Series 86 Practice Exam 1

Nero Companies has a dividend payout ratio of 20% and an annual dividend of $1.60. If the P/E is 18, what is the dividend yield of Nero Companies? A) 1.11% B) 1.68% C) 3.20% D) 3.60%

A) 1.11% To calculate the dividend yield, multiply the dividend payout ratio by the earnings yield. The earnings yield is the reciprocal of the price earnings ratio. One divided by 18 equals .0555 or 5.55%. 20% x 5.55% = 1.11%.

Which of the following combined events will indicate a use of cash by a company? A) Accounts payable declines; inventory turnover ratio declines. B) Accounts payable increases; inventory turnover ratio increases. C) Accounts payable declines; inventory turnover ratio increases. D) Accounts payable increases; inventory turnover ratio declines.

A) Accounts payable declines; inventory turnover ratio declines. An accounts payable decrease is a use of cash. If combined with a decline in the inventory turnover ratio, it would indicate a buildup of inventory and a use of cash.

A market structure in which a few suppliers control a product or service and set prices is described as: A) An oligopoly B) A monopsony C) A monopoly D) Monopolistic competition

A) An oligopoly An oligopoly is comprised of a small number of suppliers that dominate a market (e.g., auto-mobile manufacturing). A monopsony is a market with only one buyer (e.g., military aircraft built for the U.S. armed forces)

During a period of inflation, which of the following statements is TRUE? A) FIFO would be considered a more aggressive accounting method and would inflate earnings. B) LIFO would be considered a more aggressive accounting method and would inflate earnings. C) Cost of goods sold (COGS) would appear higher under FIFO. D) Cost of goods sold (COGS) would appear lower under LIFO.

A) FIFO would be considered a more aggressive accounting method and would inflate earnings. First-in, first-out (FIFO) accounting would reflect lower cost of goods sold since the oldest inventory would be produced at a lower cost. Since this inventory is used first, it's cheaper than the last-in, first-out (LIFO) inventory method during an inflationary period. This is an aggressive accounting method since it will have the effect of elevating earnings in the short run. LIFO would show lower EPS, and is considered to be more conservative.

The S&P 500 Index has a P/E of 20. Company B has a growth rate of 10% and EPS of $1. If the price is: A) $20, the PEG is 0.5 and the relative P/E is 1.0 B) $30, the PEG is 1.5 and the relative P/E is 1.5 C) $15, the PEG is 1.5 and the relative P/E is .75 D) $25, the PEG is 2.5 and the relative P/E is 1.5

C) $15, the PEG is 1.5 and the relative P/E is .75 The growth rate for the company is 10%. The price to earnings growth ratio (PEG) equals the P/E divided by the annual EPS growth rate. The growth rate is expressed as a whole number, not a percentage, for the calculation. If the price is $15 and EPS is $1.00, the P/E is 15. The PEG is 1.5 ($15 / 10). The relative P/E can be determined by comparing the current P/E to the average P/E of the S&P 500 (P/E / average P/E of S&P 500). In this comparison, the relative P/E is .75 (15 / 20).

While preparing an assessment on Company RSR, you have been asked to project the company's earnings. The company had owned marketable securities with a cost of $115 MM that were sold for $100 MM. In the same period, the company had $30 MM in pretax income. RSR is in the 40% tax bracket. Assuming stable operations, what is Company RSR's projected net income in the next period? A) $9 MM B) $18 MM C) $27 MM D) $30 MM

C) $27 MM An analyst may be asked to adjust a company's earnings due to a nonrecurring item such as the sale of a business or asset, a one-time charge, restructuring, or an impairment charge. Company RSR had $45 MM in pretax income from operations. This has been reduced by the $15 MM loss from the sale of marketable securities to $30 MM of pretax income. Assuming stable operations, Company RSR would be expected to generate $45 MM in pretax income in the next period. Since the company is in the 40% tax bracket, net income of $27 MM would be expected ($45 MM x 60%, the complement of 40%).

While preparing an assessment on a company, you have been asked to project the company's earnings. The company had owned an asset with a cost of $120 MM which was sold for $105 MM. In the same period, the company reported net income of $52 MM. The company has a marginal tax rate of 21% and an effective tax rate of 15%. What would be the company's net income without the onetime sale? A) $39.25 MM B) $40.15 MM C) $63.85 MM D) $64.75 MM

C) $63.85 MM An analyst may be asked to adjust a company's earnings due to a nonrecurring gain or loss such as the sale of a business or asset, a onetime charge, or a restructuring, or impairment charge. To calculate the projected income without the nonrecurring loss, add the tax-adjusted loss to the net income. The tax-adjusted loss is $11.85 MM ($15 MM x 79%, the complement of 21%). The net income without the loss would be $63.85 MM ($52 MM + $11.85 MM). For this type of calculation, use the marginal tax rate, not the effective tax rate. The marginal tax rate is the rate for each additional dollar of income, and does not include many of the adjustments made to calculate a company's effective tax rate (which is a blended rate and is usually lower than the marginal tax rate). (38536)

Where is the following statement found? "Certain statements in this filing relate to future events and expectations and are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as believe, estimate, will be, will, would, expect, anticipate, plan, project, intend, could, should or other similar words or expressions often identify forward-looking statements. All statements other than statements of historical fact are forward-looking statements, including, without limitation, statements regarding our outlook, projections, forecasts or trend descriptions. These statements do not guarantee future performance, and we do not undertake to update our forward-looking statements." A) Accounting opinion B) Prospectus C) 10-K D) Equity research report

C) 10-K

Company T has a beta of 1.6. It does not pay dividends and has no earnings in the current year, but the company has positive FCFF and FCFE. The risk-free rate is 4.0% and the risk premium is 4.5%. What is Company T's equity cost of capital? A) 4.8% B) 7.2% C) 11.2% D) 13.6%

C) 11.2% The cost of equity capital can be calculated by applying the Capital Asset Pricing Model (CAPM): Cost of equity = Rf + [β x (Rm - Rf)], where Rf equals the risk-free rate of return and Rm equals the expected market return. The risk premium equals the expected market return minus the risk-free rate. In this example, the expected market return is 8.5%. The equity cost of capital is 11.2% (4.0 + [1.6 x 4.5%]).

What is the return given a dividend of $1, a market price of $40 and growth rate of 15 percent? A) 2% B) 3% C) 17.88% D) Not enough info

C) 17.88% Equity returns can be measured using expected dividend and the expected appreciation of share price. To calculate equity returns, and therefore, the cost of equity; the dividend discount model may be used. The formula for the divided discount model is as follows: k = equity return or cost of equity d1 = expected dividend p = stock price g = sustainable growth rate k = d1/p + g, = [d (1+g)]/p + g = $1.00 x 1.15 / $40 + 0.15 = $1.15/$40 + 0.15 = 0.1788 or 17.88% For memory purposes, it may be thought of as the expected divided yield plus a sustainable growth rate.

A company has operating income of $520 MM, depreciation expense of $65 MM, amortization expense of $87 MM, interest expense of $35 MM, and has a marginal tax rate of 21%. What is the interest coverage ratio of this company? A) 10.51 B) 13.70 C) 19.20 D) 26.30

C) 19.20 Although some professionals use the formula of EBIT or operating income divided by interest expense to find a company's interest coverage ratio, others use EBITDA instead of EBIT as the numerator. Using this formula, the company's interest coverage ratio is 19.20 ([$520 MM + $65 MM + $87 MM] / $35MM). There is no correct answer by using EBIT divided by interest expense, and the tax rate is not required to answer this question.

If interest rates are rising in Switzerland, we should expect: A) Rising interest rates in the U.S. B) A weakening Swiss franc C) A strengthening Swiss franc D) No relationship between interest rates and the value of the Swiss franc

C) A strengthening Swiss franc An increase in Swiss interest rates will make its bonds more competitive. The increased demand for Swiss currency to purchase these bonds will cause the value of the Swiss franc to appreciate.

Relevant financial information to answer the following question is found by using Exhibit 26. Which of the companies listed in Exhibit 26 has the highest growth rate? Co. A Co. B Co. C Co. D Dividend yield 3.3% 4.0% 0.5% 7.0% Dividend per share $ 0.40 $ 0.20 $ 0.10 $ 0.60 Earnings per share $ 0.60 $ 1.00 $ 0.75 $ 0.50 PEG 1.4 1.8 1.7 1.25 A) Company A B) Company B C) Company C D) Company D

C) Company C

A company has been profitable for 20 years, but has marginal cash flow. For an analyst who is evaluating the company, he could conclude that: A) Balance sheet ratios are material in valuing this company. B) The company should be able to increase its EPS by conducting a stock repurchase. C) It's an acceptable condition if the company has a significant amount of outstanding debt, which indicates positive operating cash flow. D) It's an acceptable condition if the company has a significant amount of outstanding debt, provided its operating cash flow is greater than net income.

C) It's an acceptable condition if the company has a significant amount of outstanding debt, which indicates positive operating cash flow. Cash that is generated from the operations of a company (Revenue - Operating Expenses) is based on adjustments to net income of a company. Operating cash flows are a valuable measure of a company's viability since a business may produce profits from operations, but have insufficient cash flows to meet current obligations (e.g., interest payments). The operating cash flow includes non-cash expenses, such as depreciation and amortization plus interest and tax expense. As such, the operating cash would always be expected to be greater than net income. If the company has marginal cash flow, it has sufficient cash flow to pay interest expenses; therefore, the key to evaluating this company's financial health would be based on operating cash flows. Balance sheet ratios don't address statements of cash flow and are not material for valuing this company. A company can increase its EPS through a stock repurchase; however, there's nothing to suggest that the company has sufficient cash on hand to effect such a repurchase.

Under the equity method of accounting: A) Only dividends are recognized by shareholders B) Revenues are consolidated C) Profits and losses are absorbed on a proportionate basic D) It is used only if 100% of another business is purchased

C) Profits and losses are absorbed on a proportionate basic The equity method of accounting means that profits and losses are absorbed on a proportionate basic. If Shipbottom Corp owns 22% of Lighthouse shares, Shipbottom absorbs 22% of Lighthouse's income or loss on its books as Other Income or Loss. This method is used when ownership is between 20% and 50%.

When examining electrical power output, which of the following would not be useful in applying regression analysis? A) Population B) Temperature C) Stock market D) Economic development

C) Stock market Population and temperature are drivers for power consumption. Economic development is one of the keys for long-term construction and expansion of plants. The regulated status and services provided by this industry make it far less cyclical than the stock market.

Which of the following changes is LEAST likely to affect the valuation of a company using a discounted cash flow (DCF) model? A) The terminal growth rate increases B) Interest rates decline C) The company's common stock declines in value D) The company repurchases a portion of its outstanding common stock

C) The company's common stock declines in value Valuation using discount cash flow models are based on dividing the present value of the FCF by (1 + WACC). A change in the terminal growth rate will affect the present value of the FCF. A change in valuation will occur if any of the variables affecting either DCF or WACC change. Interest rate changes affect WACC. The repurchase of common stock affects both free cash flow (working capital declines) and WACC (an increase in the debt-to-total capitalization ratio). A change in the market value of common stock affects the enterprise value of a company.

Interest rates should rise if: A) The supply of money increases B) The economy is in a recession C) The demand for money increases D) The demand for money decreases

C) The demand for money increases Interest rates are the price of money. When the supply of money decreases (i.e., it tightens), interest rates will rise. In addition, if the economy begins to expand, the demand for money will increase and interest rates will rise. During a recession, the demand for money falls and interest rates generally fall.

Negative P/Es are not meaningful for valuation or comparison. If a company's financials indicate a negative P/E, an analyst may use alternative methods. Which of the following factors is appropriate in dealing with negative P/E ratios? A) Using trailing earnings per share in the calculation B) Using the interest coverage ratio C) Using earnings yield rather than the price/earnings ratio D) Using earnings for the highest portion of the economic cycle

C) Using earnings yield rather than the price/earnings ratio If a company is showing a negative P/E ratio, an analyst may use forward EPS rather than trailing EPS. The use of earnings yield rather than the price/earnings ratio is also a viable alternative. Earnings yield is used when ranking companies from the lowest cost per unit of earnings to the highest cost per unit of earnings. Interest coverage ratios are useful for estimating whether a business can pay additional interest expenses, but not particularly useful for overall business valuation.

The Clark trucking company has current assets of $800,000 and current liabilities of $500,000. If additional common stock of $200,000 is sold and the proceeds invested in the expansion of several terminals, the resulting current ratio would be: A) 1.40 B) 1.41 C) 1.50 D) 1.60

D) 1.60 1.60 = $800,000 / $500,000. Neither current assets nor current liabilities are affected.

A research analyst is attempting to calculate the weighted average cost of capital (WACC) for a company with an 8% pretax cost of debt. The company has $100 million of debt, $400 million of equity, and a tax rate of 30%. The risk-free rate is 3%, the market risk premium (excess market return) is 6%, and the unlevered beta for the industry is 1.2. What is the weighted average cost of capital? A) 8.99% B) 9.28% C) 9.99% D) 10.29%

D) 10.29% The levered beta = the unlevered beta of 1.2 x (1 + [(1 - 30%) x (25%)]) The levered beta = 1.2 x [1 + (.70 x .25)] The levered beta = 1.2 x [1 + (.175)]The levered beta = 1.2 x 1.175 = 1.41 The cost of equity equals:(excess market return x beta) + risk-free rate= (6% x 1.41) + 3%= 8.46% + 3%= 11.46% To calculate the after-tax cost of debt, multiply the pretax cost by the complement of the tax rate (1- tax rate).The after-tax cost of debt is equal to 8% x (1.00 - .30), or 5.6%. The weighted average cost of capital is calculated using the proportion of each component of capital ($100 million debt and $400 million equity) to the total capital ($500 million) of the firm. WACC = Weighted average cost of debt = 5.6 x .20 (percent of capital that is debt) = 1.12 Plus Weighted average cost of equity = 11.46 x .80 (percent of capital that is equity) = 9.17 WACC= 1.12 + 9.17 = 10.29

The director of research has asked an analyst to produce a pro forma valuation of a company using leveraged buyout analysis. The company has $680 million of EBITDA and the transaction value is 11.5 times EBITDA. The company has existing debt of $2.45 billion and the equity contribution is 20%. If the transaction is completed, what's the resulting debt-to-EBITDA ratio? A) 11.5 times B) 15.1 times C) 5.9 times D) 12.8 times

D) 12.8 times The transaction value is equal to $7.82 billion (11.5 x $680 million) and is being financed with 80% debt or $6.256 billion ($7.82 billion x .80). The new debt will be added to the existing debt of $2.45 billion for total debt of $8.706 billion. The resulting debt-to-EBITDA ratio will be 12.8 times ($8.706 billion / $680 million).

Company A has EBIT of $170 MM and depreciation and amortization of $54 MM. A buyer is willing to pay 8.5x EBITDA, and the buyer can expect $35 million of synergies. The adjusted EBITDA multiple is: A) 5.6 B) 8.2 C) 8.5 D) 7.3

D) 7.3 Adjusted EBITDA may be used in a potential acquisition. In this example, first multiply EBITDA of $224 ($170 MM + $54 MM) by 8.5x, which equals a transactional value of $1,904 MM. Next, add the$35 MM of synergies to the $224 MM to arrive at adjusted EBITDA of $259 MM. Divide the transactional value by the adjusted EBITDA, which equals 7.3 ($1,904 MM / $259 MM = 7.3).

A company reported net income of $12 million and EPS of $0.40 per share in the previous year. In the current year, net income increased to $15 million and EPS rose to $0.50 per share. In the footnotes of the financial statement for the current year, the company disclosed a $5 million after-tax payment based on a successful lawsuit. Which of the following statements is TRUE? A) Based on the current year's increase in net income and its non-adjusted EPS, the expectation is that this will have a positive impact on the stock price. B) Based on the current year's increase in net income and its non-adjusted EPS, the expectation is that this will have a negative impact on the stock price. C) Based on the current year's increase in net income and the adjusted EPS, the expectation is that this will have a positive impact on the stock price. D) Based on the current year's increase in net income and the adjusted EPS, the expect

D) Based on the current year's increase in net income and the adjusted EPS, the expectation is that this will have a negative impact on the stock price. Since the company reported $0.40 cents per share one year ago on net income of $12 million, and $0.50 per share in the current year on net income of $15 million, the number of outstanding shares would be 30 million ($15 million / $0.50). Without the one-time $5 million payment from the lawsuit in the current year, net income would have been $10 million, and EPS would have been $0.33 per share ($10 million / 30 million). The lower adjusted EPS would likely have a negative effect on the stock.

Which economic indicator should be monitored to analyze the residential real estate market? A) Prime rate B) Manufacturers' new orders, nondefense capital goods C) Housing starts D) Building permits, new private housing units

D) Building permits, new private housing units Although manufacturers' new orders for nondefense capital goods is a leading economic indicator, building permits for new private housing units is a leading economic indicator that is directly related to residential real estate. Building permits must be obtained before housing starts can take place. The prime rate is a lagging economic indicator.

The weighted average cost of capital is an important valuation method for capital budgeting. The reason that firms use this method is that: A) Firms raise capital primarily through equity issues B) Most firms raise capital through debt issues C) Weighted average provides the lowest cost of raising capital D) Capital is raised through common and preferred equity as well as debt

D) Capital is raised through common and preferred equity as well as debt Most companies will raise capital through various methods including long-term debt, preferred stock, and common stock. The weighted average cost of capital provides an appropriate valuation for all of these methods.

Use the following information to answer the next question. Price Earnings Yield Growth Rate Company 1 $20 5.00% 16% Company 2 $30 4.17% 14% Company 3 $40 6.67% 10% Company 4 $50 4.55% 12% Which of the companies in the above exhibit has the highest PEG ratio? A) Company 1 B) Company 2 C) Company 3 D) Company 4

D) Company 4 ( 1 / earnings yield ) / Growth Rate = PEG

Consider the following balance sheets in answering this question. Dollar amounts are in millions. Triangle Co. Octagon Ltd. Cash $80 $60 Accounts Receivable $100 $90 Inventory $150 $170 Current Liabilities $130 $200 Long-Term Debt $100 $50 Stockholders' Equity $100 $70 Triangle is acquiring Octagon for $400 million, to be financed through a $300 million bond issue and a $100 million line of credit. The quick asset ratio of the combined entity is: A) .58 B) .77 C) .83 D) 1.05

B) .77 In this example, the quick assets are cash and accounts receivable. These are divided by the new value of current liabilities. Combining the cash from both balance sheets: 80 + 60 = 140 Combining the Accounts Receivables from both balance sheets: 100 + 90 = 190 The line of credit (debt) is added to the combined current liabilities. 130 + 200 + 100 = 430 The quick asset ratio is: (140 + 190) / (130 + 220 + 100)= 330 / 430= .767 (.77 rounded off)

Use the following information to answer this question. The Touchy/Feely Gadget Company Year 1 Year 6 Sales $1,200 ? Price $8 $5 CAGR 10% What was the company's percentage growth in units sold from Year 1 to Year 6? A) 138% B) 158% C) 238% D) 258%

B) 158% To determine the sales in Year 6, it is necessary to multiply Year 1 sales by the compounded annual growth rate (CAGR) for each period: $1,200 x 1.1 x 1.1 x 1.1 x 1.1 x 1.1 = $1,933. The sales in Year 6 are divided by the price ($1,933 / $5) = 387. The number of units sold in Year 1 was 150 ($1,200 / $8). In Year 6, an additional 237 units were sold (387 - 150). This is a 158% increase in units sold (237 / 150).

Angie O'Plasty Inc. operates a chain of fast-food restaurants. It pays a quarterly dividend of $.85 and has a dividend payout ratio of 31%. If the dividend yield for the company has increased from 3.3% to 3.7%, what is Angie O'Plasty's P/E ratio? A) 5.39 B) 8.38 C) 27.02 D) 32.90

B) 8.38 The annualized dividend for the company is $3.40 ($.85 x 4). Earnings per share is calculated by dividing the annual dividend by the dividend payout ratio ($3.40 / .31 = $10.97). The current market price is calculated by dividing the annual dividend by the current dividend yield ($3.40 / .037 = $91.89). The P/E ratio is calculated by dividing the market price by the earnings per share ($91.89 / $10.97 = 8.38). A faster method of calculating the P/E ratio, given the previous information, is to divide the dividend payout ratio by the dividend yield (.31 / .037 = 8.38).

Use the following information to answer this question. Knutz, Inc. Boltz, Co. EBIT $6,250,000 $1,080,000 Net Income $4,700,000 $840,000 Earnings Available to Common $4,400,000 $840,000 Shares Outstanding 2,000,000 800,000 Price of Common Stock $24 $12 Knutz, Inc. is purchasing Boltz, Co. The acquisition price will be at a 20% premium above the market share price. Shareholders of Boltz, Co. will receive shares in Knutz, Inc. What is the effect of the acquisition on Knutz's EPS? A) No effect B) A 9 cents dilutive effect C) A 24 cents dilutive effect D) A 26 cents accretive effect

B) A 9 cents dilutive effect The acquisition price per share for Boltz, Co. is $14.40 ($12.00 x 1.2). The total acquisition cost is $11,520,000 ($14.40 x 800,000 shares outstanding). This will require 480,000 ($11,520,000 / $24.00 per share of Knutz) additional shares of Knutz, Inc. to be issued, bringing the total shares outstanding to 2,480,000. The new level of earnings available to common for Knutz would be $5,240,000 (Knutz $4,400,000 + Boltz $840,000). $5,240,000 / 2,480,000 = $2.11 EPS. The EPS of Knutz before the acquisition was $2.20 ($4,400,000 / 2,000,000). The acquisition has resulted in an earnings reduction of $.09 per share; therefore, the activity has been dilutive to the shareholders of Knutz.

Which of the following companies is the MOST overvalued? A) A company with a high earnings retention rate B) A company with a high EV/EBITDA ratio C) A company with a high dividend payout ratio D) A company with a low asset turnover ratio

B) A company with a high EV/EBITDA ratio The EV/EBTIDA ratio measures the price of a company's equity and debt (i.e., EV) relative to its free cash flow (i.e., EBITDA). A company with a high EV/EBITDA ratio is considered overvalued, since the price of its EV is large and EBITDA is relatively low. In short, it's an expensive investment that doesn't deliver significant EBITDA. By themselves, earnings retention rates, dividend payout ratios, and asset turnover ratios cannot provide an effective valuation.

A company operates five diverse business lines. Some of the business lines are profitable, but the company as a whole has had either a very small amount of positive income or a loss over the past few years. The company is considering a restructuring of its outstanding debt and the possible sale of one or more of its business lines. In this situation, what's the MOST appropriate valuation method for the entire company? A) A discounted cash flow (DCF) analysis B) A sum-of-the-parts (SOTP) analysis C) The P/E ratio D) Enterprise value/EBITDA ratio

B) A sum-of-the-parts (SOTP) analysis A company with varying business components is normally valued using the sum-of-the-parts (SOTP) valuation method. This is particularly true if different valuation metrics are applied to the different business units.

Which the following statements is TRUE regarding accounts receivable and inventories, when the company recognizes revenue sooner than permitted under accrual accounting? A) Accounts receivable is overstated, and inventory is overstated B) Accounts receivable is overstated, and inventory is understated C) Accounts receivable is understated and inventory is overstated D) Accounts receivable is understated and inventory is understated

B) Accounts receivable is overstated, and inventory is understated Accounts receivable will be overstated because sales are recognized earlier and inventory will be understated because inventories are charged earlier than permitted.

The S&P 500 has an average P/E of 25. Grind and Muck Industries is trading at 8 times its trailing EPS. Which of the following observations is implied about Grind and Muck? A) The company's earnings are expected to increase B) An external influence, such as a major lawsuit, is depressing the price of the company C) As an industrial company, a low P/E is expected D) The company is highly leveraged

B) An external influence, such as a major lawsuit, is depressing the price of the company Grind and Muck has a P/E of 8. This is significantly below the S&P 500 average. This would normally indicate a significant influence outside of the normal conditions that affect the stock price. Such external influences include major lawsuits and governmental investigations. Industrial companies generally have a lower P/E than the S&P 500 Index, but not as low as is indicated in the question. If the S&P 500 Index average is 25, an industrial company may be expected to trade at 15 to 18. A low P/E ratio is an indication that the expected growth of earnings is lower than the industry average.

The following information relates to David Corp.: Net Income $5,000,000 Preferred Dividends $500,000 Weighted Average Number of Shares Outstanding 1,000,000 The preferred stock is convertible to common stock at a ratio of 1:1. The preferred was issued at a par value of $100 to yield 5 percent. The tax rate for David Corp. is 40 percent. What is the reported basic and diluted earnings per share for David Corp.? A) Basic = $4.70, diluted = $4.70 B) Basic = $4.50, diluted = $4.50 C) Basic = $4.50, diluted = $4.55 D) Basic = $4.50, diluted = $4.46

B) Basic = $4.50, diluted = $4.50 We will first calculate the basic EPS. $5 million of net income is reduced by the preferred dividend of $500,000. The resulting $4.5 million is available to common shareholders. $4,500,000 divided by one million shares outstanding equals $4.50, the basic earnings per share. Calculation of diluted earnings per share requires that we know how many shares of preferred stock are outstanding. To do so, we first determine a par value of preferred shares which is equal to $500,000 divided by 5% or $10 million. $10 million divided by the $100 par value per share equals 100,000 preferred shares. If the preferred shares are converted, the EPS would be $5,000,000 divided by 1,100,000 shares or $4.55. Since the EPS is higher when the preferred shares are converted, the shares are antidilutive. Therefore, diluted EPS is reported as equal to basic EPS.

An industry which is dominated by only two companies is defined as a(n): A) Monopsony B) Duopoly C) Oligopoly D) Monopoly

B) Duopoly A market controlled by two companies is defined as a duopoly. A market controlled by a few companies is called an oligopoly. Monopsony is similar to a monopoly, but differs in that a large buyer (not seller) controls a large proportion of the market and drives the prices down.

Which of the following statements BEST describes the effect of a strengthening U.S. dollar on the M&A business? A) Foreign companies would become less attractive takeover targets B) Foreign companies would become more attractive takeover targets C) A weaker dollar will make U.S. companies more attractive takeover targets D) A weaker dollar will have no effect on the M&A business

B) Foreign companies would become more attractive takeover targets A strong U.S. dollar will make foreign companies more attractive as takeover targets. U.S investors would be able to exchange their higher-priced currency for a greater amount of a foreign currency. U.S. buyers will have more purchasing power with a rising dollar. U.S. companies will be less attractive takeover candidates since foreign buyers will have less buying power.

An analyst is concerned with the impact of stock option compensation paid to senior executives on the firm's future profitability. Which of the following documents would be the most useful to research? A) Form 8-K B) Form 10-K C) Form 4 D) Form 13D

B) Form 10-K The annual 10-K filing includes information on executive compensation.

Which of the following items is NOT considered part of the tangible book value of a company? A) Copyrights and patents B) Goodwill carried on the books of the company C) Inventories of work in process D) Investments in securities

B) Goodwill carried on the books of the company When calculating the tangible book value of a company, certain intangible assets may still have a salable value. These assets can be identified on the books of the firm, extracted as separately marketable items, and sold individually. Among such assets are copyrights and patents. Goodwill, however, is not such an item and would be deducted from the tangible asset value of the company.

To determine the growth rate for a particular industry, which of the following actions will an analyst take? A) Calculate the 10-year compounded annual growth rate for the industry leader in the sector. B) Interview the management of the leading public and private customers of the industry. C) Examine the 10-Q and 10-K statements of companies in the industry. D) Calculate the five-year average annual growth rate for the worst performing company in the sector.

B) Interview the management of the leading public and private customers of the industry. Interviews with the suppliers and customers of the industry provides a view of the expected supply and demand within the industry. Although the historical growth rates and SEC filings are useful in providing a historical view of the industry, they're not the best way to project future growth in the industry.

Which of the following balance sheet changes will result in an increase in the cash flow for a company? A) Inventory up and accounts payable up B) Inventory down and accounts payable up C) Accounts receivable up and inventory up D) Inventory up and accounts payable down

B) Inventory down and accounts payable up When inventory falls, we anticipate receiving cash for disposing of the inventory. This is a source of cash. When accounts payable rises, we are delaying the payment on a liability. This is also viewed as a source of cash. Changes in balance sheet items affect cash flows and are summarized as follows. Inventory falls Source of Cash Inventory rises Use of Cash Accounts receivable falls Source of Cash Accounts receivable rises Use of Cash Accounts payable rises Source of Cash Accounts payable falls Use of Cash

If casual dining is more fragmented and less mature than fast food, it's likely to exhibit all of the following, EXCEPT: A) More growth potential B) Less pricing power C) Less competition for market share D) Ability to exploit lifestyle and demographic trends

B) Less pricing power Casual dining should have more pricing power, relying less on promotional pricing (couponing) and can take advantage of two income couples and more food dollars spent outside the home

If a company's total assets increased and the total liabilities remained constant, which of the following statements is TRUE? A) The value of the treasury stock increased B) Retained earnings increased C) The par value of the common stock increased D) The par value of the common stock decreased

B) Retained earnings increased If a company's total assets increased and the total liabilities remained the same, the value of a company's shareholders' equity must have increased. An increase in retained earnings would cause shareholders' equity to increase. Treasury stock is a negative entry in the equity section of the balance sheet. It is created when a company engages in a stock buyback. Changes in the share price after the purchase do not change the entry. Changes in the par value are the result of a stock split and do not have any effect on a company's shareholders' equity.

One of the main considerations in the sum-of-the-parts analysis is that valuation is based on the concept that: A) Separate segments of the company are discounted to their present values B) Separate segments of the company may be worth more individually than combined C) The separate segments of the company are totaled and discounted to present values D) Each segment of the company will grow at the appropriate rate of return

B) Separate segments of the company may be worth more individually than combined The sum-of-the-parts analysis is based on the fact that the individual business segments of the company may be separated and sold by themselves. When added together, the total of these individual segments may be worth more than the company as a whole.

In order to determine the free cash flow yield, the correct calculation is to: A) Divide market price by the value per share B) Use the reciprocal of the price to free cash flow C) Multiply the free cash flow to the firm by the market price D) Use the reciprocal of the free cash flow to the firm

B) Use the reciprocal of the price to free cash flow The free cash flow yield is the reciprocal of the price to free cash flow ratio, therefore, the calculation is to divide 1 by the price to free cash flow ratio. For example, if the price to cash flow is 12.7, the free cash flow yield is 7.87% (1 / 12.7).

A research analyst has determined that an industry has an unlevered beta of 1.4. A company in this industry has a debt-to-equity ratio of 40% and a tax rate of 30%. What is the levered beta for this company? A) 0.84 B) 1.09 C) 1.79 D) 2.33

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. If the beta of a stock is greater than one, it implies a higher level of risk and volatility compared to the stock market. If the beta of the stock is less than one, it is less risky and volatile than the market. The beta that is calculated from a stock's movement in relation to the market is the levered beta. Levered beta is the beta that contains the effect of the capital structure (the debt and equity). The unlevered beta is the beta of a company without debt. An unlevered beta removes the financial effects of leverage. In general, the more debt a firm takes on, the higher the beta for the equity. Unlevered beta is the beta after removing the effects of the capital structure. The formulas to lever or unlever a beta are as follows. unlevered beta = levered beta / (1 + [(1 - tax rate) x (debt/equity)]) levered beta = unlevered beta x (1 + [(1 - tax rate) x (debt/equity)]) To calculate the levered beta in this example, we apply the formula as follows. The levered beta = 1.4 x (1 + [(1 - 30%) x (40%)]) The levered beta = 1.4 x [1 + (.70 x .40)] The levered beta = 1.4 x [1 + (.28)] The levered beta = 1.4 x 1.28 = 1.79

Assuming no change in working capital, which of the following calculations could an analyst use to determine a firm's free cash flow? A) Cash flow from operations + capital expenditures B) Net income + taxes - depreciation + capital expenditures C) Net income + interest expense + capital expenditures D) EBITDA - taxes - capital expenditures

D) EBITDA - taxes - capital expenditures Although there are many ways to calculate free cash flow to the firm, the most common method is cash flow from operations less capital expenditures. Other methods to define free cash flow are: EBITDA - taxes - CAPEX +/- changes in working capital, or EBIT - taxes - net CAPEX (CAPEX - depreciation) +/- change in working capital. Both of these formulas take into consideration taxes and interest expense. If a firm was unleveraged (no debt), the formula would be: net income + depreciation - CAPEX +/- changes in working capital.

In the Liquidity and Capital Resources section of the 10-K, what is discussed? A) Operating profit B) Cash, cash equivalents, and lines of credit C) Capacity utilization D) Effects of inflation and changing prices

In the 10-K, there is discussion of the cash, cash equivalents, and lines of credit at the company's disposal. The formal name of this portion of the 10-K is Liquidity and Capital Resources.

There's currently a recession in the United States. If a recovery is expected in the next year, which valuation metric should an analyst use to value a retail company? A) Enterprise value-to-EBITDA B) A discounted cash flow model using projected earnings for the next year C) Price-to-earnings ratio D) Price-to-sales ratio using next year's forecast to consider the recession

Of the choices listed, an analyst should use price-to-sales ratio based on next year's forecast to adjust for the recovery from the recession since price-to-sales incorporates sales or revenue, rather than earnings. Earnings typically decline in a recession since sales slow and expenses often don't decline by the same percentage. Sales are typically restated less often than earnings and provide a more stable value in the denominator of the price-to-sales ratio. Discounted cash flow models often incorporate more than one year's earnings, and, in some cases, project earnings in perpetuity.

Alba Tross Revenue 500 200 EBIT 75 39.5 Interest 0 10 Pretax income 75 30 Net income 50 20 Shares outstanding 50 20 Alba Corp completes a buyout of the Tross Corp in an acquisition financed by a $250 million, 8% bond, and the issuance of six million additional shares of stock. If Alba Corp currently has no debt outstanding and its effective tax rate remains unchanged, compute the earnings dilution/accretion?

Alba's tax rate is 33.33%. The taxes paid were $25 million ($75 million pretax income and $50 million net income). If Alba issues $250 MM of debt to fund the acquisition, the interest expense will increase by $20 MM ($250 MM x .08). Alba had 50 million shares outstanding prior to the acquisition; therefore, its EPS would be $1.00 ($50 MM / 50 MM shares). Since six million additional shares were issued, the EPS would still amount to $1.00 ($56.34 MM / 56 MM). The acquisition would not have any effect on the EPS.

Relevant financial information to answer the following question is found by using Exhibit 11. What is the free cash flow per share for common stockholders in 2020? 2019 2020 Total Assets $5,650,000,000 $5,730,000,000 Current Assets 2,970,000,000 2,995,000,000 Total Liabilities 4,700,000,000 4,716,000,000 Current Liabilities 2,795,000,000 2,835,000,000 Depreciation and Amortization 44,000,000 46,000,000 Capital Expenditures 110,000,000 115,000,000 Net Income 64,000,000 68,000,000 Common Stock ($2.00 par value) $40,000,000 $40,000,000 A) ($.05) B) ($.80) C) $.70 D) $1.95

C) $.70 Net Income$68,000,000 +Depreciation and Amortization$46,000,000 -Capital Expenditures$115,000,000 +Changes in Working Capital$15,000,000 =Free Cash Flow to Equity$14,000,000 The free cash flow to equity would be divided by the number of shares of common stock outstanding. The common stock account is $40,000,000 for each year. Since the par value is $2.00 per share, there are 20,000,000 shares of common stock outstanding. $14,000,000 / 20,000,000 = $.70 free cash flow per share.

A company has a price-to-earnings ratio of 18 and a dividend yield of 2.50%. What is the company's dividend payout ratio? A) 14% B) 45% C) 56% D) 72%

To calculate the dividend payout ratio we need to find the earnings yield (reciprocal of the price/earnings ratio) and divide the dividend yield by this amount. This will indicate what amount the company is paying out as a dividend as a percentage of its earnings yield. The price-to-earnings ratio is 18, so the earnings of 1/18 equal .0556. Divide the dividend yield of .025 by the earnings yield of .0556 to arrive at .4496 or 45%.

LOL Media Company had earnings before Interest and taxes of $785,000,000 in 2018. The firm's expected growth rate for the upcoming year is 8%. In 2018, the company had capital expenditures of $120,000,000, while working capital requirements increased by $105,000,000. In 2019, working capital is expected to increase by $125,500,000, and capital expenditures are expected to increase at the same rate as earnings growth. Depreciation equals 29% of capital expenditures. The projected tax rate for the company is 24% for each year. The projected free cash flow for LOL Media Company in 2019 is: A) $351,644,000 B) $426,812,000 C) $630,284,000 D) $677,812,000

To calculate the free cash flow for the firm (FCFF), begin with projected earnings before interest and taxes (EBIT). Multiply that figure by (1 - tax rate %) and add depreciation. Then subtract capital expenditures and increases in working capital. The projected earnings before interest and taxes in 2019 is $847,800,000 ($785,000,000 + 62,800,000, or $785,000,000 x 1.08). $847,800,000 EBIT x .76 (1 - tax rate of 24%) = $644,328,000. Depreciation in 2018 equals 29% of capital expenditures ($120,000,000 x 29% = $34,800,000). Capital expenditures are projected to increase in 2019 by the same percentage increase as earnings in 2018 (8%) to $129,600,000 ($120,000,000 x 1.08). Depreciation for 2019 would be projected as $37,584,000 ($129,600,000 x .29). Working capital increased by $105,000,000 in 2018. In 2019, the increase in working capital is expected to be $125,500,000.

In order to forecast financial growth for an equipment manufacturing company for the coal industry, an analyst should look at: A) Historic profit margins of utility companies B) Trailing operational production levels of coal companies C) Projected utility operational rates D) Utility rate increases

Projected utility operational rates are the growth rates for the industry. This will have an influence on the capital expenditures in the industry and the demand for equipment.

Which company MOST LIKELY has the highest depreciation expense as a percentage of annual sales? A) Cyber security company B) Shipping C) Discount retailer D) Corporate consulting

Shippers have a very high fixed asset base with significant depreciation as a percentage of sales. Other companies with significant amounts of depreciation relative to revenue are energy exploration and utilities.

The Leading Economic Indicators compiled by the Commerce Department include all of the following choices, EXCEPT: A) The S&P 500 Stock Index B) M2 money supply C) New building permits D) CPI

The CPI (Consumer Price Index) is not considered a leading economic indicator.

Which of the following metrics is the BEST valuation tool for a financial services company? A) A multiple of net tangible book value B) Enterprise value / EBITDA C) P/E-to-growth ratio (PEG) D) Precedent transaction comparable analysis

The balance sheets of financial service companies, such as banks, and insurance and reinsurance companies, are presumably liquid and are marked to the market, so the book value becomes a strong consideration in valuing the company. One of the most often-used valuation metrics for these types of companies is a multiple of net tangible book value.

Use the following information to answer this question. Price Earnings GrowthRate Blue Star, Inc. $18.50 $1.10 10% Red Moon, Inc. $22.10 $1.00 11% Green Grass, Inc. $56.60 $3.77 12% Brown Derby, Inc. $71.50 $3.58 13% If these companies are evaluated as a group, which one appears to be overvalued? A) Blue Star, Inc. B) Red Moon, Inc. C) Green Grass, Inc. D) Brown Derby, Inc.

The company with the highest PEG would be the most overvalued. PEG is determined by dividing the P/E ratio by the growth rate of the company. Remember to use the growth rate as a whole number.

What information would NOT be found in a company's annual proxy statement? A) Financial statements B) The names of the independent directors C) Last year's voting results on shareholder proposals D) The name of the independent public accounting firm performing the audit

A) Financial statements A company's financial statements would be found in its annual 10-K filing or its quarterly 10-Q filings. (Note: A company publishes three 10-Qs and one 10-K a year.) The annual proxy statement contains the names of the members of the board of directors, executive compensation, ownership of securities by holders of five percent or more of the company's common stock (based on 13D and 13G filings), the name of the independent public accounting firm performing the audit, and other information related to any other matter that will be voted on at the annual shareholder meeting. Shareholder proposals will be presented with a supporting statement, and the BOD's response, either for or against. Sometimes the same shareholder proposal that was voted on at last year's meeting and the proxy will show the results of the vote.

A manufacturing company's financials show that its depreciation expense has decreased and that it has declared and paid a cash dividend. Which of the following statements is TRUE? A) Financing cash flows would decrease. B) Operating income would decrease. C) Retained earnings would increase. D) Financing cash flows would increase.

A) Financing cash flows would decrease. Cash dividends are paid out of retained earnings, which would result in a decrease in retained earnings. Dividends are a use of cash (i.e., cash flows decrease) in the financing section of the statement of cash flows. Depreciation is an operating expense on the income statement. A reduction of operating expenses will increase operating income.

A company with a low P/E and a high dividend payout ratio has a: A) High dividend yield B) Low dividend yield C) High debt-to-equity ratio D) Low debt-to-equity ratio

A) High dividend yield Companies with a low P/E ratio have high earnings compared to price. A high dividend payout ratio indicates a high payout in view of earnings; therefore, a company with a low P/E and a high dividend payout ratio will have a high dividend yield.

Which of the following choices is considered dilutive to earnings per share (EPS)? A) In-the-money employee stock options B) A reverse stock split C) An offering of shares that are being sold by existing shareholders D) An offering of convertible debt

A) In-the-money employee stock options An event that will reduce the proportionate claim to the earnings of a corporation by the common stockholders is considered to be dilutive. In-the-money employee stock options are considered dilutive to EPS since they increase the number of shares outstanding. A stock split is not dilutive to shareholders since the shares are only adding to share count and will have a reduced value per share. Since the offering of shares is from existing shareholders (typically restricted stock), the number of outstanding shares remain unchanged. An offering of convertible debt is typically not immediately dilutive since the conversion price would be higher than the current market price. The "if converted" method is used to calculate fully diluted EPS. This method assumes that all convertible securities (preferred stock and debt) are converted into common stock during the period in which they're outstanding and the market price of the stock is higher than the conversion price.

If an analyst intends to project the growth rate for a particular industry, which of the following is the MOST useful? A) Interviews with the top suppliers and customers of the industry. B) The five-year CAGR for the industry leader in the sector. C) The SEC filings and statements of companies in the industry. D) The most recent fiscal policy enacted by Congress.

A) Interviews with the top suppliers and customers of the industry. Interviews with the suppliers and customers of the industry provide a view of the expected supply and demand within the industry. The compounded annual growth rate (CAGR) and SEC filings provide a historical view of the industry. Although the results of the industry's activities are useful, they don't provide substance for growth projections in the industry. U.S. fiscal policy will not provide much insight into the growth rate of a particular industry.

Which of the following is the best definition of free cash flow (FCF)? A) Operating cash flow minus CAPEX B) Cash flows minus CAPEX C) Net income plus CAPEX D) EBIT plus dividends payable

A) Operating cash flow minus CAPEX Free cash flow (FCF) is the operating cash flows less capital expenditures (CAPEX). FCF is often used in lending, specifically to asses if a business can afford the interest owed on a new loan or bond. FCF is also a measure of profitability that's used as an alternative to earnings per share (EPS).

A company's return on equity would increase if it: A) Sells real estate for a gain B) Sells one of its division for a loss C) Issues common stock D) Swaps assets with another entity

A) Sells real estate for a gain Selling assets for a gain increases profitability and, although the profit may be a one-time event, the return on equity (ROE) would rise. ROE = Net Income/Shareholders Equity

Which of the following provides the BEST explanation for an increase in EPS estimates for the next year? A) Switching from a LIFO inventory recognition method to FIFO during an inflationary period. B) Writing down inventory due to the market value of the inventory falling below the book value in the current assets section of the balance sheet. C) Producing patents for 75% of a business' products for 10 years, despite the fact that the industry average patent production is 40%. D) Depreciation expense that's greater than CAPEX indefinitely, thereby leading to increased cash flow for share repurchases.

A) Switching from a LIFO inventory recognition method to FIFO during an inflationary period. Switching from a last-in, first-out (LIFO) to a first-in, first-out inventory method when prices are rising will reduce cost of goods sold (COGS) and will increase both net income and earnings per share (EPS). Inventory write-downs are an expense, which will decrease EPS. Since patents need to be depreciated every year, producing more patents leads to higher expenses and lower EPS. Since depreciation is a non-cash expense, depreciation being larger than capital expenditures will not lead to additional cash flows for stock repurchases.

Tarnish Corp and Shimmer Industries are in the same business. The industry average EV/EBITDA is 17. Based on the EV/EBITDA ratios in the table, which of the following is most likely? 12/31/14 12/31/15 12/31/16 Tarnish Corp 14 14 14 Shimmer Industries 17 18 17 A) Tarnish Corp. is undervalued B) Shimmer Industries is overvalued C) Tarnish's valuation reflects its metrics D) Shimmer is experiencing accelerated growth

Although Tarnish Corp. has an EV/EBITDA ratio that is less than the industry average, an EV/EBITDA of 14 may be normal for the company given that it has been consistent throughout the years. The market has consistently priced this company at a lower ratio to Shimmer and the rest of the group. A steady ratio could be indicating that the company's earnings and enterprise value are growing at the same rate. This would result in no change to the ratio. It could also be indicating that the company's earnings have stagnated and investors are not willing to pay a high multiple or even the average multiple for its equity. Considering Shimmer's EV/EBITDA is near the industry average and appears consistent in the 17-18 range, it is not likely that Shimmer is overvalued or experiencing accelerated growth. It would be prudent to evaluate other metrics before making a determination whether either company is overvalued or undervalued.

What would a research analyst use to obtain information regarding an industry's barriers to entry and exit? A) Discussions with industry participants B) Annual reports C) Patent filings D) Financial media publications

Although most corporations don't specifically mention barriers to exit or entry in their annual reports, they will discuss industry competition and risks to their business. This could include firms' pricing power, customer loyalty, and government regulations, all of which relate to the barriers to entry or exit from an industry.

Hastings Inc. is a company that is usually profitable, but occasionally in the red. Hastings currently has positive cash flow. The industry is capital intensive. Valuation for Hastings might be based on the: A) Gordon model B) Dividend discount model C) EV / EBITDA D) ROIC-WACC

An alternative metric that has gained recognition is the EV / Sales and EV / EBITDA. In the latter, we are dividing the cost of acquiring the firm (EV) by a measurement of profitability, neutralizing the capital structure and accounting decisions affecting depreciation and amortization. The particular industry would have a range of EV / EBITDA ratios that would signify an overvalued or undervalued situation. The dividend discount model and the Gordon model are similar to each other, but the Gordon model should be used to value a firm that is in a steady state with dividends growing at a steady rate and expected to stay stable in the long term.

Which of the following would increase operating cash flow? A) Lower depreciation B) Increasing accounts receivable C) Increase in accrued vacation payable D) Lower accounts payable

An increase in accrued vacation payable indicates that the company owes its employees vacation compensation. When a liability increases it is a source of cash, because the company is delaying payment of an obligation. When that occurs, less has been paid to creditors and more cash is retained on the balance sheet. A reduction in depreciation would reduce cash flow, because depreciation expense is a noncash charge to earnings. It is added back to negate the noncash charge to earnings previously deducted for the declining value of the firm's assets and is a source of cash. An increase in accounts receivable is a use of cash, because it indicates the company is not collecting cash from its credit sales as rapidly. More money is locked up in the collection phase. When accounts receivable declines it is because customers are paying for their credit purchases sooner and is a source of cash. Lower accounts payable means the company is paying its creditors more rapidly and thus has less remaining cash. A decline in a liability is a use of cash, while an increase in a liability is a source of cash.

Determine a company's share price based on the following information: ROE 15% Intermediate-term economic growth 4% Retention rate 40% Current dividend $1.00 per share Cost of equity (k) 11.00% A) $14.86 B) $21.20 C) $20.00 D) $14.29

B) $21.20

Use the following exhibit to answer this question. Company shares outstanding 75,000,000 Market value of common $32 Convertible Preferred Stock* (6% dividend, $100 par)$250,000,000 Bond Interest Expense $150,000,000 Cash and equivalents$50,000,000 EBIT$620,000,000 Corporate Tax Rate -- 34%* Conversion price $25 What is the fully diluted EPS for Company Q? A) $3.38 B) $3.65 C) $3.94 D) $4.04

B) $3.65 EBIT $620,000,000 - Bond interest expense 150,000,000 Income from continuing operations 470,000,000 - Tax 159,800,000 Net income 310,200,000 EPS = [Earnings available to common] / [common shares outstanding] EPS = $310,200,000 / 85,000,000 EPS = $3.65

Relevant financial information to answer the following question is found by using Exhibit 28. Company D has agreed to acquire Company J. The terms of the acquisition require the issuance of 1.5 shares of Company D common stock for each share of Company J. What is the effect on the EPS of Company D following the acquisition? The acquisition has been accretive by $.12 per share. Company D Company J Revenue 1,000 900 Operating Income 98 92 --Interest Expense 10 7 --Taxes 34 32 Net Income 54 53 Shares Outstanding 60 30 A) No change B) $.03 accretive C) $.08 dilutive D) $.12 accretive

D) $.12 accretive Based on the terms of the acquisition, an additional 45 million shares of Company D common stock would be issued (1.5 x 30 MM). The total number of shares outstanding following the acquisition will be 105 MM (60 MM + 45 MM). Company D's net income following the acquisition is $107 MM (Company D's net income = $54 MM + Company J's net income $53 MM). Prior to the acquisition, Company D had $.90 EPS ($54 MM / 60 MM). The EPS following the acquisition is $1.02 ($107 MM / 105 MM), a $.12 accretive effect.

Use the following information to answer this question. The Girtz Corporation is considering the acquisition of the Yellow Company with common stock. Relevant financial information is as follows: The Girtz Corporation The Yellow Company Present earnings $4,000 $1,000 Common shares outstanding 2,000 800 Earnings per share $2.00 $1.25 Price/Earnings ratio 12 8 The Girtz Corporation is considering the acquisition of the Yellow Company using common stock. Girtz plans to offer a premium of 20% over the market value of Yellow stock. If the price/earnings ratio for the Girtz Corporation stays at 12, what is the approximate market price per share of the surviving company? A) $10.00 B) $12.00 C) $24.00 D) $25.00

D) $25.00 The number of new shares issued is based on the ratio of exchange. The exchange ratio is $12/$24 or .50, or one-half share of Girtz stock for every share of Yellow stock. The number of new shares issued equals 800,000 shares multiplied by 0.5 which equals 400,000 shares. To calculate the earnings per share for the surviving company, we assume that the profit is cumulative and that total shares outstanding equal two million plus the 400,000 newly issued shares. Surviving company earnings (in thous.) $5,000 Common shares outstanding (in thous.) 2,400 Earnings per share$2.08 ($5,000 / 2,400) Using the earnings per share based on the previous calculation and the price/earnings ratio of 12, the market price per share will be $25.00. This is calculated by multiplying the EPS of $2.08 by the price/earnings ratio of 12. $2.08 x 12 = $24.96. This has been approximated to $25.00 in choice (d).

The Big N, a company listed on the Nasdaq Global Select Market, currently has 4,000,000 shares outstanding. Its net income is currently $8,600,000 and is expected to grow at 16%. If Big N conducts a public offering of 2,500,000 shares of common stock, with the company selling 1,500,000 shares and the shareholders selling 1,000,000 shares, what is the impact of the offering on expected EPS? A) It would not be accretive or dilutive to EPS B) It would be dilutive by 96 cents C) It would be dilutive by 49 cents D) It would be dilutive by 68 cents

D) It would be dilutive by 68 cents The expected net income can be found by multiplying the current amount by the expected growth rate ($8,600,000 x 1.16 = $9,976,000). The EPS would be $2.49 ($9,976,000 / 4,000,000 shares) without the additional shares being offered. The number of outstanding shares would increase by 1,500,000 if the company conducted an offering of additional shares. (The shares sold by selling shareholders do not increase the number of outstanding shares since this amount is already included in the amount of shares outstanding.) The EPS after the offering is $1.81 and, therefore, would be dilutive by 68 cents ($2.49 - $1.81).

Episilon Financial currently has significant loan losses and holds reserves against those loans in the event that borrowers do not repay. Which of the following metrics is the BEST valuation tool for Episilon? A) Enterprise value-to-sales B) Forward price earning ratio C) Losses per million D) Price-to-book ratio

D) Price-to-book ratio Loan loss reserves represent a certain percentage of loans that will not be repaid and appear as a noncash charge to earnings. The creation of reserves provides a cushion against nonpayment. These reserves shrink when loans are charged off. The balance sheets of financial service companies, such as banks, insurance, and reinsurance companies are presumably liquid and are marked to the market, so the book value becomes a strong consideration in valuing the company. One of the most often-used valuation metrics for these types of companies is the price-to-book ratio.

The Cardinal Corporation has two business segments. Its jet engine business contributes 75% of the company's overall earnings, while the financial services division generates much lower revenues, but a significantly higher profit margin. Cardinal sold off its household appliance division in 2018 and consumer electronics division in 2019. Now that Cardinal has divested two of its most unprofitable businesses, the company is seeking acquisition candidates in the smartphone and tablet industries. What's the BEST method for valuing the Cardinal Corporation? A) EV/EBITDA should be used due to the significance of the company's industrial base B) EV/Sales should be used, since the cash position of the company will have a negative effect on enterprise value C) Price-to-book value should be used because its financial services division generates higher profit margins than the jet engine division D) The sum-of-the-parts

D) The sum-of-the-parts valuation method should be used if different valuation methods are used for the remaining business segments A sum-of-the-parts valuation method is applied when different valuation metrics are applied to separate business operations. In this example, a discounted cash flow or EV/EBITDA might be applicable to the jet engine division, while the financial services division would likely be valued based on a multiple of its book value.

The expectation is that the widget industry will be deregulated in coming months. What's the most likely immediate impact that deregulation will have on stock price of companies in the industry? A) It depends on the market capitalizations of companies in the industry B) Decrease C) Increase D) Stay the same

Deregulation of an industry will generally decrease operating costs to firms, which improves the future outlook for stocks within the industry. In addition, deregulation can add to growth and innovation in the sector which can improve revenue and earnings. Increasing regulations is generally associated with higher costs, lower profits, and decreasing stock prices.

Fair value is the: A) Price a firm would pay for another company B) Enterprise value of a company C) Purchase price of an asset minus depreciation D) Book value plus good will

Fair value is defined as an estimate of the potential market price of goods and services, the value of assets, or the value of a company. It is, therefore, the price a firm would pay to buy another company.

You are preparing to estimate the value of GHI Company's enterprise value using a DCF model. For your model, you need to calculate the company's WACC and, therefore, its cost of debt. GHI Company doesn't pay dividends and has no earnings in the current year, but the company has positive FCFF and FCFE. The beta of the company's stock is 1.7. The risk-free rate is 2.0% and the risk premium is 6.0%. What's GHI Company's equity cost of capital? A) 8.0% B) 10.2% C) 12.2% D) 13.6%

The cost of equity capital can be calculated by applying the Capital Asset Pricing Model (CAPM): Cost of equity = Rf + [β(Rm - Rf)], where Rf equals the risk-free rate of return and Rm equals the expected market return. The risk premium equals the expected market return minus the risk-free rate. The equity cost of capital is 12.2% (2.0% + [1.7 x 6.0%]). Note: In this example, the expected market return is 8.0%, which is the risk premium plus the risk-free rate (6% + 2%). Because the question stem gives us the risk premium, it's not necessary to calculate it by subtracting the risk-free rate from the market rate.

Use the following information to answer this question: Sales DaysSalesOutstanding AccountsPayableTurnover 2017 82 40 9.5 2018 90 35 9.5 Given the above information, which of the following statements is TRUE? A) The rate of cash flow for the company has increased. B) Current assets of the company increased. C) EPS increases if days sales outstanding (DSO) decreases. D) The cash flow of the company has declined.

The decline of DSO from 40 to 35 indicates that the company has collected its receivables quicker: (40 - 35) / 40 = .125 or 12.5% reduction in the time period. The rate of collection reduction exceeds the percentage increase in sales (90 - 82) / 82 = .0976 or 9.76%. This indicates the company is bringing in cash from accounts receivable at a faster rate than one year ago. Current assets remain the same. The increase in cash will be offset by an equal decline in accounts receivable on the balance sheet. A company's average collection period is calculated as: (Accounts Receivable x 365) / Total Credit Sales A low figure indicates that the company collects its outstanding receivables quickly. This ratio is often used to help determine whether a company is trying to disguise weak sales. Typically, it's analyzed either quarterly or annually (90 or 365 days). EPS is not based on the rate of collection; instead, it's based on the profitability of the company.

Enterprise value is: A) The real, tangible price at which a company may be purchased B) The value of the company after five years of operation C) The value of the company excluding its long-term debt D) The value of the company including cash and investment

The enterprise value of a company is the market capitalization of the company plus long-term debt less cash and investments. It represents the real, tangible value at which the company may be purchased.

Use the following information to answer this question. VNB Industry Year 1 2 3 4 Revenue % Increase 10% 10.5% 10% 10% Operating Margin 21% 22% 21% 21% Unit Sales Growth 10% 8% 6% 4% Operating Income 462 If an analyst assumes the present trend in the industry will continue, what is the estimate for operating income in year 5? A) 471 B) 480 C) 508 D) 559

The increase to operating income is tied to the revenue increase. The industry exhibits strong pricing power. Operating margin has remained steady even as unit sales growth has declined. To calculate the projected operating income, it is necessary to project the revenue growth. In the absence of any additional information, a 10% growth rate is assumed. The growth rate of revenues multiplied by the operating income will indicate the operating income growth (10% x 462 = 46.2), added to the previous year's operating income provides an estimate of 508 operating income in year 5. (30176)

Which ratio takes into consideration a company's growth potential along with its prospects for continued earnings? A) PEG ratio B) EV/EBITDA ratio C) EV/Sales ratio D) P/E ratio

The price/earnings-to-growth ratio (PEG) seeks to value a company in terms of growth potential and the possibility of continued earnings.

Relevant financial information to answer the following question is found by using Exhibit 63. Given the information relating to a discounted cash flow analysis, what is the implied equity value per share? The present value of the cash flows is $485 MM • The present value of the terminal value is $3,200 MM • The number of outstanding shares is 115 MM • The debt is $510 MM • The cash on the balance sheet is $225 MM A) $32.04 B) $29.56 C) $34.52 D) $38.43

Using a discounted cash flow (DCF) analysis, the implied equity value per share is determined using the following method. First, add the present value of the cash flows and the terminal value to calculate the implied enterprise value ($485 million + $3,200 million = $3,685 million). Then, subtract the debt and add the cash on the balance sheet to calculate the implied equity value ($3,685 million - $510 million + $225 million = $3,400 million). Finally, divide the implied equity value by the number of outstanding shares to calculate the implied equity value per share ($3,400 million / 115 million shares = $29.56).

A research analyst is analyzing a potential M&A transaction and is given the following information relating to a discounted cash flow analysis: The present value of the cash flows is $760.6 MM The present value of the terminal value is $5,850 MM The number of outstanding shares is 285.7 MM The debt is $960.4 MM The cash on the balance sheet is $370.2 MM What is the implied equity value per share? A) $23.33 B) $21.07 C) $23.14 D) $25.25

Using a discounted cash flow (DCF) analysis, the implied equity value per share is determined using the following method. First, add the present value of the cash flows and the terminal value to calculate the implied enterprise value ($760.6 MM + $5,850 MM = $6,610.6 MM). Then, subtract the debt and add the cash on the balance sheet to calculate the implied equity value ($6,610.6 MM - $960.4 MM + $370.2 MM = $6,020.4 MM). Finally, divide the implied equity value by the number of shares of outstanding shares to calculate the implied equity value per share ($6020.4 MM / 285.7 MM shares = $21.07).

Calculate beta given the following: Debt to total capital is 40% Cost of debt 6% Weighted cost of capital is 10% Expected market return 9%, Risk free rate is 3% A) 1.9 B) 1.2 C) 1.61 D) 14.1

WACC = After tax cost of debt x Weight of debt + Cost of equity x Weight of equity Therefore, Cost of equity = [WACC - (After tax cost of debt x Weight of debt)] / Weight of equity= [10% - (6% x 40%)] / 60%= 12.66 Cost of equity = Risk free rate + Beta (Market return risk free rate) Therefore, Beta = (Cost of equity Risk free rate) / (Market return risk free rate)= (12.66% - 3%) / (9% - 3%)= 9.66% / 6%= 1.61

***A large electronics retailer sells three-year extended warranties to 30% of its customers and is anticipating receiving revenue of $120,000,000 over three years. For tax purposes, the company wants to record the entire $120,000,000 as income. The company's marginal tax rate is 40% and its effective tax rate is 35%. The company's balance sheet would show a deferred tax: A) Liability of $32,000,000 B) Liability of $16,000,000 C) Asset of $32,000,000 D) Asset of $16,000,000

When corporate accounting income and taxable income differ, it may create a deferred tax asset or deferred tax liability on a balance sheet. If taxable income is greater than accounting income, this will create a deferred tax asset. (The opposite result will create a deferred tax liability.) In this example, the company's taxable income exceeds its accounting income. In effect, the company prepaid its taxes on the income. To calculate the deferred tax asset, first find the amount of taxable income that exceeds the accounting income and then multiply this amount by the marginal tax rate (not the effective tax rate). The company should have recorded income of $40,000,000 in each of three years. Taxable income exceeds accounting income by $80,000,000 ($120,000,000 - $40,000,000). The deferred tax asset is $32,000,000 ($80,000,000 x .40).