[i]. Which of the following statements is CORRECT?

[i]. Which of the following statements is CORRECT?

 

a.An increase in the DSO, other things held constant, could be expected to increase the ROE.

 

b.An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio.

 

c.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.

 

d.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.

 

e.If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE.

 

 

[ii]. 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.HD would have the higher net income as shown on the income statement.

 

b.HD would have the lower net income as shown on the income statement.

 

c.Without more information, we cannot tell if HD or LD would have a higher or lower net income.

 

d.HD would have to pay more in income taxes.

 

e.HD would have the lower equity multiplier for use in the Du Pont equation.

 

 

[iii]. Other things held constant, which of the following alternatives would increase a company’s cash flow for the current year?

 

a.Reduce the days’ sales outstanding (DSO) without reducing sales.

 

b.Increase the number of years over which fixed assets are depreciated.

 

c.Decrease the accounts payable balance.

 

d.Reduce the inventory turnover ratio without affecting sales.

 

e.Decrease the accrued wages balance.

 

 

[iv]. 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 has a higher ROA.

 

b.Company HD has a higher times interest earned (TIE) ratio.

 

c.Company HD has more net income.

 

d.Company HD pays less in taxes.

 

e.Company HD has a lower equity multiplier.

 

[v]. 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 ROE.

 

b.Company HD has a lower times interest earned (TIE) ratio.

 

c.Company HD has more net income.

 

d.Company HD pays more in taxes.

 

e.Company HD has a lower equity multiplier.

 

[vi]. 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 return on assets must be above the industry average.

 

b.Its total assets turnover must be above the industry average.

 

c.Its total assets turnover must be below the industry average.

 

d.Its total assets turnover must equal the industry average.

 

e.Its return on assets must equal the industry average.

 

[vii]. Which of the following statements is CORRECT?

 

a.If Firms A and B have the same earnings per share and market-to-book ratio, they must have the same price earnings ratio.

 

b.If Firms A and B have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same.

 

c.If Firms A and B have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.

 

d.If Firms A and B have the same P/E ratios, then their market-to-book ratios must also be the same.

 

e.If Firm A’s P/E ratio exceeds that of Firm B, then B is likely to be less risky and also to be expected to grow at a faster rate.

 

[viii].CompaniesHD andLD have the same total assets,sales, and operating costs, 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.Company LD has a higher basic earning power ratio (BEP).

 

b.Company HD has a higher basic earning power ratio (BEP).

 

c.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.

 

d.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.

 

e.Given this information, LD must have the higher ROE.

 

[ix]. 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 TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.

 

b.The lower the company’s EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.

 

c.Other things held constant, the lower the current asset ratio, the lower the interest rate the bank would charge the firm.

 

d.Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.

 

e.Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.

 

[x]. Walter Industries’ current ratio is 0.5. Considered alone, which of the following actions would INCREASE the company’s current ratio?

 

a.Use cash to reduce short-term notes payable.

 

b.Use cash to reduce accounts payable.

 

c.Borrow using short-term notes payable and use the cash to increase inventories.

 

d.Use cash to reduce long-term bonds outstanding.

 

e.Use cash to reduce accruals.

 

[xi]. Safeco’s total current assets are $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 this transaction?

 

a.The transaction would have no effect on the firm’ financial strength as measured by their current ratios.

 

b.The transaction would improve both firms’ financial strength as measured by their current ratios.

 

c.The transaction would lower both firm’ financial strength as measured by their current ratios.

 

d.The transactions would lower Safeco’s financial strength as measured by its current ratio but raise Risco’s current ratio.

 

e.The transaction would raise Safeco’s financial strength as measured by its current ratio but lower Risco’s current ratio.

 

PART II – Questions and Problems from Prior Test Bank not used in Part I

 

[xii]. Russell Securities has $100 million in total assets and its corporate tax rate is 40%. The company recently reported that its basic earning power (BEP) ratio was 15% and its return on assets (ROA) was 9%. What was the company’s interest expense?

 

a.$ 0

 

b.$ 2,000,000

 

c.$ 6,000,000

 

d.$15,000,000

 

e.$18,000,000

 

[xiii].You are given the following information: Stockholders’ equity = $1,250; price/earnings ratio = 5; shares outstanding = 25; and market/book ratio = 1.5. Calculate the market price of a share of the company’s stock.

 

a.$ 33.33

 

b.$ 75.00

 

c.$ 10.00

 

d.$166.67

 

e.$133.32

 

[xiv]. Meyersdale Office Supplies has common equity of $40 million. The company’s stock price is $80 per share and its market/book ratio is 4.0. How many shares of stock does the company have outstanding?

 

1. 500,000

 

1. 125,000

 

1. 2,000,000

 

d.800,000,000

 

e.Insufficient information.

 

[xv]. Strack Houseware Supplies Inc. has $2 billion in total assets, $0.2 billion in current liabilities, $0.6 billion in long-term debt, and $1.2 billion in common equity. The company’s 300 million shares of common stock are selling at $20 per share. What is Strack’s market/book ratio?

 

a.1.25

 

b.2.65

 

c.3.15

 

d.4.40

 

e.5.00

 

[xvi]. A firm has a profit margin of 15% on sales of $20,000,000. If the firm has debt of $7,500,000, total assets of $22,500,000, and an after-tax interest cost on total debt of 5%, what is the firm’s ROA?

 

8. 8.4%

 

b.10.9%

 

c.12.0%

 

d.13.3%

 

e.15.1%

 

[xvii].Culver Inc. has EBT of $300. The company’s times interest earned ratio is 7.00. Calculate the company’s interest charges.

 

a.$42.86

 

b.$50.00

 

c.$40.00

 

d.$60.00

 

e.$57.93

 

[xviii]. Tapley Dental Supply Company has the following data:

 

Net income $240

 

Sales $10,000

 

Total assets $6,000

 

Debt ratio 75%

 

TIE ratio 2.0

 

Current ratio 1.2

 

BEP ratio 13.33%

 

If Tapley could streamline operations, cut operating costs, and raise net income to $300 without affecting sales or the balance sheet (the additional profits will be paid out as dividends), by how much would its ROE increase?

 

a.3.00%

 

b.3.50%

 

c.4.00%

 

d.4.25%

 

e.5.50%

 

[xix]. A firm that has an equity multiplier of 4.0 will have a debt ratio of

 

a.4.00

 

b.3.00

 

c.1.00

 

d.0.75

 

e.0.25

 

[xx]. Your company had the following balance sheet and income statement information for 2005:

 

Balance Sheet:

 

Cash $ 20

 

A/R 1,000

 

Inventories 5,000

 

Total current assets $6,020 Debt $4,000

 

Net fixed assets 2,980 Equity 5,000

 

Total assets $9,000 Total claims $9,000

 

Income Statement:

 

Sales $10,000

 

Cost of goods sold 9,200

 

EBIT $ 800

 

Interest (10%) 400

 

EBT $ 400

 

Taxes (40%) 160

 

Net income $ 240

 

The industry average inventory turnover is 5. You think you can change your inventory control system and steer your turnover to the industry average. This change will have no effect on either sales or cost of goods sold. The cash generated from reducing inventories will be invested in tax-exempt securities that yield 7%. What will your profit margin be after the change in inventories is reflected in the income statement?

 

a.2.1%

 

b.2.4%

 

c.4.5%

 

d.5.3%

 

e.6.7%

 

[xxi]. The Wilson Corporation has the following results:

 

Sales/Total assets 2.0´

 

Return on assets (ROA) 4.0%

 

Return on equity (ROE) 6.0%

 

What is Wilson’s profit margin and debt ratio?

 

a.2%; 0.33

 

b.4%; 0.33

 

c.4%; 0.67

 

d.2%; 0.67

 

e.4%; 0.50

 

 

[xxii].The Charleston Company is a relatively small, privately owned firm. Last year the company had net income of $15,000 and 10,000 shares were outstanding. The owners were trying to determine the equilibrium market value for the stock prior to taking the company public. A similar firm that is publicly traded had a price/earnings ratio (P/E) of 5.0. Using only the information given, estimate the market value of one share of Charleston’s stock.

 

a.$10.00

 

b.$ 7.50

 

c.$ 5.00

 

d.$ 2.50

 

e.$ 1.50

 

[xxiii]. Cleveland Corporation has 100,000 shares of common stock outstanding, its net income is $750,000, and its P/E is 8. What is the company’s stock price?

 

a.$20.00

 

b.$30.00

 

c.$40.00

 

d.$50.00

 

e.$60.00

 

[xxiv].Iken Berry Farms has $5 million in current assets, $3 million in current liabilities, and its initial inventory level is $1 million. The company plans to increase its inventory, funded by additional short-term debt (notes payable). Assume that the value of the remaining current assets will not change. The company’s bond covenants require a current ratio greater than or equal to 1.5. How much inventory can be purchased before the covenants are violated?

 

a.$0.50 million

 

b.$1.00 million

 

c.$1.33 million

 

d.$1.66 million

 

e.$2.33 million

 

[xxv]. Cannon Company has enjoyed a rapid increase in sales in recent years, following a decision to sell on credit. However, the firm has noticed an increase in its collection period. Last year, total sales were $1 million, and $250,000 of these sales were on credit. During the year, the accounts receivable account averaged $41,096. It is expected that sales will increase in the forthcoming year by 50%, and, while credit sales should continue to be the same proportion of total sales, it is expected that the days sales outstanding will also increase by 50%. If the resulting increase in accounts receivable must be financed externally, how much external funding will Cannon need?

 

a.$ 41,096

 

b.$ 51,370

 

c.$ 47,359

 

d.$106,471

 

e.$ 92,466

 

[xxvi].Ruth Company currently has $1,000,000 in accounts receivable, and its days sales outstanding (DSO) is 50 days. The company wants to reduce its DSO to the industry average of 32 days by pressuring more of its customers to pay their bills on time. The company’s CFO estimates that if this policy is adopted the company’s average sales will fall by 10%. Assuming that the company adopts this change and succeeds in reducing its DSO to 32 days, what will be the level of accounts receivable following the change?

 

a.$576,000

 

b.$633,333

 

c.$750,000

 

d.$900,000

 

e.$966,667

 

[xxvii]. The Carter Co.’s return on equity (ROE) is 18%. If sales were $4 million, the debt ratio was 40%, and total liabilities were $2 million, what would be Carter’s return on assets (ROA)?

 

a.10.80%

 

1. 0.80%

 

1. 1.25%

 

d.12.60%

 

e.Insufficient information.

 

[xxviii]. Humphrey Hotels’ operating income (EBIT) is $40 million. The company’s times interest earned (TIE) ratio is 8.0, its tax rate is 40%, and its basic earning power (BEP) ratio is 10%. What is the company’s return on assets (ROA)?

 

a.6.45%

 

b.5.97%

 

c.4.33%

 

d.8.56%

 

e.5.25%

 

[xxix].Selzer Inc. sells all its merchandise on credit. It has a profit margin of 4%, days sales outstanding equal to 60 days, receivables of $150,000, total assets of $3 million, and a debt ratio of 64%. What is the firm’s return on equity (ROE)? Assume a 365-day year.

 

7. 7.1%

 

b.33.4%

 

3. 3.4%

 

d.71.0%

 

8. 8.1%

 

[xxx]. A firm has a debt ratio of 50%. Currently, its interest expense is $500,000 on $5,000,000 of total debt outstanding. Its tax rate is 40%. If the firm’s ROA is 6%, by how many percentage points is the firm’s ROE greater than its ROA?

 

a.0.0%

 

b.6.0%

 

c.5.2%

 

d.7.4%

 

e.9.0%

 

 

[xxxi].Assume Meyer Corporation is 100% equity financed. Calculate the return on equity (ROE), given the following information:

 

Earnings before taxes $1,500

 

Sales $5,000

 

Dividend payout ratio 60%

 

Total assets turnover 2.0

 

Tax rate 30%

 

a.25%

 

b.30%

 

c.35%

 

d.42%

 

e.50%

 

[xxxii]. Alumbat Corporation has $800,000 of debt outstanding, on which it pays 10% annual interest. Alumbat’s annual sales are $3,200,000, its average tax rate is 40%, and its net profit margin is 6%. The company must maintain a TIE ratio of at least 4 times or its bank will refuse to renew its loan, resulting in bankruptcy. What is Alumbat’s current TIE ratio?

 

a.2.4

 

b.3.4

 

c.3.6

 

d.4.0

 

e.5.0

 

[xxxiii]. Moss Motors has $8 billion in assets, and its tax rate is 40%. The company’s basic earning power (BEP) ratio is 12%, and its return on assets (ROA) is 3%. What is Moss’ times interest earned (TIE) ratio?

 

a.2.25

 

b.1.71

 

c.1.00

 

d.1.33

 

e.2.50

 

[xxxiv]. Lancaster Motors has total assets of $20 million. Its basic earning power is 25%, its return on assets (ROA) is 10%, and the company’s tax rate is 40%. What is Lancaster’s TIE ratio?

 

a.2.5

 

b.3.0

 

c.1.5

 

d.1.2

 

e.0.6

 

[xxxv].Peterson Packaging Corp. has a basic earning power of (BEP) of 9% on $9 billion of total assets, and its times interest earned (TIE) ratio is 3.0. Peterson’s depreciation and amortization expense totals $1 billion. It has $0.6 billion in lease payments and $0.3 billion must go towards principal payments on outstanding loans and long-term debt. What is Peterson’s EBITDA coverage ratio?

 

a.2.06

 

b.1.52

 

c.2.25

 

d.1.10

 

e.2.77

 

[xxxvi]. Last year, Kansas Office Supply had $400,000 of net income on $24,000,000 of sales, its total assets turnover was 6.0, and the company’s ROE was 15%. If the company only finances with debt and equity, what is the company’s debt ratio?

 

a.0.20

 

b.0.30

 

c.0.33

 

d.0.60

 

e.0.66

 

[xxxvii]. The Merriam Company has determined that its return on equity (ROE) is 15%. If its debt ratio is 0.35 and its total assets turnover is 2.8, what is the profit margin?

 

3. 3.48%

 

5. 5.42%

 

6. 6.96%

 

2. 2.45%

 

e.12.82%

 

[xxxviii].Collins Company had the following partial balance sheet and complete income statement information for 2005:

 

Partial Balance Sheet:

 

Cash $ 20

 

A/R 1,000

 

Inventories 2,000

 

Total current assets $ 3,020

 

Net fixed assets 2,980

 

Total assets $ 6,000

 

Income Statement:

 

Sales $10,000

 

Cost of goods sold 9,200

 

EBIT $ 800

 

Interest (10%) 400

 

EBT $ 400

 

Taxes (40%) 160

 

Net income $ 240

 

The industry average DSO is 30. Collins wants to lower its DSO to equal the industry average, which is expected to have no effect on either sales or cost of goods sold. If the cash generated from reducing receivables is used to retire debt (which was outstanding all last year and has a 10% interest rate), what will Collins’ new debt ratio be?

 

a.33.33%

 

b.45.28%

 

c.52.75%

 

d.60.00%

 

e.65.65%

 

[xxxix]. Taft Technologies has the following relationships:

 

Annual sales $1,200,000.00

 

Current liabilities $ 375,000.00

 

Days sales outstanding (DSO) (365-day year) 40.00

 

Inventory turnover ratio 4.80

 

Current ratio 1.20

 

The company’s current assets consist of cash, inventories, and accounts receivable. How much cash does Taft have on its balance sheet?

 

a.-$ 8,333

 

1. $ 68,493

 

1. $125,000

 

1. $200,000

 

1. $316,667

 

 

[xl]. Aaron Aviation recently reported the following information:

 

Net income $500,000

 

ROA 10%

 

Interest expense $200,000

 

The company’s average tax rate is 40%. What is the company’s basic earning power (BEP)?

 

a.14.12%

 

b.16.67%

 

c.17.33%

 

d.20.67%

 

e.22.50%

 

[xli]. Dean Brothers Inc. recently reported net income of $1,500,000. The company has 300,000 shares of common stock, which currently trade at $60 a share. The company continues to expand and anticipates that one year from now its net income will be $2,500,000. Over the next year the company also anticipates issuing an additional 100,000 shares of stock, so that one year from now the company will have 400,000 shares of common stock. Assuming the company’s price/earnings ratio remains at its current level, what will be the company’s stock price one year from now?

 

a.$55

 

b.$60

 

c.$65

 

d.$70

 

e.$75

 

[xlii].Parcells Jets has the following balance sheet (in millions):

 

Cash $ 100 Notes payable $ 100

 

Inventories 300 Accounts payable 200

 

Accounts receivable 400 Accruals 100

 

Total current assets $ 800 Total current liabilities $ 400

 

Net fixed assets 1,200 Long-term bonds 600

 

Total debt $1,000

 

______ Total common equity 1,000

 

Total assets $2,000 Total liabilities and equity $2,000

 

Parcells’ DSO is 40, which exceeds the industry average of 30. Assume that Parcells is able to reduce its DSO to the industry average without reducing sales, and the company uses freed-up cash to reduce its outstanding long-term bonds. What will be the new current ratio?

 

a.1.75

 

b.1.33

 

c.2.33

 

d.1.25

 

e.1.67