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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.

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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.

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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.

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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.

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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

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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.

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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

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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.

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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.

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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.

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