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Securities Analysis > Final Exam Ch 18-19 > Flashcards

Final Exam Ch 18-19 Flashcards

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SIE Exam flashcards
1
Q

4 broad classes of expenses

A

1 cost of goods sold
2 general and administrative
3 interest expense
4 taxes (state and federal)

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2
Q

Cost of goods sold is a direct cost attributable to…

A

Producing product sold by the firm

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3
Q

General and administrative…4

A

1 overhead expenses
2 salaries
3 advertising
4 other operating expenses

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4
Q

Economic earnings

A

Sustainable cash flow that can be paid out to stockholder’s

Without impairing productive capacity of the firm

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5
Q

Accounting earnings are affected by several…

A

Conventions regarding valuation of assets

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6
Q

Accounting earnings are affected by several conventions regarding the valuation of assets such as…2

A

1 inventories (FIFO, LIFO)

2 depreciation

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7
Q

The net income figure on the firm’s income statement conveys considerable information concerning a firms prospects. We see this when stock prices…

A

Rise after beating earnings

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8
Q

Common size balance sheet

A

Each item presented as percentage of total assets

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9
Q

The statement of cashflows will reveal a developing problem when it shows that…2

A

1 cash flow from operations is inadequate and

2 borrowing is used to maintain dividend payments at unsustainable levels

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10
Q

Cash flows are less smooth than accounting profits because…4

A

1 capital expenditures
2 depreciations
3 taxes
4 FIFO AND LIFO

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11
Q

2 broad activities that are the responsibility of firm’s financial managers

A

1 investment decisions

2 financing decisions

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12
Q

Investment or capital budgeting decisions pertain to…

A

Firms use of capital in business activities it is engaged in

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13
Q

Investment decisions 4

A

1 profitability
2 measurement of profitability
3 risk
4 opportunity cost of funds to pay for projects

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14
Q

Financing decisions 3

A

1 enough financing to meet needs for growth
2 does financing rely to heavily on debt
3 is there sufficient liquidity to meet unexpected cash needs

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15
Q

Efficiency is typically assessed using…

A

Several turnover ratios

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16
Q

What ratio assesses profitability of sales?

A

Profit margins

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17
Q

What 2 ratios asses whether leverage is excessive?

A

1 debt ratios

2 coverage ratios

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18
Q

4 ratios that assess if liquidity is sufficient?

A

1 current
2 quick
3 cash
4 net working capital

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19
Q

EBIT is equivalent to the…

A

Total operating income of the firm

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20
Q

ROA tells us the…

A

Income earned per dollar deployed

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21
Q

ROC tells us…

A

Income earned per dollar of long term capital invested in the firm

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22
Q

Whereas ROA and ROC measure profitability relative to funds raised by both debt and equity, ROE focuses only on…

A

Profitability of equity investments

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23
Q

ROE equals net income realized…

A

By shareholders per dollar they have invested in the firm

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24
Q

ROE is one of the two basic factors in determining…

A

A firm’s growth rate of earnings

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25
Q

Sometimes it is reasonable to assume that future ROE will approximate…

A

It’s past value

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26
Q

A high ROE does not necessarily imply…

A

A firm’s future ROE will be high

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27
Q

A declining ROE is evidence that…

A

The firm’s new investments have offered a lower ROE than its past investments

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28
Q

Expectations of future dividends and earnings determine…

A

Intrinsic value of company’s common stock

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29
Q

If ROA exceeds the borrowing rate the firm…

A

Earns more on money it pays to creditors

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30
Q

Increased debt will make a positive contribution to a firm’s ROE only if…

A

The firm’s ROA exceeds the interest rate on debt

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31
Q

Financial leverage increases…

A

Increases risk of equity returns

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32
Q

Presence of debt makes ROE…

A

More sensitive to the business cycle

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33
Q

If EBIT is equal for 2 companies they have…

A

Equal business risk

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34
Q

If 2 companies have equal business risk, but one company has higher debt, that company bears greater financial risk because, the firm’s…

A

Business risk is absorbed by a smaller base of equity investors

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35
Q

As financial leverage increases the risk of the firm’s equity, it raises the expected ROE but a…

A

Higher discount rate will offset the higher expected earnings

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36
Q

A firm’s should only be viewed as successful if the return on its projects is…

A

Better than investors could earn themselves in the capital market

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37
Q

Plowing back funds into the firm increases stock price only if the firm earns a…

A

Higher rate of return on reinvested funds than the opportunity cost of capital

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38
Q

Another name for opportunity cost of capital

A

Market capitalization rate

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39
Q

Economic value added is the spread between

A

ROC and k multiplied by capital invested in the firm

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40
Q

Symbol for opportunity cost of capital

A

k

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41
Q

Economic value added measures the…

A

Dollar value of the firm’s return in excess of its opportunity cost

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42
Q

Another term for EVA

A

Residual income

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43
Q

EVA treats opportunity cost of capital as a real cost that like other costs should be…

A

Deducted from revenues to arrive at a more meaningful bottom line

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44
Q

DuPont system helps analysts…

A

Deconstruct ROE over time and evaluate its performance compared to competitors

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45
Q

The higher the degree of financial leverage, the…

A

Lower the interest burden

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46
Q

High interest coverage ratio indicates that the…

A

Likelihood of bankruptcy is low

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47
Q

Times interest earned aka interest coverage is widely used by lenders and borrowers in determining…2

A

1 firm’s debt capacity

2 firm’s bond rating

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48
Q

Firm’s would love to have high values for both…2

A

Margins and turnover

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49
Q

Comparing margins and turnover in isolation is only useful…

A

For firm’s in same industry using similar strategies

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50
Q

Industries with high turnover tend to have lower price margins such as…2

A

Groceries or retail apparel

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51
Q

Industries with high profit margins tend to have low turnover such as…

A

Utilities

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52
Q

Fixed asset turnover ratio measures…

A

Sales per dollar of firm’s money tied up in fixed assets

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53
Q

When a ratio takes an item from the income ate net and an item from the balance sheet, common practice is to…

A

Take the average of the balance sheet item of the beginning and end of year amount

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54
Q

Inventory turnover measures the…

A

Speed at which inventory is turned over

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55
Q

Another name for days sales in receivables

A

Average collection period

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56
Q

A higher days sales receivables than the industry average implies…2

A

Higher investment in working capital and

Ultimately a lower ROA

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57
Q

Coverage ratios compare various measures of…

A

Earning power against card flow needed to satisfy debt obligations

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58
Q

The current ratio measures the ability of the firm to…

A

Pay off current liabilities by liquidating current assets

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59
Q

Another name for the quick ratio

A

Acid test ratio

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60
Q

Some analysts consider a stock with a low market to book value a…

A

Safer investment

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61
Q

A low market to book value is seen by some as…

A

Providing a margin of safety

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62
Q

Firm’s with greater growth opportunities will tend to exhibit…

A

Higher multiples of market price to book value

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63
Q

Market price to book value is determined in large part by…

A

Growth prospects

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64
Q

Low PE stocks have generally been…

A

Positive alpha investments using CAPM as a return benchmark

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65
Q

Financial ratios for industries are published by the…3

A

1 US department of commerce

2 dun and bradstreet (industry norms and key business ratios)

3 risk management association (RMA) (Annual statement studies)

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66
Q

What ratios tend to be more stable over time?2

A

Asset turnover

Total debt ratio

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67
Q

What 2 ratios tend to be more sensitive to business conditions?

A

1 ROA

2 ROE

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68
Q

The impact of inflation on reported results often depends on…

A

Particular method firm adopts for inventories and depreciation

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69
Q

Sources for non comparability of financial statements…6

A 
1 Inflation
2 depreciation
3 inventories
4 capitalization of leases and other expenses
5 treatment of pension costs
6 allowances for reserves
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70
Q

Under LIFO, the last goods produced are the first ones to be sold they are…

A

Valued at today’s cost

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71
Q

FIFO assumes that units used up or sold are the ones added to inventory first, so goods sold should be valued at…

A

Original cost

72
Q

If inventory $1 million dollars of inventory under LIFO, where cost of inventory rises by 10%, what is cost of goods sold under LIFO, what is inventory?

A

Cost of goods sold = $1.1 million

Inventory = $1 million

73
Q

In an inflationary environment, LIFO, cost of goods sold is…

Inventory is…

A

Cost of goods sold is accurate

Inventory is understated

74
Q

If inventory $1 million dollars of inventory under FIFO , where cost of inventory rises by 10%, what is cost of goods sold under FIFO, what is inventory?

A

Cost of goods sold is $1 million

Inventory is $1.1 million

75
Q

LIFO is preferred over FIFO for…

Why?

A

Computing economic earnings

Because it uses up to date prices to compute cost of goods sold

76
Q

ROE, is distorted (overstated) by LIFO because…

A

Inventory is value At original cost

77
Q

According to the economic definition, depreciation is the…

A

Amount of a firm’s operating cashflows that must be reinvested in firm to sustain real productive capacity at the current level

78
Q

Accounting measurement of depreciation is the amount of original acquisition cost of the asset that is…

A

Allocated to each accounting period over arbitrarily specified life of the asset

79
Q

Accounting will overestimate depreciation in…

A

The first half of the assets life and underestimate in second half of assets life

80
Q

Most firm’s use accelerated depreciation for…

They use straight line for…

A

Tax purposes

SL for financial reporting purposes

81
Q

Measured depreciation in periods of inflation is…

Real economic income is correspondingly…

A

Understated relative to replacement cost

Correspondingly overstated

82
Q

Inflation can cause a distortion in the measurement of a firm’s inventory and depreciation cost, it has an even greater effect on calculation of…

A

Real interest expense

83
Q

Mismeasurement of real interest means inflation…

A

Deflates the computation of real income, understating the firm’s real income

84
Q

Fair value accounting AKA mark to market accounting

A

Measure assets at fair value (instead of historical cost)

85
Q

Level 1 assets are…

A

Traded in active markets and should be valued at their market price

86
Q

Level 2 assets are…

A

Not actively traded but their assets can be estimated using observable market data of similar assets

87
Q

Level 3 assets are…

A

Hardest to value because no similar asset data available

Pricing models must be used to estimate intrinsic value

88
Q

Critics of fair value accounting argue that it relies too heavily on…

A

Estimates

89
Q

Firm’s tend to make more aggressive assumptions about returns of define pensions plans, during periods executives are…

A

Actively exercising their stock options

90
Q

Critics argue that mark to market accounting exacerbated the melt down of 2008 by…

A

Forcing banks to excessively write down asset values

91
Q

Quality of earnings

A

Extent to which we might expect reported level of earnings to be sustained

92
Q

Factors that influence quality of earnings:

Allowance for bad debt

A

Unrealistically low allowance for bad debt reduces quality of earnings

93
Q

Factors that influence quality of earnings:

Nonrecurring items 4

A

1 asset sales
2 effects of accounting changes
3 effects exchange rate movements
4 unusual investment income

94
Q

Factors that influence quality of earnings:

Earnings smoothing

A

Reserving earnings to be released in bad times

95
Q

Factors that influence quality of earnings:

Revenue recognition

A

Channel stuffing recognizing sales too soon

Especially when there is a return policy

96
Q

If you see accounts receivable increase faster than sales…

A

This is a red flag

97
Q

Factors that influence quality of earnings:

Off balance sheet assets and liabilities 2

A

Guaranteeing outstanding debt of another firm must be
Disclosed as a contingent liability

Operating leases

98
Q

Issues with IFRS:

Reserving practices

A

Other countries allow firm’s more discretion in setting aside reserves for future contingencies

99
Q

Additions to reserves result in…

A

Charge against income

100
Q

Issues with IFRS:

Depreciation

A

IFRS uses accelerated depreciation for both tax and financial reporting

Foreign countries are not allowed to report 2 sets of depreciation

101
Q

Because accelerated depreciation is used under IFRS…

A

Reported earnings are lower

102
Q

Issues with IFRS:

Intangibles

A

Treatments of intangibles vary widely under IFRS

103
Q

GAAP is…

A

Rule based

104
Q

IFRS is…

A

Principles based

More general than GAAP

105
Q

In 2010, the SEC allowed large US multinational firms to…

A

Report under IFRS instead of GAAP

106
Q

PEG ratio normalizes…

A

The PE ratio by the growth rate

107
Q

Shareholders Ina firm are sometimes called…

A

Residual claimants

108
Q

Residual claimants means…

A

Value of stake in firm is what’s left after liabilities are subtracted

109
Q

Better measure of a floor for a stock price is, the firm’s…

A

Liquidation value per share

110
Q

Some analysts believe the market value of the firm cannot remain for long too far below its replacement cost, because if it did…

A

Competitors would enter the market

111
Q

Resulting competitive pressure would drive down the market value of all firm’s until they…

A

Fell to replacement cost

112
Q

In the long run the ratio of Tobins q will tend toward…

A

1

113
Q

Intrinsic value (V0) is defined as the…

A

Present value of all cash flows of stock (dividends and stock sale)

114
Q

If intrinsic value of the stock turns out to be lower than the current market price, investors should…2

A

1 buy less than under a passive strategy

2 short the stock

115
Q

The required return k, is also referred to as the…

A

Market capitalization rate

116
Q

There is a similarity between the dividend discount model and the…

A

Bond valuation formula

117
Q

Both the dividend discount model and the bond valuation formula relate price to…

A

Present value of a stream of payments

118
Q

Key differences in dividend valuation model from bond valuation model in case of stocks…3

A

1 uncertainty of dividends

2 lack of fixed maturity date

3 unknown sales price at horizon date

119
Q

Dividend discount model of stock prices states that stock price should equal the…

A

Present value of all expected future dividends in perpetuity

120
Q

The constant growth DDM is only valid…

A

G is less than k

121
Q

If dividends were expected to grow forever at a rate faster than k, the value of the stock would…

A

Be infinite

122
Q

If an analyst derives an estimate of g, that is greater than k, the appropriate model to use is…

A

Multi stage DDM

123
Q

The constant growth DDM implies the stock’s value will be greater…3

A

1 the larger the dividend/share

2 the lower the market capitalization rate, k

3 the higher the expected growth rate of dividends

124
Q

Expected holding period return =

A

Dividend yield + capital gains yield

125
Q

When the growth rate of dividends increases, without reducing the dividend or increasing risk, the stock will increase…

A

And it’s expected return will remain the same

126
Q

If all earnings are paid out as dividends, the firm would…

A

Not grow in value

127
Q

Another implicating of the constant growth model is the stock price is expected to…

A

Grow at the same rate as dividends

128
Q

We can think of the value of the firm as the sum of…2

A

Value of assets already in place + NPV of future investments firm will make

129
Q

PVGO

A

present value of growth opportunities

130
Q

Dividend cuts are usually taken as…

A

Bad news about future prospects of the firm

131
Q

Constant dividend growth DDM formula is based on the simplifying assumption that…

A

Dividend growth rate will be constant forever

132
Q

In early years of firm, when profitable investment opportunities are ample, payout is…

A

Low

133
Q

To value companies with temporarily high growth, analysts use…

A

Multistage version of dividend discount model

134
Q

One way to obtain k is through…

A

CAPM

135
Q

k is also known as the…

A

Market capitalization rate

136
Q

It is important to perform sensitivity analysis when you…

A

Value stocks

137
Q

The PE ratio serves as a useful indicator for…

A

Growth opportunities

138
Q

As PVGO becomes an increasingly dominant contributor to price, the PE ratio can…

A

Rise dramatically

139
Q

PVGO is the ratio of…

A

Firm value due to growth opportunities to value of assets already in place

140
Q

When future growth opportunities dominate the estimate of total value, the firm will command a…

A

High price relative to earnings

141
Q

It is reasonable for a company to have a higher PE if their…

A

EPS grows at a faster rate

142
Q

The PE ratio reflects the market’s…

A

Optimism concerning the firm’s growth prospects

143
Q

The PE ratio increases with…

A

ROE

144
Q

PE ratio increases with higher plow back, b, as long as…

A

ROE exceeds k

145
Q

When ROE is less than the required return, k, investors…

A

Prefer the firm pay out earnings as dividends

146
Q

PE ratios are frequently…

A

Taken as proxies for expected growth in dividends or earnings

147
Q

Lower than average PEG ratios are still seen as…

A

Potential underpricing

148
Q

Riskier stocks will have…

A

Lower PE ratios

149
Q

Riskier firm’s will have…

A

Higher required rates of return (higher k)

150
Q

Pitfalls of PE, the denominator2

A

Comprised of accounting earnings use arbitrary rules

Like historical cost of depreciation and inventory valuation

151
Q

In times of times of high inflation historic cost depreciation and inventory costs will tend to…

A

Underrepresented true economic earnings

152
Q

In times of times of high inflation historic cost depreciation and inventory costs will tend to underrepresent true economic values because…

A

Replacement cost of both goods and capital will rise with

General price levels

153
Q

PE ratios have generally had what relationship with inflation?

A

Inverse relationship

154
Q

The market’s assessment that earnings in high inflation periods are of…

A

Lower quality, warranting lower PEs

155
Q

Earnings management is…

A

Using flexibility of accounting rules to improve the apparent profitability of the firm

156
Q

Pro for a earnings are calculated ignoring…

A

Certain expenses

157
Q

Business cycles cause earnings to…

A

Fluctuate considerably

158
Q

The business cycle causes PE ratios to…

A

Fluctuate

159
Q

There is no way of saying a PE ratio is overly high or low without referring to the company’s…2

A

1 long run growth prospects

2 current EPS relative to long run trend line

160
Q

Some analysts treat price to book value as an indicator of…

A

How aggressively the market values the firm

161
Q

Cash flow is less affected by…

A

Accounting decisions

162
Q

When calculating price to cash flow ratio analysts use either…2

A

1 operating cash flow

2 free cash flow

163
Q

Price to sales ratio is a valuation method used when…

A

The company is not profitable

164
Q

Price to sales ratios can vary markedly across industries because…

A

Profit margins vary widely

165
Q

Free cash flow is cash flow available to firm’s net of…

A

Capital expenditures

166
Q

Free cash flow mode is particularly useful for firm’s that…

A

Pay no dividends

167
Q

What is the rate at which free cash flow is discounted to achieve the value of the firm?

A

The weighted average cost of capital

168
Q

After discounting free cash flow by the weighted average cost of capital to obtain the value of the firm, how do you arrive at the value of equity?

A

Subtract the value of debt

169
Q

Another free cash flow valuation method is to start on free cash flow to equity holders and discount it directly at…

To obtain the…

A

The cost of equity

To obtain the market value of equity

170
Q

Free cash flow models use a terminal value to…

A

Avoid adding present values of an infinite sum of cash flows

171
Q

Terminal value may simply be the present value of a…

A

Constant growth perpetuity

172
Q

Terminal value may be based on a multiple of either…4

A

1 EBIT
2 book value
3 earnings
4 free cash flow

173
Q

Equity beta will decline each year the firm…

A

Reduces leverage

174
Q

Equity betas reflect both…

A

Business risk and financial risk

175
Q

Free cash flow model is consistent with and should provide the same estimate as…

A

The dividend discount model

Securities Analysis (4 decks)

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