of Year 2. Assume the debt is high-yield so no
principal is paid off, and assume an interest rate of 10%. Also assume the factories
depreciate at a rate of 10% per year. What happens? - answers After a year has
passed, Apple must pay interest expense and must record the depreciation.
Operating Income would decrease by $10 due to the 10% depreciation charge each
year, and the $10 in additional Interest Expense would decrease the Pre-Tax Income by
$20 altogether ($10 from the depreciation and $10 from Interest Expense).
Assuming a tax rate of 40%, Net Income would fall by $12.
On the Cash Flow Statement, Net Income at the top is down by $12. Depreciation is a
non-cash expense, so you add it back and the end result is that Cash Flow from
Operations is down by $2.
That's the only change on the Cash Flow Statement, so overall Cash is down by $2.
On the Balance Sheet, under Assets, Cash is down by $2 and PP&E is down by $10
due to the depreciation, so overall Assets are down by $12.
Which best describes how an investor makes money off debt? - answers not selling
Which best describes the role that government and business play in investments? -
answers they both receive capital
Since stocks can be traded online, which purpose is best served by markets? - answers
not markets regulate tr
Which can be traded in a commodities market? - answers oil
If a company pays dividends on a stock, does that mean that the stock has appreciated
in value? Why or why not? - answers No, the payment of dividends indicates that a
company has earned profits.
Which is true about investments and risk? - answers Every investment carries some
degree of risk.
Capital appreciation refers to - answers the increased value of a stock.
Which factors can affect a stock's price? Check all that apply. - answers 1,2,5
Bonds are considered to offer a guaranteed return, as they must be honored by law, but
which is still a potential risk that investors face? - answers not the issuer many not make
a profit
Which are common types of bonds that are currently issued? Check all that apply. -
answers not 1,2,3
1. Walk me through the 3 financial statements. - answers "The 3 major financial
statements are the Income Statement, Balance Sheet and Cash Flow Statement.
The Income Statement gives the company's revenue and expenses, and goes down to
Net Income, the final line on the statement.
The Balance Sheet shows the company's Assets - its resources - such as Cash,
Inventory and PP&E, as well as its Liabilities - such as Debt and Accounts Payable -
and Shareholders' Equity. Assets must equal Liabilities plus Shareholders' Equity.
The Cash Flow Statement begins with Net Income, adjusts for non-cash expenses and
working capital changes, and then lists cash flow from investing and financing activities;
at the end, you see the company's net change in cash."
,2. Can you give examples of major line items on each of the financial statements? -
answers Income Statement: Revenue; Cost of Goods Sold; SG&A (Selling, General &
Administrative Expenses); Operating Income; Pretax Income; Net Income.
Balance Sheet: Cash; Accounts Receivable; Inventory; Plants, Property & Equipment
(PP&E); Accounts Payable; Accrued Expenses; Debt; Shareholders' Equity.
Cash Flow Statement: Net Income; Depreciation & Amortization; Stock-Based
Compensation; Changes in Operating Assets & Liabilities; Cash Flow From Operations;
Capital Expenditures; Cash Flow From Investing; Sale/Purchase of Securities;
Dividends Issued; Cash Flow From Financing.
3. How do the 3 statements link together? - answers "To tie the statements together,
Net Income from the Income Statement flows into Shareholders' Equity on the Balance
Sheet, and into the top line of the Cash Flow Statement.
Changes to Balance Sheet items appear as working capital changes on the Cash Flow
Statement, and investing and financing activities affect Balance Sheet items such as
PP&E, Debt and Shareholders' Equity. The Cash and Shareholders' Equity items on the
Balance Sheet act as "plugs," with Cash flowing in from the final line on the Cash Flow
Statement."
4. If I were stranded on a desert island, only had 1 statement and I wanted to review the
overall health of a company - which statement would I use and why? - answers You
would use the Cash Flow Statement because it gives a true picture of how much cash
the company is actually generating, independent of all the non-cash expenses you
might have. And that's the #1 thing you care about when analyzing the overall financial
health of any business - its cash flow.
5. Let's say I could only look at 2 statements to assess a company's prospects - which 2
would I use and why? - answers You would pick the Income Statement and Balance
Sheet, because you can create the Cash Flow Statement from both of those (assuming,
of course that you have "before" and "after" versions of the Balance Sheet that
correspond to the same period the Income Statement is tracking).
6. Walk me through how Depreciation going up by $10 would affect the statements. -
answers Income Statement: Operating Income would decline by $10 and assuming a
40% tax rate, Net Income would go down by $6.
Cash Flow Statement: The Net Income at the top goes down by $6, but the $10
Depreciation is a non-cash expense that gets added back, so overall Cash Flow from
Operations goes up by $4. There are no changes elsewhere, so the overall Net Change
in Cash goes up by $4.
Balance Sheet: Plants, Property & Equipment goes down by $10 on the Assets side
because of the Depreciation, and Cash is up by $4 from the changes on the Cash Flow
Statement.
,Overall, Assets is down by $6. Since Net Income fell by $6 as well, Shareholders' Equity
on the Liabilities & Shareholders' Equity side is down by $6 and both sides of the
Balance Sheet balance.
Note: With this type of question I always recommend going in the order:
1. Income Statement 2. Cash Flow Statement 3. Balance Sheet
This is so you can check yourself at the end and make sure the Balance Sheet
balances.
Remember that an Asset going up decreases your Cash Flow, whereas a Liability going
up increases your Cash Flow.
7. If Depreciation is a non-cash expense, why does it affect the cash balance? -
answers Although Depreciation is a non-cash expense, it is tax-deductible. Since taxes
are a cash expense, Depreciation affects cash by reducing the amount of taxes you
pay.
8. Where does Depreciation usually show up on the Income Statement? - answers It
could be in a separate line item, or it could be embedded in Cost of Goods Sold or
Operating Expenses - every company does it differently. Note that the end result for
accounting questions is the same: Depreciation always reduces Pre-Tax Income.
9. What happens when Accrued Compensation goes up by $10? - answers For this
question, confirm that the accrued compensation is now being recognized as an
expense (as opposed to just changing non-accrued to accrued compensation).
Assuming that's the case, Operating Expenses on the Income Statement go up by $10,
Pre-Tax Income falls by $10, and Net Income falls by $6 (assuming a 40% tax rate).
On the Cash Flow Statement, Net Income is down by $6, and Accrued Compensation
will increase Cash Flow by $10, so overall Cash Flow from Operations is up by $4 and
the Net Change in Cash at the bottom is up by $4.
On the Balance Sheet, Cash is up by $4 as a result, so Assets are up by $4. On the
Liabilities & Equity side, Accrued Compensation is a liability so Liabilities are up by $10
and Retained Earnings are down by $6 due to the Net Income, so both sides balance.
10. What happens when Inventory goes up by $10, assuming you pay for it with cash? -
answers No changes to the Income Statement.
On the Cash Flow Statement, Inventory is an asset so that decreases your Cash Flow
from Operations - it goes down by $10, as does the Net Change in Cash at the bottom.
, On the Balance Sheet under Assets, Inventory is up by $10 but Cash is down by $10,
so the changes cancel out and Assets still equals Liabilities & Shareholders' Equity.
11. Why is the Income Statement not affected by changes in Inventory? - answers This
is a common interview mistake - incorrectly stating that Working Capital changes show
up on the Income Statement.
In the case of Inventory, the expense is only recorded when the goods associated with it
are sold - so if it's just sitting in a warehouse, it does not count as a Cost of Good Sold
or Operating Expense until the company manufactures it into a product and sells it.
12. Let's say Apple is buying $100 worth of new iPad factories with debt. How are all 3
statements affected at the start of "Year 1," before anything else happens? - answers At
the start of "Year 1," before anything else has happened, there would be no changes on
Apple's Income Statement (yet).
On the Cash Flow Statement, the additional investment in factories would show up
under Cash Flow from Investing as a net reduction in Cash Flow (so Cash Flow is down
by $100 so far). And the additional $100 worth of debt raised would show up as an
addition to Cash Flow, canceling out the investment activity. So the cash number stays
the same.
On the Balance Sheet, there is now an additional $100 worth of factories in the Plants,
Property & Equipment line, so PP&E is up by $100 and Assets is therefore up by $100.
On the other side, debt is up by $100 as well and so both sides balance.
13. Now let's go out 1 year, to the start of Year 2. Assume the debt is high-yield so no
principal is paid off, and assume an interest rate of 10%. Also assume the factories
depreciate at a rate of 10% per year. What happens? - answers After a year has
passed, Apple must pay interest expense and must record the depreciation.
Operating Income would decrease by $10 due to the 10% depreciation charge each
year, and the $10 in additional Interest Expense would decrease the Pre-Tax Income by
$20 altogether ($10 from the depreciation and $10 from Interest Expense).
Assuming a tax rate of 40%, Net Income would fall by $12.
On the Cash Flow Statement, Net Income at the top is down by $12. Depreciation is a
non-cash expense, so you add it back and the end result is that Cash Flow from
Operations is down by $2.
That's the only change on the Cash Flow Statement, so overall Cash is down by $2.
On the Balance Sheet, under Assets, Cash is down by $2 and PP&E is down by $10
due to the depreciation, so overall Assets are down by $12.
