Midterm_ACCT 354_Fall 2022_Solutions_Student (1)

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McGill University *

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354

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Finance

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Jan 9, 2024

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Question Answer 1 A - True 2 A - Unqualified Opinion 3 D - Shareholders and Creditors 4 A and C are TRUE - Repurchases affect WACS making EPS growth rates non-comparable. Net income is not the same as cash flow so there is no proof that money wasn't borrowed here. 5 C and D - Non-GAAP measures are not present in the financial statements or the notes thereto 6 A - More than 20%. As there are fixed costs in the cost structure, EBIT will grow faster than revenue. 7 8 B - Relevant information 9 C ($190) - See below 10 Error in question - everyone correct ($85,000) - See below 11 A (37 days) - See below 12 C - The company option to redeed does not create a liability. For a liability to exist, the shareholders must be in a position to require the company to repurchase the shares. Cash Flow - Ford Opening accounts receivable 100 Credit Sales 180 Credit sales collections (170) Closing accounts receivable 110 Cash sale collections 20 Total cash collected 190 Cash Flow - Tesla Opening fixed assets 100,000 NBV of assets sold (25,000) Depreciation expense (10,000) Purchases of fixed assets 85,000 Closing fixed assets 150,000 Proceeds of disposition 20,000 Net book value (25,000) Loss on sale (5,000) Luigi and A/R Turnover Revenues 100,000 % of credit sales 90% Credit sales 90,000 Annualized 180,000 A/R Balance 20,000 A/R Turnover 9 Days in A/R 41 Competitor delta (they are 4 days better than (4) Competitor DSO 37 B - Free cash flow to the firm includes an adjustment to add back interest costs on an after-tax basis

1 (1 MARK) Provide one situation where calculating a ratio would not provide useful i 2 (2 MARK) Assuming a company is profitable, what two conditions are required for re 3 (1 MARK) Return on equity can be decomposed using DuPont analysis. Provide the 4 (3 MARKS) Robbers sells internet services to residential customers in Canada. Cust 5 (1 MARK) From the perspective of the company, identify one advantage and one di Marks were awarded here for reasonble and correct responses. Many students prov such as calculating return on equity when both income and shareholders' equity ar calculating inventory turnover for a company without inventory. 1) The company employs leverage (e.g. Assets > Equity). 2) The after-tax cost of debt is less than return on assets, adjusted Students needed to provide the full decompositon formula with the components. ROE = (Net Income / Revenue) x (Revenue / Total Assets) x (Total Assets / Total Equ a. Pre-paying a year’s worth of services at the beginning of the year b. Paying for the service at the end of the year Ignoring the time value of money, explain how each payment timing affects the tim (1 Mark) Revenue is recorded over time, evenly throughout the year under each sc performance obligation is achieved. (1 Mark) In scenario (a), an unearned revenue liability is recorded upon payment. A recognized, it is reduced over the course of the year. (1 Mark) In scenario (b), accounts receivable is recorded as revenue is recognized. ultimate payment is made, the accounts receiveable is reversed.

6 (2 MARKS) Provide two examples of information found in the Management’s Discus 7 Advantage (1 Mark): Employee retention, avoids dilution, other valid. Disadvantage (1 Mark): Variable expense, requires a cash outlay, other valid. One mark per valid response. Many students here referred to non-GAAP measures, risk and forward-looking statements which were all valid discussions. (3 MARKS) Recently, Canadian grocery stores have been criticized for increasing p asserting that such price increases are “unfair” as grocery store profits, in dollar te increasing. If you worked for a grocery store and were tasked with defending the st practices, what counter arguments would you make? What financial ratios would su arguments? Many students correctly discussed gross margin, operating margin and net margin responses, stating that increases in prices are not "unfair" if they reflect higher cos students correctly noted that higher volumes, in general, beget higher profits which argument. To score 3 marks, students needed to provide and discuss at least two valid financi financial tools. Part marks were awarded when insufficient ratios were used or the arguments/discussions made were incorrect or lacked clarity.

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information to an analyst. eturn on equity to be greater than return on assets? decomposition formula. tomers have the ch isadvantage of issuing cash-settled stock-based compensation. vided examples re negative or uity) ming of re cenario as the As revenue is When the

ssion and Analysis (MD&A) that would NOT be found in the financial statements. , discussions of prices with many erms, are tore’s pricing upport those to support their sts. Other h was also a valid ial ratios or

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Basic Earnings Per Share Net income $ 162,000 Preferred dividends $ (20,000) Income available to common shareholders $ 142,000 1 Unweighted Weight Weighted Common shares, opening 40,000 100.00% 40,000 Share issuance 12,000 4.17% 500 0.5 Share repurchase (6,000) 83.33% (5,000) 0.5 Common shares, closing 46,000 35,500 Basic EPS $ 4.00 Diluted Earnings Per Share Half-Year Income available to common shareholders $ 142,000 Interest expense $ 12,500 0.5 Tax on interest expense $ (2,500) 0.5 Income available to common shareholders, adjusted $ 152,000 Common shares, closing, weighted 35,500 0.5 Shares assumed issued on conversion of debt (Earliest possible issue date July 2,500 0.5 Shares assumed issued on stock option exercises 10,000 0.5 Assumed repurchase Note A (7,895) 0.5 Diluted, Common shares, closing, weighted 40,105 Diluted EPS $ 3.79 Note A Number of options 10,000 Exercise price $ 15.00 The 10,000 options with an exercise price of $ Proceeds from exercise $ 150,000 Average stock price $ 19.00 Assumed repurchase 7,895 Diluted Earnings Per Share Half-Year Income available to common shareholders $ 142,000 Interest expense $ 500,000 4.44% $ 11,094 Tax on interest expense $ (2,219) Income available to common shareholders, adjusted $ 150,875 1.00 Common shares, closing, weighted 40,000 Shares assumed issued on conversion of debt (Earliest possible issue date July 2,500 Diluted, Common shares, closing, weighted 42,500 Basic EPS $ 3.55 1.00 Diluted EPS $ 3.55

Total Opening balance 125,000 $ 10,000,000 $ 1,000,000 $ 40,000,000 $ 51,000,000 Net Income - - - $ 30,450,000 $ 30,450,000 1 Dividends Paid - - - ### $ (10,000,000) SBC expense - - $ 5,625 - $ 5,625 2 Stock options exercised 4,000 $ 600,000 $ (200,000) - $ 400,000 2 Shares repurchased (10,000) $ (800,000) - $ (450,000) $ (1,250,000) 2 Closing balance 119,000 $ 9,800,000 $ 805,625 ### $ 70,605,625 Share Repurchases Historical cost per share $80 Number of shares repurchased 10,000 Reduction to common shares $800,000 Cost per share to repurchase $ 125.00 Excess over cost $45 Amount recorded in retained earnings $450,000 Stock option exercises Exercise price $ 100 Options exercised 4,000 Cash received on exercise $ 400,000 Grant Date Fair Value $ 50 Options exercised 4,000 Reclassification $ 200,000 Total impact to common shares $ 600,000 SBC Expense 2/2 Grant Date Fair Value $ 15.00 Number of options 7,500 Total Fair Value Granted $ 112,500 Months to earn 60 Months past 3 % Earned 5.00% Expense $ 5,625 Common Shares Common Shares ($) Contributed Surplus ($) Retained Earnings ($)

Part A - First Interpretation (information available in Year 1) Costs incurred $ 4,000.00 Total costs to complete $20,000.00 % Complete 20% Revenue $ 2,500 Total Revenue 12,500 Total Expected Cost (20,000) Projected Loss (7,500) Year 1 Year 2 Total Revenue $ 2,500 $ 10,000 $ 12,500 2 Costs $ (10,000) $ (10,000) $ (20,000) 1 Pre-tax profit $ (7,500) $ - $ (7,500) Part A - Second Interpretation (information available in Year 2) Costs incurred $ 4,000.00 Total costs to complete $10,000.00 % Complete 40% Revenue $ 5,000 Year 1 Year 2 Total Revenue $ 5,000 $ 7,500 $ 12,500 2 Costs $ (4,000) $ (16,000) $ (20,000) 1 Pre-tax profit $ 1,000 $ (8,500) $ (7,500) Part B Number Month Per Month % Complete Contract Price $50,000.00 1 Jul-22 3.33% 3% Price % Relative Value 2 Aug-22 #NAME? 7% Car $ 41,000 77% $ 38,318 3 Sep-22 #NAME? #NAME? Warranty $ 12,500 23% $ 11,682 4 Oct-22 #NAME? #NAME? Total $ 53,500 100% $ 50,000 5 Nov-22 #NAME? #NAME? 6 Dec-22 #NAME? #NAME? 2022 2023 Total 7 Jan-23 #NAME? #NAME? Revenue - Car $ 38,318 $ - $ 38,318 2 8 Feb-23 #NAME? #NAME? Revenue - Warranty $ 2,336 $ 5,841 $ 8,178 2 9 Mar-23 #NAME? #NAME? Total Revenue $ 40,654 $ 5,841 $ 46,495 10 Apr-23 #NAME? #NAME? Cost - Car $ (35,000) $ - $ (35,000) 2 11 May-23 #NAME? #NAME? Cost - Warranty $ (2,000) $ (5,000) $ (7,000) 2 12 Jun-23 #NAME? #NAME? Pre-Tax Profit $ 3,654 $ 841 $ 4,495 13 Jul-23 5.00% #NAME? 14 Aug-23 #NAME? #NAME? 15 Sep-23 #NAME? #NAME? 16 Oct-23 #NAME? #NAME? 17 Nov-23 #NAME? #NAME? 18 Dec-23 #NAME? 70% 19 Jan-24 #NAME? #NAME? 20 Feb-24 #NAME? #NAME? 21 Mar-24 #NAME? #NAME? 22 Apr-24 #NAME? #NAME? 23 May-24 #NAME? #NAME? 24 Jun-24 #NAME? #NAME?

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