Transportation Logistics Exercise Questions Ch8-9

D Loredon

LOG-125-0901

E. Bateh

Ch.8 Water Carriers & Pipelines

December 2, 2019

Chapter 8 Exercise Questions

1. The integrated ownership of pipelines was initially used by some oil companies to gain control of oil-producing areas. How did they use their transportation network to gain market control? What other reasons can be offered for integrated ownership? Are these reasons valid in today’s business environment?

2. The pipeline industry has approximately 100 companies, as compared to the motor carrier industry with more than 50,000. What are the underlying economic causes for this difference, given the fact that they both carry approximately the same volume of intercity ton-miles?

3. The typical pipeline company has high fixed costs. What economic factors account for this situation? What advantages and disadvantages does their cost structure present?

4. Pipelines account for more than 20 percent of the intercity ton-miles but less than 5 percent of the revenue paid by shippers to transportation companies. What factors account for this contrast? Is this situation likely to change? Why or why not?

5. The economic and market position of the pipelines has been described as mature and stable with little likelihood of significant growth in the near future. Do you agree? Why or why not?

6. Water carriers played a dominant role in the transportation system of the United States in the 18th and 19th centuries. Why has their relative position declined during the 20th century? Are they still an important component of the total transportation system? Why or why not?

7. What would be the impact of higher fuel charges on the water carrier industry? Provide a rationale for raising their user charges.

8. Technology often offers the potential of improving efficiency and effectiveness of transportation companies, but water carriers do not appear to have applied much new technology to improve their service. What impediments slow technological progress in the water carrier industry?

9. Intermodal competition is more intense than intramodal competition for water carriers. Why?

10. Why are pipelines unknown to many individuals? Do you think the pipelines should advertise to change this?

FINANCIAL STATEMENTS AND TAXES

Integrated Case Chapter 4

 

FINANCIAL STATEMENTS AND TAXES Part I of this case, presented in Chapter 3, discussed the situation of D’Leon Inc., a regional snack foods producer, after an expansion program. D’Leon had increased plant capacity and undertaken a major marketing campaign in an attempt to “go national.” Thus far, sales have not been up to the forecasted level, costs have been higher than were projected, and a large loss occurred in 2011 rather than the expected profit. As a result, its managers, directors, and investors are concerned about the firm’s survival. Donna Jamison was brought in as assistant to Fred Campo, D’Leon’s chairman, who had the task of getting the company back into a sound financial position. D’Leon’s 2010 and 2011 balance sheets and income statements, together with the projections for 2012 are given in Tables IC 4.1 and IC 4.2. In addition, Table IC 4.3 gives the company’s 2010 and 2011 financial ratios, together, together with industry average data. The 2012 projected financial statement data represent Jamison’s and Campo’s best guess for 2012 results, assuming that some new financing is arranged to get the company “over the hump”

Jason examined monthly data for 2011 (not given in the case), and she detected an improving pattern during the year. Monthly sales were rising, costs were falling, and large losses in the early months had turned to a small profit by December. Thus, the annual data looked somewhat worse than final monthly data. Also, it generate sales, and for the new manufacturing facilities to operate efficiently. In other words, the lags between spending money and deriving benefits were longer than D’Leon’s managers had anticipated. For these reasons, Jamison and Campo see hope for the company- provided it can survive in the short run.

Jamison must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken. Your assignment is to help her answer the following questions. Provide clear explanations, NOT year or not answers.

 

a. Why are the ratios useful? What are the five major categories of ratios?

b. Calculate D’Leon’s 2012 current and quick ratios based on the projected balance sheet and income statement data. What can you say about the company’s liquidity positions in 2010, in 2011, and as projected for 2012? We often thing that ratios as being useful (1) to managers to help run the business, (2) to bankers for credit analysis, and (3) to stockholder for stock valuation. Would these different types of analysts have an equal interest in the company’s liquidity ratios?

c. Calculate the 2012 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover. How does D’Leon’s utilization of assets stack up against other firms in the industry?

d. Calculate the 2012 debt to assets and times interest earned ratios. How does D’Leon compare with the industry with respect to financial leverage? What can you conclude from these ratios?

e. Calculate the 2012 operating margin, profit margin, basic earning power (BEP), return on assets (ROA), and return on equity (ROE). What can you say about these ratios?

f. Calculate the 2012 price/earnings ratio and market/book ratio. Do these ratios indicate that investors are expected to have a high or low opinion of the company?

g. Use the DuPont equation to provide a summary and overview of D’Leon’s financial condition and projected for 2012. What are the firm’s major strengths and weaknesses?

h. Use the following simplified 2012 balance sheet to show, in general terms how an improvement in the DSO would tend to affect the stock price. For example, if the company could improve its collection procedures and thereby lower its DSO from 45.6 days to the 32-day industry average without affecting sales, how would that change “ripple through” the financial statements (shown in thousands below) and influence the stock price?

 

Accounts receivable $878 Debt $1,545

Other current assets 1,802

Net fixed assets 817 Equity 1,952

Total assets $3,497 Liabilities plus equity $3,497

 

i. Does it appear that inventories could be adjusted? If so, how should that adjustment affect the D’Leon’s profitability and stock price?

j. In 2011, the company paid its suppliers much later than the due dates; also, it was not maintaining financial ratios at levels called for in its bank loans agreements. Therefore, suppliers could cut the company off, and its bank could refuse to renew the loan when it comes due in 90 days. On the basis of the data provided, would you, as a credit manager, continue to sell to D’Leon on credit?

 

 

(you could demand cash on delivery- that is, sell on terms of COD- but that might cause D’Leon to stop buying from your company) Similarly, if you were the bank loan officer, would you recommend renewing the loan or demand its repayment? Would your actions be influenced if in early 2012 D’Leon showed you its 2012 projections along with proof that is was going to raise more than $1.2 million of new equity?

k. In hindsight, what should D’Leon have done in 2010?

l. What are some potential problems and limitations of financial ratio analysis?

m. What are some qualitative factors that analysts should consider when evaluating a company’s likely future financial performance?

 

 

Table IC 4.1 Balance Sheets

 

2012E 2011 2010

Assets

Cash $85,632 $7,282 $57,600

Accounts Receivable $878,000 632,160 351,200

Inventories 1,716,480 1,287,360 715,200

Total Current assets $2,680,112 $1,926,802 $1,124,000

Gross fixed assets 1,197,160 1,202,950 491,000

Less accumulated depreciation 380,120 263,160 146,200

Net fixed assets $817,040 $939,790 $344,800

Total assets $3,497,152 2,866,592 1,468,800

 

Liabilities and Equity

Accounts payable $436,000 $524,160 $145,600

Notes Payable 300,000 636,808 200,000

Accruals 408,000 489,600 136,000

Total current liabilities $1,144,800 $1,650,568 $481,600

Long term debt 400,000 723,432 323,432

Common stock 1,721,176 460,000 460,000

Retained earnings 231,176 32,592 203,768

Total equity $1,952,352 $492,592 $663,768

Total liabilities and equity $3,497,152 $2,866,592 $1,468,800

 

Note: E indicates estimated. The 2012 data are forecasts.

 

Table IC 4.2 Income Statements

 

 

2012E 2011E 2010E

Sales $7,035,600 $6,034,000 $3,432,000

Cost of goods sold 5,875,992 5,528,000 2,864,000

Other expenses 550,000 519,988 358,672

Total operating costs excluding depreciation

and amortization $6,425,992 $6,047,988 $3,222,672

EBITDA $609,608 ($13,988) $209,328

Depreciation & Amortization 116,960 116,960 18,900

EBIT $492,648 ($130,948) $190,428

Interest Expense 70,008 136,012 43,828

EBT $422,640 ($266,960) $146,600

Taxes (40%) 169,056 ($106,784)a 58,640

Net Income $253,584 ($160,176) 87,960

 

EPS $ 1.014 ($1.602) $0.880

DPS $ 0.220 $ 0.110 $ 0.220

Book value per share $ 7.809 $4.926 $ 6.638

Stock Price $ 12.17 $2.25 $ 8.50

Shares outstanding $ 250,000 $100,000 $100,000

Tax rate 40.00% 40.00% 40.00%

Lease payments $40,000 $40,000 $40,000

Sinking fund payments 0 0 0

 

Note: E indicates estimated. The 2012 data are forecasts.

The firm has sufficient taxable income in 2009 and 2010 to obtain its full tax refund in 2011

 

 

Table IC 4.3 Ratio Analysis

 

 

2012E 2011 2010 Industry Average

Current 1.2x 2.3x 2.7x

Quick 0.4x 0.8x 1.0x

Inventory turnover 4.7x 4.8x 6.1x

Days sales outstanding (DSO)a 38.2 37.4 32.0

Fixed assets turnover 6.4x 10.0x 7.0x

Total assets turnover 2.1x 2.3x 2.6x

Debt-to-asset- ratio 82.8% 54.8% 50.0%

TIE -1.0x 4.3x 6.2x

Operating margin -2.2% 5.6% 7.3%

Profit margin -2.7% 2.6% 3.5%

Basic earning power -4.6% 13.0% 19.1%

ROA -5.6% 6.0% 9.1%

ROE -32.5 13.3% 18.2%

Price/earnings -1.4x 9.7x 14.2x

Market/book 0.5x 1.3x 2.4x

Book value per share $4.93 $6.64 n.a.

 

 

Note: E indicates estimated. The 2012 data are forecasts.

Calculation is based on a 365-day year.

CASE 7: The Financial Detective, 2005

The typical case report will be about 3 pages (single spaced) in length, not including spreadsheets and other calculations.  You must show in the report or in the appendix, all formulas used and all calculations performed to support your analysis. 

CASE 7: The Financial Detective, 2005

Synopsis and Objectives

The case presents you with financial ratios for eight pairs of unidentified companies and asks you to mate the description of the company with the financial profile derived from the ratios. The primary objective of this case is to introduce you to financial ratio analysis—in particular, the range of ratios and the insights each one affords. This case presumes that you have already been introduced to the definitions of various financial ratios through other readings or lectures, and prerequisite classes.

The structured exploration of pairs of companies within an industry affords a number of important insights into strategy and financial performance. First, the economics of individual industries account for significant variations in financial ratios because of differences in technologies, product characteristics, or competitive structures. Second, financial performance results from managerial choices: within industries, the wide variation in financial ratios is often a result of the differences in corporate strategy in marketing, operations, and finance. You should see the interaction of strategy and financial performance.

Comparisons among industries

This case is primarily about the effects of managerial strategy on financial ratios, but it also affords several insights about the effect of industry differences on financial ratios. For instance, differences in asset intensity can produce dramatically different asset structures (for example, compare the percentages of inventory and net property, plant, and equipment [PP&E] for paper products with computers). The rate of technological change can manifest itself in several ways including the reinvestment rate required to stay competitive (for example, compare dividend-payout ratios for newspapers, and books and music). Industry structure is believed to affect the profitability through the pricing power of the firm. The newspaper industry can be characterized as locally oligopolistic (in some areas, however, monopolistic); the discount retail industry is much more competitive in structure. The gross profit margins of the two industries differ substantially. The general insight is that, in conducting the financial analysis of a firm, one must understand the nature of the industry.

Some observations about the art of ratio analysis:

  • Ratio analysis is only as good as the financial statements that underlie it. In particular, one needs to understand the accounting policies that generated the statements. The various treatments of goodwill, lease obligations, and equity interests in subsidiaries appear in the discussions. In addition, the absence of data can frustrate ratio analysis.
  • Frameworks such as the DuPont system of ratios and categories of ratios (activity, profitability, liquidity, and leverage) are useful organizing schemes for an analysis.
  • Naïve ratio analysis can absorb considerable time, as one seeks to find a pattern (any pattern) in the blizzard of numbers. Effort is economized by thinking first about the underlying business that generated the ratios.

In the Case Report, you must relate the description to the company (A,B,C,etc.) and list and discuss the ratios that justify your choice.  You will need more than one ratio to support your choice.  The chosen ratio must be relevant to the industry.

 

Which Of The Following Situations Might Convince An Employer To Choose A Nonqualified Retirement Plan Over A Qualified Profit-Sharing Plan?

Exam 3 Multiple Choice Questions 1. Which of the following situations might convince an employer to choose a nonqualified retirement plan over a qualified profit-sharing plan? (a) The employer, a closely held C Corporation, is in the 15% income tax bracket and the sole owner of the employer is in the 35% income tax bracket. (b) The employer only wants to meet the organization’s objectives of attracting executives, retaining executives, and providing for a graceful transition in company leadership. The employer is not concerned with providing retirement benefits to the rank and file employees. (c) The employer is not willing to pay high administrative costs. (d) All of the above. 2. Which of the following statements concerning rabbi trusts is(are) correct? (a) A rabbi trust is a trust established and sometimes funded by the employer that is subject to the claims of the employer’s creditors, but any funds in the trust cannot generally be used by or revert back to the employer. (b) A rabbi trust calls for an irrevocable contribution from the employer to finance promises under a nonqualified plan, and funds held within the trust cannot be reached by the employer’s creditors. (c) A rabbi trust can only be established by a religious organization. (d) All of the above are correct. 3. Jackie receives incentive stock options (ISOs) with an exercise price equal to the FMV at the date of the grant of $22. Jackie exercises these options 3 years from the date of the grant when the FMV of the stock is $30. Jackie then sells the stock 3 years after exercising for $35. Which of the following statements is (are) true? 1. At the date of grant, Jackie will have ordinary income equal to $22. 2. At the date of exercise, Jackie will have W-2 income of $8. 3. At the date of sale, Jackie will have long-term capital gain of $13. 4. Jackie’s employer will not have a tax deduction related to the grant, exercise or sale of this ISO by Jackie. (a) 3 only. (b) 3 and 4. (c) 2, 3, and 4. (d) 1, 2, and 4. Page 1 of 12 4. Marguerite received nonqualified stock options (NQSOs) with an exercise price equal to the FMV at the date of the grant of $22. Marguerite exercises the options 3 years after the grant date when the FMV of the stock was $30. Marguerite then sells the stock 3 years after exercising for $35. Which of the following statements are true? 1. At the date of the grant, Marguerite will have ordinary income of $22. 2. At the date of exercise, Marguerite will have W-2 income of $8. 3. At the date of sale, Marguerite will have long term capital gain of $5. 4. Marguerite’s employer will have a deductible expense in relation to this option of $22. (a) 3 only. (b) 2 and 3. (c) 2, 3, and 4. (d) 1, 2, 3, and 4. 5. Which of the following statements concerning tax considerations of nonqualified retirement plans is (are) correct? 1. Under IRS regulations an amount becomes currently taxable to an executive even before it is actually received if it has been “constructively received.” 2. Distributions from nonqualified retirement plans are generally subject to payroll taxes. (a) 1 only. (b) 2 only. (c) 1 and 2. (d) Neither 1 nor 2. 6. James is employed by a large corporation with 400 employees. The corporation provides its employees with a no-cost gym membership at the local public YMCAs. The cost of the membership is $60/month which is completely paid for by James’ employer for all employees. How much, if any, must James include in his yearly gross income related to this fringe benefit? (a) $0. (b) $60. (c) $600. (d) $720. 7. Which of the following situations would create an inclusion in an employee’s gross income? (a) Kay is the director and manager of Holiday Hotel. As a condition of her employment, Kay is required to live at the hotel. The value of this is $1,000 per month. Page 2 of 12 (b) Natalie is a secretary at JKL Law Firm. JKL provides her with free soft drinks. Natalie estimates that she drinks $20 worth of soft drinks per month. (c) Brian is an airline pilot with We Don’t Crash Airlines, Inc. and is allowed to fly, as a passenger, for free on the airline whenever an open seat is available. (d) Eric moved from Houston to New Orleans. His expenses for the move included $400 of truck rental costs, $100 of lodging and $200 of pre-move house hunting expenses. Eric’s employer reimbursed him $600. 8. Judy is covered by a $200,000 group-term life insurance policy of which her daughter is the sole beneficiary. Judy’s employer pays the entire premium for the policy, for which the uniform annual premium is $0.75 per $1,000 per month of coverage. How much, if any, of the cost of the group-term life insurance is excluded from Judy’s gross income on an annual basis? (a) $0. (b) $450. (c) $1,350. (d) $1,800. 9. A business valued at $4,000,000 has 4 partners. The partnership purchases a life insurance policy on each partner’s interest. This is an example of: (a) A buy-sell entity insurance plan. (b) A partnership buy/sell plan. (c) A buy-sell cross-purchase insurance plan. (d) A key person plan. 10. Margaret earned $4,000 during January of this year. She was unemployed for February and March, and during April she earned an additional $3,000. She did not work again until December, during which time she earned $1,000. How many quarters of coverage has Margaret earned for Social Security during this year? (a) 1. (b) 3. (c) 4. (d) 7. 11. Which of the following statements is true? (a) Social Security payments are not adjusted for inflation. (b) A worker’s average indexed monthly earnings (AIME) will be their Social Security benefit at retirement. (c) If an individual who will reach full retirement age for Social Security purposes at the age of 67 begins taking benefits at age 62, they will take a 30 percent reduction in benefits. Page 3 of 12 (d) A 68 year old worker will have their Social Security benefits reduced based on earnings from their current employment. 12. A single individual has an adjusted gross income of $28,000, no tax-exempt interest, and Social Security benefits of $14,000. How much of this individual’s Social Security benefits is subject to income tax? (a) $5,000. (b) $5,350. (c) $7,000. (d) $11,900. 13. This year, Bo and Martha received $14,000 of Social Security income and had $6,000 of interest income. What portion of the Social Security benefits will be taxable on their married filing jointly income tax return? (a) $0. (b) $3,000. (c) $7,000. (d) $14,000. 14. Which of the following statements concerning Social Security retirement benefits is (are) correct? 1. If an individual receives retirement benefits based on his spouse’s earnings record, his benefits will cease upon his divorce from her, unless he is 62 years of age or older and he was married to that spouse for at least 10 years. 2. Widows and widowers will continue to receive survivors benefits upon remarriage of the widow or widower if 60 years of age or older. a. 1 only. b. 2 only. c. Both 1 and 2. d. Neither 1 nor 2. 15. Which of the following statements concerning long term care is (are) correct? 1. Social Security provides many benefits, including long-term care, although it is limited to the participant and the participant’s spouse. 2. Medicare is inadequate to cover long-term care, in that it will not cover custodial care, if that is all that is needed. a. 1 only. b. 2 only. c. Both 1 and 2. d. Neither 1 nor 2. Page 4 of 12 16. All of the following statements concerning the Social Security system are correct EXCEPT: a. The Social Security retirement benefit is payable at normal retirement age with reduced benefits available as early as age 59 ½, to anyone who has obtained at least a minimum amount of Social Security benefits. b. Disability benefit recipients must have a severe physical or mental impairment that is expected to either prevent them from performing “substantial” work for at least a year, or result in death. c. The family benefit is provided to certain family members of workers eligible for retirement or disability benefits. d. Survivors benefits apply to those family members listed for family benefits, and may also include the worker’s parents if the worker was their primary means of support. 17. Which of the following statements concerning the Social Security system is (are) correct? 1. To qualify for retirement benefits, a worker must be “fully insured,’ which means that a worker has earned a certain number of quarters of coverage under the Social Security system. 2. Earning a specific amount of money, regardless of when it was earned during the year, will credit the worker with a quarter of coverage for that year. a. 1 only. b. 2 only. c. Both 1 and 2. d. Neither 1 nor 2. 18. Which of the following statements concerning the Social Security system is (are) correct? 1. Workers entitled to retirement benefits can currently take early retirement benefits as early as age 55 if they are separated from service. 2. A worker who takes early retirement benefits will receive a reduced benefit because he or she is expected to receive more monthly benefit payments, as payments commence earlier than if the worker had waited and retired at full retirement age. a. 1 only. b. 2 only. c. Both 1 and 2. d. Neither 1 nor 2. Page 5 of 12 19. Which of the following statements concerning the reduction of Social Security benefits is (are) correct? 1. Besides early retirement, there are two other situations in which beneficiaries can have their benefits reduced: through the retirement earnings limitations test and through the taxation of benefits. 2. A person who has not reached full retirement age generally can continue to work even though he or she is considered “retired” under Social Security; however, those earnings for a person under normal retirement age must not exceed certain dollar limitations without an impact to their benefits. a. 1 only. b. 2 only. c. Both 1 and 2. d. Neither 1 nor 2. 20. A person, age 78, is confined to a custodial nursing home. Which of the following programs is / are likely to pay benefits towards the cost of the nursing home? 1. Medicare may pay for up to 100 days of care after a 20-day deductible. 2. Long-term care insurance may pay part if coverage of the facility type is broad enough. 3. Private medical insurance may pay part if it is a comprehensive major medical policy. 4. Medicaid may pay if the client has income and assets below state thresholds. a. 4 only. b. 1 and 3. c. 2 and 4. d. 1, 2, and 3. 21. Chris died suddenly at the age of 42, leaving behind his wife, Robin (age 44) and their six-year-old son, Myles. Chris and Robin had been married for 15 years. All of the following statements concerning Social Security benefits available to the family are correct, EXCEPT: a. Myles will be able to collect Social Security benefits on Chris’ account until he reaches age 18. b. Robin will be able to collect Social Security benefits on Chris’ account until Myles reaches the age of 18. c. Robin will receive a death benefit of $255. d. When Robin reaches age 60, assuming she does not remarry, she will be entitled to collect Social Security retirement benefits on Chris’ account. Page 6 of 12 22. For part of the summer of this year, Jordan worked full time at a local accounting firm. Jordan is a 19-year-old accounting student attending a state university, and does not work during the rest of the year. Over the summer, Jordan earned a total of $9,500. How many quarters of coverage has Jordan attained for Social Security purposes based only on this year’s earnings? a. None, since she did not work a full calendar quarter. b. 1, the maximum she can earn in a 3 month period. c. 2. d. 4. 23. Wally’s PIA for determining Social Security Retirement Benefits is $2,200. What is the approximate maximum family benefit that Wally’s family can receive? a. $2,200 b. $3,100 c. $3,850 d. $4,400 24. Benjamin retired at age 62 and began to collect Social Security retirement benefits. After a year of playing 3 rounds of golf per day, Ben is bored and decides to go back to work part-time. In 2015 (when Benjamin is age 63) he earns $25,720 at his part time job. His social security benefit before any adjustments for 2015 is $18,000. What will his actual Social Security benefit be for 2015? a. $10,000. b. $13,000. c. $14,667. d. $18,000. 25. Quinton is fed up with his supervisor, Sulky Sally, and decides his health would improve if he retires early. Quinton is 62 years old, and his normal Social Security retirement age is 66. If he retires today, and his normal age retirement PIA is $1,500, how much can Quinton expect to receive as a monthly retirement benefit? a. $1,000. b. $1,125. c. $1,250. d. $1,500. 26. Bruce is single, retired, and received Social Security retirement benefits of $18,000 this year. His other income consists of $15,000 from his former employer’s pension plan; $10,000 in tax-exempt municipal bond interest; and $1,000 in dividends. How much of Bruce’s Social Security Benefit will be subject to income tax? a. $0. b. $5,350. c. $9,000. Page 7 of 12 d. $15,300. 27. Glen is 85 years old and is covered by Medicare parts A and B. While walking down the wooden stairs at his home last week, Glen’s stylish Italian loafer slipped out from under him and he fell and broke his hip is three places. All of the following medical expenses will be covered under Part A of Medicare EXCEPT: a. Follow up visits to his primary care physician after Glen’s recovery. b. Hospital room and meals for 5 days spent in the hospital. c. Medical and surgical expenses to treat his broken hip. d. Rehabilitation services in a skilled nursing care facility for 10 days. 28. Dean is 75 years old, and is covered by Medicare. In 2015 he had spinal fusion surgery to correct problems caused by three ruptured disks, and was transferred to a skilled nursing care facility for rehabilitation after recovery in the hospital. If Dean remained in the skilled nursing facility for 30 days, how much will he have to pay as a coinsurance amount? a. $0. b. $1,575. c. $4,725 d. $6,300. 29. Martin (age 63) has enjoyed abundance during his lifetime, and decided to share that abundance with 3 wives. His first marriage to Karen (currently age 65, who has never remarried) lasted 25 years. Two years after divorcing Karen, Martin married Christine (currently age 65), but that marriage ended three years later when Christine fell madly in love with, and married, Martin’s brother. Martin and his current wife, Jean (age 58 this year), have been married for 8 years. Which of the following statements concerning spousal benefits under Social Security is correct? a. If Martin retires early this year, Jean will be able to receive a spousal benefit equal to 50% of Martin’s Social Security benefit. b. Christine can collect a spousal benefit from Martin’s Social Security record. c. Karen can collect a spousal benefit from Martin’s Social Security record. d. Jean will be able to collect a spousal benefit on Martin’s record, plus a Social Security benefit based on her own earnings when she reaches the age of 62. 30. Which of the following situations might convince an employer to choose a nonqualified retirement plan over a qualified profit-sharing plan? (a) The employer, a closely held C Corporation, is in the 15% income tax bracket and the sole owner of the employer is in the 35% income tax bracket. (b) The employer only wants to meet the organization’s objectives of attracting executives, retaining executives, and providing for a graceful Page 8 of 12 transition in company leadership. The employer is not concerned with providing retirement benefits to the rank and file employees. (c) The employer is not willing to pay high administrative costs. (d) All of the above. 31. Which of the following statements concerning rabbi trusts is(are) correct? (a) A rabbi trust is a trust established and sometimes funded by the employer that is subject to the claims of the employer’s creditors, but any funds in the trust cannot generally be used by or revert back to the employer. (b) A rabbi trust calls for an irrevocable contribution from the employer to finance promises under a nonqualified plan, and funds held within the trust cannot be reached by the employer’s creditors. (c) A rabbi trust can only be established by a religious organization. (d) All of the above are correct. 32. Mike was awarded 1,000 shares of restricted stock of B Corp at a time when the stock price was $14. Assume Mike properly makes an 83(b) election at the date of the award. The stock vests 2 years later at a price of $12 and Mike sells it then. What are Mike’s tax consequences in the year he makes the 83(b) election? (a) Mike has W-2 income of $12,000. (b) Mike has a long-term capital loss of $2,000. (c) Mike has W-2 income of $14,000. (d) Mike has a $12,000 long-term capital gain. 33. Jackie receives incentive stock options (ISOs) with an exercise price equal to the FMV at the date of the grant of $22. Jackie exercises these options 3 years from the date of the grant when the FMV of the stock is $30. Jackie then sells the stock 3 years after exercising for $35. Which of the following statements is (are) true? 1. At the date of grant, Jackie will have ordinary income equal to $22. 2. At the date of exercise, Jackie will have W-2 income of $8. 3. At the date of sale, Jackie will have long-term capital gain of $13. 4. Jackie’s employer will not have a tax deduction related to the grant, exercise or sale of this ISO by Jackie. (a) 3 only. (b) 3 and 4. (c) 2, 3, and 4. (d) 1, 2, and 4. 34. Marguerite received nonqualified stock options (NQSOs) with an exercise price equal to the FMV at the date of the grant of $22. Marguerite exercises the options 3 years after the grant date when the FMV of the stock was $30. Marguerite then sells the stock 3 years after exercising for $35. Which of the following statements are true? Page 9 of 12 1. At the date of the grant, Marguerite will have ordinary income of $22. 2. At the date of exercise, Marguerite will have W-2 income of $8. 3. At the date of sale, Marguerite will have long term capital gain of $5. 4. Marguerite’s employer will have a deductible expense in relation to this option of $22. (a) 3 only. (b) 2 and 3. (c) 2, 3, and 4. (d) 1, 2, 3, and 4. 35. On January 1 of last year, Randy was awarded 15,000 ISOs at an exercise price of $3 per share when the fair market value of the stock was equal to $3. On April 17 of this year, Randy exercised all of his ISOs when the fair market value of the stock was $5 per share. At the date of exercise, what are the tax consequences to Randy? (a) $0 W-2 income, $30,000 AMT adjustment. (b) $0 W-2 income, $75,000 AMT adjustment. (c) $30,000 ordinary income, $30,000 AMT adjustment. (d) $75,000 ordinary income, $0 AMT adjustment. 36. Which of the following statements concerning tax considerations of nonqualified retirement plans is (are) correct? 1. Under IRS regulations an amount becomes currently taxable to an executive even before it is actually received if it has been “constructively received.” 2. Distributions from nonqualified retirement plans are generally subject to payroll taxes. (a) 1 only. (b) 2 only. (c) 1 and 2. (d) Neither 1 nor 2. 37. Jennifer received 1,000 SARs at $18, the current trading price of Clippers, Inc., her employer. If Jennifer exercises the SARs three years after the grant when Clipper’s stock is $20 per share, which of the following statements is true? (a) Jennifer will have an adjusted taxable basis of $18,000 in the Clippers, Inc. stock. (b) Jennifer will have W-2 income equal to $20,000. (c) Jennifer will have long-term capital gain of $2,000. (d) Jennifer will have W-2 income equal to $2,000. 38. Marisol was granted 100 NQSOs five years ago. At the time of the option grant, the value of the underlying stock was $100 and the exercise price was equal to $100. If Marisol exercises the options on August 22 of this year when the stock is valued at Page 10 of 12 $145, what are the tax consequences (per share) to Marisol from exercising the options? (a) $45 of W-2 income, $100 of short-term capital gain. (b) $100 of W-2 income, $45 of short-term capital gain. (c) $145 of W-2 income. (d) $45 of W-2 income. 39. James is employed by a large corporation with 400 employees. The corporation provides its employees with a no-cost gym membership at the local public YMCAs. The cost of the membership is $60/month which is completely paid for by James’ employer for all employees. How much, if any, must James include in his yearly gross income related to this fringe benefit? (a) $0. (b) $60. (c) $600. (d) $720. 40. Which of the following situations would create an inclusion in an employee’s gross income? (a) Kay is the director and manager of Holiday Hotel. As a condition of her employment, Kay is required to live at the hotel. The value of this is $1,000 per month. (b) Natalie is a secretary at JKL Law Firm. JKL provides her with free soft drinks. Natalie estimates that she drinks $20 worth of soft drinks per month. (c) Brian is an airline pilot with We Don’t Crash Airlines, Inc. and is allowed to fly, as a passenger, for free on the airline whenever an open seat is available. (d) Eric moved from Houston to New Orleans. His expenses for the move included $400 of truck rental costs, $100 of lodging and $200 of pre-move house hunting expenses. Eric’s employer reimbursed him $600. 41. Mitchell LLC is a manufacturing company based in Boulder, Colorado. Mitchell manufactures car stereo equipment for high-end performance cars. Mitchell provides the following fringe benefits to employees: 1. Mitchell made an agreement with the N-Shape athletic facility in the same building as Mitchell’s offices. The monthly fee is generally $100, but is paid for by Mitchell for any employees who are interested. 2. Mitchell allows employees to purchase equipment for themselves at a 40% discount, even though the cost of goods sold is 45%. Which of these employee fringe benefits will be taxable to employees? (a) 1 only. (b) 2 only. Page 11 of 12 (c) Both 1 and 2. (d) Neither 1 nor 2. 42. Judy is covered by a $200,000 group-term life insurance policy of which her daughter is the sole beneficiary. Judy’s employer pays the entire premium for the policy, for which the uniform annual premium is $0.75 per $1,000 per month of coverage. How much, if any, of the cost of the group-term life insurance is excluded from Judy’s gross income on an annual basis? (a) $0. (b) $450. (c) $1,350. (d) $1,800. 43. A business valued at $4,000,000 has 4 partners. The partnership purchases a life insurance policy on each partner’s interest. This is an example of: (a) A buy-sell entity insurance plan. (b) A partnership buy/sell plan. (c) A buy-sell cross-purchase insurance plan. (d) A key person plan. 44. Alpha partnership has 8 partners who have entered into a binding buy/sell agreement that requires any surviving partners to purchase the partnership interest of any partner to die. The partnership uses an entity approach to fund this arrangement. How many policies are required to satisfy this arrangement? (a) 1. (b) 8. (c) 16. (d) 64. True/False Questions 45. An employee fringe benefit is a form of compensation. 46. Employee fringe benefits are not taxable as wages unless specially excluded by the IRC. 47. If an employee fringe benefit is discriminatory then it will always cause inclusion in the employee’s income. 48. In order for lodging to qualify for the exclusion from the employee’s gross income, the employee does not need to accept lodging as a condition of employment. 49. Educational assistance programs lose their tax benefits if the plan is discriminatory. 50. A qualified tuition reduction plan applies to graduate level work too. Page 12 of 12