Jefferson Co. has $2 million in total assets and $3 million in sales.

Jefferson Co. has $2 million in total assets and $3 million in sales. The company has the following balance sheet:

Cash $ 100,000 Accounts payable $ 200,000

Accounts receivable 200,000 Accruals 100,000

Inventories 500,000 Notes payable 200,000

Net fixed assets 1,200,000 Long-term debt 700,000

Common equity 800,000

Total liabilities

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

Jefferson wants to improve its inventory turnover to the industry average of 10.0´. The change is not expected to have an effect on sales. If successful, the company would use the freed-up cash from the reduction in inventories and use half of it to reduce notes payable and the other half to reduce common equity. If successful, what will be Jefferson’s current ratio?

a.1.43

b.1.50

c.2.50

d.2.00

e.1.20

[ii]. Daggy Corporation has the following simplified balance sheet:

Cash $ 25,000 Current liabilities $200,000

Inventories 190,000

Accounts receivable 125,000 Long-term debt 300,000

Net fixed assets 360,000 Common equity 200,000

Total assets $700,000 Total claims $700,000

The company has been advised to tighten their credit policy and reduce their days sales outstanding to 36 days. The increase in cash resulting from the decrease in accounts receivable will be used to reduce the company’s long-term debt. The interest rate on long-term debt is 10% and the company’s tax rate is 30%. The new credit policy is expected to reduce the company’s sales to $730,000 and EBIT to $70,000. What is the company’s expected ROE after the change in credit policy?

a.14.88%

b.16.63%

c.15.86%

d.18.38%

e.16.25%

[iii]. Austin & Company has a debt ratio of 0.5, a total assets turnover ratio of 0.25, and a profit margin of 10%. The Board of Directors is unhappy with the current return on equity (ROE), and they think it could be doubled. This could be accomplished (1) by increasing the profit margin to 12% and (2) by increasing debt utilization. Total assets turnover will not change. What new debt ratio, along with the new 12% profit margin, would be required to double the ROE?

a.55%

b.60%

c.65%

d.70%

e.75%

[iv]. Shepherd Enterprises has an ROE of 15%, a debt ratio of 40%, and a profit margin of 5%. The company’s total assets equal $800 million. What are the company’s sales? (Assume that the company has no preferred stock.)

a.$1,440,000,000

b.$2,400,000,000

c.$ 120,000,000

d.$ 360,000,000

e.$ 960,000,000

[v]. Samuels Equipment has $10 million in sales. Its ROE is 15% and its total assets turnover is 3.5´. The company is 100% equity financed. What is the company’s net income?

a.$1,500,000

b.$2,857,143

c.$ 428,571

d.$2,333,333

e.$ 52,500

[vi]. Georgia Electric reported the following income statement and balance sheet for the previous year:

Balance Sheet:

Cash $ 100,000

Inventories 1,000,000

Accounts receivable 500,000

Current assets $1,600,000

Total debt $4,000,000

Net fixed assets 4,400,000 Total equity 2,000,000

Total assets $6,000,000 Total claims $6,000,000

Income Statement:

Sales $3,000,000

Operating costs 1,600,000

Operating income (EBIT) $1,400,000

Interest 400,000

Taxable income (EBT) $1,000,000

Taxes (40%) 400,000

Net income $ 600,000

The company’s interest cost is 10%, so the company’s interest expense each year is 10% of its total debt.

While the company’s financial performance is quite strong, its CFO is always looking for ways to improve. The CFO has noticed that the company’s inventory turnover ratio is considerably weaker than the industry average, which is 6.0. As an exercise, the CFO asks what the company’s ROE would have been last year if the following had occurred:

· The company maintained the same sales, but reduced inventories enough to achieve the industry average inventory turnover ratio.

· Cash generated from the inventory reduction was used to reduce the company’s outstanding debt. So, the company’s total debt would have been $4 million less the freed-up cash from the improvement in inventory policy.

· Assume equity does not change and all earnings are paid out as dividends.

Under this scenario, what would have been the company’s ROE last year?

a.27.0%

b.29.5%

c.30.3%

d.31.5%

e.33.0%

[vii]. Roland & Company has a new management team that has developed an operating plan to improve upon last year’s ROE. The new plan would make the debt ratio 55%, which will result in interest charges of $7,000 per year. EBIT is projected to be $25,000 on sales of $270,000, it expects to have a total assets turnover ratio of 3.0, and the average tax rate will be 40%. What does Roland & Company expect its ROE to be?

a.17.65%

b.21.82%

c.26.67%

d.44.44%

e.51.25%

[viii].Savelots Stores’ current financial statements are shown below:

Balance Sheet:

Inventories $ 500 Accounts payable $ 100

Other current assets 400 Short-term notes payable 370

Fixed assets 370 Common equity 800

Total assets $1,270 Total liab. and equity $1,270

Income Statement:

Sales $2,000

Operating costs 1,843

EBIT $ 157

Interest 37

EBT $ 120

Taxes (40%) 48

Net income $ 72

Savelots’ current ratio of 1.9 is in line with the industry average. However, its accounts payable, which have no interest cost and are due entirely to purchases of inventories, amount to only 20% of inventories versus an industry average of 60%. Suppose Savelots increased its accounts payable-to-inventories ratio to the 60% industry average, but it (1) kept all of its assets at their present levels and (2) held its current ratio at 1.9. Assume that Savelots’ tax rate is 40%, that its cost of short-term debt is 10%, and that the change in payments does not affect operations. In addition, common equity will not change. What will be Savelots’ new ROE?

a.10.5%

b. 7.8%

c. 9.0%

d.13.2%

e.12.0%

[ix]. Aurillo Equipment Company (AEC) projected next year’s ROE to be 6%. However, the firm can increase its ROE by refinancing some high interest bonds currently outstanding. The firm’s total debt will remain at $200,000 and the debt ratio will hold constant at 80%, but the interest rate on the refinanced debt will be 10%. The rate on the old debt is 14%. Refinancing will not affect sales, which are projected to be $300,000. The basic earning power will be 11% and the firm’s tax rate is 40%. If AEC refinances, what will be its projected new ROE?

a. 3.0%

b. 8.2%

c.10.0%

d. 9.0%

e.18.7%

[x]. Lombardi Trucking Company has the following data:

Assets $10,000

Profit margin 3.0%

Tax rate 40%

Debt ratio 60.0%

Interest rate 10.0%

Total assets turnover 2.0

What is Lombardi’s TIE ratio?

a.0.95

b.1.75

c.2.10

d.2.67

e.3.45

[xi]. Victoria Enterprises has $1.6 million of accounts receivable.The company’s DSO is 40, its current assets are $2.5 million, and its current ratio is 1.5. The company plans to reduce its DSO to the industry average of 30 without causing a decline in sales. The freed-up cash will be used to reduce current liabilities.If the company succeeds, what will Victoria’s new current ratio be?

a.1.50

b.1.97

c.1.26

d.0.72

e.1.66

[xii]. XYZ’s balance sheet and income statement are given below:

Balance Sheet:

Cash $ 50 Accounts payable $ 100

A/R 150 Notes payable 0

Inventories 300 Long-term debt (10%) 700

Fixed assets 500 Common equity (20 shares) 200

Total assets $1,000 Total liabilities and equity$1,000

Income Statement:

Sales $1,000

Cost of goods sold 855

EBIT $ 145

Interest 70

EBT $ 75

Taxes (33.333%) 25

Net income $ 50

The industry average inventory turnover is 5, the interest rate on the firm’s long-term debt is 10%, 20 shares are outstanding, and the stock’s P/E is 8.0. If XYZ increased its inventory turnover to the industry average, if it used freed up funds to buy back common stock at the current market price and thus to reduce common equity, and if sales, the cost of goods sold, and the P/E ratio remained constant, by what dollar amount would its stock price increase?

a.$ 3.33

b.$ 6.67

c.$ 8.75

d.$10.00

e.$12.50

Du Pont equation and debt ratio Answer: e

[xiii].Company A has sales of $1,000, assets of $500, a debt ratio of 30%, and an ROE of 15%. Company B has the same sales, assets, and net income as Company A, but its ROE is 30%. What is B’s debt ratio? (Hint: Begin by looking at the Du Pont equation.)

a.25.0%

b.35.0%

c.50.0%

d.52.5%

e.65.0%

[xiv]. A company has just been taken over by new management that believes it can raise earnings before taxes (EBT) from $600 to $1,000, merely by cutting overtime pay and reducing cost of goods sold. Prior to the change, the following data applied:

Total assets $8,000

Debt ratio 45%

Tax rate 35%

BEP ratio 13.3125%

EBT $600

Sales $15,000

These data have been constant for several years, and all income is paid out as dividends. Sales, the tax rate, and the balance sheet will remain constant. What is the company’s cost of debt?

a.12.92%

b.13.23%

c.13.51%

d.13.75%

e.14.00%

[xv]. Lone Star Plastics has the following data:

Assets $100,000

Profit margin 6.0%

Tax rate 40%

Debt ratio 40.0%

Interest rate 8.0%

Total assets turnover 3.0

What is Lone Star’s EBIT?

a.$ 3,200

b.$12,000

c.$18,000

d.$30,000

e.$33,200

[xvi]. Ricardo Entertainment recently reported the following income statement:

Sales $12,000,000

Cost of goods sold 7,500,000

EBIT $ 4,500,000

Interest 1,500,000

EBT $ 3,000,000

Taxes (40%) 1,200,000

Net income $ 1,800,000

The company’s CFO, Fred Mertz, wants to see a 25% increase in net income over the next year. In other words, his target for next year’s net income is $2,250,000. Mertz has made the following observations:

· Ricardo’s operating margin (EBIT/Sales) was 37.5% this past year. Mertz expects that next year this margin will increase to
40%.

· Ricardo’s interest expense is expected to remain constant.

· Ricardo’s tax rate is expected to remain at 40%.

On the basis of these numbers, what is the percentage increase in sales that Ricardo needs in order to meet Mertz’s target for net income?

a.72.92%

b. 9.38%

c. 2.50%

d.48.44%

e.25.00%

Multiple Part:

(The following information applies to the next two problems.)

Fama’s French Bakery has a return on assets (ROA) of 10% and a return on equity (ROE) of 14%. Fama’s total assets equal total debt plus common equity (that is, there is no preferred stock). Furthermore, we know that the firm’s total assets turnover is 5.

[xvii].What is Fama’s debt ratio?

a.14.29%

b.28.00%

c.28.57%

d.55.56%

e.71.43%

[xviii]. What is Fama’s profit margin?

a.2.00%

b.4.00%

c.4.33%

d.5.33%

e.6.00%

(The following information applies to the next two problems.)

Miller Technologies recently reported the following balance sheet in its annual report (all numbers are in millions of dollars):

Cash $ 100 Accounts payable $ 300

Accounts receivable 300 Notes payable 500

Inventory 500 Total current liabilities $ 800

Total current assets $ 900 Long-term debt 1,500

Total debt $2,300

Common stock 500

Retained earnings 400

Net fixed assets 2,300 Total common equity $ 900

Total assets $3,200 Total liabilities and equity $3,200

Miller also reported sales revenues of $4.5 billion and a 20% ROE for this same year.

[xix]. What is Miller’s ROA?

a.2.500%

b.3.125%

c.4.625%

d.5.625%

e.7.826%

[xx]. Miller Technologies is considering issuing $300 million in notes payable to purchase new fixed assets (for this problem, ignore depreciation). If this plan were carried out, what would Miller’s current ratio be immediately following the transaction?

a.0.455

b.0.818

c.1.091

d.1.125

e.1.800

(The following information applies to the next three problems.)

Dokic, Inc. reported the following balance sheets for year-end 2004 and 2005 (dollars in millions):

2005 2004

Cash $ 650 $ 500

Accounts receivable 450 700

Inventories 850 600

Total current assets $1,950 $1,800

Net fixed assets 2,450 2,200

Total assets $4,400 $4,000

Accounts payable $ 680 $ 300

Notes payable 200 600

Wages payable 220 200

Total current liabilities $1,100 $1,100

Long-term bonds 1,000 1,000

Common stock 1,500 1,200

Retained earnings 800 700

Total common equity $2,300 $1,900

Total liabilities and equity $4,400 $4,000

[xxi]. Which of the following statements is NOT correct?

a.The company’s current ratio was higher in 2005 than it was in 2004.

b.The company’s debt ratio was higher in 2005 than it was in 2004.

c.The company issued new common stock during 2005.

d.If the company paid no dividends, it must have had a positive net income.

e.The company’s net working capital declined between 2004 and 2005.

[xxii].The total dividends paid to the company’s common stockholders during 2005 was $50 million. What was the company’s net income during the year 2005?

a.$ 50 million

b.$150 million

c.$250 million

d.$350 million

e.$450 million

[xxiii]. When reviewing the company’s performance for 2005, its CFO observed that the company’s inventory turnover ratio was below the industry average inventory turnover ratio of 6.0. In addition, the company’s DSO was less than the industry average of 50. What is the most likely estimate of the company’s sales (in millions of dollars) for 2005?

a.$ 2,940

b.$ 5,038

c.$ 7,250

d.$10,863

e.$30,765

(The following information applies to the next two problems.)

Below are the 2004 and 2005 year-end balance sheets for Kewell Boomerangs:

2005 2004

Cash $ 100,000 $ 85,000

Accounts receivable 432,000 350,000

Inventories 1,000,000 700,000

Total current assets $1,532,000 $1,135,000

Net fixed assets 3,000,000 2,800,000

Total assets $4,532,000 $3,935,000

Accounts payable $ 700,000 $ 545,000

Notes payable 800,000 900,000

Total current liabilities $1,500,000 $1,445,000

Long-term debt 1,200,000 1,200,000

Common stock 1,500,000 1,000,000

Retained earnings 332,000 290,000

Total common equity $1,832,000 $1,290,000

Total liabilities and equity $4,532,000 $3,935,000

Kewell Boomerangs has never paid a dividend on its common stock. Kewell issued $1,200,000 of long-term debt in 1997. This debt was non-callable and is scheduled to mature in 2027. As of the end of 2005, none of the principal on this debt has been repaid. Assume that 2004 and 2005 sales were the same in both years.

[xxiv].Which of the following statements is most correct?

a.Kewell’s current ratio in 2005 was higher than it was in 2004.

b.Kewell’s inventory turnover ratio in 2005 was higher than it was in 2004.

c.Kewell’s debt ratio in 2005 was higher than it was in 2004.

d.Since retained earnings increased, the company must have paid no dividends.

e.Because fixed assets turnover increased slower than total assets, the total assets turnover is greater than the fixed assets turnover.

[xxv]. During 2005, Kewell’s days sales outstanding was 40 days. The industry average DSO was 30 days. Assume instead that in 2005, Kewell had been able to achieve the industry-average DSO without reducing its sales, and that the freed-up cash would have been used to reduce accounts payable. If DSO were reduced, what would have been Kewell’s current ratio in 2005?

a.1.018

b.1.021

c.1.023

d.1.027

e.1.033