APPELLO JUNE
DOMANDE ACCOUNTING
1. Which of the following statements is correct?
A. Any unrealized holding gain or loss on investments in trading securities is reported on the income
statement.
B. Any unrealized holding gain or loss on investments in available-for-sale securities is reported on the
income statement.
C. All unrealized gains and losses are reported on the income statement regardless of the method used to
account for the investment.
D. Any unrealized holding gain or loss on investments in trading securities or in available-for-sale securities
is reported on the income statement.
Solution: Trading security unrealized gains and losses are reported on the income statement.
2. Gilman Company purchased 100,000 of the 250,000 shares of common stock of Burke Corporation on
January 1, 2014, at $40 per share as a long-term investment. The records of Burke Corporation showed the
following on December 31, 2014:
2014 net income $575,000
Dividends declared and paid during December, 2014 $30,000
Market price per share $42
At what amount should Gilman Company report the Burke investment on the December 31, 2014 balance
sheet?
A. $4,218,000.
B. $4,000,000.
C. $4,124,000.
D. $3,800,000.
Solution: Investment in Burke = $4,218,000.
3. On January 1, 2014, Shelley Company paid $650,000 cash for 100% of the outstanding common stock of
SCD Company. SCD's stockholders equity on the date of acquisition was $500,000. The current fair value of
SCD's plant and equipment was $100,000 in excess of the equipment's book value. If the fair value and book
value are the same for SCD's remaining assets and liabilities, what was the amount of goodwill acquired by
Shelley Company?
A. $150,000.
B. $40,000.
C. $50,000.
D. $250,000.
Solution: Goodwill = $50,000.
4. Trent Corp. purchased $1,000,000 of bonds at 96 when the market yield was 8%. The bonds pay interest
at the rate of 6%. Trent Corp. intends to hold these bonds to maturity and will not need to sell the bonds
before that date. Which of the following statements is correct?
A. Since the bonds were purchased at a discount, the cash interest will be more than interest revenue.
B. Since the bonds were purchased at a discount, the book value of the bond investment will increase
toward its maturity value.
C. The bond investment will be classified as available-for-sale.
D. The company will recognize unrealized gains or losses on the bonds.
Solution: The bond investment was purchased at other than par value and as it is amortized, the book value
approaches the maturity value. Since the bonds were bought at less than par value, they were bought at a
discount. To approach maturity value, the bonds will be increased when the cost is amortized over time.
5. On January 1, 2014, Tonika Corporation issued a four-year, $10,000, 7% bond. The interest is payable
annually each December 31. The issue price was $9,668 based on an 8% effective interest rate. Assuming
effective-interest amortization is used, the book value of the bonds as of December 31, 2014 is closest to:
A. $8,968.
B. $9,945.
C. $9,641.
D. $9,741.
Solution: 2014 interest expense = $773 = initial issue price, which is the 1/1/2014 book value × the market
(effective) interest rate = $9,668 × .08.
Cash interest payment = $700 = maturity value of the bond × the stated interest rate = $10,000 × .07.
Amortization of discount on bonds payable = $73 = interest expense - interest cash payment = $773 - $700.
December 31, 2014 book value = $9,741 = January 1, 2014 book value + amortization of discount on bonds
payable amortization = $9,668 + $73.
6. The use of consolidation accounting for a long-term investment in common stock of another company is
required when the ownership of its voting stock is
A. 20% or more.
B. less than 20%.
C. between 20% and 50%.
D. more than 50%.
Solution: An investment of more than 50% of the outstanding voting stock of another company results in
consolidation accounting.
7. On January 1, 2014, Broker Corp. issued $3,000,000 par value 12%, 10 year bonds which pay interest
each December 31. If the market rate of interest was 14%, what was the issue price of the bonds?
A. $3,339,084.
B. $2,843,172.
C. $3,000,000.
D. $2,686,896.
Solution: Bond issue price = $2,686,896 = present value of the bond maturity value + present value of the
bonds interest payments
8. A company reported the following information for its most recent year of operation: purchases, $100,000;
beginning inventory, $20,000; and cost of goods sold, $110,000. How much was the company's ending
inventory?
A. $10,000.
B. $20,000.
C. $15,000.
D. $30,000.
Beginning inventory + Purchases - Cost of Goods Sold = Ending inventory. $20,000 + $100,000 - X =
$10,000; X = $110,000.
9. On January 1, 2014, Short Company purchased as an available-for-sale investment, 20,000 shares (15%
of the outstanding voting shares) of Daniel Corporation's $1 par value common stock at a cost of $50 per
share. During November 2014, Daniel declared and paid a cash dividend of $1.25 per share. At
December 31, 2014, end of the accounting period, Daniel's shares were selling at $48. The 2014 financial
statements for Short Company should report the following amounts:
Long-term investment
A
B
C
D
$ 1,000,000
960,000
1,000,000
960,000
Unrealized holding
gains/losses
$(40,000)
0
(15,000)
(40,000)
Investment revenue
$ 25,000
0
0
25,000
A. Option A
B. Option B
C. Option C
D. Option D
Solution: Available-for-sale security unrealized gains and losses ($2 × 20,000 = $40,000) are reported on
the balance within stockholders' equity (decrease in value of 2$, from $50 to $48). The investment
account is reported on the balance sheet at fair value ($48 × 20,000 = $960,000). The investment
revenue is the dividend revenue ($1.25 × 20,000 = $25,000).
10. Which of the following statements is correct?
A. The journal entry to record bad debt expense requires a debit to bad debt expense and a credit to
accounts receivable.
B. The journal entry to record bad debt expense requires a debit to bad debt expense and a credit to
allowance for doubtful accounts.
C. The journal entry to record the write-off of an uncollectible account receivable requires a debit to bad debt
expense and a credit to accounts receivable.
D. The journal entry to record the write-off of an uncollectible account receivable requires a debit to bad debt
expense and a credit to allowance for doubtful accounts.
Solution: The journal entry to record bad debt expense requires a debit to bad debt expense and a credit to
allowance for doubtful accounts.
11. On November 1, 2013, Davis Company issued $30,000, ten-year, 7% bonds for $29,100. The bonds
were dated November 1, 2013, and interest is payable each November 1 and May 1. How much is the book
value of the bonds after the November 1, 2014 interest payment was recorded, assuming the straight-line
method of amortization is utilized?
A. $29,010.
B. $29,100.
C. $29,190.
D. $29,280.
Solution: The straight-line discount amortization = $45 = discount on bonds payable ÷ the number of semiannual interest payments = ($30,000 - $29,100) ÷ 20 payments.
The November 1, 2014 book value = $29,190 = the initial issue price + two periods of discount amortization
= $29,100 + (2 × $45).
12. Which of the following journal entries is prepared when cash is received from a customer prior to delivery
of the goods or services?
A. debit Cash and credit Revenue
B. debit Cash and credit Unearned Revenue
C. debit Unearned Revenue and credit Cash
D. debit Cash and credit Accounts Receivable
Solution: When cash is received before goods or services have been provided, cash is debited and
unearned revenue (a liability account) is credited.
13. On April 1, 2016, the premium on a one-year insurance policy was purchased for $3,000 cash with the
insurance coverage beginning on that date. The books are adjusted only at year-end. Which of the following
correctly describes the effect on the financial statements of the December 31, 2016 adjusting entry?
A. Prepaid insurance will decrease $750.
B. Insurance expense will increase $750.
C. Insurance expense will increase $2,250.
D. Prepaid insurance will increase $2,250.
Solution: $3,000 ÷ 12 = $250 per month and 9 months of coverage has been used. The insurance expense
and reduction in prepaid insurance is $250 × 9 = $2,250.
14.
Williams Company purchased a machine costing $25,000 and is depreciating it over a 10-year
estimated useful life with a residual value of $3,000. At the beginning of the eighth year, a major
overhaul on it was completed at a cost of $8,000, and the total estimated useful life was changed to
12 years with the residual value unchanged. How much is the year 8 depreciation expense assuming
use of the straight-line depreciation method?
A. $2,200.
B. $2,920.
C. $3,100.
D. $8,800.
Years 1 - 7 annual depreciation expense = $2,200 = ($25,000 - $3,000) ÷ 10.
Beginning of year 8 book value prior to overhaul = $9,600 = $25,000 - ($2,200 × 7).
15. Carter Company disposed of an asset at the end of the eighth year of its estimated life for $10,000 cash.
The asset's life was originally estimated to be 10 years. The original cost was $50,000 with an estimated
residual value of $5,000. The asset was being depreciated using the straight-line method. What was the gain
or loss on the disposal?
A. $1,000 loss.
B. $4,000 loss.
C. $5,500 gain.
D. $10,000 gain.
Solution: Annual straight-line depreciation expense = $4,500 = ($50,000 - $5,000) ÷ 10.
End of year eight book value = $14,000 = $50,000 - ($4,500 × 8).
A $4,000 loss occurs because the selling price of $10,000 is less than book value of $14,000.
DOMANDE CORPORATE FINANCE
1. Which type of risk is unaffected by portfolio diversification?
A) Unsystematic risk
B) Idiosyncratic risk
C) Total risk
D) Systematic risk
E) All types of risk are affected by portfolio diversification.
2. Suppose Simmons' common stock has a beta of 1.37, the risk-free rate is 3.4 percent, and the
market risk premium is 8.2 percent. The yield to maturity on the firm's bonds is 7.6 percent and the
debt-equity ratio is .45. What is the WACC if the tax rate is 23 percent and all interest is tax
deductible?
A) 14.07 percent
B) 10.94 percent
C) 12.60 percent
D) 10.59 percent
E) 11.91 percent
Solution:
Explanation: Re = .034 + 1.37(.082)
Re = .14634, or 14.634%
WACC = (1/1.45)(.14634) + (.45/1.45)(.076)(1 − .23)
WACC = .1191, or 11.91%
3. ABC is considering acquiring XYZ and has compiled this information on XYZ:
Year
EBIT
Capital spending
Increases in net working capital
Depreciation
1
$ 318,000
46,500
5,500
34,000
2
$ 364,000
28,000
6,500
32,100
3
$ 392,000
36,200
1,200
28,700
The applicable tax rate is 21 percent and the terminal value of XYZ as of Year 3 is $2.5 million.
What is the NPV of this acquisition if the discount rate is 7.1 percent and the acquisition cost is
$2.25 million?
A) $538,316
B) $509,482
C) $499,003
D) $506,048
E) $496,399
Solution:
Explanation: CF1 = $318,000(1 − .21) + 34,000 − 46,500 − 5,500
CF1= $233,220
CF2 = $364,000(1 − .21) + 32,100 − 28,000 − 6,500
CF2 = $285,160
CF3 = $392,000(1 − .21) + 28,700 − 36,200 − 1,200
CF3 = $300,980
NPV = −$2,250,000 + $233,220/1.071 + $285,160/1.0712 + ($300,980 + 2,500,000)/1.0713
NPV = $496,399
4.
If the CAPM is used to estimate the cost of equity capital, the expected excess market return is
equal to the:
A) return on the stock minus the risk-free rate.
B) return on the market minus the risk-free rate.
C) beta times the market risk premium.
D) beta times the risk-free rate.
E) market rate of return.
5. Which statement concerning the net present value (NPV) of an investment or a financing project
is correct?
A) A financing project should be accepted if, and only if, the NPV is exactly equal to zero.
B) An investment project should be accepted only if the NPV is equal to the initial cash flow.
C) Any type of project should be accepted if the NPV is positive and rejected if it is negative.
D) Any type of project with greater total cash inflows than total cash outflows, should always be
accepted.
E) An investment project that has positive cash flows for every time period after the initial
investment should be accepted.
6. Two mutually exclusive projects have 3-year lives and a required rate of return of 10.5 percent.
Project A costs $75,000 and has cash flows of $18,500, $42,900, and $28,600 for Years 1 to 3,
respectively. Project B costs $72,000 and has cash flows of $22,000, $38,000, and $26,500 for
Years 1 to 3, respectively. Using the IRR, which project, or projects, if either, should be accepted?
A) Accept both projects
B) Select either project as there is no significant difference between them
C) Accept Project A and reject Project B.
D) Accept Project B and reject Project A.
E) Reject both projects
Solution:
Explanation: 0 = −$75,000 + $18,500/(1 + IRR) + $42,900/(1 + IRR)2 + $28,600/(1 + IRR)3
IRR = 9.12%
0 = −$72,000 + $22,000/(1 + IRR) + $38,000/(1 + IRR)2 + $26,500/(1 + IRR)3
IRR = 9.48%
Both projects should be rejected because their IRR's are less than the required rate of return. Thus,
both projects also have negative NPVs.
7. Allison's
wants to raise $12.4 million to expand its business. To accomplish this, it plans to sell
25-year, $1,000 face value, zero-coupon bonds. The bonds will be priced to yield 6.5 percent, with
semiannual compounding. What is the minimum number of bonds the firm must sell to raise the
$12.4 million it needs?
A) 59,864
B) 52,667
C) 61,366
D) 60,107
E) 60,435
Solution:
Explanation: Number of bonds = $12,400,000/[$1,000/(1 + .065/2)25(2)]
Number of bonds = 61,366 bonds
8. Rosita's announced that its next annual dividend will be $1.65 a share and all future dividends
will increase by 2.5 percent annually. What is the maximum amount you should pay to purchase a
share of this stock if you require a rate of return of 12 percent?
A) $13.75
B) $17.80
C) $15.46
D) $16.94
E) $17.37
Solution:
Explanation: P0 = $1.65/(.12 − .025)
P0 = $17.37
9. Martin's Yachts is expected to pay annual dividends of $1.40, $1.75, and $2.00 a share over the
next three years, respectively. After that, the dividend is expected to remain constant. What is the
current value per share at a discount rate of 14 percent?
A) $12.22
B) $13.57
C) $13.08
D) $12.82
E) $13.39
Solution:
Explanation: P0 = $1.40/1.14 + $1.75/1.142 + ($2.00/.14)/1.142
P0 = $13.57
10. T&P common stock sells for $23.43 a share at a market rate of return of 11.65 percent. The
company just paid its annual dividend of $1.20. What is the dividend growth rate?
A) 5.87 percent
B) 6.43 percent
C) 5.91 percent
D) 6.07 percent
E) 6.21 percent
Explanation: $23.43 = [$1.20(1 + g)]/(.1165 − g)
g = .0621, or 6.21%
11. The correlation between Stocks A and B is computed as the:
A) covariance between A and B divided by the standard deviation of A times the standard deviation
of B.
B) standard deviation of A divided by the standard deviation of B.
C) standard deviation of AB divided by the covariance between A and B.
D) variance of A plus the variance of B divided by the covariance of AB.
E) square root of the covariance of AB.
12. Stock A is expected to return 12 percent in a normal economy and lose 7 percent in a recession.
Stock B is expected to return 8 percent in a normal economy and 2 percent in a recession. The
probability of the economy being normal is 80 percent and the probability of a recession is 20
percent. What is the covariance of these two securities?
A) .004203
B) .004115
C) .003280
D) .003876
E) .003915
Solution:
Explanation: E(RA) = .80(.12) + .20(−.07)
E(RA) = .082, or 8.2%
E(RB) = .80(.08) + .20(.02)
E(RB) = .068, or 6.8%
Product of DeviationsNormal = (.12 − .082)(.08 − .068)
Product of DeviationsNormal = .000456
Product of DeviationsRecession = (−.07 − .082)(.02 − .068)
Product of DeviationsRecession = .007296
σA,B = (.000456 + .007296)/2
σA,B = .003876
13. The effects of financial leverage depend on the operating earnings of the company. Based on
this relationship, assume you graph the EPS and EBI for a firm, while ignoring taxes. Which one of
these statements correctly states a relationship illustrated by the graph?
A) Financial leverage decreases the slope of the EPS line.
B) Below the break-even point unlevered structures have a lower EPS for every dollar of EBI than
levered structures do.
C) Above the break-even point the increase in EPS for unlevered structures is greater than that of
levered structures for every dollar increase in EBI.
D) Leverage only provides value above the break-even point.
E) Above the break-even point, the unlevered structure is preferred.
14. Webster's latest project has an initial cost of $1.23 million and unlevered perpetual cash flows
of $238,000. The firm has a debt-equity ratio of .42, a pretax cost of debt of 7.6 percent, a cost of
equity of 13.3 percent, and a tax rate of 21 percent. What is the NPV of the project?
A) $864,010
B) $887,982
C) $906,056
D) $909,411
E) $892,020
Solution
Explanation: WACC = (.42/1.42)(.076)(1 − .21) + (1/1.42)(.133)
WACC = .1114, or 11.14%
NPV = $238,000/.1114 − $1,230,000
NPV = $906,056
15. Which method(s) is(are) most applicable if a project's debt level is known over the life of the
project?
A) WACC
B) APV
C) FTE
D) Either APV or FTE
E) Either FTE or WACC