I have a general question on this topic. I am going through Schweser question bank. I think the following question is too big to answer in 1 1/2 minute. Should we expect such questions on real exam? Selected information from the financial statements of Salvo Company for the years ended December 31, 2003 and 2004 is as follows (in $ millions): 2003 2004 Sales $21 $23 Cost of Goods Sold (8) (9) Gross Profit 13 14 Cost of Franchise (6) 0 Other Expenses (6) (6) Net Income $1 $8 Cash $4 $5 Accounts Receivable 6 5 Inventory 9 7 Property, Plant & Equip. (net) 12 15 Total Assets $31 $32 Accounts Payable $7 $5 Long-term Debt 10 5 Common Stock 8 8 Retained Earnings 6 14 Total Liabilities and Equity $31 $32 Salvo’s return on average total equity for 2004 was ($8 / (($8 + $6) + ($8 + $14)) / 2 =) 44.4%. If Salvo had amortized the cost of the franchise acquired in 2003 over six years instead of expensing it, Salvo’s return on average total equity for 2004 would have decreased from 44.4% to: A) 38.9%. B) 31.1%. C) 35.6%. D) 25.6%.
Under the revised circumstances 2003 NI = 13 - 1 - 6 = 6 2004 NI = 14 - 1 - 6 = 7 2003 RE --> (assuming all NI goes into RE) would become 6 (old RE) + 6 (new NI) - 1 (Old NI) = 11 2004 RE --> (assuming all NI goes into RE) would become 11 (2003 New RE) + 7 (2004 NI) = 18. Given this ROTE = 7 / ((8+11) = (8+18) / 2) = 7 / 22.5 = 31.1% (Choice B). I think this is a very good problem to understand flows between income statement and the balance sheet, and esp. when changes occur, the relationships. Yes, this may not be a 90 sec problem, but definitely, time is not a concern on the exam at all. Both times that I answered, once narrowly failing in June and then passing in Dec – I had almost 45 mins in each session left over. Also consider that you would have plenty of definitional items, gimmes etc. which don’t take the full 90 secs. So it is good to do as many problems, of different types, maybe multiple times, so you know the method down pat, and are not scrambling for the method at the exam time. Please let me know if my answer above – Choice B is right. CP
2004NI = 7 (8-1 to account for the amortization) 2003 Equity = (8+6+5) = 19 which is the original calc adding back the unamortized portion of the cost 2004 Equity = (8+14-2+6) = 26 which is the original calc less the $2 annual amortization since 2003 plus the asset on the BS ROE = $7 / ((19+24)/2) = 31.1% edit cpk too fast
CPK and Char-Lee , many thanks for the info. your answers are correct.
one thing I do when the question’s info part is so looooong is read the last part of question first to get what question is asking, i.e. what ratio or number I need to answer? Also have a quick look at choices.Then relative formula will pop up in my brain. at last go over whole question to pick up the data or info needed. I have met some questions which not even need look at whole question to get the right answer, or not even need calculation to get ratio or number answer. To do so, will save tons of time. CPK/Char-Lee and other guru, any other good exam tips to share?