Fin 5324 – Fall 2012
Exam 1
Moore
First Examination – Finance Statement Analysis
Fall 2012 – Fin 5324
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Clearly Circle the BEST response for each of the following questions:
Multiple Choice (2 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 is correct?
a. Aggressive accounting policies (choices) lead to lower earnings and higher assets
b. The independent auditor’s opinion and statement on the 10-K guarantee the
information contained in the financial reports are correct.
c. The information contained in financial reports reflect “people-made” numbers and
choices that may contain material errors and biases.
d. 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.
3. 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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Fin 5324 – Fall 2012
Exam 1
Moore
4. Competitive Positioning is part of which main element in Figure 1-2?
a. Business Environment
b. Business Strategy
c. Capital Markets
d. Accounting Environment
e. Accounting Strategy
5. Which is the third step in a structured equity security analysis and valuation?
a. Prospective Analysis
b. Accounting Analysis
c. Financial Analysis
d. Business Strategy Analysis
e. Implementing Valuation Models
6. Acquirer Company buys Target Company. Target’s pre-acquisition balance sheet at
historical cost showed Total Assets at $630,000 and Total Liabilities at $420,000. Upon
acquisition, Acquirer revalued Target’s assets at $780,000 and liabilities at $357,000. In
addition, Acquirer paid $885,000 for the acquisition of Target. Determine the amount of
Goodwill Acquirer must recognize for the acquisition of Target.
a. $150,000
b. $462,000
c. $213,000
d. $780,000
e. $63,000
7. Identify the proper sequence in which following items would be presented on the income
statement is:
1. Net Revenue
2. Gross Profit
3. Comprehensive Income
4. Net Income
5. Operating Income
a.
b.
c.
d.
e.
8. An
a.
b.
c.
d.
e.
1,
1,
1,
1,
1,
2,
5,
2,
5,
2,
3,
2,
5,
3,
3,
4,
4,
4,
2,
5,
5
3
3
4
4
industry having a high degree of price competition would be characterized by:
Low Industry Concentration, Low Legal Barriers to Entry, High Product Differentiation
Few Exit Barriers, Low First mover advantage, Low Product Differentiation
High Industry Concentration, High Distribution Access, Low Firm Excess Capacity
Low Concentration, Low Fixed-Variable Cost Ratio, Few Legal Barriers to Entry
Supply > Demand, Low First Mover Advantage, High Fixed to Variable Cost Ratio
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Fin 5324 – Fall 2012
Exam 1
Moore
9. 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, High First Mover Advantage, High Product Differentiation
c. Low Industry Concentration, Low Distribution Access, Low Customer Switching Costs
d. High Industry Concentration, High Fixed-Variable Cost Ratio, Hi product differentiation
e. Supply > Demand, High Legal Barriers to Entry, Steep Industry Learning Curves
10. Which of the following models, theorems or hypotheses, if absolutely true in the real world,
would make the activities of information production or financial analysis a socially and
economically non-productive activities?
a. Capital Asset Pricing Model
b. Weak Form Efficient Market Hypothesis
c. Strong Form Efficient Market Hypothesis
d. Modigliani and Miller Theorem, without taxes
e. Residual Income Valuation Model
Short Problem 1 (show all work and briefly comment) (10 Points)
Assume PG is the fair insurance price for Good drivers and PB is the fair insurance price for
Bad drivers, where PG = 200, PB = 400 and 30% of the drivers are Good drivers. If
insurers do not have a mechanism to distinguish good and bad drivers, what price(s) will
result in the mandatory insurance market (assume linear risk preferences and insurers
cannot, on average, overcharge customers)? Identify which group of drivers dislike the
resulting pricing scheme and why.
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Fin 5324 – Fall 2012
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Short Problem 2 (show all work and briefly comment) (10 Points)
You are the CEO of a just formed company that will last exactly 1 year and then be liquidated.
The initial capitalization of the company consists of:
Debt:
Equity:
$10,000
$ 4,000
You have the choice of only 2 investment alternatives with the initial capital. Each project will
require the investment of the entire initial capital.
Project 1 has a 60% chance of paying $9,000 and a 40% chance of paying $7,000.
Project 2 has a 10% chance of paying $50,000 and a 90% chance of paying $3,000.
Issuers of Debt and Equity are assumed risk neutral.
Which project do bondholders want you, the CEO, to choose? Explain and provide
supporting computations where appropriate.
Which project do shareholders want you, the CEO, to choose? Explain and provide
supporting computations where appropriate.
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Fin 5324 – Fall 2012
Exam 1
Moore
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). Base your analysis on Proper GAAP. Number 10 relates to impact resulting
from the decision.
Assets
1
2
3
The company failed to write down a
50% impairment of inventory
The company used too large a
discount rate to estimate the
present value of future service costs
on a defined benefit pension plan
The company used too low a rate in
estimating account receivable
defaults
6
The company capitalized all research
and development costs
The company recognized all gift card
sales as revenues in the year sold
even though they don't expire for 3
years
The company failed to impair
goodwill despite having a
competitive advantage loss
7
Regular equipment maintenance
expenditures were recognized as
capital improvements to the assets
8
A car manufacturer knew of
potentially faulty accelerators on
new cars sold under warranty but
didn't adjust financial statement for
the estimated costs
9
The company failed to recognize
foreign currency losses related to
international sales transactions
10
The company, an importer, failed to
hedge foreign exchange risk in a year
when the dollar was strengthening
4
5
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Liabilities
Equity
Revenues
Expenses
Net Income
Fin 5324 – Fall 2012
Exam 1
Moore
Main Exam Problem – Restating Financial Statements (50 Points)
Download the excel spreadsheet with financial information for Google. This information comes
directly from GOOGLE’s annual 10-K’s for the years 2009, 2010 and 2011.
You are provided Goodwill, Operating Lease and Research and Development expense or
activity information.
Your mission is to restate the financial report in order to provide an alternative view of the
impact of Goodwill, Operating Leases and R&D of the financial condition of the firm.
After restating the financials, provide brief responses to basic questions regarding how these
restatements impact your view of Google.
Your working assumptions are that all Lease contracts are signed (renewed) on December 31.
Mergers and Acquisitions are assumed to take place on the last day of the year and the
competitive advantage captured by Goodwill is assumed to have a 5 year useful life.
Finally, Research and Development activities are presumed to take place continuously
throughout the year. The R&D cycle is assumed to be 4 Years for firms in Google’s industry.
Required: (all work is Pre-Tax)
1. On the excel spreadsheet, prepare a capitalization of lease schedule for the
Operating Leases disclosed on the 2009 and 2010 10-K’s. Be sure to show
the amortization of the capitalized lease. Use a Separate worksheet tab for
each year. Be sure to also identify annual depreciation and interest expense.
2. Prepare, on a separate tab in the worksheet a Goodwill amortization
schedule for 2009 through 2016. You should clearly identify both the annual
adjusted (restated) balances of Goodwill and the annual adjustment
(impairment or amortization) for restated goodwill.
3. Prepare, on a separate tab the adjustments for R&D if you were to capitalize
R&D activities and then amortize the R&D assets in a manner consistent with
the assumptions.
4. Prepare the trial balance adjusting entries for 2009 as they relate to
Goodwill, R&D and Capitalizing Operating Leases.
5. Prepare a restated income statement and balance sheet that reflects your
work for 2009
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Fin 5324 – Fall 2012
Exam 1
Moore
6. Briefly comment (below) how these restated financials affect your view of
Google’s operating profitability and capital structure risk as compared with
the presentation under traditional “as-stated” GAAP financial reports.
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