BUS3026W

ASSESSMENT TEST 2 15 March 2006

Total marks: 30
Time: 40 minutes
Multiple Choice Questions (Q 1 to 10): 2 marks each.
Incorrect answers: -1/2 mark each.
No answers: 0 marks each.

For Questions 1 to 10, please circle the correct answer on your question sheet.

Question 1:

Which one of the following statements is / are correct?

i. Technical analysts believe that supply and demand determines market values.
ii. Liquid shares are easier to sell.
iii. Price changes that are not accompanied by high volumes are likely to be sustainable.
iv. Contrarian investors take the majority view of the market.
a. i and ii
b. ii only
c. iii only
d. ii and iii
e. i and iv

Question 2:

Which one of the following combinations is correct in the context of the following
statement?

When sentiment is (i) ____________ , a contrarian investor will sell shares, and when
price momentum is low, a (ii) _______________ will buy shares.

a. (i) low , (ii) momentum investor

b. (i) high , (ii) momentum investor
c. (i) high , (ii) contrarian investor
d. (i) low , (ii) contrarian investor
e. None of the above.

Question 3:

Which of the following statements is/are false?

i. Corporate governance refers to the division of rights and responsibilities between

shareholders and managers.
ii. For an investor it is desirable that the Chairman of the Board of Directors is
independent.
iii. An investor should avoid investing in a company with liabilities such as potential
tobacco litigation.
a. i
b. ii
c. iii
d. i and iii
e. All 3 statements are correct.

From what I saw they nearly all got this one wrong. Statement iii is incorrect. An investor
should not avoid these shares, he/she should be aware of the liability, but if the market is
overly negative about the liability, the share itself may be a bargain, despite the liability. In
other words, if the liability is exaggerated in the price, the share may well be a great
investment (even bad companies can be good investments, if the market overreacts). The
above was said many times in class, and is a fundamental lesson to be understood.

Question 4:

Given the following for Red and Co (all numbers, except share price, in millions):

• Tax: R 15
• Depreciation and amortisation: R8
• Interest paid: R7
• Net earnings after tax: R 24
• Number of shares in issue: 110
• Current share price: 135 cps
• Market value of the company’s debt: R 65

Which of the following is closest to the (i) EBITDA: Enterprise Value multiple (EBITDA:EV), and
(ii) Price: Earnings ratio (P:E) of the company?

a) (i) 4.0 (ii) 6.2

b) (i) 3.7 (ii) 5.6
c) (i) 4.5 (ii) 7.2
d) (i) 3.7 (ii) 6.2
e) (i) 4.0 (ii) 5.6

Question 5:

Which one of the following statements is / are correct?

i. Price : tangible NAV is a more conservative valuation method than price : NAV.
ii. Book values (NAV) are normally more volatile than earnings.
iii. Most analysts use price : cashflow valuation methods.
iv. P/E ratios are not appropriate when earnings are negative.
a. i only
b. i and ii
c. i and iv
d. ii and iii
e. iv only

Question 6:
1) Irving Fisheries: Reported earnings 2001 - 2006

2002 2003 2004 2005 2006

Earnings before tax* 1500 2350 1800 1650 2150
Insurance payout received 0 400 0 0 0
Restructuring costs 200 0 0 400 0
Boat licenses 220 150 50 40 300
* After the items listed further down.

Tax Rate: 30%

Based on the above table, the normal earnings of Irving Fisheries is closest to:

a) 1400.
b) 1500.
c) 1600.
d) 2100
e) 2200.

Question 7:
Which valuation method is useful when comparing companies with different degrees of
leverage?

a. Price : tangible net asset value.

b. Tobit’s Q.
c. The PEG ratio.
d. EV : EBITDA ratios.
e. Price : sales ratios.

Question 8:
Which of the following does not artificially increase a company’s earnings in the current
period?

a. Incorrectly reducing accounting provisions.

b. Overly aggressive revenue recognition on business with a positive gross margin.
c. Depreciating a large new asset using straight line depreciation instead of an accelerated
depreciation method (e.g., “sum-of-the-year digits”).
d. Incorrect capitalisation of research and development.
e. Using a lower than justified discount rate for determination of a defined benefit
pension liability.

Question 9:
Which of the following statements is / are correct?

i. If the intrinsic value of a share is higher than its market value, it should be bought.
ii. A major problem with the dividend discount model is that it very difficult to determine dividend
growth (g) and the required rate of return (the discount rate, k).
iii. Dividends are an indicator of a company’s earnings and earnings capacity.

a) i.
b) ii.
c) iii
 d) i and ii
e) ii and iii

Question 10:

Which of the following statements on technical analysis is / are correct?

i. When the share price is above the moving average for a given period, the investor should
consider buying the share.
ii. A resistance level is formed at a price where buyers of the share consistently enter the market.
iii. Sustainable trends are based on ongoing price changes accompanied by decreasing volumes.

a) i.
b) ii.
c) iii
d) i and ii
e) ii and iii

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For Questions 11, 12 and 13, please show all your calculations / answers in the spaces
provided:

Question 11:

Given the following information for Kirby and Co for 2006/7:

• Net after tax earnings: R 55 million

• Incorrectly capitalised R&D costs R 12 million
• Tax rate: 30%
• 2,250,000 shares in issue
• Depreciation policy 25% per annum (straight-line over 4 years)
• The sector P/E 12.5

Using P/E methodology, determine the size of the required earnings adjustment, as well as
the value of one share in Kirby and Co.

a) Required earnings adjustment:

Capitalised costs: R 12 mn
Less depreciation (12/4) -R 3 mn [1 mark correct treatment of depreciation]
R 9 mn
Tax factor x 0.7
R 6.3 mn [1 mark for adjustment value]

Magnitude of adjustment: R6.3 mn

Correct earnings: R 55 mn – R 6.3 mn = R 48.7 mn [1 mark]

Value = (Correct earnings x P/E) / # shares

= (48.7 x 12.5) / 2.25

 = R 270.56 [2 marks]
Total: 5 Marks
Question 12:

Explain what the role of a director is. [1 mark]

Represents shareholders to make sure company is run to their benefit (secondary: also
determines strategic direction of business).

Question 13:

Explain the circumstances under which the “Percentage of Completion” method is used for
revenue recognition in accounting. Also explain how revenue is recognised in this method.

[2 marks]

• Used for long-term projects where revenue, costs and completion time can be reliably
estimated.

• Revenue recognised as percentage of total revenue based on percentage of project

completed or percentage of total costs incurred.

Question 14:

Name the two factors that characterise a “selling climax” according to technical analysts.

• Falling prices
• On rapidly declining volumes

[2 marks]