Q&A Hero

Q: With respect to goodwill and acquired intangibles, which of the following is most accurate concerning their treatment in computing ROIC when measuring the competiveness of the underlying business of a company? a) Remove goodwill but not acquired intangibles from the computation. b) Remove acquired intangibles but not goodwill from the computation. c) Do not rRemove neither goodwill nor acquired intangibles from the computation. d) Remove both goodwill and acquired intangibles from the computation.

Q: To measure a company’s ability to create value after paying acquisition premiums, which of the following adjustments should be made? I. Adjust reported goodwill upward to recapture historical amortization and impairments. II. Adjust acquired intangibles upward to recapture historical amortization and impairments. III. Add the hypothetical accrued interest of the notional goodwill principle. a) I and II only. b) II and III only. c) I and III only. d) I, II, and III only.

Q: For a given leased asset using an operating lease, the rental expense will be $2,000 in the next period. The pretax cost of debt is 7.2 percent, and the asset has an expected life of six years. What is the estimated asset value in the current period? a) $8,380 b) $8,640 c) $16,667 d) $21,127

Q: Which of the following are operating liabilities? I. Accounts payable. II. Accrued salaries. III. Deferred revenue. IV. Income taxes payable. a) I and II only. b) II and III only. c) I, III, and IV only. d) I, II, III, and IV.

Q: Which of the following are included in operating current assets? I. Inventory. II. Prepaid expenses. III. Marketable securities. IV. Accounts receivable. a) I, II, and III only. b) I, II, and IV only. c) II, III, and IV only. d) I, II, III, and IV.

Q: List the four basic steps in valuing a company’s common equity using the enterprise discounted cash flow methodology.

Q: Enterprise DCF and economic-profit models differ with respect to the discount rate used to estimate the future income streams.

Q: Preferred stock in well-established companies more closely resembles unsecured debt than equity.

Q: Operating leases represent the most common form of off-balance-sheet debt.

Q: Since employee options represent just the possibility of acquiring stock instead of an obligation, the value of these options should not be factored into estimating the equity value.

Q: When valuing a parent company that owns less than 100 percent of a subsidiary, the minority interest holder of the subsidiary has a claim on the company’s assets.

Q: In the APV approach, why is the unlevered cost of equity used instead of the WACC? a) To account for retained earnings risk. b) To avoid measuring the impact of debt. c) To value the company as if it were all equity financed. d) To incorporate the risk of newly issued shares.

Q: Given the following data, what is the enterprise value of the company? Free cash flow (FCF) for year 1 $50m FCF for year 2 $50m Continuing value of FCF at t = 2 $291.6m Interest tax shield (ITS) for year 1 $5m ITS for year 2 $5m Continuing value of ITS at t = 2 $17.5m Unlevered cost of equity 8% WACC 7% Midyear adjustment factor $4m Excess cash and investments $18m a) $301m b) $285m c) $349m d) $100m

Q: A firm is financed with 62 percent debt and 38 percent equity. The pretax costs of debt and equity capital are 6.6 percent and 11.3 percent, respectively. What is the tax rate if the WACC is 7 percent? a) 31 percent. b) 34 percent. c) 37 percent. d) 64 percent.

Q: Use the following information below to answer the question. NOPLATt+1 = $72.2m NOPLAT growth rate = 3% Return on new invested capital = 11.2% Weighted average cost of capital = 4% Which of the following is closest to the continuing value in year t? a) $1,005m b) $1,201m c) $4,485m d) $6,126m

Q: Given the following information, compute the estimated value per share. a) $5.80 b) $6.04 c) $7.00 d). $7.92

Q: Which of the following valuation methods use(s) the weighted average cost of capital (WACC) as the discount factor? I. The economic profit model. II. The adjusted present value model. III. The discounted cash flow model. IV. None of the above. a) I and II only. b) I and III only. c) II and III only. d) IV.

Q: Which of the following is best to use when valuing a financial institution? a) Enterprise discounted cash flow model. b) Adjusted present value (APV). c) Equity cash flow model. d) Capital cash flow model.

Q: The framework for valuation that compresses free cash flow and the interest tax shield into one number, making it difficult to compare operating performance among companies and over time, is the: a) Discounted economic profit model. b) Capital cash flow model. c) Equity cash flow model. e) Enterprise discounted cash flow (DCF) model.

Q: Explain the “portfolio treadmill” effect and what it means for a firm that wishes to sustain growth.

Q: While the pace of growth can vary greatly across products, the pattern of growth is usually the same for almost all products and services.

Q: The only way to achieve consistently high growth is to consistently find new product markets and enter them successfully in time to enjoy their more profitable high-growth phase.

Q: Average industry revenue growth varies considerably across industries, but the growth rates among companies in the same industry are fairly uniform.

Q: Incremental innovation will rarely create lasting value.

Q: For firms that grew at rates less than 5 percent in the 2000–2003 period, what percentage grew at rates greater than 10 percent in the 2010–2013 period? a) 44 percent. b) 15 percent. c) 13 percent. d) 28 percent.

Q: Which of the following explain the reasons that growth-rate rankings change among industries so much over time? I. The business cycle. II. Changing regulations. III. Fluctuating exchange rates. IV. Product life cycles. a) I and II only. b) I and IV only. c) II and III only. d) III and IV only.

Q: Companies that grow more slowly than 0 percent in one year generally within five years see their growth increase to: a) About 4 percent and then up to 4.5 percent within 10 years. b) About 1 percent and then up to 2 percent within 10 years. c) About 6 percent and then up to 8 percent within 10 years. d) About 8 percent and then up to 10 percent within 10 years.

Q: Companies that grow faster than 30 percent in one year generally within five years see their growth decline to: a) About 4 percent and then down to 2 percent within 10 years. b) About 12 percent and then down to 10 percent within 10 years. c) About 10 percent and then down to 8 percent within 10 years. d) About 8 percent and then down to 6 percent within 10 years.

Q: Which of the following is most accurate concerning the median revenue growth rates of firms over the years 1965 to 2013? a) The range was 1.5 percent to 12 percent, with a median of 7.2 percent. b) The range was 0 percent to 9 percent, with a median of 5.3 percent. c) The range was 2.2 percent to 8.8 percent, with a median of 4.2 percent. d) The range was –0.2 percent to 6.6 percent, with a median of 3.3 percent.

Q: For which situation does additional growth likely create more value? a) High-ROIC company in a mature market. b) Low-ROIC company in a fast-growing market. c) Low-ROIC company in a mature market. d) Medium-ROIC company in a mature market.

Q: Which of the following usually result in above-average value creation? I. Make large acquisitions. II. Attract new customers into the market. III. Convince existing customers to buy more of a product. IV. Make bolt-on acquisitions to accelerate product growth. a) I and II only. b) I, III, and IV only. c) II and III only. d) II, III, and IV only.

Q: Which of the following is true concerning an increase in market share that comes at the expense of established competitors? a) It rarely creates much value for long, except when it results in pushing a competitor out of the market completely. b) It generally creates value for a fairly long period, but it will decay after about 10 years. c) It never creates any value over the long run because the effects are random across firms and net to zero for any given firm over time. d) None of these.

Q: Companies in which of the following industries or sectors have had the lowest growth rates? a) Software. b) IT services. c) Automobiles. d) Health-care equipment.

Q: The strategy of making bolt-on acquisitions to accelerate product sales: a) Has not been proven to create value. b) Can create positive and about average value compared to other strategies. c) Can create positive and above-average value compared to other strategies. d) Can create positive but below-average value compared to other strategies.

Q: Which of the following is LEAST likely to result in above-average, long-run value creation? a) Create new markets through new products. b) Attract new customers into the market. c) Convince existing customers to buy more of a product. d) Gain market share from rivals through product promotion.

Q: Which of the following are types of organic revenue growth? I. Mergers. II. Acquisitions. III. Portfolio momentum. IV. Market share performance. a) I and II only. b) I, II, and III only. c) II and IV only. d) III and IV only.

Q: Which of the following is most accurate concerning corporate growth rates? a) High growth rates decay quickly, and large companies struggle to grow. b) High growth rates are sustainable for 10 years or more, but large companies struggle to grow. c) High growth rates decay quickly, but large companies grow more easily than small companies. d) High growth rates are sustainable for 10 years or more, and large companies grow more easily than small companies.

Q: Competitive advantages based on brands, as in the consumer goods industry, are often more important for long-term value creation than advantages based on product quality or innovation.

Q: Both ROIC including goodwill and ROIC excluding goodwill have been increasing at a similar rate.

Q: Certain industries are biased toward earning either high, medium, or low returns, but there is still significant variation in the rates of return for individual companies within each industry.

Q: Cost efficiencies offer any business the greatest scope for achieving an attractive ROIC, but they are usually more difficult to achieve than price premiums.

Q: Compared to industries where firms produce generic products, firms in industries where they can brand their products generally earn higher ROICs.

Q: Historically, the rates of growth of firms tend to be more stable than their ROICs.

Q: ROICs tend to be mean reverting, but firms tend to sustain their relative position to the mean (i.e., either higher or lower) for 10 years or more.

Q: Which of the following are strategies that will most likely support a sustainable ROIC? I. Extend life cycles of products and services. II. Offer generic products. III. Implement a temporary cost-reduction program. IV. Use established brands to launch new products. a) I and IV only. b) I, III, and IV only. c) II and III only. d) I, II, III, and IV.

Q: Which of the following are sources of competitive advantage that allow a firm to charge a price premium? I. Quality. II. Customer lock-in. III. Innovative products. IV. Rational price discipline. a) I and II only. b) I, III, and IV only. c) II and III only. d) I, II, III, and IV.

Q: Given that a company charges $3.40 per unit, has a cost per unit of $1.80 and a tax rate of 32 percent, and requires $16 of invested capital per unit, what is the ROIC? a) 6.8 percent. b) 10.2 percent. c) 16 percent. d) 30.3 percent.

Q: Given that a company charges $10 per unit, has a cost per unit of $9.10 and a tax rate of 28 percent, and requires $50 of invested capital per unit, what is the ROIC? a) 3.82 percent. b) 5.18 percent. c) 9.44 percent. d) 140 percent.

Q: A firm’s additional costs for producing each additional unit of its product are essentially zero. The best term for describing the firm’s product is that it is: a) A Giffen good. b) A normal good. c) A scalable product. d) An inferior good.

Q: Which of the following industries is most likely to have the lowest ROIC (where goodwill has been removed)? a) Software. b) IT services. c) Pharmaceuticals. d) Paper packaging.

Q: Which of the following is NOT one of Michael Porter’s five forces? a) Threat of entry. b) Regulatory restrictions. c) Bargaining power of buyers. d) Bargaining power of suppliers.

Q: Managers should assess whether their company’s share price has deviated more than 5 percent from its fundamental value on a weekly basis and, if it has, take appropriate action such as issuing or buying back shares.

Q: Which is most accurate concerning the behavior of a stock’s return after a stock split relative to companies whose stock has not split? a) Compared to companies whose stock has not recently split, the stock prices of companies whose stock has recently split are less sensitive to improvements in performance. b) Compared to companies whose stock has not recently split, the stock prices of companies whose stock has recently split are significantly more sensitive to improvements in performance. c) Compared to companies whose stock has not recently split, the stock prices of companies whose stock has recently split are about equally sensitive to improvements in performance. d) Compared to companies whose stock has not recently split, the stock prices of companies whose stock has recently split are more sensitive to improvements in performance, but the difference is not significant.

Q: Which of the following are valid reasons that a firm’s stock split can be followed by an increase in the value of the shares of that firm? I. Signaling. II. Liquidity. III. More shares outstanding. IV. Self-selection. a) I and IV only. b) II and III only. c) II, III, and IV only. d) None of these.

Q: Which of the following are valid reasons that cross-listing might actually improve a company’s stock performance? I. Improved corporate governance. II. Trading in multiple time zones. III. Access to an increased number of investors. IV. Affirmation effect of being listed in more than one developed market. a) I, II, and IV only. b) I and III only. c) II and III only. d) II, III, and IV only.

Q: Academic research has found that share prices of companies that are removed from a major stock index: a) Trend down until significant news arrives to reverse the trend. b) Do not experience any abnormal returns either in the short term or in the long term. c) Drop immediately and then begin trading normally. d) Drop immediately, but the decline is usually reversed within one or two months.

Q: An analysis of 50 European companies that began reporting using U.S. GAAP over the period 1997 to 2004 found which of the following? I. Earnings under GAAP were generally lower than earnings under the home country’s rules. II. The differences in earnings under the two regimes were all less than 10 percent. III. The stocks of the 50 companies generally reacted positively when the disclosures were made. IV. Executives had concerns over the impact of reporting under U.S. GAAP. a) I and II only. b) I, II, and III only. c) I, III, and IV only. d) II, III, and IV only.

Q: Voluntary option expensing has been found to have which of the following effects? a) A negative impact on share price. b) A positive impact on share price. c) No impact on share price. d) A positive impact if LIFO accounting is used and a negative effect if FIFO accounting is used.

Q: Which of the following are ways the managers of firms may try to meet earnings forecasts and have been proven to have an impact on share price? I. Deferring divestments. II. Gradually providing new information to lead analysts. III. Offering customer incentives without immediate costs. IV. Accounting adjustments such as capitalizing costs and R&D. a) I and II only. b) I and III only. c) II and IV only. d) III and IV only.

Q: Empirical research shows that goodwill impairments have no impact on a company’s share price at the time of the impairment.

Q: Empirical evidence shows that managers can effectively manage share price by focusing on EPS and meeting analysts’ estimated earnings.

Q: Researchers have found that the stock market is very concerned with earnings volatility and requires companies to meet analyst expectations.

Q: If investors focused on earnings, a move from FIFO to LIFO would increase the share price, but it generally does the opposite because of the decrease in cash flows.

Q: Long-term price-to-earnings (P/E) ratios in the U.S. stock market of around 15 times are consistent with long-term expected stock returns of around 6 to 7 percent a year in real terms

Q: What is the impact on a company’s share price of trading done by noise traders? a) Noise traders buy and sell a great deal, their volume of trading is high, and the long-term effect on share price is low. b) Noise traders buy and sell a great deal, their volume of trading is high, and the long-term effect on share price is high. c) Noise traders buy and sell a small amount, their volume of trading is low, and the long-term effect on share price is low. d) Noise traders set the boundaries for a stock’s intrinsic value.

Q: Having only fundamental investors among a company’s shareholders is the most ideal situation.

Q: Which of the following characterize noise traders? I. They do not care about intrinsic value. II. They are always in the minority. III. They can move price outside the bounds of intrinsic value. IV. They trade on small events. a) I and II only. b) I, III, and IV only. c) II, III, and IV only. d) II and IV only.

Q: Which of the following is most accurate concerning the bounds on a stock’s price set by informed investors and/or the volatility of the stock within those bounds? a) As long as the price is within the bounds, the volatility will always be relatively low. b) Share prices can be significantly volatile within the bounds but only when new information about a company has been revealed; otherwise, volatility will be relatively low. c) The bounds are set by mechanical traders and are fairly constant over time. d) Share prices can be significantly volatile within the bounds even at times when no new information about a company has been revealed.

Q: Which of the following are impediments to short selling? I. Beta risk. II. Bubble risk. III. Noise-trader risk. IV. Short-selling constraints. a) I and II only. b) I, II, and IV only. c) II and III only. d) III and IV only.

Q: Which of the following criteria do noise traders make bets on? I. Short-term price movements. II. Fundamental valuations. III. Investing only in emerging markets. a) I and II. b) II and III. c) I only. d) II only.

Q: Noise-trader risk is caused by: a) Program trading. b) Systematic risk being greater than idiosyncratic risk. c) Idiosyncratic risk being greater than systematic risk. d) Traders making bets on short-term price movements without reference to fundamental valuations.

Q: An effective compensation system of a company should focus on period to period changes in TRS performance rather than TRS relative to peers in the industry.

Q: Use the following financials to answer the next question. Total returns to shareholders is closest to: a) 8.0 percent. b) 9.5 percent. c) 11.1 percent. d) 5 percent.

Q: Use the following financials for the next question. The enhanced TRS from performance is closest to: a) –4.4 percent. b) 3.1 percent. c) 4.4 percent. d) 8.4 percent.

Q: List and describe the four-part decomposition of TRS that gives a clearer insight into how much of the measure derives from changes in operational performance.

Q: Which of the following is NOT one of the three components in the traditional approach’s three-component breakdown of total returns to shareholders? a) Percent change in cash flow. b) Percent change in earnings. c) Percent change in P/E. d) Percent change in dividend yield.

Q: The expectations treadmill refers to the fact that recent growth builds expectations of future growth.

Q: The expectations treadmill is the dynamic behind the adage that a good company and a good investment may not be the same.

Q: Which of the following are potential reasons why TRS over short periods of time may not reflect the actual performance of a company and its management? I. A well-performing company may not deliver a high TRS if the expectations include knowledge of the performance. II. When TRS is analyzed in its traditional way, it does not show the degree to which improvements in operations produced or increased the TRS. III. Outside factors such as changing interest rates can affect TRS and be unrelated to the firm’s operations. IV. TRS is difficult to calculate for short periods of time. a) II and IV. b) I and II. c) II and III. d) I, II, and III.

Q: Managers should hedge risks in their core business, as this helps eliminate some risk to investors without any reduction in returns.