Sample Questions
Question 1
Easy
The tax base of an asset is best defined as:
Solution
A is correct. The tax base of an asset is the amount that will be deductible against taxable economic benefits generated by the asset in future periods, essentially the asset's value in the eyes of the tax authority. Comparing the carrying amount with the tax base identifies the temporary difference that gives rise to a deferred tax asset or liability.
Question 2
Medium
Free cash flow to the firm (FCFF) is best calculated as:
Solution
B is correct.
FCFF represents cash available to all capital providers (debt and equity holders). Starting from net income: FCFF = NI + Non-cash charges (e.g., depreciation) + Interest expense × (1 − t) − Changes in working capital − Capital expenditures. Adding back after-tax interest is necessary because net income is after interest expense, but FCFF is a pre-financing measure.
FCFF represents cash available to all capital providers (debt and equity holders). Starting from net income: FCFF = NI + Non-cash charges (e.g., depreciation) + Interest expense × (1 − t) − Changes in working capital − Capital expenditures. Adding back after-tax interest is necessary because net income is after interest expense, but FCFF is a pre-financing measure.
Question 3
Hard
A deferred tax liability most likely arises when:
Solution
C is correct.
A deferred tax liability (DTL) arises when pretax accounting income exceeds taxable income in the current period, creating a temporary difference that will reverse in the future. The company pays less tax now but expects to pay more later (e.g., when using accelerated depreciation for tax purposes but straight-line for financial reporting).
A deferred tax liability (DTL) arises when pretax accounting income exceeds taxable income in the current period, creating a temporary difference that will reverse in the future. The company pays less tax now but expects to pay more later (e.g., when using accelerated depreciation for tax purposes but straight-line for financial reporting).
