V's set #2 s86

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What's the enterprise value of Toro Rosso? A) $1,508,400,000 B) $1,871,400,000 C) $1,888,400,000 D) $1,997,400,000

B) $1,871,400,000 INCORRECT ANSWER CHOSEN Enterprise value includes the market capitalization of both common and preferred shares. For the common stock, this totals $1,360,000,000 (40,000,000 x $34). For the preferred stock, since it's trading at a 20% discount to par, the market capitalization totals $368,000,000 (4,600,000 x $80). Enterprise value also includes long- and short-term debt as well as cash and equivalents. Long-term lease obligations are included in enterprise value. Investments in Treasury bills are considered a cash equivalent.

Recognition of income under the percentage-of-completion method is based on: A) Billings to date B) Costs incurred to date C) Collections to date D) Estimated value added to date

B) Costs incurred to date INCORRECT ANSWER CHOSEN Recognition of income under the percentage-of-completion method is based on costs incurred to date.

You have been asked to analyze an M&A transaction involving Bergen Labs, the target company in an acquisition. The company's current stock price is $97.53. There are 27.48 million shares outstanding, and the offer price for Bergen Labs is $110.00 per share. How much goodwill will be created based on the offer price of the acquisition? A) $490.3 million B) $2,189.8 million C) $2,532.5 million D) $3,022.8 million

C) $2,532.5 million INCORRECT ANSWER CHOSEN To calculate the amount of goodwill created after the acquisition, the company's net tangible assets are subtracted from the offer value. The net tangible assets are determined by subtracting the company's liabilities, existing goodwill, and intangibles from the total assets. The net tangible assets are $490.3 million (2,037,264 - [996,533 + 321,820 + 228,590]). The offer value is $3,022.8 million (27.48 million x $110.00). The amount of goodwill created is equal to $2,532.5 million (3,022.8 - 490.3).

Companies A and B are merging to realize synergies. They are the 2 largest customers of Company Y. What is likely to happen to Company Y's stock price on the day following the merger announcement? A) Nothing will happen until Company Y comments on the merger B) It will increase since Companies A and B can now increase capital spending C) It will decline since the capital spending of Companies A and B will be reduced D) Company Y's stock price is likely to be unaffected until it releases earnings

C) It will decline since the capital spending of Companies A and B will be reduced

While performing analysis, it is discovered that interest income, interest expense, and working capital have all increased during the past fiscal year. An explanation for these events might be that there was a: A) Retirement of bonds, through purchase, in the secondary market B) Conversion of debentures C) Public offering of bonds, the proceeds of which were invested in short-term instruments D) Public offering of common stock

C) Public offering of bonds, the proceeds of which were invested in short-term instruments CORRECT ANSWER CHOSEN The rise in interest expense implies an issuance of bonds. The rise in interest income implies increased investment in interest-bearing instruments. This is consistent with an increase in working capital.

A research analyst gives a "buy" rating to a widget manufacturing company based on its PE multiple. However, the supervisory analyst who reviews the rating does not believe that it's appropriate given the fact that the company's peers are all rated "neutral." In addition, the supervisory analyst believes the research analyst should use an EV-to-EBITDA valuation, rather than PE. Based on the widget manufacturer's high ROE, sales growth, and dividend yield, the research analyst disagrees. Which of the following statements is TRUE? A) The research analyst and the supervisory analyst are both incorrect. B) The research analyst is correct and the supervisory analyst is incorrect. C) The research analyst and the supervisory analyst are both correct. D) The research analyst is incorrect and the supervisory analyst is correct.

C) The research analyst and the supervisory analyst are both correct. INCORRECT ANSWER CHOSEN There's ultimately not a single, specific way to value a firm or sector. In most cases, the most appropriate course of action is to use several valuation approaches. Especially since little information is given about the widget company itself, and industry more broadly, both the analyst and her supervisor likely have valid points.

Kendall Corporation is contemplating an acquisition of Fulham Brothers Inc. What is the BEST measurement as to whether the acquisition will create value for shareholders? A) The impact on Kendall's cash position B) Whether the earnings are accretive in the near term C) Whether the ROIC exceeds the WACC D) Whether key personnel at Fulham remain after the acquisition

C) Whether the ROIC exceeds the WACC CORRECT ANSWER CHOSEN An acquisition is accretive to shareholder value if the return on invested capital (ROIC) exceeds the weighted average cost of capital (WACC).

Which of the following ratios is a key factor in the calculation of ROE? A) Days sales outstanding B) Operating margins C) Interest coverage ratio D) Asset turnover ratio

CORRECT ANSWER CHOSEN Return on Equity (ROE) is the earnings available to common shares (Net Income - Pref. Dividends) divided by the average common equity (ROE = (Net Income - Pref. Dividends) ÷ Ave. Common Equity). The DuPont formula further subdivides ROE into its components, thereby making it easier to explain how a company got its ROE. The ROE using the DuPont formula is the net profit margin (Net Income ÷ Sales), multiplied by the asset turnover ratio (Sales ÷ Average Total Assets), and then multiplied by the equity multiplier (Average Total Assets ÷ Average Shareholder's Equity). DuPont ROE = Net Profit Margin x Asset Turnover Ratio x Equity Multiplier. The DuPont formula also makes differences in ROEs easier to explain. For example, let's assume that two companies have similar ROEs. One company is very profitable, but has large shareholder's equity. The other competing company is not as profitable, but has very little shareholder's equity. Although the ROEs are similar, the two companies arrive at them very differently.

To BEST determine whether an acquisition is likely to be impactful, what should a person look for in a company's financial statements? A) Changes to retained earnings B) Inflation rates C) Excess capacity D) Asset utilization

D) Asset utilization CORRECT ANSWER CHOSEN Asset utilization refers to how efficient a company is at creating revenue and profits. Firms that efficiently use their assets to generate profits will benefit by becoming larger in a merger. When scaled up, their efficient operations could generate even larger profits. Excess capacity is a sign that consumer demand is lower than a company's ability to produce goods and services. Becoming larger through a merger will not necessarily fix the lack of demand for a company's products. Inflation and retained earnings don't directly measure the impact of a merger or acquisition.

Analysts look at all of the following to analyze a company's cash collection cycle, EXCEPT for: A) Inventory turnover B) Accounts receivable turnover C) Trade payables turnover D) Depreciation

D) Depreciation INCORRECT ANSWER CHOSEN The goal of a business is to create/sell a product and turn the sale into cash so the business can repeat the cycle over and over. Analysts would be looking at how quickly the inventory sells, how quickly accounts receivable are collected and turned into cash, and how quickly a company is meeting its short-term obligations (trade payables). Depreciation does not enter into this analysis.

Which of the following events will affect EPS and the P/E ratio if the price of common stock remains unchanged? A) Acquiring a company for cash that's neutral to earnings B) An increase in the rate of inflation in the overall economy C) Issuing debt to build an office complex D) Issuing debt at a rate that's lower than WACC

D) Issuing debt at a rate that's lower than WACC INCORRECT ANSWER CHOSEN Issuing debt will decrease the earnings of a business through higher interest costs. As a result, earnings per share (EPS) will fall and, if the stock price remains unchanged, the price-to-earnings (PE) ratio will rise. If a merger is done for cash and is neutral to earnings, the merger will have no effect on EPS or the PE ratio. Issuing debt to build a fixed asset (e.g., office complex) will not impact earnings immediately. Instead, the additional interest from the bonds will be capitalized during the construction period and increase the cost of the fixed asset. As the building is depreciated, the earnings of the company will be lower in subsequent years. Without knowing more about a business, it's hard to be sure how higher inflation will impact a business' earnings.

Of the choices listed, the term "percentage of earnings" can be found by using which of the following formulas? A) Net income/common equity B) Net income - dividends/ number of shares outstanding C) Dividends paid/retained earnings D) Net income - dividends/net income

Net income - dividends/net income The term "percentage of earnings" typically has two meanings: (1) the percentage of earnings (or net income) retained or (2) the percentage of earnings (or net income) paid out in the form of dividends.

Use the following information to answer this question:. Toro Rosso Common shares outstanding: 40,000,000 Preferred Shares Outstanding: 4,600,000 Cash: $2,600,000 Investments in Treasury Bills: $12,000,000 Short-term debt outstanding: $26,000,000 Finance Lease Obligations: $40,000,000 Long-term bond obligations: $92,000,000 The common stock has a current market value of $34.The preferred stock has a par value of $100, but is trading at a 20% discount to par. What's the enterprise value of Toro Rosso?

A) $1,508,400,000 B) $1,871,400,000 C) $1,888,400,000 D) $1,997,400,000

Determine the adjusted enterprise value for Hart Industries if a potential acquirer offers $25.00 a share. A) $819,500,000 B) $818,159,000 C) $645,175,000 D) $696,800,000

A) $819,500,000 INCORRECT ANSWER CHOSEN To determine the adjusted enterprise value, first calculate the revised enterprise value or implied offer value by assuming a market price per share of $25 and using the Treasury Method. Employee stock options will only be exercised if the options have intrinsic value (i.e., when the offer value exceeds the strike price). The options that have a strike price of $22.00 would be exercised; however, the options with a strike price of $26.00 would not be exercised. When the $22 options are exercised, they will generate proceeds to the company of $9,900,000 (450,000 x $22.00). The company can then repurchase 396,000 shares from the market ($9,900,000 / $25.00). The company needs 450,000 shares for the options, but can repurchased 396,000; therefore, it will need to issue 54,000 shares from treasury stock. The company has 31,450,000 shares outstanding (47,690,000 issued - 16,240,000 Treasury) and the new shares from treasury would bring the number of shares outstanding to 31,504,000 (31,450,000 outstanding + 54,000 shares from treasury stock). Using the new shares outstanding and the offer value, the market capitalization is $787,600,000 (31,504,000 x $25.00). Using this market cap, the Enterprise value is: Market capitalization of common $787,600,000 + Short-term debt outstanding $60,800,000 + Long-term bond obligations $93,800,000 - Cash $122,700,000 Enterprise value $819,500,000

Relevant financial information to answer the following question is found by using Exhibit 22. You have been asked about the value of Shoe Leather Express and intend to use the company's growth rate and FCFE per share to determine the price. What's a fair price for each share of Shoe Leather Express? A) $15.00 B) $20.00 C) $30.00 D) $40.00

B) $20.00 =4+.75-2-.75 = 2.00 Earnings per share $4.00 + Depreciation and amortization .75 - Projected capital expenditures: 2.00 - Increase in working capital .75 2.00 FCFE FCFE / (Expected Rate of Return - Expected Growth Rate)= Current Target Stock Price = ($2.00 / [14% - 4%])= $20.00.

To answer the following question, relevant financial information is found by using Exhibit 19. What's the basic EPS for Company Q? A) $ .80 B) $3.94 C) $5.93 D) $6.07

B) $3.94 =EPS calculation: EBIT$: 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 - Preferred dividends: 15,000,000 Earnings available to common: $295,200,000 EPS = [Earnings available to common] / [common shares outstanding]EPS = $295,200,000 / 75,000,000 = $3.94

Relevant financial information to answer the following question is found by using Exhibit 29. What is the Borgward Company's intrinsic value per share? A) $34.88 B) $39.53 C) $52.55 D) $62.50

B) $39.53 g = b x ROE Where:g = the dividend growth rateb = the earnings retention rate (the complement of the dividend payout ratio)ROE = the return on equity The dividend payout ratio is 60% ($1.50 / $2.50).The retention rate is 40%. g = 40% x 9.5% g = 3.8% P0 = d1 / (k - g) Where:P0 = present price d1 = the dividend in the next period k = the equity cost of capital g = the growth rate To determine the equity cost of capital, it is necessary to apply the Capital Asset Pricing Model, where: The expected return of the market = the return on the S&P 500 Index The risk-free rate of return = the yield on the Treasury bill Cost of equity = [(Expected return of the S&P 500 minus the T-bill yield) multiplied by beta] plus the T-bill rate. [(8.5% - 4.5%) x .9] + 4.5% = 8.1%[4.0% x .9] + 4.5% = 8.1%3.6% + 4.5% = 8.1% P0 = $1.70 / (8.1% - 3.8%) P0 = $1.70 / 4.3% P0 = $39.53

Use the following information on Durable Cardboard Corp. to answer this question. Total Capital $800MMWACC 8%Operating Income $80MMTax Rate 40% What is Durable Cardboard's residual income? A) $64 MM B) ($16 MM) C) $16 MM D) $48 MM

B) ($16 MM) Although Durable Cardboard Corp. has positive operating income of $80MM, the company has a negative $16 million in residual income, which means that there is no economic value added. In fact, given the company's negative residual value the company has experienced economic value destruction. Residual income is calculated by taking net operating profit after tax and subtracting a charge for the weighted average cost of capital (e.g., Residual Income = NOPAT - Total capital x WACC). When residual value is positive, economic value is added (EVA). When residual value is negative, economic value is destroyed.

Which of the following statements is TRUE concerning a company's ability to use net operating losses (NOLs)? A) An NOL may be carried back two years and carried forward 20 years B) An NOL may be carried forward indefinitely but may not be carried back C) An NOL may be carried back two years but not carried forward D) An NOL may be carried back two years and carried forward indefinitely

B) An NOL may be carried forward indefinitely but may not be carried back

A research analyst covers the retail sector. The sales of one of the companies he follows has dropped off significantly during the pandemic, but the analyst is anticipating a rebound in the coming year. Which of the following valuation methods would the analyst use to value this company? A) Price-to-tangible book value B) Forward price-to-earnings ratio C) Trailing price-to-earnings ratio D) Price-to-sales ratio

B) Forward price-to-earnings ratio INCORRECT ANSWER CHOSEN Of the choices listed, the forward P/E ratio would be the best valuation method since the analyst is expecting growth in earnings over the coming year. The price-to-sales- ratio is typically backward looking and is not the best valuation method to use if growth is projected in the future.

Weslake has agreed to acquire BRM for $17,000,000. The terms of the acquisition are: $4,000,000 Weslake common stock (based on a market value of $20 per share); $3,000,000 of newly issued Weslake 7.0% debentures; $10,000,000 cash to BRM shareholders obtained from Weslake's revolving credit line; and $10,000,000 in assumed debt of BRM. After the acquisition, Weslake's common stock is trading for $22.25. What is the new EV of Weslake? A) $91,350,000 B) $101,350,000 C) $111,350,000 D) $115,900,000

C) $111,350,000 INCORRECT ANSWER CHOSEN Step 1: Take common shares outstanding and multiply by current price. Weslake's 2.4 million shares plus 200,000 additional shares issued for the transaction. Step 2: Take debt from Weslake plus debt from BRM and add the $3,000,000 of newly issued debt plus $10,000,000 of debt incurred from the use of the revolving credit line. Step 3: Subtract the total cash and equivalents of Weslake and BRM: $16,500,000 and $5,000,000 totaling $21,500,000. The following table illustrates the effects of the transaction.

How should an analyst value the Diminutive Company? A) Use The Redundant Company's multiple for the entire Diminutive Company valuation B) Use The Redundant Company's multiple for the metal ferrule segment and the Miniscule Company buyout multiple for the shoelace stay segment C) Use The Redundant Company's multiple for the metal ferrule segment and 2 times the Miniscule Company buyout multiple for the shoelace stay segment D) Use Miniscule Company's EPS and multiple to value the entire Diminutive Company

B) Use The Redundant Company's multiple for the metal ferrule segment and the Miniscule Company buyout multiple for the shoelace stay segment

All of the following events will impact EPS, EXCEPT: A) Conversion of common stock from debentures B) Selling 400,000 unissued shares C) A reverse stock split D) The exercise of exchange-listed in-the-money options

D) The exercise of exchange-listed in-the-money options INCORRECT ANSWER CHOSEN Earnings per share (EPS) is the earnings available to common shareholders divided by the outstanding common shares [EPS = (Net Income - Pref. Dividends) ÷ Common Shares]. Stock options and other derivatives are not issued by a corporation. Ultimately, the exercise of an option requires another investor (not the issuer of stock) to deliver shares. As a result, the exercise of an option doesn't impact shares outstanding or EPS. Converting debentures (an unsecured bond) into common shares increases both net income and shares outstanding and typically has an impact on EPS. Issuing new common shares increases shares outstanding, while reverse stock splits reduce common shares outstanding. Therefore, both issuing new shares and reverse splits will have an impact on EPS.

DuPont ROE

The ROE using the DuPont formula is the net profit margin (Net Income ÷ Sales) X multiplied by the asset turnover ratio (Sales ÷ Average Total Assets), x the equity multiplier (Average Total Assets ÷ Average Shareholder's Equity).

Expense Items

1) Stock Option Expenses 2) R&D expenses

74 On Draft A) Revenue $197.5 MM, net income $60.26 MM B) Revenue $197.5 MM, net income $49.54 MM C) Revenue $177.5 MM, net income $56.9 MM D) Revenue $197.5 MM, net income $47.6 MM

B) Revenue $197.5 MM, net income $49.54 MM

What is the compounded annual growth rate in revenues from Year 1 to Year 4? A) -3.4% B) -3.6% C) -3.75% D) -10.8%

C) -3.75%

Non-Gaap Financial Measures

1) Examples of non-GAAP adjustments are the exclusion of special charges (e.g., asset abandonment, severance pay) 2) The exclusion of amortization of purchased intangibles, 3) The exclusion of tax-affected, acquisition-related expenses, interest expense, income tax effects, 4) Impairment of long-lived assets. EBITDA and free cash flow

Final Exam 3 Q3 Outstanding employee stock option contracts 450,000 shares at a strike price of $22.00 450,000 shares at a strike price of $26.00 Current stock price is $19.50 per share Determine the adjusted enterprise value for Hart Industries if a potential acquirer offers $25.00 a share. A) $819,500,000 B) 818,159,000 C) $645,175,000 D) $696,800,000

Relevant financial information to answer the following question is found by using Exhibit LRG Determine and then select L.R. Gamble's earnings before interest, taxes, depreciation, and amortization (EBITDA) margin. A) 13.4% B) 11.6% C) 11.1% D) 32.4%

A) 13.4% INCORRECT ANSWER CHOSEN To calculate L.R. Gamble's EBITDA margin, use the following formula. EBITDA Margin = EBITDA ÷ Sales Using L.R. Gamble's numbers: ($1,157,233 + $184,849*) ÷ $9,990,486 = 13.4% *Note that $184,849 represents depreciation for the current year; {$945,569 - $760,720}

Company W issued a nonconvertible bond at par that pays 6% interest semiannually. The bonds are currently trading at 98 and mature in 10 years. It pays taxes at a rate of 21%. What is Company W's cost of debt for the bond issue? A) 4.74% B) 4.04% C) 6.12% D) 12.0%

A) 4.74% CORRECT ANSWER CHOSEN To determine the cost of debt, it is necessary to adjust the nominal yield (the coupon rate) by the tax rate, rather than the current yield of the bond. Multiply the nominal yield by (100% - tax rate) or (100% - 21% = 79%). Although the coupons are paid semiannually, the annual coupon rate for the bond is 6%; therefore, the cost of debt is 4.74% (6% x 79%).

Within the supply chain of an industry, widget manufacturers sell their product to the XYZ Company. - XYZ sells its product to the ABC Company - XYZ purchases 70% of the widget production output - ABC purchases 90% of the output from XYZ Regulations have previously restricted ABC's capital investment in facilities. It is now unregulated. This will permit ABC to increase capital expenditures within its facilities. What is the initial effect on widget pricing and the demand for widgets? A) Demand for widgets would increase and the prices of widgets would increase B) Demand for widgets would decrease and the prices of widgets would increase C) Demand for widgets would increase and the prices of widgets would decrease D) Demand for widgets would decrease and the prices of widgets would decrease

A) Demand for widgets would increase and the prices of widgets would increase INCORRECT ANSWER CHOSEN Assuming ABC was experiencing sufficient consumer demand and deregulation would allow ABC to increase capacity, ABC's demand for widgets from its suppliers would be expected to increase. This shift in the demand for widgets would permit widget manufacturers such as XYZ to initially raise prices. As the price of widgets rises, new widget manufactures may enter into the widget industry creating additional supply and driving down prices in the long-term. This question asks, about the initial effect on widget pricing not the long-term effect.

The Balance Sheet for Company Z (All numbers in thousands) Cash and Equivalents — $3,214,000 Inventory — $5,638,000 Property, Plant, and Equipment — $11,314,000 Total Assets — $23,815,000 Long-Term Debt and other Long-Term Liabilities — $2,986,000 Shareholder Equity — $10,829,000 Based on the preceding information, this balance sheet is most representative of a company from which of the following sectors? A) Discount variety store B) Chip manufacturing C) Telecommunications D) Financial service company

A) Discount variety store CORRECT ANSWER CHOSEN A discount variety store, such as Costco, Target or Wal-Mart, typically has a balance sheet that is dominated by a large amount of inventory as a percentage of total assets. A chip manufacturer does not have a high percentage of its assets in inventory. Financial service companies have little or no inventory on their balance sheets. They have a large percentage of their assets listed on the balance sheet as cash and cash equivalents, and investments. Telecommunications companies typically have a balance sheet that is dominated by a large amount of fixed assets, long-term debt, and long-term liabilities. Inventory is insignificant as a percentage of total assets.

A) Enterprise value/revenue at the offer price is .49 times. B) Enterprise value/revenue at the offer price is .38 times. C) EV/EBITDA at the offer price is 97 times. D) EV/EBITDA at the offer price is 7.46 times.

A) Enterprise value/revenue at the offer price is .49 times. CORRECT ANSWER CHOSEN The formula for calculating enterprise value is market capitalization of equity plus debt (long-term and/or short-term) minus cash (and cash equivalents). In this example, it's necessary to use the offer price for calculations, rather than the current stock price. Since TBR has no debt, the enterprise value is $72,500,000 (15,000,000 outstanding shares x $6.50 = $97,500,000 - $25,000,000). EBITDA is found by subtracting the operation expenses from the revenue to find EBIT (operation revenue), and adding depreciation and amortization. EBIT is $5,500,000 ($146,500,000 - $141,000,000), and EBITDA is $7,500,000 ($5,500,000 + $2,000,000). TBR's EV/Revenue is .49 times ($72,500,000 / $146,500,000 = .4948) TBR's EV/EBITDA is 9.67 times ($72,500,000 / $7,500,000 = 9.67)

An analyst is seeking information on insider sales. Which of the following forms would be the best source for such information? A) Form 4 B) Form 10-K C) Form 10-Q D) Form 13D

A) Form 4 Form 4 is filed by insiders of a corporation when they buy or sell shares of their company. The form must be filed no later than 2 business day following the transaction. Form 10-K is filed annually while 10-Q is filed quarterly and is the company's filing with the SEC. 13D is used to report acquisitions of 5% or more by individuals.

Use the following information to answer the next question:MGC has agreed to a merger with EDR Energy.The terms are that each MGC shareholder may elect to receive either .99 shares of EDR Energy stock or $72.76 in cash.On the day before the merger was announced, the closing prices of both companies' stock was $59.52 for MGC and $75.04 for EDR Energy. Which of the following statements is TRUE? A) If a shareholder elects to receive cash for his shares, it would represent a premium of 22.2%. B) If a shareholder elects to receive EDR Energy stock for his shares, it would represent a premium of 26.1%. C) If a shareholder received cash for his shares, it's not a taxable event. D) If a shareholder received EDR Energy stock, it may result in a taxable event.

A) If a shareholder elects to receive cash for his shares, it would represent a premium of 22.2%. INCORRECT ANSWER CHOSEN If a shareholder elects to receive cash for his shares, it would represent a premium of 22.2%. To determine the cash premium above MGC's current market value, the cash buyout price ($72.76) is subtracted from the current MGC price ($59.52), and the premium ($13.24) is divided by the current MGC price ($13.24 / $59.52 = 22.2% premium). If a shareholder elects to receive EDR Energy stock for his shares, it would represent a premium of 24.8% ($75.04 x .99 shares equals $74.29. $74.29 - $59.52 = $14.77. $14.77 divided by $59.52 equals a 24.8% premium). If a shareholder receives cash for his shares, he would have a capital gain if his cost basis is below $72.76. Shareholders who elect to receive shares of EDR Energy stock would not have a taxable event until those shares are sold.

A research analyst is comparing two companies that are similar in all respects, except for their lease arrangements. Which of the following is a characteristic of a company that has a finance lease rather than an operating lease? A) Lower income in earlier years, due to higher interest costs B) Higher income in earlier years, due to lower interest costs C) Lower income in earlier years, due to higher amortization costs D) Higher income in earlier years, due to lower amortization costs

A) Lower income in earlier years, due to higher interest costs CORRECT ANSWER CHOSEN Finance lease expenses typically decline over the lease term since interest expense will fall and amortization will remain constant. Operating lease expenses will typically remain constant over the life of the lease. As a result, companies with finance leases will have lower income in the earlier years.

Widgets are sold by numerous wholesalers, none of whom have greater than a 5% market share. Sales of this product are commodity-like, with wholesalers frequently entering and leaving the marketplace. If one of the wholesalers of widgets leaves the industry, the price will: A) Not change B) Decrease in the short term, but will not change over the long term C) Increase in the short term, but will not change over the long term D) Increase in both the short term and long term

A) Not change CORRECT ANSWER CHOSEN The price of widgets would not be expected to change. No single wholesaler has dominance in the marketplace. The absence of any one wholesaler may increase the market share of others but, since widgets have commodity pricing characteristics, the sales are purely a price-driven event.

A company that uses GAAP will include which of the following choices as expense items? A) Stock option expenses B) Capitalized software development costs C) Amortization of goodwill D) Capitalized interest expenses

A) Stock option expenses CORRECT ANSWER CHOSEN Stock option expenses are required to be reported as an expense item. Research and development expenses are also reported as expense items. Capitalized development costs are not recorded as expenses in the accounting period in which they're paid. Goodwill doesn't have a pre-determined life and is not amortized.

The RMA Corporation regularly issues commercial paper to fund its operations. The company has reached a terminal growth rate of 5%. An analyst studying the RMA Corporation has applied a terminal multiple of 11 for the steady state of cash flows expected. If the rate on the T-bill decreases by 40 basis points, the analyst would expect the: A) Terminal value to increase B) Terminal value to decrease C) Terminal multiple to remain unchanged D) Terminal multiple to decrease

A) Terminal value to increase CORRECT ANSWER CHOSEN The discount rate applied to the cash flows uses a measure of the company's cost of capital, either the WACC (in the case of free cash flow to the firm), or the equity cost of capital (in the case of free cash flow to equity). Given the decrease in interest rates and the short-term funding requirements of the company, a decrease in the WACC is expected. This would increase the present value of the cash flows, and the terminal value of the company should be higher. The terminal multiple describes the expected period of steady state cash flows for a company. In general, as interest rates decrease, there's an increase in the terminal multiples for industry sectors.

Which of the following scenarios is consistent with an increased terminal growth rate? A) The DCF of the company increases B) The DCF of the company decreases C) The valuation of the company does not change D) The valuation of the company decreases

A) The DCF of the company increases INCORRECT ANSWER CHOSEN An increase in the growth rate for a company should result in a higher valuation of the company's discounted cash flows (DCFs) and an overall higher valuation for the company. (13616)

The following information has been extracted from the cash flow statement and income statement for the year ending December 31, 20XX. A company paid a cash dividends for the year in the amount of $342 million and net income available to common shareholders for the year was $119 million. Which of the following statements is TRUE? A) The company's stockholders' equity will decrease B) The company would need shareholder approval to pay this dividend C) The company's shareholders' equity will increase D) The company's capital surplus will decrease

A) The company's stockholders' equity will decrease CORRECT ANSWER CHOSEN A company is permitted to pay cash dividends in excess of its net income and the company would not require shareholder approval to pay a cash dividend. 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 events are dilutive to the shareholders of a corporation? A) The conversion of preferred shares into common stock B) A 10% stock dividend C) The acquisition of another company using cash D) The issuance of listed stock options

A) The conversion of preferred shares into common stock CORRECT ANSWER CHOSEN An event that reduces the proportionate ownership of a corporation is dilutive to commons shareholders. The conversion of convertible securities into common stock results in additional shares being created and is dilutive. Stock dividends creates more shares, but is not dilutive to common stockholders because each shareholder receives a proportionate amount of the new shares. The issuance of listed stock options is not dilutive because additional shares are not being issued. The acquisition of another company using cash is not dilutive; however, exchange offers create new shares and are dilutive.

Relevant financial information to answer the following question is found by using Exhibit 1, Exhibit 2, Exhibit 3, and Exhibit 4. (Clicking each link will open that exhibit into a new window). An analyst reviewing these four exhibits would conclude: A) The majority of prescription drug growth comes from volume B) Prescription drug sales are declining C) Therapeutic care is growing faster than prescription drug sales D) Price increases and switching drugs are negatively correlated

A) The majority of prescription drug growth comes from volume INCORRECT ANSWER CHOSEN Exhibit 1 (Health Care Sales %) provides a percentage of sales breakdown within four key areas of healthcare. The overall industry growth rate is stable at 3% per year. In the three time periods displayed, therapeutic care has the lowest growth rate of the segments and has declined as a percentage of sales from 20% to 16% to 11%. Based on the annual 3% increase in sales, prescription drugs have the greatest increase in sales within the industry and has grown as a percentage of sales from 31% to 32% to 42%. Exhibit 2 (Healthcare Expenditures) provides the percentage growth over a 32-year period. In Exhibit 2, the rate of growth is declining, but still above zero. In other words, prescription drug sales are increasing, but at a lower rate. Positive correlation exists between price increases and consumers switching drugs. In Exhibit 3, both prices and the frequency of switching are declining over the stated time period. The increases in revenue based on volume can be determined in Exhibit 3 and Exhibit 4. In Exhibit 3, one drug company's price increases are leveling off; however, in Exhibit 4, the entire industry's revenues are still rising. As a result, the increase is being driven by volume, rather than price increases.

One of the tools that an analyst uses to calculate relative common stock valuation is the price-to-earnings (P/E) ratio. Other methods of calculating the relative value of equity are also available. Which of the following methods is used to value common stock? A) The price-to-book value ratio B) The enterprise value-to-EBTIDA ratio C) The price-to-total debt ratio D) The debt-to-equity ratio

A) The price-to-book value ratio CORRECT ANSWER CHOSEN One method for calculating relative stock value is the price-to-book value ratio. The price-to-debt, enterprise value-to-EBITDA, and debt-to-equity ratios are not indicative of relative equity value.

When reviewing the financials of a company, how can a research analyst tell whether an acquisition likely took place? A) There is a large increase in sales accompanied by increased interest expense B) The number of shares of outstanding common stock increased C) The amount of depreciation increased D) The enterprise value remained mainly unchanged

A) There is a large increase in sales accompanied by increased interest expense CORRECT ANSWER CHOSEN If a research analyst reviewed the year-over-year changes in financials of a company to see whether it made an acquisition, there would be a significant increase in sales as the two companies combined their income statements. In many M&A transactions, the acquirer borrows funds to complete the transactions. This will lead to an increase in the company's interest expense. The interest expense could also rise as the balance sheets of the two firms are combined. An acquisition made using stock in lieu of cash would increase the share count, but that alone would not necessarily suggest an acquisition. The company may have issued additional shares to raise capital. Depreciation could have increased because of an increase in capital spending. The enterprise value of a company will increase if it has made an acquisition.

Which of the following would have the LEAST impact on a DCF model? A) company stock buyback B) A change in the discount rate used to calculate free cash flow C) An increase in the growth prospects of the company's EBIT D) A change in the terminal multiple

A) company stock buyback

Relevant financial information to answer the following question is found by using Exhibit 28. If Company D acquired Company J for $250 MM cash, raised by issuing 7% debentures, what would be the accretive effect on Company D's EPS, assuming no change in the tax rate for Company D? A) $.07 B) $.69 C) $.77 D) $.78

B) $.69 INCORRECT ANSWER CHOSEN If Company D issues $250 MM of debt to fund the acquisition, the interest expense will increase by $17.5 MM (250 x .07). Answer on drive

EBITDA may be an inadequate valuation tool because it ignores: A) Taxes B) Research and development C) Capital expenditures D) Special charges

C) Capital expenditures INCORRECT ANSWER CHOSEN Earnings before interest, taxes, depreciation, and amortization may be an inadequate measurement when comparing companies with similar financial statements because it ignores capital expenditures. Capital expenditures are necessary to maintain and grow the business.

A) company stock buyback INCORRECT ANSWER CHOSEN Discounted cash flow (DCF) values a company based on the present value of the expected cash flows. In order to calculate either the value of an entire firm (both equity and debt), or the equity value of the firm using DCF, a research analyst would need to have the following information.An estimate of the discount rate to apply to the cash flows in order to calculate the present valueAn estimate of the cash flows for a given periodAn estimate of the ending or terminal value (the terminal multiple) There are two methods of estimating the discount rate -- the weighted average cost of capital (WACC) and the cost of equity. In order to decide which discount rate to use, we need to examine the cash flows. To value an entire firm, we use the free cash flow to the firm (FCFF) and use the WACC as the discount rate. We use the WACC since this evaluates the entire firm. Terminal value can be calculated using either a DCF valuation or a multiple of comparable firms (terminal multiple). The terminal multiple is the easier method and is based on a relative valuation, usually determined by the enterprise value (EV) to EBITDA for similar companies or similar transactions in a merger analysis. Although a stock buyback would impact the number of outstanding common shares, it would not have a significant impact on the valuation of the company. The discount rate used, an increase or change in the company's free cash flow, and a change in the terminal multiple will all have a significant impact on a DCF model.

Asset Utilization

Asset utilization refers to how efficient a company is at creating revenue and profits. Firms that efficiently use their assets to generate profits will benefit by becoming larger in a merger. When scaled up, their efficient operations could generate even larger profits.

All of the following choices describe the activities related to Company W from Year 1 to Year 2, EXCEPT: A) It issued common stock B) It increased its investment in depreciable assets C) It issued preferred stock D) It issued debt

B) It increased its investment in depreciable assets INCORRECT ANSWER CHOSEN Between years 1 and 2, Company W has shown an increase in its operating margin, while the EPS and common stock price have remained the same. This indicates that either revenue increased by a greater percentage than operating expenses, or revenue declined by a smaller percentage than the decline in operating expenses. Since the EPS and common stock price have remained the same, the capital structure of the company has changed. If Company W issued bonds, the additional interest expense assumed by the company would impact the income statement below the operating expenses. This could result in identical EPS for the company. If the company issued preferred stock, it could show a higher level of net income; however, the dividend payment associated with the preferred issue could also reduce the earnings available to common stockholders to the same level as shown in Year 1, thereby resulting in identical EPS for these years. If Company W issued common stock, an increase in operating profit could result in an increase in the earnings available to common; however, due to the additional shares of common outstanding, the EPS could remain the same. If Company W increased its investment in depreciable assets, its operating expenses would increase. This would not explain the elevated level of operating margin.

The Hammer Court Company currently has a P/E ratio of 34. The company normally trades at a premium of 150% to the S&P 500 Index. The historic range of Hammer Court's P/E is 20 to 35 . If the S&P 500 Index has an average P/E of 18, which of the following descriptions BEST characterizes the company? A) It appears to be underpriced B) It is a growth company with accelerated earnings C) It is in a mature, cyclical industry D) It is expected that the earnings of the company are decelerating

B) It is a growth company with accelerated earnings CORRECT ANSWER CHOSEN A P/E that is significantly higher than the S&P 500 Index is indicative of a growth company. The company is trading at a 189% P/E premium to the S&P 500 Index, although the expected premium is 150%. This indicates accelerated growth.

Which event/change would have the biggest impact on the quality of earnings, assuming the company has a 10% operating margin? A) Research and development costs B) Lower bad-debt expense C) Share repurchase D) A decrease in the tax rate (35% to 32%)

B) Lower bad-debt expense

You are comparing Company L and O to the S&P 500 Index. The average P/E for the Index is 20. The growth rate for Company L is 10%. It has a stock price of $20 and EPS of $1. Company O has a stock price of $30 and an EPS of $1. You project the growth rate for Company O to be 50% higher than Company L. Which of the following statements is NOT TRUE? A) The relative P/E of Company L is 1 B) The PEG for Company O is 1.5 C) A one-year projection of Company L's stock price is $22 D) The relative P/E for Company O is 1.5

B) The PEG for Company O is 1.5 INCORRECT ANSWER CHOSEN Company L has earnings of $1. The projected earnings growth of 10% would project earnings of $1.10. The P/E for Company L is 20 ($20 / $1). Based on a P/E of 20, the one-year projected price would be $22.00 ($1.10 x 20). The growth rate of Company O is 50% higher than Company L; therefore, the growth rate applied for O is 15% (10% x 1.5). To determine PEG, the P/E is divided by the growth rate. The P/E for Company O is 30 ($30 / $1). The PEG of Company O is 2.0 (30 / 15). Relative P/E may be used to compare the current P/E of a company to a benchmark, such as the S&P 500. Relative P/E is determined by dividing the current company's P/E by the P/E of the benchmark. The relative P/E for Company L is 1.0 (20 / 20). The P/E for Company O is 30 ($30 / $1). The relative P/E for Company O is 1.5 (30 / 20).

Examination of residual income to determine investment opportunity is LEAST appropriate when: A) It becomes difficult to calculate the terminal value/growth B) The company has consistent dividends C) Operating cash flow is negative D) Accounting assumptions are consistent period to period

B) The company has consistent dividends Residual income is defined as FCFE minus a charge for the equity cost of capital. In the case of a leveraged firm, residual income is FCFF minus a charge for WACC. Alternatively, some models define residual income as (ROIC − WACC) multiplied by invested capital. The use of residual income as a determination of investment opportunity has advantages when it is difficult to estimate terminal values, when cash flows are negative over the forecasted period, or when the company does not pay dividends. When a company pays consistent dividends, a dividend discount model would be more appropriate.

A company leases mass transit vehicles and regularly issues commercial paper. The company has reached a terminal growth rate of 3.07337. What's to be expected if the rate on the T-bill increases by 50 basis points? A) The company's cost of debt will decrease. B) The company's cost of debt will increase. C) The weighted average cost of equity will decrease. D) The FCFF will decrease.

B) The company's cost of debt will increase. CORRECT ANSWER CHOSEN The profits of a company that frequently issues commercial paper (CP) are heavily tied to interest rates. If T-bill rates are rising, general interest rates are rising and the company will pay more on its commercial paper issuances. This will increase the company's cost of debt. Depending on a company's beta, its cost of equity could rise or fall if T-bill rates (i.e., the risk-free rate) are decreasing. As a result, it's not clear what would happen to the company's weighted average cost of capital (WACC). Free cash flow to the firm (FCFF) is a measure of profits, but it's based on earnings before interest and taxes (EBIT). Since FCFF is a pre-interest income measure, any changes to the company's cost of debt will not impact the company's FCFF.

What is the difference between FCFF and FCFE? A) FCFF is used to evaluate leveraged companies while FCFE is used to evaluate companies without debt B) There is no difference in an unleveraged company C) FCFF is used for companies with low capital expenditures while FCFE is used for companies with high depreciation D) Only FCFE is adjusted for depreciation, capital expenditures, and changes to working capital accounts

B) There is no difference in an unleveraged company INCORRECT ANSWER CHOSEN Free cash flow for the firm (FCFF) is used to evaluate the profitability of an entire business, rather than shareholder equity. The starting point for FCFF is EBIT multiplied by (1 - tax rate) and then adding depreciation and amortization, subtracting capital expenditures, and factoring in changes to working capital (WC). Increases in WC reduce FCFF; decreases in WC increase FCFF. It is also useful when evaluating companies with little or no debt. FCFE describes the funds available to owners of a company. Rather than beginning with EBIT, FCFE begins with net income. The adjustments made for depreciation and amortization, capital expenditures and working capital are the same as described for FCFF. Therefore, if a firm has no debt, FCFF and FCFE are the same.

A company has the following financial information. EBIT of $150,000,000Current Debt of $400,000,000 at 8%Current outstanding shares of 10,000,000Tax rate of 35% This company is planning an initial public offering in which it will sell four million shares. Shareholders will be selling an additional four million shares. The offering is expected to receive proceeds of $25.00 per share after underwriting expenses. If the entire proceeds to be received by the company are going to pay down debt, what is the pro forma EPS of the company after the offering? A) $4.84 B) $4.55 C) $5.85 D) $6.22

C) $5.85 CORRECT ANSWER CHOSEN Although the total offering is eight million shares, the company is selling only four million. Based on this fact, the company will receive only proceeds of $100,000,000 ($25.00 x 4,000,000). The proceeds from the other four million shares will go to the selling shareholders. The amount of debt will decline from $400 million to $300 million. In addition, since the company is selling only four million shares, the number of outstanding shares will increase to 14 million, not 18 million. When selling shareholders offer stock, it does not increase the number of outstanding shares. EBIT$150,000,000Interest$24,000,000 ($300 million at 8%)EBT$126,000,000NI$81,900,000($126,000,000 x[1.00 - 35%] or .65) The pro forma EPS is $5.85 ($81,900,000 / 14,000,000).

Wilmot Corporation selected financial data: Compute the accounts receivable turnover for 2018. A) 11.3 B) 12.3 C) 13.9 D) 16.0

C) 13.9 INCORRECT ANSWER CHOSEN To compute the accounts receivable turnover for 2018, divide sales by average accounts receivable. (438 + 338) / 2 = 388 5,400 / 388 = 13.9

Use the following information on Biz Co. to answer this question: Sales: 165 COGS: 91 Operating Expenses: 22 Depreciation and Amortization: 10 Operating Income: 52 Interest Expense: 10 Taxes: 13 Capital Expenditures: 18 No change to Working Capital Tax Rate = 31% What's the net operating margin for Biz Co.? A) 17.6% B) 25.5% C) 31.5% D) 44.8%

C) 31.5% INCORRECT ANSWER CHOSEN Net Operating Margin: Net Operating Income ÷ Net Sales. Net Operating Income = Sales - [COGS + Operating Expenses] or 165 - (91 + 22) = 52. 52 ÷ 165 (Sales) = .315 or 31.5% Note: Depreciation expense is typically included in operating expenses, as is the case in this example. The exhibit for this question is not a formal income statement; it's simply a listing of financial figures from the income statement and cash flow statement. Therefore, it shows total operating expenses from the income statement (which includes depreciation), and depreciation expense from the cash flow statement.

What is Hamilton Golf Industries' Return on Common Equity? A) 6.8% B) 7.0% C) 7.7% D) 8.0%

C) 7.7% INCORRECT ANSWER CHOSEN The Return on Common Equity formula is (Net Income - Preferred Dividends) / Common Stockholders' Equity. Net Income - Preferred Dividends ($14.175 million) is divided by the Common Stockholders' Equity ($184.05 million). Return on Common Equity: 14.175 / 184.05 = 7.7% In examples where multiple years of shareholder information are provided, it is necessary to take the average common stockholders' equity for the period. With only one year of data provided, there is no need in this example to take an average sum for the Common Stockholders' Equity.

Final Exam 4 Q95 What is Hamilton Golf Industries' Return on Common Equity? A) 6.8% B) 7.0% C) 7.7% D) 8.0%

Beyer's B-Wear, Inc. has a debt to total capitalization ratio of 50%. The company has a beta of 1.5 and a WACC of 12%. Beyer presently has $500,000,000 debt outstanding. The risk-free rate is 3% and the expected return of the S&P 500 is 11%. What is the company's debt cost of capital? A) 4.50% B) 7.50% C) 9.00% D) 12.00%

C) 9.00% INCORRECT ANSWER CHOSEN Risk Premium: Expected Market Return of S&P 500 - RF rate:11% - 3% = 8% Risk Premium x [beta]:(8% x 1.5) = 12% Equity Cost of Capital = (Risk Premium x [beta]) + RF rate: 12% + 3% = 15% Weighted Equity Cost of Capital:15% x .5 = 7.5% WACC - Weighted Equity Cost of Capital = Weighted Cost of Debt Capital:12% - 7.5% = 4.5% Weighted Cost of Debt Capital / Debt to Total Capitalization Ratio = Debt Cost of Capital:4.5% / .5 = 9% [60479]

Sycamore has the following capital structure and cost of capital: The company produces a 24% return on common equity. What is Sycamore's new WACC? A) 8.33% B) 8.91% C) 9.13% D) 9.52%

C) 9.13%

A company manufactures car parts and is highly leveraged. The company has high fixed costs and its capital consists of 67% debt and 33% equity. Which of the choices is the greatest concern for the growth in its business? A) Decreased government regulation in the auto industry B) A general overall slowdown in the economy C) A steady rise in interest rates D) A rise in the litigation of automobile companies

C) A steady rise in interest rates Of the choices listed, rising interest rates is the greatest concern. Rising rates would have a negative impact on its business, add cost on the debt it borrows, and result in higher costs and possibly lower demand for autos. Since the company is highly leveraged (67% debt), it would incur higher interest cost on its debt. It also relies heavily on fixed costs and has a high degree of operating leverage. Although a general slowdown in the economy will have a negative impact on most companies, a highly leveraged company with a high degree of operating leverage will be more impacted by rising interest rates.

When a company pays interest on its outstanding debt and receives interest income, when are they recorded on the cash flow statement? A) Both are contained within cash flow from investing activities. B) Interest paid is a part of cash flows from financing activities. C) Both are contained within cash flow from operating activities. D) Interest received is a part of cash flows from financing activities.

C) Both are contained within cash flow from operating activities. CORRECT ANSWER CHOSEN Interest that a company pays on its debt outstanding and the interest income that it receives are both a part of cash flows from operating activities. The principal payment that's made to retire outstanding debt is reported as a use of cash in the financing activities section of the cash flow statement.

Use the following information to answer this question. Company A Cost per Unit Fixed: .20 Variable: .30 Capacity Utilization: 70% Company B Cost per Unit Fixed: .25 Variable: .35 Capacity Utilization: 50% Both companies produce gadgets and sell them for the same price. Company A has greater revenues than Company B. Which of the following statements is TRUE? A) Company A has a greater opportunity to exploit economies of scale due to its greater capacity utilization B) Company A has a greater opportunity to exploit economies of scale due to its lower fixed costs C) Company B has a greater opportunity to exploit economies of scale due to its greater excess capacity D) Company B has a greater opportunity to exploit economies of scale due to its higher variable costs

C) Company B has a greater opportunity to exploit economies of scale due to its greater excess capacity INCORRECT ANSWER CHOSEN Economies of scale are the cost advantages that a business can exploit through greater production at successively lower costs. Company A has capacity utilization of 70%; therefore, it has excess capacity of 30%. Company B has capacity utilization of 50% and excess capacity of 50%. Although Company A currently is employing greater economies of scale, Company B has a greater opportunity to exploit economies of scale due to its greater excess capacity.

Relevant information to answer this question follows. Current relative P/E ratio compared to S&P 500 is 1.8.The historical range of relative P/E as compared to the S&P 500 is .6 to 1.9.Current S&P 500 Trailing P/E is 17. Based on this information, this company would be classified as: A) Mature growth B) Cyclical and nearing the top of earnings cycle C) Cyclical and nearing bottom of the earnings cycle D) Early stage growth

C) Cyclical and nearing bottom of the earnings cycle CORRECT ANSWER CHOSEN Cyclical stocks tend to rise and fall rapidly with changes in the economy. The company's relative P/E is close to the high for its historical range. This type of situation occurs when cyclical stocks are at the bottom of the earnings cycle. The earnings of the company would be depressed and, therefore, its relative P/E would be high. When the economy improves, the company's earnings would improve and its relative P/E will adjust toward the low of the historical range (less than 1.00).

C) Cyclical and nearing bottom of the earnings cycle Cyclical stocks tend to rise and fall rapidly with changes in the economy. The company's relative P/E is close to the high for its historical range. This type of situation occurs when cyclical stocks are at the bottom of the earnings cycle. The earnings of the company would be depressed and, therefore, its relative P/E would be high. When the economy improves, the company's earnings would improve and its relative P/E will adjust toward the low of the historical range (less than 1.00).

In theory, the lowest cost of financing corporate expansion is by issuing debt since shareholders demand additional returns for risk assumption on equity issues. In considering this concept, why wouldn't management always finance expansion through debt rather than equity? A) Debt is more difficult to issue than equity B) Shareholder approval is required to issue debt instruments C) Debt limitations reduce the company's ability to finance projects D) Debt is more risky to the providers of capital

C) Debt limitations reduce the company's ability to finance projects CORRECT ANSWER CHOSEN As a corporation finances new projects through the use of debt, it uses up its ability to borrow additional funds. At some point, the company will have borrowed as much as it is able to and it will reach its debt limit. Future projects must then be financed through equity issued.

Which of the following factors is be the largest inhibitor to revenue growth of a biotech company? A) Falling interest rates B) Increasing valuations of private corporations C) Decreasing cash flows allocated to CAPEX D) A slowdown of FDA approvals for new medical techniques

C) Decreasing cash flows allocated to CAPEX Companies in the biotechnology industry require a significant amount of capital as well as the reinvestment of current cash flows to develop new medical technologies. Firms that lack sufficient cash flows to spend on new capital projects are at risk of not being able to grow their revenues. Even if a biotechnology firm doesn't have the cash flows to use on CAPEX, it could get funding from the issuance of securities in the private markets. Falling interest rates and increasing valuations of private companies would make it viable to issue new securities to increase revenue growth. The FDA not approving new medical techniques would likely decrease biotech valuations. Although revenue growth may suffer, it's unlikely to have as dramatic an impact as decreasing CAPEX.

All of the following are TRUE of cost analysis, EXCEPT: A) Over the long-term, all costs are variable B) Average total cost is equal to average fixed costs plus average variable costs C) Diminishing returns occur when average variable costs exceed average fixed costs D) Diminishing returns will not occur as long as average variable costs is greater than marginal costs

C) Diminishing returns occur when average variable costs exceed average fixed costs CORRECT ANSWER CHOSEN Average variable costs plus average fixed costs equal average total cost. Diminishing returns occur when average total costs begins to rise.

Which of the following statements is TRUE? A) Free cash flow is an important measurement for the creditors of a company. B) EBIT is an important measurement for the shareholders of a company. C) Free cash flow is an important measurement for the shareholders of a company. D) Neither EBIT nor free cash flow are important measurements for any type of capital provider.

C) Free cash flow is an important measurement for the shareholders of a company. Earnings before interest and taxes (EBIT) is a measure of the cash available to pay creditors. Free cash flow is based on net income and measures the cash available to shareholders.

Which of the following is NOT defined as a leverage ratio? A) Debt-to-total capital ratio B) Debt-to-equity ratio C) Interest coverage ratio D) Debt-to-EBITDA ratio

C) Interest coverage ratio CORRECT ANSWER CHOSEN A leverage ratio is any types of financial ratio that indicates the level of debt incurred by a business entity against several other accounts in its balance sheet, income statement, or cash flow statement. The interest coverage ratio measures the ability of a company to pay interest on its debts, but not the amount.

The MackLear Corporation has invested capital of $4 billion, its ROIC is 18%, it has a debt to equity ratio of 100%, a pretax cost of debt of 10%, a marginal tax rate of 40%, its WACC is 12%, $200 million of cash and 60 million shares outstanding. An estimate of MackLear's price per share is: A) $100 B) $70 C) $67 D) $14.66

CORRECT ANSWER CHOSEN The ROIC to WACC ratio is ROIC divided by WACC. A ratio of greater than 1.0 is an indication that the company is creating value. A ratio of less than 1.0 is an indication that the company is destroying value. The ROIC to WACC ratio can be used to estimate the enterprise value (EV) of a company, which is also required to estimate MackLear's price per share. The model assumes that the ratio of enterprise value to invested capital (IC) is equal to the ratio of ROIC to WACC. (EV ÷ IC) = (ROIC ÷ WACC) Alternatively EV = IC x (ROIC ÷ WACC) EV = $4 billion x (18% ÷ 12%) EV = $4 billion x 150% EV = $6 billion With $4 billion of invested capital and a ROIC to WACC ratio of 150%, MackLear's enterprise value is estimated to be $6 billion. Notice that MackLear's estimated enterprise value is greater than the value of its invested capital of $4 billion. This is because the ROIC - WACC spread is positive. 18% - 12% = 6%. The company is adding 6 cents of value for every dollar invested. The company is earning a return that is greater than its cost of capital. In other words, providers of capital are getting a return on their investment that is greater than they expected. The estimated enterprise value of $6.0 billion, less the $2.0 billion of debt, plus the $200 million of cash results in an equity value of $4.2 billion. With 60 million shares outstanding the equity should be valued at $70 per share ($4.2 billion / 60 million shares = $70 per share.

Which of the following ratios is a key factor in the calculation of ROE? A) Days sales outstanding B) Operating margins C) Interest coverage ratio D) Asset turnover ratio

D) Asset turnover ratio CORRECT ANSWER CHOSEN Return on Equity (ROE) is the earnings available to common shares (Net Income - Pref. Dividends) divided by the average common equity (ROE = (Net Income - Pref. Dividends) ÷ Ave. Common Equity). The DuPont formula further subdivides ROE into its components, thereby making it easier to explain how a company got its ROE. The ROE using the DuPont formula is the net profit margin (Net Income ÷ Sales), multiplied by the asset turnover ratio (Sales ÷ Average Total Assets), and then multiplied by the equity multiplier (Average Total Assets ÷ Average Shareholder's Equity). DuPont ROE = Net Profit Margin x Asset Turnover Ratio x Equity Multiplier. The DuPont formula also makes differences in ROEs easier to explain. For example, let's assume that two companies have similar ROEs. One company is very profitable, but has large shareholder's equity. The other competing company is not as profitable, but has very little shareholder's equity. Although the ROEs are similar, the two companies arrive at them very differently.

The RSR Corporation has a 50% debt/equity ratio, an FCFF of $9,000,000, debt of $25,000,000, a 14% cost of equity, a long-term growth rate of 5%, an 8.00% pretax cost of debt, and a tax rate of 36%. If the company has 8,000,000 shares of common stock outstanding, what is the equity value per share using the stable growth FCFF model? A) $7.54 B) $13.34 C) $15.41 D) $16.34

D) $16.34 INCORRECT ANSWER CHOSEN The stable growth FCFF (free cash flow for the firm) model may be used when a firm has stable cash flows that are expected to grow at a certain rate. The formula to calculate the total value of the firm is the FCFF at the end of the year divided by the WACC, less the growth rate. The FCFF at the end of the period is $9,450,000 using the 5% growth rate ($9,000,000 x 1.05). Since the debt/equity ratio is 50%, it is necessary to express debt as a percentage of total capital. This can be determined by assuming an equity value of 100; since debt is 50% of equity, the total capital is 150. 100 / 150 = 67% (equity capital is 67%) and 50 / 150 = 33% (debt capital is 33%). The weighted cost of equity is .0938 or 9.38% (.14 x .67). To determine the weighted cost of debt, an adjustment for the tax shield is necessary. The pretax cost of debt is multiplied by 1 minus the tax rate (.08 x .64 = .0512). This product is multiplied by the percentage of debt capital; therefore, the weighted cost of debt is .0169 or 1.69% (.0512 x .33). The WACC equals .1107 or 11.07% (.0938 + .0169). The total value of the firm is determined by dividing the projected FCFF of $9,450,000 by (WACC minus the growth rate). The total value of the firm = $155,683,690 ($9,450,000 / .0607). If the amount of debt is $25,000,000, the value of the equity is $130,683,690 ($155,683,690 - $25,000,000). $130,683,690 divided by 8,000,000 shares outstanding equals an equity value per share of $16.34.

Use the following information on Amalgamated Faucet Corporation to answer this question. Cash Flow — $200 MM Shares — 100 MM Beta — 1.65 Risk Premium — 3.33% Risk-Free Rate — 4.0% Inflation — 3% Long-Term growth rate — 5% What is the intrinsic value of the Amalgamated Faucet Corporation? A) $32.66 B) $44.44 C) $36.72 D) $46.77

D) $46.77 CORRECT ANSWER CHOSEN The intrinsic value (share price) can be found by using the perpetual growth model, which derives from the Gordon growth model. First calculate the cost of equity using the capital asset pricing model (CAPM). Next, use the perpetual growth model to estimate the aggregate intrinsic value (equity value). Divide the aggregate intrinsic value by the number of shares outstanding to find the value per share. The inflation number can be ignored given that the traditional CAPM does not consider inflation. k = Rf + β(Risk Premium) k = 0.04 + 1.65(0.0333) k = 0.0949 P0 = [CF(1 + g)] / (k - g) P0 = 200(1.05) / (0.0949 - .05) P0 = 210 / 0.0449 P0 = 4,677.06 $4,677MM / 100MM shares = $46.77 per share.

The QMS Corporation has net income of $2,650,000 and a tax rate of 35%. The weighted average number of shares outstanding is 320,000. There is a bond issue outstanding with a 4% coupon totaling $650,000 par value. The bonds are convertible at $25. Calculate the diluted earnings per share assuming any bond conversion is done at the beginning of the year. A) $8.334 B) $7.659 C) $8.281 D) $7.708

D) $7.708 CORRECT ANSWER CHOSEN Diluted earnings per share is equal to net income, adjusted for the after-tax cost of the debt, divided by average number of shares after conversion. Step one, add back the after-tax cost of the debt. The adjustment is equal to the par value of the bonds multiplied by the interest rate multiplied by the complement of the tax bracket. $650,000 x 4% x (1.00 - .35) = $16,900. Net income $2,650,000 + $16,900 = $2,666,900. Step two, determine average number of shares after conversion. QMS Corporation has 320,000 shares outstanding. Add 26,000 shares ($650,000 par value / $25 conversion price = 26,000 shares). 320,000 shares + 26,000 shares = 346,000 shares. Step three, $2,666,900 / 346,000 = equals $7.708 per share.

Relevant financial information to answer the following question is found by using Exhibit 34. What was the company's return on common equity for 2020? A) 17.3% B) 18.9% C) 20% D) 20.7%

D) 20.7% CORRECT ANSWER CHOSEN The formula for return on equity is net income divided by average common stockholders' equity. The year-end equity is given for 2020, but it is necessary to determine the beginning value. The 2020 year-end equity ($1,850 MM) has increased by $320 MM. This is based on net income generated of $350 MM, of which $30 MM was paid out in dividends. This indicates that common equity increased by $320 MM during 2020 ($350 MM - $30 MM). The beginning period equity for the company was $1,530 MM ($1,850 MM - $320 MM). The average equity was $1,690 MM ([$1,530 MM + $1,850 MM] / 2). The return on equity for 2020 is 20.7% ($350 MM / $1,690 MM).

A corporation is planning to issue $20,000,000 face value of corporate bonds with a 6.4% coupon. The bonds will have a ten-year maturity. There are underwriting fees of 3.5%, advertising costs of 1.2%, and legal and accounting costs of 0.5%, which is 5.2% of the issue. What is the cost of capital on this debt issue? A) 5.45% B) 6.24% C) 6.42% D) 6.75%

D) 6.75% The cost of capital on this project is calculated by dividing the interest expense by the net proceeds of the issue. The flotation costs include underwriting fees, advertising, and legal and accounting costs totaling 5.2% The interest of $1,280,000 (6.4% x $20,000,000) is divided by the net proceeds of the issue which is $18,960,000. [$20,000,000 - $1,040,000 ($20,000,000 x 5.2%)]. $1,280,000 / $18,960,000 = 6.75%.

Which of the following sectors would have the greatest degree of operating leverage when GDP is increasing? A) A knee and hip replacement manufacturer B) An aerospace contractor C) A tobacco company D) A computer manufacturer

D) A computer manufacturer CORRECT ANSWER CHOSEN 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.

Funds from operations (FFO) is a valuation metric MOST commonly used when performing a relative valuation for which of the following companies? A) A transportation company B) A telecommunication company C) An oil and gas driller D) A real estate investment trust

D) A real estate investment trust CORRECT ANSWER CHOSEN The most frequently used valuation metric for a REIT is funds from operations (FFO). This is determined by taking the net income plus depreciation, and subtracting gains from the sale of assets.

Relevant financial information to answer the following question is found by using Exhibit 18. Which of the following choices could describe the activities related to Company H from Year 1 to Year 2? A) It issued common stock B) It called preferred stock C) It retired debt D) It issued debt

D) It issued debt Between years 1 and 2, Company H has shown an increase in its operating margin, while the EPS, common stock price, and net income remain the same. This indicates that either revenue increased by a greater percentage than operating expenses, or revenue declined by a smaller percentage than the decline in operating expenses. Since the EPS, common stock price, and net income have remained the same, the capital structure of the company has changed. If Company H issued bonds, the additional interest expense borne by the company would impact the income statement below the operating expenses. This could result in identical EPS for the company. If Company H issued common stock, the net income would have had to been higher in Year 2 than in Year 1, to have the same EPS and a higher operating profit margin. Additionally, net income would have had to increase if more shares were outstanding and EPS remained the same. If the company called preferred stock, the higher operating profit margin and reduced dividend expense for the preferred stock would have resulted in higher EPS. [61298]

D) It issued debt CORRECT ANSWER CHOSEN Between years 1 and 2, Company H has shown an increase in its operating margin, while the EPS, common stock price, and net income remain the same. This indicates that either revenue increased by a greater percentage than operating expenses, or revenue declined by a smaller percentage than the decline in operating expenses. Since the EPS, common stock price, and net income have remained the same, the capital structure of the company has changed. If Company H issued bonds, the additional interest expense borne by the company would impact the income statement below the operating expenses. This could result in identical EPS for the company. If Company H issued common stock, the net income would have had to been higher in Year 2 than in Year 1, to have the same EPS and a higher operating profit margin. Additionally, net income would have had to increase if more shares were outstanding and EPS remained the same. If the company called preferred stock, the higher operating profit margin and reduced dividend expense for the preferred stock would have resulted in higher EPS

D) Net income - dividends/net income CORRECT ANSWER CHOSEN The term "percentage of earnings" typically has two meanings: (1) the percentage of earnings (or net income) retained or (2) the percentage of earnings (or net income) paid out in the form of dividends.

You have been asked to review the financials of two companies. Both companies are involved in the same industry, have similar operating margins, enterprise values, net income, and P/E ratios, but the foreign company has a higher EV/EBITDA. Which of the following choices would explain the difference? A) The foreign company has higher sales growth B) The U.S. company has higher sales growth C) The foreign company pays higher taxes D) The U.S. company pays higher taxes

D) The U.S. company pays higher taxes INCORRECT ANSWER CHOSEN If both companies have similar enterprise values and P/E ratios, but one company has a higher EV/EBITDA, that company must have a lower EBITDA. For example, if both companies have EPS of $1.00 and a market price of $20, both P/E ratios would be 20. If the foreign company had an EBITDA of 25, and the U.S. company had an EBITDA of 30, and both had an enterprise value of 200, the EV/EBITDA of the foreign company would be 8 (200 / 25) and the EV/EBITDA of the U.S. company would be 6.66 (200 / 30). The higher taxes paid by the U.S. company would be a good explanation for the higher EBITDA since the net incomes were similar. Since the operating margins are similar, growth differences would not be a plausible choice.

The difference between FCFF and FCFE is: A) The addition of net borrowings and interest tax shield to derive FCFE from FCFF B) The application of a capital charge to net investment to derive FCFE from FCFF C) The deduction of net borrowing to derive FCFE from FCFF D) The application of unlevered net income to derive FCFF, rather than net income to derive FCFE

D) The application of unlevered net income to derive FCFF, rather than net income to derive FCFE CORRECT ANSWER CHOSEN A company's free cash flow to the firm (FCFF) differs from free cash flow to equity (FCFE) based on the interest expense of the company and the tax effect of the interest expense (i.e., interest tax shield). FCFF begins with EBIT x (1 - tax rate), while FCFE begins with net income. In the case of an unlevered company, there's no difference between FCFF and FCFE since an unlevered company has no interest expense and the assumed interest tax shield is neutralized. When comparing FCFF to FCFE, net borrowing is added to FCFF to derive FCFE. Net borrowing is new debt issued by a company less interest and principal payments on existing loans. The application of capital charge to net investment compares the return on invested capital (ROIC) to the cost of capital (e.g., WACC). Although this is a valuable measurement to determine the economic significance of an event, it doesn't describe the difference between FCFF and FCFE.

D) The application of unlevered net income to derive FCFF, rather than net income to derive FCFE INCORRECT ANSWER CHOSEN A company's free cash flow to the firm (FCFF) differs from free cash flow to equity (FCFE) based on the interest expense of the company and the tax effect of the interest expense (i.e., interest tax shield). FCFF begins with EBIT x (1 - tax rate), while FCFE begins with net income. In the case of an unlevered company, there's no difference between FCFF and FCFE since an unlevered company has no interest expense and the assumed interest tax shield is neutralized. When comparing FCFF to FCFE, net borrowing is added to FCFF to derive FCFE. Net borrowing is new debt issued by a company less interest and principal payments on existing loans. The application of capital charge to net investment compares the return on invested capital (ROIC) to the cost of capital (e.g., WACC). Although this is a valuable measurement to determine the economic significance of an event, it doesn't describe the difference between FCFF and FCFE.

Which of the following events is dilutive to the EPS of a company? A) Stock splits B) A tax loss carryforward C) Payment of a cash dividend D) The exercise of exchange-traded stock options

D) The exercise of exchange-traded stock options INCORRECT ANSWER CHOSEN Stock splits will increase the number of shares of common stock outstanding without changing the earnings available to common shareholders. As a result, earnings per share will decrease. Net operating loss (NOL) represents loss in excess of pre-tax income and can be carried forward indefinitely to reduce taxable income in the future. When carried forward, it's referred to as a tax-loss carryforward, but doesn't change the income statement or EPS. Cash dividends that are paid to the common shareholders don't impact earnings available to the common shareholders or EPS. The exercise of employee stock options is dilutive since new shares are being issued. Companies themselves (i.e., issuers) don't create exchange-traded options on their stock and don't create new shares when exchange-traded options are exercised.

Under the percentage of completion method, first year's income is computed by multiplying the contract price by: QID: 4600610 Mark For Review AThe ratio of first year's billings to estimated total costs BThe ratio of first year's collections to contract price CThe ratio of first year's billings to contract price D) The ratio of first year's costs to estimated total costs

D) The ratio of first year's costs to estimated total costs CORRECT ANSWER CHOSEN IRS Section 460 requires most long-term contracts to be accounted for under the percentage of completion method. The PCM requires income from the contract to be reported annually over the life of the contract and requires contract expenses to be deducted in the year that they are incurred. The income reported is that amount which is proportionate to the actual costs incurred as a percentage of total estimated costs. At the point when 50% of the estimated costs have been incurred, one should have reported 50% of the estimated income. First year's income, under the percentage of completion method, is computed by multiplying the contract price times the ratio of first year's costs to estimated total costs.

In an M&A transaction, which of the following factors is MOST important in determining the long-term value created by a potential acquisition to the acquiring company? A) A positive change in operating margin of the combined companies B) Whether the acquisition is accretive to EPS C) The growth rate of the combined companies D) Whether the acquisition will increase its return on invested capital

D) Whether the acquisition will increase its return on invested capital CORRECT ANSWER CHOSEN This question is asking for the most important factor. The acquiring company should look to the return on invested capital, and whether the acquisition will provide returns that cover the cost of invested capital. If this is accomplished, the expectation would be reflected in improvements such as earnings per share and operating margins. The acquisition being accretive to EPS is important in the short term but, in the long term, it is return on invested capital (ROIC).

D) Whether the acquisition will increase its return on invested capital INCORRECT ANSWER CHOSEN This question is asking for the most important factor. The acquiring company should look to the return on invested capital, and whether the acquisition will provide returns that cover the cost of invested capital. If this is accomplished, the expectation would be reflected in improvements such as earnings per share and operating margins. The acquisition being accretive to EPS is important in the short term but, in the long term, it is return on invested capital (ROIC).

For several years there was strong demand for computers that caused chip makers to increase their production capacity. Then, demand for desktop and laptop computers declined. How would this change be evident in the financials of the chip makers? A. Asset turnover B. Gross margins C. Sales growth D. Capital expenditures

D. Capital expenditures All of these measurements would decline as computer demand falls. What would have been particularly evident would be the initial increase in capital expenditure (CAPEX) to support the increased demand, and the subsequent decline as the industry would have to absorb the unused capacity. The sales prices for computer chips may also fall, which may lead to lower gross margins (as revenues decline) and lower asset turnover (net income ÷ average assets) as net income declines. It is also important to note in this question that none of the choices indicate if these measurements rose or fell.

Which of the following figures will change when a company pays a stock dividend? A) Current assets B) Working capital C) Current liabilities D) EPS

EPS CORRECT ANSWER CHOSEN When a company pays a stock dividend (rather than a cash dividend), additional shares of common stock are issued to existing shareholders. Net income would be divided by this increased number of shares outstanding. Earnings per share would decline. Current assets and current liabilities would remain unchanged (no money has been paid out); therefore, working capital remains unchanged.

While evaluating a company, an analyst notices a significant difference between the firm's tangible book value and stated book value. Which of the following items could account for the difference? A) Finished goods and goodwill B) Capitalized software development costs and R&D expenses C) R&D expenses and finished goods D) Goodwill and capitalized software development

Goodwill and capitalized software development INCORRECT ANSWER CHOSEN Stated book value and tangible book value differ in that stated book value is calculated by subtracting the total liabilities from the total assets total. Essentially, it reveals the equity on the balance sheet (e.g., Assets - Liabilities = Equity). In contrast, tangible book value is calculated by starting with total assets and subtracting all liabilities, goodwill, and intangibles that don't have a stand-alone market value (e.g., Assets - Liabilities - Goodwill - Intangibles with no market value). Since goodwill and intangibles with no market value are subtracted when calculating tangible book value, but are not subtracted when calculating stated book value, goodwill and capitalized software development could account for the difference in stated book value versus tangible book value. This assumes the capitalized software development has no market value, but its cost on the balance sheet has not been fully amortized. The value of finished goods in inventory would be the same when calculating stated book value and tangible book value. R&D expenses would not be a correct item choice because, if R&D is expensed, then it's not capitalized. If it's capitalized then it will be amortized over its useful life, which will result in amortization expense. Book Value = Assets - Liabilities Tangible Book Value = Assets - Liabilities - Goodwill - Intangibles with no market value

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