Which of the following statement is incorrect about Z-SCORE?
A The Z-score indicate the relative likelihood of firm not going to bankrupt
B The higher of Z score means the firm is less likely to go bankrupt
C The weights are calculated to maximize the difference in Z scores within bankrupt or non-bankrupt groups
D The weights are calculated to maximize the difference in Z score between groups
Which of the following statement is correct?
A The capital assets pricing model states that the only diversifiable risk that has to borne is the risk in the market as a whole
B All statements are correct
C The capital assets pricing model requires estimate beta which can be accurately done by running regression analysis
D Fundamental risk is the risk that an investor bears as a result of the way a firm conducts its activities
E All statements are incorrect
F Profit risk is the risk of profit margins changing for a given level of total assets
Return on common equity (ROCE)
Which of the following statement is Incorrect?
A As residual earnings is driven by return on common equity (ROCE) and growth in equity, a growth firm is one that can increase ROCE and/or grow investment that is expected to earn at a ROCE that is greater that the equity cost of capital.
- all statements are incorrect
- a growth firm is one that is expected to grow residual earnings
- Abnormal earnings growth is the same as growth in residual earnings, so it doesn’t matter
- as changes in residual earnings are equal to abnormal earnings growth, a growth firm can also be defined as one that can generate abnormal earnings growth, that is, earnings growth (cum-dividend) at a rate equal to the required rate
Which of the following statement is correct”?
A If firms issue debt to finance the growth or liquidate financial assets no growth in equity occurs.
B A trailing P/E can be high because current earning is temporarily low even though expected indicate the P/E should otherwise be low
C All statements are correct
D A firm with a high p/e and a low P/B is one where residual earning are expected to increase from the current level but are expected to be lower than zero
ReOI growth is driven by
- Increase in asset turnovers (so NOA increases but sales increase more than NOA)
- increase in accounts payable
- decrease in operating profit margins
- decrease in sales
Which of the following statement about ROCE is incorrect?
- A share repurchase increase ROCE
- ROCE increase as RNOA decreases
- a change in ROCE does not create value for shareholders – unless the repurchase is at a price that is than fair value
- ROCE and residual earnings are indeed affected by a change financial leverage
- all statements are incorrect.
Which of the following statement is incorrect?
- Free cash flow is reduced by investments, yet investment (typically) add value
- Free cash flow is a liquidation concept, not a value-added concept
- All statements are incorrect
- A highly profitable (and highly valuable) firm can have low (or even negative) free cash flows because it is investing heavily to capitalize on its investment opportunities.
- Free cash flow does incorporate accrual aspects of value added.
Which of the following statement is correct?
- EPS are higher with a stock repurchase that with a dividend
- In a stock repurchase, total equity value drops by the amount of the share repurchase, as with the dividend
- Dividends reduce the price of a firm (and the per-share price)
- All statements are incorrect
- all statements are correct
The deferred tax liability from depression (reported in the deferred tax footnote) can increase because?
- Both statements are not true
b Both statements are true
c There is a large increase in capital expenditures producing more depreciation and a greater difference between book and tax depreciation
d The firm increases its estimate of useful lives for depreciation expense on the book, thus decreasing depreciation expense and increasing the difference between book and tax depreciation
Which of the following statements is correct?
A The obligations of the special purpose entity are not on the balance sheet because the firm does not have a large enough stake in the entity to consolidate
B Of balance sheet financing is incurring obligations that do not appear on the balance sheet
C A default premium is the extra required return that a lender demands to compensate for risk that the borrower will default
D A moral hazard problem arises for a lender if the borrower has an incentive to act in a way that makes the debt more risky
E All statements are correct
F All statements are incorrect
An insurance company reported the following balance sheet at year end for 2009 (all amounts are in millions of dollars)
Insurance assets 300
Liabilities and equity
Insurance claims 700
Unearned premiums 140
Long-term debt 150
Investments are available-for-sale securities marked to market.
The company reported the following income statement for 2010
Premium revenue 365
Investment income 60
Realized gains on investments 80
Total revenue 505
Insurance losses and expenses 405
Net income 100
In addition, the company reported $65 million in unrealized losses on investments as part of other comprehensive income in its equity statement
Ignore taxes in answering the following question:
- What was the rate of return earned on investments for 2010?
- Calculate net operating assets in the insurance underwriting part of the business at the end of 2009.
- Calculate both the earnings and residual earnings from the insurance underwriting part of the business for 2010. Use a required return rate of 9% for this calculation
Below are financial statements for a firm that paid a net $16 million to shareholders in 2010. Supply the missing numbers (indicated by the capital letters) in the financial statements. Make sure to show how you got to the numbers.
Balance sheet, end of 2010
Balance Sheet, End of 2010
(In Million Dollars)
2010 2009 2010 2009
Operating Assets A 400 Operating Liabilities 200 150
Financial Assets 300 B Financial Obligations F E
Shareholders’ Equity D 180
Total 900 C Total G 830
Income Statement, 2010
Operating income after tax H
Net Financial expense, after tax 4
Comprehensive income 36
- Calculate free cash flow for 2010
- Calculate the cash flow with respect to net financial obligations
- D. Calculate return on common equity ROCE and return of net operating assets RNOA
for 2010 on beginning of year denominators.
- Show that ROCE and RNOA reconcile according to the financing leverage equation.
Berkshire Hathaway’s 13-F filling for the third quarter of 2010 reported that warren Buffett had reduced his stake in Nike, Inc. by $224 million, bringing his holding to 7.62percent of the 480 million outstanding shares. Nike reported a core return on net operating assets (RNOA) of 32.7 percent in its annual report for the year ended May, 2010. A summary of its balance sheet at fiscal-year end follows:
Net operating assets $5,318 million
Net financial assets 4, 436
Common equity $9754 million
In mid-July, at the time that the annual report was published, Nike’s shares traded at $68 each. By the end of September, the price had risen to $81.
Calculate the expected return from buying at the market price in mid-July with a forecast that Nike can grow residual operating income at 4 percent per year. Now make the same calculation for the September price. Do you see why Buffett may have sold?
The following numbers come from an equity statement for fiscal year 2011 (in millions)
Shareholder’s equity May 31, 2010 $2,700
Issue of shares for exercise of stock options 405
Repurchase of shares (132)
Net income 467
Unrealized loss on debt securities (23)
Tax benefit from the exercise of stock options 70
Common dividends paid (250)
Preferred dividends paid (10)
Shareholder’s equity May 31, 2011 3,227
The firm’s tax rate is 35%. Shareholder’s equity at May 31, 2011 includes $120million in preferred stock.
- Calculate the loss to common shareholders from the exercise of stock options.
- Present a reformulated statement of common shareholders equity that identifies comprehensive income and separates it from net payout to shareholders.
- What was the return on common equity (ROCE) for the year? (Use beginning equity in this calculation)
At the end of its June 30, 2008 fiscal year. Microsoft Corporation reported $23.7 billion in short-term interests bearing investments and cash equivalents. The firm had no debt obligations. In September, the firm announced a $40 billion stock repurchase and its intention to raise the annual dividend to 52 cents a share, from 44 cents or to a total of $4.7 billion.
Cash flow operation for fiscal year 2009 was projected to be $23.4 billion, up from $21.6 billion for 2008, interest receipts were expected to be $702 million, and the firm was expected to maintain cash investments at the 2008 level of $ 3.2 billion. Cash receipts from the issue of shares to employees were expected to be $2.5 billion. The firm’s tax rate is 36 percent.
- By applying the treasure’s rule, lay out the strategy for Microsoft’s treasurer for managing cash flows.
- At that time of share repurchase announcement, Microsoft’s shares were trading at $25 each, a two-year low. Why might Microsoft choose this moment to repurchase shares?
c.For many years, Microsoft has carried no debt (obligations). At the time of the share repurchase announcement. Microsoft also said that it had received authorization from its board of directions for debt financing up to $ 6billion. Why would the management seek such authorization at this stage?