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Series 86 c questions and answers verified 2024
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Series 86 c questions and answers verified 2024
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Series 86 - Exam 5EV-to-sales would be the appropriate multiple to use in which of the following
scenarios?
A- The company is highly leveraged
B- The company has negative cash flow
C- Companies within the sector have significant differences in profit margins
D- The company has high capital expenditures but low depreciation - correct
answer ✔A company that has negative cash flow may be evaluated based on
its enterprise value divided by sales. Since the cash flow is negative,
discounted cash flow valuation is compromised. The negative cash flow may
result from the sale of low profit margin products and a decline in sales. This
is useful when comparing companies that have differences in financial
structure rather than differences in profit margin. For example, Company L
borrows funds on a short-term basis to increase sales and Company C
consistently has a lower level of sales, but has very little debt.
An industry which is dominated by only two companies is defined as an:
A- Monopsony
B- Duopoly
C- Oligopoly
D-Monopoly - correct answer ✔A market controlled by two companies is
defined as a duopoly. A market controlled by a few companies is called an
oligopoly. Monopsony is similar to a monopoly, but differs in that a large buyer
(not seller) controls a large proportion of the market and drives the prices
down.
In order for a business to add value for its providers of capital:
,A - WACC must exceed ROIC
B - There must be an accounting profit
C - ROIC must exceed WACC
D -Taxable income must exceed interest expense - correct answer ✔ROIC in
and of itself is not an effective valuation tool, however, when compared to
another ratio, such as WACC, it can be used to determine if the company is
generating economic value. The ROIC to WACC spread is a measure of the
efficiency and effectiveness of a company's use of capital. The calculated
difference between ROIC and WACC is called economic value added (EVA).
EVA (the ROIC to WACC spread) = ROIC - WACC
Seals buys Croft to become Seals and Croft by issuing shares. Croft has 15
million shares outstanding and Seals has 12 million. The consolidated
financial statement will combine all of the following, EXCEPT for:
A- Expenses
B- Revenue
C- Assets
D- Shares - correct answer ✔Croft will prepare financial statements that
combine the revenue and expenses of the two companies, as well as assets
and liabilities. However, in the takeover, Croft's shares will disappear as Seals
will be the surviving company. The share count will reflect Seals' already
outstanding amount plus the amount Seals issued to buy Croft.
If an operating lease is compared to a finance lease, which of the following
statements is TRUE?
A- Net liabilities are larger for an operating lease.
,B- Net assets are smaller for an operating lease.
C- Net income is higher for a finance lease.
D- Both types of leases increase assets. - correct answer ✔Both operating
and finance leases lead to an increase in assets. Specifically, they increase
an asset that's referred to as "right of use (ROU)." Operating lease payments
are recorded once on a company's income statement as an operating
expense. Finance leases payments are broken into an amortization cost and
an interest expense. Since the interest portion of a finance lease payment is
not an operating expense, operating income will be higher if a company has a
finance lease.
Which TWO of the following choices would represent negative factors
influencing Company X's share price and P/E ratio?
A- Company X announces an acquisition of Company C, which is expected to
be neutral on net income through an exchange of common stock.
B- Company X purchases $500,000,000 of short-term debentures.
C- Company X issues $500,000,000 of short-term debentures.
D- A competitor of Company X announces a share buyback plan. - correct
answer ✔Since the acquisition of Company C is neutral on net income, it is
neither accretive nor dilutive, but it would increase the number of shares
outstanding. This will have a dilutive effect on the EPS and would initially bring
about a higher P/E ratio for Company X. The issuance of short-term debt will
increase the expenses of Company X, reducing its earnings. This too would
change the P/E ratio of Company X. An investment in short-term debt and
cash equivalents maintains liquidity for a company and would have no effect
on the company's share price or P/E. A competitor's repurchase of shares
may be intended to reduce the competitor's outstanding shares and increase
EPS to bring its P/E in line with the company's peer group. This would not
affect Company X's share value or P/E.
Under the equity method of accounting:
, A- Only dividends are recognized by shareholders
B- Revenues are consolidated
C- Profits and losses are absorbed on a proportionate basic
D- It is used only if 100% of another business is purchased - correct answer
✔The equity method of accounting means that profits and losses are
absorbed on a proportionate basic. If Shipbottom Corp owns 22% of
Lighthouse shares, Shipbottom absorbs 22% of Lighthouse's income or loss
on its books as Other Income or Loss. This method is used when ownership is
between 20% and 50%.
The residual income valuation method is useful in all of the following
circumstances, EXCEPT:
A- The company's free cash flow cannot be calculated
B- The company has inconsistent cash flows
C- The company does not pay dividends
D- Accounting information is not available - correct answer ✔Some of the
strengths of using the residual income method of valuation are that it can be
used when a company's free cash flow cannot be calculated, when cash flows
are inconsistent and when the company does not pay a dividend. The residual
income method relies on available accounting data.
When the focus is on the equity value of a company, residual income can be
calculated by taking net income and subtracting a charge for the equity cost of
capital (i.e., Net Income - [Equity x Cost of Equity]). When evaluating a firm
based on its total capital, residual income can be calculated by taking net
operating profit after tax (NOPAT) and subtracting a charge for the weighted
average cost of capital (i.e., Residual Income = NOPAT - [Total capital x
WACC]). When residual value is positive, economic value is added (EVA).
When residual value is negative, economic value is destroyed.
Which of the following choices constitutes financial leverage?
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