FSA 3321 – Summer II (2004) Exam 2 Moore

Second Examination – Finance 3321

Summer II (Moore)

Grader’s Name: ____________________ Printed Name: ____________________

Ethical conduct is an important component of any profession. The Texas Tech University
Code of Student Conduct is in force during this exam. Students providing or accepting
unauthorized assistance will be assigned a score of zero (0) for this piece of assessment.
Using unauthorized materials during the exam will result in the same penalty. Ours’ should
be a self-monitoring profession. It is the obligation of all students to report violations of the
honor code in this course. By signing below, you are acknowledging that you have read the
above statement and agree to abide by the stipulated terms.

Student’s Signature: ______________________________

Where indicated, use the financial statement for Dell-U-Dead, Inc. (a large computer
manufacturer and distributor that sells in both the wholesale and retail markets).

Clearly Circle the BEST response for each of the following questions:

1. Which of the following will not result in overstated asset balances?

a. Delays in writing down current assets.
b. Channel stuffing
c. Overstated amortization of goodwill
d. Overstating reserves
e. Delaying the write-down of obsolete factory equipment

2. Which of the following accounting adjustments would have to be made in the case of
improperly accelerating the recognition of revenues?
a. Sales would be increased
b. Accounts Receivable would be increased
c. Cost of Sales would be increased
d. Inventory would be increased
e. Deferred tax liabilities would have to be increased

3. Which of the following ratios would not be used in the diagnostic analysis of the quality of
financial statements as it relates to the detection of manipulated sales?
a. (Net sales)/(Cash from sales)
b. (Net sales)/(Net accounts receivable)
c. (Bad debt expense)/(Net sales)
d. (Net sales)/(Unearned revenue)
e. (Net sales)/(Warranty Liabilities)

-1-
FSA 3321 – Summer II (2004) Exam 2 Moore

Use the following information for problems 4 through 6

ABC Company is a startup company in an industry that exclusively uses capital leases for it’s
expensive medical testing and diagnostic equipment. ABC, however, used operating lease
accounting in its first year of operations. Assume the average lifespan of ABC’s leased
equipment is 15 years and that their annual cost of debt is 12%. The annual lease payments
are $3,000,000. The present value of the future lease payments is $20,432,600 (rounded).
ABC’s industry commonly uses straight-line depreciation and the effective tax rate is 35%.

4. Adjust ABC’s books to reflect the lease as being capitalized. The depreciation expense
that should have been charged against income in the first year is:
a. $200,000
b. $3,000,000
c. $1,362,173
d. $885,413
e. $1,950,000

5. Adjust ABC’s books to reflect the lease as being capitalized. The appropriate charge for
interest expense in the second year would be:
a. $2,451,912
b. $2,386,141
c. $3,000,000
d. $1,593,743
e. $1,550,992

6. The overall effect on Net Income in the first year for ABC (had the lease been capitalized)
would be (relative to the reported Net Income):
a. $3,814,085 decrease
b. $2,479,155 decrease
c. $814,085 decrease
d. $529,155 decrease
e. $548,088 increase

7. Which of the following would be indicative of manipulated core expenses for the purpose
of overstating income?
a. Unexpected (unexplained) increases in asset turnover
b. Unexpected (unexplained) declines in (Depreciation expense)/(Capital Expenditures)
c. Unexpected (unexplained) increases in (Pension expense)/(SG&A expense)
d. Unexpected (unexplained) declines in (Net sales)/(Warranty liabilities)
e. Unexpected (unexplained) increases in (Operating Cash Flow)/(Operating Income)

-2-
FSA 3321 – Summer II (2004) Exam 2 Moore
8. Aggressive use of which of the following accounting choices can lead to the problem of
“off-balance sheet financing”?
a. Operating leases
b. Failure to write down obsolete inventory
c. Reporting all related party transactions
d. Overstating depreciation for long-term assets
e. Using the intrinsic method to account for executive stock options

9. The suspect accounting practice for Lucent Technologies involved:

a. Operating leases
b. Overstating accounts receivable
c. Executive stock options
d. Overstating inventory
e. Understating pension liabilities

10.Which of the following adjustments to the accounts would have to be made when it is
found (suspected) a company overstates the balance of it’s long-term assets?
a. Increase depreciation expense
b. Decrease retained earnings
c. Increase income tax expense
d. Decrease deferred tax liability
e. Increase the asset account

Use the attached financial statements for Dell-U-Dead Corp. to answer questions 11-13

11.Dell-U-Dead’s return on equity for the year ended February 1, 2002 was
a. 377%
b. 9.2%
c. 26.5%
d. 17.9%
e. 4.0%

12.Dell-U-Dead’s debt service margin for the year ended February 1, 2001 was
a. 9.32
b. 12.66
c. 7.30
d. 8.24
e. 0.52

13.What would Dell-U-Dead’s Sustainable Growth Rate have been for the year ended
February 1, 2002 if it had maintained the same net profit margin as the previous year?
(Assume no dividends are paid. Use the previous year’s ending equity to compute ROE.)
a. 22.2%
b. 15.5%
c. 37.7%
d. 38.7%
e. 45.8%
-3-
FSA 3321 – Summer II (2004) Exam 2 Moore

14.Which of the following is not a driver of growth and profitability that is associated with
product market strategies?
a. Investment Management
b. Managing Working Capital
c. Acquiring the appropriate Fixed Assets
d. Finding the most efficient method of financing Fixed Assets
e. Developing effective marketing strategies

15.The firm’s spread and net financial leverage:

a. Move in the same direction
b. Move in opposite directions
c. Are independent of one another
d. Are two terms that mean the same thing
e. Are controlled by the investment management function

16.When comparing the firm’s performance with that of its competitors:

a. The analyst should perform time-series analysis
b. The analyst should use all the average of all members of the industry as a benchmark
c. The analyst should randomly select a member of the industry as a benchmark
d. The analyst should compare the firm with direct competitors or from segments of the
industry that are direct competitors (in terms of product market strategies).
e. The analyst should compare the firm’s ROA with the return on the S&P 500

17.Assume that Dell-U-Dead’s interest expense for the year ended February 2, 2001 was
$67,000,000. Compute the basic (not diluted) EBITDA per share for that year.
a. $ 0.78
b. $ 0.76
c. $ 0.69
d. $ 0.48
e. $ 1.46

18.Which of the following actions would increase Dell-U-Dead’s SGR?

a. Decreasing Inventory turnover
b. Purchasing Fixed Assets
c. Common Share Repurchases
d. Increasing Accounts Payable Turnover
e. Issuing more executive stock options

19.Which is not a measure of that is typically used for measuring Financial Leverage?
a. Current ratio
b. Cash ratio
c. Operating cash flow ratio
d. Debt-to-capital ratio
e. Cash Flow per share ratio

-4-
FSA 3321 – Summer II (2004) Exam 2 Moore
20.Where did Professor Moore purchase his glass sun-tea maker?
a. K-Mart
b. Nordstroms
c. Sears
d. Target
e. Wal-Mart

Short Problem # 1 (Show all work to receive full credit) – 10 Points

Compute all of the relevant liquidity and operating efficiency ratios for Dell-U-Dead for both
years. (same ratios as for Vann Inc. homework assignment). Assess the overall changes
and overall liquidity/operating efficiency from 2001 to 2002. Comment on major economic
factors could explain some of the changes (if any).

-5-
FSA 3321 – Summer II (2004) Exam 2 Moore
Short Problem # 2 (Show all work to receive full credit) – 10 Points

In performing background research on Dell-U-Dead, you find that:

a. Unearned Revenues increased from $192 million to $444 million (slightly more than
double). However, their sales of 3-year service contracts were reported to have
increased by more than 6 times. This would bring the Unearned Revenues balance to
$1,152 million. Your concern is that all contracts were booked as earned in 2002.

b. You are not convinced that production achieved increased efficiency in a down
economy during the year ended February 1, 2002. In particular, you doubt the
legitimacy of the ending inventory number and are concerned that sales may have
been “created” to make profits look better. Consequently, you need to adjust the
related items to the previous year’s levels in terms of efficiencies.

Required:
Assume a 35% tax rate. Make all of the adjustments to the relevant income statement
and balance sheet accounts that relate to the problems identified in (a) and (b).
Comment on these results.

-6-
FSA 3321 – Summer II (2004) Exam 2 Moore
Dell-U-Dead Computer Corporation
Balance Sheet (in Millions) (1 February 20XX)

ASSETS 2002 2001

Current Assets:
Cash and equivalents $ 3,641 $ 4,910
Short-term Investments 273 525
Accounts Receivable (net) 2,269 2,424
Inventories 278 400
Other 1,419 1,467
Total Current Assets $ 7,877 $ 9,726
Non-Current Assets:
Property, plant and equipment (net) 826 996
Investments 4,373 2,418
Goodwill 359 290
Other non-current assets 100 240
Total non-current assets $ 5,658 $ 3,499
Total Assets $13,535 $13,670
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts Payable $ 5,075 $ 4,286
Accrued Liabilities 1,600 1,550
Unearned Revenues 444 192
Notes Payable – Current 300 450
Other 100 300
Total Current Liabilities $ 7,519 $ 6,778
Non-Current Liabilities:
Long-Term Debt 520 509
Pension Liabilities 302 261
Other Post-Retirement Benefit Liabilities 150 120
Deferred Tax Liability 120 100
Other Liabilities 230 280
Total Non-Current Liabilities $ 1,322 $ 1,270
Total Liabilities $ 8,841 $ 8,048
Stockholders’ Equity:
Common Stock Issued and Outstanding $ 5,605 $ 4,795
Treasury Stock (2,249) ---
Retained Earnings 1,364 839
Other Comprehensive Income ( 26) (12)
Total Stockholders’ Equity $ 4,694 $ 5,622
Total Liabilities & Stockholders’ Equity $13,535 $13,670
-7-
FSA 3321 – Summer II (2004) Exam 2 Moore

Dell-U-Dead Computer Corporation

Income Statement (in Millions**)
For the Year Ending February 1, 20XX)=

2002 2001
Net Revenue $31,168 $31,888
Less: Cost of Goods Sold 25,661 25,445
Gross Profit $ 5,507 $ 6,433
Operating Expenses
Selling, General and Administrative $ 1,900 $ 2,400
Lease Expenses 884 793
Research, Development and Engineering 452 482
Special charges 482 105
Total operating expenses $ 3,718 $ 3,780
Operating Income $ 1,789 $ 2,663
Investment and other income (loss), net of tax (58) 581
Income before taxes and cumulative effect
of change in accounting principle $ 1,731 $ 3,194
Provision for income taxes 485 958
Income before cumulative effect of change
in accounting principle $ 1,246 $ 2,236
Cumulative effect of change in accounting principle --- 59
Net Income $ 1,246 $ 2,177

Earnings Per Common Share:

Basic EPS $ 0.48 $ 0.87
Diluted EPS $ 0.26 $ 0.79

Weighted Average Shares Outstanding:

Basic 2,602 2,582
Diluted 4,543 2,746

**
All items in millions of dollars except Earnings per Share data

-8-
FSA 3321 – Summer II (2004) Exam 2 Moore

Dell-U-Dead Computer Corporation

Statement of Cash Flows (in Millions)
For the Year Ending February 1, 20XX

2002 2001
Cash Flows from Operating Activities:
Net Income $ 1,246 $ 2,177
Adjustment to reconcile income to cash
provided by operating activities:
Depreciation and amortization 239 240
Tax benefits of employee stock plans 487 929
Special charges 742 105
Gains/Losses in investments 17 (307)
Other 178 135
Changes in:
Operating working capital 826 642
Non-current assets and liabilities 62 274
Net cash provided by operating activities $ 3,797 $ 4,195
Cash Flows from investing activities:
Investments in securities:
Purchases $(5,382) $(2,606)
Maturities and sales 3,425 2,331
Capital expenditures (303) (482)
Net cash used in investing activities $(2,260) $ (757)
Cash flows from financing activities:
Purchase of common stock $(3,000) $(2,700)
Issuance of common stock under employee plans 295 404
Other 3 (9)
Net cash used in financing activities $(2,702) $(2,305)
Effect of foreign exchange rates on cash (104) (32)
Net increase (decrease) in cash $(1,269) $ 1,101

-9-