Series 86 Conceptual Exam Questions

A research analyst would be MOST likely to use Funds from Operations when performing a relative valuation analysis in which of the following industry sectors? A) A real estate investment trust B) A transportation company C) A telecommunications company D) An oil and gas drilling company

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

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

A) An NOL may be carried forward indefinitely but may not be carried back Net operating losses that a company has had in past years may be used to offset income. This would enable a company to use losses in the past to lower taxable income by either carrying back or carrying forward these losses. Under IRS guidelines, an NOL may be not be carried back but carried forward indefinitely.

When a company acquires an operating lease, what's the effect on the balance sheet? A) Assets and liabilities increase B) Assets and liabilities decrease C) Assets decrease and liabilities increase D) Assets increase and liabilities decrease

A) Assets and liabilities increase A company that leases an asset must create both an asset and liability. The asset created from an operating lease is referred to as a right of use (ROU) and the liability is the lease obligation.

With respect to Company X's earnings per share (EPS), which of the following has a dilutive effect? A) Company X announces the acquisition of Company C and it's expected to be neutral on net income through an exchange of common stock B) $500,000,000 of short-term debentures that Company X previously issued have matured C) Call options on Company X's stock were issued on an SEC-registered exchange D) A competitor of Company X announces a share buyback plan

A) Company X announces the acquisition of Company C and it's expected to be neutral on net income through an exchange of common stock Since the acquisition of Company C is neutral on net income, but would increase the number of shares outstanding, it would have a dilutive effect on EPS. The maturity of debentures (a type of unsecured bond) would reduce the company's cash position. In addition, Company X's net income would increase, since interest would no longer need to be paid. Exchange-traded call options are not issued by Company X and don't impact the shares outstanding or EPS. Another company buying back its shares will not have an effect on Company X.

In the most recent year, Company X had net income of $100 million and had a 15% ownership in Company Z. During the same period, Company Z had net income of $50 million. If Company X increases its ownership level in Company Z to 60%, what's the result of this increase in ownership? A) Company X would indicate net income of $150 million B) Company X's net income would increase by $20 million C) Company Z would add non-controlling interest in the equity section of its balance sheet D) Company Z would report net income of $20 million

A) Company X would indicate net income of $150 million If one corporation owns 20% or less of another corporation, the cost method of accounting is used. Under the cost method, unless dividends are paid, Company Z's income is not recorded as part of Company X's income. The equity method is used once ownership reaches 20% and continues to be used up to a 50% ownership level. Once ownership exceeds 50%, the purchase method is applied and the financials are consolidated and reported as one company. At that point, 100% of the subsidiaries' revenues are included in the income statement. Since Company X's net income was $100 million and Company Z had net income of $50 million, the consolidated income statement would show $150 million in income.

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

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

If a company capitalizes its software, it will have: A) Higher EBITDA and higher capital costs B) Higher EBITDA and lower capital costs C) Lower EBITDA and lower capital costs D) Higher EBIT and lower capital costs

A) Higher EBITDA and higher capital costs Instead of expensing the software costs, which would be reflected in SG&A as an expense, the capitalization results in higher EBITDA. The software would then be booked as a capital expenditure.

A corporation has switched from expensing software expenditures to capitalizing them. Assuming the firm spends the same amount on software, the Cash Flow from Operations to Sales ratio will: A) Increase B) Decrease C) Not change D) Increase or decrease depending on other factors

A) Increase When a firm expenses software, it appears as an operating expense on the income statement. When a company capitalizes an expense, it appears as an asset on the balance sheet rather than an expense on the income statement. Assuming the amount of software purchases is the same, the cash flow amounts are now being recorded as an asset rather than an expense. Since cash expenses are now reduced, there will be an increase in cash flow from operations.

Economies of scope are realized through: A) Integration of related product distribution B) Maximizing production to reduce a product's cost C) Vertical integration of production capacity to minimize the costs of producing a single product D) Maximizing value by buying a product in bulk

A) Integration of related product distribution Economies of scope relate to minimizing costs across product line production, marketing, and/or distribution. The marketing department of a consumer products company employs economies of scope by using the same personnel to sell different products produced by the company, often bundling products to sell as a group. All of the other choices describe economies of scale.

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

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

A well-established property and casualty insurance company has agreed to be acquired. You are analyzing the fairness opinion in the seller's proxy. If you believe the company has reached its terminal growth rate, a multiple based on which of the following metrics is LEAST likely to be used? A) PEG B) EPS C) Book value D) Tangible book value

A) PEG The normal valuation metrics for insurance companies, banks, and financial service companies are book value, or net tangible book value. Another valuation metric used is earnings per share. PEG ratios are used for growth companies. This is not likely to be used if a company has reached its terminal growth rate (a growth rate that the company can maintain in perpetuity).

Three companies dominate the dinky industry. If one of these companies leaves the industry, what is likely to happen to pricing? A) Prices will increase B) Prices will decrease C) Prices will decrease sharply as the companies attempt to gain market share D) Prices are not likely to change

A) Prices will increase As competition is reduced in a market, price constraints on producers ease. It is likely that the remaining companies in the industry will increase price levels.

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

A) Retained earnings increase on the balance sheet The reduction in depreciation will increase net income, which normally leads to an increase in retained earnings. Although the dividend payments are deducted from net income to determine retained earnings, since the dividend is so much lower than depreciation, it's likely that retained earnings will rise. The dividend payment will cause cash flows from financing activities to decrease.

An analyst notes that the price of product X has increased due to decreases in supply. Shortly thereafter, the demand for product Y increases. X and Y are probably: A) Substitute goods B) Complementary goods C) Equilibrium equivalents D) Sold in noncompetitive markets

A) Substitute goods

Investment in individual equity securities is LEAST impacted by: A) Systematic risk B) Accounting fraud C) Bankruptcy D) Event driven risk

A) Systematic risk Systematic risk is used to describe the risk of holding securities that are exposed to movements in the market rather than risk associated with investing in individual companies.

Which of the following sectors benefit from an increase in capital spending? A) Technology and industrial B) Banking and brokerage C) Energy and healthcare D) Apparel and consumer nondurables

A) Technology and industrial Capital spending is frequently oriented toward minimizing labor costs, as well as speeding up transactions and processes. As a result, technology benefits as businesses seek greater efficiency. The industrial sector benefits because some of that capital spending flows to industrial equipment makers, who in turn, supply capital equipment to auto and aircraft assemblers as well as other manufacturing companies.

If T-Bill rate increases, analyst would expect: A) Terminal value to increase B) Terminal value to decrease C) Terminal multiple to remain unchanged D) Terminal multiple to decrease

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

If a company has a high dividend yield and low PE, what does it mean for the company? A) The company has a high dividend payout and is undervalued relative to its earnings. B) The company has little debt. C) The company has a low dividend payout and high FCF yield. D) The company has a high dividend payout.

A) The company has a high dividend payout and is undervalued relative to its earnings. The dividend yield is the dividend divided by the stock price (Dividend Yield = Dividend ÷ Stock Price) and the price-to-earnings (PE) is the stock price divided by the earnings per share (EPS) (PE = Stock Price ÷ EPS). If the dividend yield is high, this is a sign that the dividends paid represent a large proportion of the EPS (i.e., high payout ratio). Since the PE ratio is also low, the company's share price is low or undervalued, at least in relation to its EPS.

A price/earnings-to-growth ratio of greater than 1.0 would indicate which of the following situations? A) The company is most likely overvalued B) The company is most likely undervalued C) The market price of the stock is lower than the P/E ratio of the company D) The market price of the stock is lower than the growth projections

A) The company is most likely overvalued A PEG, price/earnings-to-growth, ratio of greater than 1.0 indicates that the price of the stock may be overvalued. The price of the stock is trading at greater than the projected growth of the company and, therefore, there may be a downward correction.

A firm is contemplating numerous business activities in an attempt to increase its ROE. Which of the following events would increase the company's return on equity? A) The company sells real estate for a gain B) The company sells one of its divisions for a loss C) The company issues common stock D) The company repurchases a portion of its outstanding debt at a premium

A) The company sells real estate for a gain Selling assets for a gain increases profitability and, although the profit may be a one-time event, the return on equity (ROE) would rise. The sale of assets at a loss, or the repurchase of bonds at a premium, will reduce the ROE. An issue of additional shares of common stock will increase the shares outstanding and reduce ROE.

Which of the following events are dilutive to the shareholders of a corporation? A) The conversion of preferred shares into common stock B) A 10% stock dividend C) The acquisition of another company using cash D) The issuance of listed stock options

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

Which of the following events is dilutive to the shareholders of a corporation? A) The conversion of preferred shares into common stock B) A 10% stock dividend C) The repurchase of 10 million shares of common stock D) The issuance of listed stock options

A) The conversion of preferred shares into common stock Any event that reduces the proportionate claim to the earnings of a corporation by the common stockholders is considered to be dilutive. The conversion of convertible securities into common stock results in additional shares owned by new shareholders and is dilutive. A stock dividend will reduce the amount of EPS, but is not considered dilutive to common stockholders since shareholders will receive a proportionate number of the new shares. The issuance of listed stock options will not affect the EPS of a company since the exercise of these options will cause the change in ownership of outstanding shares of common stock (i.e., there are no new shares being issued).

Which information would LEAST likely be found in a company's proxy statement? A) The most recent financial statements B) The compensation received by the independent directors C) The biographies of the executive officers D) The company's stock compensation plan

A) The most recent financial statements A company's proxy statement is a document given to shareholders of a company providing them with information concerning issues on which they are being asked to vote. It contains detailed information concerning compensation and holdings of executive officers and directors of the company, their biographies, stock compensation plans, and any other matters on which they are being asked to vote. The most recent financial statements and the other information listed could be found in a company's 10-K filing. The proxy, however, is the best source to view how much and what type of compensation is being paid to the executives of a company.

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

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

Which of the following descriptions BEST defines the term cost of capital? A) The required rate of return necessary to finance corporate projects B) The rate of return derived on a corporate investment C) The amount of money necessary to invest in a corporation D) The opportunity cost produced after the investment is made

A) The required rate of return necessary to finance corporate projects The cost of capital is considered the required rate of return necessary to enter into and finance corporate projects. It is the opportunity cost of the funds employed as a result of a business decision.

If an analyst wanted to calculate the market cap of a company, she would multiply the market price of the stock by the: A) Total outstanding shares, including those held by institutions, retail investors, and restricted shares held by insiders B) Total outstanding shares, including those held by institutions, retail investors, and restricted shares held by insiders plus treasury stock C) Public float, which is outstanding shares minus restricted stock D) Shares held by institutions only

A) Total outstanding shares, including those held by institutions, retail investors, and restricted shares held by insiders To calculate the market capitalization of a company, the representative would multiply the current market price of the common stock by the total outstanding shares, including those held by institutions, retail investors, and restricted shares held by insiders.

Walt Mickey Company, a diversified entertainment company has agreed to acquire Levram Entertainment, a film entertainment company. The film entertainment sector is a niche business with only one other publicly traded company, but there are a few companies in the diversified entertainment sector. Some of these companies have recently acquired film entertainment companies. As an analyst, you have been asked to conduct a comparable company analysis. Which of the following choices would be the BEST alternative? A) Use both the company in the film entertainment business and others from the diversified entertainment sector B) Use the only other publicly traded company from the film entertainment business C) Use only the companies from the diversified entertainment sector D) Use only marketing companies that distribute the content produced by the film entertainment business

A) Use both the company in the film entertainment business and others from the diversified entertainment sector Comparable company analysis is used to value a company based on a comparison of that company's financial statistics with that of other, similar companies. In other words, valuing is based on the assumption that companies with similar characteristics should have similar valuations. In many cases, it is very difficult to find direct comparables, even if the companies are in the same business sector. The first step in finding those companies is reviewing both the operational aspects of the business as well as the financials. A company's operations selection might focus on similar lines of business, size, the products and services provided, the industry sector, its customers and suppliers, geographical location, where the company falls in the distributional channel, and both the company's and industry's cyclicality. Financial aspects might focus on the growth prospects, its operational and financial leverage, and other methods of financial analysis.

ABC Corporation will be issuing $100 million of bonds. The underwriting group expects each bond to be priced at $1,000 (par value). The effect of the issuance of the bonds is an increase in: A) Working capital and long-term liabilities B) Current liabilities and shareholders' equity C) Current and fixed assets D) Shareholders' equity and current assets

A) Working capital and long-term liabilities When bonds are issued, the cash received from the sale of bonds increases current assets. This is true because working capital equals current assets minus current liabilities (Working Capital = CA - CL). Since bonds are a long-term liability, not a current liability, working capital will also increase. In order to balance the balance sheet, long-term liabilities will rise after the bonds are issued with no change to shareholders' equity.

The return on equity (ROE) of a company will most likely increase if: A) loss is realized on the sale of an asset B) A gain is realized on the sale of an asset C) The company pays a preferred stock dividend D) The company's interest expenses increase

B) A gain is realized on the sale of an asset Return on equity (ROE) is the earnings available to common shareholders divided by the average shareholder's equity (ROE = (Net Income - Pref. Dividends)/Ave. Common Equity). The sale of an asset for more than its book value creates a gain for the corporation and will result in both net income and ROE increasing. Preferred stock dividends lower both the earnings available to common shareholders and ROE. Increasing the interest a company pays will lower its net income and will likely decrease the ROE.

Which of the following has the largest negative effect on a stock's price? A) A realized gain from selling equipment B) An all-stock acquisition that's neutral to earnings C) Buying convertible notes D) A competitor repurchases shares

B) An all-stock acquisition that's neutral to earnings An acquisition that's neutral to earnings doesn't add any additional net income for shareholders and, because the transaction is all-stock, additional shares must be created. This will be dilutive to earnings per share (EPS), which will cause the stock price to fall. Issuing (rather than buying) convertible notes and bonds is dilutive to EPS, but only after investors convert their securities.

When accounting for an operating lease: A) Liabilities will not change B) Assets will increase C) Shareholders' equity will decrease D) An interest expense will appear on the income statement

B) Assets will increase Operating leases will increase both assets and liabilities. Unlike a finance lease, operating leases don't have a separate interest component recorded on the income statement. Operating leases don't directly impact shareholders' equity.

If electric car companies are taking market share from hybrid auto makers, fossil fuel costs continue on an upward trend, and hybrid auto makers do not change their business plans, what is the forecast for the hybrid auto industry? A) They die in the business cycle B) Bearish short-term and long-term C) They will recover, because fossil fuel prices can decline as well D) Bullish over the long-term, because electric cars are incredibly expensive

B) Bearish short-term and long-term Based on the fact pattern in the question stem and the assumption of rising fossil fuel prices, electric auto makers will continue to gain market share versus manufacturers of gas and hybrid vehicles.

A company is issuing $200 million of debentures with a 7% coupon to finance the acquisition of new machinery. Where will the interest paid on the debt be located on the Cash Flow Statement? A) Cash Flow from Investing B) Cash Flow from Operations C) Cash Flow from Financing D) Cash Flow from Working Capital

B) Cash Flow from Operations Operating cash flows begin with net income from the income statement, which means that expenses included on the income statement (e.g., interest paid) are included in operating cash flows. Although the loan is being used to finance equipment, the interest paid is in cash flows from operations.

Two automobile manufacturers have defined benefit pension plans. Company ZBT uses a discount rate of 5% to calculate its pension fund liabilities, and Company SMI uses a 7.5% discount rate to calculate its pension fund liabilities. Which of the following statements is TRUE? A) Company ZBT is using a more aggressive method of accounting B) Company SMI is using a more aggressive method of accounting C) Company ZBT will have higher pension fund assets D) Company SMI will have higher pension fund assets

B) Company SMI is using a more aggressive method of accounting Aggressive accounting refers to a method of accounting that is used to report lower expenses and higher income, or to overstate assets while understating (not recognizing or lowering) liabilities. In regard to accounting practices for defined benefit pension plans, using a low discount rate is conservative, and using a higher discount rate would be aggressive. The present value calculation is based on dividing the liabilities by (1.0 + discount rate). Therefore, the higher the discount rate, the lower the present value of the fund's long-term liabilities. In order to calculate either company's pension fund assets, you would need to be given the expected return on the assets in the plan.

Which of the following is a macroeconomic driver for the fast food industry? A) Changing beef prices B) Disposable income C) Customer satisfaction D) Low employee turnover

B) Disposable income Restaurants are positively impacted when consumers have more disposable income

A company headquartered in the United States manufactures and markets its products in Europe. The price of a basket of foreign currencies increases. Which of the following statements is TRUE? A) Operating margin remains flat and the operating profit remains flat B) Gross margin remain flat and the operating profit increases C) Operating margin rises and the operating profit falls D) Operating margin falls and the operating profit increases

B) Gross margin remain flat and the operating profit increases The company's income statement is reported in U.S. dollars. In this question, we are stating that the price of a basket of foreign currencies increases, which means the dollar has weakened against several currencies. When foreign-based sales and expenses are converted into dollars, both rise proportionately, so margins would remain the same. However, the actual operating profit amount would increase.

Which of the following statements is TRUE when calculating tangible book value per share? A) All intangibles are deducted from the calculation B) Intangibles with an identifiable market value may be included in the tangible book value per share C) Goodwill is always included in the tangible book value per share D) Intangibles will not have a market value if the company is sold

B) Intangibles with an identifiable market value may be included in the tangible book value per share Intangibles such as copyrights and patents may have a separate and definable market value. They may be identified and sold separately from the other assets of the company. Therefore, they may be included in the tangible book value of the company.

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

B) Lower bad-debt expense Internal (often operational) issues, rather than external issues, define a change in the quality of earnings. It should represent the underlying economics of the business and be persistent and predictable. An external change such as a change in the tax rate is not associated with quality of earnings. Share repurchase can improve ROE, but does not improve the quality of earnings. R&D is not immediately quantifiable for its impact on earnings. Lowering bad-debt expenses (improved performance of account receivables) is qualitative and quantifiable for improvement of the quality of earnings. It is based on the economics of the business (account receivables) and, provided the decline is consistent (an increase in the quality and reliability of customers), the persistent and predictable characteristics are satisfied.

Assuming that interest rates are rising, a company that uses a FIFO inventory method will have all of the following, EXCEPT: A) Lower cost of goods sold B) Lower taxes C) Higher inventory valuation D) Higher profits

B) Lower taxes First-in, first-out (FIFO) accounting will reflect a lower cost of goods sold. The oldest inventory will be produced at a lower cost and therefore result in a higher profit and higher (not lower) taxes. Since this inventory is used first, it is cheaper than the last-in, first-out (LIFO) inventory during an inflationary or rising interest rate environment.

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

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

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

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

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

B) The company will account for any unrealized gain or loss on these investments by adjusting the balance sheet, but not the income statement. If a company has investments which are classified as "available for sale," this means that the company intends to retain these securities for a period, rather than trade the securities or hold them to maturity. They're required to be recorded on the balance sheet at fair value versus cost value. Any unrealized gain or loss is not recorded on the income statement. Since the value can change each year on the balance sheet, but not the income statement, an entry must be made in the shareholders' equity section titled, "unrealized gain/loss in other comprehensive income." If "available-for-sale" securities are sold, the only impact is on the income statement.

Who should a research analyst speak to if he's concerned about the financial performance of senior executives? A) The chief financial officer B) The company's executive compensation consultant C) The chairman of the board of directors D) The chief executive officer

B) The company's executive compensation consultant In order to align executive compensation with shareholder interests, exchange-listed companies must establish a compensation committee. The committee is made up of independent members of the board of directors. In many cases, the compensation committee will also hire a compensation consultant who advise the committee on the fairness of the executives' compensation. These consultants would provide the best perspective on executive compensation. The CEOs and CFOs of companies will naturally be biased since they're executives of the company.

A company's operating income and tax rate are flat from the previous year. If the net income of the company increased by 7%, which of the following statements is TRUE? A) The company's operating expenses have increased B) The company's interest expense has decreased C) The company's preferred dividend payments have increased D) The depreciation expenses of the company have decreased

B) The company's interest expense has decreased If operating income and the tax rate remain flat, and the net income has increased, the only possible answer is that the company's interest expenses have decreased. Since we are not given the total sales or revenue, we cannot conclude whether depreciation or operating expenses have increased or decreased. Preferred dividends are subtracted after, not prior to, calculating net income.

During an inflationary time, if a company switches its inventory accounting method from last-in, first-out (LIFO) to first-in, first-out (FIFO), which of the following will happen? A) The company will have a lower EBITDA. B) The cost of goods sold will decrease. C) The company will have lower profit margins. D) The company's taxes paid will decrease.

B) The cost of goods sold will decrease. When prices are rising (i.e., inflationary time), using LIFO for a company's inventory will lead to a higher cost of goods sold (COGS). Since prices are rising, LIFO will use the most expensive inventory (i.e., last) first to calculate a firm's net income. If a company switches to FIFO, it will then be using the cheapest (i.e., first) inventory first. By switching to FIFO during an inflationary period, a company will lower its COGS and increase its EBIT and EBITDA. A higher EBIT and EBITDA will also lead to a higher tax liability.

Which of the following descriptions BEST defines the term enterprise value? A) The purchase price of a company an acquirer will pay to buy the firm B) The current market value of the common stock plus the net debt C) Equity plus capital expenditures minus cash and equivalents D) The economic profit of an ongoing enterprise

B) The current market value of the common stock plus the net debt The current market value of common stock plus net debt (debt minus cash and investments) defines enterprise value (EV). Although it may also refer to the tangible value of a company, the question asked for the definition of EV. An acquirer may need to pay a higher price for the common stock which would increase the market capitalization and therefore its enterprise value.

Which of the following is included when calculating a company's public float? A) The number of shares held by institutional and retail investors B) The number of shares held by institutional investors, retail investors, and company insiders C) The number of shares of restricted stock only D) The number of shares of treasury stock only

B) The number of shares held by institutional investors, retail investors, and company insiders The public float of a company is the number of shares held by public investors, both retail and institutional. It excludes stock owned by affiliated persons of a company and is found by subtracting restricted stock from the number of outstanding shares. By contrast, market capitalization is determined by multiplying the number of outstanding shares by the current market price per share. Outstanding shares include those held by institutions, retail investors, restricted shares, and shares held by insiders, but do not include treasury stock (shares repurchased by the company).

The book value per share of a company is greater than the market price of the stock prior to a stock buyback. After the stock buyback: A) The return on equity will increase and the book value per share will decrease B) The return on equity will increase and the book value per share will increase C) The return on equity will decrease and the book value per share will decrease D) The return on equity will decrease and the book value per share will increase

B) The return on equity will increase and the book value per share will increase Since the formula for calculating Return on Equity is: Earnings Available to Common Shares ÷ Average Common Equity, ROE will increase. Unless the question states otherwise, it should be assumed that earnings available to common shares doesn't change. Since the shareholders' equity (including common equity) is falling, the ROE will increase. As a general rule, if the market price per share is greater than book value per share after the stock repurchase (buyback), the book value per share (BVPS) will decrease. Conversely, if the market price per share is less than the BVPS, the BVPS will increase. (13096)

An American company manufactures its products in the U.S. and sells them in Spain. Which of the following statements would be TRUE if the euro depreciated? A) The price of products in euros would fall. B) The sales would translate into lower dollar amounts. C) The company's sales volume would increase. D) U.S. consumers would stop buying Spanish goods

B) The sales would translate into lower dollar amounts. The dollar value of the sales when translated or exchanged for U.S. dollars would fall. In the longer term, a euro that depreciated in price would tend to increase the cost of imported goods and decrease unit sales.

Fremont Corp has grown through acquisitions and now operates four separate business lines, but has no net income. What valuation tool is appropriate A) The dividend discount model B) The sum-of-the-parts method C) The P/E ratio D) ROA

B) The sum-of-the-parts method A company with varying business components would normally use the sum-of-the-parts valuation method.

Gross Domestic Product (GDP) has declined for two consecutive quarters in the U.S. Which of the following industries would most likely be negatively affected by this downturn in the economy? A) Cosmetics B) Transportation C) Food D) Medical

B) Transportation A downturn in GDP for two consecutive quarters is indicative of a recession. During a recession, cyclical industries, such as transportation, construction, and steel, will generally decline. Defensive industries, including cosmetics, food, and medicine, will not be as strongly affected.

All of the following will impact EPS, EXCEPT: A) A stock dividend B) A preferred stock cash dividend C) A common stock cash dividend D) Convertible debt

C) A common stock cash dividend Cash dividends that are paid to common shareholders are paid from earnings available to common shareholders. As a result, cash dividends that are paid to the common shareholders, don't impact EPS. A preferred stock cash dividend is subtracted from net income to find earnings available to common shareholders, which impacts EPS. A stock dividend increases the number of common shares outstanding, which decreases EPS. Lastly, convertible debt increases the hypothetical number of common shares and is included when calculating fully diluted EPS.

Which of the following choices is considered dilutive to shareholders? A) A stock spilt B) A stock dividend distribution C) A conversion of convertible preferred stock to common D) An increase in treasury stock

C) A conversion of convertible preferred stock to common The conversion from preferred stock to common stock is dilutive because the number of common shares outstanding increases and the ownership percentage for existing shareholders will decline. A stock dividend is distributed to existing shareholders and, although the stock dividend will increase the number of shares outstanding, each shareholder will receive a proportionate amount of the new shares and dilution doesn't occur. Similarly, stock splits will adjust the number of shares proportionately and dilution doesn't occur. Treasury stock increases after a stock buyback, which is accretive, rather than an issuance of new shares, which is dilutive.

A trucking company has current assets of $800,000 and current liabilities of $500,000. If the company borrows $100,000 in the short term to carry an increase in receivables of the same amount, the increase in debt results in: A) A decrease in the current ratio and working capital B) No change to working capital or the current ratio C) A decrease in the current ratio, but no change to working capital D) An increase in working capital, but no change to the current ratio

C) A decrease in the current ratio, but no change to working capital When a company takes a short-term loan to carry more receivables, working capital remains the same since current assets (i.e., receivables) increase by the same amount as current liabilities (i.e., short-term loan). The current ratio will decrease because the trucking company's current assets ($800,000) are greater than its current liabilities ($500,000) before the loan. The current ratio will increase when current assets are less than current liabilities. Working Capital = Current Assets - Current liabilities Working Capital (Before) = $800,000 - $500,000 = $300,000Working Capital (After) = $900,000 - $600,000 = $300,000 Current Ratio = Current Assets / Current Liabilities Current Ratio Before = $800,000 / $500,000 = 1.60Current Ratio After = $900,000 / $600,000 = 1.50

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

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

Which of the following industries is least likely to be affected by an increase in interest rates? A) transportation firm B) A utility company C) An accounting firm D) An automotive company

C) An accounting firm Service industries are less capital intensive, and are therefore less susceptible to interest rate changes.

Which of the following actions is viewed as an aggressive accounting technique? A) Expensing stock options B) Expensing purchased software C) Capitalizing research and development D) Recognizing goodwill impairment

C) Capitalizing research and development From an accounting context, the term "aggressive" means to report lower expenses and higher income, or to overstate assets while understating or not recognizing liabilities. Accounting standards require firms to follow promulgated opinions; however, in some cases, there are gray areas. Capitalizing software would defer the recognition of expenses and boost earnings in the short-term. Capitalizing research and development increases the cost basis of the future product, but is not taken as an expense in the short run, thereby boosting earnings. Expensing stock options and software will lower earnings in the short term. Writing off goodwill through impairment also lowers earnings and is conservative.

Companies A and B dominate the market for widgets, but Company C recently entered as a competitor. Soon thereafter, unit prices for widgets decline. What explains the unit price decline? A) The demand for widgets has increased. B) Widgets are a luxury good. C) Company C has entered the market with aggressive pricing. D) The market is based on monopolistic competition.

C) Company C has entered the market with aggressive pricing. The decline in unit pricing is likely due to aggressive pricing by Company C. It's unlikely for the companies that dominate the market to lower prices based solely on the entry of a competitor, unless significant pricing pressure existed. The ability to obtain market share through aggressive pricing is associated with commodities, especially where brand loyalty is not a factor. The price of highly customized products and luxury goods are price inelastic. In other wors, their prices will not be dramatically impacted by a new competitor that's offering lower prices.

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

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

In the last quarter, a company has increased its sales by 33%. In the past, the company has been involved in channel stuffing. For an analyst who follows this company, what area should be reviewed to gain a better understanding of the quarter? A) Footnotes and the disclosure statement of nonrecurring items B) Sales growth exceeding accounts receivable growth C) Days sales outstanding (DSO) D) Revenue recognition policy

C) Days sales outstanding (DSO) Channel stuffing is a deceptive business practice that's used by a company to inflate its sales and earnings figures by deliberately sending retailers along its distribution channel more products than they're able to sell to the public. Through channel stuffing, distributors temporarily increase accounts receivables, but when retailers cannot sell the excess products, the products will be returned to the distributor in the following accounting period. This means that accounts receivable will grow faster than revenues and could be a sign of channel stuffing. Days sales outstanding (DSO) measures how quickly receivables are turned into cash. If a company's DSO is rising rapidly, it could also be a sign of channel stuffing.

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

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

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

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

Which one of the following calculations provides a measure of free cash flow? A) Net income plus working capital B) Net income plus capital expenditures C) EBITDA minus capital expenditures D) Net income plus interest plus the effect of taxation

C) EBITDA minus capital expenditures Free cash flow is used to describe the amount of funds a company has after paying all expenses. EBITDA is often used as a proxy for cash flow from operations for the purpose of calculating debt coverage ratios. EBITDA minus capital expenditures may be used as an approximation of free cash flow.

All of the following statements are TRUE about finance and operating leases, EXCEPT: A) Operating leases will increase assets. B) Operating lease expenses will decrease net income. C) Finance leases will not impact the balance sheet. D) Finance leases will increase liabilities.

C) Finance leases will not impact the balance sheet. Both operating and finance leases will increase assets and liabilities. Operating lease payments will be shown as a single expense on the income statement, while finance lease payments will be separated into an interest and amortization expense. However, both types of leases will decrease the overall net income of a corporation.

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

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

In which of the following ways does GDP differ from GNP? A) GNP includes transfer payments B) GDP includes transfer payments C) GNP includes U.S. ex-patriot production D) GDP includes U.S. ex-patriot production

C) GNP includes U.S. ex-patriot production Transfer payments, such as social security, are excluded from both GDP and GNP. Gross National Product includes overseas production by U.S. citizens and companies overseas. Gross Domestic Product doesn't, but does include production of foreign citizens and companies doing business inside the U.S

When the FRB concludes that the current growth rate is too strong and therefore inflationary, it will probably: A) Buy U.S. Treasuries B) Decrease the reserve requirement C) Increase the discount rate D) Cut the fed funds rate

C) Increase the discount rate If economic indicators point toward the presence of inflationary pressure, the FRB will look to deter economic activity. Raising lending rates and making it more difficult for individuals to acquire credit accomplishes this. The only choice that meets these criteria is increasing the discount rate. If the FRB were instead to buy U.S. Treasuries, they'd be putting money into the system, which will increase the money supply and ultimately lower lending rates. As is expected, this would lead to stronger demand and more inflation.

Which of the items below could be a reason for a difference between income from continuing operations and net income? A) Non-recurring items B) Additional shares issued C) Loss or gain on the sale of a business segment D) Extraordinary loss on retirement of debt

C) Loss or gain on the sale of a business segment A loss or a gain from the sale of a business segment could be the reason for the difference between earnings from continuing operations and net income. An earnings report should distinguish between the income arising from the normal activities of the company and those arising from any special activities or transactions a company engages in. A gain or loss from the sale of an individual asset is reported as a non-recurring item prior to the calculation of income tax. However, the gain or loss from the divestiture of a group of assets, such as an entire division or business segment should be isolated on the income statement as discontinued operations. When reporting discontinued operations, revenue and expense from the discontinued operations are stripped from continuing operations and reported separately on an after tax basis. On the income statement, both Income from continuing operations and discontinued operations must be shown in aggregate, as well as on a per share basis, as illustrated in the example below.

Which of the following would be classified as a relative valuation tool? A) Book value B) EPS C) PE D) Discounted cash flow

C) PE

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

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

A U.S. corporation owns a brewery in Germany. The beer produced in Germany is sold in the U.S. Recently, the euro has depreciated against the dollar. All of the following factors will be reflected on the income statement of the U.S. corporation, EXCEPT: A) Cost of goods sold will decrease B) Operating profit will increase C) Revenue will increase D) Profit margin will increase

C) Revenue will increase Revenues are still based in U.S. dollars since the beer is sold in the U.S. This will result in the same amount of revenue. The reduced costs of goods sold due to the lower value of the euro will result in higher profits and a higher profit margin.

If a research analyst wants to direct questions concerning the financial statement and financial reporting policies of a company, she should contact: A) The chairman of the board B) The leadership development and compensation committee C) The audit and risk oversight committee D) The directors and corporate governance committee

C) The audit and risk oversight committee SEC rules and exchange listing standards impose certain requirements on the committee structure of a public company's board. In general, there are three committees required: Audit, Compensation, and Nominating/Corporate Governance. Although the names may be slightly different among corporations, they're typically broken down into these three categories. The audit committee is responsible for overseeing the company's auditors, financial statements and financial reporting. The compensation committee is responsible for executive compensation policies and procedures. Corporate governance is responsible for its governance policies. Companies may have additional committees and may add or delete committees depending on certain circumstances.

An analyst is evaluating two companies and has noticed that, for inventory valuation purposes, one of the companies uses LIFO and the other uses FIFO. If interest rates have been rising, the conclusion is that: A) The company using FIFO will have lower earnings B) The company using LIFO will have higher taxes C) The company using FIFO will have lower cost of goods sold D) The company using LIFO will have higher earnings

C) The company using FIFO will have lower cost of goods sold During a period of rising rates or inflation, prices are also rising. The effect on inventory valuation is summarized as follows: First in, first out (FIFO) is an inventory method that matches the first costs with the first units sold. The ending inventory is matched with the cost of the most recent purchases. FIFO has lower COGS, but higher margins, higher profits (earnings), higher taxes, and higher inventory valuation. Last in, first out (LIFO) is an inventory method that matches the last costs with the first units sold. The ending inventory is matched with prior purchases. The earliest purchases are assumed to be available for sale. LIFO has higher COGS, but lower margins, lower profits (earnings), lower taxes, and lower inventory valuation.

A research analyst is covering the widget industry and a company within in the industry has developed a new, more scalable widget. The industry has also seen a general decrease in the cost of unit components. What reason may the widget company provide in its Form 10-K as to why the demand for its widgets has decreased? A) The company failed to keep up with product transition. B) The company's inventory management systems were out of date. C) The company's economies of scale were not as large as the companies with scalable products. D) The company's dividend policy is different from other industry participants.

C) The company's economies of scale were not as large as the companies with scalable products. Scalable products allow a company to increase its production faster than its costs. This is closely associated with economies of scale. However, if one company is producing more without dramatically increasing its costs, it will be able to offer lower cost goods to its consumers. Competitors with less scalable products most likely be unable to compete on costs; therefore, demand for their products could fall.

A company uses FIFO for is inventory valuation method and its gross profit margin increased by 2% in the third quarter. In the fourth quarter, the gross profit margin also increased. Which of the following statements is TRUE? A) The sales will continue to grow. B) The gross margin will continue to grow. C) The cost of goods sold (COGS) declined. D) The cost of goods sold (COGS) increased.

C) The cost of goods sold (COGS) declined. The gross profit margin is found by dividing the gross profit by sales/revenue. If sales and COGS increase or decrease by the same percentage, the gross margin remains unchanged. COGS is the direct costs for the production of goods and services and includes material cost (affected by the choice of inventory valuation, such as FIFO or LIFO), direct labor costs, and any other overhead cost related to producing the goods and service of the company. Since the gross margins are increasing, the best answer is that COGS have been decreasing.

All of the following metrics are included when calculating a company's market capitalization, EXCEPT: A) The number of shares held by institutional investors B) The number of shares of restricted stock C) The number of shares of treasury stock D) The number of shares held by insiders

C) The number of shares of treasury stock Market capitalization is determined by multiplying the number of outstanding shares by the current market price per share. Outstanding shares include those held by institutions, retail investors, restricted shares, and shares held by insiders, but do not include treasury stock (shares repurchased by the company).

Which of the following choices is MOST relevant when analyzing a biotech company that has not yet had any drug approved by the FDA? A) Sum of the parts analysis B) The PEG ratio C) The phase of research the company is in D) EV-to-EBITDA

C) The phase of research the company is in A biotech company that has not yet had a drug approved by the FDA would not have revenue or earnings. Therefore, PEG ratio and EV-to-EBITDA would not be relevant. The phase of research is very important to analyze since it would be the best estimate on when the company would begin earning revenue. Sum of the parts analysis is useful for large companies with several different business units.

If market interest rates are declining, what happens to future pension obligations on a business' balance sheet? A) The future value will increase. B) The future value will decrease. C) The present value will increase. D) The present value will decrease.

C) The present value will increase. On their balance sheets, corporations must document the present value of their pension obligations. This requires adjusting the future liability using the present value formula. Since the future value is divided by a factor that includes the discount rate, a smaller discount rate will result in a larger present value.

A major difference between price/earnings and price-to-book value calculations is that the price-to-book value: A) Results in a higher ratio than the P/E B) Results in a lower ratio than the P/E C) Uses balance sheet data rather than income statement figures D) Cannot result in a negative ratio

C) Uses balance sheet data rather than income statement figures The P/E ratio relates the price of the stock of the company to earnings, an income statement figure, whereas the price-to-book ratio relates the price of the stock to the book value of the company which is a balance sheet calculation.

What is the fair value of a firm? A) A method that uses average multiples of earnings and EV / EBITDA to arrive at a valuation B) Determined by normalized PE C) What an unsolicited buyer would pay D) In a range of 2 to 3 times book

C) What an unsolicited buyer would pay Fair value of a company is what an unsolicited buyer would pay a seller when neither the buyer nor seller are under any pressure to complete the transaction. Fair value may be estimated by using a multiple of sales, EBITDA, EBIT or price, within a range of multiples that are common to the sector.

Which of the following events would lower the risk of investing in Genero Drugs, a manufacturer of generic pharmaceutical products? A) Genero Drugs invests significant capital in research and development for new drugs B) The head of R&D for Genero Drugs leaves the company C) An announcement is expected regarding Medicare reimbursements D) A competitor has won a lawsuit involving the marketing of a generic drug

D) A competitor has won a lawsuit involving the marketing of a generic drug A successful lawsuit permitting the marketing of a generic drug would be beneficial for other manufacturers of generic drugs. This may reduce the risk of investing in this type of company. The development and testing cycles of new drugs last for several years, without any assurance that the drugs will (1) be effective (2) be approved or (3) penetrate the market if approved. The head of R&D leaving would increase the risk of investing in the company. An announcement that is expected regarding Medicare reimbursements could be good news (expanded coverage), or bad news (reduced coverage).

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

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

A European company owns a cycling business in Italy and sells its products in the United States. Recently, unlike the rest of the world, interest rates have risen in the United States. Assuming no other changes in the company's business, in dollar terms, what effect will this currency movement have on the company? A) Both revenue and gross margins will decline. B) Revenue will increase and the gross profit margins will remain the same. C) Revenue will decrease, but the gross margin will remain unchanged. D) Both revenue and gross margins will increase.

D) Both revenue and gross margins will increase. Rising interest rates in the U.S. will cause the U.S dollar to strengthen against the Euro. Since sales are generated in U.S. dollars, the revenue will increase as the dollar rises against the Euro. Since costs remain unchanged and revenue increases, the gross margin will increase.

When attempting to value an initial public offering of securities, an analyst would NOT use: A) Sum-of-the-parts analysis B) Discounted cash flow analysis C) Comparable company analysis D) Comparable transaction analysis

D) Comparable transaction analysis Comparable transaction analysis, or M&A comparable analysis, is a valuation method used to value a company by comparing it to the transactional value of other companies in the same or similar industry sector. It is used to value the price an acquirer may offer a target company and would generally not be used to value an IPO. The other valuation methods may be used to value a company in order to determine its intrinsic value.

A new phone has recently been released which is 10 times more expensive than the average phone's price. How would a research analyst rank demographic metrics for the total addressable market (TAM) of new phones from the MOST to the LEAST important? A) Age of the purchaser, cell phone minutes used, the mix between personal and business use, and disposable income B) Age of the purchaser, the mix between personal and business use, cell phone minutes used, and disposable income C) The mix between personal and business use, age of the purchaser, disposable income, and cell phone minutes used D) Disposable income, the mix between personal and business use, age of the purchaser, and cell phone minutes used

D) Disposable income, the mix between personal and business use, age of the purchaser, and cell phone minutes used Due to the new phone's cost, disposable income is the most important demographic factor. Businesses have less demand elasticity and are less sensitive to price. The personal/business use mix is the next most important factor. Age of the purchaser can play a role since younger people own new phones at higher rates than older consumers. However, older consumers typically have more disposable income to purchase a more expensive phone. Cell phone minutes used is the least important factor.

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

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

A company has two different business segments, one producing 90 percent of company's revenue and the other 10 percent. The segment producing 10 percent of the revenue produces one third of the profits. What is the rational for using sum of the parts analysis? A) The smaller segment has several high multiple comparables B) There is no rationale because one segment produces the lion's share of revenue C) Each segment has a different growth rate D) Each segment is in an unrelated business that requires the use of different valuation metrics

D) Each segment is in an unrelated business that requires the use of different valuation metrics Sum-of-the-parts analysis would be appropriate when the business segments have unrelated business operations where different valuation metrics would be applicable. For example, the segment that produces 90 percent of the revenue and two thirds of the profit might be in the Tech segment and valued based on a multiple of sales, while the segment that produces 10 percent of the revenue and one third of the profit might be in financial services and valued based on a multiple of book value.

Which of the following situations occur when the U.S. dollar strengthens? A) Foreigners will purchase more U.S. goods and services B) U.S. exports become more competitive C) Foreign exports become less competitive D) Foreign exports become more competitive

D) Foreign exports become more competitive cheaper to buy these goods since currency is worth less

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

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

Which of the following statements is TRUE when comparing free cash flow to the firm versus free cash flow to equity? A) Free cash flow to the firm is not impacted by depreciation expenses. B) Free cash flow to the firm is calculated after payment of interest. C) Free cash flow to equity is calculated before payment of interest. D) Free cash flow to equity is calculated after payment of interest.

D) Free cash flow to equity is calculated after payment of interest. Free cash flow to the firm (FCFF) is calculated prior to the payment of interest, while free cash flow to equity (FCFE) is calculated after deducting the payment of interest. Since depreciation is a non-cash expense, it must be added back to find both FCFF and FCFE.

Company WHL uses straight-line depreciation in a sector in which other companies use accelerated depreciation. Company WHL will have: A) Lower accumulated earnings B) Higher accumulated earnings C) Higher earnings in the long run D) Higher earnings in the short run

D) Higher earnings in the short run Accelerated depreciation provides a larger level of expenses in the earlier years of an asset's life, thereby creating a lower earnings level being reported in the short run. Since this company is using straight-line depreciation, it will have a higher level of earnings in the short run. Accumulated earnings, which is another term for retained earnings, are directly impacted by the type of depreciation used.

A research analyst suspects that a company is channel stuffing. Which of the following would indicate that channel stuffing may have occurred? A) Inventory up, and receivables down B) Inventory down, and receivables down C) Inventory up, and receivables up D) Inventory down, and receivables up

D) Inventory down, and receivables up Channel stuffing occurs when a business sells more goods to a retailer than can be sold. In the current accounting period, inventories will go down and accounts receivable will go up. Receivables will increase because the distributors cannot sell the goods, which also means they cannot pay for them. Channel stuffing may also cause inventory to fall as the producing company ships its inventory to distributors. However, businesses involved in channel stuffing will typically see lower sales or more inventory returned in subsequent accounting periods as their distributors return unsold goods.

A research analyst is comparing two companies that are similar in all respects, except for their lease arrangements. Which of the following is a characteristic of a company that has finance leases rather than operating leases? A) It has higher assets at the commencement date of the lease. B) It has higher liabilities at the commencement date of the lease. C) It has higher financing cash flows. D) It has both amortization and interest expenses on the income statement.

D) It has both amortization and interest expenses on the income statement.

Cyclical changes in the business cycle would most likely have the greatest effect on the stock of a: A) Utility company B) Food retailer C) Brewery D) Machine tool company

D) Machine tool company The stock price of a machine tool company is cyclical and fluctuates with the business cycle. The other choices are necessities or staples and are considered defensive due to their resistance to a recession.

Which of the following companies would be least affected by changes in the business cycle? A) A construction company B) A machine tool company C) An automobile manufacturer D) Pharmaceutical company

D) Pharmaceutical company Changes in the business cycle would have the least effect on a defensive company (such as pharmaceuticals or utilities). The demand for the products produced by defensive companies would not be hurt by a downturn in the economy. The other choices are examples of cyclical companies. These companies would tend to parallel the economy of the country. If the economy is expected to prosper, then a person can expect a cyclical company to prosper. If the economy is expected to decline, then a person can expect a cyclical company to be less prosperous.

An analyst is discussing widget production with the plant manager at Worldwide Widgets, an industry leader. What's the MOST important factor to discuss with the plant manager? A) Shortfalls in the company's pension plan B) The company's dividend policies C) Product pricing D) Supply chain bottlenecks

D) Supply chain bottlenecks The plant manager will have the best insight on production and having the necessary inputs and resources to meet those objectives. This includes the lack of supplies caused by parts shortages, transportation problems, and labor concerns (e.g., supply chain bottlenecks). Pension plan shortfalls, product pricing, and dividend policies are not concerns of a plant manager. Instead, those are concerns for senior management.

Which of the following is dilutive to a company's shareholders? A) The company issuing convertible bonds B) The company issuing out-of-the-money options to senior personnel. C) The company announcing a 3-for-2 stock split. D) The company issuing 500,000 new shares.

D) The company issuing 500,000 new shares. Issuing new shares of common stock is dilutive to earnings per share, since the company will have more common shares outstanding. Issuing options and convertible bonds could be dilutive, but only after the exercise or conversion of those securities. Stock splits are not dilutive since the shares are proportionately adjusted for every shareholder.

Which of the following BEST defines the term public float? A_) The number of shares held by retail investors B) The number of shares of restricted stock held by insiders C) The number of shares of restricted stock added to the number of shares of outstanding stock D) The number of shares of restricted stock subtracted from the number of shares of outstanding stock

D) The number of shares of restricted stock subtracted from the number of shares of outstanding stock The public float of a company represents the number of shares held by public investors—both retail and institutional. Public float excludes any stock that is owned by affiliated persons of a company and is found by subtracting restricted stock from the number of outstanding shares. By contrast, a company's market capitalization is determined by multiplying the number of outstanding shares by the current market price per share. Outstanding shares include restricted shares as well as those held by institutions, retail investors, and insiders, however, treasury stock (shares that are repurchased by the company) is not included.

When comparing one company to another using a forward P/E ratio, which of the following statements is TRUE? A) Income from continuing operations cannot be adjusted for non-recurring items. B) Both companies must be in the same industry sector. C) Both companies must have the same number of shares outstanding. D) The same time frames must be used for both companies.

D) The same time frames must be used for both companies. Forward P/E is calculated by dividing a company's stock price by its expected earnings for a future period. The time frame used for both companies must be identical. For example, it would not be a valid comparison to use expected quarterly earnings for one company and expected annual earnings for another company. In addition, before calculating expected earnings, current earnings must be adjusted for non-recurring items. Using companies that have similar market caps would be relevant because small-cap companies typically grow at a faster rate than established large-cap companies, but the number of shares outstanding would not be important.

The Flanders Company has issued debt to finance the construction of a factory. As construction begins, the price of the stock has remained unchanged. Which of the following statements best describes the impact on operating income and P/E? A) Operating income will increase, P/E will decline B) Operating income will decline, P/E will increase C) Operating income will increase, P/E will increase D) There will be no impact on operating income or P/E

D) There will be no impact on operating income or P/E According to FASB Interpretation 34, construction period interest is capitalized and added to the total cost of the project. Earnings are unaffected by the interest expense incurred during the construction period. Operating income (EBIT) is not affected by interest expense.