86 New

Last year, the nominal gross domestic product (GDP) was $15.9 trillion. If the GDP deflator is 102.5 and the Consumer Price Index is 3.5, what was last year's real GDP?

$15.51 trillion ($15.9 trillion ÷ 102.5) x 100%).

Real GDP Formula

(Nominal GDP ÷ GDP Deflator) x 100%)

Non-Gaap Measures

1) Exclusion of special charges (e.g., asset abandonment, severance pay), 2) Exclusion of amortization of purchased intangibles, 3) The exclusion of tax-affected acquisition expenses, 4) Interest expense 5) Income tax effects 6) Impairment of long-lived assets 7) EBITDA 8) Free cash flow

Aggresive accounting

1) High discount rate 2) Using an overly optimistic return on plan assets 3) Assuming a low rate of compensation

DCF Limitations

1) It is not a suitable metric when examining companies that have little or no sales. 2) Additionally, if the expected rate of return, or the size and timing of cash flows are not estimated, the fair value result will be in error. 3) Another potential bias in the valuation is based on the discount rate selected for the present value of the future cash flows. 4) An additional drawback of DCF analysis is the assumption of a constant (stable) capital structure (a.k.a. constant WACC).

Conservative Accounting

1) Low discount rate that increases service costs 2) An expected return on the pension plan assets that is near the discount rate increases the cost to the plan 3) A high assumed rate of salary increase leads to higher pension benefit obligations (PBOs) for employees

Cyclical Stocks

1) Manufacturing 2) Homebuilders 3) Transportation 4) Durable Goods 5) Household Appliances 6) Construction, Steel 7) Housing 8) Shipping

Coincident Economic Indicators

1) Manufacturing and Trade Sales 2) Industrial Production 3) Employees on non-agricultural payrolls 4) Personal income less transfer payments

Leading Economic Indicators

1) Money Supply 2) S&P 500 Index 3) New Orders for Goods and Services 4) New Building Permits 5) Interest rate spreads

Defensive Stocks

1) Pharmaceuticals 2) Utilities 3) Cosmetics 4) Food 5) Consumer Nondurable

1) Which are more volatile short term interest rates or long term rates? 2) As the economy expands do interest rates rise or decrease

1) Short Term 2) Rise

Lagging Economic Indicators

1) The average duration of unemployment 2) The relationship of inventories to sales, manufacturing, and trade 3) Labor cost per unit of output for manufactured goods 4) The average prime rate charged by banks 5) Commercial and industrial loans outstanding 6) The relationship of consumer installment credit to personal income 7) The consumer price index for services

Invested Capital [Formula]

1) Total Assets - Non-Interest-Bearing Current Liabilities - Excess Cashor 2) Debt + Equity

Consolidation Method

1) Used if ownership interest exceeds 50% 2) Balance sheet and income statements are combined 3) Subtract NCI from Company B Net Income

Equity Method

1) Used if ownership interest is 20% to 50% Ex: If ABC owns 30% of XYZ, and XYZ had $120,000 of income, ABC would have reported an additional $36,000 (30% of $120,000), and would report this amount under other income.

Cost Method

1) Used when a company owns less than 20% of a subsidiary 2) They are carried at original cost basis 3) Gains and Losses are realized when the shares are sold 4) If shares experience a significant or perceived permanent decline, they may be written down

When is it appropriate to use the Gordon Growth Model for stock valuation?

1) When the stock pays dividends 2) The dividends are projected to grow at a constant rate for an infinite period 3) The required rate of return is greater than the growth rate.

Stock Dividend

A distribution by a corporation of its own stock to its stockholders.

Relevant financial information to answer the following question is found by using Exhibit 16. Red Wing Aircraft Co. is purchasing Flyer's Graphics, Inc. for $250 million in cash, plus the assumption of Flyer's debt. Red Wing will fund the acquisition by issuing debt. The data in Exhibit 16 presents financial information for each company prior to the acquisition. Red Wing will assume Flyer's debt of $200 million and will issue $250 million of 6.0% debentures to acquire Flyer's outstanding shares. Assuming no other financial changes, what will be the after-tax net income of the combined entities? Revenue: $700 Revenue: $270 EBIT: $90 EBIT: $60 Interest Expense: $15 Interest Expense: $12 Pretax Income: $75 Pretax Income: $48 Taxes: $25 Taxes: 16 Net Income: $50 Net Income: $32 Shares Outstanding: 20 million Shares Outstanding: 10 million

A) $72 million B) $82 million C) $84 million D) $88 million CORRECT ANSWER CHOSEN In order to find the after-tax income of the combined entities, the additional interest expense of $15 million ($250 million debentures x .06 interest rate) must first be determined. The total interest expenses of Red Wing will increase to $42 million ($15 million Red Wing's interest + $12 million Flyer's interest + $15 million new interest expense). The tax rate applied to Red Wing will remain 33.3% ($25 million paid in taxes ÷ $75 million pre-tax income). Given the combined EBIT of $150 million ($90 million Red Wing's EBIT + $60 million Flyer's EBIT) for the merged companies, and the new interest expense of $42 million, the taxable income will be $108 million ($150 million EBIT - $42 million interest expense). Based on the current tax rate of 33.3%, the net after-tax income for the combined companies will be $72 million ($108 million x (1 - 33.3%) = $72 million)

A research analyst is reviewing a press release which discloses a positive settlement of litigation for a company, thereby resulting in an after-tax gain for the next accounting period. What's the MOST concerning aspect of the press release for the research analyst? A) Earnings estimates B) Sales growth C) Implication of the litigation D) Dilution

A) Earnings estimates One-time events, such as the settlement of a lawsuit, will impact a company's net income and earnings per share, but only in one accounting period. When projecting earnings for future periods, research analysts will need to adjust their estimates for one-time events. A gain from a litigation settlement is not dilutive and, while it affects net income, it's not included in sales.

Leisure Wear Inc. and Knockoff Designs are suppliers to Floor-Mart. Floor-Mart purchases 92% of the output from both suppliers. Leisure Wear and Knockoff are merging to realize cost synergies. Floor-Mart has not commented on the merger. As an analyst, what would you expect to happen to the share price of Floor-Mart stock? A) Floor-Mart's price is unlikely to be affected B) Floor-Mart's price will likely go up as it achieves collateral price efficiencies C) Floor-Mart's price will follow the direction of price changes of its supplier D) Floor-Mart's price will likely go down due to pressure by the supplier

A) Floor-Mart's price is unlikely to be affected INCORRECT ANSWER CHOSEN A monopsony is a single buyer in a market. If Floor-Mart does not comment on the activities of its suppliers, it is unlikely that the merger will have an impact on the price of Floor-Mart's stock.

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

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 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.

A corporation based in the United States imports components from a company based in China. The importer uses these components to assemble a finished product that it exports back to China. The U.S. dollar has recently been devalued against the Chinese yuan. All of the following items will increase in value, EXCEPT the? A) Operating expenses B) Revenue C) Operating profit margin D) Cost of goods sold

A) Operating expenses The operating expenses of the company would be expressed in U.S. dollars. These expenses are unaffected by a devaluation of the dollar against the yuan. The cost of goods sold will increase since the dollar has declined in value against the Chinese yuan. The decline of the dollar, however, will also increase the revenue the company will receive once the yuans (received for the sale of the finished products) are converted into U.S. dollars. A portion of the cost of goods sold (assembly of the finished product) is payable in U.S. dollars. The devaluation of the dollar will not impact this portion of the cost of goods sold. Since the increase in the revenue would be a greater percentage than the percentage increase in cost of goods sold, the profit margin will increase.

A company is mature, stable, and nearly 100% of its operations occur in its domestic market. Which of the following statements is TRUE? A) Real GDP can be used as the company's growth rate because it will indicate demand for the company's products. B) Nominal GDP can be used as the company's growth rate. C) Stable companies generally don't grow and should be valued using constant cash flows. D) The correlation between non-farm payrolls and the company's dividend payment is the best way to estimate its sales growth.

A) Real GDP can be used as the company's growth rate because it will indicate demand for the company's products.

What's the effect on a company's financial statements if depreciation declined by $50 million and the company paid out a dividend of $8 million? A) Retained earnings increases on the balance sheet B) Cash flows from operating activities decreases C) Net income decreases on the income statement D) Retained earnings will not change on the balance sheet

A) Retained earnings increases on the balance sheet Incorrect Answer Chosen The reduction in depreciation will increase net income which normally leads to an increase in retained earnings. Although the dividend payments are deducted from net income to determine retained earnings, because the dividend is so much lower than depreciation, it's likely that retained earnings will rise. Since depreciation is a non-cash expense, it will not affect the cash flows.

When analyzing a high-end retailer an analyst would look at: A) Stock market levels B) Unemployment rate C) Labor market participation D) Market for collectibles

A) Stock market levels INCORRECT ANSWER CHOSEN Rising stock market levels result in unrealized gains for stock market participants. Investors perceive they are wealthier when the market rises and are more likely to engage in the purchase of high end goods. This is known as the wealth effect. As the stock market rises, high end retailers typically experience an increase in sales as consumers "spend" their unrealized equity market gains at places like Michael Kors and Tiffany. In general, a rising stock market would have little effect on stores like Dollar General and other discounters whose clientele are less heavily invested in the stock market and less likely to experience the wealth effect.

An analyst believes that the sector she covers is highly correlated with new building permits and housing starts. Which of the following choices would be the most useful to supplement the industry's trend forecast? A) The inflection point in interest rates B) The current P/E ratio of the S&P 500 compared to its historic average C) The inflection point in industrial production D) The fluctuation of the U.S. dollar vs. a basket of foreign currencies

A) The inflection point in interest rates INCORRECT ANSWER CHOSEN An inflection point occurs at the top or at the bottom of a cycle and indicates a change in direction. The inflection point in interest rates represents the lowest point or the highest point in an interest-rate cycle (and also illustrates the point at which the cycle changes). Of the choices given, a change in interest rates is the most important factor for new building permits and housing starts. Since this sector is highly correlated with housing starts, this would be the most useful for forecasting its trend.

A company is headquartered in the United States. All of its products are produced in Korea. Sales of the company are split between the U.S. (40%) and Korea (60%). What would be the effect on the company's operating profit margin and revenue if the U.S. dollar declines by 10% against the Korean won? A) The operating profit margin will decline and revenue will increase B) The operating profit margin and revenue will decline C) The operating profit margin will increase and revenue will decline D) The operating profit margin and revenue will increase

A) The operating profit margin will decline and revenue will increase Operating profit margin will decline and revenue will increase. If the company had $100 of revenue and operating expense of $50, $60 of the revenue was generated through sales in Korea while $50 of operating expenses was incurred in Korea. A 10% decline in the U.S. dollar (a 10% increase in the value of the Korean won), would increase revenues to $106 [($60 x 1.1) + $40], while operating expenses would increase to $55 ($50 x 1.1). The operating expense would increase from 50% ($50 / $100) to 52% ($55 / $106) and the operating profit margin would fall to 48% [($106 - $55) / $106 = 0.48].

Where would an analyst likely use EV / EBITDA as a valuation tool? A) Truck manufacturing B) Biotech C) Publishing D) Craft stores

A) Truck manufacturing Capital intensive industries are frequently evaluated using an EV / EBITDA approach. EV is an abbreviation for enterprise value (market value of shares plus debt minus cash). EBITDA is sometimes viewed as core profitability, removing the influences of interest, taxes, depreciation and amortization.

Calculate Change in Cash

Add the previous year cash first into the equation

U.S. corporate issuers would expect the cost of securing financing to increase for all of the following reasons, EXCEPT: A) Unemployment falling to new lows B) GDP declining C) Inflation rising sharply D) Interest rates rising

B) GDP declining Corporate issuers will pay more for financing (money) when interest rates increase. The only choice that will normally lead to falling interest rates is where the economy is showing negative growth. In that case, the Fed is much more likely to lower rates to spur investment and borrowing. Rapidly falling unemployment is a sign of growth, which could be inflationary.

All of the following items are considered part of the tangible book value of a company, EXCEPT: A) Copyrights B) Goodwill C) Inventories of work in process D) Investments in securities

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

A company currently has a debt/equity ratio of 28% and it's considering redeeming some of its debt and replacing it with preferred stock. If the company takes this action and its cost of preferred stock is equal to its cost of debt, the WACC is expected to: A) Decline B) Increase C) Remain the same D) Increase due to the increase in the company's capital base

B) Increase The WACC should increase since there's a tax shield (tax advantage) associated with debt. Interest on debt is tax-deductible, while preferred stock dividends are paid after-tax. If the bonds being redeemed have the same cost as the new preferred shares, the company loses the tax deduction on the bonds and ends up with a higher Weighted Average Cost of Capital (WACC). The redemption of debt for preferred shares will not change the total capital of the corporation.

The National Corporation produces computer chips that are used in the ignition system of automobiles. National has three customers that account for 75% of its sales. The industry is highly competitive and this product is subject to commodity pricing characteristics. If National were the first in the industry to change from fixed to variable pricing, offering quantity discounts to its customers, what would an analyst expect if auto manufacturers increase production? A)) Due to the change in pricing structure, other chip manufacturers in the industry will increase market share at the expense of National. B) National would have had a higher unit profit margin if the fixed pricing structure continued. C) National's profit margins per unit will increase due to the commodity pricing characteristics of computer chips. D) National will lose market share as a result of the change in the pricing structure.

B) National would have had a higher unit profit margin if the fixed pricing structure continued. Increases in auto manufacturing will increase the demand for National's chips. The new pricing permits automakers to receive price breaks from National. Although National's market share will rise, its profit margin per unit will decline due to the lower unit pricing.

Which of the following statements is TRUE regarding the impact of finance leases over the life of the lease? A) Total expenses increase B) Operating cash flow increases C) Taxable income fallsterm-166 D) Interest coverage declines

B) Operating cash flow increases A finance lease has declining expenses since interest on the lease obligation declines over the life of the lease. As a result, the declining interest expense will cause operating cash flows to increase over the lease's life. It also increases the net income of the company and taxable income. Assuming revenues remain unchanged, the interest coverage will rise as the interest expense declines.

Use the following information to answer this question. Exeter Ltd. produces widgets Unit Sales: 800,000 Cost/unit: $.80 Price: $1.50 Fixed costs: $300,000 Variable costs: $340,000 The price of widgets declines by 10% while the demand for widgets increases by 10%. Calculate the changes to revenue and gross profit. A) Revenue declines by 1% and gross profit increases to 46.7% B) Revenue declines by 1% and gross profit declines to 43.3% C) Revenue increases by 1% and gross profit declines to 43.3% D) Revenue increases by 10% and gross profit increases to 46.7%

B) Revenue declines by 1% and gross profit declines to 43.3% Original revenue: 800,000 units x $1.50 price = $1,200,000Revenue after 10% increase in demand and 10% decline in price:880,000 new units sold x $1.35 new price = $1,188,000 new revenue Revenue has declined by $12,000 ($1,188,000 new revenue - $1,200,000 original revenue). $12,000 decline in revenue / $1,200,000 original revenue = 1% decline in revenue Original total costs: $300,000 fixed costs + $340,000 variable costs = $640,000 total original costs The fixed costs will not be impacted by a 10% increase in demand; however, total variable costs will rise if the firm produces 10% more to meet the demand. The original variable cost per unit: $340,000 original variable costs / 800,000 units = $.425 per unit;New variable costs: 880,000 new units x $.425 variable cost per unit = $374,000 new variable costsNew total costs: $300,000 fixed + $374,000 new variable costs = $674,000 new total costs Original gross profit: $1,200,000 original revenue - $640,000 original total costs = $560,000 original gross income Original gross margin: $560,000 gross income / $1,200,000 original revenue = .467, or 46.7% Gross profit after changes: $1,188,000 new revenue - $674,000 new total costs = $514,000 new gross income New gross margin: $514,000 new gross income / $1,188,000 new revenue = .433, or 43.3%

If a company has investments which are classified as "available-for-sale," which of the following statements is TRUE? A) The company will account for any unrealized gain or loss on these investments by adjusting both the balance sheet and income statement. B) The company will account for any unrealized gain or loss on these investments by adjusting the balance sheet, but not the income statement. C) The company will not account for any unrealized gain or loss on these investments on either the balance sheet or the income statement. D) The company will account for any unrealized gain or loss on these investments by adjusting the income statement, but not the balance sheet.

B) The company will account for any unrealized gain or loss on these investments by adjusting the balance sheet, but not the income statement.

Which of the following is a leading economic indicator? A) The average duration of unemployment B) The spread between 10-year Treasuries and the fed funds rate C) Non-farm payrolls D) CPI for services

B) The spread between 10-year Treasuries and the fed funds rate Interest rate spreads, especially 10-year Treasuries and the fed funds rate, are a leading economic indicator. Non-agricultural payrolls is a coincident indicator. The CPI for services and average duration of unemployment are both lagging economic indicators.

Which information could be found by an analyst who's reviewing a company's most recent 10-K filing? A) A statement from the SEC certifying the accuracy of the filing B) list of directors and executive officers C) A list of the company's clients D) Projected earnings of the company for the next fiscal year

B) list of directors and executive officers A Form 10-K will include certain information that a company is required to disclose to the SEC. Thereafter, this information is available to the public. Some of the information includes the business line and assets of the company, any legal proceedings in which the company is involved, risk factors, footnotes of accounting policies, the market for the company's equity securities, and a list of the company's directors and executive officers. The document gives a detailed overview of the past year's results of the company and its business. Although the Form 10-K may make mention of the future, it cannot make any financial projections.

Capitalizing Costs

Boosting earnings in the short run by depreciating the cost over some years deferring the recognition of expenses.

A corporation has net income of $340,000 and 150,000 shares outstanding for the prior accounting period. The corporation also has outstanding options for 6,000 shares with a strike of $30 per share and the average market price of the common stock during the previous accounting period was $40. Using the Treasury Method, what's the corporation's diluted earnings per share (EPS)? A) $2.267 B) $1.098 C) $2.244 D) $3.987

C) $2.244 When using the Treasury Method to determine diluted EPS, the proceeds from exercising outstanding stock options and warrants must first be calculated. In this question, the proceeds from the exercise of the options equals $180,000 (6,000 shares x $30). Next, it must be assumed that the corporation will buy as many shares as possible using the sales proceeds from the options. The corporation can buy back 4,500 shares ($180,000 proceeds ÷ $40 market price). Finally, the number of shares the corporation will issue to fulfill the options must be calculated (i.e., the number of shares that it was unable to buy back). In this question, the corporation needed 6,000 shares, but only bought back 4,500. Therefore, the issuer needs to create 1,500 (6,000 - 4,500) additional shares, which will be added to shares outstanding in order to calculate diluted EPS. To calculate the diluted earnings per share, the $340,000 of net income for the year is divided by 151,500 shares (150,000 shares plus 1,500 new shares), which equals $2.244 per share.

Hamilton Golf Industries Income Statement ($ millions) Sales 198.000 Cost of Goods Sold 104.000 Xxxxxx 94.000 Operating Expenses 61.000 Xxxxxx 33.000 Interest Expense 12.000 Taxes 6.300 Xxxxx 14.700 Preferred Dividend 0.525 Xxxxx 14.175 Common Dividend 1.160 Xxxxx 13.015 Shareholder Information Preferred Stock ($50 Par) 7.500 Common Stock ($1.00 Par) 3.000 Additional Paid-In Capital 57.000 Treasury Stock (100,000 Shares) (2.500) Retained Earnings 126.550 What is Hamilton Golf Industries' Return on Common Equity? A) 6.8% B) 7.0% C) 7.7% D) 8.0%

C) 7.7% 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.

Stuart Corp. is popular with income investors because it has a high dividend payout ratio. It is also known for making acquisitions annually. Future dividends would be vulnerable if: A) Margins came under seasonal pressure B) A plant shut down for retooling C) A company recently acquired has an underfunded pension plan D) The payout ratio currently equals 100% percent of earnings

C) A company recently acquired has an underfunded pension plan An underfunded pension plan would cause Stuart Corp. to use cash to bolster the pension plan, which would have a higher priority than the maintenance of the cash dividend. The fund could be underfunded because of poor performance, lengthening mortality of current and retired employees, and overly generous benefits. In addition, some businesses keep the discount rate used to determine the present value of those benefits artificially high; when it is lowered to a more realistic level, the plan may suddenly become underfunded.

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.

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 INCORRECT 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).

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 CORRECT ANSWER CHOSEN 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 Average variable costs plus average fixed costs equal average total cost. Diminishing returns occur when average total costs begins to rise. (18004)

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.

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 INCORRECT ANSWER CHOSEN Company Y's stock price is likely to decline. The expectation of pricing pressure by the now-merged customers and the reduction of spending as a result of cost synergies would lead to an expectation of reduced revenues for Company Y.

The payment of a stock dividend causes a change in the balance sheet entries for: A) Current Assets B) Total Liabilities C) Shareholder Equity D) EPS

C) Shareholder Equity INCORRECT ANSWER CHOSEN The payment of a stock dividend will create a change within components of shareholder equity. Retained earnings will decline, while the common stock account and additional paid-in capital will increase. Assets and liabilities will not change based on a stock dividend. EPS will decline, but this measurement is not a balance sheet entry.

What is capital spending?

CapEx

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.

RBG Corporation has earnings per share of $4.20 and has 1.5 million shares outstanding. If a 20% stock dividend is paid, what's RBG's new earnings per share? A) $1.80 per share B) $4.20 per share C) $3.36 per share D) $3.50 per share

D) $3.50 per share INCORRECT ANSWER CHOSEN Originally, RBG's earnings equal $6.3 million, which is calculated by multiplying the 1.5 million shares outstanding by the earnings per share of $4.20. There will be no change to the aggregate earnings as a result of the stock dividend. Instead, the same amount of earnings will be distributed over an increased number of shares outstanding. After the 20% stock dividend, 300,000 new shares are created (1.5 million x 20%) and shares outstanding increases to 1.8 million (1.5 million + 300,000). As a result, the new EPS is $3.50 ($6.3 million earnings divided by 1.8 million shares).

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? Common Equity 2020 Net Income: 350 Common dividends: 30 Common equity (year-end): 1,850 A) 17.3% B) 18.9% C) 20% D) 20.7%

D) 20.7% 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).

CWG Corporation has a PEG of 1.40. Its EPS is $1.85 and the analyst is estimating that next year's EPS will be $2.05. Based on this information, the analyst's price target for CWG is: A) 10 B) 15 C) 28 D) 31

D) 31 To calculate the price target, first find the growth rate, then the price earnings ratio, and then multiply this number by the EPS estimate. The growth rate is $2.05 - $1.85 = .20/$1.85 = .108 or 10.8%. To find the P/E ratio, multiply the growth rate by the PEG (10.8 x 1.40 = 15.1). Next, multiply the P/E ratio by the EPS estimate (15.1 x $2.05 = 30.96 rounded to the nearest whole number, 31).

Using the information in the table below, how many years would it take for a company to be come profitable? Startup Costs $10,000 Average Sale Price per Unit $50 Variable Cost Per Unit Sold $10 Contribution Margin $40 Estimated Unit Sales per Year 58 Estimated Sales per Year $2,900 A3.4 years B3.6 years C) 2.5 years D) 4.3 years

D) 4.3 years The breakeven point can be calculated by taking fixed costs and dividing by the contribution margin (Breakeven Point = Fixed Costs/Contribution Margin). Contribution margin for a product is the sales price per unit less variable costs per unit (Contribution Margin = Sales Price - Variable Unit Costs). In this question, the fixed costs are $10,000 and the contribution margin is $40 ($50 sales price per unit - $10 variable cost per unit); therefore, the company will breakeven when it sells 250 units, which is $12,500 in total sales (250 units x $50 sales price per unit). The company estimates total annual sales of $2,900; therefore, it will breakeven in approximately 4.3 years ($12,500 sales to breakeven / $2,900 annual sales = 4.310 years).

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

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

An easing of money and credit in the economy is likely the result of which of the following? A) Increasing reserve requirements B) Increasing the discount rate C) The Fed selling securities in open market transactions D) Decreasing the discount rate

D) Decreasing the discount rate An easing of money and credit in the economy means that more money is available and interest rates are decreasing. Decreasing the discount rate means that banks can borrow from the Fed at a lower rate. Banks can then lend money out at a lower rate, thereby making more money available to consumers. Increasing the discount rate, increasing the reserve requirement, and the Fed selling securities are all ways to tighten the money supply which leads to higher interest rates.

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 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.

Which event is LEAST likely to increase the risk of investing in a financial services firm that securitizes debt into tranches? A) Increased mortgage default rates B) Changes in laws governing securitization C) Lower interest rates D) Unemployment decreases

D) Unemployment decreases When evaluating a financial services company, it is necessary to evaluate the risks underlying the products created by, marketed through, or invested in by, the company. A decrease in unemployment rates is a positive event when evaluating securitization risk. Increased mortgage default rates increase the overall risk, due to declining creditworthiness. Changes in laws governing securitization may have a significant impact on the instruments.

Does Treasury Stock increase or decrease stockholders equity?

Decrease

How does Diminshing costs occur?

Diminishing returns occur when average total costs begins to rise.

What is is used as a measure for the cash to pay creditors?

EBIT

Current FCFE Target

Earnings per share + Depreciation and amortization. - Projected capital expenditures - Increase in working capital. = FCFE FCFE/(Expected Rate of Return - Expected Growth Rate)

Breakeven

Fixed Costs/Contribution Margin

What is used as a measure of cash available to shareholders?

Free Cash Flow based on net income

Nominal GDP

GDP that isn't adjusted for inflation

If available for sale securities are sold

If "available-for-sale" securities are sold, the only impact is on the income statement.

Available For Sale

If a company has investments which are classified as "available for sale," this means that the company intends to retain these securities for a period, rather than trade the securities or hold them to maturity. They're required to be recorded on the balance sheet at fair value versus cost value.

A company with a higher operating leverage can increase or decrease margins

Increase Margins

Real GDP

Inflation-adjusted value of GDP using constant dollars

Company H has shown an increase in its operating margin, while the EPS, common stock price, and net income remain the same what happened?

It issued debt

What does a reduction in depreciation do?

It will increase net income which normally leads to an increase in retained earnings.

Expensing Costs

Lowers earnings by expensing on income statement. EX: while writing off goodwill through impairment (as opposed to amortizing over a length

Easing of money and credit

Means that more money is available and interest rates are decreasing

Return on Capital/ ROIC

NOPAT/Invested Capital

Relative Valuation

P/E Price/Book

Finance Lease or Capital Lease

Part of the lease payment is interest expense and the remainder is loan amortization. It hits the balance sheet and depreciates over time. Finance lease expenses typically decline over the lease term since interest expense will fall and depreciation will remain constant.

Contribution Margin

Sales - variable Costs

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

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. Equity value can be calculated from enterprise value by subtracting debt and adding cash. Because MackLear has invested capital of $4 billion and a debt to equity ratio of 100%, the debt is 50% of total capital. For example, if debt is 100% of equity, then there must be 100 units of debt for every 100 units of equity; therefore, total capital would be debt + equity or 100 units of debt + 100 units of equity, which equals 200 units of total capital. 100 units of debt as a percentage of 200 units of total capital, equals 50% of total capital (100 / 200). Given that MackLear has $4 billion of total capital, 50% of total capital equals $2 billion of debt. 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.

Operating Lease

With an operating lease, a corporation will recognize its lease payments as an operating expense in the income statement. In addition, operating lease payments will remain constant over the lease's term. Operating lease expenses will typically remain constant over the life of the lease.

Operating Leverage

fixed costs/total costs

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 the second business day following the transaction.

Unlevered Beta

levered beta / (1 + [(1 - tax rate) x (debt/equity)])

Levered Beta

unlevered beta x (1 + [(1 - tax rate) x (debt/equity)])