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Free CFA-Level-I Exam Braindumps (page: 484)

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The current economic environment is one of steady inflation. A firm uses historical cost accounting. Which of the following is/are true?

  1. The firm's book value is overstated.
    II. The firm's depreciation expense is understated.
    III. The firm's tax expense is overstated.
    IV. The firm's net income is understated.
  2. II & III
  3. I & IV
  4. I & III
  5. I, II & IV

Answer(s): A

Explanation:

Since the assets are carried at historical values which are lower than the current asset values due to inflation, the depreciation expense is understated. Therefore, income is overstated, leading to an overstatement of taxes.
Historical cost accounting in inflationary environment implies that the asset values are understated.



Which of the following is /are true?

  1. A simple capital structure is one that does not include any common stock equivalents or dilutive contingent securities.
    II. A firm with common stock, preferred equity and debt can be considered to have a simple capital structure.
    III. Any security that is dilutive must be included in the calculation of Diluted EPS.
  2. I & II
  3. II & III
  4. I, II & III
  5. I only

Answer(s): C

Explanation:

A simple capital structure consists of only common stock and non-convertible senior securities while a complex structure is one which contains potentially dilutive securities. Since there is no contingent conversion associated with straight, preferred equity, it is considered to be a part of a simple capital structure. Finally, only dilutive securities i.e. securities that do not increase earnings or decrease losses are included in the calculation of DEPS. Anti-dilutive securities are ignored in the calculations.



Which of the following would affect both net income and cash flow from operations?

  1. credit sale to a customer
  2. sale of marketable security for a gain
  3. interest payment on capitalized interest
  4. none of these answers

Answer(s): D

Explanation:

The sale of a marketable security falls under an investing activity. Interest payments fall under financing activities. Credit sale to a customer doesn't apply.



A firm has 400 preferred stocks outstanding. It started the year with 900 common stocks and over the year, had the following transactions:

Feb 15 Issued 300 common shares.
May 1 Redeemed 100 preferred shares.
Aug 15 Repurchased 150 common shares.
Nov. 30 Issued 400 common shares.

In the calculation of EPS, the number in the denominator would be closest to:

  1. 1440
  2. 1140
  3. 1220
  4. 1540

Answer(s): B

Explanation:

The number of preferred stocks is not relevant in the calculation of the denominator of simple EPS. It had 900- 150 = 750 shares for 12 months, 150 shares for 7.5 months (repurchased in Aug), 300 shares for 10.5 months (issued in Feb) and 400 shares for 1 month (issued in Nov). Hence, weighted # of shares = 750 + (7.5/12*150) + (10.5/12*300) + (1/12*400) = 1,139.6






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