The Mock AM questions that got me why, understand, function, correct

waldziuchna

I’ve been able to use the search function to find some of my questions but it would be easiest if I could just get the answers in one consolidated place. If you recall the questions, please help out. Thanks.
14. Their calculation of Operating Income/Sales = (Sales-COGS-SG&A-R&D)/Sales. Being that Operating Income is EBIT, why don’t they subtract depreciation?
25. I’m able to understand why “prices that are volatile and at historic lows” is correct and understand their whole answer except for the first sentence; “Positive roll yield occurs when the futures price is above the full carry price.” How can that be right, if backwardation occurs when futures prices are less than spot prices?
36. I assume that “prepared a consolidated balance sheet” is another why of saying “had we accounted for the transaction via the consolidation method.” Therefore, this is the reason we add the minority interest to get the total S/E. Please confirm.
45. In the accounting income formula, for the interest component they multiply 12% by $300,000. But we’re in year 2. The asset has depreciated by $60,000 in year 1 and another $60,000 in year 2. I don’t get why we don’t multiply 12% by $180,000 to get the interest expense.
60. Statement 1 should NOT be correct because she says “company’s dividends have been substantially different from its FCFE.” It WOULD be right if she had said Net Income instead of FCFE–should there be a relation between dividends and FCFE?

joehogue

#60, I agree with you. I haven’t seen it worded like they do, but I guess there is a relationship between dividends and FCFE.

d2rockstar

#45, It’s mentioned in the vignette that the company will pay the full principle at the end of the project, if i remember correctly. I don’t think depreciation and interest payments are related. You pay interest on the principle, not based on depreciation.

comp_sci_kid

45. yeah bro…interest has nothing to do with depreciation

KungFuPanda

45. Ok I got why you multiply the 12% by 300,000 each year, but what does it mean that the full principal will be paid at the end of the fifth year? You have an initial cash outflow in year 0 of 300,000 and you pay interest each year on the 300,000, so why do you need to make a principal payment in year 5? This payment isn’t included in the NPV calculation.
Also any help on the other Q?

chandsingh

full payment of principal paid in the 5th year just means it is an interest only loan. Off course it will be paid back once the project has finished. The loan is also not included in NPV calculations as it is not their cash.

firat

14. I got this answer correct, but mostly due to luck. I calculated the operating income/sales ratio as EBIT/sales and also did the LTD/capitalization ratio. I saw these two were improving, but I knew both of these answers couldn’t be right at the same time. I came to the conclusion that EBIT/Sales isn’t a very reliable indicator when determining credit quality, especially since it is before interest. Is it nice to know? Yes. But it probably wouldn’t be able to tell us whether or not the company is able to pay off its debt.
25. Futures price
36. I got this question wrong because I calculated NCI using the full goodwill method. Your assumptions are correct.
45. The loan is an interest only loan, which is presented in the following sentence: “Scott learns that the equipment is to be financed entirely with a loan at 12%, with interest paid annually for five years and the full principal paid at the end of the fifth year.”
60. I got this question wrong too and spent a lot of time going back and forth on the first statement. Basically, if a firm is showing an upward trend in FCFE and not increasing their dividends, there lies an inconsistency between profitability and dividend payouts. Therefore, the DDM model should be avoided.

ohai

So annoying… CFAI is reusing questions from last year… the sample 1 of 2009 is the Mock Ethics vignette from AM 2010 =(

jcole21

Thanks bpdulog. A few followups:
14. I did the same exact thing as you and determined that EBIT/Sales is less relevant to credit worthiness than LTD/Capital. Going back to the original question, have you figured out why they calculate Operating Income/Sales as EBITDA/Sales?
25. Yes, that’s positive roll yield. But that doesn’t confer with their statement: “Positive roll yield occurs when the futures price is above the full carry price.”
45. Does the calculation of interest change at all if it is not an interest only loan?
60. Another way you can think of this is to say that to use DDM, dividends should be consisntent with NI. But NI should be consistent with cash flow, and FCFE is a measure of CF. Additionally, NI is a component of FCFE. So avoid DDM because dividends are not consistent with NI or CF.