Exam 1
FSA3321 (Moore)-1
Spring 2008
Exam 1 – Spring 2008
Finance 3321 – Moore
Section (Time):_____________________
Name:______________________
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Student’s Signature:
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Clearly Circle the BEST response for each of the following questions (3 Points Each):
1. According to classical financial theory, the objective of the firm’s management should be:
a. Maximize the book value of assets
b. Minimize the market value of liabilities
c. Maximize revenues
d. Minimize expenses
e. Maximize shareholder wealth
2. Which of the following organizational forms continues to exist when one or more of the
owners of the firm ceases to exist (e.g. die)?
a. Sole Proprietorships
b. General Partnerships
c. Corporations
d. Joint Ventures
e. Special purpose entities with contractual guarantees
3. Which one of the following is considered to be the second step of a structured business
valuation analysis?
a. Accounting Analysis
b. Financial Analysis
c. Forecasting Future Financial Performance
d. Estimating the value of the business (firm)
e. Business Strategy Analysis
4. Which one of the following is considered to be the last step of a structured business
valuation analysis?
a. Accounting Analysis
b. Financial Analysis
c. Forecasting Future Financial Performance
d. Estimating the value of the business (firm)
e. Business Strategy Analysis
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Exam 1
FSA3321 (Moore)-1
Spring 2008
5. Market failure and the value of information, within the context of the insurance industry,
has been examined. Assume PG is the fair insurance price for Good drivers and PB is the
fair insurance price for Bad drivers, where PG < PB and 40% of the drivers are Good
drivers. If insurers do not have a mechanism to distinguish good and bad drivers, what
price will result in the mandatory insurance market?
a. PG
b. PB
c. (PG + PB )/2
d. (.4PG + .6PB )
6. The market failure described in Question 5 (above) results from:
a. Efficient market hypothesis (semi-strong form)
b. Efficient market hypothesis (weak form)
c. The Modigliani and Miller Theorem
d. Information Asymmetry
e. The Capital Asset Pricing Model
7. Which of the following IS NOT an accounting strategy choice for the firm? (Figure 1-2)
a. Accounting Policies
b. Contracting and Governance
c. Accounting Estimates
d. Reporting Format
e. Supplementary Disclosure
8. Which one of the following is an element of the Business Environment (Fig 1-2):
a. Competitive Positioning
b. Operating Activities
c. Product Markets
d. Third-Party Auditors
e. Reporting the economic consequences of business activities
9. Which one of the following business analysis tools involves the use of models to assign a
fair price to the item being analyzed?
a. Business strategy analysis
b. Prospective analysis
c. Accounting analysis
d. Financial analysis
e. Valuation
10. Which of the following is correct regarding accrual accounting?
a. Accrual accounting is the information basis of inputs for most classical finance models
b. Accrual accounting attempts to measure the period in which cash flows occur
c. Accrual accounting attempts to measure economic activities in the period exchange
transactions take place, regardless of when cash flows transpire.
d. Accrual accounting forces land acquisitions to be recorded at historical cost.
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Exam 1
11.
a.
b.
c.
d.
e.
FSA3321 (Moore)-1
Spring 2008
Which of the following is correct?
Conservative accounting choices are mandated by republicans
Aggressive accounting policies (choices) lead to lower earnings and higher assets
The independent auditor’s opinion and statement on the 10-K guarantee the
information contained in the financial reports are correct.
The information contained in financial reports reflect “people-made” numbers and
choices that may contain material errors and biases.
The information contained in audited financial reports are unquestioned facts because
GAAP and the SEC required perfect information to be contained in 10-K’s.
12. What is the third step of a structured accounting analysis (per text)
a. Identify potential “red flags”
b. Assess the degree of potential accounting flexibility
c. Evaluate the actual accounting strategy
d. Undo accounting distortions
e. Identify key accounting policies
13. What is the fifth step of a structured accounting analysis (per text)
a. Identify potential “red flags”
b. Assess the degree of potential accounting flexibility
c. Evaluate the actual accounting strategy
d. Undo accounting distortions
e. Identify key accounting policies
14. The fact that a regulator would use a different set of information to analyze a firm than
would an equity analyst is a result of:
a. Managers’ superior information on business activities
b. Noise from estimation errors
c. Business strategy analysis
d. Business application context
e. Financial Analysis
15. Which of the following would lead to the lowest degree of price competition?
a. Low Product differentiation
b. Low industry growth rates
c. High barriers to exit industry
d. High threat of new entrants to the industry
e. Low industry-wide fixed/variable cost ratios
16. An industry displaying a mixture of price competition and product differentiation would be
characterized by:
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, Low Investment in R&D, High Excess Capacity
d. High Concentration, Low Fixed-Variable Cost Ratio, High Differentiation
e. Supply > Demand, High Investment in R&D, Steep Industry Learning Curves
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Exam 1
FSA3321 (Moore)-1
Spring 2008
17. Which of the following would lead to the lowest degree of industry price competition?
a. Low Industry Concentration, Low Legal Barriers to Entry, Low Product Differentiation
b. Few Exit Barriers, Low First mover advantage, High Product Differentiation
c. Low Industry Concentration, Low Distribution Access, Low Customer Switching Costs
d. High Industry Concentration, Low Fixed-Variable Cost Ratio, Low Customer Switching
Costs
e. Supply < Demand, High Legal Barriers to Entry, Steep Industry Learning Curves
18. Which of the following strategies would lead to pure cost leadership or pure product
differentiation strategies?
a. Economies of scale and scope, high R&D investment, tight cost control
b. Superior product variety, lower input costs, High investment in R&D
c. Lower input costs, flexible distribution, low investment in R&D
d. Low investment in brand image, Low investment in R&D, Focus on Cost Control
e. Simpler product designs, Tight cost control, superior product quality
19. Determining whether the firm currently has the resources and capabilities to deal with the
identified key success factors is an example of which?
a. Competitive Strategy Analysis
b. Differentiation Analysis
c. Analysis of the Degree of Actual and Potential Competition
d. Analysis of the Threat of Substitute Products
e. Analysis of the Bargaining Power in Input and Output Markets
20. WalMart’s inability to dictate price & delivery terms to cutomers is an example of:
a. Bargaining power WalMart over Customers
b. Bargaining power of Customers over WalMart
c. Bargaining power of Suppliers over WalMart
d. Bargaining power of WalMart over Suppliers
21. The main purpose of a firm’s financial reports is to:
a. Present Assets, Liabilities and Equity
b. Present Revenues and Expenses
c. Present Operating, Investing and Financing Cash Flows
d. Provide equity investors a means of determining the market value of the firm
e. Credibly communicate economic consequences of business activities.
22. Which of the following components of the annual financial report is not audited:
a. Balance Sheet
b. Income Statement
c. Management discussion and Analysis
d. Statement of Cash Flows
e. Statement of Owners Equity
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Exam 1
FSA3321 (Moore)-1
Spring 2008
23. An example of conservatism in accounting that can lead to understating the perceived
value of assets is:
a. Recording physical assets at historical cost
b. Capitalizing goodwill
c. Incorporating comprehensive income adjustments in shareholder equity
d. Marking financial assets to current market value
e. Marking physical assets to current market value
24. Target Company has a pre-acquisition balance sheet with the following values: Assets =
$25,000; Liabilities = $15,000 and Equity = $10,000. Acquirer Company buys Target for
$35,000 and revalues assets at $20,000 and liabilities at $14,000. The amount of Goodwill
that Acquirer will recognize on its balance sheet resulting from the acquisition is:
a. $25,000
b. $21,000
c. $14,000
d. $9,000
e. none of the above
Use the following information for Problems 25 and 26
ABC Company was established in 2006 and sells product warranty contracts on household
appliances. These product service contracts last for 4 years. On January 1, 2006, ABC sold
$16,000,000 of service contracts. All $16,000,000 were credited to revenue for 2003. In 2007,
the auditor caught the error in accounting and forced ABC to adjust its accounts to reflect
service contract liabilities. Assume a tax rate of 30%.
25. The adjustment to 2006 revenues would be:
a. Increase revenues $16,000,000
b. Decrease revenues $16,000,000
c. Decrease revenues $12,000,000
d. Decrease revenues $4,000,000
26. The long term portion of unearned service contract revenues, at the end of 2007, would be
(assume no further sales contracts during 2007)?
a. $4,000,000
b. $8,000,000
c. $12,000,000
d. $16,000,000
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Exam 1
FSA3321 (Moore)-1
Spring 2008
Use the following information for Problems 27 through 30
ABC Company is a startup company in an industry that exclusively uses capital leases for it’s
expensive highway construction equipment. ABC, however, used operating lease accounting
in its first year of operations. Assume the average lifespan of ABC’s leased equipment is 25
years and that their annual cost of debt is 8.08%. The annual lease payments are
$5,000,000. The present value of the future lease payments is $53,000,000 (rounded). ABC’s
industry commonly uses straight-line depreciation and the effective tax rate is 35%.
27. Adjust ABC’s books to reflect the lease as being capitalized. Adjusting for the initial
recognition of the capital lease would have the following impact on the balance sheet
(Asset and Liability Accounts) in terms of debits and credits
a. Debit Lease Liabilities for $125,000,000 and Credit Leased Assets for $125,000,000
b. Debit Leased Assets for $80,000,000 and Credit Lease Liabilities for $80,000,000
c. Debit Leased Assets for $53,000,000 and Credit Lease Liabilities for $53,000,000
d. Debit Leased Assets for $125,000,000 and Credit Lease Liabilities for $125,000,000
e. Debit Lease Liabilities for $53,000,000 and Credit Leased Assets for $53,000,000
28. Adjust ABC’s books to reflect the lease as being capitalized.
liabilities after the second payment is:
a. $717,600
b. $775,582
c. $838,249
d. $4,224,418
e. $4,282,400
29. Adjust ABC’s books to reflect the lease as being capitalized.
charge for interest expense in the third year.
a. $5,000,000
b. $4,282,400
c. $4,224,418
d. $4,161,751
e. $4,094,020
The reduction in lease
Compute the appropriate
30. Compute the overall effect on Net Income in the first year for ABC (had the lease been
capitalized) would be (relative to the reported Net Income, net of tax).
a. $6,402,400 Lower
b. $1,402,400 Higher
c. $1,402,400 Lower
d. $911,560 Lower
e. $490,840 Lower
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Exam 1
FSA3321 (Moore)-1
Spring 2008
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)
Assets
1
The company capitalized 50% of
advertising costs
2
The company used too large a
discount rate to estimate the present
value of future service costs on a
defined benefit pension plan
3
The company took a "big bath" when
impairing goodwill
4
The initial impact of using an
operating lease when capital lease
recognition is appropriate
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Liabilities
Equity
Revenues
Expenses
Net Income