D366 Financial Statement Analysis - Set 1 - Part 2

Correct Answer: Market multiples allow for better comparisons across firms

Market multiples such as PE or EV/EBITDA ratios are useful for comparing companies within the same industry or sector because they adjust for differences in firm size or capital structure.

Correct Answer: Net income will be overstated

Failure to record a contingent liability means that the associated expense is not recognized, leading to an overstatement of net income.

Correct Answer: The firm must report the sale when the sale of the asset differs from that of book values

When the sale of a long-lived asset results in a loss, it is recorded in the investing section and reflects any difference from the book value of the asset.

Correct Answer: Income statement

The gain from increased demand and higher prices will be reflected in the income statement, which tracks revenue and profits.

Correct Answer: ROE will decrease

Issuing new shares increases equity, which in turn lowers the return on equity if net income remains unchanged, as ROE is calculated as net income divided by equity.

Correct Answer: It increases cash flow

When accounts receivable decrease, it means the company has collected cash from customers, increasing cash flow from operations.

Correct Answer: The stock is inaccurately reflective of intrinsic value until the acquisition is complete

The market value reflects investor speculation, but until the acquisition is finalized, the stock's intrinsic value may not align with the market price.

Correct Answer: Accrual-based earnings management

Accrual-based earnings management involves adjusting accruals such as revenue recognition and expense deferrals within the bounds of GAAP to influence reported earnings without affecting actual cash flow.

Correct Answer: They both exclude depreciation expenses

Both EBITDA and cash flow from operations exclude depreciation, a non-cash expense, though they differ in the treatment of interest and taxes.

Correct Answer: By optimizing its debt-to-equity mix and reducing risk

An optimal debt-to-equity mix, with minimal risk, can lower the company's cost of capital by reducing interest payments and required returns by equity holders.

Correct Answer: It spreads the cost over time, reducing immediate expenses and increasing assets

Capitalizing an expense turns it into a long-term asset, spreading the cost over its useful life, which reduces immediate expense recognition.

Correct Answer: It reduces shareholders' equity

Stock repurchases reduce the number of shares outstanding, thereby decreasing shareholders' equity.

Correct Answer: To determine the firm's ability to pay off long-term and short-term debt

Liquidity and solvency are crucial measures of a firm's ability to meet its debt obligations, which are essential for the lender's risk assessment.

Correct Answer: ROA will decrease

Higher operating leverage means higher fixed costs relative to sales, which can lead to lower returns on assets if sales do not significantly increase to cover those costs.

Correct Answer: Residual income will decrease

Residual income is the amount of income earned above the required return on equity. If the return on the new project is lower than the cost of equity, residual income will decrease.

Correct Answer: It increases ROE if the return on assets exceeds the cost of debt

If the return on assets exceeds the cost of debt, leverage amplifies the returns to equity holders, thereby increasing ROE.

Correct Answer: The balance sheet

The balance sheet provides information about a companys current assets and liabilities, which are key indicators of its liquidity position.

Correct Answer: Cash flow from investing activities

Cash flows related to the purchase or sale of long-term assets, like property and equipment, are reported under investing activities.

Correct Answer: Rising interest rates typically decrease bond prices

As interest rates rise, the prices of existing bonds typically decrease because new bonds are issued at higher yields, making older bonds less attractive.

Correct Answer: Investing activities

Gains and losses from the sale of long-term assets are reported under investing activities on the statement of cash flows.