Indian Institute of Management Nagpur

PGP 2019 – 2021

Feb 2, 2021
Financial Statement Analysis
Mid -Term Examination (Time 2 hours)
Question and Answer Booklet
1. All answers have to be submitted in this Word File (Question and Answer Booklet). If
you do any computations in excel please email the file to me at premc@iima.ac.in.

2. Please rename the file with your roll number. E.g. (P19XXX.docx).

3. Please ensure that your answers start in the line below the question.

4. Please highlight your selection in the multiple choice section in yellow..

5. Please remember to enter your name and roll number in the space provided

6. All questions are required to be answered.

7. This paper has 8 pages

Name: Roll Number

Questions 1 to 20 carry 1 mark each

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1. Which of the following ratios best measures the profitability of a company?
A. Return on equity
B. Gross margin
C. Current ratio
D. Net operating asset turnover

2 Which of the following statements is correct?

A. Net operating profit margin divided by net operating asset turnover equals return on
net operating assets.

B. Return on net operating assets can be disaggregated into net operating profit
margin and leverage.

C. Return on equity equals return on net operating assets less interest, net of tax.

D. Return on equity can be disaggregated into net operating profit margin, net
operating asset turnover and leverage.

3 Err Company has a major lawsuit against them for unsafe products. It recognizes a huge
liability in 2004 of $300 million. The effect of this liability is to decrease stockholders' equity
by 50%. In 2005, the effect of recognizing this liability, all else equal, is:
A. return on net operating assets will increase dramatically.

B. return on net operating assets will decrease dramatically.

C. return on equity will increase dramatically.

D. return on equity will decrease dramatically.

4 Which of the following will cause an increase in net operating income (NOPLAT)?
A. Increase in the return on net operating assets

B. Decrease in the return on net operating assets

C. No change in the return on net operating assets

D. There is not sufficient information

5 Which of the following would explain an observed decrease in return on equity, all else
equal?

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 A. Decrease in tax rate

B. Increase in interest rate on debt

C. Stock split

D. Stock dividend

6 Which of the following is the best measure of operating efficiency?

A. Return on net operating assets

B. Return on equity

C. Return on sales

D. Return on inventory

7 As a general rule, revenue is normally recognized when it is:

A. measurable and earned.

B. measurable and received.

C. realizable and earned.

D. realizable and measurable.

8 Which of the following measures of accounting income is typically reported in an income

statement?
A. Net income

B. Comprehensive income

C. Continuing income

D. All of the above

9 Which of the following statements concerning deferred taxes is correct?

A. Deferred taxes will not be found in the asset section of a balance sheet.

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 B. Deferred taxes arise from permanent differences in GAAP and tax accounting.

C. Deferred taxes will only decrease when a cash payment is made.

D. Deferred taxes arising from the depreciation of a specific asset will ultimately reduce
to zero as the item is depreciated.

10 Which of the following combinations of accounting practices will lead to the highest
reported earnings in an inflationary environment?
A. Option A

B. Option B

C. Option C

D. Option D

The following is to be used for questions 11 to 13

Tektronix Company reported in its annual report software refinement expenses of ₹12 million, ₹15
million, and ₹18 million for fiscal years 2005, 2006, and 2007, respectively. At the end of fiscal 2007,
it had total assets of ₹140 million. Net income was ₹20 million for fiscal 2007, and it had a marginal
tax rate of 35%.
11. If software refinement had been capitalized each year and amortized over a three-year
period beginning in the year the cost was incurred, total assets at the end of fiscal 2007
would have been:
A. ₹185 million.

B. ₹172 million.

C. ₹158 million.

D. ₹157 million.

12. If software refinement had been capitalized each year and amortized over a three-year
period beginning in the year the cost was incurred, net income for fiscal 2007 would have
been:
A. ₹31.7 million.

B. ₹29.75 million.

C. ₹21.95 million.

D. ₹14.95 million.
13. If the software refinement had been capitalized and amortized over a three-year period
beginning in the year the cost was incurred, but was expensed for tax purposes, the deferred tax
position at the end of fiscal 2005 would have been:

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 A. a deferred tax credit of ₹2.8 million.

B. a deferred tax credit of ₹3.5 million.

C. a deferred tax credit of ₹5.2 million.

D. a deferred tax debit of ₹4 million.

The following is to be used for questions 14 to 18

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies
producing widgets. Below are selected data:

Widget Co Tools Inc

Net Operating assets / Equity 1.37 1.53
Net operating profit margin 19% 21%
Income Tax rate 47% 28%
Revenues / Net operating assets 0.81 0.61
EBIT / Revenues 38% 32%

14 Which of the following statements is the most plausible explanation of the difference in
observed net operating profit margins?
A. Widget Co's lower financial leverage

B. Widget Co uses LIFO and Tools uses FIFO

C. Widget Co's lower tax rate

D. Widget Co's net operating asset turnover

15 Which of the following statements best explains the difference in observed net operating
asset turnover?
A. Widget Co's lower financial leverage

B. Widget Co uses FIFO and Tools uses LIFO

C. Widget Co's lower tax rate

D. Widget Co has significant operating leases and Tool Inc. has no leases

16 Which of the following statements is correct?

A. Widget has higher RNOA than Tools.

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 B. Widget has lower RNOA than Tools.

C. Widget has same RNOA as Tools.

D. Insufficient information to calculate RNOA.

17 Which of the following statements could explain the difference in observed tax rates?
A. Widget uses straight-line depreciation and Tool uses MACRS.

B. Widget uses LIFO and Tool uses FIFO.

C. Tool has foreign subsidiaries in countries with much lower tax rates.

D. Widget has significant amounts of interest income from municipal bonds.

MACRS – Modified accelerated cost recovery system

18 Widget has a higher EBIT/Revenue but lower net operating profit margin than Tool. Which of
the following statements could explain this better as a percentage of sales?
A. Widget has greater interest expense and taxes.

B. Widget has greater interest expense but lower taxes.

C. Widget has lower interest expense but higher taxes.

D. Widget has lower interest expense and taxes.

The following information is to be used for questions 19 and 20

Below is a selected information for TRICOR

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 Year1 Year2
Net Operating assets / Equity 1.37 1.53
Net operating profit margin 19% 21%
Income Tax rate 47% 28%
Revenues / Net operating assets 0.81 0.61
EBIT / Revenues 38% 32%

19 Return on net operating assets for Year 1 is:

A. 30.8%.

B. 16.3%.

C. 15.4%.

D. 14.5%.

20 Return on common equity for Year 1 is:

A. 19.0%.

B. 19.60%.

C. 21.08%.

D. 26.03%.

21 (Total 10 marks)

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 Sakshi group reported net Income totalling ₹1,000,000 for the year 2006. The following is
additional information obtained from the Sakshi groups financial reports:

 The company purchased 100,000 shares of Alpha specialities for ₹10 per share During
the 4th quarter of 2006. The investment is accounted for as “available for sale. The value
of the share is ₹9 at the end of 2006. “
 The company purchased 10,000 shares of sunrise industries for ₹20 per share doing the
4th quarter of 2006 the investment is accounted for as “trading” securities. The value of
the share is ₹22at the end of 2006.
 The company began operations in Southeast Asia during the year and reports a foreign
currency translation gain at the end of 2006 of ₹50,000.
 The actual return on assets in its pension fund total ₹150,000. The expected return was
₹ 110, 000.
 The company has substantial prior service cost associated with its employee pension
plan. As a result, the company had to record an additional minimum pension liability
during the year totalling ₹25,000.
 The company reported unrealised holding losses on derivative instruments totalling
₹12,000.

Required:

1. computer comprehensive income for Sakshi group.

2. For each item in comprehensive income, discuss balance sheet account affected by the item.

22. (Total 30 marks)

The historical data for Fairway Limited is given in the Excel sheet accompanying this paper.

Prepare the following based on the data in the Excel file. Please note clarity and
completeness of presentation will carry credit in grading:

 Invested Capital and Net Operating Profit Less Adjusted Taxes (NOPLAT) statements. All
heads of items and reconciliation must be shown.
 Reconcile the NOPLAT to Net Income in a separate statement
 Produce a ROIC tree, first remove the impact of tax, then compute profitability and the
efficiency of utilization of Invested capital in generating sales.
 Develop a free cash flow statement – computing free cash flow from operations and free
cash flow to investors
 Develop an Economic Profit statement (EVA) assuming a weighted average cost of
capital of 11.1%.
 Compare and contrast the cash flow and economic profit statements.

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