ACCT Ch.15

Question 1

No income or loss can arise between ____

Answer 1

the firm and its owners

Question 2

____ are not expenses that reduce net income

Answer 2

dividend payments to shareholders

Question 3

___ equity shares sold to investors

Answer 3

common stock

Question 4

___ the shareholders potential loss is limited to the original purchase price of the common stock

Answer 4

limited liability

Question 5

common stock conveys ____ and ____

Answer 5

ownership

limited liability

Question 6

____ per share dollar amount printed on each stock certificate

Answer 6

par value

face value

Question 7

___ when a corporation buys back its own shares and holds them for later use

Answer 7

treasury stock

Question 8

What are the 5 reasons why firms reacquire their own stock?

Answer 8

• employee stock option redemption
• company shares are undervalued
• distribute surplus cash to shareholders
• offset share dilution
• boost EPS

Question 9

Why would a company want to boost EPS?

Answer 9

camouflage business slowdowns

Question 10

Reasons why shareholders would sell their stock back to firms

Answer 10

• capture a price premium

- lower tax rate

Question 11

Reasons why shareholders wont sell their stock back to firms

Answer 11

capture an above market return on their investment

Question 12

___ the amount over and above the cash needed for day to day operating activities

Answer 12

surplus cash

Question 13

How can surplus cash be a problem for management?

Answer 13

an investor man use the company’s own cash surplus to partially finance a hostile takeover

Question 14

How can surplus cash be a problem for investors?

Answer 14

management might spend the surplus on unprofitable projects and lavish “perks”

Question 15

What are the 3 benefits of preferred stocks to investors?

Answer 15

• holders must be paid their dividends in full before a distribution to common shareholders
• if the company is liquidated, preferred holders must receive cash or other assets at least equal to the par value of their shares before any assets are distributed to common holders
• tax incentives

Question 16

preferred share dividends are expressed as ____

Answer 16

a percentage of the stated value

Question 17

What is a disadvantage of preferred stock to investors?

Answer 17

they hold no voting rights

Question 18

What are the 3 reasons why corporations issue preferred stock?

Answer 18

• less risky than debt
• treated as equity rather than debt on financial statements
• a new source of money for companies who no longer have tax advantages from loss

Question 19

___ requires the issuing company to retire it (as with debt) at some future date– 5-10 years

Answer 19

mandatory redeemable preferred stock

Question 20

many consider mandatory redeemable preferred stock to be ___

Answer 20

debt disguised as equity

Question 21

____ the issuing company has the option, but not the obligation, to redeem

Answer 21

redeemable preferred stock

Question 22

The SEC requires companies to differentiate between ____ on the balance sheet

Answer 22

common and preferred stock

Question 23

GAAP requires companies to disclose the dollar amount of ____ for each of the 5 years following the BS due date

Answer 23

preferred stock redemption requirements

Question 24

___ law governs corporate dividend distributions to shareholders

Answer 24

state law

Question 25

Why does the law govern dividend distribution to shareholders?

Answer 25

with the intent to prohibit companies from distribute excessive assets to owners and becoming incapable of paying creditors

Question 26

___ used to evaluate day to day valuation of a firm

Answer 26

earnings per share

Question 27

___ exists when a company has no convertible securities and no stock options or warrants outstanding

Answer 27

simple capital structure

Question 28

When a company has a simple capital structure, it uses ____ to make day to day valuations

Answer 28

basic EPS

Question 29

How do you find basic EPS?

Answer 29

EPS=(NI-preferred dividends)/weighted average# of common shares

Question 30

___ exists when a firms financing includes either securities that can be converted into common stock or options and warrants that entitle holders to obtain common stock under specified conditions

Answer 30

complex capital structure

Question 31

___ corporate securities, usually in the form of preferred shares, that are exchangeable for other securities such as common shares at the option of the securities holder

Answer 31

convertables

Question 32

convertibles increase the likelihood that ___

Answer 32

additional common shares will be issued in the future

Question 33

Companies with a complex capital structure must use ___ to make day to day valuations

Answer 33

diluted EPS

Question 34

___ once additional common shares are issued, those who did not receive any of the new shares own a smaller slice of the company

Answer 34

potencial dilution

Question 35

What are 3 reasons why EPS can be misleading?

Answer 35

• managers can distort reported earnings (EPS numerator)
• stock repurchase can be used to distort EPS denominator
• EPS ignores the capital required to generate reported earnings

Question 36

___ gives the right, but not the obligation, to purchase stock at a specified price within a certain time period

Answer 36

stock option

Question 37

___ the specified price, usually equal or higher than the market price of the shares at the time the option is issued

Answer 37

exercise price

Question 38

When the excise price exceeds the current share price, the stock option is____

Answer 38

“out of money”

Question 39

What are 3 reasons why companies use stock options for compensation?

Answer 39

• to align employee and owner’s interest
• start ups and high growth companies may be cash starved
• tax savings

Question 40

What question is at the heart of the stock option debate?

Answer 40

should stock options be recorded as a current years expense or when the employee receives cash?

Question 41

What are the 5 pro expense stock option arguments?

Answer 41

• 75% of executive pay are options
• more accurate
• there are some costs involved
• wont get $ from selling stock
• executives have incentives to pump up stock price for short run maneuvers

Question 42

What are the 5 non-expense stock option arguments?

Answer 42

• no cash outlay
• no universal standard for evaluating option
• valuations are based on assumptions and estimates
• used for aligning interests of managers and shareholders
• tech firms and innovation depends on options

Question 43

What is the current GAAP requirements for stock options?

Answer 43

requires firms to record options as compensation expense at grant date value

Question 44

Stock options have declined since ____

Answer 44

2000

Question 45

___ shares issued to employees that can be sold only in the future after the stock vests (lets say 3 years)

Answer 45

restricted stock

Question 46

What is a popular alternative to stock options?

Answer 46

restricted stock

Question 47

If an employee with a restricted stock leaves the company during the vesting period, what happens?

Answer 47

they lose their shares