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Series 86 d questions with complete solutions 2024
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Series 86 d questions with complete solutions 2024
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Series 86 - Exam 3Which of the following is the BEST metric to analyze profitability between
companies and industries?
A-EBITDA
B- EBIT
C- Interest coverage ratio
D -Working Capital - correct answer ✔Since EBITDA adds back depreciation
and amortization (D&A) to earnings before interest in taxes (EBIT), it
neutralizes the difference in accounting decisions between firms and
industries. In other words, EBITDA can more easily be compared between
companies than EBIT. The interest coverage ratio and working capital are not
profit measures.
Company X's earnings have risen by 15%, while the earnings of the suppliers
used by Company X have declined by 5%. Which of the following is the most
relevant to the forward earnings projections of Company X?
A- Review Company X's Form 10-K.
B- Interview the distributors of Company X's product.
C- Interview the suppliers to Company X.
D- Interview the companies with the largest market share in the same sector
as Company X. - correct answer ✔Interviews with the distributors will provide
an idea of where the company will be in sub- sequent quarters. This will help
to determine if the distributors are experiencing shrinking margins and/or if
costs are increasing. Interviewing suppliers would only allow an analyst to
determine potential costs to be passed on to Company X. Interviewing the
companies with largest market share in the same sector is somewhat limited.
It's an overview of the sector perceptions. Lastly, a review of Company X's
,financial statements will only provide the historic results of the company. It
doesn't provide the best gauge to project future results.
Revenue recognition under the percentage-of-completion method recognizes
revenues and expenses:
A- At the end of the contract
B- As a percentage of the work to be completed
C- On the basis of work certified
D- In proportion to the work completed - correct answer ✔The percentage-of-
completion method of revenue recognition recognizes revenues and expenses
in proportion to the work completed.
While performing analysis, it is discovered that interest income, interest
expense, and working capital have all increased during the past fiscal year.
An explanation for these events might be that there was a:
A- Retirement of bonds, through purchase, in the secondary market
B- Conversion of debentures
C- Public offering of bonds, the proceeds of which were invested in short-term
instruments
D- Public offering of common stock - correct answer ✔The rise in interest
expense implies an issuance of bonds. The rise in interest income implies
increased investment in interest-bearing instruments. This is consistent with
an increase in working capital.
A good measure of analyzing the ability of a company to pay off its debt is its:
A- Debt-to-equity ratio
,B- Cost of debt
C- Debt-to-EBITDA ratio
D- Debt-to-total capitalization ratio - correct answer ✔The debt-to-EBITDA
ratio is calculated by adding short-term and long-term debt and dividing by the
earnings before interest, taxes, depreciation, and amortization (EBITDA). The
ratio that results is an indication of the company's leverage; that is, the higher
the ratio, the greater the leverage. A high ratio is an indication of a greater
likelihood that a company may default on its debt. A low ratio is an indication
that a company may incur additional debt, without a significant increase in the
risk of default. The debt-to-equity and debt-to-total capitalization ratios
measure debt capital, but not a company's ability to pay it off.
In a mature company, if WACC increases, which of the following results would
be expected?
A- The terminal value decreases and the valuation of the company increases
B- The terminal value decreases and the valuation of the company decreases
C- The terminal value increases and the valuation of the company decreases
D- The terminal value and company value remain the same - correct answer
✔If the weighted average cost of capital (WACC) increases, the valuation of a
company (including terminal value) decreases. Using a DCF approach in
calculating the terminal value, the formula is, the last expected cash flow /
(WACC - terminal growth rate). If WACC increases, the terminal value would
decline. Since the valuation of the company is based upon the terminal value,
it would also decline.
A cyclical company is characterized by which TWO of the following situations?
I. Continuous revenue growth
II. Erratic sales trends
III. Peak profitability toward the latter stages of an expansion
IV. Revenue concentrated around winter holidays
, A- I and III
B- I and IV
C- II and III
D- III and IV - correct answer ✔The revenue of a cyclical company is not
concentrated around any particular time period. However, sales can increase
dramatically during an expansion, but flatten or even drop during an economic
contraction. Cyclical industries include automobiles, rubber, steel, paper,
homebuilding, and cement.
Company X intends to increase operating cash flow under generally accepted
accounting principles. This would be accomplished through:
A- A reduction of current assets
B- A reduction of current liabilities
C- Lowering capital expenditures
D- The sale of an investment - correct answer ✔Operating cash flow is part
of the Statement of Cash Flows. It may be described as revenues minus
operating expenses. If current assets decline, this is a source of cash for the
company. For example,if balance sheet entries for inventories decline from
Period 1 to Period 2, this reduction of inventory indicates increased cash flow
due to the sale of the inventory. The same would be true of a reduction of
accounts receivable. Conversely, a decline in current liabilities indicates a use
of cash. Lower capital expenditures would be part of investing cash flows. The
sale of an investment would increase investment cash flows, rather than
operating cash flows.
If Company A has a lower gross margin than Company B, but both companies
have an identical EPS, you would conclude:
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