Second Examination – Finance 3321



First Examination – Finance 3321

Spring 2016 (Moore) – Version 1

Printed Name: ____________________ Registered Section Time: ___________

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: ______________________________

Clearly Circle the BEST response for each Multiple Choice question: 3 Points Each

1. Which of the following is not considered an information intermediary?

a. Accountants

b. Bond Raters

c. Financial Analysts

d. Venture Capitalists

e. Media

2. In the US, the accounting treatment (GAAP) for recognizing bad debt expense under the allowance method is determined and justified by:

a. The corporate controller

b. Matching Principle

c. Periodicity Principle

d. Revenue Recognition Principle

e. The IASB

3. The last possible line item reported on the income statement is:

a. Net Revenue

b. Operating Income

c. Comprehensive Income

d. Income from Continuing Operations

e. Gross Profit

4. One of the main reasons that firms are allowed flexible financial accounting standards under GAAP is:

a. It provides firms a better opportunity to report the underlying economic substance of transactions and events.

b. It gives the firms the opportunity to reduce the volatility of earnings so that investors can provide better forecasts of future performance.

c. It allows managers to better tie earning to performance for compensation purposes.

d. It gives firms the opportunity to mark-to-market the physical assets so that balance sheet values are more relevant to decision makers.

e. None of the above.

5. The ability of diamond miners ability to dictate price and quantity to jewelry makers and sellers is an example of:

a. Bargaining power of the Customer

b. Bargaining power of the Supplier

c. Product differentiation

d. Fixed-Variable Cost ratios

e. Exit Barriers

6. An industry having a high degree of price competition would be characterized by:

a. Low Industry Concentration, High Legal Barriers to Entry, Low Product Differentiation

b. Few Exit Barriers, High First mover advantage, High Product Differentiation

c. High Industry Concentration, Low Distribution Access, High Switching Costs

d. Low Concentration, High Fixed-Variable Cost Ratio, Low Switching Costs

e. Supply < Demand, Low Supplier Switching Costs, Steep Industry Learning Curves

7. Aggressive use of operating lease accounting when capital lease accounting is appropriate will always lead to which of the following financial statement effects?

a. Overstated asset balances

b. Understated liability balances

c. Overstated Revenues

d. Understated Expenses

e. Overstated Operating Cash flows

8. Which of the following will result in overstated asset balances?

a. Failure to recognize the impairment of Goodwill.

b. Using operating lease accounting when the leased asset should be capitalized

c. Overstated amortization of goodwill

d. Overstating liability reserves

e. Failing to recognize contingent liabilities on the balance sheet

Use the following information for problems 9 through 11

ABC Company is a startup company in an industry that exclusively uses capital leases for its expensive medical testing and diagnostic equipment. ABC, however, used operating lease accounting in its first year of operations. Assume the average lifespan of ABC’s leased equipment is 10 years and that their annual cost of debt is 8%. The annual lease payments stated on the 2015 10-K are $12,000,000 for the next 10 years. Assume that new leases are signed on the last day of the year and that annual lease payments are paid in arrears on the last day of the year. Use straight-line depreciation and the effective tax rate is 35%.

9. Adjust ABC’s books to reflect the lease as being capitalized. The Capitalized operating lease rights (assets) that should be shown on the 2015 Balance Sheet as a result of the restatement is:

a. $68,959,668

b. $74,962,655

c. $120,000,000

d. $12,000,000

e. $80,520,977

10. Now, assume the 2015 adjusted balances of the capitalized lease asset and liability are $96,000,000. The appropriate charge for interest expense in 2016 that relates to these lease adjustments would be:

a. $7,680,000

b. $7,334,400

c. $6,441,678

d. $5,997,012

e. $4,927,716

11. The overall effect on Pre-Tax Income in 2016 for ABC (had the lease been capitalized) relative to reported Pre-Tax Income in will be (relative to the reported Net Income) – Use the PV assumptions from the previous problem:

a. $17,280,000 decrease

b. $16,502,000 decrease

c. $ 3,432,000 decrease

d. $ 5,280,000 decrease

e. $ 4,502,400 decrease

12. Which of the following does not necessarily create corporate value?

a. Managing the value chain

b. Maintaining a good fit between the company’s specialized resources and the portfolio of businesses in which the company is operating.

c. Good allocation of decision rights between the headquarters office and the business units to realize all the potential economies of scope.

d. Having internal measurement, information, and incentive systems to reduce agency costs.

e. Investing significant resources to product advertising and marketing activities.

13. Competitive Positioning is part of which main element in Figure 1-2?

a. Business Environment

b. Business Strategy

c. Capital Markets

d. Accounting Environment

e. Accounting Strategy

14. Which is the fifth step in a structured equity security analysis and valuation?

a. Prospective Analysis

b. Accounting Analysis

c. Financial Analysis

d. Business Strategy Analysis

e. Implementing Valuation Models

15. Acquirer Company buys Target Company. Target’s pre-acquisition balance sheet at historical cost showed Total Assets at $900,000 and Total Liabilities at $300,000. Upon acquisition, Acquirer revalued Target’s identifiable assets at $1,600,000 and liabilities at $360,000. Acquirer paid $2,000,000 in cash for Target. Determine the amount of Goodwill Acquirer must recognize in the purchase of Target.

a. $1,460,000

b. $1,400,000

c. $ 760,000

d. $ 780,000

e. $ 820,000

16. An industry having a high degree of price competition would be characterized by:

f. Low Industry Concentration, Few Legal Barriers to Entry, Low Product Differentiation

g. Few Exit Barriers, High First mover advantage, Low Product Differentiation

h. High Industry Concentration, High Distribution Access, Low Firm Excess Capacity

i. Low Concentration, Low Fixed-Variable Cost Ratio, Few Legal Barriers to Entry

j. Supply < Demand, Low First Mover Advantage, High Fixed to Variable Cost Ratio

17. Which of the following would lead to a mixed degree of industry price competition?

a. Low Industry Concentration, Few Legal Barriers to Entry, Low Product Differentiation

b. Few Exit Barriers, High First Mover Advantage, High Product Differentiation

c. Low Industry Concentration, Easy Distribution Access, Low Fixed-Variable Cost Ratio

d. High Industry Concentration, Low Fixed-Variable Cost Ratio, Hi product differentiation

e. Supply > Demand, Few Legal Barriers to Entry, Low Product Differentiation

18. Assume a company has been classified as belonging in a pure cost leadership industry (commodity goods). Which one of the following disclosures would be considered a key accounting policy?

a. Net Sales/Warranty Liabilities

b. Inventory is measured on a Lifo basis at lower of cost or market

c. Disclosure regarding new product development R&D expenses

d. Disclosure new customer service programs

e. Disclosure regarding strategic placement of new distribution centers to reduce costs.

19. Which of the following strategies would lead to a mixture of cost leadership and product differentiation?

a. Economies of scale and scope, simpler product design, Lower input costs

b. Superior product variety, more flexible delivery, High Brand Advertising

c. Lower input costs, Low-cost Distribution, Low investment in R&D

d. High investment in brand image, High investment in R&D, Low Cost Distribution

e. Complex product designs, Superior Product Quality, Superior customer service

20. Assume PG is the fair insurance price for Good drivers and PB is the fair insurance price for Bad drivers, where PG = 200, PB = 400 and 40% of the drivers are Good drivers. If insurers have a mechanism to perfectly distinguish good and bad drivers, what price(s) will result in the voluntary insurance market (assume linear risk preferences)?

a. Good drivers pay 200 and Bad drivers pay 400

b. All drivers pay 200

c. All drivers pay 300

d. All drivers pay 320

e. All drivers pay 400

Use the following information for problems 21 – 22. (Income Statements)

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21. Estimate the total variable Cost of Goods Sold for the year ending 31 Dec., 2015.

a. $25,836,800

b. $32,296,000

c. $64,592,000

d. $38,755,200

e. $96,888,000

22. Assume the variable cost of goods sold (per sales dollar) is $0.20 (20% of sales) in both 2014 and 2015. Estimate the total fixed cost of goods sold for 2014.

a. $25,836,800

b. $32,296,000

c. $64,592,000

d. $38,755,200

e. $96,888,000

Problem 1 – Overs and Unders (10 Points)

Analyze the following transactions (omissions or incorrect accounting treatments) and assess whether the accounts are Overstated, Understated, or No Effect. Fill in the appropriate boxes as (O), (U), (N)

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Short Answer Problem 1 (Fill in the Blanks below) (4 Points)

Company Your Group is Valuing: ___________________________________

Identify the three relevant competitors your group is using for industry benchmarks:

1. ______________________________

2. ______________________________

3. ______________________________

Short Problem 2 (show all work and briefly comment) (10 Points)

You are the CEO of a just formed company that will last exactly 1 year and then be liquidated. You own 2% of the shares. The initial capitalization of the company consists of:

Debt: $25,000

Equity: $10,000

You have the choice of only 2 investment alternatives with the initial capital. Each project will require the investment of the entire initial capital.

Project 1 has a 60% chance of paying $22,000 and a 40% chance of paying $18,000.

Project 2 has a 5% chance of paying $100,000 and a 95% chance of paying $15,000.

Issuers of Debt and Equity are assumed risk neutral.

Which project do bondholders want you, the CEO, to choose? Explain and provide supporting computations where appropriate.

Which project do shareholders want you, the CEO, to choose? Explain and provide supporting computations where appropriate.

Short Essay Problem 2 (Use bullet points with complete sentences for clarity) (10 Points)

This Essay is directly related to the company your group is analyzing.

Company Your Group is Valuing: ___________________________________

Identify 5 (five) specific value drivers for the industry you analyzed and explain, briefly, how these business activities create value and lead to creating or maintaining competitive advantages.

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