Exam 11: Equity Analysis and Valuation

Quality of earnings is said to be high if analysts' earnings forecasts have a small standard deviation.

Which of the following can affect earnings quality? I. Management's choice of accounting principle II. Management's choice of dividend policy III. Management's estimates IV. Management's discretionary expenditures

Hupta Corporation Net income \ 6,000 Dividends \ 2,000 Total assets-12/31/05 \ 50,000 Total liabilities-12/31/05 \ 20,000 Number of shares outstanding 1,000 Cost of equity 10\% -Net income is expected to increase by 10% for the next year, and dividend payout ratio is expected to remain constant. After 2006, residual earnings are expected to decrease to zero. Using the earnings-based valuation method, what is the value per share of Hupta stock as of 12/31/05?

The SEC requires only quarterly financial reports to be filed (Form 10-Q).

Consider each of the scenarios below independently. 1. Luxury Limos is in the business of renting limousines in New York City. It has a fleet of 200 limos. It owns the limousines that it rents, and keeps them on average for five years. In Year 3, Luxury Limos showed a loss on the sale of limos of $5,000. In Years 1 and 2, it recorded a loss on sale of $2,000 and $1,000, respectively. Should the gains and losses on the sale of limos be ignored when determining earnings persistence or not? 2. Turnaround Corporation has just hired new top management. In the new management's first year, they take a huge restructuring charge (looks as though they are taking a "big bath"). Included in the restructuring charge are: • Recognition of a contingent liability for probable environmental clean-up • Write-down of assets (which amounted to a 50% write-down of all assets) • A charge for a future upgrade of its computer system For each of the items included in the restructuring charge, and considering management's possible motivation for taking a "big bath", identify how these items might affect future recorded income?

Although growth is often touted as one of the key drivers of the value of a stock, no amount of growth will increase the value of a company if its return to providers of capital is less than the cost of that capital.

To produce a reliable forecast of earnings, an analyst must first separate the persistent components of earnings from the nonrecurring components.

Adjustments to income statement numbers should be done following the estimation of the earnings persistence.

The quality of earnings is affected by the volatility of a company's sales.

Variability in earning numbers:

The number of outstanding shares of a company will affect its price-to-earnings ratio.

A retrenching company with poor prospects would generally have:

Two companies operate in the same industry, but one has a much higher PE ratio than the other. One reason for the difference in PE ratio could be the quality of earnings.

A growing company with disappointing profitability would generally have:

The number of authorized shares of a company will affect its earnings per share ratio.

Extrapolation is one of the most reliable analytical tools in forecasting earnings.

When examining quarterly results of a company in a seasonal business, it is useful to:

Which of the following statements concerning quality of earnings is correct?

A typical time horizon for measuring earnings power is 5 years.

All other things being equal, the price-to-earnings ratio would be expected to increase as the cost of equity capital increases.