Question 1

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?

Accepted Answer

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.

Question 2

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?

Accepted Answer

A)  $52,230 
B)  $54,979 
C)  $57,873 
D)  $60,919 
E)  $64,125

Question 3

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?

Accepted Answer

A)  6.49% 
B)  6.83% 
C)  7.19% 
D)  7.55% 
E)  7.92%

Question 4

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 P/E ratio?

Accepted Answer

A)  13.84 
B)  14.57 
C)  15.29 
D)  16.06 
E)  16.86

Question 5

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?

Accepted Answer

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.

Question 6

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.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following statements is CORRECT?

Accepted Answer

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.

Question 8

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.

Accepted Answer

A) True 
 B)False

Question 9

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?

Accepted Answer

A)  7.32 
B)  7.70 
C)  8.09 
D)  8.49 
E)  8.92

Question 10

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.

Accepted Answer

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.

Question 11

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 easy 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 income/Sales. 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.
-Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000. What was its total assets turnover ratio (TATO)?

Accepted Answer

A)  2.03 
B)  2.13 
C)  2.25 
D)  2.36 
E)  2.48

Question 12

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?

Accepted Answer

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.

Question 13

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.

Accepted Answer

A) True 
 B)False

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?

Accepted Answer

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.

Question 16

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?

Accepted Answer

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.

Question 17

(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
-What is the firm's ROE?

Accepted Answer

A)  8.54% 
B)  8.99% 
C)  9.44% 
D)  9.91% 
E)  10.41%

Question 18

The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.

Accepted Answer

A) True 
 B)False

Question 19

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?

Accepted Answer

A)  4.72 
B)  4.97 
C)  5.23 
D)  5.51 
E)  5.80

Question 20

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?

Accepted Answer

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.

Exam 3: Analysis of Financial Statements Part 2 Fixed Income Securities

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?

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 P/E ratio?

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?

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.

Which of the following statements is CORRECT?

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.

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.

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 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 firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?

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?

The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.

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?

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?