Financial Analysis and Valuation
Exam Materials
Course Introduction
Financial Analysis and Valuation introduces students to the foundational tools and techniques used to assess the financial health and intrinsic value of businesses. The course covers the interpretation of financial statements, ratio analysis, cash flow analysis, and forecasting. Students learn various methods of valuing companies, including discounted cash flow (DCF), comparable company analysis, and precedent transactions. Emphasis is placed on applying analytical frameworks to real-world situations, making informed judgments about a firms performance, and understanding the assumptions and limitations inherent in valuation processes. This course is essential for those interested in careers in investment banking, corporate finance, equity research, and consulting.
Recommended Textbook
Financial Reporting Financial Statement Analysis and Valuation 9th Edition James M.
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Wahlen
Chapter 1: Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
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Sample Questions
Q1) Which of the following is not considered to be a liability?
A) Wages payable.
B) Accounts payable.
C) Notes payable.
D) Cost of goods sold.
Answer: D
Q2) Which forces typically represent horizontal competition in a value chain?
A) Rivalry among existing firms and supplier power.
B) Potential entry and buyer power.
C) Substitutes and potential entry.
D) Buyer power and supplier power.
Answer: C
Q3) ___________________________________ equals net income for a period plus or minus the changes in shareholders' equity accounts other than from net income and transactions with owners.
Answer: Comprehensive income
Q4) What is an industry's value chain?
Answer: An industry's value chain is the sequence of activities involved in the creation,manufacture and distribution of its products and services.
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Chapter 2: Asset and Liability Valuation and Income Recognition
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Sample Questions
Q1) At origination which of the following temporary differences would create a deferred tax asset?
A) Tax basis of an asset exceeds its financial reporting basis.
B) Tax basis of a liability exceeds its financial reporting basis.
C) Financial reporting basis of an asset is equal to its tax basis.
D) Financial reporting basis of an asset exceeds its tax basis.
Answer: A
Q2) When recognizing deferred tax assets and liabilities,the income statement approach and the balance sheet approach yield identical results:
A) when enacted tax rates applicable to future periods do not change.
B) when the firm recognizes no valuation allowance on deferred tax assets.
C) Both (a) and (b) are correct.
D) None of these answers is correct.
Answer: C
Q3) U.S.GAAP,IFRS,and other major accounting standards are best characterized as:
A) historical accounting models.
B) current value accounting models.
C) acquisition cost accounting models.
D) mixed attribute accounting models.
Answer: D
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) While preparing a statement of cash flows,you encountered the following transaction:
February 1,2011: Galvinize Corporation acquired a small office building in exchange for 5,000 shares of its own common stock; par value $10 per share; market value $15 per share.
A.Should this transaction be shown on the statement of cash flows?
B.Why or why not?
Answer: A.Yes
B.Because it is a direct exchange,it is reported on the statement of cash flows in a supplemental schedule or note as "Office building,acquired for 5,000 shares of Galvinize Corporation's common stock,$75,000."
Q2) The receipt of cash when employees exercise stock options is a(n)____________________ activity.
Answer: financing
Q3) Under the _________________________,firms begin with net income to calculate cash flow from operations for the period. Answer: indirect method
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Page 5
Chapter 4: Profitability Analysis
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Sample Questions
Q1) Which of the following is the primary objective in most financial statement analysis?
A) To value a firm's equity securities
B) To look for unrecorded liabilities
C) To establish a firm's strategy within the industry
D) To define markets for the firm
Q2) Freedom Company reported net income for 2010 of $2,031 million on sales of $25,600 million.Interest expense for 2010 was $235 million,and minority interest was $344 million for 2010.The income tax rate is 40 percent.Total assets were $10,800 million at the beginning of 2010 and $14,874 million at the end of 2010.Compute the rate of ROA for 2010 and disaggregate ROA into profit margin for ROA and asset turnover components.
Q3) One problem with using EPS as a measure of profitability is that it does not consider the amount of ____________________ or ____________________ required to generate a particular level of earnings.
Q4) Firms and industries characterized by heavy fixed capacity costs and lengthy periods required to add new capacity operate under a(n)___________________________________.
Q5) When calculating Basic earnings per share net income is adjusted by____________
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Chapter 5: Risk Analysis
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Sample Questions
Q1) The current risk-free rate of return in the economy is 6%.In addition,the market rate of return is currently 8.5%.
A.Given this information,what would be the expected return on common stock for a company with a systemic risk level (Beta) of 1.3? Show your calculations.
B.Describe systemic risk.
Q2) Cash flow from operations indicates the amount of cash that the firm derived from operations after funding ______________________________.
Q3) Refer to the information for Mobile Company.Mobile's days receivables outstanding at the end of 2010 was:
A) 43.20 days
B) 40.50 days
C) 45.25 days
D) 8.50 days
Q4) When a financial analyst examines the credit risk of a company,it is common that he or she uses a set of factors that all begin with the letter "C." Each factor provides a consideration that enters into the lending decision.List and discuss how each of the factors affects a company's credit risk.
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Chapter 6: Accounting Quality
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Sample Questions
Q1) The assessment of earnings quality is best accomplished through the use of which one of the following?
A) Balance sheet and cash flow statement.
B) Single-step financial statements.
C) Single-step income statement, balance sheet, and cash flow statement.
D) Multi-step income statement, balance sheet, and cash flow statement.
Q2) Users of financial statements should consider which of the following when evaluating the quality of accounting information?
A) Economic faithfulness of accounting measurements and classifications.
B) Reliability of the measurements.
C) Reasonableness of the estimates made in applying GAAP or IFRS.
D) All of these should be considered.
Q3) Quality accounting information seeks to maximize relevance and economic faithfulness,subject to the constraints of the ____________________ of the measurements.
Q4) 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.
Q5) A change in the useful life of an asset is treated as a(n)_____________
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Chapter 7: Financing Activities
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Sample Questions
Q1) Assume that you are currently negotiating a lease transaction in the role of the lessee.Discuss whether you would rather structure the lease as an operating lease or a capital lease and why.In addition,provide the conditions that would require that the lease be accounted for as a capital lease.
Q2) Where in the financial statements are changes in the fair value of cash flow hedges reported:
A) On the Balance Sheet as part of retained earnings
B) On the Income Statement as other gains/losses
C) As other comprehensive income and accumulated in other comprehensive income on the Balance Sheet.
D) On the Statement of Stockholder's Equity
Q3) One criterion that must be satisfied for a firm to recognize an obligation is that the transaction or event giving rise to the obligation has already
Q4) Many firms use derivative instruments to hedge exposure to changes in the fair value of an asset or liability,or to hedge exposure to variability in expected future cash flows.As an analyst examining the financial reports of a company that uses derivative instruments to hedge,what questions should you ask when thinking about derivatives and accounting quality?
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Chapter 8: Investing Activities
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Sample Questions
Q1) Assume that Hsu Company needs to acquire a large special-purpose materials handling facility.Given that no outside vendor exists for this type of facility and that the company has available engineering,management,and productive capacity,the Hsu borrows funds and builds the facility.Identify the costs that should be capitalized as part of this facility.
Q2) When a foreign entity has the U.S.dollar as its functional currency,it uses which exchange rate to translate monetary assets and liabilities?
A) the average exchange rate during the period
B) the end of the period exchange rate
C) the historical exchange rate
D) the exchange rate on the date the asset or liability was obtained
Q3) Expenditures included in the cost of a long-lived asset are:
A) intangible.
B) charged off.
C) expensed.
D) capitalized.
Q4) Financial reporting requires firms to ____________________ immediately all R&D costs incurred internally.
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Page 10
Chapter 9: Operating Activities
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Sample Questions
Q1) Using the information provided by Falcon Networks determine the combined effective tax rate for 2012.
A) 33.52%
B) 35.00%
C) 42.25%
D) 45.49%
Q2) Deferred tax liabilities result in future tax ____________________ when temporary differences reverse.
Q3) Which of the following statements best describes the difference between U.S.GAAP and IFRS with respect to revenue recognition?
A) IFRS has a substantial amount of industry specific guidance for revenue recognition.
B) IFRS revenue recognition is not consistent with U.S.GAAP in principle.
C) There are subtle differences in the wording of U.S.GAAP as compared with IFRS.
D) IFRS has four criteria and U.S.GAAP has five conditions for revenue recognition.
Q4) Dividing a company's income tax expense by its book income before income taxes provides the company's ___________________________________.
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Page 11
Chapter 10: Forecasting Financial Statements
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Sample Questions
Q1) Firms that have differentiated ___________________________________ for its products may have a greater potential to increase prices.
Q2) Nichols and Wahlen's 2004 study showed that superior forecasting provides the potential to earn superior security returns.Nichols and Wahlen's findings indicate:
A) that an investor could earn excess returns if the investor could predict accurately the sign of the change in earnings one year ahead.
B) that an investor could earn excess returns if the investor could predict accurately the magnitude of the change in earnings one year ahead.
C) that an investor could earn excess returns if the investor could predict accurately the sign of the change in cash flows from operations one year ahead.
D) that an investor could earn excess returns if the investor could predict accurately the sign of the change in working capital one year ahead.
Q3) When projecting ____________________,the analyst should consider economy-wide factors such as the expected rate of general price inflation in the economy.
Q4) The formula for forecasting inventory is ____________ /365 X.
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Chapter 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach
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Sample Questions
Q1) 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.
Q2) Explain the theory behind the dividends valuation approach.Why are dividends value-relevant to common equity shareholders?
Q3) Because the market equity beta reflects the level of operating leverage,financial leverage,variability of sales,and other characteristics of a firm,there are situations where an analyst might have to adjust the beta because of changes in the capital structure.A situation that might require an analyst to estimate a new levered beta is a(n)___________________________________.
Q4) 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.
Page 13
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Chapter 12: Valuation: Cash-Flow-Based Approaches
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Sample Questions
Q1) If an analyst wants to value a potential investment in the common stock equity of a firm,the analyst should discount the projected free cash flows at the:
A) required return on equity capital.
B) weighted average cost of capital.
C) risk-free rate.
D) market risk premium.
Q2) 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.
Q3) The cash-flow-based valuation approach measures and values the cash flows that are "free" to be ________________________________________ unencumbered by necessary reinvestments in operating assets or required payments to debt holders.
Q4) Provide the rationale for using expected free cash flow in valuation.
Q5) What is the purpose of a free cash flow analysis?
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Chapter 13: Valuation: Earnings-Based Approaches
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Sample Questions
Q1) Accounting earnings numbers provide a basis for valuation because earnings are the primary measure of ______________________________ produced by the accrual accounting system.
Q2) Assume that a firm had shareholders' equity on the balance sheet at a book value of $1,600 at the end of 2010.During 2011 the firm earns net income of $1,300,pays dividends to shareholders of $600,and uses $300 to repurchase common shares.The book value of shareholders' equity at the end of 2011 is:
A) $2,000
B) $400
C) $3,800
D) $2,600
Q3) 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.
Q4) Clean surplus accounting means that net income includes all of the recognized elements of income for the firm for
Q5) What is meant by the term clean surplus accounting?
Q6) What is the rationale for using expected earnings as a basis for valuations?
Page 15
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Chapter 14: Valuation: Market-Based Approaches
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Sample Questions
Q1) Market multiples capture ____________________ valuation per dollar of book value or per dollar of earnings.
Q2) To estimate security's risk-neutral value we can use the _____________________________________________ and risk-free rates of return.
Q3) When a company has a high market to book ratio this could be a result of the company having
Q4) A company is expected to have a value of $142,857 at the start of next period and investors require a 14 percent return on equity capital.Using the assumptions of the price-earnings ratio,what would be the company's earnings for the current year?
A) $20,000
B) $14,286
C) $2,800
D) $12,500
Q5) The differences in industry market-to-book ratios may be the result of differences in growth,ROCE relative to RE,as well as differences in
Q6) Explain the analysts' role in making the capital markets efficient.
Page 16
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