Analysis-Fundamental

Formula Acid Test Ratio (Quick Ratio)

(Current Assets - Inventory & Prepaid Expenses) / Current Liabilities

Bond Interest Coverage Ratio

= Operating Income / Bond Interest Expense

Dividend Payout Ratio

=Common Dividends / Earnings for Common

Return on Common Equity

=Earnings for Common / Common Stockholders Equity

Earnings for Common

=Net Income after Tax - Preferred Dividends Paid

A corporation's "Acid Test" ratio would measure: Correct A. liquidity StatusB B. leverage StatusC C. profitability StatusD D. marketability

The best answer is A. The "Acid Test" ratio measures a corporation's ability to pay its bills as they come due, and hence is a measure of liquidity. It is the ratio of:

Forumla Inventory Turnover Ratio

COGS / Inventory

Formula Current Ratio

Current Assets / Current Liabilities

Earnings Per Share

EPS = Net Income / Total Common Shares Outstanding

Formula Net Worth

NW=Total Assets - Total Liabilities

Formula Net Working Capital

NWC=Current Assets - Current Liabilities

Formula Preferred Stock Ratio

Pf Stock Ratio = Pf Stockholder's Equity / Total Long Term Capital

Formula Accounts Receivable Turnover Ratio

Sales / Year End Accounts Receivable

A corporation issues a stock dividend. Which of the following statements are TRUE? I Total stockholders' equity will increase II Total stockholders' equity will remain the same III Par value per common share will decrease IV Par value per common share will remain the same StatusA A. I and III StatusB B. I and IV StatusC C. II and III StatusD D. II and IV

The best answer is D. If a corporation declares a stock dividend, the 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.

Which ratio is the least stringent test of liquidity? A. Cash assets ratio B. Quick ratio C. Acid test ratio D. Current ratio

The best answer is D. 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.

Formula Debt or Bond Ratio

Bond Ratio = Total Long Term Debt / Total Long Term Capital

The reported net income of a company has declined at a faster rate than operating income. This could result only from an increase in: Incorrect Answer A. depreciation expense Correct Answer B. interest expense StatusC C. cost of goods sold StatusD D. product returns

The best answer is B. Cost of good sold, product returns, and depreciation expense are all deductions used to arrive at operating income. Once operating income is computed, interest expense is deducted to get Net Income before tax. The only way for net income to fall faster than operating income is for interest expense to increase by a disproportionate amount.

Debt Service Coverage Ratio

=Operating Income / Bond Interest Expense + Current Portion of Principal Repayment

A corporate issuer declares a reverse stock split. After the split is effected, which of the following statements are TRUE? I The market price of the corporation's shares will increase II The market price of the corporation's shares will decrease III The reported earnings per common share will increase IV The reported earnings per common share will decrease StatusA A. I and III StatusB B. I and IV StatusC C. II and III StatusD D. II and IV

The best answer is A. In a reverse split, the number of outstanding shares of the corporation is reduced. This increases reported earnings per share. If earnings per share increases, this tends to raise the price of the company's stock in the market. After the reverse split, each shareholder's proportionate ownership interest remains the same. The only difference is that the shareholder's ownership interest is represented by fewer shares.

A corporation has an operating margin of profit of 9.50%. This means that for every $9.50 of profit, the company had $100 of: Incorrect Answer A. expenses Correct Answer B. revenues StatusC C. assets StatusD D. liabilities

The best answer is B. 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.)

A corporation declares a cash dividend to shareholders. Which of the following choices are affected? I Current Assets II Current Liabilities III Net Worth IV Net Working Capital StatusA A. I and III StatusB B. I, II, III Correct Answer C. II, III, IV Incorrect Answer D. I, II, III, IV

The best answer is C. If a dividend is declared, then it is not yet paid. Dividends payable increases (a current liability) and net worth decreases (since the dividend is appropriated from retained earnings). If current liabilities increase, then working capital falls.

All of the following are components of total long term capital of a corporation EXCEPT: A. Common Stockholders' Equity B. Preferred Stockholders' Equity C. Long Term Bonded Debt D. Current Liabilities

The best answer is D. 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.

ABC Corporation splits its stock 4:1. As a result of the split, which of the following will occur? I The per share price of ABC stock is reduced II The par value of ABC stock is reduced III The retained earnings of ABC Corporation are reduced IV The Price / Earnings ratio for ABC stock is reduced StatusA A. I and II StatusB B. II and III StatusC C. III and IV StatusD D. I, II, III, IV

The best answer is A. If a corporation splits its stock, the number of shares is increased proportionately; and the par value per share is reduced proportionately. On the "ex" date, the exchange reduces the market price of the stock to reflect the split. Thus, both Choices I and II are correct. There is no effect on Retained Earnings for a split (though there is a reduction to retained earnings if a "dividend" is paid). Finally, the company's "Price / Earnings" ratio will stay the same, because both the stock's market price and earnings per share will be reduced in the same proportion as a result of the split, keeping the ratio constant.

Accelerated depreciation deductions: I increase reported expenses in early years II decrease reported expenses in early years III increase reported expenses in later years IV decrease reported expenses in later years StatusA A. I and III Correct B. I and IV StatusC C. II and III StatusD D. II and IV

The best answer is B. 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 the lower deductions in later years will decrease reported expenses for those years.

A corporation would repurchase its debt for all of the following reasons EXCEPT to: StatusA A. refinance at lower interest rates Correct B. increase its capitalization StatusC C. increase the market value of its equity issues StatusD D. reduce its sensitivity to earnings fluctuations due to cyclical conditions

The best answer is B. 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.

A corporation receives, but has not paid for, a shipment of goods that go into inventory. Which of the following choices are affected? I Current Assets II Current Liabilities III Net Worth IV Net Working Capital StatusA A. I only StatusB B. I and II StatusC C. III only StatusD D. III and IV

The best answer is B. 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.

All of the following will affect the reported net income per share of a corporation EXCEPT: StatusA A. discontinuance of operations of an operating division StatusB B. declaration of a common dividend StatusC C. decrease in the number of common shares outstanding StatusD D. change in accounting method for valuing inventories

The best answer is B. 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 shutdown. 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.

In an environment of rapid inflation, which inventory method would report the highest net income? A. LIFO B. FIFO C. Average Cost D. FISH

The best answer is B. When prices are rapidly rising, "first-in, first-out" accounting for inventory will result in the highest reported profit. This occurs because the "older" less expensive inventory is the first to be taken out of inventory and matched to sales revenue when a sale occurs, while the "newer" more expensive inventory stays in inventory and is taken out and matched to revenue after the older (less expensive) items are depleted. (For those of you with a sense of humor, FISH stands for "First In, Still Here" - a jokey term for inventory that is slow to move.)

A corporation issues $100,000,000 of 10% convertible debentures, convertible at $50. If all bondholders convert, which of the following choices are affected? I Total Assets II Total Liabilities III Net Working Capital IV Stockholders' Equity StatusA A. I and II StatusB B. II and IV StatusC C. II, III, IV StatusD D. I, II, III, IV

The best answer is B. If all bondholders convert, long term liabilities fall (because the bonds are eliminated) and stockholders' equity increases (because new common shares are issued). There is no effect on Total Assets or Net Working Capital.

A corporation is preparing a registration statement for a new issue offering consisting of 300,000 new shares and 200,000 existing shares held by officers. The Public Offering Price is $30 per share. The spread taken by the underwriters is $2 per share. Which of the following will be changed as a result of the offering? I Net working capital II The number of outstanding shares III Retained earnings (earned surplus) IV Net worth StatusA A. I and IV only StatusB B. II and III only StatusC C. I, II, IV StatusD D. I, II, III, IV

The best answer is C. The company receives $8,400,000 from the offering, increasing net working capital. An additional 300,000 shares will be outstanding, increasing the Common Stock and Capital in Excess of Par accounts by $8,400,000. Retained Earnings remains unaffected. (The items that affect retained earnings are net income or loss for the year and dividend payouts)

All of the following statements are true about a company that is highly leveraged EXCEPT: StatusA A. the company has the greatest portion of its capitalization as debt StatusB B. if the company's operating earnings are highly variable, it may default in an economic downturn StatusC C. they "trade on the equity," producing a disproportionate increase in earnings per share once earnings cover debt service StatusD D. the more highly leveraged the company, the lower the credit risk of the issuer

The best answer is D. A highly leveraged company is one having a disproportionate amount of debt in its capital structure. Because interest on debt is a fixed annual amount, and is quite large in highly leveraged companies, if operating earnings drop in a bad year, debt service costs may not be covered. On the other hand, once debt service costs are covered, if earnings increase, all of the increase accrues to the shareholders. Because of this, leveraged companies are said to "trade on the equity" - meaning that once debt service costs are covered, reported earnings per share can rise dramatically. The more highly leveraged a company, the lower the credit rating because of increased default risk.

In fundamental analysis, "extraordinary items" are: I found on the balance sheet II found on the income statement III gains and losses from the company's regular business operations IV gains and losses outside the company's regular business operations StatusA A. I and III StatusB B. I and IV StatusC C. II and III Correct D. II and IV

The best answer is D. An "extraordinary" item is found on the Income Statement. Extraordinary items are gains or losses that occur outside the company's normal scope of operations and are one time events. For example, a gain from selling part of a business is an Extraordinary Item. These are disclosed separately on the income statement.

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: StatusA A. 3% StatusB B. 14% StatusC C. 27% StatusD D. 32%

The best answer is D. The formula for the common stock ratio is: Common Equity / Total Capital = Common Stock Ratio $200,000 + $800,000 + $6,000,000 (Common Equity) $7,000,000 + $5,000,000 + $10,000,000 (Total Capital)

A corporation has an operating margin of profit of 9.50%. What does this mean? StatusA A. For every $9.50 of expenses, the company had $1 of revenue Incorrect Answer B. For every $9.50 of expenses, the company had $100 of revenue StatusC C. For every $90.50 of expenses, the company had $1 of revenue Correct Answer D. 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%