cityboy

21. For the most recent year a manufacturing company reports the following items on their income statement:

Interest expense $62,500

Loss on disposal of fixed assets $50,000

Realized gain on sale of available-for-sale securities $17,750

Which of the items is classified as an operating item in the company’s income statement?

A. Interest expense.

B. Loss on disposal of fixed assets.

C. Realized gain on sale of available-for-sale securities.

  
  Ans: B.

The loss on the disposal of fixed assets is an unusual or infrequent item but it is still part of normal operating activities.

  

A is incorrect. The interest expense is the result of financing activities and would be classified as a nonoperating expense by nonfinancial service companies.

  

C is incorrect.The realized gain on sale of available for sale securities is an investing activity and would also be classified as a nonoperating gain by a manufacturing company.

cityboy

22. An analyst gathers the following information about a company: Average market price per share of common stock during the year $40 Exercise price per share for options on 50,000 common shares $50 Exercise price per share for warrants on 20,000 common shares $30 Using the treasury stock method, the number of incremental shares used to compute diluted earnings per share is closest to: A. 5,000. B. 15,000. C. 20,000.

Ans: A. Diluted EPS is calculated using the treasury stock method that considers what would be the effect if the options or warrants had been exercised. Only options or warrants that are in-the-money are included, as out-of-the-money options would not be exercised. Therefore only the warrants are dilutive: their exercise price is below the average market price of the stock. Using the treasury stock method, the number of new shares issued on exercise is reduced by the number of shares that could be purchased with the cash received upon exercise of the warrants: 20,000($30) = $600,000 in proceeds. $600,000 / $40 = 15,000 shares treasury stock. Incremental shares using the treasury stock method = 20,000 – 15,000 = 5,000.

cityboy

23. An analyst gathers the following information about a company: Shares of common stock outstanding 1,000,000 Net income for the year $1,500,000 Par value of convertible bonds with a 4 percent coupon rate $10,000,000 Par value of cumulative preferred stock with a 7 percent dividend rate $2,000,000 Tax rate 30% The bonds were issued at par and can be converted into 300,000 common shares. All securities were outstanding for the entire year. Diluted earnings per share is closest to: A. $1.05. B. $1.26. C. $1.36.

Ans: B. Dividends of $140,000 (0.07 x 2,000,000) should be deducted from net income to determine the amount available to common shareholders: $1,360,000 = (1,500,000 –140,000). Basic EPS would be $1,360,000 / 1,000,000 or $1.36 per share. Diluted EPS would consider the convertible bonds if they were dilutive. Interest on the bonds is $400,000 and the after-tax amount add back to net income is $400,000 (1-.30) = $280,000. Diluted EPS, assuming conversion, is ($1,360,000 + 280,000) / (1,000,000 +300,000) = 1,640,000/1,300,000= $1.26 per share. The bonds are dilutive.

cityboy

24. An analyst gathers the following data about a company and the industry in which it operates: Company ($ millions) Industry Averages as a percent of sales Revenues 5,000 100% Cost of goods sold 2,100 45% Operating expenses 1,750 32% Profit margin 475 9.5% Which of the following conclusions is most reasonable? Compared to the industry, the company: A. has the same cost structure and net profit margin. B. has a lower gross profit margin and spends more on its operating costs. C. is better at controlling product costs, but less effective at controlling operating costs.

Ans: C. Company Industry Conclusion Gross Profit 5,000-2,100 =2,900 Gross Profit Margin 2,900/5,000 =58% 1-0.45 =55% The company’s cost of goods sold, or product costs, is lower; it is controlling them better. Operating Costs 1,750/5,000 =35% 32% The company’s operating costs are higher. It is not as effective at controlling its operating costs asthe industry.

cityboy

25. An analyst is forecasting EPS for a company. She prepares the following common sized data from its recent annual report and estimates sales for 2009. 2009 forecast 2008 actual 2007 actual Sales $ millions 2,250.0 2,150.0 1,990.0 Sales as % of sales 100.00% 100.00% COGS 45.00% 45.00% Operating expenses 40.00% 40.00% Interest expense 3.72% 4.02% Restructuring expense 7.20% Per-tax margin 11.28% 3.78% Taxes (35%) 3.95% 1.32% Net income 7.33% 2.46% The capital structure of the company has not changed and the company has no short term interest bearing debt outstanding. The projected net income (in $ millions) for 2009 is closest to: A. 162.8. B. 164.9. C. 167.4.

Ans: C. The cost of goods sold and operating expenses are constant over the two-year period and they can reasonably be used to forecast 2009. Interest expense is declining as a percent of sales, implying it is a fixed cost. Conversion into dollars for each year shows what interest expense has been; 2008 =$80 (3.72% x 2,150); 2007=$80 (4.02 x 1,990) and that would be a reasonable projected amount to use. The restructuring charge should not be included as it is a non-recurring item. The tax rate, 35%, is given. Sales                                                   $2,250.00 COGS (45%)                                        1,012.50 Operating expenses (40%)                       900.00 Interest expense                                          80.00 Pretax margin                                            257.50 Tax (35%)                                                      90.1 Net Income                                                 167.40

cityboy

26. The unrealized gains and losses arising from changes in the market value of available-for-sale securities are reported under U.S. GAAP and International Financial Reporting Standards (IFRS) in the:

A. equity section for both.

B. equity section for U.S. GAAP and the income statement for IFRS.

C. income statement for U.S. GAAP and the equity section for IFRS.

  
  Ans: A.

Under both U.S. GAAP and IFRS the unrealized gains and losses arising from carrying available-for-sale securities at market value are reported in equity as part of accumulated other comprehensive income.

cityboy

27.  The following information is available from a company’s according records: €millions Revenues for the year 12,500 Total expenses for the year 10,000 Gains from available-for-sale securities 1,475 Loss on foreign currency translation adjustments on a foreign subsidiary 325 500 The company’s total comprehensive income (in million) is closest to: A. €1,150 B. €3,150 C. €3,650

Ans: C. Total comprehensive income= net income + other comprehensive income Net income  revenue – expenses Other comprehensive income includes gains or losses on available-for-sale securities and translation adjustments on foreign subsidiaries. (revenue - expense) + gain on AFS – loss on FX translation (12,500-10,000)+1.475-325=3,650

cityboy

28. During 2012, Nagano Incorporated, a manufacturing company, reported the following items on their income statement: Loss on disposal of fixed assets $50,000 Interest expense $62,500 Under U.S.GAAP, the correct classification of each of these items on the income statement would be as a(n): Loss on disposal of fixed assets Interest expense A Operating item Operating item B Operating item Nonoperating item C Nonoperating item Operating item A. Answer A. B. Answer B. C. Answer C.

Ans: B. Under U.S.GAAP: The loss on the disposal of fixed assets is an unusual or infrequent item but it is still part of normal operating activities. The interest expense is the result of financing activities and would be classified as a nonoperating expense by nonfinancial service companies.

cityboy

29. Melbourne Manufacturing has equipment with an original cost of $850,000, accumulated amortization of $300,000 and 5 year of estimated remaining useful life. Due to a change in market conditions Melbourne now estimate that the equipment will only generate cash flow of $80,000 per year over its remaining useful life. The company’s incremental borrowing rate is 8%. What is the amount of the impairment loss closest to and what would be the effect on the company’s return on asset (ROA) in future periods?(under U.S.GAAP) Impairment loss Effect on ROA in future periods A $150,000 Increase B $150,000 Decrease C $230,583 increase A. Answer A. B. Answer B. C. Answer C.

Ans: C. The equipment is impaired. NBV=$550,000, which is greater than the sum of the undiscounted cash flow 5 years x$80,000=$400,000 The amount of the impairment is 550,000-PV of the cash flow=550,000-319,417(PMT=80,000, N=5,i=8%)=230,583. The company’s ROA will increase. ROA= There will be lower depreciation charges in the future, which will increase net income, and a lower carrying value of assets, which decreases total assets. Both factors would increase any future ROA.

cityboy

30. An analyst gathered the following information about a company: Average market price per share of common stock during the year $40 Exercise price per share for options on 50,000 common shares $50 Exercise price per share for warrants on 20,000 common shares $30 Using the treasury stock method, the number of incremental shares should be used to compute diluted earnings per share is closest to: A. 5,000. B. 12,500. C. 15,000.

Ans: A. Diluted EPS is calculated using the treasury stock method that considers what would be the effect if the options or warrants had been exercised. Only options or warrants that are in-the-money are included, as out-of-the-money options would not be e3xercised. Therefore, only the warrants are dilutive, the exercise preice is below the average market price of the stock. Using the treasury stock method: 20,000($30)=$600,000 in proceeds. $600,000/$40=15,000 shares treasury stock. Incremental shares using the treasury stock method = 20,000 – 15,000 = 5,000.