SIE: Analysis (Fundamental Analysis)

A corporation issues $100,000,000 of 10% convertible debentures, convertible at $50. Upon issuance, all of the following are affected EXCEPT:

Stockholders' Equity When bonds are issued, the corporation receives the cash from the sale (increasing current assets) and shows the long term liability to repay the bonds (increasing long term debt). Therefore, Total Assets increase; Total Liabilities increase; and Net Working Capital increases because of the increase in current assets. Stockholders' Equity is unaffected since only a profit or loss, or the sale of new equity securities, or the declaration of a cash dividend, will cause a change in Stockholders' Equity.

Which item would be found on a company's income statement?

Taxes paid Taxes paid for that period show on a company's income statement. Retained earnings shows on the company's balance sheet. Dividends paid show on a company's Statement of Retained Earnings; reinvested dividends would be dividends paid to a shareholder that are reinvested in new share purchases and these are not shown in a company's financial statements. Finally, while annual depreciation expense shows on a company's income statement; the accumulation depreciation that reduces an asset's book value shows only on the balance sheet.

If a corporation decides to split its stock 3 for 1, which of the following will occur after the split?

The Earnings Per Share changes A stock split or dividend will have no effect on the Price / Earnings ratio of an issuer. The market price is adjusted downward on "ex date" for the split; and the earnings per share are restated downward to reflect the increased number of shares that will be issued. Since both decrease proportionately, the ratio stays the same. A corporation will split its stock when the market price gets too high, thus making the stock more accessible to the small investor after the market price is reduced on "ex" date for the split. If a corporation splits its stock, the par value per share is reduced; and the number of outstanding shares is increased proportionately. In aggregate, the par value of the common stock does not change. Earnings per share will be reduced because there are more shares outstanding. The stock's price will be reduced proportionately on the ex-date to reflect the split. Since both the earnings per share and the market price per share are reduced proportionately, the Price / Earnings ratio is unaffected.

If a corporation has an operating margin of profit of 9.50%, this means that for every $1 of revenue, the company has:

$.905 of expenses An income statement starts with revenues and deducts all operating expenses to arrive at operating income. The "margin" is a profitability or loss percentage. Gross Sales - Operating Expenses Operating Income The "margin" is a profitability or loss percentage. The Operating Margin of Profit is: Operating Income / Revenues. (Also note that the term "Operating Margin of Profit" is a wording that is now rarely used - instead the current wording is simply Operating Profit Margin or Operating Margin - but it may still be used on the exam.) If the company has an Operating Margin of Profit of 9.50%, this means that it had operating income of $.095 for each $1 of revenue ($.095 / $1 = 9.50%). Because operating expenses are deducted from revenue to arrive at the operating margin, this means that for every $1 of revenue, there were $.905 of expenses.

What is the current ratio: Cash and Equivalents 12,000,000 Notes Payable 5,000,000 Accounts Receivable 22,000,000 Current Maturity - Long Term Debt 3,000,000 Inventory 26,000,000 Accrued Income Taxes 4,000,000 Prepaid Expenses 2,000,000 Accounts Payable 19,000,000 Total Current Assets 62,000,000 Total Current Liabilities 31,000,000

2:1 The formula for the Current Ratio is: current ratio = current assets / current liabilities $62,000,000 $31,000,000 = 2:1

What is ACME Corporation's Quick Ratio? 60k in current assets, 10k in inventory, 40k in liabilities

1.25 to 1 The formula for the "Quick" Ratio is: acid test = (current assets - inventory) / current liabilities $60,000,000 - $10,000,000 $40,000,000 = $50,000,000 $40,000,000 = 1.25:1

What is ABC Corporation's Preferred Stock Ratio?

15% The formula for the Preferred Stock Ratio is: preferred stock ratio = preferred stock / total long term capital $3,000,000 $20,000,000 = 15% Total Long Term Capital consists of long term debt ($8,000,000), preferred stock ($3,000,000) and common equity ($9,000,000), with common equity consisting of common at par, capital in excess of par and retained earnings. long term debt + preferred stock + common equities (common stock, common stock in excess of par, retained earnings) = TOTAL LONG TERM CAPITAL

A company has reported operating income of $5,000,000. The bond interest expense for the year is $500,000 and principal repayments on bonds totaled $1,500,000. The company's debt service coverage ratio is:

2.5:1 The debt service coverage ratio determines if operating income is sufficient to pay not only interest on the bonds but upcoming principal repayments (within the coming year). The ratio is: debt service coverage ratio = operating income / (annual interest cost + principal repayments) $5,000,000 $500,000 + $1,500,000 = 2.5 : 1

A company has reported operating income of $12,500,000. The bond interest expense for the year is $4,000,000 and principal repayments on bonds totaled $1,000,000. The company's debt service coverage ratio is:

2.5:1 The debt service coverage ratio determines if operating income is sufficient to pay not only interest on the bonds but upcoming principal repayments (within the coming year). The ratio is: debt service coverage ratio = operating income / (annual interest cost + principal repayments) $12,500,000 $4,000,000 + $1,000,000 = 2.5 : 1

What is XYZ Corporation's Preferred Stock Ratio?

24% The formula for the Preferred Stock Ratio is: preferred stock ratio = preferred stock / total long term capital $80,000,000 $338,000,000 = 24% Common equity consists of common at par ($10,000,000), capital in excess of par ($64,000,000), and retained earnings ($124,000,000) for a total of $198,000,000. Total Long Term Capital consists of long term debt ($60,000,000), preferred stock ($80,000,000) and common equity ($198,000,000).

ABC Corporation's Bond Interest Coverage Ratio is:

3.75x The formula for the Interest Coverage Ratio is: interest coverage ratio = total operating and non-operating income /annual bond interest expense $3,000,000 $800,000 = 3.75 x

A corporation's capitalization is: 1st Mortgage Bonds 9% M '45 $10,000,000 Preferred Stock 8% 5,000,000 Common Stock ($.10 par) 200,000 Capital in Excess of Par 800,000 Retained Earnings 6,000,000 The company's common stock ratio is:

32% The formula for the common stock ratio is: common stock ratio = (capital @ par + capital in excess of par + retained earnings) / total long term capital $200,000 + $800,000 + $6,000,000 = $7,000,000 = 32% $7,000,000 + $5,000,000 + $10,000,000 $22,000,000

What is ACME Corporation's Debt or Bond Ratio?

33% The formula for the "Debt Ratio" is: bond ratio = long term debt / total long term capital $10,000,000 $30,000,000 = 33% Long Term Capital consists of $10,000,000 of long term debt + $1,000,000 of preferred stock and $19,000,000 of common equity. Common equity consists of common at par ($6,000,000), capital in excess of par ($7,800,000), and retained earnings ($5,200,000) for a total of $19,000,000.

DEF Corporation Income Statement Net Sales $30,000,000 Cost of Goods Sold 15,000,000 Gross Margin 15,000,000 Operating Expenses 5,000,000 Operating Income 10,000,000 Bond Interest 2,000,000 Net Income Before Tax 8,000,000 Tax at 50% 4,000,000 Net Income After Tax $4,000,000 What is DEF's bond interest coverage ratio?

5:1 The formula for the Interest Coverage Ratio is: interest coverage ratio = total operating and non-operating income /annual bond interest expense $10,000,000 $2,000,000 = 5 x

If a corporation declares a cash dividend, which of the following statements are TRUE?

Both net working capital and stockholders' equity decrease If a dividend is declared, then it is not yet paid. Dividends payable increases (a current liability) and net worth (stockholders' equity) decreases (since the dividend is appropriated from retained earnings). If current liabilities increase, then net working capital (current assets - current liabilities) falls.

If a corporation declares a stock dividend, which statement is FALSE?

Capital in Excess of Par decreases If a corporation declares a stock dividend, the dividend is "appropriated" from retained earnings (reducing retained earnings) and is used to increase the number of common shares outstanding (increasing aggregate par value and capital in excess of par proportionately). At the same time, par value per common share remains the same. The net result is a "wash," with no dollar change in total stockholders' equity. For example, assume the following corporation declares and pays a 10% stock dividend, with the common stock worth $5 per share. Prior to the dividend, stockholders' equity consisted of: Existing Stockholders' Equity Common at Par ($1) (1,000,000 shares outstanding) $1,000,000 Capital in Excess of Par 4,000,000 Retained Earnings 5,000,000 Total Stockholders' Equity $10,000,000 After the 10% stock dividend is paid (10% of 1,000,000 shares = 100,000 shares x $5 per share = $500,000 total dividend), stockholders' equity would show: Stockholders' Equity After 10% Stock Dividend Common at Par ($1) (1,100,000 shares outstanding) $1,100,000 Capital in Excess of Par 4,400,000 Retained Earnings 4,500,000 Total Stockholders' Equity $10,000,000 Please note that the treatment of s stock split is very different. In a split, par value per share is reduced and the number of common shares increased proportionately. If this company had split its stock 2 for 1, stockholders' equity would now show: Stockholders' Equity After 2 for 1 Stock Split Common Stock ($.50) (2,000,000 shares outstanding) $1,000,000 Capital in Excess of Par 4,000,000 Retained Earnings 5,000,000 Total Stockholders' Equity $10,000,000

A corporation buys furniture and fixtures, paying cash. What is affected?

Current Assets If furniture is bought with cash, then cash goes down (a current asset) and property, plant and equipment increases (a long term asset). If current assets drop, then working capital drops. There is no effect on current liabilities because the furniture is paid for; net worth is only affected by a profit, loss, dividend payout, or capital structure change.

A corporation has previously declared a cash dividend. When the dividend is actually paid, which of the following are reduced?

Current Assets and Current Liabilities When the dividend is paid, cash drops (a current asset) and dividends payable drop (a current liability). Because both current assets and current liabilities fall by the same amount, net working capital is unchanged. This transaction has no effect on net worth.

All of the following are components of total long term capital of a corporation EXCEPT:

Current Liabilities A corporation's long term capital consists of common stockholders' equity (common at par; capital in excess of par; and retained earnings); preferred stockholders' equity; and long term debt. These are all sources of long term capital for the corporation. Current liabilities are just that, bills that must be paid within 1 year. They are not a source of capital for a corporation.

A corporation receives, but has not paid for, a shipment of goods that go into inventory. Which of the following choices is TRUE?

Current Liabilities increases If inventory is purchased, but is not paid for, inventory (a current asset) increases and accounts payable (a current liability) increases. Because both current assets and current liabilities increase by the same amount, net working capital is unaffected. This transaction has no bearing on net worth. Cash is unaffected because payment had not been made for the shipment.

Which ratio is the least stringent test of liquidity?

Current ratio The cash assets ratio is the ratio of cash to current liabilities; this is the most stringent test of liquidity. The quick ratio (or "acid test") is the ratio of current assets - inventories and prepaid expenses to current liabilities. This is a less stringent test than the cash assets ratio. The current ratio is the ratio of all current assets to current liabilities. This is the least stringent test of liquidity.

Which of the following will reduce net working capital?

Declaration of a cash dividend When a cash dividend is declared, it is appropriated from retained earnings and set up as a current liability - Dividends Payable. An increase in current liabilities reduces net working capital. When a stock dividend is declared, it is appropriated from retained earnings and used to increase common at par and capital in excess of par. There is no effect on net working capital. If a company reduces its allowance for bad debts, this increases accounts receivable (a current asset). If current assets rise, working capital rises. Increased depreciation deductions decrease the value of fixed assets and do not affect working capital.

All of the following will affect the reported net income per share of a corporation EXCEPT:

Declaration of a common dividend Since dividends are paid out of reported net income, they have no effect on the amount of net income that the corporation reports. If a corporation discontinues operations of a division, it usually takes a charge to net income to pay for the cost of the shut down. If the number of common shares is increased, reported net income per share will fall. If a corporation changes accounting methods for valuing inventories, any decrease in inventory value is taken as a charge to net income; while any increase in inventory value will increase reported net income. A memory device to remember the order of the income statement is: "GONNER" "Every Boy Trades Puts and Calls" (EBTPC) If you can remember "GONNER;" and "Every Boy Trades Puts and Calls" (EBTPC); - then you can remember the order of the income statement. The income statement components are: Gross Sales - Expenses Operating Income - Bond Interest Expense Net Income Before Tax - Taxes Net income After Tax - Preferred Dividend Earnings For Common - Common Dividend Retained Earnings

A corporation has an operating margin of profit of 9.50%. What does this mean?

For every $90.50 of expenses, the company had $100 of revenue The best answer is D. An income statement starts with revenues and deducts all operating expenses to arrive at operating income. Gross Sales - Operating Expenses Operating Income The "margin" is a profitability or loss percentage. The Operating Margin of Profit is: Operating Income / Revenues. (Also note that the term "Operating Margin of Profit" is a wording that is now rarely used - instead the current wording is simply Operating Profit Margin or Operating Margin - but it may still be used on the exam.) If the company has an Operating Margin of Profit of 9.50%, this means that it had operating income of $9.50 for each $100 of revenue ($9.50 / $100 = 9.50%). Because operating expenses are deducted from revenue to arrive at the operating margin, this means that for every $100 of revenue, there were $90.50 of expenses. Gross Sales $ 100.00 - Operating Expenses $ 90.50 Operating Income $ 9.50 The Operating Margin is $9.50 / $100 = $9.50%

All of the following are components of common stockholders' equity EXCEPT:

Intangibles If a corporation sells stock at a price above par value, the par value received is shown on the balance sheet as "par value," while the excess funds are credited to the corporation's capital surplus account. Retained earnings and earned surplus are different names for the same account - corporate earnings that are not paid out as dividends are credited annually to retained earnings; this is technically owned by the common shareholders. Intangibles are assets of a corporation, such as the value of copyrights, patents or trademarks. They are not a component of common stockholders' equity. Common Stockholders' Equity consists of 3 components: Common at Par Value - the amount paid by common stockholders who bought the shares on the initial public offering that is attributed to the arbitrary "par value" per share. Capital in Excess of Par - the amount above par value paid by common stockholders who bought the shares on the initial public offering. Retained Earnings - corporate earnings that have not been paid to common shareholders as dividends; rather they are being retained by the corporation and used to fund future growth.

All of the following ratios measure a company's ability to pay bills as they come due, EXCEPT:

Inventory turnover ratio The cash assets ratio is the ratio of cash to current liabilities; this is the most stringent test of liquidity. The quick ratio (or "acid test") is the ratio of current assets - inventories and prepaid expenses to current liabilities. This is a less stringent test than the cash assets ratio. The current ratio is the ratio of all current assets to current liabilities. This is the least stringent test of liquidity. The inventory turnover ratio is the ratio of annual cost of sales to year end inventory. It shows how quickly a company is selling and replacing its inventory.

All of the following are methods of depreciation EXCEPT:

Last In; First Out Methods of depreciation include straight line, double declining balance (an accelerated method), and sum of the year's digits (another accelerated method). Last-in; first-out (LIFO) is a method of accounting for inventories.

A corporation issues a stock dividend. All of the following are affected EXCEPT:

Net Worth If a corporation "pays" a stock dividend, it is taken from retained earnings and transferred to the common stock account. Common at par will increase in aggregate, as will capital in excess of par. while retained earnings will drop by an equal amount. Net worth as a whole, and stockholders' equity as a whole, will remain unchanged.

A corporation issues a stock dividend. Which statement is TRUE?

Par value per common share will remain the same If a corporation declares a stock dividend, the market price of the stock will fall since there will be additional shares outstanding. The stock dividend is appropriated from retained earnings (reducing retained earnings) and used to increase the number of common shares outstanding. Par value per share remains the same, but since there are more shares outstanding, aggregate par value increases (as does capital in excess of par). The dollar decrease in retained earnings exactly equals the increase in common at par, and capital in excess of par, so the net result is a "wash," with no dollar change in total stockholders' equity.

ABC Corporation declares a 1:5 stock split. As a result of this action all of the following will occur EXCEPT the:

Price / Earnings ratio of ABC common stock will increase Reverse stock split will: market price of ABC common stock will increase number of common shares of ABC outstanding will decrease Earnings per Share of ABC common stock will increase In a reverse stock split, the number of common shares outstanding is decreased and the market price per share is increased proportionately on the "ex" date. Because the corporations' earnings will be spread over fewer shares, earnings per share will increase. However, the company's Price / Earnings ratio will remain constant because both the stock market price and the earnings per share will increase in the same proportion keeping the Price / Earnings ratio unchanged.

If a corporation repurchases its debt, which statement is TRUE?

The company will be deleveraged Deleveraged is a slang term that means a corporation has reduced its debt load, so its capitalization will decrease. "Leverage" is the use of debt in a corporation's capital base - the term comes from the fact that as corporate income increases, its fixed interest cost does not increase, and the increase accrues to the shareholders, "leveraging" earnings. Corporations will repurchase debt to refinance at lower interest rates (not higher ones); to increase the market value of the corporation's common stock (since the corporation has less debt, the common stock would be valued more highly by the market); and to reduce the corporation's earnings fluctuation's due to cyclical conditions. Corporate sales decrease due to cyclical conditions, but fixed interest charges do not. This causes earnings for common shareholders to fall greatly or become non-existent in period of falling sales. To reduce this possibility, a corporation can repurchase its debt.

Corporate financial reports that are filed with the SEC by publicly traded companies are required to use:

accrual accounting Corporate financial records are kept using accrual accounting - a method that attempts to match revenues and expenses. Very small non-public companies can use cash accounting, which simply records revenues when cash payment is received; and liabilities when payment is made. In contrast, accrual accounting books revenue when services or product is delivered (but payment typically occurs in the future); and liabilities when incurred (again, payment of the liability typically occurs in the future).

Stockholders' Equity (Net Worth) is affected by all of the following EXCEPT:

declaration of a stock dividend Stockholders' Equity consists of: Common at Par + Capital in Excess of Par + Retained Earnings. When a cash dividend is declared, it is deducted (debited) from Retained Earnings and credited to Dividends Payable - a current liability. Thus, Stockholders' Equity drops. When Treasury Stock is purchased, Common at Par and Capital in Excess of Par are reduced by the purchase amount and cash (a current asset) is reduced (to reflect the payment made to buy the Treasury stock). Thus, Stockholders' Equity decreases. When new stock is issued, Common at Par and Capital in Excess of Par are increased by the sale amount and cash (a current asset) is increased (to reflect the cash received from selling the new stock). Thus, Stockholders' Equity increases. When a stock dividend is "paid," it is debited to Retained Earnings (a reduction) and credited to Common at Par and Capital in Excess of Par. Since these are all accounts within Stockholders' Equity, there is no net change to the total Stockholders' Equity amount.

XYZ Company has 100,000,000 authorized common shares. 25,000,000 shares have been issued and another 10,000,000 shares are currently in registration. The sale of the 10,000,000 shares will result in all of the following EXCEPT a(n)

decrease in net working capital will cause: decrease in earnings per share increase in net worth increase in the number of shares outstanding If a company sells additional common shares, the funds from the sale increase cash (thus increasing net working capital) and are credited to the company's capital at par and capital surplus (thus increasing net worth). As the number of outstanding shares increase, earnings per common share will fall (become diluted).

Bond interest expense of a corporation is :

deductible before taxes The basic corporate income statement is: Gross Sales - Operating Expenses Operating Income - Bond Interest Net Income Before Tax - Taxes Net Income After Tax From the order of the income statement, bond interest expense is deducted after operating expenses but before taxes. Choice D is nonsense, the question is not asking about taxation of interest to an investor.

A corporation would repurchase its debt for all of the following reasons EXCEPT to:

increase its capitalization If a corporation repurchases its debt, then its capitalization will decrease (a corporation's long term capital consists of equity and long term debt). Corporations will repurchase debt to refinance at lower interest rates; to increase the market value of the corporation's common stock (since the corporation has less debt, the common stock would be valued more highly by the market); and to reduce the corporation's earnings fluctuations due to cyclical conditions. Corporate sales decrease due to cyclical conditions, but fixed interest charges do not. This causes earnings for common shareholders to fall greatly or become non-existent in period of falling sales. To reduce this possibility, a corporation can repurchase its debt.

Accelerated depreciation deductions:

increase reported expenses but decrease reported income in early years Accelerated depreciation deductions, when compared to straight-line depreciation deductions, are "front loaded." The depreciation deduction is higher in earlier years; but the deduction is lower in later years (as compared to straight line depreciation). Because there are higher deductions in the earlier years, this will increase reported expenses in those years while reducing reportable income. The lower deductions in later years will decrease reported expenses but increase reportable income .

Accelerated depreciation deductions:

increase reported expenses in early years Accelerated depreciation deductions, when compared to straight-line depreciation deductions, are "front loaded." The depreciation deduction is higher in earlier years; but the deduction is lower in later years (as compared to straight line depreciation). Because there are higher deductions in the earlier years, this will reduce reported income in those years and reduce tax liability. While in later years, lower deductions in later will increase reported income and increase tax liability. Remember, depreciation expense is applied to man-made items while depletion allowances are used for natural resources.

If current liabilities of a company are subtracted from current assets of a company, the result is the company's:

net working capital current assets - current liabilities = net working capital (In contrast, the formula for Net Worth is: Total Assets minus Total Liabilities.)

All assets minus all liabilities equals:

net worth total assets - total liabilities = net worth (In contrast, the formula for Net Working Capital is: Current Assets minus Current Liabilities.)

A corporation would repurchase its debt for each of the following reasons EXCEPT:

to refinance at higher interest rates increase of leverage (true) If a corporation repurchases its debt, then its capitalization will decrease (a corporation's long term capital consists of equity and long term debt). Decreasing debt levels results in reduced leverage. Leverage is a slang term used to describe the capitalization mix of a company. A highly leveraged company has a large percentage of its capitalization in debt. Corporations will repurchase debt to refinance at lower interest rates (not higher ones); to increase the market value of the corporation's common stock (since the corporation has less debt, the common stock would be valued more highly by the market); and to reduce the corporation's earnings fluctuations due to cyclical conditions. Corporate sales decrease due to cyclical conditions, but fixed interest charges do not. This causes earnings for common shareholders to fall greatly or become non-existent in period of falling sales. To reduce this possibility, a corporation can repurchase its debt.