Exam 1
FSA3321 (Moore)-1
Fall 2008
Exam 1 – Fall 2008
Finance 3321 – Moore
Section (Time):_____________________
Name:______________________
Ethical conduct is an important component of any profession. The Texas Tech University Code
of Student Conduct is in force during this exam. Students providing or accepting unauthorized
assistance will be assigned a score of zero (0) for this piece of assessment. Using
unauthorized materials during the exam will result in the same penalty. Ours’ should be a selfmonitoring profession. It is the obligation of all students to report violations of the honor code
in this course. By signing below, you are acknowledging that you have read the above
statement and agree to abide by the stipulated terms.
Student’s Signature:
______________________________
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 guarantees the maximum loss to equity
investors is the amount invested in the firm?
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 first 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 third 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
-1-
Exam 1
FSA3321 (Moore)-1
Fall 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 voluntary insurance market?
a. PG
b. PB
c. (PG + PB )/2
d. (.4PG + .6PB )
6. If, in Question 5 (above), imperfect information regarding the type of driver were available
to insurers and insurance were mandatory, what prices would obtain?
a. Good drivers pay more than PG but less than (.4PG + .6PB) while bad drivers pay PB
b. Good drivers pay PG and bad drivers pay PB
c. Good drivers pay PG and bad drivers pay more than PB
d. Good drivers pay more than PG but less than (.4PG + .6PB) while bad drivers pay less
than PB but more than (.4PG + .6PB)
e. Both Good and Bad drivers pay (PG + PB )/2 since information is imperfect
7. Which of the following IS NOT part of the firm’s accounting environment? (Figure 1-2)
a. Choice of Accounting Policies
b. Contracting and Governance
c. Capital Market Structure
d. Tax and Financial Accounting Linkages
e. Third Party Auditing
8. Which one of the following is an element of the Business Environment (Fig 1-2):
a. Scope of Business
b. Operating Activities
c. The Accounting System
d. Third-Party Auditors
e. Product Markets
9. After 2011, which of the following organizations will the SEC allow to establish US GAAP?
a. APB
b. CASB
c. FASB
d. GASB
e. IASB
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.
-2-
Exam 1
11.
a.
b.
c.
d.
e.
FSA3321 (Moore)-1
Fall 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 fourth 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. The $35 rise in oil on 22 September 2008 was attributed to which of the following?
a. A short squeeze in the spot oil market
b. A long cover in the spot oil market
c. A short cover rally in the oil futures market
d. A short squeeze in the oil futures market
e. The destruction of oil production resources resulting from Hurricane Ike
14. The fact that a credit analyst 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 highest degree of price competition?
a. High Product differentiation
b. Low industry growth rates
c. Low barriers to exit industry
d. Low threat of new entrants to the industry
e. High industry concentration
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
-3-
Exam 1
FSA3321 (Moore)-1
Fall 2008
17. Which of the following would lead to the highest degree of industry price competition?
a. High Industry Concentration, Low Legal Barriers to Entry, Low Product Differentiation
b. Many Exit Barriers, Low First mover advantage, Low Product Differentiation
c. Low Industry Concentration, Low Distribution Access, Steep Learning Curves
d. High Industry Concentration, High Fixed-Variable Cost Ratio, Low Industry Growth
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 ability to dictate price & delivery terms to suppliers 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 to users of
financial statements.
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
-4-
Exam 1
FSA3321 (Moore)-1
Fall 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 =
$35,000; Liabilities = $15,000 and Equity = $20,000. Acquirer Company buys Target for
$35,000 and revalues assets at $60,000 and liabilities at $30,000. The amount of Goodwill
that Acquirer will recognize on its balance sheet resulting from the acquisition is:
a. $30,000
b. $15,000
c. $10,000
d. $5,000
e. none of the above
Use the following information for Problems 25 and 26
ABC Company failed to write down $10,000,000 of obsolete inventory in 2007. The error was
caught in 2008 and an amended 10-K was issued in April 2008 to correct the mistake. Assume
a tax rate of 30% for ABC.
25. The impact to the original 2007 10-K would be:
a. Revenues were overstated by $10,000,000
b. Expenses were overstated by $10,000,000
c. Equity was overstated by $10,000,000
d. Assets were overstated by $10,000,000
e. Liabilities were overstated by $10,000,000
26. The amended 2007 10-K would reflect which one of the following adjustments?
a. Reduce revenues by $10,000,000
b. Increase net income by $10,000,000
c. Increase assets by $10,000,000
d. Reduce owners equity by $7,000,000
e. Reduce net income by $10,000,000
-5-
Exam 1
FSA3321 (Moore)-1
Fall 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 20
years and that their annual cost of debt is 7.12%. The annual lease payments are
$8,000,000. The present value of the future lease payments is $84,000,000 (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 $160,000,000 and Credit Leased Assets for $160,000,000
b. Debit Leased Assets for $8,000,000 and Credit Lease Liabilities for $8,000,000
c. Debit Leased Assets for $84,000,000 and Credit Lease Liabilities for $84,000,000
d. Debit Leased Assets for $160,000,000 and Credit Lease Liabilities for $160,000,000
e. Debit Lease Liabilities for $84,000,000 and Credit Leased Assets for $84,000,000
28. Adjust ABC’s books to reflect the lease as being capitalized. The reduction in lease
liabilities after the third payment is (assume payments made at the end of the year):
a. $2,162,967
b. $2,316,970
c. $5,683,030
d. $5,837,033
e. $8,000,000
29. Adjust ABC’s books to reflect the lease as being capitalized.
charge for interest expense in the second year.
a. $8,000,000
b. $5,837,033
c. $5,683,030
d. $2,162,967
e. $1,417,520
Compute the appropriate
30. Compute the overall effect on Net Income in the second year for ABC (had the lease
been capitalized) would be (relative to the reported Net Income, net of tax).
a. $2,180,800 Lower
b. $2,037,033 Lower
c. $1,883,030 Lower
d. $1,417,520 Lower
e. $1,324,071 Lower
-6-
Exam 1
FSA3321 (Moore)-1
Fall 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 used an unrealistically
low bad debt expense ratio
2
The company used too small a
growth rate to estimate the present
value of future medical benefit costs
on a defined benefit pension
healthcare plan
3
The company took a "big bath" when
recording restructuring charges
4
The company recognized revenues
on customer deposits before they
were earned
-7-
Liabilities
Equity
Revenues
Expenses
Net Income