Financial Statement Analysis and Valuation MC Questions and Answers

Financial Statement Analysis and Valuation MC Questions and Answers Bally Corporation purchases an investment in Monte Carlo, Inc. at a purchase price of $7 million cash, representing 40% of the book value of Monte Carlo, Inc. During the year, Monte Carlo reports net income of $1,200,000 and pays $295,000 of cash dividends. At the end of the year, the market value of Bally's investment is $8.5 million. What is the year-end balance of the equity investment in Monte Carlo? The year-end balance of the investment account is computed as follows: Beginning balance $7,000,000 + Share of investee's net income ($1,200,000 × 40%) = 480,000 - Dividends received from Best Pictures ($295,000 × 40%) = (118,000) Ending balance $7,362,000 Valley View Corporation reported that short-term investments consisted of the following (in millions) on December 31, 2018: Amortized cost Fair value Short-term investments/ available-for-sale securities: $528.3 $528.4 Short-term investments/ trading securities: $62.2 $51.0 Total short-term investments: $590.5 $579.4 Which of the following is true? A) Valley View's 2013 balance sheet includes short-term investments of $590.5 million. B) Unrealized losses of $11.2 million on trading securities are included in 2018 income. C) There are no net unrealized gains on available-for-sale securities. D) Accumulated other comprehensive income included no unrealized gains or losses. (B) Unrealized gains and losses for trading securities are included in current-year income. Answer Ais not correct because the investments are recorded at fair value of $579.4 million on the balance sheet. Answer C and D are not correct since a net unrealized gain of 0.1 million on available-for-sale securities is included in accumulated other comprehensive income. Selected 2015 balance sheet and income statement information for The Gap, Inc. (in millions) follows: Year-end accounts payable: $ 1,242 Average accounts payable: $1,193 Sales: $16,148 Cost of goods sold: $9,855 Accounts payable days outstanding (also called days purchases in accounts payable for our term project using the Campbell Soup Company handout) for 2015 is: APDO = Accounts payable / average daily COGS = $1,242 / [$9,855 / 365 days] = 46.0 days A Contingent Liability must have the following criteria before the loss and liability must be recorded in the financial statements: The obligation will probably require payment at some point in the future and the obligation is estimable. Watson Electric Corp. sells $200,000 of bonds to private investors. The bonds have a 9% coupon rate and interest is paid semiannually. The bonds were sold to yield 10%. What periodic (semi-annual) interest payment does Watson make? Coupon rates are used to compute the dollar amount in interest payments paid to the bondholder semiannually. Watson pays $200,000 × 9% × ½ year = $9,000. Which one of the following is not correct? A) For debt issued at par: interest expense reported on the income statement equals the cash paid for interest. B) For bond repurchases: Gain (loss) on bond repurchase = Cash paid to repurchase minus Net book value of bonds. C) For debt issued at a discount: interest expense reported on the income statement equals cash interest payment. D) For debt issued at a premium, interest expense reported on the income statement equals cash interest payment less amortization of the premium. (C) For debt issued at a discount, interest expense reported on the income statement is cash interest paid plus amortization of the discount. Credit analysis concerns which of the following? A) The price of a company's stock B) The ability of a company to consistently pay dividends C) The probability a company will make timely payments on its debt D) An assessment of a company's credit-granting policies (C) The probability a company will make timely payments, that is, the potential risk of default. Bond investors are primarily concerned with a company's ability to make interest and principal payments per the bond agreement. Which of the following business factors does not play a role in determining a company's credit rating? A) Industry characteristics B) Capital structure C) Management D) Corporate marketing E) Profitability (D) Corporate marketing is not a risk factored into the rating agencies' determination of a company's credit rating. In general, how do credit analysts determine the risk-free rate? The risk-free rate is the yield on U.S. Government borrowings such as treasury bills, notes, and bonds. If a bond sells at a discount below its par value then: Its coupon rate is less than its effective market interest rate. On January 1, Harrington, Inc. borrows $63,000 from First Estate Bank. The loan is due in one year along with 4% interest. The company is preparing its quarterly report for March 31. Which of the following best describes the necessary accrual for interest expense? A) $630 increase liabilities, increase expenses B) $2,520 decrease liabilities, decrease cash C) $2,520 increase expenses, decrease cash D) $2,520 increase liabilities, decrease expenses E) $630 decrease liabilities, decrease cash (A) The quarterly interest charge is calculated by multiplying the loan amount ($63,000) by the interest rate (4%) and then by the portion of the year outstanding (3/12), or $630 accrued interest. The company needs to reflect the outstanding interest owed (accrued interest) by increasing liabilities and increasing interest expense. Leahy Corp. sells $300,000 of bonds to private investors. The bonds are due in five years, have a 6% coupon rate, and interest is paid semiannually. The bonds were sold to yield 4%. What proceeds does Leahy receive from the investors? Using a financial calculator, the present value of the bonds = $326,948. N = 10 I/Yr = 2 PMT = -9,000 FV = -300,000 Moran Corp. sells $250,000 of bonds to private investors. The bonds are due in 10 years, have an 8% coupon rate and interest is paid semiannually. Moran received $287,195 for the bonds at issuance. The effective rate on these bonds is: Using a financial calculator, the semi-annual effective interest rate on the bonds equals 3%, resulting in an annual effective rate of 6%. N = 10 PV = 287,195 PMT = -10,000 FV = -300,000 Why might a company repurchase its own stock? It believes that the market has undervalued its shares, to offset dilutive effects of employee stock options granted, and/or to improve earnings per share by reducing the denominator in the EPS calculation. In June 2014, Pena Inc. announced a 3-for-1 stock split. On the split date, Pena had about 54.6 million shares outstanding. After the split the number of shares outstanding was: A 3-for-1 stock split means that the company distributes two additional shares of stock for every share owned by a current shareholder. 54.6 million × 3 = 163.8 million. If a company issues 2,500 shares of common stock at a market price of $32 per share, which of the following is the correct balance sheet effect? A) Increase cash by $80,000 and increase contributed capital by $80,000 B) Increase cash by $80,000 and increase earned capital by $80,000 C) Increase stock revenues by $80,000 D) Stock issuances are not reported on the balance sheet (A) Increase cash by $80,000 and increase contributed capital by $80,000 eBay's footnote regarding employee stock compensation details the grant of 2 million options during the year of 2013, the fair-value of which was computed as $15.39. If the options have, on average, a four-year vesting schedule and the company faces a 35% tax rate on income, what affect would this option grant have on eBay's accounts in 2013? To compute the expense for the current grant, we must multiply the value of the options by the number granted and recognize this amount over the vesting period of the options. 2,000,000 × $15.39 = $30,780,000/4 = $7,695,000 We credit this amount to paid-in capital and debit wage expense. In order to determine the deferred tax asset, we take the expense and multiply it by the tax rate: $7,695,000 × 0.35 = $2,693,250 Because of the timing difference between the recognition of the expense and the tax deductibility of the expense, we record a deferred tax asset on the balance sheet and a credit to tax expense. During fiscal 2014, Abercrombie & Fitch reported the exercise of 7,500 shares at a weighted-average exercise price of $28.24. If Abercrombie's stock was trading at $37.19 in January and $31.55 in December, which of the following details an impact of this transaction on Abercrombie's accounts? A) A decrease of $67,125to additional paid-in capital B) An increase of $211,800 to cash C) A decrease of $42,300 to additional paid-in capital D) An increase of $278,925 to cash (B) The exercise of 7,500 shares at the price of $28.42 would imply: 7,500 × $28.24 = $211,800 This amount is credited to paid-in capital and debited to cash. The amount the stock is trading at doesn't impact the financial statements of the company. On its 2013 balance sheet, Walgreen Co, reports treasury stock at cost of $3,114 million. The company has a total of 1,028,180,150 shares issued and 946,595,578 shares outstanding. What average price did Walgreen pay for treasury shares? Price per share is total treasury shares at cost divided by treasury shares. $3,114,000,000 / (1,028,180,150 - 946,595,578) = $38.17 per share. Professional Partners Inc., declares a small stock dividend of 14% of the outstanding shares of common stock. Currently, Professional Partners has 1,300,000 shares of $1 par value common stock outstanding. The current market price of the stock is $75.80 per share. Professional Partners will record a dividend of: Retained earnings are reduced by market value for small stock dividends: 1,300,000 shares × 14% × market value per share $75.80 = $13,795,600 Lavender, Inc. announces a large stock dividend of 65% of the 3.1 million outstanding shares of common stock. The current price per share is $8.85. Par value of the stock is $0.01 per share. What effect does this dividend have on retained earnings? Retained earnings are reduced by the par value of the stock = 3.1 million shares × 65% × $0.01 = $20,150 decrease Which of the following should not be included in accumulated other comprehensive income? A) Minimum pension liability B) Currency translation adjustment C) Unrealized gains and losses on available-for-sale securities D) Unrealized gains and losses on trading securities (D) Unrealized gain on trading securities is recorded in the income statement rather than as equity, while all the other three items should be categorized within comprehensive income. Matrix, Inc., reported a net gain of $69,000 on its foreign assets due to the weakening of the U.S. dollar in 2013. In the same year, the company disclosed unrealized gains of $1,598,000 on its available-for-sale securities and a $188,000 unrealized gain on its trading securities. The company also reported a $927,000 loss on the sale of some equipment. Which of the following best describes the impact of these transactions on Matrix Company's accounts? A) $1,855,000 increase to net income. B) $1,667,000 increase to accumulated other comprehensive income. C) $1,667,000 increase to net income. D) $ 257,000 increase to accumulated other comprehensive income. (B) Only the gain on Matrix's foreign currency translation and the gain on its available-for-sale securities should be included in accumulated other comprehensive income. These items are kept separate from income until sold and hence do not impact it. Savannah Inc. has 35,000 common shares issued at a $1.50 par value of which 22,000 are outstanding. If Savannah has no other outstanding stock, what size dividend must be paid such that each share receives $2? Only outstanding shares are included in dividend distributions. Hence, to pay 22,000 shares $2 each, Savannah must pay: 22,000 × $2 = $44,000 As of 2014, Fischer Corp. has $10 par, 4% preferred stock, 6,000 shares outstanding, and $1 par common stock with 38,000 shares outstanding. The preferred stock is cumulative and preferred stockholders last received a dividend in 2011. If the company wants to distribute $3 per share to the common stockholders in 2014, what is the total amount of dividends that the company must pay in the current year? Since the preferred stock is cumulative, it must be paid in arrears for 2012, 2013 and 2014 before common holders can be paid anything in 2014. $10 × 0.04 × 6,000 = $2,400 preferred dividend per year. $2,400 × 3 years = $7,200. In order to give common holders $3 per share, Fischer must pay $114,000 ($3 × 38,000 shares). Altogether, Fischer must pay $7,200 + $114,000 = $121,200. Which of the following is not a correct statement about non-controlling interest? A) Non-controlling interest is reported as a component of stockholders' equity on the balance sheet. B) Non-controlling interest represents their claim to their proportionate share of the net assets and net income of the subsidiary in which they own stock. C) Non-controlling interest is a residual claim, like that of any other shareholder. D) Non-controlling interests are entitled to preference in dividends and payouts in liquidation. (D) Non-controlling interests are not entitled to preference in dividends and payouts in liquidation. When the fair value of a company's portfolio of available-for-sale equity securities exceeds its book value, the difference should be: Added to the Investment: Available-for-sale securities are accounted for on a fair-value basis; therefore, an increase in fair value would result in an increase in both of the investment account and the stockholders' equity (through accumulated other comprehensive income/loss). Note that answer b is incorrect because the unrealized gain is added to the investor's equity and not the investee's equity. Which of the following statements is not true of the fair-value method of accounting for marketable securities? A) The investment account is recorded at current fair value on the balance sheet. B) Interim changes in the investments' fair value may or may not affect income depending on the securities' classification. C) This method is used when the reporting company generally owns less than 20% of the investee company. D) Dividends are treated as a return of the capital invested. (D) Dividends are reported as income, rather than a return of the capital invested, which is the case for equity method investments. Following is a portion of the debt investments footnote from Allstate's 2015 10-K (in millions). Amortized cost of available-for-sale securities: $59,008 Gross unrealized gains: $2,475 What amount does Allstate report for available-for-sale securities on its 2015 balance sheet? Available-for-sale investments are reported at fair value on the balance sheet. Thus, Allstate's bond investments are reported as $59,008 + $2,475 = $61,483 million as of 2013. In footnotes to its 2018 annual report, Bancfirst Corp. reported that held-to-maturity securities with an amortized cost of $11,986 thousand had an estimated fair value of $12,094 thousand. The balance sheet reported held-to-maturity assets of: Held-to-maturity securities are recorded at amortized cost, which is $11,986 thousand. The unrealized gains of $108 thousand are not reported on the balance sheet, but disclosed in the footnotes only. Parker Corp. holds a 15% equity investment in Schmidt Inc. Tanner Investments holds 35% of Schmidt Inc. stock. On May 1, 2014, Schmidt Inc. declares and pays dividends to its stockholders. How will the dividend affect each company's balance sheet account: Schmidt Inc. investment? Parker Corp. Tanner Investments A) No effect Decrease B) No effect No effect C) Decrease No effect D) Decrease Decrease (A) Parker Corp. should use the fair-value method to account for its investment in Schmidt Inc.; therefore, a dividend would not affect its investment account. Tanner Investments should use the equity method to account for its investment in Schmidt Inc. Therefore, a dividend will be deducted from its investment account and added to cash. Significant influence is often presumed when the investor owns: Ownership between 20% and 50% is often sufficient. However, significant influence can also exist when ownership is less then 20% if the investor company gains a seat on the board of directors due to its investment, or if the investor controls some sort of technical know-how or patents that the investee uses. At the beginning of fiscal 2014, Standard Rate Company acquired a small savings and loan association for $68 million. The book value of the assets of the acquired company were $174 million, its liabilities $115 million. An appraiser determined that the acquiree's land had a fair value of $2 million in excess of its net book value. Standard Rate also determined that the acquiree had an unrecorded liability of $4.5 million relating to a lawsuit. The book value of all other assets and liabilities approximated fair value. What did Standard Rate Company record as goodwill for this acquisition? Goodwill = Cost to acquire - Fair value of net assets acquired $68 million - ($174 million + $2 million - $115 million - $4.5 million) = $11.5 million This type of lease is considered a form of off-balance-sheet financing. Operating lease. Under operating leases, neither the leased asset nor the lease liability appear on the lessee's balance sheet. Therefore, operating leases are a form of off-balance-sheet financing. How are operating leases reported in the lessee's balance sheet? Operating leases are not reported on a company's balance sheet. However, operating leases are noted in the footnotes to the financial statements, which provide key details regarding the company's current and future lease payment obligations. Failure to appropriately capitalize leased assets and liabilities results in a number of distortions in the ROE disaggregation analysis. Which of the following is not a distortion? A) Net operating asset turnover is overstated due to the non-reporting of lease assets. B) Reported total expense is lower in the early years of a capital lease relative to an operating lease, but is higher in later years. C) Financial leverage is understated. D) Total assets are understated. (B) Reported expense is higher in the early years of a capital lease relative to an operating lease, but is lower in later years. Capital leases report a depreciation (operating) expense and an interest (non-operating) expense; whereas, operating leases report rent (operating) expenses only. Which of the following is not a condition requiring the use of the capital lease reporting method? A) The lease, by its terms, automatically transfers ownership of the leased asset from the lessor to the lessee at the termination of the lease. B) The lease term is at least 75% of the economic useful life of the leased asset C) The lease, by its terms, does not automatically transfer ownership of the leased asset from thelessor to the lessee at the termination of the lease. D) The lease provides that the lessee can purchase the leased asset for a nominal amount(bargain purchase price) at the termination of the lease. (C) For using the operating lease reporting method, the lease, by its terms, does not automatically transfer ownership of the leased asset from the lessor to the lessee at the termination of the lease. Transfer of ownership of the leased asset from the lessor to the lessee at the termination of the lease would be accounted for using the capitalized lease method. Which of the following is not a benefit of utilizing operating leases for the lessee? A) NOPAT is higher. B) Measures of leverage are improved. C) Lease liability is not reported on the balance sheet. D) Net operating asset turnover is higher. (A) NOPAT is lower with operating leases, as all of the rent payments are classified as an operating expense. With capital leases, a portion of the payment is classified as non-operating interest expense. All other choices are benefits of operating leases for the lessee. What are the three basic components of pension expense? Service cost, interest cost, and expected return on plan assets Actual returns affect the pension assets but not the expense; benefits paid affect the PBO and plan assets but not the expense. Actuarial gains and losses arise from: Changes in pension plan details, mortality rates, discount rate, and inflation rates The first step in stock valuation requires: Analyzing the business and its accounting Google has a market beta of 1.16, if the market increases by 1.4% on a given day we would expect that Google's stock price would: Beta x 1.4% = Increase by 1.62% The average borrowing rate for interest bearing debt is calculated as: Interest Expense divided by Average Interest-bearing debt When calculating the after-tax cost of debt capital you must multiply the average borrowing rate by: 1 - Marginal income tax rate (Interest expense is tax deductible) The weighted average cost of capital is used when valuing the payoffs: To both equity and debt holders (i. e., when valuing the total firm value) If a company has preferred stock, the cost of preferred equity used in the company's weighted average cost of capital calculation is: Equal to the preferred dividend rate The proper discount rate when using the dividend discount valuation model is the: Cost of equity capital Great Deal Company forecasts a $1.45 dividend for 2014, $1.56 dividend for 2015 and a $1.65 dividend for 2016 for Beach Corporation. For year 2017, Great Deal Company forecasts that Beach will pay a $1.72 dividend and that dividend will continue to grow by 4% each year. Using the dividend discount valuation model determine the intrinsic value of Beach Corporation, assuming the company's cost of equity capital is 7%. Sum of PVs is: $1.36 + $1.36 + $1.35 + $47.61 = $51.68 period 4: Future value = D/(r-g) = $1.72 / (0.07 - 0.04) = $57.33 Wesleyan Corporation is expected to pay a $1.40 dividend next period, that is expected to grow at a constant growth rate of g percent to perpetuity, and its current stock price is $42.80. Assuming the company's cost of equity capital is 7% use the dividend discount valuation model to estimate the company's growth rate. $42.80 = $1.40 / (0.07 - g) = 0.03729