4.George Quayle teaches an entry-level business class at 8 a.m. on Mondays, Wednesdays, and Fridays at Southern Coastal Idaho Polytechnic. This morning, Quayle plans to introduce his students to strategies for market analysis. He starts the class out with a discussion of competition and its effect on industries as well as individual stocks. Halfway through the class, Quayle passes out a handout listing the characteristics of markets in which investors are able to earn above-average returns. Here are some of the characteristics listed on the handout:

§ A Herfindahl index value of more than 2.0

§ Moderate bargaining power for buyers

§ A government that tends to intervene

§ Substantial barriers to entry

After finishing up his discussion of competition, Quayle makes the following statement about economic growth: “The most important driver of economic growth is technological advancement. When growth slows, private-sector innovators see opportunities and work even harder to develop products people can use. This dynamic can continue indefinitely, preventing the economy from regressing to a long-run steady growth rate.”

The 9 a.m. investing class has been studying the business cycle. Today, Quayle breaks down the business cycle, discussing the characteristics of all five stages: recovery, early upswing, late upswing, economy slows, and recession. Quayle explains how each stage of the business cycle is generally accompanied by a particular set of economic cues. He then quizzes the class on the signs of each stage, and which investments perform well during each stage. The students are then given the following information and asked to identify the business-cycle stage being described.

After the quiz, Quayle ends the study of the business cycle and moves on to valuing stocks. He begins with a discussion of the franchise value, stating that only when a firm’s return on equity (ROE) exceeds its cost of capital should it reinvest in itself rather than distribute profits back to shareholders. As an introduction to the concept of franchise value, Quayle tells the students to calculate the intrinsic P/E value for Golden Goblets, a stemware company. Golden Goblets earns an ROE of 15.4 percent and has a payout ratio of 28 percent. The required market return on equity is 14.6 percent, and the risk-free rate is 7.5 percent.

In Quayle’s 10 a.m. accounting class, he explains the vagaries of international accounting systems that don’t always match U.S. standards. Quayle discusses the global moves toward “convergence,” or efforts to move International Accounting Standards Board and U.S. Financial Accounting Standards Board requirements together.

Next, Quayle tackles the problems U.S. analysts face in interpreting the financial statements of foreign firms. He says foreign financial reports are more difficult for U.S. analysts to handle than domestic statements, and presents four chief reasons for that difficulty:

1) Many countries’ financial-reporting rules are arcane or confusing.
2) Some companies do not publish their financial reports in English.
3) Some countries allow companies to produce financial reports infrequently, or long after the period covered in the reports.
4) Not all countries enforce regulations with enough vigor to ensure reliable financial statements.

After discussing the accounting issues, Quayle gives his students an assignment to research what would happen if the United States adopted IAS guidelines for leases.

The intrinsic P/E value of Golden Goblets is closest to:

A)   6.85.

B)   7.97.

C)   5.73.

D)   7.76.

5.Which of Quayle’s statements regarding foreign financial information is least relevant to his contention that foreign financial reports are more difficult to analyze?

A)   Many countries’ financial-reporting rules are arcane or confusing.

B)   Some companies do not publish their financial reports in English.

C)   Some countries allow companies to produce financial reports infrequently, or long after the period covered in the reports.

D)   Not all countries enforce regulations with enough vigor to ensure reliable financial statements.

6.Which of the following characteristics is least likely to indicate a market in which investors can earn high returns?

A)   A Herfindahl index value of more than 0.2.

B)   Moderate bargaining power for buyers.

C)   A government that tends to intervene.

D)   Substantial barriers to entry.

7.If the U.S. adopted the IAS treatment of financial leases, what would happen to the average company’s:

A)     Decrease                              No change

B)     Increase                                Increase

C)     Decrease                              Increase

D)     Increase                               No change

8.Quayle’s statement about economic growth is indicative of which of the following theories?

A)   Neoclassical growth.

B)   Keynesian economics.

C)   Classical growth.

D)   Endogenous growth.

9.In the quiz Quayle gave to his 9 a.m. class, which business-cycle stages are most likely being described?

A)     Recession                               Late upswing

B)     Economy slows                      Recovery

C)     Economy slows                     Early upswing

D)     Recession                               Late upswing

4.George Quayle teaches an entry-level business class at 8 a.m. on Mondays, Wednesdays, and Fridays at Southern Coastal Idaho Polytechnic. This morning, Quayle plans to introduce his students to strategies for market analysis. He starts the class out with a discussion of competition and its effect on industries as well as individual stocks. Halfway through the class, Quayle passes out a handout listing the characteristics of markets in which investors are able to earn above-average returns. Here are some of the characteristics listed on the handout:

§ A Herfindahl index value of more than 2.0

§ Moderate bargaining power for buyers

§ A government that tends to intervene

§ Substantial barriers to entry

After finishing up his discussion of competition, Quayle makes the following statement about economic growth: “The most important driver of economic growth is technological advancement. When growth slows, private-sector innovators see opportunities and work even harder to develop products people can use. This dynamic can continue indefinitely, preventing the economy from regressing to a long-run steady growth rate.”

The 9 a.m. investing class has been studying the business cycle. Today, Quayle breaks down the business cycle, discussing the characteristics of all five stages: recovery, early upswing, late upswing, economy slows, and recession. Quayle explains how each stage of the business cycle is generally accompanied by a particular set of economic cues. He then quizzes the class on the signs of each stage, and which investments perform well during each stage. The students are then given the following information and asked to identify the business-cycle stage being described.

After the quiz, Quayle ends the study of the business cycle and moves on to valuing stocks. He begins with a discussion of the franchise value, stating that only when a firm’s return on equity (ROE) exceeds its cost of capital should it reinvest in itself rather than distribute profits back to shareholders. As an introduction to the concept of franchise value, Quayle tells the students to calculate the intrinsic P/E value for Golden Goblets, a stemware company. Golden Goblets earns an ROE of 15.4 percent and has a payout ratio of 28 percent. The required market return on equity is 14.6 percent, and the risk-free rate is 7.5 percent.

In Quayle’s 10 a.m. accounting class, he explains the vagaries of international accounting systems that don’t always match U.S. standards. Quayle discusses the global moves toward “convergence,” or efforts to move International Accounting Standards Board and U.S. Financial Accounting Standards Board requirements together.

Next, Quayle tackles the problems U.S. analysts face in interpreting the financial statements of foreign firms. He says foreign financial reports are more difficult for U.S. analysts to handle than domestic statements, and presents four chief reasons for that difficulty:

1) Many countries’ financial-reporting rules are arcane or confusing.
2) Some companies do not publish their financial reports in English.
3) Some countries allow companies to produce financial reports infrequently, or long after the period covered in the reports.
4) Not all countries enforce regulations with enough vigor to ensure reliable financial statements.

After discussing the accounting issues, Quayle gives his students an assignment to research what would happen if the United States adopted IAS guidelines for leases.

The intrinsic P/E value of Golden Goblets is closest to:

A)   6.85.

B)   7.97.

C)   5.73.

D)   7.76.

The correct answer was B)

The intrinsic P/E value is the sum of the tangible P/E value and the franchise P/E value.
To calculate the tangible P/E value, we divide 1 by the 14.6% required rate of return, for a value of 6.85.
To calculate the franchise P/E value, we multiply the franchise factor (FF) by the growth factor (G).
FF = (1 / rate of return) – (1 / ROE) = 0.36.
G = sustainable growth rate / (rate of return – sustainable growth rate).
Sustainable growth rate = ROE x retention ratio = 15.4% * 72% = 11.09%.
G = 11.09% / (14.6% - 11.09%) = 3.16.
Franchise P/E value = 0.36 x 3.16 = 1.14.
Intrinsic P/E value = 6.85 + 1.14 = 7.99.

5.Which of Quayle’s statements regarding foreign financial information is least relevant to his contention that foreign financial reports are more difficult to analyze?

A)   Many countries’ financial-reporting rules are arcane or confusing.

B)   Some companies do not publish their financial reports in English.

C)   Some countries allow companies to produce financial reports infrequently, or long after the period covered in the reports.

D)   Not all countries enforce regulations with enough vigor to ensure reliable financial statements.

The correct answer was A)

Many accountants have said that U.S. financial-reporting rules are arcane and confusing compared to other countries’ rules. The other statements are accurate and support Quayle’s assertion about the difficulty of analyzing foreign financial reports relative to U.S. reports.

6.Which of the following characteristics is least likely to indicate a market in which investors can earn high returns?

A)   A Herfindahl index value of more than 0.2.

B)   Moderate bargaining power for buyers.

C)   A government that tends to intervene.

D)   Substantial barriers to entry.

The correct answer was C)

A Herfindahl index value of more than 0.2 suggests a market or industry is not too competitive. In such markets, it is easier for individual companies to generate profits and for investors in such companies to earn superior returns. Markets with strong barriers to entry or in which buyers do not have a lot of bargaining power are also likely to provide high returns. Government intervention is a more difficult issue. Sometimes it boosts investment returns, sometimes it hurts them. Intervention does not necessarily mean assistance.

7.If the U.S. adopted the IAS treatment of financial leases, what would happen to the average company’s:

A)     Decrease                              No change

B)     Increase                                Increase

C)     Decrease                              Increase

D)     Increase                               No change

The correct answer was D)

IAS requires all leases to be capitalized. As such, if the U.S. adopted IAS guidelines, all operating leases, which are currently reflected on the income statement as an expense, would instead move to the balance sheet, where they would be recorded as assets and liabilities. The lack of lease expense would increase profits, which would in turn raise ROE. Since in most cases leases are accounted for as long-term assets and liabilities, there would be no change in current ratios.

8.Quayle’s statement about economic growth is indicative of which of the following theories?

A)   Neoclassical growth.

B)   Keynesian economics.

C)   Classical growth.

D)   Endogenous growth.

The correct answer was D)

The endogenous growth theory holds that innovation and increased efficiency can keep an economy growing at a rate higher than the theoretical long-run steady state.

9.In the quiz Quayle gave to his 9 a.m. class, which business-cycle stages are most likely being described?

A)     Recession                               Late upswing

B)     Economy slows                      Recovery

C)     Economy slows                     Early upswing

D)     Recession                               Late upswing

The correct answer was C)

During the start of the economic slowdown, interest rates often decline, boosting bond prices and lifting interest-sensitive stocks. Rates often fall during the recession as well, but bonds don’t normally perform well during that stage. Real estate is most attractive in the early stage of the upswing. That is also the period in which we are likely to see the strongest gains in consumer confidence.