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12.  An analyst gathers the following information about 2011 actual results for a company and its projected sales, COGS, and assets for 2012: 2011actual 2012projected Sales ￡9,000,000 ￡9,900,000 COGS ￡3,000,000 ￡3,450,000 Total assets ￡4,500,000 ￡4,450,000 Current assets ￡1,800,000 Current liabilities ￡1,200,000 Based on the projected sales increase, the best estimate of 2010 projected current assets is closest to: A. ￡1,890,000. B. ￡1,980,000. C. ￡2,070,000.

Ans: B. Current assets are sales driven and hence would be expected to increase by 10%, the same amount as sales. The increase is sales is (9,900,000-9,000,000)/9,000,000=10%. Therefore, projected current assets are 1.10x1,800,000=1,980,000

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11. As a result of a change in strategy to selling differentiated products at premium prices, a company’s gross margin ratio increased by 5% (i.e., from 35% to 40%). The most likely effect on the company’s operating margin ratio as a result of the change in strategy would be an increase: A. equal to 5%. B. less than 5%. C. greater than 5%.

Ans: B. A strategy of selling differentiated products at premium prices usually requires additional advertising or research and development to support the differentiating features, therefore, the effect on operating profit is normally less than the effect on gross profit margin.

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10. Selected information about a company is as follows: ($’000) 2012 31 December 2013 projection Sales 2,200 2,500 Variable operating cost (% of sales) 28% 30% Fixed operating costs 1,400 1,400 Tax rate 25% 25% Dividends paid 55 60 Interest bearing debt at 5% 500 500 The forecasted net income (in ‘000) for 2013 is closest to: A. $169. B. $202. C. $244.

Ans: C. Net income is calculated as follows: Sales $2,500 Given Variable operating cost (750) 30% of sales Fixed operating costs (1,400) given Interest expense (25) 0.05x500 average debt Earnings before taxes 325 Taxes (81.25) 25%of EBT NI $243.75

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9. At the beginning of a year, Company X has opted to sell all of its $450,000 of receivables to finance a reduction in its long-term debt. The receivables and the risk of default are transferred at 80% of their book value. The debt reduction will reduce interest expense from $50,000 to $25,000 per year. The effective tax rate is 30%. Assuming that the current year’s EBIT is $142,500, at the end of the year, the results of the receivables sale will be an interest coverage ratio closest to: A. 1.1X. B. 2.1X. C. 3.1X.

Ans: B. Post-sale Original EBIT $142,500 Loss on receivables (90,000) Revised EBIT 52,500 Interest expense 25,000 Interest coverage = EBIT / Interest expense                              = 52,500 / 25,000 = 2.10 X

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8. The 2012 income statement for a subject company is as follows: ($millions) 2012 Net sales $475.0 COGS 294.5 SG@A expenses 118.8     Operating earnings 61.7 Interest expense 7.2     Earnings before tax 54.5 Income tax expense 21.8     Net income 32.6 For 2013, net sales are projected to increase by 12%, gross profit margin is expected to increase by 2% while SG&A expenses as a percent of net sales is expected to remain constant, total debt is not expected to change, and the effective tax rate is expected to remain constant. Based on the above information, the company’s 2013 projected net income (in millions) is closest to: A. $33. B. $44. C. $55.

Ans: B. Projected 2013 net income is determined as follows: ($millions) 2012 2013E Net sales $475.0 $532.0 ($475.0x1.12) COGS 294.5 319.2 (0.60 of net sales) SG@A expenses 118.8 133.0 (0.25 of net sales)     Operating earnings 61.7 79.8 Interest expense 7.2 7.2 (no change)     Earnings before tax 54.5 72.6 Income tax expense 21.8 29.0 (EBT X 0.40)     Net income 32.6 43.6 NOTE: 2% increase in gross profit margin means that COGS percentage drops by 2%.

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7. Kim Lee, CFA, is trying to forecast net income for Robinson’s Ltd, a chain of retail furniture outlets. He has prepared the following common sized data from their recent annual report and has estimated sales for 2013 using a forecast model his firm developed for consumer goods. 2013 forecast 2012 actual 2011 actual Sales $millions 2,250 2,150 1,990 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 0% 7.2% Pre-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. The projected net income (in $ millions) for 2008 is closest to: A. 110.1. B. 162.8. C. 167.4.

Ans: C. The COGS and operating expenses are relatively constant over the tow-year period and averages of then can reasonably be used to forecast 2013. 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 (2007=$80, 2006 +$80) 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, 30%, is given. Sales $2,250.000 COGS (45%) 1,012.50 Operating expenses (40%) 900.00 Interest expense 80.00 Pretax margin $257.50 Tax (35%) 90.10 Net income $167.40

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6. An analyst uses a stock screener and selects the following metrics: a global equity index, P/E ratio lower than the median P/E ratio, and a price-book value ratio lower than the median price-book value ratio. The stocks so selected would be most appropriate for portfolios of which type of investors? A. Value investors. B. Growth investors. C. Market-oriented investors.

Ans: A. Value investors look for relatively cheap stocks, so they often use relative valuation methods such as P/E and P/BV criteria. Metrics such as low P/E and low price-book are aimed at selecting value companies; therefore the portfolio is most appropriate for value investors. B is incorrect. Growth investors typically look for growing earnings, and some refine that further to accelerating growth in earning. C is incorrect. Market-oriented investors look for securities in which they can make an excess return regardless of the style.

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5. When analyzing a company that prepares its financial statements according to U.S. GAAP, calculating the price/tangible book value ratio instead of the price/book value ratio is most appropriate if it: A. grows primarily through acquisitions. B. develops its patents and processes internally. C. invests a substantial amount in new capital assets.

Ans: A. A company that grows primarily through acquisition will have more goodwill and other intangible assets on its balance sheet than a company with fewer acquisitions or that has grown internally. To provide for comparisons with companies that do not follow such a growth strategy, an analyst would remove all intangibles and focus on tangible book value.

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4. An equity manager conducted a stock screen on 5,000 U.S. stocks that comprise her investment universe. The results of the screen are presented in the table below. Criterion % of Stocks Meeting Criterion Price per share/Sales per share <1.25 35.0 Total asset/Equity ≤ 2.5 48.2 Dividends >0 58.6 Consensus forecast EPS >0 75.0 Meeting all 4 criteria simultaneously 10.8 If all the criteria were completely independent of each other, the number of stocks meeting all four criteria would be closest to: A. 293. B. 371. C. 540.

Ans: B. If the criteria are independent of one another, the probability that all will occur is the product of the individual probabilities (Multiplication Rule for Independent Events), i.e., 0.35 x 0.482 x 0.586 x 0.75 = 0.074, or 7.4%, which would produce 371 meeting the criteria, i.e., 7.4% x 5,000.

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3. An equity analyst is forecasting the next year’s net profit margin of a heavy equipment manufacturing firm, by using the average net profit margin over the past three years. In making his profit projection, he is concerned about the following three items: · The company suffered losses from discontinued operations in each of the past three years. · The most recent year’s tax rate was only one half the prior two years’ rate as a result of a fiscal stimulus. · The company experienced gains on the sale of investments in each of the past three years. Which of the following statements about the preparation of the forecast is most accurate? The analyst would: A. use the most recent tax rate because that is the best predictor of future tax rates. B. exclude the gains on the sale from investments because the company is a manufacturing firm. C. include the discontinued operations because they appear to be an on-going feature for this company.

Ans: B. The company is a heavy equipment manufacturer - since gains on investments is not a core part of its business, they should not be viewed as an ongoing source of earnings. A is incorrect. The change in the current tax rate is best viewed as temporary (in the absence) of additional information and should not be the basis of the calculation of the average tax rate. C is incorrect. Discontinued operations are considered to be nonrecurring items (even though they have occurred in the past three years); they are normally treated as random and unsustainable and should not be included in a short-term forecast.