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financial statement analysis
Financial Statement Analysis Equity Investments VOLUME 3 CFA Institute - Solutions
explain how deferred tax liabilities and assets are created and the factors that determine how a company’s deferred tax liabilities and assets should be treated for the purposes of financial analysis
contrast accounting profit, taxable income, taxes payable, and income tax expense and temporary versus permanent differences between accounting profit and taxable income
. Which type of equity valuation model is most likely to be preferable when one is comparing similar companies?A. A multiplier model.B. A present value model.C. An asset-based valuation model.
. Which of the following is most likely a reason for using asset-based valuation?A. The analyst is valuing a privately held company.B. The company has a relatively high level of intangible assets.C. The market values of assets and liabilities are different from the balance sheet values.
. Asset-based valuation models are best suited to companies where the capital structure does not have a high proportion of:A. debt.B. intangible assets.C. current assets and liabilities.
. A disadvantage of the EV method for valuing equity is that the following information may be difficult to obtain:A. Operating income.B. Market value of debt.C. Market value of equity.
. Enterprise value is most often determined as market capitalization of common equity and preferred stock minus the value of cash equivalents plus the:A. book value of debt.B. market value of debt.C. market value of long-term debt.
. An analyst has determined that the appropriate EV/EBITDA for Rainbow Company is 10.2. The analyst has also collected the following forecasted information for Rainbow Company:EBITDA = $22,000,000 Market value of debt = $56,000,000 Cash = $1,500,000 The value of equity for Rainbow Company is
. Which of the following statements regarding the calculation of the enterprise value multiple is most likely correct?A. Operating income may be used instead of EBITDA.B. EBITDA may not be used if company earnings are negative.C. Book value of debt may be used instead of market value of debt.
. The market value of equity for a company can be calculated as enterprise value:A. minus market value of debt, preferred stock, and short-term investments.B. plus market value of debt and preferred stock minus short-term investments.C. minus market value of debt and preferred stock plus short-term
. An analyst gathers the following information about similar companies in the banking sector:First Bank Prime Bank Pioneer Trust P/B 1.10 0.60 0.60 P/E 8.40 11.10 8.30 Which of the companies is most likely to be undervalued?A. First Bank.B. Prime Bank.C. Pioneer Trust.
. An analyst gathers the following information about two companies:Alpha Corp. Delta Co.Current price per share $57.32 $18.93 Last year’s EPS $3.82 $1.35 Current year’s estimated EPS $4.75 $1.40 Which of the following statements is most accurate?A. Delta has the higher trailing P/E multiple and
. An analyst has prepared a table of the average trailing twelve-month price-to-earning (P/E), price-to-cash flow (P/CF), and price-to-sales (P/S) for the Tanaka Corporation for the years 2014 to 2017.Year P/E P/CF P/S 2014 4.9 5.4 1.2 2015 6.1 8.6 1.5 2016 8.3 7.3 1.9 2017 9.2 7.9 2.3 As of the
. An analyst has gathered the following information for the Oudin Corporation:Expected earnings per share = €5.70 Expected dividends per share = €2.70 Dividends are expected to grow at 2.75 percent per year indefinitely The required rate of return is 8.35 percent Based on the information
. An analyst makes the following statement: “Use of P/E and other multiples for analysis is not effective because the multiples are based on historical data and because not all companies have positive accounting earnings.” The analyst’s statement is most likely:A. inaccurate with respect to
. The primary difference between P/E multiples based on comparables and P/E multiples based on fundamentals is that fundamentals-based P/Es take into account:A. future expectations.B. the law of one price.C. historical information.
. A price earnings ratio that is derived from the Gordon growth model is inversely related to the:A. growth rate.B. dividend payout ratio.C. required rate of return.
. An equity analyst has been asked to estimate the intrinsic value of the common stock of Omega Corporation, a leading manufacturer of automobile seats. Omega is in a mature industry, and both its earnings and dividends are expected to grow at a rate of 3 percent annually. Which of the following is
. The best model to use when valuing a young dividend-paying company that is just entering the growth phase is most likely the:A. Gordon growth model.B. two-stage dividend discount model.C. three-stage dividend discount model.
. Hideki Corporation has just paid a dividend of ¥450 per share. Annual dividends are expected to grow at the rate of 4 percent per year over the next four years. At the end of four years, shares of Hideki Corporation are expected to sell for ¥9000.If the required rate of return is 12 percent,
. An analyst is attempting to value shares of the Dominion Company. The company has just paid a dividend of $0.58 per share. Dividends are expected to grow by 20 percent next year and 15 percent the year after that. From the third year onward, dividends are expected to grow at 5.6 percent per year
. An analyst gathers or estimates the following information about a stock:Current price per share €22.56 Current annual dividend per share €1.60 Annual dividend growth rate for Years 1–4 9.00%Annual dividend growth rate for Years 5+ 4.00%Required rate of return 12%Based on a dividend discount
. Which of the following is most likely considered a weakness of present value models?A. Present value models cannot be used for companies that do not pay dividends.B. Small changes in model assumptions and inputs can result in large changes in the computed intrinsic value of the security.C. The
. The Gordon growth model can be used to value dividend-paying companies that are:A. expected to grow very fast.B. in a mature phase of growth.C. very sensitive to the business cycle.
. An investor is considering the purchase of a common stock with a $2.00 annual dividend. The dividend is expected to grow at a rate of 4 percent annually. If the investor’s required rate of return is 7 percent, the intrinsic value of the stock is closest to:A. $50.00.B. $66.67.C. $69.33.
. The Beasley Corporation has just paid a dividend of $1.75 per share. If the required rate of return is 12.3 percent per year and dividends are expected to grow indefinitely at a constant rate of 9.2 percent per year, the intrinsic value of Beasley Corporation stock is closest to:A. $15.54.B.
. Two analysts estimating the value of a non-convertible, non-callable, perpetual preferred stock with a constant dividend arrive at different estimated values. The most likely reason for the difference is that the analysts used different:A. time horizons.B. required rates of return.C. estimated
. A Canadian life insurance company has an issue of 4.80 percent, $25 par value, perpetual, non-convertible, non-callable preferred shares outstanding. The required rate of return on similar issues is 4.49 percent. The intrinsic value of a preferred share is closest to:A. $25.00.B. $26.75.C. $28.50.
. With respect to present value models, which of the following statements is most accurate?A. Present value models can be used only if a stock pays a dividend.B. Present value models can be used only if a stock pays a dividend or is expected to pay a dividend.C. Present value models can be used for
. In the free cash flow to equity (FCFE) model, the intrinsic value of a share of stock is calculated as:A. the present value of future expected FCFE.B. the present value of future expected FCFE plus net borrowing.C. the present value of future expected FCFE minus fixed capital investment.
. An investor expects to purchase shares of common stock today and sell them after two years. The investor has estimated dividends for the next two years, D1 and D2, and the selling price of the stock two years from now, P2. According to the dividend discount model, the intrinsic value of the stock
. An analyst who bases the calculation of intrinsic value on dividend-paying capac-ity rather than expected dividends will most likely use the:A. dividend discount model.B. free cash flow to equity model.C. cash flow from operations model.
. An analyst is attempting to calculate the intrinsic value of a company and has gathered the following company data: EBITDA, total market value, and market value of cash and short-term investments, liabilities, and preferred shares. The analyst is least likely to use:A. a multiplier model.B. a
. Book value is least likely to be considered when using:A. a multiplier model.B. an asset-based valuation model.C. a present value model.
. Which of the following is most likely used in a present value model?A. Enterprise value.B. Price to free cash flow.C. Free cash flow to equity.
. In asset-based valuation models, the intrinsic value of a common share of stock is based on the:A. estimated market value of the company’s assets.B. estimated market value of the company’s assets plus liabilities.C. estimated market value of the company’s assets minus liabilities.
. An analyst determines the intrinsic value of an equity security to be equal to $55.If the current price is $47, the equity is most likely:A. undervalued.B. fairly valued.C. overvalued.
. An analyst estimates the intrinsic value of a stock to be in the range of €17.85 to€21.45. The current market price of the stock is €24.35. This stock is most likely:A. overvalued.B. undervalued.C. fairly valued.
. An analyst predicts that if a company’s technological developments are a success, the company’s operating costs will be reduced by 15%. As a result of the reduction in costs, the company will reduce the average selling price of its products by 5% and the volume of sales will increase by 8%.
. An analyst notes that a company’s capital expenditures do not follow a discernible pattern; the company seems to have periods of very low capital expenditures and periods of high capital expenditures. Management does not provide any guidance on capital expenditures. The analyst should develop a
. An analyst is forecasting operating costs for a company with relatively high fixed costs, sensitivity to economic conditions, and commodity inputs with volatile pricing. The company does not follow a hedging strategy for commodity purchases but tries to buy when prices are low. Which of the
. A clothing company, which initially produced designer clothing, has increasingly entered into the mass market. Which of the following approaches to forecasting revenues is least appropriate?A. Historical results B. Analyst’s discretionary forecast C. Historical base rates and convergence
. An analyst forecasts a company’s sales using a historical results approach and top-down drivers (expected industry sales and expected market share). The analyst observes that the forecast is within the range of management guidance on sales but is toward the upper end and not closer to the
. Which of the following is an example of a top-down driver of revenues for a passenger airline?A. Market share of routes B. Number of planes in fleet C. Average ticket price per mile flown
. Management guidance is most appropriately used by analysts in forecasting:A. capital expenditures of a company.B. pricing of commodities sold by a company.C. revenue of a company sensitive to the business cycle.
. Forecast objects should be:A. based on independent third-party reports.B. based on individual discrete items, not aggregations.C. disclosed regularly or based on items that are disclosed regularly.
. Which of the following is most likely a risk of executing a differentiation competitive strategy?A. pricing premiums become too high B. larger competitors outcompete on price C. a desire for premium-ization among customers
. The means of executing cost leadership competitive strategies do not include which of the following?A. proximity to customers B. favorable access to raw materials C. economies of scale from fixed costs
. PESTLE analysis is a framework for identifying:A. industry themes.B. the level of industry concentration.C. determinants of industry profitability.
. The CEO of a large law firm is concerned about a new mobile application that uses algorithms to auto-complete legal forms and questions in discovery and provides recommendations for small-claims matters at a much lower cost than a traditional law firm charges. As a result, the CEO is
. Increased environmental regulations on automotive manufacturers will most likely have which of the following effects on the threat of new entrants?A. An increase B. A decrease C. No change
. Lower industry concentration is usually associated with a high degree of competitive intensity unless the industry is most likely:A. global.B. service-oriented.C. one with low product differentiation.
. A market consists of three firms with market shares of 50%, 30%, and 20%. The Herfindahl-Hirschman Index (HHI) is closest to:A. 0.38.B. 2,500.C. 3,800.
. An alternative method of grouping companies by geography is least likely to be completed using:A. location of head office.B. geographic composition of revenue.C. primary listing of its equity securities.
. The first step in reviewing a company’s capital investments is to:A. evaluate management’s investments.B. identify operating cash flow drivers.C. determine the major sources and uses of cash.
. OldShips’ cash conversion cycle (CCC) is:A. lower than CleanYards’.B. similar to CleanYards’.C. higher than CleanYards’.
. When conducting company analysis, which of the following is least relevant to determining a company’s business model?A. Company annual report describing the firm’s product lines B. Comments by management about competing products and substitutes C. Industry white papers regarding the
. Assuming both companies have similar equity multipliers, OldShips is most likely to have a:A. much lower ROE than CleanYards.B. similar ROE to CleanYards’.C. much higher ROE than CleanYards.
. In 2X19, NewShips’ revenue was closest to:A. $173 million.B. $1.46 billion.C. $3.63 billion.
. Shipping is a highly cyclical industry. Which of the following companies most likely has the most ability to ramp up capacity to meet increased demand for shipping services?A. OldShips B. NewShips C. CleanYards
. Which of the following is most likely to be an element of Hu’s subsequent reports?A. Industry size, growth rate, and key drivers B. Summary of changes to the recommendation C. Ownership structure and management composition
. A company’s cost of equity is often used as a proxy for investors’:A. average required rate of return.B. minimum required rate of return.C. maximum required rate of return.
. Which of the following measures is the most difficult to estimate?A. The cost of debt.B. The cost of equity.C. Investors’ required rate of return on debt.
. Holding all other factors constant, which of the following situations will most likely lead to an increase in a company’s return on equity?A. The market price of the company’s shares increases.B. Net income increases at a slower rate than shareholders’ equity.C. The company issues debt to
. Calculate the return on equity (ROE) of a stable company using the following data:Total sales £2,500,000 Net income £2,000,000 Beginning of year total assets £50,000,000 Beginning of year total liabilities £35,000,000 Number of shares outstanding at the end of the year 1,000,000 Price per
. Which of the following statements is least accurate in describing a company’s market value?A. Management’s decisions do not influence the company’s market value.B. Increases in book value may not be reflected in the company’s market value.C. Market value reflects the collective and
. Calculate the book value of a company using the following information:Number of shares outstanding 100,000 Price per share €52 Total assets €12,000,000 Total liabilities €7,500,000 Net Income €2,000,000 A. €4,500,000.B. €5,200,000.C. €6,500,000.
. Which of the following statements is most accurate in describing a company’s book value?A. Book value increases when a company retains its net income.B. Book value is usually equal to the company’s market value.C. The ultimate goal of management is to maximize book value.
. Which of the following is not a primary goal of raising equity capital?A. To finance the purchase of long-lived assets.B. To finance the company’s revenue-generating activities.C. To ensure that the company continues as a going concern.
. Which of the following is least likely to be a reason for a company to issue equity securities on the primary market?A. To raise capital.B. To increase liquidity.C. To increase return on equity.
. From an investor’s point of view, which of the following equity securities is the least risky?A. Putable preference shares.B. Callable preference shares.C. Non-callable preference shares.
. Which of the following is incorrect about the risk of an equity security? The risk of an equity security is:A. based on the uncertainty of its cash flows.B. based on the uncertainty of its future price.C. measured using the standard deviation of its dividends.
. If a US-based investor purchases a euro-denominated ETF and the euro subsequently depreciates in value relative to the dollar, the investor will have a total return that is:A. lower than the ETF’s total return.B. higher than the ETF’s total return.C. the same as the ETF’s total return.
. Calculate the total return on a share of equity using the following data:Purchase price: $50 Sale price: $42 Dividend paid during holding period: $2 A. –12.0%B. –14.3%C. –16.0%
. A basket of listed depository receipts, or an exchange-traded fund, would most likely be used for:A. gaining exposure to a single equity.B. hedging exposure to a single equity.C. gaining exposure to multiple equities.
. With respect to Level III sponsored ADRs, which of the following is least likely to be accurate? They:A. have low listing fees.B. are traded on the NYSE, NASDAQ, and AMEX.C. are used to raise equity capital in US markets.
. When investing in unsponsored depository receipts, the voting rights to the shares in the trust belong to:A. the depository bank.B. the investors in the depository receipts.C. the issuer of the shares held in the trust.
. Emerging markets have benefited from recent trends in international markets.Which of the following has not been a benefit of these trends?A. Emerging market companies do not have to worry about a lack of liquidity in their home equity markets.B. Emerging market companies have found it easier to
. Which of the following statements most accurately describes one difference between private and public equity firms?A. Private equity firms are focused more on short-term results than public firms.B. Private equity firms’ regulatory and investor relations operations are less costly than those of
. Venture capital investments:A. can be publicly traded.B. do not require a long-term commitment of funds.C. provide mezzanine financing to early-stage companies.
. Which of the following statements about private equity securities is incorrect?A. They cannot be sold on secondary markets.B. They have market-determined quoted prices.C. They are primarily issued to institutional investors.
. Participating preference shares entitle shareholders to:A. participate in the decision-making process of the company.B. convert their shares into a specified number of common shares.C. receive an additional dividend if the company’s profits exceed a pre-determined level.
. All of the following are characteristics of preference shares except:A. They are either callable or putable.B. They generally do not have voting rights.C. They do not share in the operating performance of the company.
. The type of equity voting right that grants one vote for each share of equity owned is referred to as:A. proxy voting.B. statutory voting.C. cumulative voting.
. Which of the following is not a characteristic of common equity?A. It represents an ownership interest in the company.B. Shareholders participate in the decision-making process.C. The company is obligated to make periodic dividend payments.
. Like traditional finance models, the behavioral theory of loss aversion assumes that investors dislike risk; however, the dislike of risk in behavioral theory is assumed to be:A. leptokurtic.B. symmetrical.C. asymmetrical.
. Observed overreactions in markets can be explained by an investor’s degree of:A. risk aversion.B. loss aversion.C. confidence in the market.
. With respect to rational and irrational investment decisions, the efficient market hypothesis requires:A. only that the market is rational.B. that all investors make rational decisions.C. that some investors make irrational decisions.
. With respect to efficient markets, a company whose share price changes gradually after the public release of its annual report most likely indicates that the market where the company trades is:A. semi-strong-form efficient.B. subject to behavioral biases.C. receiving additional information about
. Which of the following market anomalies is inconsistent with weak-form market efficiency?A. Earnings surprise.B. Momentum pattern.C. Closed-end fund discount.
. Researchers have found that value stocks have consistently outperformed growth stocks. An investor wishing to exploit the value effect should purchase the stock of companies with above-average:A. dividend yields.B. market-to-book ratios.C. price-to-earnings ratios.
. If a researcher conducting empirical tests of a trading strategy using time series of returns finds statistically significant abnormal returns, then the researcher has most likely found:A. a market anomaly.B. evidence of market inefficiency.C. a strategy to produce future abnormal returns.
. Which of the following is least likely to explain the January effect anomaly?A. Tax-loss selling.B. Release of new information in January.C. Window dressing of portfolio holdings.
. If a market is weak-form efficient but semi-strong-form inefficient, then which of the following types of portfolio management is most likely to produce abnormal returns?A. Passive portfolio management.B. Active portfolio management based on technical analysis.C. Active portfolio management based
. Fundamental analysts assume that markets are:A. weak-form inefficient.B. semi-strong-form efficient.C. semi-strong-form inefficient.
. Technical analysts assume that markets are:A. weak-form efficient.B. weak-form inefficient.C. semi-strong-form efficient.
. If a market is semi-strong-form efficient, the risk-adjusted returns of a passively managed portfolio relative to an actively managed portfolio are most likely:A. lower.B. higher.C. the same.
. If markets are semi-strong-form efficient, then passive portfolio management strategies are most likely to:A. earn abnormal returns.B. outperform active trading strategies.C. underperform active trading strategies.
. If markets are semi-strong efficient, standard fundamental analysis will yield abnormal trading profits that are:A. negative.B. equal to zero.C. positive.
. If prices reflect all public and private information, the market is best described as:A. weak-form efficient.B. strong-form efficient.C. semi-strong-form efficient.
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