Income Statement Question: FRA Question Bank

CFA Level I FRA
#1

The following data are available for a company and its industry:

Company Common-Size Balance Sheet As of 31 December 2013

Percent** AssetsCash and short-term investments 43.2 Accounts receivable 9.4 Inventory 0.6 Total current assets 53.2 Net property, plant, and equipment (PP&E) 3.9 Goodwill 40.0 Other long-term assets 2.9 Total assets 100.0Liabilities and Shareholders’ Equity Short-term debt 1.6 Accrued liabilities and accounts payable 17.8 Total current liabilities 19.4 Long-term debt 20.1 Other long-term liabilities 6.5 Total liabilities 46.0 Total stockholders’ equity 54.0 Total liabilities and shareholders’ equity 100.0 Data for Comparison **Industry Debt to equity 50.0% Long-term debt to equity 40.0%

Which of the following statements about the company is most appropriate? The company:

  1. has more financial leverage than the industry.
  2. has made significant acquisitions in the past.
  3. is an electric utility.

I answered 1. but the answer is 2.

Isn’t financial leverage equal to Assets/Equity which for the company is 100/54 = 1.85 while for the industry it must be 1.5 i.e (we know D/E = 0.5 so D = 0.5E we also know A = D+E so A = 1.5E so A/E aka fin. leverage is 1.5)

Am I missing something?

#2

Bump, I have the same doubt. It is clear that B is right, but why would A be wrong?

#3

Because debt isn’t the same as liabilities; debt bears interest.

1 Like