Investments Ch 10 Flashcards

1
Q

EQUITY SECURITIES ANALYSIS

Two approaches:

A

EQUITY SECURITIES ANALYSIS

Two approaches:

  1. Fundamental analysis is the process of determining the intrinsic
    value of a firm or security and then comparing it to the market
    price.
  2. Technical analysis is a method that may help determine the price
    at which an investor should buy, sell, or hold an individual equity
    security
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q
A

FUNDAMENTAL ANALYSIS –

BOTTOM-UP APPROACH

  • Begins by analyzing individual firms based on an intrinsic value and
    relative value basis.
  • Relevant input variables include operating cash flows, quality of the
    board of directors, skill set of the executive leadership team, capital
    structure, dividend policy, and mergers.
  • Direct comparisons between firms is common. For example, an
    analyst might compare two retail companies, such as Wal Mart and
    target.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q
A

FUNDAMENTAL ANALYSIS –
TOP-DOWN APPROACH

  1. ECONOMY
    1. INDUSTRY
      1. COMPANY
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q
A

ECONOMIC ANALYSIS

  • To conduct a thorough equity analysis, one must understand the
    macroeconomic environment in which all companies operate.
  • Some of the most important economic variables to consider are:
  • Gross Domestic Product
  • Inflation
  • Interest Rates
  • Unemployment
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q
A

Gross Domestic Product (GDP)

  • A measure of the total output of an economy.
  • Total value of goods and services that are produced within a country in a certain period.
  • GDP is calculated in both current (nominal) dollars and real dollars.

REAL GDP Suggests in the future
_______________________________________________________________________
higher than long RUN Higher Interest Rates, Neg. for consumer
average durables, housing and industry

Lower than Long Run Low Interest rates, Positive for consumer
average durables, housing and industry

Recession Defensive industries such as food, alcohol,
tobacco may be appropriate

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

INFLATION

A

INFLATION

  • The inflation rate is the general level of price changes in the
    economy.
  • Inflation has historically averaged 2 to 3 percent per year.
  • The Federal Reserve attempts to keep inflation at a “healthy” low
    level.
  • Consumer Price Index
  • Producer Price Index
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q
A

UNEMPLOYMENT

  • The unemployment rate is the percentage of people in the
    workforce who are seeking but do not have a job.
  • Calculated by dividing the number of persons unemployed by the
    number of persons in the labor force.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

INTEREST RATES

A

INTEREST RATES

  • Interest rates are an important economic variable on many levels.
  • Rates directly influence the present value of future cash flows, thus
    greatly impact the intrinsic value of many investments.
  • Higher interest rates make many investments unattractive.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

MONETARY POLICY

A

MONETARY POLICY

  • Monetary policy represents the intended influence on the money
    supply and interest rates by the Federal Reserve.

The four primary monetary policy TOOLS are:
1. Reserve Requirement
2. Discount Rate / Federal Funds Rate
3. Open Market Operations
4. Excess Reserve Deposits

MONETARY POLICY GOALS
The Federal Reserve has 3 primary goals:
1. Maintain price levels
2. Maintain long-term economic growth
3. Maintain full employment

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

RESERVE REQUIREMENT

A

RESERVE REQUIREMENT

The Federal Reserve
* Requires that banks maintain a certain percentage of their deposits
on hand, in the form of cash known as their reserve requirement.

  • Has the ability to increase or decrease the reserve requirement which directly impacts the money supply and ultimately influences interest rates.

Monetary Policy Reserve Requirement Money Interest
Supply Rates
———————————————————————————————–
TIGHTEN &raquo_space;> increase Decrease Increase

EASE &raquo_space;» Decease Increase Decrease

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

DISCOUNT RATE

A

DISCOUNT RATE

  • The interest rate that the Federal Reserve charges financial
    institutions for short-term loans.
  • It is the overnight rate that banks are charged for funds used to meet their reserve requirement or other liquidity issues.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

OPEN MARKET OPERATIONS

A

OPEN MARKET OPERATIONS

  • Open market operations refers to the buying and selling of U.S.
    Treasury securities by the Federal Reserve.
  • Through open market operations, the Federal Reserve can directly
    influence the money supply and interest rates.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

EXCESS RESERVES

A

EXCESS RESERVES

  • Excess reserves represent the amount of cash or deposits with the
    Federal Reserve in excess of the minimum amount required.
  • The Fed has the ability to increase or decrease the interest rate paid
    on excess reserves to help control the money supply.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

FISCAL POLICY

TAX POLICY

SPENDING

A

FISCAL POLICY

  • the responsibility of Congress
  • uses taxes and government spending
  • attempts to either stimulate or reduce aggregate demand

TAX POLICY
* Congress controls taxes through income tax rates, deductions, and
credits.
* A tax decrease causes aggregate demand to increase.
* A tax increase causes aggregate demand to decrease

SPENDING
* Government spending can directly impact aggregate demand.
* Spending on roads, law enforcement, and national defense, may
result in a positive impact on unemployment.
* Deficit spending: When the U.S. government spends more money
than it collects in taxes. The government borrows money, which
increases the federal deficit.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q
A

BUSINESS CYCLES

Business cycles are very difficult to predict.

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months.

  • Normally visible in real GDP, real income, employment, industrial
    production, and wholesale-retail sales.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

INDUSTRY LIFE CYCLE

A

INDUSTRY LIFE CYCLE

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

PORTER’S FIVE COMPETITIVE FORCES

Michael Porter identified five forces:

A

PORTER’S FIVE COMPETITIVE FORCES

Michael Porter identified five forces:
1. Rivalry Among Present Competitors
2. Threat of New Entrants
3. Threat of Substitute Products
4. Bargaining Power of Buyers
5. Bargaining Power of Suppliers

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

COMPANY ANALYSIS

A

COMPANY ANALYSIS

  • Fundamental or quantitative analysis at the company level is the
    process by which investors analyze corporate financial statements
    and try to determine the value of a particular stock.
  • Financial statements include:
  • Income statement
  • Balance sheet
  • Statement of retained earnings
  • Statement of cash flows
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

SWOT ANALYSIS
SWOT (Strengths and Weaknesses, Opportunities and Threats)

A

SWOT Analysis

SWOT (Strengths and Weaknesses, Opportunities and Threats)
Analysis

  • A strategic planning tool to help assess the operating strength and
    quality of companies.
  • Strengths and weaknesses are internal to a firm.
  • Opportunities and threats are external forces.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

SWOT ANALYSIS: SAMPLE

A

SWOT ANALYSIS: SAMPLE

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

RATIO ANALYSIS

A

RATIO ANALYSIS

  • There are several key things to consider when conducting ratio
    analysis:
  1. An appropriate benchmark is needed for meaningful
    comparison.
  2. A combination of several different ratios should be used to
    assess the financial situation of a company.
  3. Year-end values may not be representative.
  4. Ratios depend on the accounting methods chosen.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

LIQUIDITY RATIOS

A

LIQUIDITY RATIOS ______________________________________

  • Liquidity is defined as a company’s ability to meet its financial
    obligations within the current period.
  • A liquid asset is one that can easily be traded in a market and thus be converted to cash

CURRENT RATIO_________________________________________
* The most important liquidity ratio is the current ratio.
* The current ratio indicates how well current liabilities (obligations) are covered by current assets.

                               Current Assets  Current Ratio =    -------------------------------
                              Current Liabilities
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

QUICK RATIOS

A

QUICK RATIOS

  • Inventories are the least liquid of the firm’s current assets. The quick ratio adjusts for inventories.
                       Current Assets  -   Current Inventory  Quick Ratio = ------------------------------------------------------
                                        Current Liabilities 
    
                     Cash+Short Term Marketable Securities+AcctReceiavable Quick Ratio = -------------------------------------------------------------------------------
                                            Current Liabilities
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

ASSET MANAGEMENT RATIOS
sets.

A

ASSET MANAGEMENT RATIOS

  • Asset management ratios help to determine whether a company is
    generating sufficient sales given its investment in assets.

TURNOVER RATIOS________________________________________
* The total assets turnover ratio measures how effectively a company
uses all its assets to generate sales

                                            Sales  Total Asset Turnover =   -------------------
                                      Total Assets 

The inventory turnover ratio measures the efficiency with which a
firm uses its inventory to generate sales. A low value of this ratio can
indicate that the company is holding too much inventory.

                                                   Cost of Goods Sold  Inventory Turnover Ratio  =    -----------------------------------
                                                    Average Inventory
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q
A

DAYS SALES OUTSTANDING

Days Sales Outstanding Ratio

  • Reflects how long it takes a company on average to collect cash from sales on credit
  • Also referred to as Average Collection Period
                                                    Receivables                    Receivables Days Sales Outstanding =--------------------------------- = -------------------------
                                            Average Sales per Day       nnual Sales / 365
26
Q

FINANCIAL LEVERAGE RATIOS

A

FINANCIAL LEVERAGE RATIOS

Financial Leverage Ratio
* Provide an indication of the long-term solvency of the firm.
* They measure the extent to which the firm is using long-term debt.

Debt Ratio
* The ratio of total debt to total assets
* Includes all current liabilities and long-term debt
* Creditors prefer low debt ratios because it means lower risk.

                        Total Debt  Debt Ratio = ------------------------
                      Total Assets
27
Q
A

PROFITABILITY RATIOS

Gross Profit Margin _____________________________
* Measure the success of the firm at generating profits

                                      Sales   -   Cost of Goods Sold  Gross Profit Margin = ----------------------------------------------
                                                         Sales

PROFIT MARGIN_________________
Profit Margin (or net profit margin)
* Measures the percentage of each sale that results in net income

                             Net Income  Profit Margin = ---------------------------
                               Sales
28
Q
A

ROA AND ROE
* Return on assets is a measure of how effectively the firm’s assets are being used to generate profits

              Net Income  ROA  = ------------------------------
              Total Assets 
  • Return on equity measures the profits earned for each dollar of
    common equity.
                Net Income  ROE =  -------------------------------
             Shareholder Equity 
  • A company’s sustainable growth rate is the maximum growth rate for a company, while maintaining its capital structure.

Growth Rate = ROE x ( 1- Payout Ratio )

29
Q
A

DUPONT FORMULA
The DuPont formula disaggregates ROE into three basic components:
* Profit margin
* Total asset turnover
* Financial leverage

        Net Income        Sales                     Total Assets  ROE = ------------------ x ----------------------x ----------------------
        Sales                   Total Assets           Equity
30
Q

DEGREE OF LEVERAGE

A

DEGREE OF LEVERAGE

Degree of Opening Leverage ( DOL ) _________________

         % change in   EBIT  DOL = ----------------------------
        % change in Sales 

Degree of Financial Leverage ( DFL )__________________

       % change in   EPS DOL = ----------------------------
        % change in EBIT 

Degree of total Leverage ( DTL )______________________

DTL = DOL x DFL

31
Q
A

MARKET VALUE RATIOS

  • Give insight into how the market and other investors perceive a
    company’s risk and future prospects.

PE Ratio
* Expresses how much investors are willing to pay for a dollar of
profits.
Price per Share
PE Ratio = ———————————–
Earnings per Share ( EPS )

32
Q
A

OTHER MARKET VALUE RATIOS

PEG Ratio
* Compares a stock’s PE ratio to the expected growth of that stock’s
earnings per share.

                          PE    Ratio  PEG Ratio = ------------------------------
                Expected EPS Growth
33
Q
A

Price-to-Book Ratio

  • Expresses how much investors in the market are willing to pay for a
    dollar of book value (equity).
                            Share Price  Price to Book = ------------------------------  
                         Book Value per Share 
    
                                           Shareholders Equity  Book Value per Share  = ---------------------------------  
                                            Shares Outstanding
34
Q
A

DIVIDEND POLICY RATIOS

DIVIDEND YIELD
* Dividend yield is a company’s dividends relative to the stock price

                         Dividends per share  Dividend Yield = -------------------------------
                               Share Price 

PAYOUT RATIO
* Payout ratio is the percentage of earnings paid out to the shareholders in the form of dividends.

                          Dividends per Share  Payout Ratio = ----------------------------------
                          Earnings per Share
35
Q

TECHNICAL ANALYSIS

A

TECHNICAL ANALYSIS

  • Technical analysis is another method that may help determine the
    price at which an investor should buy, sell, or hold an individual equity security.
  • Technical analysis largely ignores the fundamentals

MARKET VOLUME
The total number of shares traded each day:
* Based upon supply and demand of securities
* Indicator of investor sentiment
* Provides insight as to the market’s strength or weakness

BREADTH OF THE MARKET
* Measures the number of advancing stocks versus declining stocks
* Technical analysts use this measure to assess the direction of the
market

ADVANCE-DECLINE LINE
* A/D line is a graphical depiction of periodic changes in advancing and declining issues on an exchange.
* Each point on the chart is determined by taking the difference
between the number of advancing and declining stocks

SHORT INTEREST
* Measurement of the total number of shares currently sold short in a particular market
* An increase in short selling may indicate negative sentiment regarding present market conditions.

ODD LOT TRADING
* A trade in any amount that is less than 100 shares, most made by
individual investors
* Sophisticated investors view the average individual investor as being unable to accurately time market trends.

CHARTING
* The Dow Theory premise is that trend behavior signals the end of
both bear and bull markets.
* Primary trends
* Secondary movements
* Ripples

MOVING AVERAGE
* A tool that smooths out minor, short-term variations in price changes
* Is a useful indicator of long-term trends
* Is an arithmetic mean of stock prices
* The prices used in the calculation “move” or shift forward by one day each trading day

36
Q

POINT AND FIGURE CHART

A

POINT AND FIGURE CHART

37
Q

SUPPORT AND RESISTANCE LEVELS

A

SUPPORT AND RESISTANCE LEVELS

Support Levels
* Indicate the floor price below which an asset is not expected to trade Resistance Levels
* Represent a “ceiling” for the stock price trading range

38
Q

A company has 2 million shares of common stock outstanding. Annual sales are $26 million. The net profit margin is 8% and the dividend payout ratio is 40%. Currently the stock trades at $17.68 per share.
What is the P/E ratio of and Dividend yield ?

A 17 and a dividend yield of 3.20%.
B 17 and a dividend yield of 2.35%.
C 16 and a dividend yield of 3.20%.
D 16 and a dividend yield of 2.35%

A

Solution: The correct answer is B.
Net Income
Profit margin = ——————
Sales

OR

Net Income = Sales x Profit margin = 2 mill x .08 = $ 2,080,000

          Net income                   2,080,000  EPS  =  -----------------------------  = ---------------   =   1.04  EPS      
        Shares outstanding         2,000,000  ---------------------------------------------------------------------------------
         Price  PE  = ----------------
         EPS  OR

Stock Price = P/E x EPS

17.68 = P/E x 1.04

        17.68 PE =  -------------  = 17 
         1.04 

                        Div per Share  Payout Ratio = ---------------------   or Div per Share = Payout Ratio X EPS
                             EPS 

Div Yield= Div per share Payout Ratio x EPS
——————– = —————————
Price Price

        .40  x  1.04           .416  so  ---------------------- = -------------- -- =  .0235 = 2.35 %
        $ 17.68                $ 17.68
39
Q

Given a current ratio of 1.25, which of the following transactions will increase the current ratio?

Sell marketable securities to raise cash.

Prepay part of long-term debt.

Pay accounts payable from cash.

Delay payment of accounts payable.

A

Pay accounts payable from cash.

Rationale

The current ratio is equal to current assets divided by current liabilities and indicates a company’s ability to cover current liabilities.

Cash and marketable securities are considered current assets, so a sale of marketable securities for cash would not increase current assets or the current ratio.

Prepaying part of long-term debt would decrease the current ratio.

Delaying payment of accounts payable will not change current cash or current liabilities.

The payment of accounts payable with cash will decrease both balances (current assets and current liabilities), but because the old current ratio exceeds 1.0, the impact will be an increase in the new current ratio.

If current assets = 125,000 and current liabilities = 100,000, the current ratio is 1.25.
Payment of 25,000 in current liabilities reduces cash to 100,000 and liabilities to 75,000.
The new current ratio equals 100,000/75,000 = 1.33.

Though cash and payables decrease by the same amount, the new ratio goes up because it is greater than 1.0. Given a current ratio of less than 1, and the same set of circumstances, the new current ratio would be reduced.

40
Q

Acme Industries manufactures mouse traps in its production facility. It sells its mouse traps for $15 each. Acme’s fixed costs are $540,000. The variable cost for each mouse trap is $1.50.
If Acme sells 70,000 mouse traps, what is its degree of operational leverage?

A

2.3.

Rationale

       % chg in EBIT   (Total unitsx $ /unit) - (Total units x var cost/unit) DOL=---------------------= --------------------------------------------
        % chg in Sales       (the above figure )    - Fixed cost         

             Q(P-V) DOL =   -----------------
            (Q(P-V)-F)  

                     70   (15-1.5)
           ------------------------------- = 2.333
          ( 70  (15-1.5 )   -540 )
41
Q

Arrow Inc. earned $1m in EBIT this year. If it earns $1.2m in EBIT next year and it has 2.0 degree of operating leverage, what is the change in EPS?

A

40%.

Rationale

EBIT x DOL = EPS increase

20% increase in EBIT x 2.0 DOL = 40%: EPS increase

42
Q

CJD Enterprise’s EPS increased from $2.00 last year to $4.00 this year with a 20% increase in sales. If CJD’s degree of operating leverage is 3.0, then

what is CJD’s degree of financial leverage?

A

1.67.

Rationale

EPS increased by 100%.

           % change in EPS ?? DFL =   -----------------------------
            % change EBIT 

          EPS --------------------------------    =   DFL  ( sales increase x DOL )

   100%                      .10 -----------------------   =  -----------   = 1.67 (   20%   x   3.0 )            .06
43
Q

Acme’s sales increase by 20%. Acme has a degree of operating leverage (DOL) of 3.0 and degree of financial leverage of 1.5.

What is the impact of the increase in sales on EPS?

A

Rationale

Operating leverage magnifies EBIT and financial leverage magnifies EPS.
Therefore, if sales increase by 20%, then EPS will increase by 90% (20% x 3.0 x 1.5).

       % change in EPS  <<<<< want to solve for this  DFL = ----------------------      
      % change in EBIT

OR

% change in EPS = % change in EBIT x DFL

  1. What % change in EBIT ?
         % change in EBIT                       EBIT  DOL =-------------------------      or  3 = -----------     = .60 = 60 % 
         % change in sales                 .20 

so

% change in EPS = % change in EBIT x DFL

.60 x 1.5 = .90 = 90%

44
Q

Which statement regarding financial leverage is most accurate?

A

The variation in ROE and EPS is identical to the variation in EBIT if the firm is unleveraged.

The variation in ROE and EPS is always greater than the variation in EBIT if the firm is leveraged.

Financial risk is the additional variation in ROE and EPS arising from the use of debt.

All of the above.

Rationale

All of the statements are correct.

45
Q

A firm with a higher concentration of fixed costs than long-term debt is more likely to be exposed to which of the following risks?

A

Business risk.

Rationale

Business risk refers to the variability in earnings caused by the industry in which the company operates. Variability in income from operations can be caused by volatility in sales and higher than average fixed costs.

Financial risk refers to the variability of returns to stockholders based on the introduction of long-term debt to the capital structure.

Default risk is the risk that the company won’t be able to pay their debt, and systematic risk is market risk (nondiversifiable).

46
Q

Which of the following amplifies EPS?

Degree of operational leverage.
Degree of financial leverage.
Both of the above.
Neither of the above.

A

Both of the above.

Rationale

Both DOL and DFL will amplify EPS.

DOL amplifies EBIT, which then amplifies EPS.

DFL does not amplify EBIT, but amplifies EPS.

47
Q

Prestige has revenue of $50 million with 20% variable costs. It has $20 million of bonds financed at 6% and has fixed costs of $30 million.
What is Prestige’s degree of total leverage?

A

Must solve for DTL = DOL x DFL
__________________________________________________________________

            Sales    -   ( variable cost  )  DOL = ------------------------------------------------
          ( Sales - Variable cost)   - Fixed cost 

             ($50m - (0.2 x $50m))                        40 DOL= ----------------------------------------------=  -------------   = 4
      [($50m - (0.2 x $50m)) -  $30m]          40 - 30 
  (  Sales - variable cost ) -  Fixed cost  \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

EBIT = ( Sales - Var cost ) - Fixed Cost

EBIT = $50m - $10m VC - $30m FC = $10m
___________________________________________________________________

                        EBIT DFL  = ----------------------------------------
             EBIT  -  interest Expense

Interest = $20 million x 6% = $1.2 million

                    EBIT                                        $10mill DFL =----------------------------------  =     ----------------------------------       = 1.136
                  (EBIT – I)                      ($10 million - $1.2 million)  

__________________________________________________________________
DTL = DOL x DFL = 4 x 1.136 = 4.545

48
Q

Use the information below to answer this question.

ABC Corporation
Selected Financial Statement Information for the Year Ended December 31 (In millions except per share data)

BALANCE SHEET
20x1 (Beginning) 20x1 (Endings)
Assets
Cash 360 380
Marketable Securities 300 100
Receivables 1,100 130
Inventories 600 910
Other 1,900 660
Total Current Assets 4,260 2,180
Property, Plant & Equipment 5,230 3,400
Other Assets 2,300 1,000
Total Assets $11,790 $6,580

Liabilities and Shareholder’s Equity
Accounts Payable 2,800 1,300
Long-Term Debt 2,400 900
Other Liabilities 1,500 1,400
Total Liabilities 6,700 3,600
8% Preferred Stock 500 500
Common Stock 2,000 1,800
Retained Earnings 2,590 680
Total Liabilities & Shareholder’s Equity $11,790 $6,580

Which of the following is the quick ratio for ABC Corporation (for this question, assume that the “other” current assets are additional inventory)?

A

Use the information below to answer this question.

ABC Corporation
Selected Financial Statement Information for the Year Ended December 31 (In millions except per share data)

BALANCE SHEET
20x1 (Beginning) 20x1 (Endings)
Assets
Cash 360 380
Marketable Securities 300 100
Receivables 1,100 130
Inventories 600 910
Other 1,900 660
Total Current Assets 4,260 2,180
Property, Plant & Equipment 5,230 3,400
Other Assets 2,300 1,000
Total Assets $11,790 $6,580

Liabilities and Shareholder’s Equity
Accounts Payable 2,800 1,300
Long-Term Debt 2,400 900
Other Liabilities 1,500 1,400
Total Liabilities 6,700 3,600
8% Preferred Stock 500 500
Common Stock 2,000 1,800
Retained Earnings 2,590 680
Total Liabilities & Shareholder’s Equity $11,790 $6,580

Which of the following is the quick ratio for ABC Corporation (for this question, assume that the “other” current assets are additional inventory)?

0.47.
Rationale
Cash + Marketable Securities + Accts Receivable
Quick Ratio= ————————————————————————
Current Liabilities

380 cash + 100 marketable + 130 receivables
—————————————————————————– = .4692
1300 ( only use Accounts Payable )

49
Q

Which of the following best describes the usefulness of the Dow theory in technical analysis?

A

It determines the end of a bull or bear market.
Rationale

According to the Dow Theory once a primary trend is established asset prices tend to move in that direction. The primary trend will be supported by the same directional movement in both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA). The primary trend will continue until the trend is reversed, as evidenced by both the DJIA and the DJTA.

50
Q

A firm has operating leverage if it uses which of the following?

A

Fixed costs.

Rationale

Operating leverage comes from low variable costs.

Once fixed costs are covered,
increases in sales drop to the bottom line.

51
Q

Walt Co.’s EBIT increases by 20%. If Walt Co. has a degree of financial leverage (DFL) of 2.5,

what is the expected change in earnings per share (EPS)?

A

EBIT increase is 20 %

DFL = 2.5

What is the expected change in earnings per share (EPS) ?

       % change in EPS  DFL = -----------------------    OR    % change in EPS = DFL x % change EBIT
       % change in EBIT 

So

EPS = DFL x % change EBIT

        2.5    x   20 %  =  50 %
52
Q

Use the information below to answer this question.

ABC Corporation
Selected Financial Statement Information for the Year Ended December 31 (In millions except per share data)

BALANCE SHEET
20x1 (Beginning) 20x1 (Endings)
Assets
Cash 360 380
Marketable Securities 300 100
Receivables 1,100 130
Inventories 600 910
Other 1,900 660
Total Current Assets 4,260 2,180
Property, Plant & Equipment 5,230 3,400
Other Assets 2,300 1,000
Total Assets $11,790 $6,580

Liabilities and Shareholder’s Equity
Accounts Payable 2,800 1,300
Long-Term Debt 2,400 900
Other Liabilities 1,500 1,400
Total Liabilities 6,700 3,600
8% Preferred Stock 500 500
Common Stock 2,000 1,800
Retained Earnings 2,590 680
Total Liabilities & Shareholder’s Equity $11,790 $6,580

The debt to equity ratio is closest to:

A

The debt to equity ratio is closest to: 1.21

Rationale

Total Debt 3600
—————– = —————– = 1.21
Total Assets 2,980

53
Q

Which firm has high operating leverage? One with:

High fixed costs and low variable cost.

High fixed cost and high variable cost.

Low fixed cost and low variable cost.

Low fixed cost and high variable cos

A

HIGH fixed cost & LOW variable cost.

Rationale

Operating leverage occurs with high fixed costs and low variable costs. Once breakeven has occurred, the majority of sales increases will also increase net income if the firm has low variable costs.

54
Q

Acme Industries manufactures mouse traps in its production facility. It sells mouse traps for $15 each. Acme’s fixed costs are $540,000. The variable cost for each mouse trap is $1.50.
How many units must Acme sell to break even?

A

40,000.

Rationale

  $540,000   --------------------------  =   40,000   ($15.00  - $1.50)  

   Total Cost  -------------------------------- ( total cost - variable cost )
55
Q
A

TEST

  • Purpose of financial ratios

− Insight into past performance
− Allows for comparison across firms
− Allows for comparison of firms with industry averages

  • Calculate
    − EPS
    − PE Ratio
    − Stock Price using PE
    − Relative PE ratio
    − PEG
  • Usefulness and meaning
56
Q
A

TEST

  • Ratio analysis is the study of the relationships between financial
    statement accounts, and it provides a historical perspective.
  • May infer future performance based on historical perspective.
  • Understanding key ratios allow investor to better understand
    the connection between different elements of financial
    performance.
57
Q
A

TEST

  • Dividend per Share = Annual Dividend / # of Common Shares
    Outstanding
  • Payout Ratio = Dividend per Share / Earnings per Share
  • g (growth rate)

− one method of estimating the firm’s growth rate is:

            g = b x ROE

b = retention rate ( which is 1 – dividend payout ratio )
ROE = return on equity

58
Q

Examples of monetary policy would most likely exclude:

A

Lending at the prime rate of interest.
Rationale

The Federal Reserve Board operates in the open market, can change both the discount rate and excess reserve, but has no direct control over the prime lending rate.

59
Q

During a period of recession/contraction, which of the following would be true?

The supply of goods and services would increase.

Interest rates would increase.

Unemployment rates would decrease.

Inflation would decrease.

A

Inflation would decrease.

Rationale

During a recession/contraction, there is a decline in demand. GDP is decreasing, inflation is decreasing, and unemployment is increasing. Since demand is decreasing, the supply of goods and services will also be decreasing. To stimulate economic growth, the money supply will likely increase, causing interest rates to decline.

60
Q

Which firm has high operating leverage? One with:

High fixed costs and low variable cost.

High fixed cost and high variable cost.

Low fixed cost and low variable cost.

Low fixed cost and high variable cost.

A

High fixed costs and low variable cost.

61
Q

Mardt’s, Inc. just announced that they will be paying a $1.80 per share as an annual dividend next year and that the dividends will then be increasing by 2.5% annually thereafter. The common stock of Mardt’s is currently selling at $18.95 a share. What is the dividend yield on this stock?

A

Solution: The correct answer is B.

DY = Dividend ÷ Stock Price = 1.80 ÷ 18.95 = .0949