Question

1. Which of the following characteristics of a firm would limit the firm’s attractiveness as a potential LBO candidate?

1. Substantial tangible assets
2. High reinvestment requirements
3. High R&D requirements
4. B and C
5. All of the above

1.          Which of the following is not true about generally accepted accounting principles (GAAP)?

1. GAAP provide specific guidelines as to how to account for specific events impacting the financial

performance of the firm

2. The scrupulous application GAAP accounting rules does ensure consistency in comparing one

firm’s financial performance to another

3. It is customary for definitive agreements of purchase and sale to require that a target company

represent that its financial books are kept in accordance with GAAP.

              d.            GAAP guarantees that a firm’s financial books are accurate.

              e.            Differences between how a firm records actual financial transactions and how they should be recorded based on GAAP may indicate fraud or mismanagement.

2.           Which of the following is not true about common size financial statements?

1. Such statements are used to uncover data irregularities.
2. Such statements are constructed by calculating the percentage each line item of the income statement, balance sheet, and cash flow statement is of annual sales.
3. Such statements are useful for comparing businesses of different sizes in the same industry at different moments in time.
4. Common size statements applied over a number of consecutive periods may be used to determine if the target firm is deferring necessary spending.
5. Common size statements may be calculated for both quarterly and annual financial data.

Answer 1

1. Leveraged Buyout (LBO) is the acquisition of another Company by using borrowed capital as a major part of the financing. The assets of the target company are generally used to raise debt and the payment of interest on the debt is made through the cash flows of the target company. There are many characteristics that are required in a target firm for the acquirer to decide on doing an LBO.

One of the requirements in a target company is the availability of substantial tangible assets so that the acquirer can pay off the debt by using tangible assets.

Generally, the acquirer sells the target company within 5 to 7 years of an LBO. Hence, the acquirer company will not target a company that will need a major amount of earnings to be reinvested in the firm.

Further, one of the characteristics to look out for in a target firm is the low amount of capital expenditures in the future.

So, it can be said that high reinvestment requirements and high research and development requirements would limit a firm’s attractiveness to be a potential LBO candidate.

Hence, the answer to the question is d.

2. GAAP is a set of principles that are set out to help improve the reporting of financial statements. However, GAAP does not guarantee that financial statements prepared using GAAP are free from any errors.

Hence, the answer is d.

3. Common size financial statements are statements which shows all items as a percentage of an individual item. The numerical values of items are not displayed in these statements. The aim of preparing common size financial statements is to help analysis of data with previous years or with other companies. Common size financial statements include a common size balance sheet, common size income statement and common-size cash flow statement. There are different base figures considered for comparison of each of the different statements. For the common size balance sheet, the base figure may be total assets or total liabilities or any of the balance sheet items. For a common-size cash flow statement, the base figure can be total cash inflow or outflow or any other cash flow item. For the common size income statement, the base figure can be total sales or profit or any other item from the income statement.

Hence, it cannot be said that common size statements are constructed by calculating the percentage each line item of the income statement, balance sheet, and cash flow statement is of annual sales.

Hence, the answer is b.