CFA Practice Question

There are 334 practice questions for this study session.

CFA Practice Question

Which of the following statements is (are) true with respect to the effects that the various acquisition methods will have on the various financial ratios?

I. During an inflationary period, the year in which the companies merge, the acquiring firm will see its profit margins decrease if it were to use the acquisition method as opposed to the pooling method.
II. If the acquired firm's financial leverage ratio is lower than that of the acquiring firm, then the interest coverage ratio on a post merger basis will be higher using the acquisition method as opposed to using the pooling method.
III. If the fair market value exceeds the book value of the acquired firm's net assets, then the asset turnover ratio of the consolidated firm will be lower under the acquisition method than it would be under the pooling method.
IV. If the fair market value exceeds the book value of the acquired firm's net assets, then the profitability ratios of the consolidated firm will be lower under the acquisition method than it would be under the pooling method.
A. I and IV
B. III and IV
C. I, III and IV
Explanation: I is true because during an inflationary period, the fair market value of the acquired firm's inventory will be higher than its book value. Consequently, under the acquisition method, these higher inventory values will translate into higher cost of goods sold and thus, lower profit margins.

II is incorrect because if the acquired firm's financial leverage ratio is lower than that of the acquiring firm, then the interest coverage ratio on a post merger basis will be lower using the acquisition method as opposed to using the pooling method. Remember, it's the pooling method that simply adds up the book values of both firms. Under the acquisition method, as assets are written up, the associated expenses will increase, thus reducing the interest coverage ratios.

III is true because the acquisition method would require the asset values to be written up, thus increasing the denominator of the turnover ratio, which would in turn lower the turnover ratio.

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