Series 79 Practice Questions

A banker determines that the transactions in Exhibit 36 are relevant to Jay's Jeans Inc (see Exhibits 60-63). Assuming that Equity Value/LTM Net Income is the best metric and based on the mean of the precedents and on basic shares outstanding, what is a reasonable share price for Jay's Jeans Inc?

$0.57 Explanation: The mean P/E ratio is (12.5 + 14.6 + 16.2 + 13.2)/4 = 14.125, which is then multiplied by the net income of 2,601 and divided by the number of basic shares outstanding to give 14.125 × 2,601/64,440 = $0.57.

Use exhibits 79 through 82 to answer the following question. What is EBIT for FSI Incorporated (FSI) for the year ended November 30, 2012?

$1,180,191,000 Explanation: EBIT is sourced from the income statement. It could also be referred to as operating profit or income from continuing operations. It is located above interest expense and taxes on the income statement and below operating expenses.

Use Exhibit 12 to answer the following question. ABC Co, Inc., with existing balance sheet data as shown, issues $100 million of debt. What is the company's new enterprise value?

$1.21 billion Explanation: Enterprise value is considered independent of capital structure, meaning that changes in a company's capital structure do not affect its enterprise value. If a company raises additional debt that is held on the balance sheet as cash, its enterprise value remains constant as the new debt is offset by the increase in cash (i.e., net debt remains the same). Therefore, if a company raises $100 million of debt, its enterprise value remains the same, as debt increases by $100 million and so does cash. In the enterprise value calculation, cash is subtracted; hence the increase in debt is offset by the increase in cash.

Using the information provided in Exhibit 1, what are Alpha's Company's 2009E Retained Earnings?

$1.275 billion Explanation: Retained earnings are increased by net income and decreased by dividend distributions. As such, 2009 Ending Retained Earnings = 2008 Ending Retained Earnings + 2009 Net Income - 2009 Dividends = $1,200 + $100 - $25 = $1,275.

Consider Exhibit 8. Assuming that M&R Amusement has a share price of $7.45 and 124 million Shares Outstanding, what is its Enterprise Value?

$1.47bn Explanation: The Equity Value is 7.45 × 124 = 923.8. Enterprise Value is then Equity Value + Total Debt - Cash = 923.8 + 580 - 30 = 1,473.8 million = 1.47 billion

Company M refinances $50,000,000 in outstanding bonds from 12% to 7%. What would be the increase to Company M's Net Income, assuming a 40% marginal tax rate?

$1.5 million Explanation: When Company M refinances a 12% bond to 7% it realizes an annual interest savings of 5% x $50,000,000 = $2,500,000. Company M will be required to pay additional taxes on this savings, so the after-tax impact to net income = $2.5 million x (1 - tax rate) = $2.5 million x 60% = $1.5 million.

Use the information in Exhibit 33 to answer the following question. In addition to the financial data listed, Company B's had earnings per share of $.87 during the last twelve months What is its current stock price?

$14.53 Explanation: Current stock price = LTM P/E ratio x LTM EPS = 16.7 x $.87 = $14.53.

At the end of 2013, Company B has retained earnings of $150,000,000. During 2014 the company earns pre-tax income of $25,000,000. Also, in December, 2014, the company declares a dividend of $0.40 per share on 25,000,000 outstanding shares, to be paid in January, 2015. The company has a marginal tax rate of 40% and a corporate tax rate of 28%. What are Company B's retained earnings at the end of 2014?

$155,000,000 Explanation: Ending retained earnings = beginning retained earnings + Net Income - Declared Dividends. Net Income = Pre-tax earnings x (1 - marginal tax rate) = $25,000,000 x (1 - 40%) = $15,000,000. Total dividends = Dividend / share x outstanding shares = $0.40 x 25,000,000 = $10,000,000. Therefore, Ending Retained Earnings = $150,000,000 beginning retained earnings + $15,000,000 net income - $10,000,000 declared dividends = $155,000,000. Note that dividends reduce retained earnings at the time they are declared, even if they are not paid until the following year.

At the end of 2013, Company C has retained earnings of $150,000,000. During 2014 the company earns pre-tax income of $30,000,000. Historically, the company has not paid dividends. However, in December, 2014, the company announces a change in dividend policy whereby beginning in 2015 it will pay $0.40 per share on 20,000,000 outstanding shares, to be paid in January, 2015. The company has a marginal tax rate of 40% and a corporate tax rate of 32%. What is Company C's retained earnings at the end of 2014?

$168,000,000 Explanation: Ending retained earnings = beginning retained earnings + Net Income - Declared Dividends. However, this question is tricky because the company is not actually declaring a dividend. Rather, it is announcing a change in dividend policy and will begin declaring and paying dividends the following year. Therefore, the dividends will not be deducted from retained earnings until they are actually declared. So, ending retailed earnings = beginning retained earnings + net income. Net Income = Pre-tax earnings x (1 - marginal tax rate) = $30,000,000 x (1 - 40%) = $18,000,000. Ending Retained Earnings = $150,000,000 beginning retained earnings + $18,000,000 net income = $168,000,000.

Consider Exhibit 74. What is Company T's Enterprise Value?

$19.6 million

Currently XYZ Corp. has $1,000 million of debt. Restrictive covenants allow XYZ Corp. to take on levels of debt that will not exceed 7 times its EBITDA. XYZ purchases ABC Corp. To help pay for the acquisition XYZ sells off redundant assets raising 300 million of cash. A pro-forma analysis shows the new combined entity will have annual EBIT of $400 million with annual depreciation & amortization totaling $100 million. Assuming XYZ wishes to finance this acquisition by taking on additional debt, what is the maximum amount it can afford to pay to acquire ABC?

$2,800 million Explanation: ($400+$100) = $500 EBITDA 7x$500=$3,500 maximum debt allowed. $3,500 - $1,000 existing debt = $2,500 additional debt that can be taken on. $2,500 + $300 cash = $2,800 maximum amount that can be offered to acquire ABC Corp.

In a quarterly report, a public company reports net income of $2.5 million, interest expense of $300,000, dividends on preferred shares of $100,000, and taxes of $600,000. What is its net income available to common shareholders?

$2.4 million Explanation: The only subtraction from net income, to arrive at net income available to common shareholders, is dividends on preferred shares. Taxes and interest have already been included in the calculation of net income.

A company has a stock price of $20 and 10 million shares outstanding. The market value of its debt is $50 million. Its cash and equivalents are $15 million. What is its enterprise value (EV)?

$235 million Explanation: Start with market cap which is stock price multiplied by shares outstanding. ($20 X 10 million = $200 million). Add the market value of debt and subtract cash and equivalents. $200 million + $50 million - $15 million = $235 million.

Use exhibits 50 through 53 to answer the following question. What is the net debt of GoodPancakeHouse, Inc. (GPH) as of December 30, 2009?

$252,141,000 Explanation: Net debt = total debt cash. Total debt = Short-term debt (sometimes referred to as current maturities) + loans + notes + bonds + debentures + capital leases. Therefore, Total debt = $900,000 Current maturities of notes and debentures + $3,725,000 Current maturities of capital lease obligations + $254,357,000 Notes and debentures + $19,684,000 Capital lease obligations = $278,666,000 total debt. Therefore, net debt = $278,666,000 total debt $26,525,000 cash = $252,141,000.

Use the information in Exhibit 33 to answer the following question. In addition to the financial data listed, Company A has $300 million in noncontrolling interests, $150 million in cash, and no preferred stock on its balance sheet. What is its net debt?

$3.795 bn Explanation: Plugging in the Enterprise Values and Equity Values (from the exhibit), and Noncontrolling interest from the question, Net Debt = Enterprise Value - Equity Value - Preferred Stock - Noncontrolling Interest = $7,877 - $3,782 - $0 - $300 = $3,795mm.

Company A, with $350 million of EBITDA, is a target for a takeover by Company B. The M&A banker for Company B notices that the Company A CEO was paid excessive compensation of $5 million. Also, the CEO incurred a $2 million expense for use of the company's corporate jet. What EBITDA number will the banker likely use in their analysis of the transaction?

$357 million Explanation: Excessive CEO compensation and corporate jet expenses are typically considered to be non-recurring expenses and would likely be backed out of a company's financials for acquisition purposes. If a banker calculated EBITDA, without those two expenses, the company's profit would have been higher by $7 million.

At the start of an accounting period, a company has retained earnings of $360 million. During the period, it reports net income of $40 million and declares dividends of $25 million. What are retained earnings at the end of the period?

$375 million

Use exhibits 56 through 59 to answer the following question. What is GoodPerson, Inc. (GP)'s equity value, with a given stock price of $7.75?

$384,413,609 Explanation: Equity Value = $7.75 stock price x 49,601,756 outstanding shares = $384,413,609. Outstanding shares is sourced from the cover of the 10k. Using the share count from the cover page is more accurate, and recent, than the share count provided on the financial statements.

At the end of 2013, Company C has retained earnings of $5,000,000. During 2014 the company earns pre-tax income of $750,000. Also, in December, 2014, the company declares a dividend of $0.42 per share on 1,500,000 outstanding shares, to be paid in January, 2015. The company has a marginal tax rate of 42% and a corporate tax rate of 35%. What are Company C's retained earnings at the end of 2014?

$4,805,000 Explanation: Ending retained earnings = beginning retained earnings + Net Income Declared Dividends. Net Income = Pre-tax earnings x (1 marginal tax rate) = $750,000 x (1 42%) = $435,000. Total dividends = Dividend / share x outstanding shares = $0.42 x 1,500,000 = $630,000. Therefore, Ending Retained Earnings = $5,000,000 beginning retained earnings + $435,000 net income $630,000 declared dividends = $4,805,000. Note that dividends reduce retained earnings at the time they are declared, even if they are not paid until the following year.

For the quarter, ABC Corporation, Inc. has gross income of $1 million, depreciation of $100,000, interest expense of $50,000, taxes of $50,000 and operating expenses (excluding depreciation) of $500,000. What is its operating income?

$400,000 Explanation: Operating income = Gross profit - operating expenses (i.e. SG&A) - depreciation = $1mm - $500,000 - $100,000 = $400,000. Operating income is also known as EBIT (earnings before interest and taxes).

A company has 40 million basic common shares outstanding and a current share price of $9. It has "in-the-money" securities convertible into 5 million shares and "out of the money" securities convertible into 8 million shares. What is its diluted equity value?

$405 million Explanation: Diluted Equity value ("market capitalization") is equal to the current share price multiplied by diluted shares outstanding. Diluted shares outstanding = basic shares outstanding + "in-the-money" exercisable stock options and warrants or convertible securities. "Out-of-the-money" exercisable options, warrants or convertible securities and excluded from the calculation. In this case, diluted shares outstanding = 40 million basic shares + 5 million shares represented by convertible in-the-money securities = 45 million shares. Equity value = 45 million shares x $9 per share = $405 million.

Consider Exhibits 60 - 63. What is Jay's Jeans Inc's Book Value of Equity for 2010?

$64.9m Explanation: The book value of equity is shown in the balance sheet (Exhibit 61) as "Total stockholders' equity".

Use exhibits 83 through 86 to answer the following question. What is the total debt of ACC, Inc. (ACC) as of December 31, 2012?

$647,728,000 Explanation: Total Debt = Short-term debt (sometimes referred to as current maturities) + loans + notes + bonds + debentures + capital leases. Therefore, total debt = $3,570,000 notes payable + $23,796,000 Current installments of long-term debt + $39,343,000 Current installments of obligations under capital leases + $380,682,000 Long-term debt, less current + $200,337,000 Obligations under capital leases, less current = $647,728,000 total debt.

Use exhibits 60 through 63 to answer the following question. Calculate Jay's Jeans, Inc. (JJ)'s enterprise value, with a given stock price of $1.12?

$65,763,406 Explanation: Enterprise Value = Equity Value + Total Debt + Preferred Stock + Noncontrolling Interest cash. Equity Value = $1.12 stock price x 64,440,541 outstanding shares = $72,173,406. Outstanding shares is sourced from the cover of the 10k. Total Debt = Short-term debt (sometimes referred to as current maturities) + loans + notes + bonds + debentures + capital leases. However, this company has no debt outstanding. Preferred stock & non-controlling interest, if any, are sourced from the shareholders equity section on the balance sheet. Cash is sourced from current assets on the balance sheet. Therefore, Enterprise Value = $72,173,406 Equity Value + $0 Total Debt + $0 Preferred Stock + $0 Noncontrolling Interest $6,410,000 Cash = $65,763,406.

Consider Exhibit 12. Assuming that ABC Company has 120 million shares outstanding, what is its share price?

$7.08 Explanation: Equity Value = Share Price × Shares Outstanding, so Share Price = Equity Value/Shares Outstanding = 850/120 = $7.08. The other line items in the Exhibit are not required.

Use Exhibit 54 to answer the following question. What is the difference in the equity value of Company Y implied by companies B & E?

$78.3 million Explanation: Company Y equity value must be calculated using Company B multiples and then Company E multiples. Since EBITDA can be calculated as EBIT + D&A = $25 + $4 = $29mm, using Enterprise Value / EBITDA multiples and then subtracting net debt is the best way to calculate equity value. Company Y Equity Value (using Company B multiple) = $29mm EBITDA x 8.7 EBITDA multiple - $60mm net debt = $192.3mm. Company Y Equity Value (using Company E multiple) = $29mm EBITDA x 6.0 EBITDA multiple - $60mm net debt = $114.0mm. $192.3mm - $114.0mm = $78.3mm.

Use the information in Exhibit 35 to answer the following question. Furniture & Things, Inc. a company in the same sector as XYZ, GFI Capital, SQI International & KLM Manufacturing, has a stock price of $33 per share and 200 million shares outstanding on a fully diluted basis. Assuming that a banker feels that the premiums paid to the stock prices 7 days prior to the announcement in the acquisitions of those companies reflect current industry trends, what would be a reasonable equity value to assign to Furniture & Things in a potential acquisition?

$9.0 bn Explanation: Furniture & Things' stock price adjusted after the average 36% premium paid would reflect an offer price of $44.88 per share, or $8.976 billion total equity value based on 200 million outstanding shares.

A junior banker prepares a valuation of Company G (see Exhibit 69) based on Price/EPS and the comparables in Exhibit 54. A senior banker reviews the analysis and asks the junior banker to change from using the mean to using the median. What is the change in the Equity Value of Company G?

-$2.835m Explanation: The mean of P/E ratio is 15.325. Applying that to Net Income of 12.6m gives an equity value of 193.095m. The median P/E ratio is 15.1, giving an equity value of 15.1 × 12.6 = 190.26. The median-based value is $2.835m lower than the mean-based value.

Use Exhibits 301A and 301B to answer the following question. What is Cubs Enterprises, Inc. diluted shares outstanding, calculated in accordance with the Treasury Stock Method?

1,954,043,478 Explanation: When diluting a company's total outstanding shares, any in-the-money options are exercised, and employees will purchase shares at the strike price. In this scenario, since the weighted average exercise price of $2.50 is below the current market price of $5.75 (as sourced from the 10K), the options are in-the-money. The funds raised from the options will be used by Cubs Enterprises, Inc. to repurchase shares in the open market, at the current market price of $5.75. The net new number of shares issued, taking into account the options shares purchased and the shares repurchased in the open market = (current stock price average strike price)/current stock price x options shares = ($5.75 - $2.50)/$5.75 x 85,000,000. Therefore, the diluted shares = reported shares (as sourced from 10K) + net new shares issued = 1,906,000,000 + 48,043,478 = 1,954,043,478.

What percentage of shareholders in a corporation must consent to a Subchapter S election, for the election to be valid?

100% Explanation: All shareholders must consent to the Subchapter S election. Even one dissenter can prevent a company from making the election.

Using the information in Exhibit 13, determine the company's forward 2011 P/E ratio.

15x Explanation: Given diluted EPS of $1.00, $1.10, and $1.21 in 2008, 2009, and 2010, respectively, an implied annual growth rate of 10% is calculated. Applying the 10% growth rate to 2010 diluted EPS of $1.21 provides a 2011E diluted EPS of $1.33. Based on the information provided, a forward 2011 P/E of 15.0x is determined. Forward P/E = $20.00/1.33 = 15.0x.

Company X has Net Income of $12.8bn, a share price of $152.89, 1.356bn Shares Outstanding, Book Value of Equity of $250mm and Enterprise Value of $345mm. What is Company X's P/E ratio?

16.2x Explanation: EPS = 12.8 net income /1.356 sgares = $9.44. P/E = Share Price/EPS = $152.89/$9.44 = 16.2x.

Consider Exhibit 65. Company B is trading at $1.25. What is its Dividend Yield?

20% Explanation: Dividend Yield = Dividends Paid/Market Cap = Dividends Paid/(Share Price × Outstanding Shares) = 2,000,000/(1.25 * 8,000,000) = 20%

XYZ Company, Inc. reports 25 million shares outstanding on its most recent 10-Q. In addition, the company reports exercisable in-the-money employee stock options covering 1.2 million shares with a weighted average strike price of $10.00. Assuming XYZ Co's common stock is currently trading at $14.10, what are XYZ Co's diluted shares outstanding, in accordance with the treasury stock method?

25.35m Explanation: Under the Treasury Stock Method of accounting for stock options, proceeds from in-the-money options (i.e. where the strike price is below the market price), are used to repurchase shares, resulting in a net increase of shares. In this scenario, the exercisable options are in the money, resulting in the company receiving $12 mm in cash to repurchase shares (1.2 mm x $10 strike price). The company will subsequently use the cash to repurchase 851,064 shares ($12mm / $14.10 stock price). The net increase in shares = 1.2mm shares - 851,064 shares = 348,936. When added to previous shares outstanding, the diluted shares outstanding = 25mm shares + 348,936 shares = 25,348,936 shares.

JKL Corp. is aware the price paid in their industry for an acquisition has been 6 times EBITDA. JKL offers $2,100 million to purchase 100% of ABC Corp in a strategic acquisition. ABC Corp's EBITDA is $300 million. The banker working on the deal believes JKL can achieve after-tax synergies of $150 million by acquiring ABC. Assuming the marginal tax rate is 40%, what is the effective multiple for the transaction?

3.82 Explanation: JKL paid 7 times EBITDA ($2,100 for EBITDA of $300). Given they can achieve synergies of $150 million they paid a lower effective multiple than 7. It is important to note this question couched the $150 of synergies as after-tax. Since EBITDA is a pre-tax measurement, we must first gross up the $150 million. ($150/(1-T)) or $150/.6 = $250 of pre-tax synergies. The new adjusted EBITDA JKL acquired is $550. ($300+$250). The effective multiple paid is: $2,100/$550 = 3.82

Consider Exhibit 49. What is ABC Co's Diluted Shares Outstanding?

30.75 m Explanation: First note that the options are in-the-money. The Proceeds from exercise of in-the-money options are 1,500,000 × 12.75 = $19.125 million. At the current share price, the company can repurchase 19.125m/25.52 = 749,412 shares with the proceeds. It must therefore issue 1,500,000 - 749,412 = 750,588 new shares and hence ABC Co's diluted shares outstanding are 30,000,000 + 750,588 = 30.75 million

Consider Exhibit 47. What is EricaCo's Diluted Shares Outstanding?

50.85m Explanation: First note that the options are in-the-money. The Proceeds from exercise of in-the-money options are 2,000,000 × 18.22 = $36.44 million. At the current share price, the company can repurchase 36.44m/31.75 = 1,147,716 shares with the proceeds. It must therefore issue 2,000,000 - 1,147,716 = 852,284 new shares and hence EricaCo's diluted shares outstanding are 50,000,000 + 852,284 = 50.85 million

ABC Corp. increases sales by 11% in 2017. -3% of the growth came from developing a niche market. -6% came from acquiring XYZ Corp. in January of 2017. -2% was a result a successful marketing campaign. How much of ABC's 2017 growth was inorganic?

6% Explanation: Inorganic sales growth comes from the outside. Acquiring another company will increase ABC's sales because the sales of the newly acquired company are consolidated onto ABC's income statement. The sales growth from the marketing campaign and developing a niche market is considered to be organic growth.

A company has total quarterly revenue of $10 million, operating expenses of $5 million, and cost of sales of $3 million. Interest expense is $1 million. What is its gross profit margin?

70% Explanation: Gross profit = total revenue - cost of sales = $10mm - $3mm = $7mm. Gross profit margin = gross profit/total revenue = $7mm/$10mm = 70%.

Consider Exhibit 4. SpencerCo Inc is trading at $15.40 and has 420 million Shares Outstanding. What is SpencerCo's 2009 Price-to-Tangible-Book value?

8.09x Explanation: Price-to-Tangible-Book value = (15.4 × 420)/(1,300 - 500) = 8.1×

Consider Exhibit 58. What is Goodperson Inc's net profit margin?

8.87% Net Profit Margin = Net Income/Revenue = 7,763/87,490 = 8.9%

Denise is a sophisticated investor who has agreed to invest $200,000 in a PIPE transaction. When must she receive a prospectus?

A prospectus is not required Explanation: A PIPE (private investment in public equity) is a private placement exempt transaction, so no prospectus is required. Typically, the terms of a PIPE transaction may be described in a term sheet or disclosure document that is not subject to SEC rules or review and therefore may be less robust than information available in public offerings. This is a risk factor in PIPEs.

The Millers are a married couple who own the following assets: A first home worth $2 million with no mortgage, a second home worth $2 million with a $1 million mortgage, a bank account worth $1.5 million, and a brokerage account worth $1.5 million. Do they meet the standard for qualified purchasers (QPs)?

A; no, because they do not have more than $5 million of investment assets Explanation: The SEC defines QPs as individuals or couples who have more than $5 million in investments. Note that this threshold doesn't measure net worth, real estate or personal property. QPs can invest in certain types of unregistered private funds.

Which of the following is a key difference between a limited partnership (LP) and a master limited partnership (MLP)?

An MLP is exchange-traded and has more easily transferable interests Explanation: MLPs are publicly offered limited partnership, and they usually are traded on exchanges, with large numbers of limited partners and freely transferable interests.

Which company would likely have the lowest Operating Leverage?

An artisanal mayonnaise company Explanation: The pharmaceutical and software companies would have high R&D expenses and hence high fixed costs. Similarly, launching satellites is an expensive fixed cost. On the other hand, producing artisanal mayonnaise is likely to be labor intensive and therefore would have high variable costs. High operating leverage means high fixed costs.

For a given company, what does Noncontrolling Interest refer to?

Another entity's minority interest in a company's subsidiary

Howard is an entrepreneur who wants to buy a money-losing fast food franchise. His goal is to gradually turn the losses into profits over time while taking the losses on his personal tax return right away. Which form of business organization should he avoid?

C Corp A major disadvantage of C corporations is that their losses cannot be personally deducted by stockholders, for income tax purposes. Only the entity itself can claim losses, on its corporate tax return. In both S corporations and limited partnerships, profits and losses flow through to individual owners, as they also do (within limits) in sole proprietorships.

A privately held company specializing in online fitness memberships is organized as a partnership. However, it wishes to go public in two or three years and will need to change to another form of organization. Which form is most practical?

C Corp Explanation: Several types of corporations including MLPs, REITs and C Corps can list on exchanges. However, MLPs and REITS work best for companies in specialized industries, such as energy or real estate. An LLC that wishes to go public would likely have to re-organize to do so.

During a period of rising costs which statement is false about the outcomes under LIFO vs. FIFO?

COGS would be higher under the FIFO method than the LIFO method. Explanation: This question is asking for a FALSE statement. With inflation, LIFO results in a lower ending inventory, higher COGS, and lower gross margins, and thus less taxes than FIFO. FIFO results in a lower COGS boosting profit margins. This question is asking for a false statement.

Companies headquartered in more than 50 foreign countries list their common stocks for sale in the U.S. through American Depository Receipts (ADR's). Which country is not among them?

Canada Explanation: Canadian companies do not issue ADR's. They can directly list their common stocks on U.S. exchanges.

In which scenario could a company's Equity Value be greater than its Enterprise Value,?

Cash > Debt

Venture capital firm A likes to invest in the earliest capital-raising rounds of high-growth tech companies. Venture capital firm B likes to wait and invest in later rounds of these same companies. Which one of the following statements is false?

Company B is likely to earn more profit per investment than Company A Explanation: Venture capital is inherently risky. Many investments lose all (or almost all) of investors' capital. Over the 5-10 years that it typically takes a start-up to reach the public market, even the hottest trends in VC investing can turn cold. To balance the high risk, VC investing offers large potential upside returns - often 50% or more annualized. The rule of thumb is that the earliest companies to invest bear the most risk and stand to earn the highest returns. Later-stage VC investors have more results to evaluate but also tend to invest at higher valuations. Note: The question is asking which statement is false.

An oil and gas drilling deal structured with a general partner who makes management decisions and several passive limited partner investors is referred to as a

Direct Participation Program Explanation: FINRA rules cover underwritings of Direct Participation Programs (DPPs) offered to the public. These programs typically are structured as partnerships to pass revenues and tax deductions directly through to limited partners.

For valuation multiples, why is Enterprise Value used as a multiple of EBITDA as opposed to Net Income?

EBITDA is an unlevered financial statistic Explanation: Enterprise Value represents the capital provided by both lenders and equity holders. EBITDA is a financial metric calculated prior to distributions to lenders and equity holders as such, it is an unlevered financial metric that provides a fair means of comparison to Enterprise Value. Enterprise Value would never be taken in conjunction with an equity only return, such as net income.

Standard Co. borrows $100 million in long-term debt and uses the money to repurchase its shares. What impact will this have on earnings per share (EPS) and the debt/equity ratio?

EPS will increase and the debt/equity ratio will rise. Explanation: A = L + E is key for situations like this in order to see the flow of cash, debt & equity. When raising debt a company is simultaneously collecting cash. Assets increase by the cash amount and liabilities increase by the debt amount. The company in this scenario is using the debt raise to fund the repurchase of its shares. This means that the company will take the cash (from the debt raise) and repurchase shares in the market. The balance sheet changes here will be: assets will decrease (by the cash amount) and shareholders equity will decrease proportionately as well. Nothing happened to debt because it's still a liability on the balance sheet. Now look at EPS. EPS = Earnings per Share. There are no changes in earnings but a decrease in the share amount (since the company repurchased shares). This will mean that the denominator decreases, making EPS increase overall. The practical application of a share buyback - the point of why a company would do this - is if they want to boost their EPS and hit certain targets. Next, the question asks about debt/equity changes. The company raised $100mm in debt and therefore the debt side of the ratio increases. On the denominator, equity decreased because the company bought back shares. If debt is increasing the ratio gets larger and if equity decreases the ratio gets larger as well. Debt/equity will therefore rise.

Which of the following refers to the sum of all ownership interests in a company and claims on its assets from both debt and equity holders?

Enterprise value

A company buys back 100,000 shares of common stock for cash at a cost of $50 per share. At the same time, the company raises cash by selling $20mm in bonds with a coupon of 9%. What is the impact on enterprise value of these two transactions?

Enterprise value is not affected Explanation: Enterprise value is the sum of all ownership interests in the company and claims on assets. It is considered independent of changes in capital structure, meaning that changes in capital structure do not affect it. Buying back stock for cash and selling bonds to raise cash are changes in capital structure. Enterprise Value = Equity value + total debt + preferred stock + noncontrolling interest cash; so as cash is generated or used to issue or repurchase debt or equity, changes in cash exactly offset changes in equity value and total debt in the equation.

Enterprise value is determined using which of the following formulas?

Equity value + total debt + preferred stock + noncontrolling interest - cash and cash equivalents.

An investment banker is searching for a company's most recent basic shares outstanding count. Where is the best place to look?

Front cover of the company's most recent Form 10-K or 10-Q Explanation: The front cover of a company's most recent 10-K or 10-Q is typically the best place to locate the most recent basic shares outstanding count. In some cases, the annual proxy statement provides a basic shares outstanding count that may be more recent than that contained in the latest 10-K or 10-Q.

Which investment strategy would most likely target a company with a low price-earnings multiple?

Growth at a Reasonable Price (GARP) Explanation: A GARP strategy is looking for companies that have growth potential with a low price-earnings multiple compared to its peers. Index Investing involves replication of a group of stocks that closely tracks an index. The other investment strategies tend to target companies with higher multiples.

A company pays a previously declared dividend. Which of following accounts on the balance sheet would be impacted? I: Cash II: Dividends Payable III: Long-Term Debt IV: Retained Earnings

I and II Explanation: Companies pay dividends from Cash, so Cash would decrease. Since the dividend has already been declared, there would a liability under "Dividends Payable" which would be decreased/eliminated by paying the dividend. Retained Earnings would only be affected when the dividend is declared not when it is paid.

Which of the following characteristics would likely translate into higher trading valuation multiples? I. High growth II. High enterprise value III. High inventory IV. High ROIC

I and IV Explanation: high inventory level is usually a bad financial indicator for a company as it constricts return metrics and may indicate operational efficiency and / or slowing sales demand for its products. enterprise value represents the sum of ownership interests in the company, and taken alone, cannot be extrapolated to a trading multiple

Why might a seller choose to pursue an IPO rather than the sale of a company? I. Potential buyers are sidelined II. Preserves equity upside to share in future growth III. Implied IPO valuation is higher than that expected in a sale IV. Favorable equity capital markets

I, II, III, and IV Explanation: A seller may choose to pursue an IPO as opposed to a sale of the company for a variety of reasons. A sale process is designed to maximize value for the target's shareholders; if some of the identified buyers are not in a position to currently bid due to market conditions or business factors, then waiting to sell may be a viable option. If the seller wants to maintain a sizeable equity stake in the business and share in the future growth in the enterprise, then an IPO is the best option. Often, bankers pursue a dual-track process when seeking to maximize the value of a business 1) a sale and 2) a IPO. If the valuation implied by the IPO is greater than the sale, then the IPO may be pursued. Finally, if market conditions for IPOs are favorable, private companies will take advantage.

Which of the following are key sources of capital in the equity funding life cycle of a company? I. Venture capital II. Private equity III. Initial public offering IV. Follow-on offering

I, II, III, and IV Explanation: All of the equity capital types listed are part of the equity funding life cycle. Venture capital is for the start-up stage, private equity is for product development, an initial public offering is for revenue growth, and a follow-on offering is for net income growth as well as market share growth.

Comparable companies analysis is used in which of the following transaction situations? I. Mergers & acquisitions II. Restructurings III.Investments IV. Initial public offerings

I, II, III, and IV Explanation: Comparable companies has a broad range of applications, most notably for various mergers & acquisitions (M&A) situations, initial public offerings (IPOs), restructurings, and investment decisions.

Which statement is true about income statement margins?

If COGS decreases in absolute dollars by more than operating expenses increase in absolute dollars, the company's operating margin should increase. Explanation: If sales increase the possibility exists that gross profit will increase and that EBIT will also increase, but there is no evidence that the gross profit margin or that the EBIT margin will increase. If sales decrease earnings could actually rise if enough expenses are eliminated. For example, if a company disposed of a losing division, sales would drop but earnings could actually increase. However, if COGS decreased by $3 and operating expenses increased by $1, EBIT would be $2 higher leading to a higher operating margin (EBIT/Sales).

"_____ _____ _____" represent incremental shares outstanding on a diluted basis, calculated in accordance with the Treasury Stock Method.

In the money exercisable options

A private company seeking to fund growth and development and clean up its balance sheet should consider what type of capital raise?

Initial Public Offering Explanation: A private company that needs cash and desires liquidity should consider pursing an initial public offering. This company should demonstrate high revenue growth potential and at least a couple quarters of profitability or a clear path to profitability. In addition, an IPO provides an exit for existing owners and investors.

The first sale of stock in the public equity markets by a privately held company is known as a(n)

Initial Public Offering Explanation: An initial public offering (IPO) is the first sale of stock in the public equity markets by a privately held company. An IPO provides numerous benefits for the issuer including; obtaining growth capital; providing liquidity of capital stock; realizing a true market valuation; providing acquisition funding; repaying debt, and offering equity incentives to employees. A follow-on, or seasoned equity offering is an offering of additional common stock to the public equity market by an issuer that is already a public company. Equity-linked securities or hybrid securities are debt instruments, such as convertible bonds or convertible preferred stock, that are exchangeable into a defined number of shares of common stock at the holder's option.

Which of the following companies would most likely issue common stock that is listed on an exchange?

Master Limited Partnership Explanation: Master Limited Partnerships (MLPs) are limited partnerships that can do a public offering and list stock on an exchange. Hedge funds, real estate firms and oil & gas firms are commonly organized as MLPs. S-Corps (max 100) and sole proprietorships do not have enough shareholders to list on an exchange. LLCs are pass through vehicles that are rarely listed.

Use the information in Exhibit 35 to answer the following question. BJM, Inc. a company in the same sector as XYZ, GFI Capital, SQI International & KLM Manufacturing, is acquired for $40 per share, reflecting a 30% premium to its close the day before. Assuming that the company has 50 million shares outstanding and had LTM Net Income of $150mm, how does its Equity Value/LTM Net Income multiple compare to those of the other transactions

More than that of the Nopper/KLM deal but less than that of the Marks/GFI deal Explanation: Based on the $40 per share acquisition price and 50 million shares outstanding, the equity value of the acquisition is $2.0 billion, which yields an EV/LTM Net Income multiple = $2.0 billion/$150 million = 13.3x. The unaffected share price or premium paid is not relevant to this calculation.

Which of the following refers to the residual profit after all of a company's expenses have been netted out?

Net income Explanation: Net income is the profit after all of a company's expenses have been subtracted from revenues. It represents the earnings available to shareholders after all obligations (e.g. debt, payable to vendors, etc.) have been paid. EBITDA is a widely used proxy for operating cash flow as it reflects the company's total cash operating costs for producing its products and services. Gross Profit is defined as sales less cost of goods sold (COGS). Sales is the first line item on an income statement.

A private offering of a stock by a publicly traded issuer is known as a

PIPE Explanation: A private investment in public equity (PIPE) refers to a transaction in which investors buy securities directly from a public company via a private placement. These securities are classified as restricted by the SEC and cannot be resold to the public market immediately after purchase.

Which of the following refers to a transaction where a group of investors negotiates directly with a public company to acquire a private equity positions?

PIPE Explanation: A private investment in public equity (PIPE) refers to a transaction where an investor acquires the stock of a public company at a discount through a privately negotiated transaction. A leveraged buyout (LBO) is the acquisition of a company, division, business, or collection of assets using debt to finance a large portion of the purchase price. A management buyout (MBO) is an LBO originated and led by a target's existing management team. An exchange offer is a type of tender offer where new securities are offered in exchange for existing securities.

An accounting line-item representing cash paid for an expense incurred but for which the service has not yet been received is referred to as a(n)

Prepaid expense Explanation: A prepaid expense refers to the payment for goods or services to be provided at a future date. The expense is recorded as a current asset initially then expensed as the benefit is received. Accrued expenses refer to expenses incurred, but not recognized as cash has not yet been paid. Amortization refers to the expensing of the value of intangible assets over time.

Genosys Inc. wants to expand in the hot environmental sciences industry and reduce its emphasis on slower-growth waste disposal. To fund its growth in environmental sciences, it wants to sell its waste management division. Which type of firm would be the most likely buyer?

Private Equity Firm Explanation: Hedge funds and business development companies usually focus on passive investments. This transaction requires a more active investor. Private equity firms tend to be actively involved in investments, and they often specialize in slower-growth industries and turnaround situations like this.

A corporation that elects to pass corporate income and losses to its shareholders is known as a(n)

S Corporation Explanation: S corporations pass income and losses, as well as deductions and credits to their shareholders. Shareholders report these line items, which are taxed at their respective personal rates, on their individual income statements.

There are different types of entities that are afforded different treatment under United States Tax Law. Which of the following statements accurately depict the status or tax situations of S Corporations?

S Corps are pass thru entities. This means that they don't pay taxes, but instead the shareholders pay the tax. Explanation: S Corps are pass thru entities, while C Corps are subject to tax. Only U.S. citizens or U.S. residents can be shareholders of an S Corp. Because the maximum number of shareholders in S Corps are limited to 100, an S Corp. cannot be publicly traded.

Accrued liabilities refer to which of the following?

Salaries, rent, interest, and taxes that have been accrued to the balance sheet, but have not yet been paid Explanation: Accrued liabilities are expenses such as salaries, rent, interest, and taxes that have been incurred by a company but not yet paid. Accrued liabilities show up on the balance sheet as a current liability if they can reasonably be expected to be paid within one year.

Which one of the following inputs is not needed to calculate enterprise value (EV)?

Shareholder equity

Which of the following depreciation methods assumes a uniform depreciation expense over the estimated useful life of an asset?

Straight-line Explanation: Depreciation expenses are typically scheduled over several years corresponding to the useful life of each of the company's respective asset classes. The straight-line depreciation method assumes a uniform depreciation expense over the estimated useful life of an asset. For example, an asset purchased for $100 million that is determined to have a ten-year useful life with no salvage value would be assumed to have an annual depreciation expense of $10 million per year for ten years. Most other depreciation methods fall under the category of accelerated depreciation, which assumes that an asset loses most of its value in the early years of its life (i.e., the asset is depreciated on an accelerated schedule allowing for greater deductions earlier on). The modified accelerated cost recovery system (MACRS) and double declining methods are both forms of accelerated depreciation.

Company Z produces inventory as follows: January: 200 units at $9.00 each February: 150 units at $10.00 each March: 120 units at $10.50 each In April, Company Z sells 300 units for $19 each. Which of the following is true assuming a 40% marginal tax rate?

Tax expense would be lower under LIFO than FIFO Explanation: Since the answer choices did not involve calculations we want to understand this question from a conceptual point of view. In a rising cost environment FIFO shows higher gross profit, because of lower COGS, caused by higher ending inventory. The tax expense will also be higher because of the higher profit being shown. LIFO saves taxes in an inflationary situation because it generates a lower gross profit than FIFO.

For a company organized under Subchapter S of the Uniform Practice Code, which of the following is TRUE regarding its capital structure?

The corporation will pass through gains and losses Explanation: In a Subchapter-S corporation, ownership rules are somewhat limited, due primarily to the ability to pass through gains and losses. All investors must be individual investors and they must be domestic investors. Even then, there is a limit of 100 shareholders, which would preclude listing on an exchange.

If a company has shareholders' equity of $250 million and total assets of $750 million, which of the following must be TRUE?

Total liabilities is $500 million

A business disruption that results in a loss of income due to a hurricane would be classified as a(n)

an extraordinary item on the income statement An extraordinary item must be distinguished by 1) their unusual nature, and 2) by the infrequency of their occurrence. In addition, extraordinary items are shown on the income statement and not on the balance sheet.

The first outside financing that many new companies receive - apart from friends and family - is from a source called

angel investors Explanation: Angel investors represent the first outside financing that many start-up companies receive. Most angels are wealthy investors who can afford to take risk and understand start-up companies. They may be successful entrepreneurs themselves.

Limited Partnership interests are typically regulated

as securities, under federal and state laws Explanation: Limited partnership interests are considered securities and are subject to SEC registration and state blue sky laws.

What analysis compares revenues and expenses?

cash flow analysis Explanation: Cash flows are generated largely from revenues and expenses. Therefore, cash flow analysis is the best answer choice of those that are provided. Net capital analysis is a measure of liquidity. Liquidity analysis address current liabilities and current assets. Capital analysis refers to shareholders equity.

Which of the following items is normally included in the calculation of an EBITDA multiple?

continuing research and development costs Explanation: The EBITDA multiple is an important valuation metric for investment banking purposes. It is enterprise value divided by EBITDA. Like the P/E ratio, lower ratios indicate better value. Continuing costs such as research and development are reflected in EBITDA. All the other items reflect one-time or non-recurring events that are not regular occurrences for the company and thus would only be included in special situations.

Un-exercisable options are not accounted for in the calculation of _______ shares outstanding in accordance with the Treasury Stock Method.

diluted

A bakery uses peanut butter as a raw ingredient to make peanut butter cookies. On its financial reports, it allocates peanut butter to the peanut butter cookie product line. For purposes of reporting on this line, peanut butter is considered what type of expense?

direct variable Explanation: A variable expense is tied to the volume of goods produced. A fixed expense is incurred regardless of volume. Peanut butter is a variable expense. Since it is tracked to the cookie product line, peanut butter is a direct expense of this line. The more peanut butter cookies the bakery makes, the more peanut butter it will use.

An unregulated investment fund that can engage in a variety of investment strategies is known as a(n)

hedge fund Explanation: Hedge funds are unregulated investment vehicles that use one or more investment strategies with the aim of generating substantial returns to investors. Investors in hedge funds are generally accredited investors.

If a corporation that has regularly paid dividends skips payment of dividends for two quarters

investor interest in the stock may decrease Explanation: When a corporation that has regularly paid dividends skips dividend payments, investors may shun the stock. Less buyer interest will cause the price to fall, and the current yield (annual dividends/market price) to outstanding shareholders will decrease. Dividend payments are not guaranteed to outstanding shareholders, so it is not a violation of shareholder rights to skip a dividend.

To find goodwill listed on a corporate balance sheet, you should look under

non-current assets

What financial metric is impacted by both the interest income a company is generating and the interest expense it is paying?

operating cash flow Explanation: Interest income and interest expense are both considered components of operating cash flow. They are not cash flow from financing activities. This is because they are continuing income and cost items not one-off events. Interest income factors into both EBIT and EBITDA but interest cost does not. (It is an expense.)

All of the following are key differentiators of PE funds EXCEPT

prime broker Explanation: The size of a sponsor's fund(s), which can range from tens of millions to tens of billions of dollars (based on its ability to raise capital), helps dictate its investment parameters. Some firms specialize in specific sectors (such as industrials or media, for example) while others focus on specific situations (such as distressed companies/turnarounds, roll-ups, or corporate divestitures).

Institutional investors include all of the following EXCEPT:

regulators Institutional market participants are organizations that trade securities in large dollar quantities such as pension funds, life insurance companies, and hedge funds. Regulators are typically prohibited from participating in the markets in which they have oversight.

A company sells a product that it produces as part of normal business operations and receives cash in return. This event would be classified on the income statement as

revenues Explanation: Sales (or Revenue) is differentiated from gains as it is part of normal business operations of a company. Selling a product to a customer in return for cash would be booked as a sale and shown on the company's income statement. A gain refers to receipt of cash or other consideration for an event that is not part of the normal business operations of a company.

Which of the following is TRUE regarding enterprise value multiples?

the denominator employs a financial statistic that flows to both debt and equity holders

A firm that invests equity capital in early-stage, high growth potential companies would be a

venture capital fund Explanation: Venture capital funds invest equity capital in early-stage, high growth potential companies with the goal of monetizing their investments via an exit event such as a sale or initial public offering.