Q's from Sample exam 1

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Jamms

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Some good review questions based on just taking sample exam 1:

1. With a net deferred tax asset, when tax rates decrease, equity decreases. (q 24)

What happens if you have a net deferred tax liability... if tax rates decrease, do you have an increase in equity? Or if tax rates increase, do you have a decrease in equity?

2. Can someone explain the logic behind why npv and irr give conflicting decisions when WACC is less than the crossover rate, and what that means?

3. For bond indexes, what is the "trader prices" upon which the indexes are calculated?

4. Key difference b/w a growth stock vs. a growth company? How should we analyze growth stocks?

5. How is the Total Return objective different from the Capital Appreciation objective?

6. There was an ethics question in which a public relations firm had to disclose that it owned stock in the company for which it was providing PR for. Wasn't there something about how in certain cases disclosure isn't necessary since it could be reasonably ascertained by third parties that the PR firm will display the client in a good light... ?
 
3) I believe because it's a call market and not a continuous market - can't get prices from a "Nasdaq" so to speak, prices come from traders

5) Total return seeks income and capital appreciation
 
I got #1 wrong as well. I think the reason is as follows:

Equity includes RE, and RE is, in part, determined by NI, which is in turn determined by revenue vs. expenses.

Since Income Tax Expense = Income Tax Payable + Change in DTL - Change in DTA, if tax rates go down, the NET DTA goes down. The change is negative, so the equation becomes:

Income Tax Expense = Income Tax Payable + Change in Net DTA

So income tax expense increases, which decreases net income, which decreases equity.

If there were a net DTL, the equity would INCREASE by the amount of the change in the net dtl.



Edited 1 time(s). Last edit at Thursday, June 5, 2008 at 06:29PM by Cubemonkey.
 
anyone have any good answers for q's 1 and 2?
 
1) For a DTL, you have recognized more income tax expense that taxes payable (i.e. you will have to pay the tax to uncle sam in the future). If rates go down, your liability will go down as well. The offset should also go to equity (in order to keep everything balanced).

2) I think the easiest way to understand this is to look at the graph in the book (or draw a picture). The steeper line will cross the horizontal axis at a lower rate (lower IRR), but will intersect the vertical axis at a higher point. If you are to the left of the crossover rate (where they intersect), the steeper line will be above the flatter one (signifying higher NPV). On the right side of the crossover rate, the flatter line will be higher (with higher NPV), and it will extend further to the right, giving it a higher IRR. If you draw the picture, its easier to understand the intuition.
 
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