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QUESTION: 305

A vendor offered ABC Co. $25,000 compensation for losses resulting from faulty raw materials.
Alternately, a lawyer offered to represent ABC in a lawsuit against the vendor for a $12,000 retainer and 50% of any award over $35,000. Possible court awards with their associated probabilities are:

Compared to accepting the vendor's offer, the expected value for ABC to litigate the matter to verdict provides a:

$4,000 loss.
$18,200 gain.
$21,000 gain.
$38,000 gain.

Answer(s): A

Explanation:

Choice "a" is correct.

Choices "b", "c", and "d" are incorrect based on the above Explanation.

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QUESTION: 306

Under frost-free conditions, ABC company expects its strawberry crop to have a $60,000 market value. An unprotected crop subject to frost has an expected market value of $40,000. If ABC protects the strawberries against frost, then the market value of the crop is still expected to be $60,000 under frostfree conditions and $90,000 if there is a frost. What must be the probability of a frost for ABC to be indifferent to spending $10,000 for frost protection?

.167
.200
.250
.333

Answer(s): B

Explanation:

Choice "b" is correct. If there is no frost, then there is no difference between ABC's income with or without the insurance-the crop is worth $60,000 either way. However, if the insurance is purchased and a frost occurs, ABC earns $50,000 more with insurance ($90,000 − $40,000) than he would without the insurance.
The expected value of having the insurance is therefore:
Probability of frost x $50,000 + Probability of no frost x $0
ABC will be indifferent to spending $10,000 for frost protection when the expected value of the insurance equals the cost of the insurance:
Probability of frost x $50,000 = $10,000 Probability = 20%
Choices "a", "c", and "d" are incorrect based on the above Explanation.

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QUESTION: 307

During 1994, ABC Corp. experienced the following power outages:

Each power outage results in out-of-pocket costs of $400. For $500 per month, ABC can lease an auxiliary generator to provide power during outages. If ABC leases an auxiliary generator in 1995, the estimated savings (or additional expenditures) for 1995 would be:

($3,600)
($1,200)
$1,600
$1,900

Answer(s): C

Explanation:

Choice "c" is correct.

Choice "a" is incorrect. The estimated savings is dependent on the number of outages and on the number of months, since there are two costs involved.
Choice "b" is incorrect. The estimated savings is not the difference between the out-of-pocket costs and cost of generator, times 12 months.
Choice "d" is incorrect. The cost of the generator is a monthly cost, not dependent on the number of power outages.

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QUESTION: 308

What would be the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt?

To cause the price of the company's stock to rise.
To lower the company's bond rating.
To reduce the risk for existing bondholders.
To reduce the interest rate on the bonds being sold.

Answer(s): D

Explanation:

Note: The material tested in this question does not appear specifically on-point in our textbook, as the topic has rarely shown up on the CPA exam. The topics are covered in general in parts of our textbook, so we believe that our students would have answered this question correctly given the information they had. However, we have expanded our Explanation of this question to provide you with more detailed information.

Choice "d" is correct. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is to reduce the interest rate on NEW bonds being sold. A debt covenant is a provision in a bond indenture (contract between the bond issuer and the bond holders) that the bond issuer will either do (affirmative covenants) or not do (negative covenants) certain things. In this question, the issuer would agree not to issue bonds in the future over a certain percentage of its long-term debt.
Such a provision would be good for the potential bondholders and would probably reduce the interest rate on the bonds being sold.

Choice "a" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to cause the price of the company's stock to rise. Bond covenants affect bonds, not equity (at least not directly).

Choice "b" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to lower the company's bond rating. Such a covenant might raise, not lower, a company's bond rating because there would be less risk. Besides, why would a bond covenant be signed if it would lower the company's bond rating?

Choice "c" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to reduce the risk of existing bondholders, although a reduction in the risk of the existing bondholders certainly might result from such a covenant. As a general rule, more debt means more risk, less debt means less risk. So less debt would reduce the risk of all bondholders.
This answer is a very close second.

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Venkatesh commented on September 08, 2023
I don't see Internal Control/Information technology related questions
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Jay jain commented on May 25, 2023
This is nice platform
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