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QUIZ Answers
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1.

FALSE Paying a dividend to common stockholders is something the board of directors may choose to do with company earnings. It does not reduce earnings.

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2.

TRUE Earnings per share really means earnings per common share. Preferred dividends are deducted from earnings to get earnings available for common shareholders. This latter figure is divided by the number of common shares outstanding to get earnings per share. This is covered in Chapter 12.

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3.

FALSE Retained earnings is one component of Ownership Equity. It cannot be greater than Ownership Equity. See Chapter 2, where you will also learn about Paid in Capital, Additional Paid in Capital, and Common at Par Value.

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4.

TRUE A primary offering just means the company is selling new shares. A primary offering may be the company's initial public offering, or it may be the company's second public offering, or third public offering, etc. See Chapter 5 to learn the difference between a primary offering, a secondary offering, and an initial public offering. Also see question 5 below.

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5.

FALSE
The word "secondary" is a source of confusion. A secondary offering, correctly speaking, is an offering of already outstanding shares, not new share. Therefore it would have no effect on the company, and would not be dilutive. Such secondaries usually reflect insider shares, or venture capital shares which have not yet been registered with the SEC, and are now being registered and being resold to the public. Unfortunately, the word "secondary" in recent years has also come to be used to mean any primary offering of new shares other than the initial public offering. With this improper use of "secondary" the correct answer to the question is True (because this is really a primary offering). This is initially confusing, but is explained in Chapter 5. Return to Quiz

6.

FALSE

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An IPO can also be a secondary offering. That is, the shares being registered and sold to the public are unregistered shares which are currently owned by company founders, venture capitalists, and the like. An initial public offering simply means that some of the company's shares are being offered to the public for the first time. It makes no difference whether these shares are primary (new shares being created by the company), or secondary (already outstanding shares) which had not yet been registered.
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7.

FALSE Not necessarily. The price/earnings ratio is usually related to the company's growth rate. A company whose earnings per share are growing at 20% per year is likely to have a much higher price/earnings ratio than a company which is only growing at only 5% per year. The slower growing company might be a lot riskier.

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8.

TRUE Companies which have high depreciation and low earnings, for example, may be better valued using a multiple of cash flow. See Chapter 19, but please read Chapters 14 and 16 first.

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9.

FALSE They fall by half. This was an easy one.

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10.

MAYBE A stock split by itself does not change the value of anybody's stock holdings. See Chapter 6. But sometimes there is a psychological effect which results in the stock rising slightly at about the time of the split, or when the split is first announced.

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11.

TRUE As long as the company has the cash, it can pay what it wants

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(usually). Can you think of two exceptions?

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12.

TRUE Capitalizing R & D costs means taking less expense that year, leaving higher profit. See Chapter 15. Important if you follow companies which have a lot of R & D expense, such as software companies.

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13.

FALSE Accelerated depreciation is usually greater than straight-line depreciation. Therefore, changing to accelerated depreciation increases expenses, which lowers earnings. See Chapter 14.

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14.

TRUE
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The increased depreciation expense will result in lower pretax profit, hence lower taxes, which will result in increased cash flow. See Chapter 14. The difference between cash flow and earnings is a very important concept.

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15.

FALSE Amortization is an expense. Increasing expenses lowers pretax profit. Questions 12-15 are easy once these terms and concepts are explained clearly. And you need to understand it if you want to discuss investments at a professional level.

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16.

FALSE Bonds are safer because they are secured by specific assets as well as the company's contractual commitment to pay interest and principal. Debentures are only backed by the latter. I can think of an exception. Can you?

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17.

FALSE Preferred stockholders are paid off ahead of common stockholders, but after all bondholders.

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18.

TRUE But when long term debt is much greater than equity, the company typically has a low interest coverage ratio, which implies risk. See Chapter 4.

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19.

TRUE The current yield is just the coupon (annual interest payment) divided by the current price of the bond. The yield-to-maturity also considers the coupon, but in addition, the yield-to-maturity adds the capital gain the bondholder will have if the bond is bought below par and held to maturity. If you want to understand the difference between coupon yield, current yield, and yield-to-maturity, read Chapter 9.

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20.

FALSE Return on capital is a profitability ratio. An increasing return on capital implies improving profitability. The company is most likely becoming less risky. See Chapter 4.
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THESE QUESTIONS WERE NOT REALLY HARD. READ THE BOOK. YOU WILL LEARN ALL THIS, PLUS A LOT MORE.

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