Clean surplus accounting for most common stock transactions holds for shares accounted for at market value. An exception to this is:

Question 1

1. All of the following are steps in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value except:

a. Analyze the firm’s strategy in terms of the competition.
b. Assess the quality of the firm’s accounting and financial reporting.
c. Derive forecasts of future earnings from the firm’s projected financial statements.
d. Obtain the national ranking of the firm’s external auditors.

1.2 points   

Question 2

1. Clean surplus accounting for most common stock transactions holds for shares accounted for at market value. An exception to this is:

a. issuance of common equity shares for employee stock options exercises
b. repurchase of common shares
c. issuance of common shares to new shareholders in public exchanges
d. none of these.

1.2 points   

Question 3

1. Which of the following is not a problem with using a dividend-based valuation formula

a. some firms do not pay a regular periodic dividend
b. dividends represent a transfer of wealth to shareholders
c. dividends are arbitrarily established
d. it is a challenge to forecast the final liquidating dividend

1.2 points   

Question 4

1. Which of the following would likely be the most useful when valuing a dot.com company?

a. Price-earnings
b. Net asset value
c. Dividend yield
d. Discounted cash flow

1.2 points   

Question 5

1. In theory, all three valuation models, when correctly implemented with internally consistent assumptions, will produce the same estimates of value.  However, in practice, which of the following errors can result in different value estimates?

a. incomplete or inconsistent earnings and cash flow forecasts.
b. inconsistent estimates of weighted average costs of capital.
c. incorrect continuing value computations.
d. All of these errors result in different value estimates.

1.2 points   

Question 6

1. At the beginning of 2012 investors had invested $25,000 of common equity in Grant Corp.and expect to earn a return of 11% per year. In addition, investors expect Grant Corp. to pay out 100% of income in dividends each year. Forecasts of Grant’s net income are as follows:             2012 – $3,500             2013 – $3,200             2014 – $2,900             2015 and beyond – $2,750 Using this information what is Grant’s residual income valuation at the beginning of 2012?

a. $26,151
b. $26,041
c. $25,000
d. $26,350

1.2 points   

Question 7

1. In some industries, competitive dynamics eventually drive long-run projections of the future returns earned by the firm to an equilibrium level equal to the long-run expected cost of equity capital in the firm. At that point, a firm can be expected to earn ____________ residual income in the future.

a. decreasing.
b. increasing.
c. zero.
d. There is not enough information to answer this question.

1.2 points   

Question 8

1. Early in a period in which sales were increasing at a modest rate and plan expansion and start-up costs were occurring at a rapid rate, a successful business would likely experience

a. Increased profits and no change in financing requirements.
b. Decreased profits and increased financing requirements because of an increasing cash shortage.
c. Decreased profits and decreased financing requirements because of an increasing cash surplus.
d. Increased profits and increased financing requirements because of an increasing cash shortage.

1.2 points   

Question 9

1. If an analyst expects a firm to generate net income each period exactly equal to required earnings, then the value of the firm will be

a. less than the book value of common shareholders’ equity.
b. greater than the book value of common shareholders’ equity.
c. exactly equal to the book value of common shareholders’ equity.
d. exactly equal to working capital.

1.2 points   

Question 10

1. Zonk Corp. The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):

Total assets $6,840
Interest-bearing debt $3,562
Average pre-tax borrowing cost 11.5%
Common equity:  
     Book value $2,560
     Market value $12,850
Income tax rate 35%
Market equity beta 1.24

2. Using the above information, calculate Zonk’s weighted-average cost of capital:

a. 11.89%
b. 10.90%
c. 11.5%
d. 7.48%

1.2 points   

Question 11

1. Residual income is

a. the difference between the net income the analyst expects the firm to generate and the required earnings of the firm.
b. adjusted net income the firm reports.
c. the difference between the net income the analyst expects the firm to generate and the reported earnings of the firm.
d. the book value of common equity capital at the beginning of the period multiplied by the required rate of return on common equity capital.

1.2 points   

Question 12

1. Jarrett Corp. At the end of 2010 Jarrett Corp. developed the following forecasts of net income:

  Forecasted
Year Net Income
2011 $20,856
2012 $22,733
2013 $24,552
2014 $27,252
2015 $29,978

2. Management believes that after 2015 Jarrett will grow at a rate of 7% each year. Total common shareholders’ was $112,768 on December 31, 2010. Jarrett has notestablished a dividend and does not plan to paying dividends during 2011 to 2015. Its cost of equity capital is 12%. What would be Jarrett’s common shareholders’ equity at the end of 2014?

a. $95,540
b. $180,909
c. $208,161
d. $112,768

1.2 points   

Question 13

1. At the beginning of 2012 investors had invested $125,000 of common equity in Jan Corp.and expect to earn a return of 15% per year. In addition, investors expect Jan Corp. to pay out 100% of income in dividends each year. Forecasts of Jan’s net income are as follows:             2012 – $41,000             2013 – $35,400             2014 – $33,200             2015 and beyond – $25,000 Using this information what is Jan’s residual income valuation at the beginning of 2012?

a. $190,262
b. $260,415
c. $184,600
d. $125,000

1.2 points   

Question 14

1. Equity valuation models based on dividends, cash flows, and earnings have been the topic of many theoretical and empirical research studies in recent years. All of the following are true regarding these studies except:

a. temporary deviations of price from value occur
b. unexpected changes in earnings, dividends, and cash flows do not correlate closely with changes in stock prices
c. share prices in the capital markets generally correlate closely with share value
d. share prices do not always equal share values

1.2 points   

Question 15

1. Zonk Corp. The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):

Total assets $6,840
Interest-bearing debt $3,562
Average pre-tax borrowing cost 11.5%
Common equity:  
     Book value $2,560
     Market value $12,850
Income tax rate 35%
Market equity beta 1.24

2. Determine the weight on debt capital that should be used to calculate Zonk’s weighted-average cost of capital:

a. 78.3%
b. 58.2%
c. 50%
d. 21.7%

1.2 points   

Question 16

1. Assume that a firm’s book value at the beginning of the year is $17,800 and that the firm reports net income of $6,200. If the firm’s book value at the end of the year is $20,000 what was the amount of dividends paid during the year?

a. $4,000
b. $8,800
c. Insufficient information to determine
d. $2,200

1.2 points   

Question 17

1. Dirty surplus items in U.S. GAAP typically arise from all of the following except:

a. realized gains
b. interest rates
c. foreign currency exchange rates
d. changes in investment security fair values

1.2 points   

Question 18

1. Firm-specific factors that increase the firm’s nondiversifiable risk include all of the following except:

a. exposure to interest rate changes
b. exposure to management competence
c. exposure to cyclicality
d. exposure to inflation

1.2 points   

Question 19

1. Assume that a firm had shareholders’ equity on the balance sheet at a book value of $1,600 at the end of 2010. During 2011 the firm earns net income of $1,300, pays dividends to shareholders of $600, and uses $300 to repurchase common shares. The book value of shareholders equity at the end of 2011 is:

a. $2,600
b. $3,800
c. $400
d. $2,000

1.2 points   

Question 20

1. Under the cash-flow-based valuation approach, free cash flows can be used instead of dividends as the expected future payoffs to the investor in the numerator of the general valuation model because:

a. over the life of the firm, the free cash flows out of the firm for investments and cash flows paid into the firm in dividends from these investments will be equivalent.
b. this approach focuses on wealth distribution to shareholders.
c. this approach focuses on earnings as a measure of the capital that a firm creates.
d. over the life of the firm, the free cash flows into the firm and cash flows paid out of the firm in dividends to shareholders will be equivalent.

1.2 points   

Question 21

1. Jarrett Corp. At the end of 2010 Jarrett Corp. developed the following forecasts of net income:

  Forecasted
Year Net Income
2011 $20,856
2012 $22,733
2013 $24,552
2014 $27,252
2015 $29,978

2. Management believes that after 2015 Jarrett will grow at a rate of 7% each year. Total common shareholders’ was $112,768 on December 31, 2010. Jarrett has notestablished a dividend and does not plan to paying dividends during 2011 to 2015. Its cost of equity capital is 12%. Compute the value of Jarrett Corp. on January 1, 2011, using the residual income valuation model. Use the half-year adjustment.

a. $112,768
b. $185,329
c. $195,540
d. $133,624

1.2 points   

Question 22

1. One rationale for using expected dividends in valuation is

a. Dividends are paid in cash, and cash serves as a measurable common denominator for comparing the future benefits of alternative investment opportunities.
b. Dividend payout ratios are set based on profitability.
c. Dividends are a necessary payment in order for a firm to have value.
d. Dividends are the most reliable measure of value because most companies payout dividends to shareholders.

1.2 points   

Question 23

1. Zonk Corp. The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions):

Total assets $6,840
Interest-bearing debt $3,562
Average pre-tax borrowing cost 11.5%
Common equity:  
     Book value $2,560
     Market value $12,850
Income tax rate 35%
Market equity beta 1.24

2. Assuming that riskless rate is 4.2% and the market premium is 6.2% calculate Zonk’s cost of equity capital:

a. 10.4%
b. 2.0%
c. 11.89%
d. 7.69%

1.2 points   

Question 24

1. Required earnings are the

a. net income the analyst expects the firm to generate multiplied by the required rate of return on common equity capital.
b. the market value of common equity capital at the beginning of the period multiplied by the required rate of return on common equity capital.
c. the book value of common equity capital at the beginning of the period multiplied by the required rate of return on common equity capital.
d. adjusted net income multiplied by the required rate of return on common equity capital.

1.2 points   

Question 25

1. Jarrett Corp. At the end of 2010 Jarrett Corp. developed the following forecasts of net income:

  Forecasted
Year Net Income
2011 $20,856
2012 $22,733
2013 $24,552
2014 $27,252
2015 $29,978

2. Management believes that after 2015 Jarrett will grow at a rate of 7% each year. Total common shareholders’ was $112,768 on December 31, 2010. Jarrett has notestablished a dividend and does not plan to paying dividends during 2011 to 2015. Its cost of equity capital is 12%. What would be Jarrett’s residual income in 2013?

a. $5,200
b. $5,789
c. $24,552
d. $18,763
 

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