Business Analysis and Valuation
Exam Materials
Course Introduction
This course provides an in-depth understanding of how to analyze financial statements and other business information for the purpose of making informed business decisions and valuing firms. Students will learn key concepts and tools in accounting, finance, and strategy to evaluate a companys performance, assess its financial health, and estimate its intrinsic value. The curriculum covers topics such as profitability assessment, risk analysis, cash flow forecasting, and a range of valuation techniques including discounted cash flow (DCF) and relative valuation models. Case studies and real-world examples are used to illustrate analytical approaches and to develop practical skills for roles in investment banking, equity research, corporate finance, and consultancy.
Recommended Textbook
Financial Reporting Financial Statement Analysis and Valuation 9th Edition James M. Wahlen
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14 Chapters
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Page 2
Chapter 1: Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
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Sample Questions
Q1) What is comprehensive income?
Answer: Comprehensive income equals net income for a period plus or minus the changes in shareholders' equity accounts other than from net income and transactions with owners.Items affecting comprehensive income include foreign currency translation adjustments,cash flow hedge accounting,minimum pension liability adjustments and unrealized gains and losses from holding investment securities classified as available for sale.
Q2) Extraordinary gains and losses arise from events that have all the following characteristics except:
A) They are unusual given the nature of the firm's activity.
B) They are nonrecurring.
C) They are material in amount.
D) They result from terminated involvement in a line of business.
Answer: D
Q3) Depreciation is a(n)___________________ added back to net income when preparing the operating activities section of the Statement of Cash Flows.
Answer: Non-cash expenditure
Q4) Normally,intense rivalries have a tendency to reduce ____________________.
Answer: profitability
Page 3
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Chapter 2: Asset and Liability Valuation and Income Recognition
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Sample Questions
Q1) Firms recognize the reduction in service potential of assets such as patents and trademarks using the process of ____________________.
Answer: amortization
Q2) If a portfolio manager had to estimate the fair value of real estate,which of the following would he/she most likely identify as the level of inputs to determine this?
A) Level 1.
B) Level 2.
C) Level 3.
D) None of these.
Answer: B
Q3) Refer to Balance Sheet Equation.ORP Corporation Purchases land for $9,000 cash and 1,000 shares of common stock values at 10 per share.This transaction results in ORP recording a decrease in cash of $9,000,an increase in non-cash assets of $ 19,000,and an increase in ______________________________ of $10,000
Answer: contributed capital
Q4) Acquisition costs includes all costs necessary to get an asset ready for its
Answer: intended use
Page 4
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Chapter 3: Income Flows versus Cash Flows: Understanding
the Statement of Cash Flows
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Sample Questions
Q1) Which of the following transactions would not create a cash flow?
A) Payment of a cash dividend.
B) The company purchased some of its own stock from a stockholder.
C) Amortization of patent for the period.
D) Sale of equipment at book value (i.e.no gain or loss).
Answer: C
Q2) Discuss operating,investing,and financing cash flows in relation to the various stages of the product life cycle.
Answer: 1.Operating cash flows begin negative in the introduction phase and start becoming positive in the growth phase.Operating cash flows reach their peak in the maturity phase and start to decrease at the end of the maturity phase and into the decline phase.
2.Investing cash flows begin negative in the introduction phase and stays negative in the growth phase.Investing cash flows become positive in the maturity phase and start to decrease at the end of the maturity phase and into the decline phase.
3.Financing cash flows are positive in the introduction and growth phase.Financing cash flows start to decrease at the end of the maturity phase and continue to decrease in the decline phase.
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Chapter 4: Profitability Analysis
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Sample Questions
Q1) Firms that have either convertible securities or stock options or warrants outstanding have __________________________________________________.
Q2) The ability of a firm to generate income from operations given a particular level of sales is measured by the ______________________________.
Q3) Refer to the information for Net Devices Inc.What is Net Devices' earnings per share for 2011?
A) $1.00
B) $1.70
C) $1.96
D) $0
Q4) Hall and Porter argue that firms have two generic alternative strategies for any particular product.These strategies are:
A) low risk focus, low risk focus
B) retail customer focus, wholesale customer focus
C) product differentiation, low-cost leadership
D) low operating leverage, high operating leverage
Q5) When the financial analysts multiplies the profit margin for ROA with the assets turnover ratio the result is called ______________
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Chapter 5: Risk Analysis
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Sample Questions
Q1) Marker's 2012 Long-term Debt to Long-Term Capital ratio is:
A) 31.4%
B) 29.4%
C) 34.0%
D) 25.4%
Q2) A.Hammer Corporation wrote off $185,000 of obsolete inventory at December 31,2011.
Required:
What effect did this write-off have on the company's 2011 current and quick ratios?
B.Assume that Hammer Company did not write off their inventory.How will this affect the company's financial position?
Q3) When the excess of ROA over the after-tax cost of borrowing declines,additional ________________________________________ begins to reduce the return to common shareholders.
Q4) Cash flow from operations indicates the amount of cash that the firm derived from operations after funding ______________________________.
Q5) A.What are the three measures that are used to analyze long-term solvency risk?
B.describe each measure briefly
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Chapter 6: Accounting Quality
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Sample Questions
Q1) One definition of earnings management is that it occurs when managers use:
A) judgment in financial reporting to alter financial reports to mislead stakeholder.
B) an accounting method that is inconsistent with other industry members.
C) more conservative accounting estimates than other companies.
D) pro forma accounting results as opposed to GAAP results.
Q2) Many times an analyst will have to make judgments as to whether to include unrealized gains and losses when assessing earnings persistence and predicting future profitability.Discuss the case for and the case against including unrealized gains and losses as part of sustainable earnings when examining earnings persistence and future profitability.
Q3) When evaluating the quality of accounting information the user should consider the ____________________ of the firm's disclosures.
Q4) Accounting information should provide relevant information to forecast the firm's expected future earnings and _________________________.
Q5) Earnings are informative if they signal the portion of current period's due to a new product and the additional earnings in the future as a result of the ____________________ of this new earnings stream.
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Page 8
Chapter 7: Financing Activities
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Sample Questions
Q1) Assuming that Santa Corporation was required to capitalize its operating lease,how would the company's fixed asset ratio change under this assumption?
A) increase
B) decrease
C) no effect
D) unable to determine
Q2) Derivative instruments acquired to hedge exposure to variability in expected future cash are _________________________ hedges.
Q3) A(n)____________________ lease arrangement is one in which the lessee enjoys the use of the property for a set period of time.
Q4) Discuss the difference between transferring receivables with and without recourse. When a company transfers receivables to the factor without recourse the factor pays the company a percentage of the total receivables and in effect it is a sale of the receivables to the factor.
The factor takes the receivables with recourse if any uncollected receivables can be returned to the company for a refund.
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Chapter 8: Investing Activities
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Sample Questions
Q1) Under IFRS,when an asset is revalued upwards,subsequent depreciation is based on:
A) the asset's fair value.
B) the asset's original cost.
C) the method used for determining depreciation on the company's tax returns.
D) the amount of future cash flows the asset is expected to generate.
Q2) The three types of costs incurred in coal production are acquisition costs (costs to acquire the coal rich lands plus the present value of future cash flows necessary to restore the sites minus the cost of the land),exploration costs (costs of mining),and development costs (pipes,roads,and so on,to extract and transport the coal to customers).
Required: Should each of these costs be capitalized or expensed? Explain.
Q3) When dividends from an investment are recognized as income,the investment must have been of which type?
A) Minority, Passive Investment
B) Majority, Passive Investment
C) Majority, Active Investment
D) Minority, Active Investment
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Chapter 9: Operating Activities
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Q1) Deferred tax liabilities result in future tax ____________________ when temporary differences reverse.
Q2) Regarding actuarial assumptions,firms must disclose in notes to the financial statements all of the following except:
A) the discount rate used to compute the pension benefit obligation.
B) the expected rate of return on pension investments.
C) estimates of the number of retirees over the future 10 years.
D) the rate of compensation increase.
Q3) U.S.GAAP requires firms to report the assets and liabilities of defined benefit plans _______________________________________________________.
Q4) All of the following are true regarding accrual accounting except:
A) Accrual basis measures operating success by the extent to which accomplishments exceed efforts.
B) Accrual basis measures operating success by the extent to which revenues exceed expenses.
C) Accrual basis reports operating activities in terms of their success in generating value.
D) Accrual basis for the recognition of expenses is not required under IFRS.
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Chapter 10: Forecasting Financial Statements
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Sample Questions
Q1) Using Sparky's financial information what is the company's inventory turnover ratio for 2012?
A) 0.69
B) 1.00
C) 3.35
D) 4.03
Q2) Financial statement forecasts should rely on ____________________ within financial statements.
Q3) If a company has very low operating leverage (i.e.,a low proportion of fixed costs in the cost structure)and no changes are expected in operations:
A) percentage change income statement percentages can serve as the basis for projecting operating expenses.
B) using common-size income statement percentages will overstate future projected operating expenses.
C) using common-size income statement percentages will understate future projected operating expenses.
D) using common-size income statement percentages can serve as a reasonable basis for projecting future operating expenses.
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Chapter 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach
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Q1) To determine the appropriate weights to use in the weighted average cost of capital,an analyst will need to determine the ______________________________ of the debt,preferred stock and common equity capital.
Q2) When deriving the equity value of a firm,an analyst forecasts the real dividends expected to be paid in the future.In this case,which discount rate should be used?
A) The nominal rate of return
B) The real rate of return
C) The risk-free rate of return
D) The risk adjusted rate of return
Q3) Provide the rationale for using expected dividends in a valuation model.
Q4) One rationale for using expected dividends in valuation is:
A) Dividends are a necessary payment in order for a firm to have value.
B) Dividends are paid in cash, and cash serves as a measurable common denominator for comparing the future benefits of alternative investment opportunities.
C) Dividends are the most reliable measure of value because most companies payout dividends to shareholders.
D) Dividend payout ratios are set based on profitability.
Q5) Why are dividends value-relevant to common equity shareholders?
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Chapter 12: Valuation: Cash-Flow-Based Approaches
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Sample Questions
Q1) An equity security with systematic risk equal to the average amount of systematic risk of all equity securities in the market:
A) has a market beta equal to one.
B) should expect to earn the same rate of return as the average stock in the market portfolio.
C) gives no insight into the risk premium of stock.
D) Both a and b are correct.
Q2) If a firm generates a rate of return on __________________________________________________ equal to the discount rate used by the investor then it does not matter if an analyst uses cash flows to the investor or cash flows to the firm.
Q3) Regarding the equity buyout,compute the cost of equity capital with the new capital structure that results from the LBO.Assume a risk-free rate of 3.75percent and a market risk premium of 5.0 percent.
Q4) Net income for the year for Tanglewood Inc.was $750,000,but the statement of cash flows reports that cash provided by operating activities was $860,000.Tanglewood also reported capital expenditures of $75,000 and paid dividends in the amount of $30,000.Compute Tanglewood's free cash flow.
Q5) Provide the rationale for using expected free cash flow in valuation.
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Chapter 13: Valuation: Earnings-Based Approaches
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Sample Questions
Q1) Assume that a firm's book value at the beginning of the year is $12,500 and that the firm reports net income of $3,200 and pays dividends of $1,100.What will the firm's book value at the end of the year?
A) $2,100
B) $15,700
C) $14,600
D) $16,800
Q2) If an analyst expects a firm to generate net income each period exactly equal to required earnings,then the value of the firm will be equal to the ______________________________ of common shareholders' equity.
Q3) Where is comprehensive income reported and what is its relevancy to the computation of residual income?
Q4) If investors have invested $20,000 of common equity in a company and it is determined that the required earnings of the company are $$1,250 each period,then investors must expect to earn what return?
A) the risk free rate
B) 9%
C) 6.25%
D) the market premium
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Chapter 14: Valuation: Market-Based Approaches
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Q1) In the value-to-book model growth adds value to shareholders only if the growth is
Q2) What information can a PEG ratio provide about a company's stock price? What does a PEG ratio greater than one mean? Less than one?
Q3) The value-to-book model indicates that a firm in steady state equilibrium earnings ROCE=RE will be valued at _________________________.
Q4) Firms with low P/E ratios tend to have current residual income that is greater than _____________________________________________.
Q5) Which of the following ratios give a perspective on risk in the capital structure?
A) Book value per share
B) Price/earnings ratio
C) Degree of financial leverage
D) Dividend yield
Q6) Explain the analysts' role in making the capital markets efficient.
Q7) Discuss how risk and profitability factors cause differences in price-earnings ratios across firms.Explain the difference between abnormal and normal earnings.
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