Complete Test Bank Analyzing Performance Ch.10 6th Edition - Valuation Measuring and Managing the Value of Companies 6th Edition Exam Pack by The book title does not provide the names of the authors.. DOCX document preview.
Chapter: Chapter 10: Analyzing Performance
True/False
1. Since profit is measured over an entire year, whereas capital is measured at only one point in time, it is recommended that return on invested capital (ROIC) use the average of starting and ending invested capital.
Response: []
Multiple Choice
2. With respect to the performance measures return on invested capital (ROIC), return on equity (ROE), and return on assets (ROA), which of the following is most accurate concerning the relative superiority of the three as analytical tools for understanding a company’s performance?
a) ROE is better than ROA, which is better than ROIC.
b) ROA is better than ROIC, which is better than ROE.
c) ROIC is better than ROA, which is better than ROE.
d) ROE is better than ROIC, which is better than ROA.
Response: [ROIC is a better analytical tool for understanding the company’s performance than return on equity (ROE) or return on assets (ROA) because it focuses solely on a company’s operations. Return on equity mixes operating performance with capital structure, making peer group analysis and trend analysis less meaningful.]
3. Compute ROIC given the following information: EBITA = $800, revenues = $2,200, invested capital = $4,000, operating cash tax rate = 34%.
a) 6.8 percent.
b) 13.2 percent.
c) 24.0 percent.
d) 36.3 percent.
Response: [
]
4. You are an equity analyst and have computed the following figures for two cement companies. The first, CementCo, has NOPLAT of $1,550 million, invested capital without goodwill of $15,000 million, and goodwill of $1,950 million. The second, CementExports, has NOPLAT of $1,750 million, invested capital without goodwill of $16,000 million, and no goodwill. If the cost of capital for both firms is 10 percent, what is the ROIC for each company? Which company is creating value in this year?
a) ROIC excluding goodwill is 10.3 percent for CementCo and 10.9 percent for CementExports; both companies are creating value.
b) ROIC including goodwill is 9.1 percent for CementCo and 10.9 percent for CementExports; both companies are creating value.
c) ROIC including goodwill is 9.1 percent for CementCo and 10.9 percent for CementExports; only CementExports is creating value.
d) ROIC including goodwill is 9.1 percent for CementCo and 10.9 percent for CementExports; neither of the companies is creating value.
Response: [ROIC = NOPLAT/Invested capital
For CementCo:
ROIC excluding goodwill = 1,550/15,000 = 10.3%
ROIC including goodwill = 1,550/(15,000 + 1,950) = 9.1%
For CementExports:
ROIC excluding and including goodwill (as there is no goodwill) = 1,750/16,000 = 10.9%
One should include goodwill, as this required an outlay by the firm.]
True/False
5. An analyst would include goodwill in invested capital when measuring aggregate value creation for a company’s shareholders.
Response: []
6. ROIC excluding goodwill is useful when measuring underlying operating performance of the company and its businesses, and it is useful for comparing performance against peers and to analyze trends.
Response: []
7. A company’s ROIC is driven by its ability to maximize profitability (EBITA divided by revenues or the operating margin), optimize capital turnover (measured by revenues over invested capital), or minimize operating taxes.
Response: []
Use the following table, which provides historical data for SnacksCo, a manufacturer of snack foods, to answer the next four questions. Assume an operating tax rate of 30 percent and a cost of capital of 9 percent.
Income statement | Year 1 | Year 2 |
Revenues | 540.0 | 555.0 |
Cost of sales | (350.0) | (360.5) |
Selling, general, and administrative | (50.0) | (50.5) |
Depreciation | (10.0) | (10.5) |
EBIT | 130.0 | 133.5 |
Interest expense | (7.5) | (7.5) |
Gain/(loss) on sale of assets | – | (30.0) |
Earnings before taxes | 122.5 | 96.0 |
Taxes | (24.8) | (21.5) |
Net income | 97.7 | 74.5 |
Balance sheet | Year 1 | Year 2 |
Operating cash | 10.6 | 15.0 |
Excess cash and marketable securities | 102.8 | 100.0 |
Accounts receivable | 90.0 | 94.5 |
Inventory | 150.0 | 157.5 |
Current assets | 353.4 | 367.0 |
|
| |
Property, plant, and equipment | 206.7 | 219.8 |
Equity investments | 180.0 | 180.0 |
Total assets | 740.1 | 766.8 |
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|
|
Accounts payable | 116.6 | 119.6 |
Short-term debt | 45.0 | 45.0 |
Accrued expenses | 90.1 | 89.0 |
Current liabilities | 251.7 | 253.7 |
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|
Long-term debt | 68.4 | 80.6 |
Common stock | 120.0 | 120.0 |
Retained earnings | 300.0 | 312.5 |
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|
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Total liabilities and equity | 740.1 | 766.8 |
Multiple Choice
8. What is SnackCo’s operating margin in year 2?
a) 13.4 percent.
b) 16.8 percent.
c) 24.0 percent.
d) 35.3 percent.
Response: [NOPLAT = Operating profit * (1 – Tax rate)
Operating profit = Revenues – Cost of sales – Selling costs – Depreciation – Taxes
Operating profit in year 2 = 555.0 – 360.5 – 50.5 – 10.5 = 133.5
NOPLAT in year 2 = 133.5 * (1 – 30%) = 93.5
Operating margin = NOPLAT/Revenues = 93.5/555 = 16.8%]
9. What is SnackCo’s capital turnover in year 2 using average invested capital?
a) 2.1×
b) 2.0×
c) 1.5×
d) 0.5×
Response: [Invested capital = Working capital + PPE
Working capital = Working cash + Accounts receivable + Inventories – Accounts payable – Accrued expenses
Working capital in Year 2 = 15 + 94.5 + 157.5 – 119.6 – 89 = 58.4
Invested capital in year 2 = 58.4 + 219.8 = 278.2
Working capital in Year 1 = 10.6 + 90 + 150 – 116.6 – 90.1 = 43.9
Invested capital in year 1 = 43.9 + 206.7 = 250.6
Average invested capital = (278.2 + 250.6)/2 = 264.4
Capital turnover = Revenues/Average invested capital = 555/264.4 = 2.1×]
10. What is SnackCo’s ROIC in year 2?
a) 20.3 percent.
b) 24.8 percent.
c) 33.6 percent.
d) 35.4 percent.
Response: [ROIC in year 2 (based on average invested capital) = 93.5/264.4 = 35.4%
Operating margin = NOPLAT/Revenues = 93.5/555 = 16.8%
Capital turnover = Revenues/Average invested capital = 555/264.4 = 2.1x]
True/False
11. SnackCo is creating value in year 2.
Response: [Since the ROIC is greater than the WACC, value is being created.]
Multiple Choice
12. Which of the following is the best method of determining whether the financial performance between competitors is sustainable?
a) Linking operating drivers directly to return on capital.
b) Comparing the respective ROE and ROA measures.
c) Breaking ROE down into ROIC, tax, interest rate, and leverage effects.
d) Distinguishing between pretax ROIC and the operating-cash tax rate.
Response: []
| 2015 | 2016 |
Current assets | $860 | $896 |
Current liabilities | 710 | 818 |
Debt in current liabilities | 1 | 39 |
Long-term debt | 506 | 408 |
Total assets | 2,293 | 2,307 |
Capital expenditures | 111 | 117 |
Change in deferred taxes | –29 | –20 |
Sales | 4,100 | 4,192 |
Operating expenses | 3,307 | 3,260 |
Rental expense | 0 | 248 |
General expenses | 562 | 528 |
Depreciation | 139 | 136 |
Interest expense | 39 | 30 |
Income taxes | 5 | 8 |
13. Using the preceding table, if receivables, inventories, and other current assets are $520 in 2015, then what is the number of days in cash?
a) 28 days.
b) 29 days.
c) 30 days.
d) 31 days.
Response: [Days = 365 × (Cash/Revenues). Cash = Current assets – (Receivables + Inventories + Other current assets). Cash = $860 – $520 = $340. Days = 365 × ($340/$4,100) = 30.27 days.]
14. In order to get a more accurate forecast of revenue growth, an analyst should remove the effects of which of the following?
I. Deferred taxes.
II. Changes in currency values.
III. Mergers and acquisitions.
IV. Changes in accounting policies.
a) I and II only.
b) I and III only.
c) III and IV only.
d) II, III, and IV only.
Response: [The three prime culprits distorting revenue growth are the effects of changes in currency values, mergers and acquisitions, and changes in accounting policies. Strip out from revenues any distortions created by these effects in order to base forecast revenues for valuation on sustainable precedents.]
15. Assuming that both the acquiring and target firms have fiscal years ending on December 31, if the target is acquired on December 1, 2015, which of the following is the most accurate?
a) Revenues of the target would be consolidated from 2016 onward.
b) Revenues of the target would be consolidated 100 percent for 2015.
c) Revenues of the target would be consolidated post-acquisition—that is, one month of revenues of the target for 2015.
d) No consolidation of revenues will happen.
Response: []
True/False
16. Liquidity measures the company’s ability to meet obligations over the short term.
Response: []
17. Leverage measures the company’s ability to meet obligations over the long term.
Response: []
Multiple Choice
18. The company’s ability to meet short-term obligations is measured with ratios that incorporate three measures of earnings. Which of the following is NOT one of those measures of earnings?
a) Earnings before interest, taxes, and amortization (EBITA).
b) Earnings before interest, taxes, depreciation, and amortization (EBITDA).
c) Earnings before interest, taxes, amortization, and preferred dividends (EBITAD).
d) Earnings before interest, taxes, depreciation, amortization, and rental expense (EBITDAR).
Response: []
True/False
19. By using the debt-to-EBITDA ratio, one can build a more comprehensive picture of the risk of leverage.
Response: [There has been a large increase in the use of convertible securities in recent years. Many convertibles compensate through the potential conversion to equity rather than interest, making interest coverage ratios artificially high.]
20. To evaluate leverage in the recent low-interest-rate environment, many analysts are now evaluating debt multiples such as debt to EBITDA or debt to EBITA.
Response: [Over the past decade, interest rates have dropped to unprecedented lows, making interest coverage ratios uncharacteristically high. Given its much larger denominator, the debt-to-EBITDA multiple tends to be more stable, making assessments over time much clearer.]
Multiple Choice
21. With regard to the interest coverage ratio, which of the following is the most accurate?
a) If near-term bankruptcy is an issue, EBITDA can be used to measure survival only over the short term.
b) EBITDA should be used to measure survival over both the short and the long term.
c) EBITA should be used to measure survival only in the short term (vs. long term).
d) None of the above are true.
Response: [If near-term bankruptcy is an issue, EBITDA can be used to meet interest obligations, and maintenance capital will consequently fall to zero. Unless the company plans to wind down operations, depreciation must eventually be reinvested to maintain operations. Therefore, EBITDA can be used to measure survival only over the short term. Over the long term, EBITA is a better ratio.]
22. Use the following data to answer the question: What are the three interest coverage ratios based on pretax income and interest expense?
| 2015 | 2016 |
Current assets | $860 | $896 |
Current liabilities | 710 | 818 |
Debt in current liabilities | 1 | 39 |
Long-term debt | 506 | 408 |
Total assets | 2,293 | 2,307 |
Capital expenditures | 111 | 117 |
Change in deferred taxes | –29 | –20 |
Sales | 4,100 | 4,200 |
Operating expenses | 3,307 | 3,260 |
Rental expense | 0 | 248 |
General expenses | 562 | 528 |
Depreciation | 139 | 136 |
Interest expense | 39 | 30 |
Income taxes | 5 | 8 |
a) For 2016, interest coverage ratios based on EBIT, EBITDA, and EBITDAR are 5.47, 5.47, and 1.48, respectively.
b) For 2016, interest coverage ratios based on EBIT, EBITDA, and EBITDAR are 2.36, 5.92, and 13.73, respectively.
c) For 2016, interest coverage ratios based on EBIT, EBITDA, and EBITDAR are 0.93, 5.47, and 1.48, respectively.
d) For 2016, interest coverage ratios based on EBIT, EBITDA, and EBITDAR are 0.93, 5.47, and 13.73, respectively.
Response: [
2015 | EBIT Interest | EBITDA Interest | EBITDAR (Interest + Rental expense) |
|---|---|---|---|
Numerator | 92 | 231 | 231 |
Denominator | 39 | 39 | 39 |
Ratio | 2.36 | 5.92 | 5.92 |
2016 | EBIT Interest | EBITDA Interest | EBITDAR (Interest + Rental expense) |
Numerator | 28 | 164 | 412 |
Denominator | 30 | 30 | 278 |
Ratio | 0.93 | 5.47 | 1.48 |
]
23. For a given company, the return on invested capital (ROIC) is 13.5 percent, the tax rate is 34 percent, and the pretax cost of debt is 8.8 percent. If its debt-to-equity ratio is equal to 2.0, what is the return on equity (ROE)?
a) 16.30 percent.
b) 17.80 percent.
c) 28.88 percent.
d) 25.30 percent.
Response: [ROE = ROIC + {ROIC – (1 – T) * kd} * D/E
ROE = 13.5% + {13.5% – (1 – 34%) * 8.8%} * 2
ROE = 28.88%]
24. Given that ROIC, the interest rate on debt, and the debt-to-equity ratio are constant, how will increasing the tax rate affect ROE?
a) Decrease it.
b) Not affect it.
c) Increase it.
d) There is no set relationship.
Response: []
True/False
25. An analysis of a company’s historical financial performance should go back a maximum of five years.
Response: [An analyst should look back as far as possible (at least 10 years). Long time horizons will allow you to determine whether the company and industry tend to revert to some normal level of performance, and whether short-term trends are likely to be permanent.]
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Valuation Measuring and Managing the Value of Companies 6th Edition Exam Pack
By The book title does not provide the names of the authors.