ACCT/FIN 447

Example Questions 2

Group 3 Questions

1.  Which of the following is a potential problem for financial analysts when evaluating financial performance of a corporation?

    1. Self interest of managers (e.g., based on bonuses)
    2. Lack of or incomplete disclosure
    3. Earnings manipulation techniques used by companies
    4. Complexity of economic reality
    5. All of the above          2.  An Income Mutual Fund usually looks for stocks that:
    1. Pay no dividends and have high price earnings ratios
    2. Have high earnings growth potential, but dividends are irrelevant
    3. Have a high dividend yield, lower price earnings ratios, and modest growth potential
    4. Have very high market to book value of net assets
    5. All of the above

3. Barf Foods has equipment with an original cost of $23,000, salvage value of $3,000 and depreciable life of 5 years. Using the straight-line method, depreciation expense in year 2 is:

    1. $3,000
    2. $3,600
    1. $4,000
    2. $4,500
    3. Some other amount
  1.   4.  Given the information from 3 above, Year 1 depreciation expense using double declining balance method is:
    1. $4,000
    2. $4,600
    1. $8,000
    2. $9,200
    3. Some other amount
  1. 5.   ABC Co. has the following accounts:

Current assets $10,000
Property, plant & equipment $120,000
Less: accumulated depreciation 30,000 90,000
Total assets $100,000
Gross profit $50,000
Depreciation expense 10,000
Tax expense 5,000
Net Income $35,000

The average age of fixed asset is estimated to be:

    1. 1 year
    2. 3 years
    1. 9 years
    2. 12 years
    3. None of the above
  1. 6.   Given the information from 5 above, the average depreciable life of fixed assets is:
    1. 2.25 years
    2. 3 years
    1. 9 years
    2. 12 years
    3. None of the above
  1. 7.   Which of the following items represents an example of using intraperiod tax allocation?
    1. Goodwill
    2. Straight line vs double declining balance depreciation
    3. Extraordinary items
    4. FIFO vs average inventory method
    5. None of the above
  1. 8.  Gumbo Co. uses straight line depreciation for financial reporting and double declining balance for tax. Using straight line the company reports tax of $18,000; under double declining balance tax is $14,000. Gumbo would report:
    1. Deferred tax asset of $4,000
    2. Deferred tax liability of $4,000
    3. Deferred tax asset of $14,000
    1. Taxes payable of $4,000
    2. None of the above

9. Big Bucks has the following tax information for this year:

Pretax income $5,300
Taxes payable 1,600
Income tax expense 1,900
Income tax paid 1,400

The reported effective tax rate is:

    1. 26.4%
    2. 30.2%
    3. 35.8%
    4. 135.7%
    5. Some other amount
  1. 10.  Given the information from 9, what is the income tax paid rate for Big Bucks?
    1. 26.4%
    2. 30.2%
    3. 35.8%
    4. 135.7%
    5. Some other amount
  1. 11.  Which of the following is always expensed when the transaction takes place according to GAAP?

a. Acquisition of fixed assets using a capital lease

    1. Oil and gas drilling costs
    2. Goodwill from a purchase acquisition
    3. Research and development costs
    4. All of the above
  1. 12.   Major oil and gas drilling companies typically use successful efforts for drilling costs rather than full costing. Using successful efforts results in:
    1. Lower income
    2. Higher assets and net assets
    3. Higher revenues
    4. Higher income taxes
    5. All of the above

13. Assume the managers want to maximize bonuses, which are based on current net income. Managers should prefer:

    1. Successful efforts rather than full costing of oil & gas drilling
    2. Expensing research & development costs
    3. Amortizing goodwill over a very short period (rather than 40 years)
    4. Using straight-line rather than accelerated depreciation for financial statement purposes
    5. All of the above

14. According to SFAS No. 13, a capital lease:

    1. Results when the lease term is less than 50% of estimated economic life
    2. Is used for off-balance-sheet accounting
    3. Is never reported on the balance sheet
    4. Transfers the risks and rewards of ownership
    5. All of the above
  1. 15.   Relative to a capital lease, an operating lease will result in:
    1. Higher total assets
    2. Higher interest expenses early in the lease
    3. Higher reported liabilities
    4. Higher profits reported in the early years of the lease
    5. All of the above
  1. 16.   A defined benefit pension plan is associated with:
    1. A company committed to specific retiree benefit levels at retirement
    2. A company committed to specific levels of contributions to the pension plan of the employee
    1. A company committed to no cash payments for pensions until the employee actually retires
    2. Early retirement of all employees
    3. None of the above
  1. 17.  Company incentives for using a defined contribution pension plan include:

                       a. Employer has no future liability beyond contributions

    1. Tax exemption for pension investment earnings
    1. Potential for earnings management
    2. Paternalistic attitude to employees, since employer maintains all obligation risks
    3. All of the above
  1. 18.  ABC Co. uses a defined benefit pension plan. At year-end the pension obligation is $27.4 million and plan assets $24.5 million. ABC’s balance sheet will report:
    1. An asset of $27.4 million and a separate liability of $24.5 million
    2. A net asset (prepaid pension cost) of $2.9 million
    3. A net pension liability of $2.9 million
    4. Nothing, only footnote disclosure is required
    5. None of the above

19. Other postemployment benefits include:

    1. Benefits to former employees beyond pensions, such as health insurance
    2. Bonuses and stock options
    3. Medicare payments
    4. Direct pension payments
    5. All of the above

20. ABC Co. adopted SFAS No. 106 in the early 1990s. To avoid the use of "Big Bath" writeoffs, ABC:

    1. Took a huge loss for all post retirement benefits
    2. Capitalized existing postemployment benefits as a liability to be amortized over a maximum 20 years
    3. Reported post retirement obligations in footnotes only
    4. Continued to record postemployment benefits on a cash (pay-as-you-go) basis
    5. None of the above
  1. 21.  Generally, the impact of stock options is:
    1. Employees pay cash directly to the company for these options when granted
    2. Stock options are almost never exercised by employees
    3. The cost of stock options is recorded as an extraordinary item
    4. Dilution of equity, but no compensation expense recorded when exercised
    5. None of the above
  1. 22.  ABC Co. issued stock options of 50,000 at the current market price of $8 per share. The stock price of ABC rises to $55 and all options are exercised. The effect of exercising these options is:
    1. The company records revenues of $2.75 million
    2. The company receives cash of $400,000 and increases outstanding common stock by 50,000 shares
    3. The company receives cash of $2.75 million and increases treasury stock by 50,000 shares
    4. The company records cash of $2.75 million, revenues of $2.35 and stockholders equity of $400,000
    5. None of the above
  1. 23.  Given the information from 22 above, except the stock price falls to $6 and all options expire without being exercised. The company would:
    1. Record a loss of $100,000
    2. Not record a transaction
    3. Decrease stockholders equity by $400,000
    4. Record a compensation expense of $100,000
    5. None of the above
  1. 24.  Octopus Inc. meets 7 of 12 pooling of interest criteria of APB opinion 16 for the acquisition of Target Co. The acquisition would be recorded as a:
    1. Pooling of interest
    2. Purchase
    3. Spinoff
    4. Cannot be determined from the above information
    5. None of the above
  1. 25.  Dell Computers buys out a specialized computer chip manufacturer to expand into related fields. This is an example of a:
    1. Horizontal merger
    2. Vertical merger
    3. Conglomerate merger
    4. Push-down merger
    5. None of the above
  1. 26.  XYZ Co. has marketable securities classified as trading securities according to SFAS No. 115. These are recorded as:
    1. Assets using amortized cost
    2. Assets reported at fair value and unrealized gains & losses included in earnings
    3. Assets reported at fair value and unrealized gains & losses reported in shareholders’ equity
    4. Assets reported at fair value and unrealized gains & losses reported as extraordinary items
    5. None of the above
  1. 27.  Using mark-to market for marketable securities, the total portfolio return includes:
    1. Interest only
    2. Dividends and interest payments
    3. Dividends, interest, and realized gains & losses
    4. Dividends, interest, realized gains & losses, and unrealized gains & losses

e. None of the above

  1. 28.  ABC Co. has the following segment reporting information for 1998

Net sales Operating profit Identifiable assets

Widgets                                           $12.7             $1.3                     $10.5
Gidgets                                             15.8                 .9                         15.1

Widgets has an operating profit margin of:

    1. 4.6%
    2. 10.2%
    3. 12.4%
    4. 82.7%
    5. Some other amount
  1. 29.  Given the information from 28 above, Gidgets has a return on assets of:
    1. 5.7%
    2. 6.0%
    3. 10.2%
    4. 104.6%
    5. Some other amount

30. Octopus Inc. acquires Target. Target has a book value of $25 million and a market value of $40 million. Octopus will pay $60 million in Octopus common stock to acquire all outstanding shares. Balance sheet information for Target includes:

                                            Book Value Fair Value

Accounts Receivable     $5.0 million $4.5 million
Inventory                           7.5                 9.7
Fixed Assets                     15.6             22.5
Patents                                 0                14.0
Liabilities                        (3.1)                (3.1)
Total                              $25.0 million $47.6 million

If this acquisition is recorded as a pooling of interest the books of Octopus will include:

    1. A credit to stockholders’ equity of $40 million and debit net assets $40 million
    2. Debit to patents of $14 million, other net assets of $46 million and a credit to cash of $60 million
    3. Debt Target acquisition of $60 million and credit stockholders’ equity of $60 million
    4. Debit net assets $25.0 million (various asset & liability accounts) and credit stockholders’ equity $25.0 million
    1. None of the above
  1. 31.  Given the information from 30 above, if the purchase method were used, goodwill would be recorded for:
    1. $0
    2. $12.4 million
    1. $20.0 million
    2. $35.0 million
    1. Some other amount
  1. 32.  According to SFAS No. 52, the all-current method for foreign currency translation is used when:
    1. The functional currency of the foreign subsidiary is the reporting (patent) currency
    2. The functional currency of the foreign subsidiary is the local currency of the subsidiary
    3. The function currency is the Euro, the common currency of the European Union
    4. The price of gold is used as the translation standard
    5. None of the above
  1. 33.  According to SFAS No. 52, under the temporal method, inventory and fixed assets would be translated at:
    1. The currency rate at the time of the original transaction
    2. At the average currency rate for the accounting period
    3. At the currency rate at the beginning of the period
    4. At the currency rate at the balance sheet date
    5. None of the above

34. The German subsidiary of the U.S. firm Max. Co. has the following balance sheet information for its first year of operation:

                                    German Marks

Cash                                 100
Inventory                         450
Fixed assets (net)           780
Total                               1,330

Accounts payable         120
Common stock             1,000
Retained earnings          90
Total                               1,330

The U.S. controller will use the all-current method for foreign currency translation, where the translation rate at the beginning of the year was 3.0 marks to the dollar, the average rate 3.5 marks to the dollar, and the year-end rate at 4 marks to the dollar.

Using the all-current method, inventory would be translated (to the nearest penny) at:

    1. $112.50
    2. $128.57
    3. $150.00
    4. $450.00
    5. Some other amount
  1. 35.  Given the information from 34 above, using the all-current method, total assets for the Max Co. subsidiary would be translated at:
    1. $332.50
    2. $380.00
    3. $435.00
    4. $1,330.00
    5. Some other amount
  1. 36.  Given the information from 34 above, the translation of Max’s German subsidiary using the all-current method results in a foreign currency translation gain of $35. This is recorded on the books of Max as:
    1. An asset of $35
    2. A credit to cumulative translation adjustment of $35, a component of stockholders’ equity
    3. An ordinary gain of $35
    4. An extraordinary gain of $35, net of tax
    5. None of the above
  1. 37.  A derivative is:

a. A corporate mandate to buy back outstanding shares of its own common stock

    1. A liability derived from potential contingencies
    2. A financial instrument deriving its value from another financial instrument
    3. A long-term bond subject to debt covenants
    4. All of the above

38. A call option for 5000 shares of IBM allows the party to:

    1. Buy 5000 shares of IBM at a specific price until a specified maturity date
    2. Swap 5000 shares of IBM for another stock or bond
    3. Sell 5000 shares of IBM at a specific price until a specified maturity date
    4. Sell 5000 shares of IBM at a large discount to market price usually for a 1-5 year period
    5. None of the above
  1. 39.  The advantage of a put option is:
    1. The party receives a premium
    2. The transaction favors the buyer
    3. The transaction will only be exercised if favorable to the buyer
    4. This is a natural hedge against major market downturns
    5. None of the above
  1. 40.  A futures contract is:
    1. A swap that exchanges one series of payments for another
    2. A sales contract traded on an organized exchange where the amount , maturity and price are set in advance
    3. A contract that establishes a specific maturity date and amount, but not the specific price
    4. A derivative that limits the effects of fluctuations beyond a predetermined range
    5. None of the above

Possible Answers

1.  E    11.  C     21.  D    31.  B
2.  C    12.  A    22.  B    32.  B
3.  C    13.  D    23.  B    33.  A
4.  D    14.  D    24.  B    34. A
5.  B    15.  D    25.  B    35.  A
6.  D    16.  A    26.  B    36.  B
7.  C    17.  A    27.  D    37.  C
8.  B    18.  C    28.  B    38.  A
9.  C    19.  A    29.  B    39. A
10. A   20.  B    30.  D    40. B

2. Other Questions:  Workout

Group A

I. Given the information below calculate the following (20 points):

                                                            1998 1997

Sales                                                $9,500 $6,790
Cost of Goods Sold                         7,200 5,365
Earnings Before Interest & Taxes 1,800 1,425
Interest                                                 550 500
Taxes                                                     600 385
Net Income                                           700 540
Total Assets                                 12,500 9,980

Current Liabilities                             2,000 900
Stockholders’ Equity (common-1,000 shares outstanding) 8,000 4,045
Cash Flows from operations         1,500 1,875
Dividends                                             300 285
Market price per share                       $21 $20

A. Calculate the following ratios for 1998:

PE ratio _____________

Dividend yield _____________

Times interest earned _____________

Cash flow from operations (operating cash flow ratio) _____________

Debt (total liabilities) to market equity _____________
 

B. Calculate the Du Pont Model (3 Component Disaggregation) for 1998:

Profitability _____________

Activity _____________

Solvency _____________

Return on Equity _____________

Under the Du Pont Model return on assets (ROA) is: ____________%
 
 

II. Matching (10 points)

1. Liabilities __________

2. Free cash flow __________

3. Benchmarking __________

4. Basic Earnings Per Share __________

5. Length of Cash Cycle __________

6. Extraordinary items __________

7. Du Pont Model __________

8. Book value per share __________

9. Users of financial information __________

10. Quarterly report issued to SEC __________

  1. Cash available for discretionary use
  2. Drafting, negotiating and safeguarding a contract
  3. 10-Q
  4. A type of integrated analysis using interrelated ratios
  5. Use of industry averages or rules of thumb
  6. Unusual in nature & infrequent in occurrence
  7. Earnings available to common stockholders / weighted average Number of shares of common stock outstanding
  8. Probable future economic sacrifices
  9. Net assets / shares outstanding
  10. 365 [(1 / inventory turnover) + (1 / receivables turnover)] - 365[sales/average accounts payable]
  11. Creditors & equity investors
  12. Dividend yield

III. Short answer essay (10 points)

A. List three reasons why a high tech company such as Dell Computer should be evaluated for possible investment in a growth fund.

_________________________________________________________________________

_________________________________________________________________________

_________________________________________________________________________

B. The drug industry has a price to book ratio of 1351 and average PE ratios of 44 (compared to the steel industry with price to book of 101 and PE of 10). Explain how this is possible (give 4 major reasons):

_________________________________________________________________________

_________________________________________________________________________

_________________________________________________________________________

_________________________________________________________________________

C. List three solvency ratios: _________________

_________________

_________________

Possible Answers

I. A.

PE ratio 21/.7 30
Dividend yield .3/21 1.4%
Time Interest Earned 1800/550 3.3x
CFO ratio 1500/2000 75%
Debt t0 market equity 4500/(21x1000) 21.4%

B.

Profitability 700/9500 7.4%
Activity 9500/11240 84.5%
Solvency 11240/6022.5 186.6%
Return on Equity 700/6022.5 11.6%
Return on Assets 700/11240 6.2%

II. 1. H 6. F

  1. A 7. D
  1. E 8. I
  2. G 9. K
  3. J 10. C

III.  (examples)

A. High PE ratio; high earnings growth potential; high market to book value; market leader; new product growth potential

B. "Real assets" understated on balance sheet; high growth potential (sales & earnings); research & development potential understated (based on book value); product demand relatively insensitive to the business cycle; "monopoly" potential for successful new drugs.

C. Debt/equity; Times interest earned; debt to market equity; average total assets/average equity capital

Group B

I. Matching (12 points)

  1. Caa __________
  2. Capital lease __________
  3. Research & development cost __________
  4. Cost of dry holes __________

5. Chapter 11 __________

  1. Type I error __________
  1. Earnings management __________
  2. Earnings manipulation by classification __________
  3. Accounting Principles Board __________

10. Institutional Brokers Estimate System __________

  1. E(Yt) = Yt-1 __________
  1. Quarterly time series model __________
  1. E(Qt) = Qt-4 + a(Qt-1 -Qt-5) + D
  2. Stated interest rate on bond
  3. Federal bankruptcy proceeding to attempt reorganization
  4. A source of analyst’s forecasts
  5. Standards setting body before the Financial Accounting Standards Board
  6. A investment grade bond rating by Standard & Poors
  7. Attempt to influence accounting income for some purpose such as income smoothing
  8. A contract requiring recording an asset and liability on the balance sheet
  9. Recorded as an asset when using full costing
  10. Predicting a bankrupt firm will not go bankrupt
  11. Predicting a non-bankrupt firm will go bankrupt
  12. Recording a gain or loss as a nonrecurring item rather than part of continuing operations
  13. Expensed according to SFAS 2
  14. Random walk model

o. A junk bond rating by Moody’s

II. Inventory (10 points)

A firm has the following inventory information:

                                        Units Per Unit Cost

Beginning inventory      200     $10
Purchase                     1 400         $11
Purchase                    2 300       $12

During the year the firm sold 500 units.

  1. Calculate ending inventory using FIFO $__________

B. Calculate ending inventory using LIFO $__________

C. Calculate cost of goods sold using LIFO $__________

D. Calculate cost of goods sold using average cost $__________

E. Which method results in the highest net income? __________

III. Altman’s Z-score (8 points)

Given the following information for ABC Co., calculate Altman’s Z-score

Current Assets $2,000 Sales $18,000
Total Assets 20,000 Earnings before interest & taxes 4,000
Current Liabilities 1,000 Stock price $33
Debt 8,000 Shares outstanding 1,000
Retained Earnings 5,000

(Working capital / Total assets) x 1.2 ___________
(Retained earnings / total assets) x 1.4 ___________
(Earnings before interest & taxes / total assets) x 3.3 ___________
(Market value of equity / book value of debt) x .6 ___________
(Sales / Total assets) x 1.0 ___________
Z score ___________

The indeterminate range is 1.81-2.99. Therefore, this firm is categorized as _____________________

Possible Answers

  1. 1. C 11. B 21. D 31. B
  1. A 12. B 22. C 32. D
  2. D 13. A 23. A 33. B
  3. C 14. D 24. C 34. D
  4. C 15. A 25. E 35. D
  5. A 16. C 26. D
  6. D 17. C 27. A
  7. E 18. D 28. B
  8. B 19. D 29. C
  9. D 20. A 30. B
  1. 1. O 7. G
  1. H 8. L
  2. M 9. E
  3. I 10. D
  4. C 11. N
  5. J 12. A
  1. A. $4,700
  1. $4,200
  2. $5,800
  3. $5,555
  4. FIFO

IV. WC/TA .06

RE/TA .35

EBIT/TA .66

EQ/Debt 2.48

Sales/TA .90

Z 4.45 Healthy
 
 
 
 
 
 
 

II.1. G 7. O

2. L 8. H

3. E 9. M

4. D 10. I

5. N 11. C

6. A 12. J

III. WC/TA .109

RE/TA .318

EBIT/TA .601

EQ/Debt 2.625

Sales/TA .909

Z 4.562 Healthy
 
 

IV. A. $4,700

  1. $4,300
  2. $5,800
  3. $5,610
  4. FIFO