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Study Session 8 Sample Questions Investment Tools, Financial Statement Analysis Financial Ratios and Earnings per Share

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Study Session 8 Sample Questions Investment Tools

Financial Statement Analysis Financial Ratios and Earnings per Share

Analysis of Financial Statements 1. Internal liquidity or solvency ratios indicate the ability of the firm to:

A. meet future short term financial obligations B. meet future long term financial obligations C. settle current debt with fixed assets D. settle future short term debt with fixed assets

Answer

A.

Internal liquidity and solvency ratios

Internal liquidity or solvency ratios indicate the ability of the firm to meet future short term financial obligations.

Reference Investment Analysis and Portfolio Management, 6th edition, Frank K. Reilly and Keith C. Brown (Dryden, 2000) Study Session 8 2003, Analysis of Financial Statements, LOS 1b



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2. The return on owner’s equity ratio indicates:

A. the rate of return that management has earned on the capital provided by the owner after accounting for payments to all other capital suppliers

B. how management uses its assets and capital, measured in terms of the sales generated by various assets or capital categories

C. the rate of return that management has earned on the capital provided by the owner after accounting for payments to all other capital suppliers

D. the rate of return that management has earned on the capital provided by the owner before accounting for payments to all other capital suppliers

Answer B. The return on owner’s equity ratio

The return on owner’s equity ratio indicates how management uses its assets and capital, measured in terms of the sales generated by various assets or capital categories.

Reference Investment Analysis and Portfolio Management, 6th edition, Frank K. Reilly and Keith C. Brown (Dryden, 2000) Study Session 8 2003, Analysis of Financial Statements, LOS 1c



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3. Three companies had the following results during the recent period.

A B C Net profit margin 0.03 0.05 0.08 Total asset turnover

2.4 2.2 1.8

Total assets/equity

2.6 2.4 2.0

The ROE for company B is equal to:

A. 5.280 B. 0.264 C. 0.110 D. 0.120

Answer

B.

Calculating ROE

The ROE for company B is equal to 0.264 ROE = Total asset turnover x Total assets/equity x Net profit margin

ROE = 2.2 x 2.4 x 0.05 = 0.264




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4. Consider a jewellery store and a grocery store. How would they differ in

terms of asset turnover and profit margin as well as return on total assets assuming equal business risk?

A. Jewelry store Grocery Store Asset turnover Low High Profit margin High Low ROE Equal Equal B. Jewelry store Grocery Store Asset turnover High Low Profit margin High Low ROE Equal Equal C. Jewelry store Grocery Store Asset turnover Low High Profit margin Low High ROE Equal Equal D. Jewelry store Grocery Store Asset turnover Low High Profit margin High Low ROE High Low Answer

A.



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Ratios and different industries Consider a jewellery store and a grocery store. They differ in terms of asset turnover and profit margin as well as return on total assets assuming equal business risk as follows:

Jewelry store Grocery Store Asset turnover Low High Profit margin High Low ROE Equal Equal


Use the following information in answering Questions 5 and 6

5. Given the following information for three companies:

A B C Net profit margin

0.03 0.05 0.08

Total asset turnover

2.4 2.2 1.8

Total assets/equity

2.6 2.4 2.0

Earnings/share 2.78 3.30 4.9 Dividends/share 1.67 1.5 1.2

The growth rate for company A is: A. 18.7% B. 27.8% C. 6.7% D. 7.5%



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Answer

D. Calculating growth rate

The growth rate for company A is 7.5%

ROE = Total asset turnover x Total assets / equity x Net profit margin ROE = 2.4 x 2.6 x 0.03 = 0.187 Growth rate = (1 - Payout ratio) x ROE

Growth rate = ROEshareperEarningshareperDividends1 ×−

Growth rate = (1-1.67/2.78) x 0.187 = 0.075


6. The growth rate for company B is:

A. 26.4% B. 24% C. 14.4% D. 22%

Answer C.



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Calculating growth rate The growth rate for company B is 14.4% ROE = Total asset turnover x Total assets/equity x Net profit margin ROE = 2.2 x 2.4 x 0.05 = 0.264 Growth rate = (1-1.5/3.3) x 0.264 = 0.144


Use the following information in answering Questions 7 and 8

Given the following data:

20X2 19X8 INCOME STATEMENT DATA Revenues 1,626 2,937 Operating income 114 228 Depreciation and amortization 9 27 Interest expense 9 0 Pretax income 96 201 Income taxes 39 111 Net income after tax 57 90 BALANCE SHEET DATA Fixed assets 123 210 Total assets 735 873 Working capital 369 471 Total debt 48 0 Total shareholders’ equity 477 660



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7. Using the DuPont formula, calculate the asset turnover for 20X2:

A. 0.298x

B. 4.23x C. 3.36x D. 0.98x Answer C.

Asset turnover and the DuPont formula

Using the DuPont formula, the asset turnover for 20X2 is 3.36x Asset turnover =

assetsTotalSales =

8732,937 = 3.36x


8. Using the DuPont formula, calculate the interest burden for 20X2:

A. 1% B. 2% C. 3% D. 0%

Answer

D.



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Interest burden and the DuPont formula

Using the DuPont formula, the interest burden for 20X2 is 0%

Interest burden =

assetsTotalexpenseInterest =

8730 = 0%


2. Dilutive Securities and Earnings Per Share 1. When stock dividends or stock splits occur, which of the following

statements describes the effect, if any, on the weighted average number of shares outstanding?

A. The computation of the weighted average number of shares

outstanding does not require restatement of the shares outstanding before the stock dividend or split.

B. The computation of the weighted average number of shares outstanding requires restatement of the shares outstanding after the stock dividend or split.

C. The computation of the weighted average number of shares outstanding requires restatement of the shares outstanding before the stock dividend but after the stock split.

D. The computation of the weighted average number of shares outstanding requires restatement of the shares outstanding before the stock dividend or split.

Answer D.



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The effect on the weighted average number of shares outstanding with stock dividends and stock splits

When stock dividends or stock splits occur, the computation of the weighted average number of shares outstanding requires restatement of the shares outstanding before the stock dividend or split.

Reference Investment Analysis and Portfolio Management, 6th edition, Frank K. Reilly and Keith C. Brown (Dryden, 2000) Study Session 8 2003, Dilutive Securities and Earnings per Share, LOS 2d

2. Consider the following information relating to Bex Company, whose year-

end is December 31. Income before extraordinary item 2,320,000 Extraordinary gain, net of tax 960,000 Preference dividends declared $4 on 100,000 shares The changes in common stock during 20X2 is as follows: Dates Share changes Shares outstanding January 1 Beginning balance 720,000 May 1 Purchased 120,000 treasury shares 120,000 600,000 July 1 1,200,000 additional shares (3 for 1 stock split) 1,200,000 1,800,000 December 31 Issued 200,000 shares for cash 200,000 December 31 Ending balance 2000,000



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The earnings per share for income before extraordinary items for Bex Company for the year ended December 31 is:

A. $1.208 B. $1.50 C. $0.50 D. $1.00

Answer

D. Calculating earnings per share

The earnings per share for income before extraordinary items for Bex Company for the year ended December 31 is $1.00.

Weighted shares:

Dates outstanding

Shares outstanding (A)

Restatement (B)

Fraction of year (C)

Weighted shares (A x B x C)

Jan.1 – May 1

720,000 3 4/12 720,000

May 1 – Dec. 31

600,000 3 8/12 1,200,000

Weighted 1,920,000 Income available to common stockholders Income before extraordinary item 2,320,000 Pref div (100 000 x 4) 400,000 Income 1,920,000 Extraordinary gain, net of tax 960,000 Income available to common stockholders 2,880,000



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EPS calculation

Income (A) Weighted

shares (B) EPS (C)

Income before extraordinary item

1,920,000 1,920,000 1.00

Extraordinary item

960,000 1,920,000 0.5

Income available 2,880,000 1.920,000 1.5

Reference Investment Analysis and Portfolio Management, 6th edition, Frank K. Reilly and Keith C. Brown (Dryden, 2000) Study Session 8 2003, Dilutive Securities and Earnings per Share, LOS 2d

Use the following information in answering Questions 3 and 4 Consider the following information relating to Brittany Corporation. Net income for the year 420,000 Weighted average shares outstanding 200,000 The company has two convertible debenture bond issues outstanding as

follows:

6% issue sold at 100 (total $2,000,000) in a prior year and convertible into 40,000 common shares.

10% issue sold at 100 (total $2,000,000) on 1 April of the current year and convertible into 64,000 common shares.

The tax rate is 40%. The year-end is December 31.



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3. The basic earnings per share for the year-ended December 31 is:

A. $2.02 B. $2.46 C. $2.10 D. $2.55

Answer

C.

Calculating basic earnings per share and convertibles The basic earnings per share for the year-ended December 31 is $2.10

Net income for the year 420,000 Add: adjustment for interest (net of tax) 6% debentures (2,000,000 x 6%) x (0.6) 72,000 10% debentures (2,000,000 x 10% x 9/12 x 0.6) 90,000 Adjusted net income 582,000 Weighted average number of shares outstanding 200,000 Add: Shares assumed to be issued: 6% debentures 40,000 10% debentures (9/12 x 64,000) 48,000 Weighted average number of shares adjusted 288,000

for dilutive securities Basic earnings per share = 420,000/200,000 = $2.10

Reference Investment Analysis and Portfolio Management, 6th edition, Frank K. Reilly and Keith C. Brown (Dryden, 2000) Study Session 8 2003, Dilutive Securities and Earnings per Share, LOS 2f



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4. The diluted earnings per share for the year-ended December 31 is:

A. $2.10 B. $2.46 C. $2.55 D. $2.02

Answer D.

Calculating diluted earnings per share with convertibles The diluted earnings per share for the year-ended December 31 is $2.02

Net income for the year 420,000 Add: adjustment for interest (net of tax) 6% debentures (2,000,000 x 6%) x (0.6) 72,000 10% debentures (2,000,000 x 10% x 9/12 x 0.6) 90,000 Adjusted net income 582,000 Weighted average number of shares outstanding 200,000 Add: Shares assumed to be issued: 6% debentures 40,000 10% debentures (9/12 x 64,000) 48,000 Weighted average number of shares adjusted for 288,000

dilutive securities

Diluted earnings per share = 582,000/288,000 = $2.02 Reference Investment Analysis and Portfolio Management, 6th edition, Frank K. Reilly and Keith C. Brown (Dryden, 2000) Study Session 8 2003, Dilutive Securities and Earnings per Share, LOS 2g



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5. Under what condition(s) is/are convertible securities considered to be

dilutive securities?

A. whenever interest per share obtainable on conversion is more than the EPS amount computed without assuming conversion

B. whenever interest per share obtainable on conversion is less than the EPS amount computed assuming conversion

C. whenever interest per share obtainable on conversion is less than the EPS amount computed without assuming conversion

D. whenever interest per share obtainable on conversion is more than the EPS amount computed assuming conversion

Answer

C.

Dilutive securities and convertible securities Convertible securities are considered to be dilutive securities whenever interest per share obtainable on conversion is less than the EPS amount computed without assuming conversion. Reference Investment Analysis and Portfolio Management, 6th edition, Frank K. Reilly and Keith C. Brown (Dryden, 2000) Study Session 8 2003, Dilutive Securities and Earnings per Share, LOS 2e

6. Potential common stock can be described as:

A. common stock in form B. not common stock in form but with voting powers of common stock C. stock that has the potential to be common stock D. not common stock in form but enabling holders to obtain common

stock upon exercise or conversion



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Answer

D. Potential common stock

Potential common stock can be described as not common stock in form but they enable holders to obtain common stock upon exercise or conversion. Reference Investment Analysis and Portfolio Management, 6th edition, Frank K. Reilly and Keith C. Brown (Dryden, 2000) Study Session 8 2003, Dilutive Securities and Earnings per Share, LOS 2a

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Study Session 8 Sample Questions Investment …cfaresources.narod.ru/modlin8questions.pdf© 2003 Study Session 8 Sample Questions Investment Tools, Financial Statement Analysis Financial