FIN 534 Week 3 Quiz 2 Chapter
2 and 3
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Strayer FIN 534 Quiz
Chapter and 3 Week 3
CHAPTER 2
FINANCIAL STATEMENTS,
CASH FLOW, AND TAXES
True/False
:
(2.1)
Annual report F
K Answer:
. The annual report contains four
basic financial statements: the income statement, balance sheet, statement of
cash flows, and statement of stockholders’ equity.
a. True
b. False
(2.1)
Annual report and expectations F K Answer:
. The primary reason the annual
report is important in finance is that it is used by investors when they form
expectations about the firm's future earnings and dividends, and the riskiness
of those cash flows.
a. True
b. False
(2.2)
Retained earnings versus cash C
K Answer:
. Consider the balance sheet of
Wilkes Industries as shown below.
Because Wilkes has $800,000 of retained earnings, the company would be
able to pay cash to buy an asset with a cost of $200,000.
Cash $
50,000 Accounts
payable $ 100,000
Inventory 200,000 Accruals 100,000
Accounts
receivable 250,000 Total
CL $ 200,000
Total
CA $ 500,000 Debt 200,000
Net
fixed assets $ 900,000 Common
stock 200,000
Retained
earnings 800,000
Total
assets $1,400,000 Total L & E $1,400,000
a. True
b. False
(2.2)
Balance sheet F
K Answer:
. On the balance sheet, total assets
must always equal total liabilities and equity.
a. True
b. False
(2.2)
Balance sheet: non-cash assets F K Answer:
. Assets other than cash are
expected to produce cash over time, but the amount of cash they eventually
produce could be higher or lower than the values at which these assets are
carried on the books.
a. True
b. False
(2.3)
Income statement F
K Answer:
. The income statement shows the
difference between a firm's income and its costs--i.e., its profits--during a
specified period of time. However, not
all reported income comes in the form or cash, and reported costs likewise may
not correctly reflect cash outlays.
Therefore, there may be a substantial difference between a firm's
reported profits and its actual cash flow for the same period.
a. True
b. False
(2.7)
Net operating working capital F
K Answer:
. Net operating working capital is
equal to operating current assets minus operating current liabilities.
a. True
b. False
(2.7)
Total net operating capital F
K Answer:
. Total net operating capital is
equal to net fixed assets.
a. True
b. False
(2.7)
Net operating profit after taxes (NOPAT) F
K Answer:
. Net operating profit after taxes
(NOPAT) is the amount of net income a company would generate from its
operations if it had no interest income or interest expense.
a. True
b. False
(2.9)
Federal income taxes: interest income F K Answer:
. The fact that 70% of the interest
income received by a corporation is excluded from its taxable income encourages
firms to use more debt financing than they would in the absence of this tax law
provision.
a. True
b. False
(2.9)
Federal income taxes: interest expense F K Answer:
. If the tax laws were changed so
that $0.50 out of every $1.00 of interest paid by a corporation was allowed as
a tax-deductible expense, this would probably encourage companies to use more
debt financing than they presently do, other things held constant.
a. True
b. False
(2.9)
Federal income taxes:int expense and dividends FK Answer:
. The interest and dividends paid by
a corporation are considered to be deductible operating expenses, hence they
decrease the firm's tax liability.
a. True
b. False
(Comp:
2.2,2.3) Financial statements F K Answer:
. The balance sheet is a financial
statement that measures the flow of funds into and out of various accounts over
time, while the income statement measures the firm's financial position at a
point in time.
a. True
b. False
:
(2.4)
Retained earnings F
K Answer:
. Its retained earnings is the
actual cash that the firm has generated through operations less the cash that
has been paid out to stockholders as dividends.
Retained earnings are kept in cash or near cash accounts and, thus,
these cash accounts, when added together, will always be equal to the firm's
total retained earnings.
a. True
b. False
(2.4)
Retained earnings F
K Answer:
. The retained earnings account on
the balance sheet does not represent cash.
Rather, it represents part of stockholders' claims against the firm's
existing assets. This implies that
retained earnings are in fact stockholders' reinvested earnings.
a. True
b. False
(2.5)
Cash flow and net income F K Answer:
. In accounting, emphasis is placed
on determining net income in accordance with generally accepted accounting
principles. In finance, the primary
emphasis is also on net income because that is what investors use to value the
firm. However, a secondary financial
consideration is cash flow, because cash is needed to operate the business.
a. True
b. False
(2.6)
Statement of cash flows F
K Answer:
. To estimate the cash flow from
operations, depreciation must be added back to net income because it is a
non-cash charge that has been deducted from revenue.
a. True
b. False
(2.7)
Future cash flows F
K Answer:
. The current cash flow from
existing assets is highly relevant to the investor. However, since the value of the firm depends
primarily upon its growth opportunities, profit projections from those
opportunities are the only relevant future flows with which investors are
concerned.
a. True
b. False
(2.9)
Federal income taxes:int exp and dividends F K Answer:
. Interest paid by a corporation is
a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant,
tends to encourage the use of debt financing by corporations.
a. True
b. False
(Comp:
2.1-2.3,2.6)Financial stmts:time dimension FK Answer:
. The time dimension is important in
financial statement analysis. The balance sheet shows the firm's financial
position at a given point in time, the income statement shows results over a
period of time, and the statement of cash flows reflects changes in the firm's
accounts over that period of time.
a. True
b. False
Multiple Choice:
Conceptual
:
(2.1)
Financial statements C K Answer:
. Which of the following statements
is CORRECT?
a. The four most important financial
statements provided in the annual report are the balance sheet, income
statement, cash budget, and the statement of stockholders’ equity.
b. The balance sheet gives us a picture
of the firm’s financial position at a point in time.
c. The income statement gives us a
picture of the firm’s financial position at a point in time.
d. The statement of cash flows tells us
how much cash the firm has in the form of currency and demand deposits.
e. The statement of cash needs tells us
how much cash the firm will require during some future period, generally a
month or a year.
(2.2)
Balance sheet C K Answer:
. Which of the following statements
is CORRECT?
a. The balance sheet for a given year,
say 2008, is designed to give us an idea of what happened to the firm during
that year.
b. The balance sheet for a given year,
say 2008, tells us how much money the company earned during that year.
c. The difference between the total
assets reported on the balance sheet and the debts reported on this statement
tells us the current market value of the stockholders' equity, assuming the
statements are prepared in accordance with generally accepted accounting
principles (GAAP).
d. For most companies, the market value
of the stock equals the book value of the stock as reported on the balance
sheet.
e. A typical industrial company’s
balance sheet lists the firm's assets that will be converted to cash first, and
then goes on down to list the firm's longest lived assets last.
(2.2)
Balance sheet C
K Answer:
. Other things held constant, which
of the following actions would increase the amount of cash on a company’s
balance sheet?
a. The company repurchases common
stock.
b. The company pays a dividend.
c. The company issues new common
stock.
d. The company gives customers more
time to pay their bills.
e. The company purchases a new piece of
equipment.
(2.2)
Current assets C
K Answer:
. Which of the following items is
NOT included in current assets?
a. Accounts receivable.
b. Inventory.
c. Bonds.
d. Cash.
e. Short-term, highly liquid,
marketable securities.
(2.2)
Current liabilities C K
Answer:
. Which of the following items
cannot be found on a firm’s balance sheet under current liabilities?
a. Accounts payable.
b. Short-term notes payable to the
bank.
c. Accrued wages.
d. Cost of goods sold.
e. Accrued payroll taxes.
(2.3)
Income statement C
K Answer:
. Which of the following statements
is CORRECT?
a. The focal point of the income
statement is the cash account, because that account cannot be manipulated by
“accounting tricks.”
b. The reported income of two otherwise
identical firms cannot be manipulated by different accounting procedures
provided the firms follow Generally Accepted Accounting Principles (GAAP).
c. The reported income of two
otherwise identical firms must be identical if the firms are publicly owned,
provided they follow procedures that are permitted by the Securities and
Exchange Commission (SEC).
d. If a firm follows Generally Accepted
Accounting Principles (GAAP), then its reported net income will be identical to
its reported net cash flow.
e. The income statement for a given
year, say 2007, is designed to give us an idea of how much the firm earned
during that year.
:
(2.2)
Balance sheet C
K Answer:
. Below are the 2008 and 2009
year-end balance sheets for Wolken Enterprises:
Assets: 2009 2008
Cash $ 200,000 $ 170,000
Accounts
receivable 864,000 700,000
Inventories 2,000,000
1,400,000
Total current assets $
3,064,000 $2,270,000
Net
fixed assets 6,000,000
5,600,000
Total
assets $ 9,064,000 $7,870,000
Liabilities
and equity:
Accounts
payable $ 1,400,000 $1,090,000
Notes
payable 1,600,000
1,800,000
Total current liabilities $
3,000,000 $2,890,000
Long-term
debt 2,400,000
2,400,000
Common
stock 3,000,000
2,000,000
Retained
earnings 664,000 580,000
Total common equity $ 3,664,000 $2,580,000
Total
liabilities and equity $ 9,064,000 $7,870,000
Wolken
has never paid a dividend on its common stock, and it issued $2,400,000 of
10-year non-callable, long-term debt in 2008.
As of the end of 2009, none of the principal on this debt had been
repaid. Assume that the company’s sales
in 2008 and 2009 were the same. Which of
the following statements must be CORRECT?
a. Wolken increased its short-term bank
debt in 2009.
b. Wolken issued long-term debt in 2009.
c. Wolken issued new common stock in
2009.
d. Wolken repurchased some common stock
in 2009.
e. Wolken had negative net income in
2009.
(3.2)
Balance sheet C
K Answer:
. On its 2010 balance sheet,
Barngrover Books showed $510 million of retained earnings, and exactly that
same amount was shown the following year.
Assuming that no earnings restatements were issued, which of the
following statements is CORRECT?
a. If the company lost money in 2010,
they must have paid dividends.
b. The company must have had zero net
income in 2010.
c. The company must have paid out half
of its earnings as dividends.
d. The company must have paid no
dividends in 2010.
e. Dividends could have been paid in
2010, but they would have had to equal the earnings for the year.
(2.2)
Balance sheet C
K Answer:
. Below is the common equity section
(in millions) of Teweles Technology’s last two year-end balance sheets:
2009 2008
Common
stock $2,000 $1,000
Retained
earnings 2,000 2,340
Total
common equity $4,000 $3,340
Teweles
has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?
a. The company’s net income in 2009 was
higher than in 2008.
b. Teweles issued common stock in 2009.
c. The market price of Teweles' stock
doubled in 2009.
d. Teweles had positive net income in
both 2008 and 2009, but the company’s net income in 2009 was lower than it was
in 2008.
e. The company has more equity than
debt on its balance sheet.
(2.3)
EPS, DPS, BVPS, and stock price C K Answer:
. Which of the following statements
is CORRECT?
a. Typically, a firm’s DPS should
exceed its EPS.
b. Typically, a firm’s EBIT should
exceed its EBITDA.
c. If a firm is more profitable than
average (e.g., Google), we would normally expect to see its stock price exceed
its book value per share.
d. If a firm is more profitable than
most other firms, we would normally expect to see its book value per share exceed
its stock price, especially after several years of high inflation.
e. The more depreciation a firm has in
a given year, the higher its EPS, other things held constant.
(2.5)
Depreciation,amortization,and net cash flow CK Answer:
. Which of the following statements
is CORRECT?
a. The more depreciation a firm
reports, the higher its tax bill, other things held constant.
b. People sometimes talk about the
firm’s net cash flow, which is shown as the lowest entry on the income statement,
hence it is often called "the bottom line.”
c. Depreciation reduces a firm’s cash
balance, so an increase in depreciation would normally lead to a reduction in
the firm’s net cash flow.
d. Net cash flow (NCF) is often defined
as follows:
Net
Cash Flow = Net Income + Depreciation and Amortization Charges.
e. Depreciation and amortization are
not cash charges, so neither of them has an effect on a firm’s reported
profits.
(2.5)
Changes in depreciation C
K Answer:
. Which of the following would be
most likely to occur in the year after Congress, in an effort to increase tax
revenue, passed legislation that forced companies to depreciate equipment over
longer lives? Assume that sales, other operating
costs, and tax rates are not affected, and assume that the same depreciation
method is used for tax and stockholder reporting purposes.
a. Companies’ net operating profits
after taxes (NOPAT) would decline.
b. Companies’ physical stocks of fixed
assets would increase.
c. Companies’ net cash flows would
increase.
d. Companies’ cash positions would
decline.
e. Companies’ reported net incomes
would decline.
(2.6)
Net cash flow C
K Answer:
. Which of the following factors
could explain why Dellva Energy had a negative net cash flow last year, even
though the cash on its balance sheet increased?
a. The company sold a new issue of
bonds.
b. The company made a large investment
in new plant and equipment.
c. The company paid a large dividend.
d. The company had high amortization
expenses.
e. The company repurchased 20% of its
common stock.
(2.6)
Net cash flow C
K Answer:
. Analysts who follow Howe
Industries recently noted that, relative to the previous year, the company’s
operating net cash flow increased, yet cash as reported on the balance sheet
decreased. Which of the following factors could explain this situation?
a. The company cut its dividend.
b. The company made a large investment
in a profitable new plant.
c. The company sold a division and
received cash in return.
d. The company issued new common stock.
e. The company issued new long-term
debt.
(2.6)
Net cash flow and net income C
K Answer:
. A security analyst obtained the
following information from Prestopino Products’ financial statements:
• Retained earnings at the end of
2009 were $700,000, but retained earnings at the end of 2010 had declined to
$320,000.
• The company does not pay dividends.
• The company’s depreciation expense
is its only non-cash expense; it has no amortization charges.
• The company has no non-cash
revenues.
• The company’s net cash flow (NCF)
for 2010 was $150,000.
On the
basis of this information, which of the following statements is CORRECT?
a. Prestopino had negative net income
in 2010.
b. Prestopino’s depreciation expense in
2010 was less than $150,000.
c. Prestopino had positive net income
in 2010, but its income was less than its 2009 income.
d. Prestopino's NCF in 2010 must be higher
than its NCF in 2009.
e. Prestopino’s cash on the balance
sheet at the end of 2010 must be lower than the cash it had on the balance
sheet at the end of 2009.
(2.6)
Net cash flow and net income C
K Answer:
. Aubey Aircraft recently announced
that its net income increased sharply from the previous year, yet its net cash
flow from operations declined. Which of
the following could explain this performance?
a. The company’s operating income
declined.
b. The company’s expenditures on fixed
assets declined.
c. The company’s cost of goods sold
increased.
d. The company’s depreciation and
amortization expenses declined.
e. The company’s interest expense
increased.
(2.6)
Statement of cash flows C
K Answer:
. Which of the following statements
is CORRECT?
a. The statement of cash flows reflects
cash flows from operations, but it does not reflect the effects of buying or
selling fixed assets.
b. The statement of cash flows shows
where the firm’s cash is located; indeed, it provides a listing of all banks
and brokerage houses where cash is on deposit.
c. The statement of cash flows
reflects cash flows from continuing operations, but it does not reflect the
effects of changes in working capital.
d. The statement of cash flows reflects
cash flows from operations and from borrowings, but it does not reflect cash
obtained by selling new common stock.
e. The statement of cash flows shows
how much the firm’s cash--the total of currency, bank deposits, and short-term
liquid securities (or cash equivalents)--increased or decreased during a given
year.
(2.6)
Statement of cash flows C
K Answer:
. Which of the following statements
is CORRECT?
a. In the statement of cash flows, a
decrease in accounts receivable is reported as a use of cash.
b. Dividends do not show up in the
statement of cash flows because dividends are considered to be a financing
activity, not an operating activity.
c. In the statement of cash flows, a
decrease in accounts payable is reported as a use of cash.
d. In the statement of cash flows,
depreciation charges are reported as a use of cash.
e. In the statement of cash flows, a
decrease in inventories is reported as a use of cash.
(2.7) Modifying
acct data for managerial purposes CK Answer:
. For managerial purposes, i.e.,
making decisions regarding the firm's operations, the standard financial
statements as prepared by accountants under Generally Accepted Accounting
Principles (GAAP) are often modified and used to create alternative data and
metrics that provide a somewhat different picture of a firm's operations.
Related to these modifications, which of the following statements is CORRECT?
a. The standard statements make adjustments
to reflect the effects of inflation on asset values, and these adjustments are
normally carried into any adjustment that managers make to the standard
statements.
b. The standard statements focus on
accounting income for the entire corporation, not cash flows, and the two can
be quite different during any given accounting period. However, for valuation purposes we need to
discount cash flows, not accounting income.
Moreover, since many firms have a number of separate divisions, and
since division managers should be compensated on their divisions’ performance,
not that of the entire firm, information that focuses on the divisions is
needed. These factors have led to the
development of information that is focused on cash flows and the operations of individual
units.
c. The standard statements provide
useful information on the firm’s individual operating units, but management
needs more information on the firm’s overall operations than the standard
statements provide.
d. The standard statements focus on
cash flows, but managers are less concerned with cash flows than with
accounting income as defined by GAAP.
e. The best feature of standard
statements is that, if they are prepared under GAAP, the data are always
consistent from firm to firm. Thus, under
GAAP, there is no room for accountants to “adjust” the results to make earnings
look better.
(2.7)Depreciation,amortization,and
free cash flow CK Answer:
. Which of the following statements
is CORRECT?
a. Operating cash flow (OCF) is defined
as follows:
OCF
= EBIT(1-T) - Depreciation and Amortization.
b. Changes in working capital have no
effect on free cash flow.
c. Free cash flow (FCF) is defined as
follows:
FCF
= EBIT(1 - T)
+
Depreciation and Amortization
- Capital
expenditures required to sustain operations
-
Required changes in net operating working capital.
d. Free cash flow (FCF) is defined as
follows:
FCF
= EBIT(1-T)+ Depreciation and Amortization + Capital expenditures.
e. Operating cash flow is the same as
free cash flow (FCF).
(2.8)
MVA and EVA C
K Answer:
. Which of the following statements
is CORRECT?
a. The primary difference between EVA
and accounting net income is that when net income is calculated, a deduction is
made to account for the cost of common equity, whereas EVA represents net
income before deducting the cost of the equity capital the firm uses.
b. MVA gives us an idea about how much
value a firm’s management has added during the last year.
c. MVA stands for market value added,
and it is defined as follows:
MVA
= (Shares outstanding)(Stock price) + Book value of common equity.
d. EVA stands for economic value added,
and it is defined as follows:
EVA
= EBIT(1-T) – (Investor-supplied op. capital) x (A-T cost of capital).
e. EVA gives us an idea about how much
value a firm’s management has added over the firm’s life.
(2.9)
Federal income tax system C
K Answer:
. Which of the following statements
is CORRECT?
a. Since companies can deduct dividends
paid but not interest paid, our tax system favors the use of equity financing
over debt financing, and this causes companies’ debt ratios to be lower than
they would be if interest and dividends were both deductible.
b. Interest paid to an individual is
counted as income for tax purposes and taxed at the individual’s regular tax
rate, which in 2008 could go up to 35%, but dividends received were taxed at a
maximum rate of 15%.
c. The maximum federal tax rate on
corporate income in 2008 was 50%.
d. Corporations obtain capital for use
in their operations by borrowing and by raising equity capital, either by
selling new common stock or by retaining earnings. The cost of debt capital is the interest paid
on the debt, and the cost of the equity is the dividends paid on the
stock. Both of these costs are
deductible from income when calculating income for tax purposes.
e. The maximum federal tax rate on
personal income in 2008 was 50%.
(2.9)
Federal income tax system C
K Answer:
. Which of the following statements
is CORRECT?
a. The income of certain small
corporations that qualify under the Tax Code is completely exempt from
corporate income taxes. Thus, the
federal government receives no tax revenue from these businesses.
b. All businesses, regardless of their
legal form of organization, are taxed under the Business Tax Provisions of the
Internal Revenue Code.
c. Small businesses that qualify under
the Tax Code can elect not to pay corporate taxes, but then their owners must
report their pro rata shares of the firm’s income as personal income and pay
taxes on that income.
d. Congress recently changed the tax
laws to make dividend income received by individuals exempt from income taxes.
Prior to the enactment of that law, corporate income was subject to double
taxation, where the firm was first taxed on the income and stockholders were
taxed again on the income when it was paid to them as dividends.
e. All corporations other than
non-profit corporations are subject to corporate income taxes, which are 15%
for the lowest amounts of income and 35% for the highest amounts of income.
(Comp:
2.6,2.7) NCF, FCF, and cash C
K Answer:
. Last year, Tucker Technologies had
(1) a negative net cash flow from operations, (2) a negative free cash flow,
and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain
this situation?
a. The company had a sharp increase in
its inventories.
b. The company had a sharp increase in
its accrued liabilities.
c. The company sold a new issue of
common stock.
d. The company made a large capital
investment early in the year.
e. The company had a sharp increase in
its depreciation and amortization expenses.
(Comp:
2.2,2.3,2.6,2.9) Changes in depreciation C K Answer:
. Assume that Congress recently
passed a provision that will enable Bev's Beverages Inc. (BBI) to double its
depreciation expense for the upcoming year but will have no effect on its sales
revenue or tax rate. Prior to the new provision, BBI’s net income after taxes
was forecasted to be $4 million. Which of the following best describes the
impact of the new provision on BBI’s financial statements versus the statements
without the provision? Assume that the
company uses the same depreciation method for tax and stockholder reporting
purposes.
a. The provision will reduce the
company’s net cash flow.
b. The provision will increase the
company’s tax payments.
c. Net fixed assets on the balance
sheet will increase.
d. The provision will increase the
company’s net income.
e. Net fixed assets on the balance
sheet will decrease.
(Comp:
2.2,2.3,2.6,2.9) Changes in depreciation C K Answer:
. The Nantell Corporation just
purchased an expensive piece of equipment. Assume that the firm planned to
depreciate the equipment over 5 years on a straight-line basis, but Congress
then passed a provision that requires the company to depreciate the equipment
on a straight-line basis over 7 years.
Other things held constant, which of the following will occur as a
result of this Congressional action? Assume that the company uses the same
depreciation method for tax and stockholder reporting purposes.
a. Nantell’s taxable income will be
lower.
b. Nantell’s net fixed assets as shown
on the balance sheet will be higher at the end of the year.
c. Nantell’s cash position will
improve (increase).
d. Nantell’s reported net income after
taxes for the year will be lower.
e. Nantell’s tax liability for the year
will be lower.
(Comp:
2.2,2.3,2.6) Changes in depreciation C
K Answer:
. Assume that Pappas Company
commenced operations on January 1, 2010, and it was granted permission to use
the same depreciation calculations for shareholder reporting and income tax
purposes. The company planned to
depreciate its fixed assets over 15 years, but in December 2010 management
realized that the assets would last for only 10 years. The firm's accountants
plan to report the 2010 financial statements based on this new information. How
would the new depreciation assumption affect the company’s financial
statements?
a. The firm’s reported net fixed assets
would increase.
b. The firm’s EBIT would increase.
c. The firm's reported 2010 earnings
per share would increase.
d. The firm's cash position in 2010 and
2011 would increase.
e. The firm’s net liabilities would
increase.
(Comp:
2.2,2.3,2.9) Changes in depreciation C
K Answer:
. A start-up firm is making an
initial investment in new plant and equipment. Assume that currently its
equipment must be depreciated on a straight-line basis over 10 years, but
Congress is considering legislation that would require the firm to depreciate
the equipment over 7 years. If the legislation becomes law, which of the
following would occur in the year following the change?
a. The firm’s operating income (EBIT)
would increase.
b. The firm’s taxable income would
increase.
c. The firm’s net cash flow would
increase.
d. The firm’s tax payments would
increase.
e. The firm’s reported net income would
increase.
(Comp:
2.1-2.3,2.6) Financial statements C
K Answer:
. Which of the following statements
is CORRECT?
a. Dividends paid reduce the net income
that is reported on a company’s income statement.
b. If a company uses some of its bank
deposits to buy short-term, highly liquid marketable securities, this will
cause a decline in its current assets as shown on the balance sheet.
c. If a company issues new long-term
bonds during the current year, this will increase its reported current
liabilities at the end of the year.
d. Accounts receivable are reported as
a current liability on the balance sheet.
e. If a company pays more in dividends
than it generates in net income, its retained earnings as reported on the
balance sheet will decline from the previous year's balance.
(Comp:
2.5,2.6,2.8) EVA, CF, and net income C
K Answer:
. Which of the following statements
is CORRECT?
a. One way to increase EVA is to
achieve the same level of operating income but with more investor-supplied
capital.
b. If a firm reports positive net
income, its EVA must also be positive.
c. One drawback of EVA as a
performance measure is that it mistakenly assumes that equity capital is free.
d. One way to increase EVA is to
generate the same level of operating income but with less investor-supplied
capital.
e. Actions that increase reported net
income will always increase net cash flow.
(Comp:
2.2,2.3,2.6) Retained earnings C K Answer:
. Which of the following statements
is CORRECT?
a. Since depreciation is a source of
funds, the more depreciation a company has, the larger its retained earnings
will be, other things held constant.
b. A firm can show a large amount of
retained earnings on its balance sheet yet need to borrow cash to make required
payments.
c. Common equity includes common stock
and retained earnings, less accumulated depreciation.
d. The retained earnings account as
shown on the balance sheet shows the amount of cash that is available for
paying dividends.
e. If a firm reports a loss on its
income statement, then the retained earnings account as shown on the balance
sheet will be negative.
/:
(Comp:
2.2,2.3,2.9) Changes in leverage C
K Answer: /
. The CFO of Shalit Industries plans
to have the company issue $300 million of new common stock and use the proceeds
to pay off some of its outstanding bonds.
Assume that the company, which does not pay any dividends, takes this
action, and that total assets, operating income (EBIT), and its tax rate all
remain constant. Which of the following would occur?
a. The company’s taxable income would
fall.
b. The company’s interest expense would
remain constant.
c. The company would have less common
equity than before.
d. The company’s net income would
increase.
e. The company would have to pay less
taxes.
:
(2.6)
Net cash flow C
K Answer:
. Last year Roussakis Company’s
operations provided a negative net cash flow, yet the cash shown on its balance
sheet increased. Which of the following
statements could explain the increase in cash, assuming the company’s financial
statements were prepared under generally accepted accounting principles?
a. The company repurchased some of its
common stock.
b. The company dramatically increased
its capital expenditures.
c. The company retired a large amount
of its long-term debt.
d. The company sold some of its fixed
assets.
e. The company had high depreciation
expenses.
Multiple Choice:
Problems
:
A good bit of relatively simple arithmetic is involved in
some of these problems, and although the calculations are simple, it will take
students some time to set up the problem and do the arithmetic. We allow for this when assigning problems for
a timed test. Also, students must use a
number of definitions to answer some of the questions, and to avoid excessive
memorization, we provide students with a list of formulas and definitions for
use on exams.
(2.2)
Balance sheet: market value vs. book value
C K Answer:
. Tucker Electronic System's current
balance sheet shows total common equity of $3,125,000. The company has 125,000 shares of stock
outstanding, and they sell at a price of $52.50 per share. By how much do the firm's market and book
values per share differ?
a. $27.50
b. $28.88
c. $30.32
d. $31.83
e. $33.43
(2.2)
Balance sheet:change in BVPS from RE addition CK Answer:
. Hunter Manufacturing Inc.'s
December 31, 2009 balance sheet showed total common equity of $2,050,000 and
100,000 shares of stock outstanding.
During 2010, Hunter had $250,000 of net income, and it paid out $100,000
as dividends. What was the book value
per share at 12/31/10, assuming that Hunter neither issued nor retired any
common stock during 2010?
a. $20.90
b. $22.00
c. $23.10
d. $24.26
e. $25.47
(2.3)
Income statement: EBIT C
K Answer:
. Companies generate income from
their "regular" operations and from other sources like interest
earned on the securities they hold, which is called non-operating income. Lindley Textiles recently reported $12,500 of
sales, $7,250 of operating costs other than depreciation, and $1,000 of
depreciation. The company had no
amortization charges and no non-operating income. It had $8,000 of bonds outstanding that carry
a 7.5% interest rate, and its federal-plus-state income tax rate was 40%. How much was Lindley's operating income, or
EBIT?
a. $3,462
b. $3,644
c. $3,836
d. $4,038
e. $4,250
(2.3)
Income statement: taxable income C
K Answer:
. Frederickson Office Supplies
recently reported $12,500 of sales, $7,250 of operating costs other than
depreciation, and $1,250 of depreciation.
The company had no amortization charges and no non-operating
income. It had $8,000 of bonds
outstanding that carry a 7.5% interest rate, and its federal-plus-state income
tax rate was 40%. How much was the
firm's taxable income, or earnings before taxes (EBT)?
a. $3,230.00
b. $3,400.00
c. $3,570.00
d. $3,748.50
e. $3,935.93
(2.5)
Net cash flow C
K Answer:
. JBS Inc. recently reported net
income of $4,750 and depreciation of $885.
How much was its net cash flow, assuming it had no amortization expense
and sold none of its fixed assets.
a. $4,831.31
b. $5,085.59
c. $5,353.25
d. $5,635.00
e. $5,916.75
(2.7)
Net operating working capital C
K Answer:
. Swinnerton Clothing Company's
balance sheet showed total current assets of $2,250, all of which were required
in operations. Its current liabilities
consisted of $575 of accounts payable, $300 of 6% short-term notes payable to
the bank, and $145 of accrued wages and taxes.
What was its net operating working capital that was financed by
investors?
a. $1,454
b. $1,530
c. $1,607
d. $1,687
e. $1,771
(2.8)
MVA C
K Answer:
. Over the years, Janjigian
Corporation's stockholders have provided $15,250 of capital, part when they
purchased new issues of stock and part when they allowed management to retain
some of the firm's earnings. The firm
now has 1,000 shares of common stock outstanding, and it sells at a price of
$42.00 per share. How much value has
Janjigian's management added to stockholder wealth over the years, i.e., what
is Janjigian's MVA?
a. $21,788
b. $22,935
c. $24,142
d. $25,413
e. $26,750
:
(2.3)
Income statement:net after-tax income C K Answer:
. Meric Mining Inc. recently
reported $15,000 of sales, $7,500 of operating costs other than depreciation,
and $1,200 of depreciation. The company
had no amortization charges, it had outstanding $6,500 of bonds that carry a
6.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net income after
taxes? Meric uses the same depreciation
expense for tax and stockholder reporting purposes.
a. $3,284.55
b. $3,457.42
c. $3,639.39
d. $3,830.94
e. $4,022.48
(2.4)
Statement of stockholders’ equity: dividends C
K Answer:
. On 12/31/10, Heaton Industries
Inc. reported retained earnings of $675,000 on its balance sheet, and it
reported that it had $172,500 of net income during the year. On its previous
balance sheet, at 12/31/09, the company had reported $555,000 of retained
earnings. No shares were repurchased during 2010. How much in dividends did
Heaton pay during 2010?
a. $47,381
b. $49,875
c. $52,500
d. $55,125
e. $57,881
(2.4)
Statement of stockholders’ equity: NI CK Answer:
. During the year, Bascom Bakery
Inc. paid out $21,750 of common dividends.
It ended the year with $187,500 of retained earnings versus the prior
year’s retained earnings of $132,250.
How much net income did the firm earn during the year?
a. $77,000
b. $80,850
c. $84,893
d. $89,137
e. $93,594
(2.7)
Total operating capital C
K Answer:
. NNR Inc.'s balance sheet showed
total current assets of $1,875,000 plus $4,225,000 of net fixed assets. All of these assets were required in
operations. The firm's current liabilities consisted of $475,000 of accounts
payable, $375,000 of 6% short-term notes payable to the bank, and $150,000 of
accrued wages and taxes. Its remaining
capital consisted of long-term debt and common equity. What was NNR's total investor-provided operating
capital?
a. $4,694,128
b. $4,941,188
c. $5,201,250
d. $5,475,000
e. $5,748,750
:
(2.3)
Income statement: change in net income C
K Answer:
. Last year Tiemann Technologies
reported $10,500 of sales, $6,250 of operating costs other than depreciation,
and $1,300 of depreciation. The company
had no amortization charges, it had $5,000 of bonds that carry a 6.5% interest
rate, and its federal-plus-state income tax rate was 35%. This year's data are expected to remain
unchanged except for one item, depreciation, which is expected to increase by
$750. By how much will net after-tax
income change as a result of the change in depreciation? The company uses the same depreciation
calculations for tax and stockholder reporting purposes.
a. -463.13
b. -487.50
c. -511.88
d. -537.47
e. -564.34
(2.7)
Free cash flow C
K Answer:
. TSW Inc. had the following data
for last year: Net income = $800; Net
operating profit after taxes (NOPAT) = $700; Total assets = $3,000; and Total
operating capital = $2,000. Information
for the just-completed year is as follows:
Net income = $1,000; Net operating profit after taxes (NOPAT) = $925;
Total assets = $2,600; and Total operating capital = $2,500. How much free cash flow did the firm generate
during the just-completed year?
a. $383
b. $425
c. $468
d. $514
e. $566
(2.7)
Net operating working capital C
K Answer:
. Rao Corporation has the following
balance sheet. How much net operating
working capital does the firm have?
Cash $ 10 Accounts payable $ 20
Short-term
investments
Accruals 20
Accounts
receivable 50 Notes payable 50
Inventory
40 Current liabilities $ 90
Current assets $130 Long-term debt 0
Net
fixed assets
100 Common equity 30
Retained earnings 50
Total
assets $230 Total liab. & equity $230
a. $54.00
b. $60.00
c. $66.00
d. $72.60
e. $79.86
(2.7)
Net operating profit after taxes (NOPAT) C
K Answer:
. Bae Inc. has the following income
statement. How much net operating profit
after taxes (NOPAT) does the firm have?
Sales $2,000.00
Costs 1,200.00
Depreciation 100.00
EBIT $ 700.00
Interest
expense 200.00
EBT $ 500.00
Taxes
(35%) 175.00
Net
income $ 325.00
a. $370.60
b. $390.11
c. $410.64
d. $432.25
e. $455.00
(2.7)
Net operating profit after taxes (NOPAT) C
K Answer:
.
EP Enterprises has the following income statement. How much net operating profit after taxes
(NOPAT) does the firm have?
Sales $1,800.00
Costs 1,400.00
Depreciation 250.00
EBIT $ 150.00
Interest
expense 70.00
EBT $ 80.00
Taxes
(40%) 32.00
Net
income $ 48.00
a. $81.23
b. $85.50
c. $90.00
d. $94.50
e. $99.23
(2.7)
Return on invested capital (ROIC) C K Answer:
. Tibbs Inc. had the following data
for the year ending 12/31/07: Net income
= $300; Net operating profit after taxes (NOPAT) = $400; Total assets = $2,500;
Short-term investments = $200; Stockholders' equity = $1,800; Total debt =
$700; and Total operating capital = $2,300.
What was its return on invested capital (ROIC)?
a. 14.91%
b. 15.70%
c. 16.52%
d. 17.39%
e. 18.26%
(2.7)
Total operating capital C
K Answer:
. Zumbahlen Inc. has the following
balance sheet. How much total operating
capital does the firm have?
Cash $ 20.00 Accounts
payable $ 30.00
Short-term
investments 50.00 Accruals 50.00
Accounts
receivable 20.00 Notes
payable 30.00
Inventory
60.00 Current liabilities $110.00
Current assets $150.00 Long-term debt 70.00
Gross
fixed assets $140.00 Common stock 30.00
Accumulated
deprec. 40.00 Retained earnings
40.00
Net
fixed assets $100.00
Total common equity $ 70.00
Total
assets $250.00 Total liab. & equity $250.00
a. $114.00
b. $120.00
c. $126.00
d. $132.30
e. $138.92
(2.8)
Economic Value Added (EVA) C
K Answer:
. Barnes’ Brothers has the following
data for the year ending 12/31/10: Net
income = $600; Net operating profit after taxes (NOPAT) = $700; Total assets =
$2,500; Short-term investments = $200; Stockholders' equity = $1,800; Total
debt = $700; and Total operating capital = $2,100. Barnes' weighted average cost of capital is
10%. What is its economic value added
(EVA)?
a. $399.11
b. $420.11
c. $442.23
d. $465.50
e. $490.00
(Comp:
2.3,2.5) Income statement: net cash flow C K Answer:
. Edwards Electronics recently
reported $11,250 of sales, $5,500 of operating costs other than depreciation,
and $1,250 of depreciation. The company
had no amortization charges, it had $3,500 of bonds that carry a 6.25% interest
rate, and its federal-plus-state income tax rate was 35%. How much was its net cash flow?
a. $3,284.75
b. $3,457.63
c. $3,639.61
d. $3,831.17
e. $4,032.81
(Comp: 2.3,2.7) Income statement:free cash flow C K Answer:
. Wells Water Systems recently
reported $8,250 of sales, $4,500 of operating costs other than depreciation,
and $950 of depreciation. The company
had no amortization charges, it had $3,250 of outstanding bonds that carry a
6.75% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus
generate sales and cash flows in the future, the firm was required to spend
$750 to buy new fixed assets and to invest $250 in net operating working
capital. How much free cash flow did
Wells generate?
a. $1,770.00
b. $1,858.50
c. $1,951.43
d. $2,049.00
e. $2,151.45
:
(2.8)
EVA C
K Answer:
. HHH Inc. reported $12,500 of sales
and $7,025 of operating costs (including depreciation). The company had $18,750 of investor-supplied
operating assets (or capital), the weighted average cost of that capital (the
WACC) was 9.5%, and the federal-plus-state income tax rate was 40%. What was HHH's Economic Value Added (EVA),
i.e., how much value did management add to stockholders' wealth during the
year?
a. $1,357.13
b. $1,428.56
c. $1,503.75
d. $1,578.94
e. $1,657.88
(Comp: 2.3,2.7)
Changes in net income and NCF C K Answer:
. Last year, Michelson Manufacturing
reported $10,250 of sales, $3,500 of operating costs other than depreciation,
and $1,250 of depreciation. The company
had no amortization charges, it had $3,500 of bonds outstanding that carry a
6.5% interest rate, and its federal-plus-state income tax rate was 35%. This year's data are expected to remain
unchanged except for one item, depreciation, which is expected to increase by
$725. By how much will the depreciation
change cause the firm's net after-tax income and its net cash flow to
change? Note that the company uses the
same depreciation calculations for tax and stockholder reporting purposes.
a. -$383.84; $206.68
b. -$404.04; $217.56
c. -$425.30; $229.01
d. -$447.69; $241.06
e. -$471.25; $253.75
. (Comp: 2.3,2.7) Income stmt: FCF
vs. net income C K Answer:
Bartling
Energy Systems recently reported $9,250 of sales, $5,750 of operating costs
other than depreciation, and $700 of depreciation. The company had no amortization charges, it
had $3,200 of outstanding bonds that carry a 5% interest rate, and its
federal-plus-state income tax rate was 35%.
In order to sustain its operations and thus generate sales and cash
flows in the future, the firm was required to make $1,250 of capital
expenditures on new fixed assets and to invest $300 in net operating working
capital. By how much did the firm's net
income exceed its free cash flow?
a. $673.27
b. $708.70
c. $746.00
d. $783.30
e. $822.47
CHAPTER 3
ANALYSIS OF FINANCIAL
STATEMENTS
Please see the preface for information on the AACSB letter
indicators (F, M, etc.) on the subject lines
TrueFalse
:
We tell our students (1) that to answer some of these
questions it is useful to write out the relevant ratio or ratios, then think
about how the ratios would change if the accounting data changed, and (2) that
sometimes it is useful to make up illustrative data to help see what would
happen.
(3.1)
Ratio analysis F
K Answer:
. Ratio analysis involves analyzing
financial statements in order to appraise a firm's financial position and
strength.
a. True
b. False
(3.2)
Liquidity ratios F
K Answer:
. The current ratio and inventory
turnover ratios both help us measure the firm's liquidity. The current ratio measures the relationship
of a firm's current assets to its current liabilities, while the inventory
turnover ratio gives us an indication of how long it takes the firm to convert
its inventory into cash.
a. True
b. False
(3.2)
Liquidity ratios F
K Answer:
. Although a full liquidity analysis
requires the use of a cash budget, the current and quick ratios provide fast
and -to-use measures of a firm's liquidity position.
a. True
b. False
(3.2)
Current ratio F
K Answer:
. High current and quick ratios
always indicate that a firm is managing its liquidity position well.
a. True
b. False
(3.3)
Asset management ratios F
K Answer:
. The inventory turnover ratio and
days sales outstanding (DSO) are two ratios that are used to assess how
effectively a firm is managing its assets.
a. True
b. False
(3.3)
Inventory turnover ratio F K Answer:
. A decline in a firm's inventory
turnover ratio suggests that it is managing its inventory more efficiently and
also that its liquidity position is improving, i.e., it is becoming more
liquid.
a. True
b. False
(3.4)
Debt management ratios F
K Answer:
. Debt management ratios show the
extent to which a firm's managers are attempting to magnify returns on owners'
capital through the use of financial leverage.
a. True
b. False
(3.4)
TIE ratio F
K Answer:
. The times-interest-earned ratio is
one, but not the only, indication of a firm's ability to meet its long-term and
short-term debt obligations.
a. True
b. False
(3.5)
Profitability ratios F K Answer:
. Profitability ratios show the
combined effects of liquidity, asset management, and debt management on
operating results.
a. True
b. False
(3.6)
Market value ratios F
K Answer:
. Market value ratios provide
management with an indication of how investors view the firm's past performance
and especially its future prospects.
a. True
b. False
(3.7)
Trend analysis F
K Answer:
. Determining whether a firm's
financial position is improving or deteriorating requires analyzing more than
the ratios for a given year. Trend
analysis is one method of measuring changes in a firm's performance over time.
a. True
b. False
(3.10)
Balance sheet changes F
K Answer:
. The "apparent," but not
the "true," financial position of a company whose sales are seasonal can
differ dramatically, depending on the time of year when the financial
statements are constructed.
a. True
b. False
(3.10)
Limitations of ratio analysis F
K Answer:
. Significant variations in
accounting methods among firms make meaningful ratio comparisons between firms
more difficult than if all firms used similar accounting methods.
a. True
b. False
:
(3.5)
Basic earning power ratio F K Answer:
. The basic earning power ratio (BEP)
reflects the earning power of a firm's assets after giving consideration to
financial leverage and tax effects.
a. True
b. False
:
(3.3)
Inventory turnover ratio F K Answer:
. The inventory turnover and current
ratio are related. The combination of a
high current ratio and a low inventory turnover ratio, relative to industry
norms, suggests that the firm has an above-average inventory level andor that
part of the inventory is obsolete or damaged.
a. True
b. False
(3.3)
Fixed assets turnover F
K Answer:
. It is appropriate to use the fixed
assets turnover ratio to appraise firms' effectiveness in managing their fixed
assets if and only if all the firms being compared have the same proportion of
fixed assets to total assets.
a. True
b. False
(3.5)
ROA F
K Answer:
. Since the ROA measures the firm's
effective utilization of assets (without considering how these assets are
financed), two firms with the same EBIT must have the same ROA.
a. True
b. False
(3.8)
Du Pont equation F
K Answer:
. Suppose firms follow similar
financing policies, face similar risks, have equal access to capital, and
operate in competitive product and capital markets. Under these conditions, then firms that have
high profit margins will tend to have high asset turnover ratios, and firms
with low profit margins will tend to have low turnover ratios.
a. True
b. False
:
(3.2)
Liquidity ratios F
K Answer:
. Even though Firm A's current ratio
exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then
we can be certain that A's current ratio is also larger than that of B.
a. True
b. False
(3.2)
Liquidity ratios F
K Answer:
. Firms A and B have the same
current ratio, 0.75, the same amount of sales, and the same amount of current
liabilities. However, Firm A has a
higher inventory turnover ratio than B.
Therefore, we can conclude that A's quick ratio must be smaller than
B's.
a. True
b. False
(3.4)
TIE ratio F
K Answer:
. Suppose a firm wants to maintain a
specific TIE ratio. It knows the amount
of its debt, the interest rate on that debt, the applicable tax rate, and its
operating costs. With this information, the
firm can calculate the amount of sales required to achieve its target TIE ratio.
a. True
b. False
(3.5)
BEP and ROE F
K Answer:
. Suppose Firms A and B have the
same amount of assets, pay the same interest rate on their debt, have the same
basic earning power (BEP), and have the same tax rate. However, Firm A has a higher debt ratio. If BEP is greater than the interest rate on
debt, Firm A will have a higher ROE as a result of its higher debt ratio.
a. True
b. False
(3.8)
Equity multiplier F
K Answer:
. If a firm finances with only debt
and common equity, and if its equity multiplier is 3.0, then its debt ratio
must be 0.667.
a. True
b. False
(3.10)
Limitations of ratio analysis F
K Answer:
. One problem with ratio analysis is
that relationships can be manipulated.
For example, if our current ratio is greater than 1.5, then borrowing on
a short-term basis and using the funds to build up our cash account would cause
the current ratio to increase.
a. True
b. False
(3.10)
Limitations of ratio analysis F
K Answer:
. One problem with ratio analysis is
that relationships can be manipulated.
For example, we know that if our current ratio is less than 1.0, then using
some of our cash to pay off some of our current liabilities would cause the
current ratio to increase and thus make the firm look stronger.
a. True
b. False
Multiple Choice:
Conceptual
:
We tell our students (1) that to answer some of these
questions it is useful to write out the relevant ratio or ratios, then think
about how the ratios would change if the accounting data changed, and (2) that
sometimes it is useful to make up illustrative data to help see what would
happen.
(3.2)
Current ratio C
K Answer:
. Considered alone, which of the
following would increase a company’s current ratio?
a. An increase in net fixed assets.
b. An increase in accrued liabilities.
c. An increase in notes payable.
d. An increase in accounts receivable.
e. An increase in accounts payable.
(3.2)
Current ratio C
K Answer:
. Which of the following would,
generally, indicate an improvement in a company’s financial position, holding
other things constant?
a. The TIE declines.
b. The DSO increases.
c. The EBITDA coverage ratio
increases.
d. The current and quick ratios both
decline.
e. The total assets turnover decreases.
(3.2)
Current ratio C
K Answer:
. A firm wants to strengthen its
financial position. Which of the
following actions would increase its current ratio?
a. Reduce the company’s days’ sales
outstanding to the industry average and use the resulting cash savings to
purchase plant and equipment.
b. Use cash to repurchase some of the
company’s own stock.
c. Borrow using short-term debt and
use the proceeds to repay debt that has a maturity of more than one year.
d. Issue new stock and then use some of
the proceeds to purchase additional inventory and hold the remainder as cash.
e. Use cash to increase inventory
holdings.
(3.3)
Inventories C
K Answer:
. Which of the following statements
is CORRECT?
a. A reduction in inventories held
would have no effect on the current ratio.
b. An increase in inventories would
have no effect on the current ratio.
c. If a firm increases its sales while
holding its inventories constant, then, other things held constant, its
inventory turnover ratio will increase.
d. A reduction in the inventory
turnover ratio will generally lead to an increase in the ROE.
e. If a firm increases its sales while
holding its inventories constant, then, other things held constant, its
inventory turnover ratio will decrease.
(3.6)
Financial statement analysis C
K Answer:
. Companies E and P each reported
the same earnings per share (EPS), but Company E’s stock trades at a higher
price. Which of the following statements is CORRECT?
a. Company E probably has fewer growth
opportunities.
b. Company E is probably judged by
investors to be riskier.
c. Company E must have a higher
market-to-book ratio.
d. Company E must pay a lower dividend.
e. Company E trades at a higher PE
ratio.
(3.6)
Market value ratios C
K Answer:
. Which of the following statements
is CORRECT?
a. If a firm has the highest
priceearnings ratio of any firm in its industry, then, other things held
constant, this suggests that the board of directors should fire the president.
b. If a firm has the highest marketbook
ratio of any firm in its industry, then, other things held constant, this
suggests that the board of directors should fire the president.
c. Other things held constant, the
higher a firm’s expected future growth rate, the lower its PE ratio is likely
to be.
d. The higher the marketbook ratio,
then, other things held constant, the higher one would expect to find the
Market Value Added (MVA).
e. If a firm has a history of high
Economic Value Added (EVA) numbers each year, and if investors expect this
situation to continue, then its marketbook ratio and MVA are both likely to be
below average.
(3.10)
Window dressing C
K Answer:
. Which of the following statements
is CORRECT?
a. Borrowing by using short-term notes
payable and then using the proceeds to retire long-term debt is an example of
“window dressing.” Offering discounts to customers who pay with cash rather
than buy on credit and then using the funds that come in quicker to purchase
additional inventories is another example of “window dressing.”
b. Borrowing on a long-term basis and
using the proceeds to retire short-term debt would improve the current ratio
and thus could be considered to be an example of “window dressing.”
c. Offering discounts to customers who
pay with cash rather than buy on credit and then using the funds that come in
quicker to purchase additional inventories is an example of “window dressing.”
d. Using some of the firm’s cash to
reduce long-term debt is an example of “window dressing.”
e. “Window dressing” is any action that
improves a firm’s fundamental, long-run position and thus increases its
intrinsic value.
(Comp:
3.2,3.4-3.6) Miscellaneous ratios C
K Answer:
. Casey Communications recently
issued new common stock and used the proceeds to pay off some of its short-term
notes payable. This action had no effect
on the company’s total assets or operating income. Which of the following effects would occur as
a result of this action?
a. The company’s current ratio
increased.
b. The company’s times interest earned
ratio decreased.
c. The company’s basic earning power
ratio increased.
d. The company’s equity multiplier
increased.
e. The company’s debt ratio increased.
(Comp:
3.2,3.3,3.5) Miscellaneous ratios C
K Answer:
. A firm’s new president wants to
strengthen the company’s financial position.
Which of the following actions would make it financially stronger?
a. Increase accounts receivable while
holding sales constant.
b. Increase EBIT while holding sales
constant.
c. Increase accounts payable while
holding sales constant.
d. Increase notes payable while holding
sales constant.
e. Increase inventories while holding
sales constant.
(Comp:
3.3-3.5) Miscellaneous ratios C K Answer:
. If the CEO of a large,
diversified, firm were filling out a fitness report on a division manager
(i.e., “grading” the manager), which of the following situations would be
likely to cause the manager to receive a better grade? In all cases, assume that other things are
held constant.
a. The division’s basic earning power
ratio is above the average of other firms in its industry.
b. The division’s total assets turnover
ratio is below the average for other firms in its industry.
c. The division’s debt ratio is above
the average for other firms in the industry.
d. The division’s inventory turnover is
6, whereas the average for its competitors is 8.
e. The division’s DSO (days’ sales
outstanding) is 40, whereas the average for its competitors is 30.
(Comp:
3.2-3.5) Miscellaneous ratios C K Answer:
. Which of the following would
indicate an improvement in a company’s financial position, holding other things
constant?
a. The inventory and total assets
turnover ratios both decline.
b. The debt ratio increases.
c. The profit margin declines.
d. The EBITDA coverage ratio declines.
e. The current and quick ratios both
increase.
(Comp:
3.2,3.4) Miscellaneous ratios C K Answer:
. If a bank loan officer were
considering a company’s request for a loan, which of the following statements
would you consider to be CORRECT?
a. The lower the company’s EBITDA
coverage ratio, other things held constant, the lower the interest rate the
bank would charge the firm.
b. Other things held constant, the
higher the debt ratio, the lower the interest rate the bank would charge the
firm.
c. Other things held constant, the
lower the debt ratio, the lower the interest rate the bank would charge the
firm.
d. The lower the company’s TIE ratio,
other things held constant, the lower the interest rate the bank would charge
the firm.
e. Other things held constant, the
lower the current ratio, the lower the interest rate the bank would charge the
firm.
(Comp:
3.4,3.5,3.8) Effects of leverage C K Answer:
. Which of the following statements
is CORRECT?
a. The use of debt financing will tend
to lower the basic earning power ratio, other things held constant.
b. A firm that employs financial
leverage will have a higher equity multiplier than an otherwise identical firm
that has no debt in its capital structure.
c. If two firms have identical sales,
interest rates paid, operating costs, and assets, but differ in the way they
are financed, the firm with less debt will generally have the higher expected
ROE.
d. Holding bonds is better than holding
stock for investors because income from bonds is taxed on a more favorable
basis than income from stock.
e. All else equal, increasing the debt
ratio will increase the ROA.
:
(3.2)
Quick ratio C
K Answer:
. A firm wants to strengthen its
financial position. Which of the
following actions would increase its quick ratio?
a. Offer price reductions along with
generous credit terms that would (1) enable the firm to sell some of its excess
inventory and (2)lead to an increase in accounts receivable.
b. Issue new common stock and use the
proceeds to increase inventories.
c. Speed up the collection of
receivables and use the cash generated to increase inventories.
d. Use some of its cash to purchase
additional inventories.
e. Issue new common stock and use the
proceeds to acquire additional fixed assets.
:
(3.2)
Current ratio C
K Answer:
. Amram Company’s current ratio is
1.9. Considered alone, which of the
following actions would reduce the company’s current ratio?
a. Borrow using short-term notes
payable and use the proceeds to reduce accruals.
b. Borrow using short-term notes
payable and use the proceeds to reduce long-term debt.
c. Use cash to reduce accruals.
d. Use cash to reduce short-term notes
payable.
e. Use cash to reduce accounts payable.
(3.3)
Accounts receivable C
K Answer:
. Which of the following statements
is CORRECT?
a. If a security analyst saw that a
firm’s days’ sales outstanding (DSO) was higher than the industry average and
was also increasing and trending still higher, this would be interpreted as a
sign of strength.
b. If a firm increases its sales while
holding its accounts receivable constant, then, other things held constant, its
days’ sales outstanding (DSO) will increase.
c. There is no relationship between
the days’ sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different
things.
d. A reduction in accounts receivable
would have no effect on the current ratio, but it would lead to an increase in
the quick ratio.
e. If a firm increases its sales while holding
its accounts receivable constant, then, other things held constant, its days’
sales outstanding will decline.
(3.4)
Leverage effects; debt management C
K Answer:
. Which of the following statements
is CORRECT?
a. If one firm has a higher debt ratio
than another, we can be certain that the firm with the higher debt ratio will
have the lower TIE ratio, as that ratio depends entirely on the amount of debt
a firm uses.
b. A firm’s use of debt will have no
effect on its profit margin on sales.
c. If two firms differ only in their
use of debt—i.e., they have identical assets, sales, operating costs, interest
rates on their debt, and tax rates—but one firm has a higher debt ratio, the
firm that uses more debt will have a lower profit margin on sales.
d. The debt ratio as it is generally
calculated makes an adjustment for the use of assets leased under operating
leases, so the debt ratios of firms that lease different percentages of their
assets are still comparable.
e. If two firms differ only in their
use of debt—i.e., they have identical assets, sales, operating costs, and tax
rates—but one firm has a higher debt ratio, the firm that uses more debt will
have a higher profit margin on sales.
(3.6)
Market value ratios C
K Answer:
. Which of the following statements
is CORRECT?
a. If Firms X and Y have the same PE
ratios, then their market-to-book ratios must also be the same.
b. If Firms X and Y have the same net
income, number of shares outstanding, and price per share, then their PE ratios
must also be the same.
c. If Firms X and Y have the same
earnings per share and market-to-book ratio, they must have the same price
earnings ratio.
d. If Firm X’s PE ratio exceeds that of
Firm Y, then Y is likely to be less risky and also to be expected to grow at a
faster rate.
e. If Firms X and Y have the same net
income, number of shares outstanding, and price per share, then their
market-to-book ratios must also be the same.
(3.8)
Du Pont analysis C
K Answer:
. Which of the following statements
is CORRECT?
a. Suppose a firm’s total assets
turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin
rises from 9% to 10% and its debt increases from 40% of total assets to
60%. Under these conditions, the ROE
will increase.
b. Suppose a firm’s total assets
turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin
rises from 9% to 10% and its debt increases from 40% of total assets to
60%. Without additional information, we
cannot tell what will happen to the ROE.
c. The modified Du Pont equation
provides information about how operations affect the ROE, but the equation does
not include the effects of debt on the ROE.
d. Other things held constant, an
increase in the debt ratio will result in an increase in the profit margin on
sales.
e. Suppose a firm’s total assets
turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin
rises from 9% to 10%, and its debt increases from 40% of total assets to
60%. Under these conditions, the ROE
will decrease.
(3.8)
Du Pont analysis C
K Answer:
. You observe that a firm’s ROE is
above the industry average, but its profit margin and debt ratio are both below
the industry average. Which of the
following statements is CORRECT?
a. Its total assets turnover must be
above the industry average.
b. Its return on assets must equal the
industry average.
c. Its TIE ratio must be below the
industry average.
d. Its total assets turnover must be
below the industry average.
e. Its total assets turnover must equal
the industry average.
(3.8)
Du Pont analysis C
K Answer:
. Companies HD and LD are both
profitable, and they have the same total assets (TA), Sales (S), return on
assets (ROA), and profit margin (PM). However, Company HD has the higher debt
ratio. Which of the following statements
is CORRECT?
a. Company HD has a lower total assets
turnover than Company LD.
b. Company HD has a lower equity
multiplier than Company LD.
c. Company HD has a higher fixed
assets turnover than Company B.
d. Company HD has a higher ROE than
Company LD.
e. Company HD has a lower operating
income (EBIT) than Company LD.
(Comp:
3.4,3.5) Financial statement analysis C
K Answer:
. Taggart Technologies is
considering issuing new common stock and using the proceeds to reduce its
outstanding debt. The stock issue would
have no effect on total assets, the interest rate Taggart pays, EBIT, or the
tax rate. Which of the following is
likely to occur if the company goes ahead with the stock issue?
a. The ROA will decline.
b. Taxable income will decrease.
c. The tax bill will increase.
d. Net income will decrease.
e. The times interest earned ratio will
decrease.
(Comp:
3.3-3.5) Financial statement analysis C
K Answer:
. Which of the following statements
is CORRECT?
a. The ratio of long-term debt to total
capital is more likely to experience seasonal fluctuations than is either the
DSO or the inventory turnover ratio.
b. If two firms have the same ROA, the
firm with the most debt can be expected to have the lower ROE.
c. An increase in the DSO, other
things held constant, could be expected to increase the total assets turnover
ratio.
d. An increase in the DSO, other things
held constant, could be expected to increase the ROE.
e. An increase in a firm’s debt ratio,
with no changes in its sales or operating costs, could be expected to lower the
profit margin.
(Comp:
3.4,3.5,3.8) Financial statement analysis C K Answer:
. HD Corp. and LD Corp. have
identical assets, sales, interest rates paid on their debt, tax rates, and
EBIT. However, HD uses more debt than
LD. Which of the following statements is
CORRECT?
a. Without more information, we cannot
tell if HD or LD would have a higher or lower net income.
b. HD would have the lower equity
multiplier for use in the Du Pont equation.
c. HD would have to pay more in income
taxes.
d. HD would have the lower net income
as shown on the income statement.
e. HD would have the higher net income
as shown on the income statement.
(Comp:
3.2,3.3) Cash flows C
K Answer:
. Other things held constant, which
of the following alternatives would increase a company’s cash flow for the
current year?
a. Increase the number of years over
which fixed assets are depreciated for tax purposes.
b. Pay down the accounts payables.
c. Reduce the days’ sales outstanding
(DSO) without affecting sales or operating costs.
d. Pay workers more frequently to
decrease the accrued wages balance.
e. Reduce the inventory turnover ratio
without affecting sales or operating costs.
(Comp:
3.4,3.5,3.8) Leverage, taxes, and ratios C
K Answer:
. Companies HD and LD have the same
sales, tax rate, interest rate on their debt, total assets, and basic earning
power. Both companies have positive net
incomes. Company HD has a higher debt
ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?
a. Company HD pays less in taxes.
b. Company HD has a lower equity
multiplier.
c. Company HD has a higher ROA.
d. Company HD has a higher times
interest earned (TIE) ratio.
e. Company HD has more net income.
(Comp:
3.4,3.5,3.8) Leverage, taxes, and ratios C
K Answer:
. Companies HD and LD have the same
tax rate, sales, total assets, and basic earning power. Both companies have positive net
incomes. Company HD has a higher debt
ratio and, therefore, a higher interest expense. Which of the following
statements is CORRECT?
a. Company HD has a lower equity
multiplier.
b. Company HD has more net income.
c. Company HD pays more in taxes.
d. Company HD has a lower ROE.
e. Company HD has a lower times
interest earned (TIE) ratio.
:
(3.2)
Current ratio C
K Answer:
. Walter Industries’ current ratio
is 0.5. Considered alone, which of the
following actions would increase the company’s current ratio?
a. Borrow using short-term notes
payable and use the cash to increase inventories.
b. Use cash to reduce accruals.
c. Use cash to reduce accounts
payable.
d. Use cash to reduce short-term notes
payable.
e. Use cash to reduce long-term bonds
outstanding.
(3.2)
Current ratio C
K Answer:
. Safeco’s current assets total to
$20 million versus $10 million of current liabilities, while Risco’s current
assets are $10 million versus $20 million of current liabilities. Both firms would like to “window dress” their
end-of-year financial statements, and to do so they tentatively plan to borrow
$10 million on a short-term basis and to then hold the borrowed funds in their
cash accounts. Which of the statements
below best describes the results of these transactions?
a. The transactions would raise
Safeco’s financial strength as measured by its current ratio but lower Risco’s
current ratio.
b. The transactions would lower
Safeco’s financial strength as measured by its current ratio but raise Risco’s
current ratio.
c. The transaction would have no
effect on the firm’ financial strength as measured by their current ratios.
d. The transaction would lower both
firm’ financial strength as measured by their current ratios.
e. The transaction would improve both
firms’ financial strength as measured by their current ratios.
(Comp:3.4,3.5)Effects
of financial leverage C K Answer:
. Companies HD and LD have the same
total assets, sales, operating costs, and tax rates, and they pay the same
interest rate on their debt. However,
company HD has a higher debt ratio. Which of the following statements is
CORRECT?
a. Given this information, LD must have
the higher ROE.
b. Company LD has a higher basic
earning power ratio (BEP).
c. Company HD has a higher basic
earning power ratio (BEP).
d. If the interest rate the companies
pay on their debt is more than their basic earning power (BEP), then Company HD
will have the higher ROE.
e. If the interest rate the companies
pay on their debt is less than their basic earning power (BEP), then Company HD
will have the higher ROE.
Multiple Choice:
Problems
A good bit of relatively simple arithmetic is involved in
some of these problems, and although the calculations are simple, it will take
students time to set up the problems and do the arithmetic. We allow for this when assigning problems for
a timed test. Also, note that students must
know the definitions of a number of ratios to answer the questions. We provide our students with a formula sheet
on exams, using the relevant sections of Appendix D at the end of the text.
The difficulty of the problems depends on (1) whether or not
students are provided with a formula sheet and (2) the amount of time they have
to work the problems. Our difficulty
assessments assume that they have a formula sheet and a "reasonable"
amount of time for the test. Note that
some problems are trivially if students
have formula sheets.
To work some of the problems, students must transpose
equations and solve for items that are normally inputs. For example, the equation for the profit
margin is given as Profit margin = Net incomeSales. We might have a problem where sales and the
profit margin are given and then require students to find the firm's net
income. We explain to students in class
before the exam that they will have to transpose terms in the formulas to work
some problems.
Problems 57 to 86 are all stand-alone problems with
individualized data, but problems 87 through 105 are all based on a common set
of data, and they require students to calculate ratios and find items like EPS,
TIE, and the like using this data set.
The statements can be changed algorithmically, and this changes the
calculated ratios and other items.
:
(3.3)
Total assets turnover C
K Answer:
. Arshadi Corp.'s sales last year
were $52,000, and its total assets were $22,000. What was its total assets turnover ratio
(TATO)?
a. 2.03
b. 2.13
c. 2.25
d. 2.36
e. 2.48
(3.4)
Debt ratio:find the debt, given the DA ratio C K Answer:
. Beranek Corp. has $410,000 of
assets, and it uses no debt--it is financed only with common equity. The new CFO wants to employ enough debt to
bring the debtassets ratio to 40%, using the proceeds from the borrowing to buy
back common stock at its book value. How
much must the firm borrow to achieve the target debt ratio?
a. $155,800
b. $164,000
c. $172,200
d. $180,810
e. $189,851
(3.4)
Times interest earned C
K Answer:
. Orono Corp.'s sales last year were
$435,000, its operating costs were $362,500, and its interest charges were
$12,500. What was the firm's times
interest earned (TIE) ratio?
a. 4.72
b. 4.97
c. 5.23
d. 5.51
e. 5.80
(3.5)
Profit margin on sales C
K Answer:
. Rappaport Corp.'s sales last year
were $320,000, and its net income after taxes was $23,000. What was its profit margin on sales?
a. 6.49%
b. 6.83%
c. 7.19%
d. 7.55%
e. 7.92%
(3.5)
Return on total assets (ROA) C
K Answer:
. Branch Corp.'s total assets at the
end of last year were $315,000 and its net income after taxes was $22,750. What was its return on total assets?
a. 7.22%
b. 7.58%
c. 7.96%
d. 8.36%
e. 8.78%
(3.5)
Basic earning power (BEP) C K Answer:
. Chambliss Corp.'s total assets at
the end of last year were $305,000 and its EBIT was 62,500. What was its basic earning power (BEP)?
a. 18.49%
b. 19.47%
c. 20.49%
d. 21.52%
e. 22.59%
(3.5)
Return on equity (ROE) C
K Answer:
. Nikko Corp.'s total common equity
at the end of last year was $305,000 and its net income after taxes was
$60,000. What was its ROE?
a. 16.87%
b. 17.75%
c. 18.69%
d. 19.67%
e. 20.66%
(3.5)
Return on equity (ROE): finding net income C K Answer:
. An investor is considering
starting a new business. The company
would require $475,000 of assets, and it would be financed entirely with common
stock. The investor will go forward only
if she thinks the firm can provide a 13.5% return on the invested capital,
which means that the firm must have an ROE of 13.5%. How much net income must be expected to
warrant starting the business?
a. $52,230
b. $54,979
c. $57,873
d. $60,919
e. $64,125
(3.6)
PriceEarnings ratio (PE) C
K Answer:
. Vang Corp.'s stock price at the
end of last year was $33.50 and its earnings per share for the year were
$2.30. What was its PE ratio?
a. 13.84
b. 14.57
c. 15.29
d. 16.06
e. 16.86
(3.6)
PriceEarnings ratio (PE) C
K Answer:
. Lindley Corp.'s stock price at the
end of last year was $33.50, and its book value per share was $25.00. What was its marketbook ratio?
a. 1.34
b. 1.41
c. 1.48
d. 1.55
e. 1.63
(3.8)
Du Pont equation: basic calculation C K Answer:
. Northwest Lumber had a profit
margin of 5.25%, a total assets turnover of 1.5, and an equity multiplier of
1.8. What was the firm's ROE?
a. 12.79%
b. 13.47%
c. 14.18%
d. 14.88%
e. 15.63%
:
(3.4)
Debt ratio C
K Answer:
. Pace Corp.'s assets are $625,000,
and its total debt outstanding is $185,000.
The new CFO wants to employ a debt ratio of 55%. How much debt must the company add or
subtract to achieve the target debt ratio?
a. $158,750
b. $166,688
c. $175,022
d. $183,773
e. $192,962
(3.6)
EPS, DPS, and payout C
K Answer:
. Helmuth Inc.'s latest net income
was $1,250,000, and it had 225,000 shares outstanding. The company wants to pay out 45% of its
income. What dividend per share should
it declare?
a. $2.14
b. $2.26
c. $2.38
d. $2.50
e. $2.63
:
(3.3)
Effect of lowering the DSO on net income C K Answer:
. Aziz Industries has sales of
$100,000 and accounts receivable of $11,500, and it gives its customers 30 days
to pay. The industry average DSO is 27
days, based on a 365-day year. If the
company changes its credit and collection policy sufficiently to cause its DSO
to fall to the industry average, and if it earns 8.0% on any cash freed-up by
this change, how would that affect its net income, assuming other things are
held constant?
a. $267.34
b. $281.41
c. $296.22
d. $311.81
e. $328.22
(3.3)
Days sales outstanding (DSO) C
K Answer:
. Heaton Corp. sells on terms that
allow customers 45 days to pay for merchandise.
Its sales last year were $425,000, and its year-end receivables were
$60,000. If its DSO is less than the
45-day credit period, then customers are paying on time. Otherwise, they are paying late. By how much are customers paying early or
late? Base your answer on this equation:
DSO - Credit period = days early or late, and use a 365-day year when
calculating the DSO. A positive answer
indicates late payments, while a negative answer indicates early payments.
a. 6.20
b. 6.53
c. 6.86
d. 7.20
e. 7.56
(3.3)
DSO: days of free credit C
K Answer:
. Harper Corp.'s sales last year
were $395,000, and its year-end receivables were $42,500. Harper sells on terms that call for customers
to pay 30 days after the purchase, but many delay payment beyond Day 30. On average, how many days late do customers
pay? Base your answer on this
equation: DSO - Allowed credit period =
Average days late, and use a 365-day year when calculating the DSO.
a. 7.95
b. 8.37
c. 8.81
d. 9.27
e. 9.74
(3.3)
Total assets turnover ratio (TATO) C K Answer:
. Bonner Corp.'s sales last year
were $415,000, and its year-end total assets were $355,000. The average firm in the industry has a total
assets turnover ratio (TATO) of 2.4. Bonner's
new CFO believes the firm has excess assets that can be sold so as to bring the
TATO down to the industry average without affecting sales. By how much must the assets be reduced to
bring the TATO to the industry average, holding sales constant?
a. $164,330
b. $172,979
c. $182,083
d. $191,188
e. $200,747
(3.4)Max
debt ratio consistent with given TIE ratio CK Answer:
. A new firm is developing its
business plan. It will require $565,000
of assets, and it projects $452,800 of sales and $354,300 of operating costs
for the first year. Management is quite
sure of these numbers because of contracts with its customers and
suppliers. It can borrow at a rate of 7.5%,
but the bank requires it to have a TIE of at least 4.0, and if the TIE falls
below this level the bank will call in the loan and the firm will go
bankrupt. What is the maximum debt ratio
the firm can use? (Hint: Find the
maximum dollars of interest, then the debt that produces that interest, and
then the related debt ratio.)
a. 47.33%
b. 49.82%
c. 52.45%
d. 55.21%
e. 58.11%
(3.4)
EBITDA coverage C
K Answer:
. Ziebart Corp.'s EBITDA last year
was $390,000 (= EBIT + depreciation + amortization), its interest charges were $9,500,
it had to repay $26,000 of long-term debt, and it had to make a payment of
$17,400 under a long-term lease. The
firm had no amortization charges. What
was the EBITDA coverage ratio?
a. 7.32
b. 7.70
c. 8.09
d. 8.49
e. 8.92
(3.5)
Profit margin and ROE C
K Answer:
. LeCompte Corp. has $312,900 of
assets, and it uses only common equity capital (zero debt). Its sales for the last year were $620,000,
and its net income after taxes was $24,655.
Stockholders recently voted in a new management team that has promised
to lower costs and get the return on equity up to 15%. What profit margin would LeCompte need in
order to achieve the 15% ROE, holding everything else constant?
a. 7.57%
b. 7.95%
c. 8.35%
d. 8.76%
e. 9.20%
(3.5)
Effect of reducing costs on the ROE C
K Answer:
. Last year Urbana Corp. had
$197,500 of assets, $307,500 of sales, $19,575 of net income, and a
debt-to-total-assets ratio of 37.5%. The
new CFO believes a new computer program will enable it to reduce costs and thus
raise net income to $33,000. Assets,
sales, and the debt ratio would not be affected. By how much would the cost reduction improve
the ROE?
a. 9.32%
b. 9.82%
c. 10.33%
d. 10.88%
e. 11.42%
(3.6)
EPS, book value, and debt ratio C K Answer:
. Stewart Inc.'s latest EPS was
$3.50, its book value per share was $22.75, it had 215,000 shares outstanding,
and its debt ratio was 46%. How much
debt was outstanding?
a. $3,393,738
b. $3,572,356
c. $3,760,375
d. $3,958,289
e. $4,166,620
(3.8)
Du Pont equation: basic calculation C
K Answer:
. Last year Vaughn Corp. had sales
of $315,000 and a net income of $17,832, and its year-end assets were
$210,000. The firm's
total-debt-to-total-assets ratio was 42.5%.
Based on the Du Pont equation, what was Vaughn's ROE?
a. 14.77%
b. 15.51%
c. 16.28%
d. 17.10%
e. 17.95%
(3.8)
Du Pont eqn: effect of reducing assets on ROE CK Answer:
. Last year Central Chemicals had
sales of $205,000, assets of $127,500, a profit margin of 5.3%, and an equity
multiplier of 1.2. The CFO believes that
the company could reduce its assets by $21,000 without affecting either sales
or costs. Had it reduced its assets in
this amount, and had the debt ratio, sales, and costs remained constant, by how
much would the ROE have changed?
a. 1.81%
b. 2.02%
c. 2.22%
d. 2.44%
e. 2.68%
(3.8)
Du Pont eqn: effect of reducing costs on ROE CK Answer:
. Last year Mason Inc. had a total
assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were $195,000 and its net income
was $10,549. The CFO believes that the
company could have operated more efficiently, lowered its costs, and increased
its net income by $5,250 without changing its sales, assets, or capital
structure. Had it cut costs and
increased its net income in this amount, by how much would the ROE have
changed?
a. 5.66%
b. 5.95%
c. 6.27%
d. 6.58%
e. 6.91%
(3.8)
Du Pont equation: changing the debt ratio C K Answer:
. Last year Rosenberg Corp. had $195,000
of assets, $18,775 of net income, and a debt-to-total-assets ratio of 32%. Now suppose the new CFO convinces the
president to increase the debt ratio to 48%.
Sales and total assets will not be affected, but interest expenses would
increase. However, the CFO believes that
better cost controls would be sufficient to offset the higher interest expense
and thus keep net income unchanged. By
how much would the change in the capital structure improve the ROE?
a. 4.36%
b. 4.57%
c. 4.80%
d. 5.04%
e. 5.30%
(Comp:
3.3-3.5) Asset reduction: turnover and ROE C K Answer:
. Last year Altman Corp. had
$205,000 of assets, $303,500 of sales, $18,250 of net income, and a
debt-to-total-assets ratio of 41%. The new
CFO believes the firm has excessive fixed assets and inventory that could be
sold, enabling it to reduce its total assets to $152,500. Sales, costs, and net income would not be
affected, and the firm would maintain the 41% debt ratio. By how much would the reduction in assets
improve the ROE?
a. 4.69%
b. 4.93%
c. 5.19%
d. 5.45%
e. 5.73%
:
(3.3)
DSO and its effect on net income C K Answer:
. Muscarella Inc. has the following
balance sheet and income statement data:
Cash $ 14,000 Accounts
payable $ 42,000
Receivables 70,000 Other
current liabilities 28,000
Inventories 210,000
Total CL $ 70,000
Total CA $294,000 Long-term debt 70,000
Net
fixed assets 126,000 Common equity 280,000
Total assets $420,000 Total liab. and equity $420,000
Sales $280,000
Net
income $ 21,000
The new
CFO thinks that inventories are excessive and could be lowered sufficiently to
cause the current ratio to equal the industry average, 2.70, without affecting
either sales or net income. Assuming
that inventories are sold off and not replaced to get the current ratio to the
target level, and that the funds generated are used to buy back common stock at
book value, by how much would the ROE change?
a. 4.28%
b. 4.50%
c. 4.73%
d. 4.96%
e. 5.21%
(Comp:
3.4,3.5) ROE changing with debt ratio C
K Answer:
. Last year Swensen Corp. had sales
of $303,225, operating costs of $267,500, and year-end assets of $195,000. The debt-to-total-assets ratio was 27%, the
interest rate on the debt was 8.2%, and the firm's tax rate was 37%. The new CFO wants to see how the ROE would
have been affected if the firm had used a 45% debt ratio. Assume that sales and total assets would not
be affected, and that the interest rate and tax rate would both remain
constant. By how much would the ROE
change in response to the change in the capital structure?
a. 2.08%
b. 2.32%
c. 2.57%
d. 2.86%
e. 3.14%
(Comp:
3.4,3.5) Maximum debt constrained by TIE C
K Answer:
. Quigley Inc. is considering two
financial plans for the coming year.
Management expects sales to be $301,770, operating costs to be $266,545,
assets to be $200,000, and its tax rate to be 35%. Under Plan A it would use 25% debt and 75%
common equity. The interest rate on the
debt would be 8.8%, but the TIE ratio would have to be kept at 4.00 or
more. Under Plan B the maximum debt that
met the TIE constraint would be employed.
Assuming that sales, operating costs, assets, the interest rate, and the
tax rate would all remain constant, by how much would the ROE change in
response to the change in the capital structure?
a. 3.83%
b. 4.02%
c. 4.22%
d. 4.43%
e. 4.65%
Multi-part:
(The following data apply to Problems 87 through 105.)
The balance sheet and income statement shown below are for
Pettijohn Inc. Note that the firm has no
amortization charges, it does not lease any assets, none of its debt must be
retired during the next 5 years, and the notes payable will be rolled over.
Balance Sheet (Millions of $)
Assets 2010
Cash and securities $1,554.0
Accounts receivable 9,660.0
Inventories 13,440.0
Total current assets $24,654.0
Net plant and equipment 17,346.0
Total assets $42,000.0
Liabilities and Equity
Accounts payable $7,980.0
Notes payable 5,880.0
Accruals 4,620.0
Total current liabilities $18,480.0
Long-term bonds 10,920.0
Total debt $29,400.0
Common stock 3,360.0
Retained earnings 9,240.0
Total common equity $12,600.0
Total liabilities and equity $42,000.0
Income Statement (Millions of $) 2010
Net sales $58,800.00
Operating costs except depr’n $54,978.0
Depreciation $1,029.0
Earnings bef int and taxes (EBIT) $2,793.0
Less interest 1,050.0
Earnings before taxes (EBT) $1,743.0
Taxes $610.1
Net income $1,133.0
Other data:
Shares outstanding (millions) 175.00
Common dividends $509.83
Int rate on notes payable & L-T bonds 6.25%
Federal plus state income tax rate 35%
Year-end stock price $77.69
(3.2)
Calculating ratios given financial stmts CK Answer:
. What is the firm's current ratio?
a. 0.97
b. 1.08
c. 1.20
d. 1.33
e. 1.47
(3.2)
Calculating ratios given financial stmts CK Answer:
. What is the firm's quick ratio?
a. 0.49
b. 0.61
c. 0.73
d. 0.87
e. 1.05
(3.3)
Calculating ratios given financial stmts CK Answer:
. What is the firm's days sales
outstanding? Assume a 360-day year for
this calculation.
a. 48.17
b. 50.71
c. 53.38
d. 56.19
e. 59.14
(3.3)
Calculating ratios given financial stmts CK Answer:
. What is the firm's total assets
turnover?
a. 0.90
b. 1.12
c. 1.40
d. 1.68
e. 2.02
(3.3)
Calculating ratios given financial stmts CK Answer:
. What is the firm's inventory
turnover ratio?
a. 4.38
b. 4.59
c. 4.82
d. 5.06
e. 5.32
(3.4)
Calculating ratios given financial stmts CK Answer:
. What is the firm's TIE?
a. 1.94
b. 2.15
c. 2.39
d. 2.66
e. 2.93
(3.4)
Calculating ratios given financial stmts CK Answer:
. What is the firm's EBITDA
coverage?
a. 3.29
b. 3.46
c. 3.64
d. 3.82
e. 4.01
(3.4)
Calculating ratios given financial stmts CK Answer:
. What is the firm's debt ratio?
a. 45.93%
b. 51.03%
c. 56.70%
d. 63.00%
e. 70.00%
(3.5)
Calculating ratios given financial stmts CK Answer:
. What is the firm's ROA?
a. 2.70%
b. 2.97%
c. 3.26%
d. 3.59%
e. 3.95%
(3.5)
Calculating ratios given financial stmts CK Answer:
. What is the firm's ROE?
a. 8.54%
b. 8.99%
c. 9.44%
d. 9.91%
e. 10.41%
(3.5)
Calculating ratios given financial stmts CK Answer:
. What is the firm's BEP?
a. 6.00%
b. 6.32%
c. 6.65%
d. 6.98%
e. 7.33%
(3.5)
Calculating ratios given financial stmts CK Answer:
. What is the firm's profit margin?
a. 1.40%
b. 1.56%
c. 1.73%
d. 1.93%
e. 2.12%
(3.5)
Calculating ratios given financial stmts CK Answer:
. What is the firm's dividends per
share?
a. $2.62
b. $2.91
c. $3.20
d. $3.53
e. $3.88
(3.5)
Calculating ratios given financial stmts CK Answer:
. What is the firm's cash flow per
share?
a. $10.06
b. $10.59
c. $11.15
d. $11.74
e. $12.35
(3.6)
Calculating ratios given financial stmts CK Answer:
. What is the firm's EPS?
a. $5.84
b. $6.15
c. $6.47
d. $6.80
e. $7.14
(3.6)
Calculating ratios given financial stmts CK Answer:
. What is the firm's PE ratio?
a. 12.0
b. 12.6
c. 13.2
d. 13.9
e. 14.6
(3.6)
Calculating ratios given financial stmts CK Answer:
. What is the firm's book value per
share?
a. $61.73
b. $64.98
c. $68.40
d. $72.00
e. $75.60
(3.6)
Calculating ratios given financial stmts CK Answer:
. What is the firm's market-to-book
ratio?
a. 0.56
b. 0.66
c. 0.78
d. 0.92
e. 1.08
(3.8)
Calculating ratios given financial stmts CK Answer:
. What is the firm's equity
multiplier?
a. 3.33
b. 3.50
c. 3.68
d. 3.86
e. 4.05
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