79 - Ch. 8

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$63.85 MM B$39.25 MM C$64.75 MM D$40.15 MM

A. An investment banking representative 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).

Axis Chemicals has contacted your firm with the intention of expanding its capital base through an additional offering of common stock. The company's results show an increase in sales of 33% during the last quarter; however, in the past, the company has been involved in channel stuffing. As an investment banking representative, which TWO areas should be reviewed to gain a better understanding of the company's revenues during the last quarter? Footnotes and the disclosure statement of nonrecurring items Accounts receivable growth exceeding sales growth Days sales outstanding (DSO) Revenue recognition policy AII and III BI and II CIII and IV DI and IV

A. Channel stuffing is a deceptive business practice used by a company to inflate its sales and earnings figures by deliberately sending retailers along its distribution channel more products than they are able to sell to the public. Through channel stuffing, distributors temporarily increase accounts receivables. However, if unable to sell the excess products, retailers will return the excess items to the distributor. The distributor must adjust accounts receivable and its bottom line. Channel stuffing ultimately catches up with the company. It cannot maintain sales at the rate it is stuffing. This is usually done fraudulently to raise the value of the stock. Channel stuffing is illegal. An investment banking representative would want to carefully review a company's financial statements to see if the accounts receivable growth rate exceeds the sales growth rate and analyze any significant changes in a company's Days Sales Outstanding (DSO).

MSD Pharmaceuticals has retained earnings at the end of 2017 of $39,095.1 MM and net income in 2017 of $3,325.5 MM. In 2018, the company's net income increased by 8% and at the end of the year it paid a cash dividend of $3,310.7 MM. What is the 2018 ending balance of the company's retained earnings if it has a 21% tax rate? A$39,375.9 MM B$42,686.6 MM C$39,109.9 MM D$42,405.8 MM

A. The company's tax rate is irrelevant since we are given net income (an after-tax number). The company's net income in 2018 is $3,591.5 MM ($3,325.5 MM x 1.08). The company paid a cash dividend of $3,310.7 MM and, therefore, the difference between the net income and the dividends paid is $280.8 MM ($3,591.5 MM - $3,310.7 MM), which would increase the company's retained earnings. The ending retained earnings balance would be $39,375.9 ($39,095.1 MM + $280.8 MM).

Relevant financial information to answer the following question is found in Exhibit 7. (Clicking the link will open the exhibit in a new window). Based upon this data, what would be the expected EPS for 2014? A$5.86 B$6.03 C$5.69 D$6.14

A. This is the type of question where you need to examine the data given, find a pattern, and then answer the question. There is a year-over-year increase of 5% from 2010 - 2013. In the absence of any other factors, 2014 EPS should increase by 5% ($5.58 x 1.05 = $5.86).

Two automobile manufacturers have defined benefit pension plans. Company ZBT uses a discount rate of 5% to calculate its pension fund liabilities, and Company SMI uses a 7.5% discount rate to calculate its pension fund liabilities. Which of the following statements is TRUE? ACompany SMI is using a more aggressive method of accounting BCompany ZBT is using a more aggressive method of accounting CCompany SMI will have higher pension fund assets DCompany ZBT will have higher pension fund assets

Aggressive accounting refers to a method of accounting that is used to report lower expenses and higher income, or to overstate assets while understating (not recognizing or lowering) liabilities. In regard to accounting practices for defined benefit pension plans, using a low discount rate is conservative, and using a higher discount rate would be aggressive. The present value calculation is based on dividing the liabilities by (1.0 + discount rate). Therefore, the higher the discount rate, the lower the present value of the fund's long-term liabilities. In order to calculate either company's pension fund assets, you would need to be given the expected return on the assets in the plan.

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 $130 MM. In the same period, the company reported net income of $35 MM. The company has a marginal tax rate of 40% and an effective tax rate of 30%. What would be the company's net income without the onetime sale? A$29 MM B$28 MM C$41 MM D$42 MM

An investment banking representative 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 gain, subtract the tax-adjusted gain from the net income. The tax-adjusted gain is $6 MM ($10 MM x 60%, the complement of 40%). The net income without the gain would be $29 MM ($35 MM - $6 MM). For this type of calculation, use the marginal tax rate, not the effective tax rate since it is a more conservative number. The marginal tax rate includes both the statutory federal and state taxes, is considered the rate for any additional dollars 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).

You are an investment banking representative evaluating two companies in the same sector. Which of the following choices describes why net sales would be used, rather than net income? ANet sales will provide a higher ratio calculation BNet sales eliminates the effects of depreciation and amortization CNet income eliminates the effects of depreciation and amortization DNet sales eliminates the payment of taxes

B, By using net sales rather than net income, an investment banking representative can neutralize or eliminate different methods of depreciation or amortization. It makes comparing two companies more equitable.

Two companies have defined benefit pension plans. Company A uses a discount rate of 4% to calculate its pension fund liabilities, and Company B uses a 6.5% discount rate to calculate its pension fund liabilities. Which of the following statements is TRUE? ACompany B will have higher pension fund assets BCompany A will have higher pension fund assets CCompany B is using a more aggressive method of accounting DCompany A is using a more aggressive method of accounting

C. Aggressive accounting refers to a method of accounting that is used to report lower expenses and higher income, or to overstate assets while understating (not recognizing or lowering) liabilities. In regard to accounting practices for defined benefit pension plans, using a low discount rate is conservative, and using a higher discount rate is aggressive. The present value calculation is based on dividing the liabilities by (1.0 + discount rate). Therefore, the higher the discount rate, the lower the present value of the fund's long-term liabilities. In order to calculate either company's pension fund assets, you would need to be given the expected return on the assets in the plan.

In calculating a company's market capitalization, the treasury stock of a corporation is: AAdded to market value at purchase cost BSubtracted from the market value of outstanding shares at cost CIgnored DSubtracted from market value at market value

C. In order to calculate the market capitalization of a company, multiply the number of outstanding shares of common stock by the current market price. The number of outstanding shares does not include treasury shares, so the latter may be ignored. A company's outstanding shares are found by subtracting the number of treasury shares from the number of shares the company has issued.

Relevant financial information to answer the following question is found in Exhibit 2. (Clicking the link will open the exhibit in a new window). Ginger Corp. incurred a net loss of $2 million during the year. Based on the cash flow statement in 2013, which of the following statements is TRUE concerning Ginger Corporation's current ratio from 2012 to 2013? AIt remained unchanged BIt declined substantially due to the operational loss CIt increased marginally DIt increased due to depreciation and the sale of bonds

C. The 2012 current assets were $145 (40 + 50 + 55) and the 2012 current liabilities were $95 (55 + 40). The 2013 current assets are $183 (55 + 60 + 68) and the 2013 current liabilities are $116 (70 + 46). In calculating the 2013 cash amount on the balance sheet you must remember to add or subtract the amount on the cash flow statement. In our example, the amount is a positive $15 (-2 + 12 - 13 - 10 + 15 + 6 + 10 - 3). In this example the current ratio increases marginally from 1.53 (145 / 95) to 1.57 (183 / 116). Additionally, there was a net increase in cash. **Use BS and CF adding CF to last year's BS to get next year BS to compare ratio to

The following information has been extracted from the cash flow statement and income statement for the year ending December 31, 20XX. Dividends paid for the year were $275 million and net income available to common shareholders for the year was $187 million. Which of the following statements is TRUE? AThe company's shareholders' equity will increase BThe company's capital surplus will decrease CThe company has violated GAAP standards DThe company's stockholders' equity will decrease

D. A company is permitted to pay cash dividends in excess of its net income. In terms of financial accounting, cash dividends are paid out of retained earnings that are part of shareholders' equity. Therefore, cash dividends paid will reduce shareholders' equity. The company could have easily paid the cash dividend based on retained earnings from the previous year. In cash flow accounting, the company may have sufficient cash flow to pay out a cash dividend in excess of its net income. This may be the case if the company has positive cash flow in its investing or financing activities. In some instances companies have borrowed funds in order to pay cash dividends. Shares are often priced well above par value in an offering. This excess is recorded on the balance sheet as capital surplus. Cash dividends have no effect on capital surplus.

Which of the following sectors would have the greatest degree of operating leverage when GDP is increasing? AAn aerospace contractor BA tobacco company CA knee and hip replacement manufacturer DA computer manufacturer

D. Operating leverage is the degree to which a firm or a project relies on fixed, rather than variable, costs. In this question, you would look for the cyclical company with a high level of fixed costs. All the companies listed are manufacturers and would have some degree of operating leverage, but which entity will benefit most in an economic turnaround? The computer manufacturer is cyclical, while having a high fixed-cost structure. The tobacco company and knee/hip company are more defensive and their revenues will generally not rise as much as the revenues of the computer manufacturer. The aerospace contractor will benefit from an upturn in the aerospace cycle, which is contingent on government spending, not necessarily with a broad economic expansion.

Binary, Inc. is a supercomputer manufacturer. Its revenues are earned from a relatively small number of sales of very expensive units. Each unit has a lengthy production period. Although a significant deposit is received at the time of order acceptance, the majority of revenue is realized when the computers become operational. Meeting payrolls and other immediate bills have been somewhat problematic, due to the time spans between product manufacture and final payment. Which of the following ratios would be the best test of Binary's ability to meet its current obligations? AFixed charge coverage ratio BQuick asset ratio CNet profit margin DBond ratio

Since Binary's problem is meeting current obligations, it is concerned with having cash available. The quick asset ratio (also called the acid test ratio) focuses on those assets that can be quickly turned into cash. It is calculated by dividing the sum of cash, marketable securities, and accounts receivable by current liabilities.

In 2013, Barton & Addante had operating income of $7.9 MM, depreciation and amortization expense of $400,000 and interest expense of $5.0 MM. The company spent $2.8 MM on infrastructure improvements (CAPEX) and carries $13.6 MM of long-term debt. The company pays 35% of its earnings to the IRS annually. What is the company's interest coverage ratio? A1.03 B1.07 C1.66 D2.72

The interest coverage ratio measures how many times a company's income covers its interest expense. It is calculated by dividing earnings before interest, taxes, depreciation, and amortization (EBITDA), by the interest expense. EBITDA is $8,300,000 ($7,900,000 + $400,000). The interest coverage ratio for Barton & Addante is 1.66 ($8,300,000 / $5,000,000).

Relevant financial information to answer the following question is found in Exhibit 57. (Clicking the link will open the exhibit in a new window). Calculate the debt-to-total-capital ratio for The General Outlet Company. A42% B37% C58% D63%

There are a few different methods used to calculate the debt-to-total-capital ratio for a company. Two of the most popular methods are using the book value of both the debt and equity, and using the market value of the debt and equity. The information in Exhibit 2 allows us to calculate the market value of the equity, but not the market value of the debt. Since we are given the book or balance sheet value for both debt and equity, we will use this formula. Long-term debt is $221,665,000 and the stockholder equity is $130,566,000. The debt-to-total-capital ratio is 63% ($221,665,000 / [$221,665,000 + $130,566,000]).