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Series 86,., Questions and answers verified 2024
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Series 86,., Questions and answers verified 2024
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Series 86What does it mean to have aggressive accounting? - correct answer
✔Aggressive accounting refers to a practice of reporting lower expenses and
higher income or to overstate assets while understating liabilities. With regard
to accounting practices, using a low discount rate is conservative and using a
higher discount rate is aggressive.
Which two of the following events will affect EPS and P/E ratio if the price of
common stock remains unchanged after the event?
I. acquiring a company that is neutral to earnings
II. Issuing debt at a rate that is lower than WACC
III. Issuing debt to build an office complex
IV. Purchasing debt at a rate that is below WACC - correct answer ✔Answer
II and IV
Explanation: Issuing debt at a rate that is lower than WACC will cause an
increased interest expense which will lower EPS and raise P/E. Purchasing
debt at a rate that is below WACC will increase interest income and EPS and
lower P/E. Acquiring a company that is neutral to earnings will not have an
impact on EPS or P/E. Finally for issuing debt to build an office complex is
actually capitalized on the balance sheet (maybe the interest expense to get
the complex ready actually goes into the cost of preparing the land which then
is depreciated over time).
What Beta is used in the CAPM/WACC calculation? - correct answer
✔Levered Beta. So if you are given an unlevered industry beta you must lever
it. This is done by multiplying it by (1 + ((1-tax rate)*Debt/Equity)). Debt and
Equity are the debt and equity of the company.
When would sum of the parts valuation be applicable? - correct answer
✔Sum of the parts analysis is applicable when two business units have very
distinct business functions. The key is that sum of the parts should be used
, when different valuation methods are appropriate for two distinct sectors
within a business.
Percentage completion method - correct answer ✔Requires first years
income to be computed by multiplying the contract price by the ratio of first
years costs to estimated total costs.
If a company's operating margins have increased but the EPS has stayed the
same, what are three things that could have happened to the stock? - correct
answer ✔1. Issued Debt ( this would increase interest expense which is a
below the line expense and therefore operating margin could still increase
while EPS would stay the same)
2. Issue common shares. This would further dilute a higher EPS which was
greater because of the operating margin increase
3. Issue Preferred shares. This would increase the preferred dividend which is
subtracted from net income when calculating EPS and could therefore keep
EPS the same.
How do you calculate the exchange ratio of stock? - correct answer ✔The
stock being purchase (including any premium)/the stock of the company doing
the purchase
You have net income of 5,000,000, preferred dividends of 500,000 and
1,000,000 shares outstanding. The preferred stock is convertible to common
stock at a ratio of 1:1 and the preferred shares were issued at a par of 100
with a 5% yield. What are the basic and diluted EPS numbers - correct
answer ✔Basic 4.50 and that is found by doing:
(5,000,000 - 500,000)/1,000,000 = 4.50
Diluted = 4.50 and this is a unique condition. Because first when you are
calculating diluted EPS the preferred dividends that were once paid out are no
longer paid so in the numerator you have 5,000,000 and in the denominator
you now have 1,100,000. This would cause diluted EPS to be 4.54 but
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