Second Examination – Finance 3321



Second Examination – Finance 3321

Fall 2006 (Moore) – Version 1

Grader’s Name: ____________________ Printed Name: ____________________

Ethical conduct is an important component of any profession. The Texas Tech University Code of Student Conduct is in force during this exam. Students providing or accepting unauthorized assistance will be assigned a score of zero (0) for this piece of assessment. Using unauthorized materials during the exam will result in the same penalty. Ours’ should be a self-monitoring profession. It is the obligation of all students to report violations of the honor code in this course. By signing below, you are acknowledging that you have read the above statement and agree to abide by the stipulated terms.

Student’s Signature: ______________________________

Where indicated, use the financial statements for Alamo Distributing (a small electrical components distributor that sells in both the wholesale and retail markets).

Clearly Circle the BEST response for each of the following questions:

Use the attached financial statements for Alamo to answer questions 1-8

1. Compute Alamo’s current ratio for the year ended 20X2

2. Compute Alamo’s Day’s Sales Outstanding 20X1.

3. Compute Alamo’s EBITDA for the year ended 20X2

4. Compute Alamo’s SGR for 20X2

5. Compute Alamo’s IGR for 20X2

6. Compute Alamo’s ROA for 20X2

7. Compute Alamo’s Times Interest Earned for 20X1

8. Compute Alamo’s Debt Service Margin for 20X2

9. The major benefit of using method of comparables as a stock price screening tool is:

a. It provides consistent results

b. It is grounded in financial theory

c. It requires extensive forecasts and analysis

d. It requires little judgment

e. It is quick and easy to implement

10 Aggressive use of which of the following accounting choices can lead to the problem of “off-balance sheet financing”?

a. Operating leases

b. Failure to write down obsolete inventory

c. Reporting all related party transactions

d. Overstating depreciation for long-term assets

e. Using the intrinsic method to account for executive stock options

11 The suspect accounting practice for Lucent Technologies involved:

a. Operating leases

b. Overstating accounts receivable

c. Executive stock options

d. Overstating inventory

e. Understating pension liabilities

12 Which of the following adjustments to the accounts would have to be made when it is found (suspected) a company understates the balance of it’s long-term assets?

a. Increase depreciation expense

b. Decrease liabilities

c. Increase income tax expense

d. Decrease post-retirement benefits liability

e. Decrease the asset account

13. Which of the following will result in understated liability balances?

a. Delays in the write-down (expensing) of current assets such as inventory.

b. Understating the growth rate in future post-retirement benefit costs

c. Overstated amortization of goodwill

d. Overstating the growth rate in future post-retirement benefit costs

e. Delaying the write-down (expensing) of obsolete factory equipment

14. Which of the following will result in increasing operating efficiency?

a. Increasing Days Supply of inventory.

b. Increasing Working Capital Inventory.

c. Extending more generous credit terms from 30 days to 60 days

d. Decreasing Accounts Receivable Turnover

e. Increasing the Cash to Cash Cycle

15. Identify the best statement regarding seasonal adjustments.

a. Seasonal adjustments should be applied to annual data

b. Seasonal adjustments with an underlying growth should be computed using the same quarter in previous years and applying an annual growth rate for the year.

c. Seasonal adjustments with an underlying growth should be computed using the same quarter in previous years and applying a growth rate based on the quarters.

d. Seasonal adjustments should never incorporate underlying growth.

e. Seasonal data can be directly identified in the 10-K financial statements.

Short Problem # 1 (Show all work to receive full credit) – 15 Points

Valuation with P/E and P/B multiples

Kinder Morgan is a natural gas producer and distributor that you are trying to value. Using the method of comparables, assess the value of Kinder Morgan. Information is provided concerning the current share price (PPS), current earnings per share (EPS) and the current book value of equity per share (BPS) for Kinder Morgan and three of its main competitors.

Required: Value CrossTex using the P/E and P/B multiples. Briefly comment on which method comes closest to the observed market price of $63.40 per share.

PPS EPS BPS

CrossTex Industries 41.75 2.83 28.13

RGC Resources 24.33 1.78 17.82

Atmos Engergy Corp. 25.75 1.55 18.15

Kinder Morgan 63.40 3.11 21.75

Problem 2 (Common Size Financial Statements) – 10 Points

Prepare a common size income statement for Alamo Distributing for 20X1

Problem 3(Operating and Capital Lease Adjustments) – 15 Points

Use the following information for Part A through Part D

ABC Company is a startup company in an industry that exclusively uses capital leases for it’s expensive highway construction equipment. ABC, however, used operating lease accounting in its first year of operations. Assume the average lifespan of ABC’s leased equipment is 20 years and that their annual cost of debt is .092%. The annual lease payments are $4,000,000. The present value of the future lease payments is $36,000,000 (rounded). ABC’s industry commonly uses straight-line depreciation and the effective tax rate is 35%.

A. Adjust ABC’s books to reflect the lease as being capitalized. Show initial recognition of the capital lease would have the following impact on the balance sheet (Asset and Liability Accounts) in terms of debits and credits

B. Adjust ABC’s books to reflect the lease as being capitalized. The depreciation expense that should have been charged against income in the first year is:

C. Adjust ABC’s books to reflect the lease as being capitalized. Compute the appropriate charge for interest expense in the second year.

D. Compute the overall effect on Net Income in the first year for ABC (had the lease been capitalized) would be (relative to the reported Net Income, net of tax). Assume the first year interest expense under lease capitalization is $3,312,000.

ALAMO DISTRIBUTING COMPANY

BALANCE SHEETS

December 31, 20X1 and 20X2

ASSETS

Current Assets: 20X1 20X2

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Cash $ 70,000 $ 38,000

Accounts Receivable (net) 65,000 105,000

Inventories (at FIFO Cost) 31,000 52,000

Prepaid Expenses 6,000 4,500

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Total Current Assets $172,000 $199,500

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Non-current Assets (at cost):

Land $208,000 $237,000

Buildings 150,000 150,000

Equipment 460,000 681,000

Less: Accumulated Depreciation (240,000) (338,000)

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Total Non-current Assets $578,000 $730,000

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Total Assets $750,000 $929,500

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LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:

Accounts Payable $ 22,000 $ 47,000

Notes Payable 60,000 32,000

Accrued Liabilities 18,000 24,000

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Total Current Liabilities $100,000 $103,000

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Notes Payable - Long Term 312,000 400,500

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Total Liabilities $412,000 $503,500

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Stockholders' Equity:

Common Stock (no par value) $200,000 $220,000

Retained Earnings 138,000 206,000

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Total Stockholders' Equity $338,000 $426,000

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Total Liabilities & Stockholder Equity $750,000 $929,500

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ALAMO DISTRIBUTING COMPANY

INCOME STATEMENTS

For Years Ending December 31, 20X1 and 20X2

20X1 20X2

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Sales $900,000 $1,200,000

Cost of Goods Sold (350,000) (580,000)

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Gross Profit on Sales $550,000 $ 620,000

Selling Expenses (110,000) (133,500)

Administrative Expenses (238,000) (250,000)

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Income from Operations $202,000 $ 236,500

Interest Expense (52,000) (65,000)

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Income before Taxes $150,000 $ 171,500

Income Tax Expense (60,000) (63,500)

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Net Income $ 90,000 $ 108,000

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Earnings per Common Share* $1.80 $1.96

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Total Depreciation Expense

included above ..... $ 82,000 $ 98,000

* Based on 50,000 and 55,000 average common shares outstanding in 20X1 and 20X2, respectively.

Summary of Cash Flow Statements

20X1 20X2

Cash Flow from Operating Activities $150,000 $180,000

Cash Flow from Investing Activities -$ 90,000 -$130,000

Cash Flow from Financing Activities $ 20,000 $10,000

Dividends Paid $30,000 $40,000

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