FINC Statements

As a firm progresses through the decline life-cycle stage, what type of flexible account will it be more likely to use to balance the balance sheet? a. stock repurchase b. issued debt c. issued equity d. growth related assets

a. stock repurchase

Assuming that Ska Company's cost of equity capital is 18% and it expects to grow earnings at a rate of 10% per year, we would expect Ska's P/E ratio to be: a. 11.5 b. 12.5 c. 10.0 d. 14.0

b. 12.5

The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions): Total assets $37,460 Interest-bearing debt $3,652 Average pre-tax borrowing cost 8.5% Common equity: Book value $2,950 Market value $14,000 Income tax rate 35% Market equity beta 1.10 Using the above information, calculate Zonk's weighted-average cost of capital: a. 14.0% b. 8.08% c. 10.90% d. 9.84%

b. 8.08%

The dividends-based valuation approach cannot be used for firms that do not pay dividends. a. True b. False

b. False

As a firm progresses through the introduction stage of its life cycle, what type of financial flexible account will it be more likely to use to balance the balance sheet? a. Dividends b. Issued equity c. Share repurchases d. Property, plant & equipment

b. Issued equity

Ch 14 Using the value-to-book version of the residual income valuation approach, the value-to-book ratio is determined as a. book value of common equity capital at the beginning of the period multiplied by the required rate of return on common equity capital. b. one plus the present value of future residual ROCE. c. market value of common equity plus the present value of expected future residual income. d. one plus the present value of future comprehensive income divided by book value of common equity.

b. one plus the present value of future residual ROCE.

Sparky's sells auto parts. Provided below is selected financial information from the company's annual report: Sparky's Selected Financial Statement data Fiscal year end Year 2 Year 1 (amounts in thousands of dollars) Net sales $125,410 $106,380 Cost of Goods Sold -104,090 -89,359 Gross Profit $21,320 $17,021 Inventory $15,000 $14,000 Using Sparky's financial information what is the company's inventory turnover ratio for Year 2? a. 0.14 b. 6.94 c. 7.18 d. 8.36

c. 7.18

Projecting sales price changes depends on factors specific to the firm and its industry that might affect demand and price elasticity. Which of the following types of companies would most likely be able to increase prices? a. A firm in a capital intensive industry in which excess capacity exists. b. A firm operating in an industry that is expected to experience technological improvements in its production process. c. A firm in a capital intensive industry that is expected to operate near capacity for the near future. d. A firm operating in an industry that is transitioning from the high growth to the maturity phase of its life cycle.

c. A firm in a capital intensive industry that is expected to operate near capacity for the near future.

Which of the following ratios give a perspective on risk in the capital structure? a. Book value per share b. Price/earnings ratio c. Degree of financial leverage d. Dividend yield

c. Degree of financial leverage

Investors typically accept a lower risk-adjusted rate of return on debt capital than on equity capital because: a. equity capital costs are tax deductible. b. the yield to maturity on equity is inversely related to its market value. c. equity claims bear more risk than fixed claims on debt obligations. d. equity bears less residual risk than debt.

c. equity claims bear more risk than fixed claims on debt obligations.

Financial assets include all of the following except: a. long-term investments b. short term investments c. land d. excess cash

c. land

Suppose a firm has a beta of 1.25, the risk-free yield on long-term government securities is 4.0%, and the market-risk premium is 6.0%. The expected return under the CAPM is a. 4.0%. b. 6.0%. c. 7.5%. d. 11.5%.

d. 11.5%.

Under the CAPM, the expected rate of return compensates investors for a. unsystematic risk. b. systematic risk. c. the time value of money. d. both systematic risk and the time value of money.

d. both systematic risk and the time value of money.

At the beginning of 2017, investors had invested $25,000 of common equity in Grant Corp. and expect to earn a return of 11% per year. In addition, investors expect Grant Corp. to pay out 100% of income in dividends each year. Forecasts of Grant's net income are as follows: 2017: $3,500 2018: $3,200 2019: $2,900 2020 and beyond: $2,750 (no growth) Use this information to compute Grant Corp.'s expected continuing value, based on expected residual income in the year 2020 and beyond. a. $0 b. $25,000 c. $150 d. $2,900

a. $0

t the beginning of Year 2 investors had invested $100,000 of common equity in Jan Corp. and expect to earn a return of 15% per year. In addition, investors expect Jan Corp. to pay out 100% of income in dividends each year. Forecasts of Jan's net income are as follows: Year 2 - $20,000 Year 3 - $18,000 Year 4 - $16,000 Year 5 and beyond - $15,000 Using this information, what is Jan's residual income valuation at the beginning of Year 2? a. $107,274 b. $157,556 c. $160,000 d. $109,000

a. $107,274

At the beginning of 2017, investors had invested $25,000 of common equity in Grant Corp. and expect to earn a return of 11% per year. In addition, investors expect Grant Corp. to pay out 100% of income in dividends each year. Forecasts of Grant's net income are as follows: 2017: $3,500 2018: $3,200 2019: $2,900 2020 and beyond: $2,750 (no growth) Use this information to compute Grant Corp.'s expected residual income for the year 2019. a. $150 b. -$150 c. $2,900 d. $450

a. $150

Jarrett Corp.At the end of Year 0 Jarrett Corp. developed the following forecasts of net income: Forecasted Year Net Income Year 1 $20,856 Year 2 $22,733 Year 3 $24,552 Year 4 $27,252 Year 5 $29,978 Management believes that after Year 5 Jarrett will grow at a rate of 7% each year. Total common shareholders' equity was $110,000 on December 31, Year 0. Jarrett has not established a dividend and does not plan to paying dividends during Year 1 to Year 5. Its cost of equity capital is 12%. Compute the value of Jarrett Corp. on January 1, Year 1, using the residual income valuation model. Use the half-year adjustment. a. $182,395 b. $172,071 c. $140,300 d. $149,713

a. $182,395

Sparky's sells auto parts. Provided below is selected financial information from the company's annual report: Sparky's Selected Financial Statement data Fiscal year end Year 2 Year 1 (amounts in thousands of dollars) Net sales $125,410 $106,380 Cost of Goods Sold -104,090 -89,359 Gross Profit $21,320 $17,021 Inventory $15,000 $14,000 Sparky's forecasts that sales will grow by 25% in Year 3 and that its cost of goods sold to sales ratio will be the same in Year 3 as it was in Year 2. If these assumptions prove correct and Sparky's inventory turnover ratio for Year 3 is 6.5 what will be the level of inventory at the end of Year 3? a. $25,035 b. $24,117 c. $14,000 d. $20,017

a. $25,035

Project year-end retained earnings for Construction Company for 20X3 based on the following facts: Retained earnings at 31 December 20X2: $126,000 Other comprehensive income items in 20X3: $1,500 Dividends declared in 20X3: $20,000 Net loss for 20X3: ($78,000) Common shares issued in 20X3: $22,000 No other equity transactions in 20X3 a. $28,000 b. $48,000 c. $50,000 d. $29,500

a. $28,000

Plough Corporation reports the following information: Net cash provided by operating activities $500,000 Average current liabilities 150,000 Average long-term liabilities 100,000 Dividends paid 80,000 Capital expenditures 140,000 Payments of debt 35,000 Plough's free cash flow is: a. $280,000 b. $245,000 c. $420,000 d. $325,000

a. $280,000

Assume that a firm had shareholders' equity on the balance sheet at a book value of $3,600 at the beginning of the year. During the year the firm earns net income of $360, pays dividends to shareholders of $60, and uses $200 to repurchase common shares. The book value of shareholders' equity at the end of the year is: a. $3,700 b. $4,220 c. $4,100 d. $3,900

a. $3,700

Jarrett Corp.At the end of Year 0 Jarrett Corp. developed the following forecasts of net income: Forecasted Year Net Income Year 1 $20,856 Year 2 $22,733 Year 3 $24,552 Year 4 $27,252 Year 5 $29,978 Management believes that after Year 5 Jarrett will grow at a rate of 7% each year. Total common shareholders' equity was $110,000 on December 31, Year 0. Jarrett has not established a dividend and does not plan to paying dividends during Year 1 to Year 5. Its cost of equity capital is 12%. What would be Jarrett's residual income in Year 5? a. $4,998 b. $22,358 c. $5,543 d. $5,789

a. $4,998

Check My Work Card Sharks, Inc., maintains a cash balance equivalent to 30 days of sales. Sales in 20X1 amounted to $352,412 and the company expects growth in 20X2 of 33% and in 20X3 of 40%. Given the information provided, what is Card Sharks' projected 2013 sales? a. $656,191 b. $187,483 c. $542,333 d. $493,377

a. $656,191

At the beginning of 2017, investors had invested $25,000 of common equity in Grant Corp. and expect to earn a return of 11% per year. In addition, investors expect Grant Corp. to pay out 100% of income in dividends each year. Forecasts of Grant's net income are as follows: 2017: $3,500 2018: $3,200 2019: $2,900 2020 and beyond: $2,750 (no growth) Use this information to compute Grant Corp.'s expected residual income for the year 2017. a. $750 b. $2,750 c. $3,500 d. -$750

a. $750

A company is expected to generate $175,000 in earnings next period and requires a 20% return on equity capital. Using the assumptions of the price-earnings ratio, what would be the company's value at the beginning of next period? a. $875,000 b. $2,000,000 c. $1,250,000 d. $781,250

a. $875,000

The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions): Total assets $7,460 Interest-bearing debt $4,334 Average pre-tax borrowing cost 10.5% Common equity: Book value $2,950 Market value $13,003 Income tax rate 35% Market equity beta 1.13 Determine the weight on debt capital that should be used to calculate Zonk's weighted-average cost of capital: a. 25.0% b. 21.7% c. 50.0% d. 58.2%

a. 25.0%

The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions): Total assets $7,460 Interest-bearing debt $3,652 Average pre-tax borrowing cost 10.5% Common equity: Book value $2,950 Market value $13,685 Income tax rate 35% Market equity beta 1.10 Assume that Zonk is a potential leveraged buyout candidate. Assume that the buyer intends to put in place a capital structure that has 80 percent debt with a pretax borrowing cost of 14 percent and 20 percent common equity. Compute the revised equity beta for Zonk based on the new capital structure. a. 7.26 b. 9.10 c. 7.70 d. 6.60

a. 7.26

Total assets $7,460 Interest-bearing debt $3,652 Average pre-tax borrowing cost 10.5% Common equity: Book value $2,950 Market value $13,685 Income tax rate 35% Market equity beta 1.10 Assume that Zonk is a potential leveraged buyout candidate. Assume that the buyer intends to put in place a capital structure that has 80 percent debt with a pretax borrowing cost of 14 percent and 20 percent common equity. Compute the weighted average cost of capital for Zonk based on the new capital structure. a. 8.94% b. 7.26% c. 7.28% d. 9.94%

a. 8.94%

The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions): Total assets $7,460 Interest-bearing debt $3,652 Average pre-tax borrowing cost 10.5% Common equity: Book value $2,950 Market value $13,685 Income tax rate 35% Market equity beta .60 Assuming that riskless rate is 4.6% and the market premium is 7.3%, calculate Zonk's cost of equity capital: a. 8.98% b. 10.5% c. 6.8% d. 11.9%

a. 8.98%

Describe which types of cash flows are not free for common equity shareholders? a. Cash flows required to repay debt principal and cash flows required to pay interest expense b. Cash flows received from issuing debt c. Cash flows available to pay dividends d. Cash flows received from issuing preferred stock

a. Cash flows required to repay debt principal and cash flows required to pay interest expense

The historical discount rate of the firm may be a good indicator of the appropriate discount rate to apply to the firm in the future, when all of the following conditions hold true except: a. Expected future interest rates are likely to exceed current interest rates. b. The existing capital structure of the firm is the same as the expected future capital structure of the firm. c. The current mix of debt and equity financing remains the same. d. The current risk of the firm is the same as the expected future risk of the firm.

a. Expected future interest rates are likely to exceed current interest rates.

Explain the concept of "free" cash flows. What makes them "free"? a. Free cash flows are cash flows that are generated by the operations of the firm and, after making necessary investments in future operating and investing activities, are unencumbered and available to be distributed to shareholders and debtholders. b. Free cash flows are simply measured as cash flows from operating activities plus or minus cash flows from investing activities on the statement of cash flows. c. Free cash flows emanate from the balance sheet, after projecting how all of the assets and liabilities will generate future cash flows. d. Free cash flows are cash flows already owned by the firm, and so the firm does not have to incur costs to raise these cash flows.

a. Free cash flows are cash flows that are generated by the operations of the firm and, after making necessary investments in future operating and investing activities, are unencumbered and available to be distributed to shareholders and debtholders.

Which of the following ratios usually reflects investor's opinions of the future prospects for the firm? a. Price/earnings ratio b. Earnings per share c. Book value per share d. Dividend yield

a. Price/earnings ratio

Describe circumstances when free cash flows to equity shareholders and free cash flows to all debt and equity stakeholders will be identical. a. When the firm is only financed by common shareholders' equity, with no outstanding debt or preferred stock b. When the capital structure is exactly balanced, with 50% debt financing and 50% equity financing c. When the cost of debt capital is exactly equal to the required rate of return on equity, according to the CAPM d. During the start-up phase of life, when free cash flows for both debt and equity will typically be negative

a. When the firm is only financed by common shareholders' equity, with no outstanding debt or preferred stock

A firm that is increasing its capital structure leverage and increasing profitability will likely experience a (an) a. increasing value-to-book ratio b. decreasing return on assets c. volatile price-earnings ratio d. None of these answer choices are correct.

a. increasing value-to-book ratio

Financial statement forecasts rely on additivity within financial statements and articulation across financial statements. Given this information, forecasts of future growth in accounts payable is most likely impacted by growth in: a. inventory. b. depreciation. c. salary payable. d. accounts receivables.

a. inventory.

Under the value-to-book model a firm in steady state equilibrium earning ROCE = RE will: a. maintain shareholder wealth and be valued at book value. b. destroy shareholder wealth and be valued below book value. c. create additional shareholder wealth and be valued above book value. d. be in a no-growth state

a. maintain shareholder wealth and be valued at book value.

The objective of forecasting is to develop: a. realistic expectations for the outcomes of a firm's future business activities. b. stand-alone financial statements for future analysis. c. financial statements for comparison to industry averages. d. a balance sheet and income statement that articulate.

a. realistic expectations for the outcomes of a firm's future business activities.

An equity security with systematic risk equal to the average amount of systematic risk of all equity securities in the market: a. should expect to earn the same rate of return as the average stock in the market portfolio. b. has a market beta greater than one. c. gives no insight into the risk premium of stock. d. has a market beta less than one.

a. should expect to earn the same rate of return as the average stock in the market portfolio.

To ensure that the financial statements articulate, it is important that the projected change in the cash balance on the balance sheet each year agrees with a. the net change in cash on the projected statement of cash flows. b. the cash collections from sales in the projected income statement. c. the cash provided by or used by operations on the projected statement of cash flows. d. the net change in working capital from period to period.

a. the net change in cash on the projected statement of cash flows.

Card Sharks, Inc. sells baseball cards and other memorabilia. The company tries to maintain a cash balance equivalent to approximately 30 days of sales. Sales in Year 1 amounted to $352,000 and the company expects growth in Year 2 of 20% and in Year 3 of 25%. Given the information provided about Card Sharks, what is the company's Year 3 projected year-end cash balance? a. $1,157 b. $43,397 c. $34,718 d. $50,834

b. $43,397

Suppose for a particular year a firm had comprehensive income of $9,000, a beginning book value of equity of $76,000, and an ending book value of equity of $77,000. Using the clean surplus accounting relation, how much were the firm's dividends that year? a. $85,000 b. $8,000 c. $9,000 d. $0

b. $8,000

Residual income is defined as: a. The addition of comprehensive income to net income for the year b. Difference between expected comprehensive income and required earnings by the firm c. Difference between comprehensive income and the company's book value d. Difference between comprehensive income and retained earnings

b. Difference between expected comprehensive income and required earnings by the firm

The free cash flow-based valuation approach cannot be used for firms that generate negative cash flows. a. True b. False

b. False

How do free cash flows available for debt and equity stakeholders differ from free cash flows available for common equity shareholders? a. Free cash flows available for debt and equity stakeholders are always larger than free cash flows available for common equity shareholders in every year. b. Free cash flows available for debt and equity stakeholders include cash flows that are available to repay debtholders, whereas free cash flows available for common equity shareholders do not. c. Free cash flows available for debt and equity stakeholders subtract cash flows paid for interest expense (after tax), whereas free cash flows available for common equity shareholders add cash paid for interest expense. d. All of these answer choices are correct

b. Free cash flows available for debt and equity stakeholders include cash flows that are available to repay debtholders, whereas free cash flows available for common equity shareholders do not.

If the firm borrows cash by issuing debt, how does that transaction affect free cash flows for common equity shareholders? a. Borrowing should increase the firm's leverage and risk, and therefore the expected return for equity shareholders. b. In that period, borrowing increases cash flows available for equity shareholders but reduces the available cash flows in future periods when the debt must be repaid. c. Borrowing affects cash flows for debtholders but not equity holders. d. Borrowing creates additional cash flows from tax savings from interest and principal payments.

b. In that period, borrowing increases cash flows available for equity shareholders but reduces the available cash flows in future periods when the debt must be repaid.

Suppose you are seeking to value a stream of expected future cash flows that will be used to pay all future debt and equity holder financing claims. What is the appropriate discount rate? a. 6.0% b. The weighted-average cost of capital c. The required rate of return on equity, according to the CAPM d. 12.0%

b. The weighted-average cost of capital

Forecasting financial statements requires identifying financial flexibility in order to project how the firm will a. increase assets and earnings. b. balance future resources with future claims on resources. c. generate profitable growth and cash flows. d. All of these answer choices are correct

b. balance future resources with future claims on resources.

As a firm progresses through the introduction life-cycle stage, what type of flexible account will it be more likely to use to balance the balance sheet? a. stock buy-backs b. capital c. growth related assets d. dividends

b. capital

Free cash flow is calculated as net cash provided by operating activities less: a. depreciation. b. capital expenditures and dividends. c. interest. d. income taxes.

b. capital expenditures and dividends.

A firm's value-to-book ratio might be greater than 1.0 due to fundamental reasons. An example of a fundamental reason that would cause the value-to-book ratio to increase is a. growth in shareholders' equity by issuing stock. b. creating growth in profitable operations that generate ROCE that exceeds RE. c. increasing risk. d. being profitable.

b. creating growth in profitable operations that generate ROCE that exceeds RE.

The theory supporting dividends-based valuation is a. dividends represent the free cash flows into the firm. b. dividends are value-relevant to common equity shareholders because the dividends are cash flows directly to the equity shareholders. c. dividends are equivalent to the difference between the comprehensive income and the required income ("normal earnings") of the firm. d. dividends are established by the policies of the managers and the board of directors of the firm.

b. dividends are value-relevant to common equity shareholders because the dividends are cash flows directly to the equity shareholders.

If a firm's stock returns co-vary identically with returns to a market-wide portfolio, then its market beta from such a regression is: a. less than one. b. equal to one. c. greater than one. d. equal to zero.

b. equal to one.

The theory supporting free cash flow-based valuation is that a. free cash flows are equivalent to the difference between the comprehensive income and the required income ("normal earnings") of the firm. b. free cash flows into the firm are value-relevant to common equity shareholders because they represent the cash flows that will be available to pay future dividends to the equity shareholders. c. free cash flows represent firm performance and how well the firm is generating value for shareholders each year. d. cash is cash. Cash is king.

b. free cash flows into the firm are value-relevant to common equity shareholders because they represent the cash flows that will be available to pay future dividends to the equity shareholders.

A firm's market-to-book ratio might be greater than 1.0 due to accounting reasons. An example of an accounting reason that would cause the market-to-book ratio to increase is a. straight-line methods of depreciation. b. off-balance-sheet assets arising from investments in successful research and development programs that are expensed according to conservative accounting principles. c. level 1 fair values. d. using LIFO versus FIFO for inventory.

b. off-balance-sheet assets arising from investments in successful research and development programs that are expensed according to conservative accounting principles.

Under the cash-flow-based valuation approach, free cash flows can be used instead of dividends as the expected future payoffs to the investor in the numerator of the general valuation model because: a. this approach focuses on wealth distribution to shareholders. b. over the life of the firm, the free cash flows into the firm and cash flows paid out of the firm in dividends to shareholders will be equivalent. c. this approach focuses on earnings as a measure of the capital that a firm creates. d. over the life of the firm, the free cash flows out of the firm for investments and cash flows paid into the firm in dividends from these investments are the same.

b. over the life of the firm, the free cash flows into the firm and cash flows paid out of the firm in dividends to shareholders will be equivalent.

If an analyst wants to value a potential investment in the common stock equity of a firm, the analyst should discount the projected free cash flows at the: a. market risk premium. b. required return on equity capital. c. weighted average cost of capital. d. risk-free rate.

b. required return on equity capital.

When projecting operating expenses, it is important to determine the mix of fixed and variable costs. One clue suggesting the presence of fixed costs in cost of goods sold is a. low capital intensity in the production process. b. that the percentage increase in cost of goods sold in prior years is significantly less than the percentage increase in sales. c. that the percentage increase in cost of goods sold in prior years is significantly greater than the percentage increase in sales. d. that the percentage increase in sales in prior years is significantly greater than the percentage increase in receivables.

b. that the percentage increase in cost of goods sold in prior years is significantly less than the percentage increase in sales.

Residual income is measured as a. reported comprehensive income. b. the difference between the comprehensive income and the required income ("normal earnings") of the firm. c. the difference between the comprehensive income and the reported income of the firm. d. the book value of common equity capital at the beginning of the period multiplied by the required rate of return on common equity capital.

b. the difference between the comprehensive income and the required income ("normal earnings") of the firm.

When a firm has a value-to-book ratio that is greater than 1, it implies a. the firm must be very profitable. b. the firm's shares may be overpriced, underpriced, or correctly priced, depending on how the value-to-book ratio compares to the market-to-book ratio. c. the firm's shares are overpriced. d. the firm's shares are underpriced.

b. the firm's shares may be overpriced, underpriced, or correctly priced, depending on how the value-to-book ratio compares to the market-to-book ratio.

If an analyst wants to value a potential investment in the net operating assets of a division of another firm, the analyst should discount the projected free cash flows at the: a. cost of equity capital. b. weighted average cost of capital. c. cost of debt capital. d. risk-free rate.

b. weighted average cost of capital.

A company is expected to have a value of $150,000 at the start of next period and investors require a 8 percent return on equity capital. Using the assumptions of the price-earnings ratio, what would be the company's earnings for the current year? a. $12,500 b. $15,000 c. $12,000 d. $20,000

c. $12,000

Plough Corporation reports the following information: Net cash provided by operating activities $500,000 Average current liabilities 150,000 Average long-term liabilities 100,000 Dividends paid 60,000 Capital expenditures 110,000 Payments of debt 35,000 Sun's free cash flow is: a. $440,000 b. $295,000 c. $330,000 d. $355,000

c. $330,000

Card Sharks, Inc., maintains a cash balance equivalent to 30 days of sales. Sales in 20X1 amounted to $352,412 and the company expects growth in 20X2 of 33% and in 20X3 of 40%. Given the information provided, what is Card Sharks' 20X2 projected year-end cash balance? a. $28,965 b. $966 c. $38,524 d. $15,623

c. $38,524

At the beginning of 2017, investors had invested $25,000 of common equity in Grant Corp. and expect to earn a return of 11% per year. Forecasts of Grant's net income are as follows: 2017: $3,500 2018: $3,200 2019: $2,900 2020 and beyond: $2,750 (no growth) Use the information above to compute Grant Corp.'s expected residual income for the year 2019, but assume that Grant pays zero dividends in 2017 and 2018. a. $587 b. $2,750 c. -$587 d. $2,900

c. -$587

Wolverwine Company's current stock price is $40 per share and the company's trailing earnings per share were $3.50. Given that analysts are forecasting growth of 10% for Wolverwine, what is the company's PEG ratio? a. 1.52 b. 14.00 c. 1.14 d. .09

c. 1.14

In forecasting revenue, projecting changes in future selling prices for a firm's products depends on factors specific to the firm and its industry that might affect demand and price elasticity. Which of the following companies would most likely not be able to increase prices in the near future? a. A firm operating in an industry that is expected to maintain its current production processes. b. A firm in a capital-intensive industry that is expected to operate near capacity. c. A firm in a capital-intensive industry in which excess capacity exists. d. A firm operating in an industry that is transitioning from the introduction phase to the high-growth phase of its life cycle.

c. A firm in a capital-intensive industry in which excess capacity exists.

A firm's price-earnings ratio will a. increase sharply when a firm recognizes a temporary decrease in earnings per share. b. decrease sharply when a firm recognizes a temporary increase in earnings per share. c. Either an increase or a decrease can happen. d. Neither an increase nor a decrease can happen.

c. Either an increase or a decrease can happen.

As a firm progresses through the maturity stage of its life cycle, what type of financial flexible account will it be more likely to use to balance the balance sheet? a. Issued debt b. Issued equity c. Share repurchases d. Property, plant & equipment

c. Share repurchases

As a firm progresses through the growth life-cycle stage, what type of flexible account will it be more likely to use to balance the balance sheet? a. paying down of debt b. dividends c. additional debt d. stock buy-backs

c. additional debt

Under the residual income valuation approach, the value of common equity is determined as a. book value of common equity capital at the beginning of the period multiplied by the required rate of return on common equity capital. b. book value of common equity plus the present value of future free cash flows to common equity shareholders. c. book value of common equity plus the present value of expected future residual income. d. book value of common equity plus the present value of future comprehensive income.

c. book value of common equity plus the present value of expected future residual income.

If the market expects a firm to generate net income each period exactly equal to required earnings (ROCE = RE), then the value-to-book ratio of the firm will be a. greater than the price-earnings ratio of the firm. b. a multiple of the book value of common shareholders' equity. c. exactly equal to one. d. less than the price-earnings ratio of the firm.

c. exactly equal to one.

If an analyst wants to value a potential investment in the common stock equity in a firm, the relevant cash flows the analyst should use are: a. cash flow from operations. b. free cash flow from operations. c. free cash flows to common equity shareholders. d. free cash flows for all debt and equity capital stakeholders.

c. free cash flows to common equity shareholders.

If an analyst expects a firm to generate net income each period greater than required earnings, then the value of the firm will be: a. equal to working capital. b. less than the book value of common shareholders' equity. c. greater than the book value of common shareholders' equity. d. equal to the book value of common shareholders' equity.

c. greater than the book value of common shareholders' equity.

A very high degree of capital market efficiency a. means share prices always correctly reflect all available information. b. the capital markets anticipate and price correctly all possible future payoffs and states of the world. c. means share prices react quickly, completely, and without bias once new value-relevant information is available to the market. d. mispricing never occurs.

c. means share prices react quickly, completely, and without bias once new value-relevant information is available to the market.

Companies value-to-book and market-to-book ratios may differ due to accounting reasons. An example of an accounting reason that would create a difference is: a. high operating leverage. b. using LIFO versus FIFO for inventory. c. off-balance sheet brand assets. d. accelerated methods of depreciation.

c. off-balance sheet brand assets.

Ch 13 Required income is measured as a. the difference between the comprehensive income and the required income ("normal earnings") of the firm. b. the difference between the comprehensive income and the reported income of the firm. c. the book value of common equity capital at the beginning of the period multiplied by the required rate of return on common equity capital. d. reported comprehensive income.

c. the book value of common equity capital at the beginning of the period multiplied by the required rate of return on common equity capital.

Equity valuation models based on dividends, cash flows, and earnings have been the topic of many theoretical and empirical research studies in recent years. All of the following are true regarding evidence from these studies except a. share prices do not always equal share values. b. share prices in the capital markets generally correlate closely with share value. c. unexpected changes in earnings do not correlate with changes in stock prices. d. temporary deviations of price from value occur.

c. unexpected changes in earnings do not correlate with changes in stock prices.

If a company has very low operating leverage (i.e., a low proportion of fixed costs in the cost structure) and no changes are expected in operations, then a. using common-size income statement percentages will understate future projected operating expenses. b. rate of change income statement percentages can serve as a good basis for projecting operating expenses. c. using common-size income statement percentages can serve as a reasonable basis for projecting future operating expenses. d. using common-size income statement percentages will overstate future projected operating expenses.

c. using common-size income statement percentages can serve as a reasonable basis for projecting future operating expenses.

Jarrett Corp.At the end of Year 0 Jarrett Corp. developed the following forecasts of net income: Forecasted Year Net Income Year 1 $20,856 Year 2 $22,733 Year 3 $24,552 Year 4 $27,252 Year 5 $29,978 Management believes that after Year 5 Jarrett will grow at a rate of 7% each year. Total common shareholders' equity was $110,000 on December 31, Year 0. Jarrett has not established a dividend and does not plan to paying dividends during Year 1 to Year 5. Its cost of equity capital is 12%. What would be Jarrett's common shareholders' equity at the end of Year 5? a. $208,161 b. $95,540 c. $135,126 d. $238,139

d. $238,139

At the beginning of Year 2 investors had invested $24,000 of common equity in Grant Corp. and expect to earn a return of 10% per year. In addition, investors expect Grant Corp. to pay out 100% of income in dividends each year. Forecasts of Grant's net income are as follows: Year 2 - $3,100 Year 3 - $2,900 Year 4 - $2,700 Year 5 and beyond - $2,400 Using this information, what is Grant's residual income valuation at the beginning of Year 2? a. $34,373 b. $22,500 c. $25,500 d. $25,275

d. $25,275

Assume that a firm had shareholders' equity on the balance sheet at a book value of $3,600 at the beginning of the year. During the year the firm earns net income of $360, pays dividends to shareholders of $60, and issues new stock to raise $200 of capital. The book value of shareholders' equity at the end of the year is: a. $3,900 b. $3,700 c. $4,220 d. $4,100

d. $4,100

If investors have invested $25,000 of common equity in a company and it is determined that the required earnings of the company are $2,250 each period, then investors must expect to earn what return? a. the risk free rate b. the market premium c. 6.25% d. 9%

d. 9%

Conceptually, why should you expect valuation based on dividends and valuation based on the free cash flows for common equity shareholders to yield identical value estimates? a. Both approaches use the same data and forecasts for the same company. b. Both approaches should use the same discount rates and long-term growth rates. c. The free cash flows available for common equity shareholders will be the future cash flows the firm has available to pay future dividends and repurchase shares. d. All of these answer choices are correct.

d. All of these answer choices are correct.

Price-earnings valuation multiples make the following strong assumptions: a. Earnings are persistent, not transitory. b. Current period earnings will be constant in the future. c. The cost of equity capital will remain constant in the future. d. All of these answer choices are correct.

d. All of these answer choices are correct.

Reverse engineering share prices is an exercise in deductive reasoning. If we assume market price reflects share value, then through reverse engineering we can infer what the market assumes about a. the expected rate of return on equity capital, holding expected profitability and long-run growth constant. b. the expected profitability, holding the expected rate of return on equity capital and long-run growth constant. c. the expected long-run growth, holding the expected rate of return on equity capital and expected profitability constant. d. All of these answer choices are correct.

d. All of these answer choices are correct.

Suppose a firm holds a competitive advantage in an industry, but the advantage is not likely to be sustainable for more than a few years. As the firm's competitive advantage diminishes, what effect will that have on that firm's residual income? a. No effect b. Increase c. There is not enough information in order to make this determination. d. Decrease

d. Decrease

One rationale for using expected dividends in valuation is: a. Dividends are a necessary payment in order for a firm to have value. b. Dividends are the most reliable measure of value because most companies payout dividends to shareholders. c. Dividend payout ratios are set based on profitability. d. Dividends can be used to compare the future benefits of alternative investment opportunities.

d. Dividends can be used to compare the future benefits of alternative investment opportunities.

If the firm borrows capital from a bank and invests it in assets that earn a return greater than the interest rate charged by the bank, what effect will that have on residual income for the firm? a. Decrease b. There is not enough information in order to make this determination. c. No effect d. Increase

d. Increase

All of the following are steps in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value except: a. Derive forecasts of future earnings from the firm's projected financial statements. b. Analyze the firm's strategy in terms of the competition. c. Assess the quality of the firm's accounting and financial reporting. d. Obtain the national ranking of the firm's banking partners.

d. Obtain the national ranking of the firm's banking partners.

Dividends are value-relevant and we can value firms using the present value of expected future dividends. However, a firm's dividend policy (whether and when it pays dividends) can be irrelevant for valuation under a strong assumption. What is that strong assumption? a. The assumption of continuing growth after the forecast horizon b. The assumption that the firm always issues and repurchases shares for fair value. c. The assumption that the firm will be liquidated at some time in the future d. The assumption that the firm will be able to reinvest capital that is not paid out in dividends, and earn a rate of return equal to the investors' expected rate of return

d. The assumption that the firm will be able to reinvest capital that is not paid out in dividends, and earn a rate of return equal to the investors' expected rate of return

Suppose you are valuing a healthy, growing, profitable firm and you project that the firm will generate negative free cash flows for equity shareholders in each of the next five years. Explain how a free-cash-flows approach can produce positive valuations of a firm that is expected to generate negative free cash flows over the next five years. a. Negative cash flows are a sign of distress; the free cash flows-based valuation approach should not be used for firms in distress. b. You can certainly use the free cash flows-based valuation approach, but you will get a negative value. c. You cannot use the free cash flows-based valuation approach in this case because you will get a negative value. d. You can use the free cash flows-based valuation approach in this case and determine a positive value of the firm as long as the long-run cash flows (beyond the five-year forecast horizon) will be positive.

d. You can use the free cash flows-based valuation approach in this case and determine a positive value of the firm as long as the long-run cash flows (beyond the five-year forecast horizon) will be positive.

Examples of types of risks that are diversifiable within the market-wide portfolio of stocks might include a. the effects of competition on the demand for a firm's products. b. changes in economy-wide prices for specific inputs, like coffee. c. labor strikes. d. all of these answer choices are correct.

d. all of these answer choices are correct.

Under the CAPM, the expected rate of return is based on the following component(s): a. the risk-free rate of return. b. the firm's systematic risk, estimated with the firm's market beta. c. the market risk premium. d. all of these responses are correct.

d. all of these responses are correct.

Examples of types of risks that are nondiversifiable within the market-wide portfolio of stocks might include a. economy-wide inflation. b. recessionary economic conditions. c. technological discoveries in an industry. d. both economy-wide inflation and recessionary economic conditions.

d. both economy-wide inflation and recessionary economic conditions.

Financial statement forecasts rely on additivity within financial statements and articulation across financial statements. Given this information, accounts receivable forecasts are most likely impacted by growth in: a. cost of sales. b. depreciation. c. salaries. d. sales.

d. sales.

A company with a PEG ratio of less than one would be interpreted as having a stock price: a. that is priced to reflect the company's growth prospects. b. that is high relative to the company's growth prospects. c. that is overpriced. d. that is underpriced given earnings and expected earnings growth.

d. that is underpriced given earnings and expected earnings growth.

If a firm's residual income for a particular year is negative, it indicates a. the firm reported a loss on the income statement. b. the firm has a higher than normal expected rate of return on common equity. c. the firm's shares are overpriced. d. the firm generated comprehensive income that did not exceed the required income.

d. the firm generated comprehensive income that did not exceed the required income.

Over the life of a firm, the capital invested in the firm by the shareholders plus the income of the firm will reflect: a. the free cash flows available to shareholders. b. the cash generated from financing activities. c. the dividend paying ability of the firm. d. the value of the firm to shareholders.

d. the value of the firm to shareholders.

Financial liabilities include all of the following except: a. mortgages payable b. bonds payable c. current maturities of long-term debt d. unearned revenue

d. unearned revenue