Unit 14 - Economics and Analysis

Buying stocks with high PE ratios normally reflects which of the following investment styles? A) Turnaround. B) Special situations. C) Growth. D) Value.

Your answer, Growth., was correct!. The purchase of stocks with high PE ratios represents a growth investment style. Growth-oriented investors will pay for high PE ratios. Value investment style is associated with the purchase of low PE stocks or stocks trading below their intrinsic value. Reference: 14.5.1.3 in the License Exam Manual.

A corporation has $12 million net income after taxes, 5 million common shares outstanding, and $10 million of 6% preferred stock ($100 par). What is the corporation's earnings per share (EPS)? A) $2.52. B) $1.20. C) $2.28. D) $2.40.

Your answer, $2.40., was incorrect. The correct answer was: $2.28. Begin by calculating how much of the net income is available for common stockholders (net income after taxes minus preferred dividends equals earnings available for common stockholders). The preferred stockholders received $600,000 in dividends (100,000 pfd shares × $6 per share dividends = $600,000). After subtracting $600,000 from the net income of $12 million, this leaves $11.4 million (earnings available for common stockholders). Compute EPS (earnings available for common ÷ number of common shares outstanding = $11.4 million / 5 million shares = $2.28 per share EPS). Reference: 14.7.3.1 in the License Exam Manual.

Which of the following is the most stringent test of liquidity? A) Assets / current liabilities. B) (Cash + marketable securities) / current liabilities. C) (Current assets - inventory) / current liabilities. D) Current assets / current liabilities.

Your answer, (Cash + marketable securities) / current liabilities., was correct!. Of the answers given, the cash assets ratio is the most stringent because it excludes inventories and accounts receivable. Reference: 14.7.2 in the License Exam Manual.

To stimulate a sluggish economy using fiscal policy measures, policymakers would: A) reduce income taxes. B) increase income taxes. C) reduce the money supply. D) increase the money supply.

Your answer, increase the money supply., was incorrect. The correct answer was: reduce income taxes. Reducing income taxes is a fiscal policy tool intended to increase overall demand for goods and services. Adjusting the money supply is a monetary policy tool. Reference: 14.1.2.1.1 in the License Exam Manual.

The board of ABC has voted to pay a $.32 dividend to holders of its common stock. These dividends will be paid from: A) new stock issues. B) debt service. C) operating income. D) retained earnings.

Your answer, retained earnings., was correct!. Cash dividends are typically paid from retained earnings. Reference: 14.6.1.3.3 in the License Exam Manual.

A customer buys XYZ stock at $60 per share. The stock is currently trading at a 10:1 price-to-earnings (PE) ratio. The firm declares a 3:1 stock split. What will the PE ratio be after the split if earnings remain unchanged? A) 3:1. B) 5:1. C) 10:1. D) 12:1.

Your answer, 3:1., was incorrect. The correct answer was: 10:1. If earnings remain unchanged, the PE ratio remains the same, 10:1. Earnings are currently $6 per share ($60 / 10). After a 3:1 split, each share will be valued at $20. If earnings are unchanged, the same $6 of earnings is now applicable to 3 shares or $2 per share. Price divided by earnings equals PE ratio ($20 / $2 = 10:1 PE ratio). Reference: 14.6.2.6 in the License Exam Manual.

What is the balance sheet equation? A) Assets = liabilities + shareholders' equity. B) Assets = shareholders' equity − liabilities. C) Assets = net worth. D) Assets = liabilities − shareholders' equity.

Your answer, Assets = shareholders' equity − liabilities., was incorrect. The correct answer was: Assets = liabilities + shareholders' equity. Total assets equal total liabilities plus total shareholders' equity. Reference: 14.6.1.2 in the License Exam Manual.

All of the following ratios are measures of the liquidity of a corporation EXCEPT: A) debt/equity ratio. B) current ratio. C) quick ratio. D) acid-test ratio.

Your answer, debt/equity ratio., was correct!. Liquidity ratios measure a firm's ability to meet its current financial obligations and include the current ratio and acid-test (quick) ratio. However, the debt/equity ratio is a capitalization ratio and measures the amount of leverage compared to equity in a company's overall capital structure. Reference: 14.7.2 in the License Exam Manual.

Which of the following analyze corporate financial statements and trends in sales and income? A) Technicians. B) Fundamentalists. C) Chartists. D) Market timers.

Your answer, Fundamentalists., was correct!. Fundamental analysts obtain information from corporate financial statements as well as other relevant sources. Technical analysts review market charts while fundamental analysts are concerned with the earnings ability of corporations derived from corporate financial statements. Reference: 14.5 in the License Exam Manual.

If the Federal Reserve Board (FRB) decides that the rate of inflation is too high, which is it most likely to do? Tighten the money supply. Loosen the money supply. Lower the discount rate. Raise the discount rate. A) II and IV. B) I and III. C) II and III. D) I and IV.

Your answer, I and IV., was correct!. If the FRB decides to attempt to curb inflation, it can raise the discount rate which in turn tightens the money supply. Reference: 14.2.1.2.2 in the License Exam Manual.

Which of the following balance sheet entries may be affected when a company pays a cash dividend? Shareholders' equity. Total assets. Total liabilities. Working capital. A) II and III. B) I and III. C) II and IV. D) I and IV.

Your answer, I and IV., was incorrect. The correct answer was: II and III. When a company pays a cash dividend, the dividends payable (a current liability) and the cash account (current assets) are reduced by the same amount. Working capital is not affected as both current assets and current liabilities are reduced the by same amount. Shareholders' equity, or net worth, is also not affected when the dividend is paid. Net worth is reduced and liabilities are increased when a dividend is declared. Reference: 14.6.2.5 in the License Exam Manual.

An increase in which of the following economic indicators would predict a decrease in business activity? A) Levels of inventories. B) Building permits. C) Personal incomes. D) Expenditures on plant and equipment.

Your answer, Levels of inventories., was correct!. The buildup of inventories is a disincentive for manufacturers to produce more goods and, therefore, may indicate a decrease in business activity. Increase in personal incomes, building permits, and expenditures on plant and equipment point to an increase in business activity. Reference: 14.6.2.1 in the License Exam Manual.

When a company issues additional preferred stock and bonds, which of the following will be the net result? A) Leverage is not affected since one issue is equity, the other is debt, and the net effect on leverage is zero. B) Leverage is increased. C) It is impossible to tell without the specific amounts of equity and debt issued. D) Leverage is decreased.

Your answer, Leverage is increased., was correct!. Leverage is the use of someone else's money at a fixed cost to benefit the common shareholders. Both preferred stock and bonds are fixed rate issues. Therefore, issuing more preferred stock or bonds increases the leverage of the common stockholders. Reference: 14.7.1.1 in the License Exam Manual.

One company is guaranteeing the debt service of another company (guaranteed bond). In which of the following scenarios is this most likely to occur? A) In a spin-off where one company, the parent company, has divested itself of some equity and some debt to form a separate company B) Never, because SEC rules prohibit "guaranteed" bonds C) When a company guarantees the debt of one of its own existing creditors D) When 2 competitors have merged

Your answer, When 2 competitors have merged, was incorrect. The correct answer was: In a spin-off where one company, the parent company, has divested itself of some equity and some debt to form a separate company Of the scenarios listed, in a spin-off, where one company, a parent company, divests itself of some of its equity and debt to form a new separate company, it is likely that the parent company would guarantee the debt of the new company. Reference: 14.6.2.7 in the License Exam Manual.

Each of the following would cause a decrease in the balance of trade deficit EXCEPT: A) an increase in exports of U.S. products. B) an increase in imports of foreign products. C) an increase in dividends paid on foreign stocks to U.S. investors. D) an increase in dividends paid on U.S. stocks held by foreign investors.

Your answer, an increase in exports of U.S. products., was incorrect. The correct answer was: an increase in imports of foreign products. The trade deficit occurs when imports exceed exports (as they have for years). We want to know which one of these would not be helpful to our balance of trade-that is, which one would cause the negative balance to increase. If you read it correctly, an increase in foreign imports is obviously correct since it is bad for our trade balance and would cause an increase in the deficit instead of a decrease. Reference: 14.3.1.1 in the License Exam Manual.

Under what circumstances will a dilution of equity occur? A) Stock split. B) Stock dividend. C) Conversion of convertible bonds into common stocks. D) Issue of mortgage bonds to replace debentures.

Your answer, Conversion of convertible bonds into common stocks., was correct!. Dilution of equity occurs when stockholders experience a reduction in their percentage ownership of the company. If bonds are converted, more common shares are issued and the shareholder's equity is diluted. A stock dividend or stock split does not change a stockholder's percentage of ownership. Refunding debts has no effect on stockholders. Reference: 14.7.3.2 in the License Exam Manual.

Which of the following balance sheet items is NOT a current liability? A) Accounts payable. B) Mortgages. C) Accrued taxes. D) Long-term debt amount that is due within 1 year.

Your answer, Mortgages., was correct!. Short-term or current liabilities are those entries on a balance sheet that are due in 1 year or less. Accounts payable, accrued taxes, and that portion of long-term debt due within the year are all current liabilities. Mortgages are generally long-term liabilities, although that portion of a mortgage that is due within the year would be classified on the balance sheet as a current liability. Reference: 14.6.1.2.2 in the License Exam Manual.

XYZ Aircraft Manufacturing Corporation announces a multimillion dollar order for its new jumbo jet from Fly Airlines, a Japanese carrier. When the sale is completed, there will be: A) a debit to the current account of the U.S. B) a credit to the current account of Japan. C) no effect on the balance of trade. D) a credit to the current account of the U.S.

Your answer, a credit to the current account of Japan., was incorrect. The correct answer was: a credit to the current account of the U.S. Whenever money from a foreign source enters the United States, it becomes a credit item in the U.S. balance of payments. Reference: 14.3.1.1 in the License Exam Manual.

XYZ corporation divests itself of all of the shares of another company it owns. This is known as: A) an acquisition. B) a spin-off. C) a recapitalization. D) a merger.

Your answer, a spin-off., was correct!. When one company sells all of the shares of another it owns, this is called a spin-off. Reference: 14.6.2.7 in the License Exam Manual.

Wall Street closely monitors Federal Open Market Committee (FOMC) activities because of its effect on all of the following EXCEPT: A) income tax rates. B) interest rates. C) money supply. D) bank excess reserves.

Your answer, income tax rates., was correct!. The FOMC is one of the most influential committees in the Federal Reserve System, and its decisions affect the money supply, interest rates, and reserves that member banks must maintain. Their decisions do not affect income tax rates. Reference: 14.2.1.2.1 in the License Exam Manual.