Equity Analysis
Exam Answer Key
Course Introduction
Equity Analysis is a comprehensive course that delves into the methodologies and tools used to evaluate the value and potential of publicly traded companies. Students will learn principles of financial statement analysis, industry comparisons, valuation techniques such as discounted cash flow (DCF) and relative valuation, as well as qualitative factors affecting equity prices. The course emphasizes practical application through case studies and real-world examples, preparing students to make informed investment decisions, construct research reports, and understand the broader dynamics of equity markets.
Recommended Textbook
Financial Reporting Financial Statement Analysis and Valuation 8th Edition by James M. Wahlen
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Page 2
Chapter 1: Overview of Financial Reporting, financial
Statement Analysis, and Valuation
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Q1) The primary purpose of the balance sheet is to:
A) Report the current value of the business.
B) Measure the net income of a business up to a particular point in time.
C) Report the difference between cash inflows and cash outflows for the period.
D) Report the financial position of the reporting entity at a particular point in time.
Answer: D
Q2) Statements that express all items in a particular financial statement as a percentage of some common base are called _________________________ statements.
Answer: common size
Q3) The main components that make up the stockholder's equity section of the balance sheet are_________________ and _______________________
Answer: retained earnings ,common stock
Q4) Nonmonetary assets include assets that are ____________________,such as inventories,and assets that are ____________________ such as brand names.
Answer: tangible,intangible
Q5) Cash and cash equivalents are considered ____________________ assets.
Answer: Monetary
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Chapter 2: Asset and Liability Valuation and Income Measurement
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Q1) Permanent tax differences are revenues and expenses
A) that firms include in income tax returns, but do not appear in the income statement.
B) that are included in both the tax return and income statement, but in different accounting periods.
C) that firms include in the income statement, but do not appear in income tax returns.
D) that are not included in either the tax return or the income statement.
Answer: C
Q2) Which of the following transactions is consistent with recognizing value changes on the balance sheet and income statement when they are realized in a market transaction?
A) Selling land at a cost greater than its original purchase price.
B) Recording an increase in the fair value of investments at year end.
C) Translating foreign operations accounted for in Yen back to U.S. dollars in order to prepare consolidated financial statements.
D) Writing down the value of an asset due to obsolescent.
Answer: A
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Chapter 3: Income Flows Versus Cash Flows:
Understanding the Statement of Cash Flows
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Q1) As a complement to the balance sheet and the income statement,the statement of cash flows is an informative statement for analysts for all the following reasons except:
A) The statement of cash flows provides information to assess the financial health of a firm. Analysts increasingly recognize that cash flows do not necessarily track income flows. A firm with a healthy income statement is not necessarily financially healthy, and vice versa. Cash requirements to service debt, for example, may outstrip the ability of operations to generate cash.
B) The existence of negative cash flows from operations can be eliminated by using this financial statement.
C) The statement of cash flows highlights accounting accruals, which can provide insight into the overall sustainability and quality of a firm's reported earnings.
D) Analysts who understand the types of information this statement presents and the kinds of interpretations that are appropriate find that the statement of cash flows reveals information about the economic characteristics of a firm's industry, its strategy, And the stage in its life cycle.
Answer: B
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Chapter 4: Profitability Analysis
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Q1) Return on common equity can be disaggregated into profit margin for ROCE,capital structure leverage and
Q2) Operating income is negative in an amount equal to _________________________ when revenues are zero.
Q3) Carridine Company reported net income of $1,903 on revenues of $55,618 for Year4.Interest expense totaled $459,and preferred dividends totaled $13.5.Average total assets for Year 4 were $17,500.The income tax rate is 40 percent.Average preferred shareholders' equity totaled $250,and average common shareholders' equity totaled $7,500.Assume that all the following amounts are in thousands.
REQUIRED:a.Compute the rate of ROA.Disaggregate ROA into profit margin for ROA and assets turnover components.
b.Compute the rate of ROCE.Disaggregate ROCE into profit margin for ROCE,assets turnover,and capital leverage ratio components.
c.Calculate the amount of net income to common shareholders derived from the excess return on creditors' capital,the excess return on preferred shareholders' capital, and the return on common shareholders' capital.
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Chapter 5: Risk Analysis
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Q1) The source of risk related to management competence,strategic direction and lawsuits is _________________________.
Q2) Foxmoor Company's merchandise inventory and other related accounts for 2012 follow:
\[\begin{array} { | l | r | }
\hline \text { Sales } & \text { \$3,100,00] } \\
\hline \text { Cast of Gades Sold } & 2,153,200 \\
\hline \text { Merchanthise Inventary } & \\
\hline \text { Beginning of Year } & 850,000 \\
\hline \text { End of Year } & 995,000 \\
\hline
\end{array}\]
Required:
Calculate Foxmoor's inventory turnover during 2012 assuming that the merchandise inventory buildup was relatively constant during the year.
Q3) When management takes deliberate steps at a balance sheet date to produce a better current ratio than is normal it is called
Q4) The current ratio is one of the measures of__________ of the firm.
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Chapter 6: Accounting Quality
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Q1) In a restructuring it is possible that managers may use the opportunity to write down assets that do not even relate directly to the restructuring action.Why might a manager decide to write down an asset that is not included in the restructuring action?
A) The manager is practicing conservatism.
B) The write down relieves future periods of depreciation expense, which increases cash flows.
C) Normally the stock market reacts positively to restructuring and the greater the amount the better.
D) The write down relieves future periods of depreciation expense, which increases earnings.
Q2) ____________________ represents the concept of being able to compare financial statement data across years for any particular firm.
Q3) Accounting information should provide relevant information to forecast the firm's expected future earnings and _________________________.
Q4) Gains and losses differ from revenues and expenses in that they are produced by ____________________ activities.
Q5) A change in the useful life of an asset is treated as a _____________
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Chapter 7: Financing Activities
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Q1) Which kind of dividend is a return of the original investment by shareholders?
A) cash dividend
B) stock dividend
C) liquidating dividend
D) scrip dividend
Q2) __________ means that a company will buy back those receivables that are not collected by the company they are factored to.
Q3) Under U.S.GAAP,which of the following items would require a lessee to classify a lease of equipment as a capital lease?
A) There is no transfer of ownership to the lessee at the end of the lease term.
B) The lease does not contain a bargain purchase option.
C) The lease term is 90% of the estimated economic life of the lease property.
D) The present value of the contractual minimum lease payments is 75% of the fair value of the leased property.
Q4) Which of the following is the date on which the dividend distribution occurs?
A) date of record
B) commitment date
C) date of declaration
D) date of payment
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Chapter 8: Investing Activities
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Q1) You are trying to determine the functional currency of a foreign unit.For the following three factors determine what conditions would result in the foreign currency being the functional currency:a.Sales Prices
b.Financing
c.Relationships between the Parent and the Foreign Unit
Q2) For some transactions U.S.GAAP requires that value changes are recognized on the balance sheet and the income statement when they occur,even if not realized.Discuss what types of transactions get this type of treatment and the logic behind this accounting.
Q3) Goodwill represents
A) the synergies that will be achieved through the acquisition.
B) the difference between the acquisition cost and the market value of the identifiable assets and liabilities.
C) the difference between the acquisition cost and the book value of the identifiable assets and liabilities.
D) the merger premium.
Q4) Interpretation No.46R relates to the issue of whether an investing firm is the primary beneficiary in a variable-interest entity.When is an entity classified as a variable interest entity?
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Chapter 9: Operating Activities
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Q1) A company that uses FIFO will find that its ___________________________________ account tends to be somewhat out of date.
Q2) Using the information provided by Falcon Networks determine the foreign effective tax rate for 2012.
A) 33.52%
B) 35.00%
C) 42.25%
D) 45.49%
Q3) All of the following conditions signal that revenue recognition may have been recorded too early except:
A) large and volatile amounts of uncollectible accounts receivable.
B) a decrease in the number of days accounts receivable are outstanding.
C) unusually large amounts of returned goods.
D) excessive warranty expenditures.
Q4) When firms use derivatives effectively to manage risks,the net gain or loss each period should be relatively ____________________.
Q5) U.S.GAAP requires firms to report the assets and liabilities of defined benefit plans
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Chapter 10: Forecasting Financial Statements
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Q1) Given the information provided about Card Sharks,what is the company's 2012 projected year-end cash balance?
A) $966
B) $50,820
C) $15,623
D) $38,524
Q2) The authors set forth a seven-step forecasting game plan for preparing pro forma financial statements.Discuss the seven steps necessary to prepare the three principal financial statements.
Q3) The formula for forecasting inventory is ____________ /365 X .
Q4) Sparky's forecasts that sales will grow by 25% in 2013 and that its cost of goods sold to sales ratio will be the same in 2013 as it was in 2012.If these assumptions prove correct and Sparky's inventory turnover ratio for 2013 is 4.5 what will be the level of inventory at the end of 2013?
A) $31,353
B) $26,475
C) $40,000
D) $42,314
Q5) Realistic expectations are ____________________ and ____________________.
Page 12
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Chapter 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach
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Q1) An analyst wants to value the common shareholders' equity of Bridgetron,compute the relevant cost of capital that should be used.
Q2) A company with a new Capital structure will increase the __________ and at the same time the __________ risk.
Q3) Why do investors typically accept a lower risk-adjusted rate of return on debt capital than equity capital? Suppose a stable,financially healthy,profitable,tax-paying firm that has been financed with all equity and no debt decides to add a reasonable amount of debt to its capital structure.What effect will that change in capital structure likely have on the firm's weighted average cost of capital?
Q4) Using the above information,calculate Zonk's weighted-average cost of capital:
A) 11.5%
B) 7.97%
C) 7.48% D) 10.90%
Q5) Why are dividends value-relevant to common equity shareholders?
Page 13
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Chapter 12: Valuation: Cash-Flow-Based Approaches
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Q1) A disadvantage of the free cash flow valuation method is A) The terminal value tends to dominate the total value in many cases.
B) The projection of free cash flows depends on earnings estimates.
C) The free cash flow method is not rigorous.
D) The free cash flow method is not used widely in practice.
Q2) Steady-state growth in free cash flows could be driven by long-run expectations for growth attributable to A) interest rates
B) national exports
C) general economic productivity
D) balance of payments
Q3) Regarding the equity buyout,compute the unlevered market equity (asset)beta of Simpson before consideration of the LBO.Assume that the book value of the debt equals its market value.The income tax rate is 35 percent.
Q4) The risk-adjusted discount rate used to compute the present value of all the projected free cash flows for common equity shareholders equals the
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Chapter 13: Valuation: Earnings-Based Approaches
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Q1) Over the life of a firm,the capital invested in the firm by the shareholders plus the income of the firm will reflect the ______________________________ to the shareholders.
Q2) In some industries,competitive dynamics eventually drive long-run projections of the future returns earned by the firm to an equilibrium level equal to the long-run expected cost of equity capital in the firm.At that point,a firm can be expected to earn ____________ residual income in the future.
A) increasing.
B) zero.
C) decreasing.
D) There is not enough information to answer this question.
Q3) Dirty surplus items in U.S.GAAP typically arise from all of the following except:
A) changes in investment security fair values
B) foreign currency exchange rates
C) interest rates
D) realized gains
Q4) ______________________________ is the amount by which expected future earnings exceed the required earnings.
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Chapter 14: Valuation: Market-Based Approaches
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Q1) Which of the following ratios usually reflects investor's opinions of the future prospects for the firm?
A) Earnings per share
B) Dividend yield
C) Price/earnings ratio
D) Book value per share
Q2) Economics teaches that,in equilibrium,firms will earn a return equal to the ______________________________.
Q3) A company with a PEG ratio of lessthan one would be interpreted as having a stock price that is low relative to ______________________________.
Q4) Which of the following would not be an example of the use of a multiple when valuing common equity?
A) Price-to-operating cash flow
B) Price-to-book.
C) Price-to-earnings.
D) Multiperiod discounted earnings models.
Q5) Firms with low P/E ratios tend to have current residual income that is greater than _____________________________________________.
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