REVIEWER - MIDTERM EXAMINATION

PART ONE
FINANCIAL MANAGEMENT

TRUE/FALSE (RATIO ANALYSIS)

1. Ratio analysis involves analyzing financial statements to help appraise a firm's financial position
and strength.

2. The current and inventory turnover ratios both help us measure a firm's liquidity. The current ratio
measures the relationship of the 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.

3. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios
provide fast and easy-to-use estimates of a firm's liquidity position.

4. High current and quick ratios always indicate that the firm is managing its liquidity position well.

5. If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would
probably not change much, but its quick ratio would decline.

6. If a firm sold some inventory on credit, its current ratio would probably not change much, but its
quick ratio would increase.

7. If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either
its current or quick ratio would change.

8. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to
assess how effectively a firm is managing its current assets.

9. A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory
management and its liquidity position, i.e., that it is becoming more liquid.

10. In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio
indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose
sales as a result of running out of stock.

11. The days sales outstanding tells us how long it takes, on average, to collect after a sale is made.
The DSO can be compared with the firm's credit terms to get an idea of whether customers are
paying on time.

12. If a firm's fixed assets turnover ratio is significantly higher than its industry average, this could
indicate that it uses its fixed assets very efficiently or is operating at over capacity and should
probably add fixed assets.

13. 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.
14. The more conservative a firm's management is, the higher its debt ratio is likely to be.

15. Other things held constant, the higher a firm's debt ratio, the higher its TIE ratio will be.

16. 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.

17. Profitability ratios show the combined effects of liquidity, asset management, and debt
management on a firm's operating results.

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.

19. The operating margin measures operating income per dollar of assets.

20. The profit margin measures net income per dollar of sales.

21. The "apparent," but not necessarily the "true," financial position of a company whose sales are
seasonal can change dramatically during a given year, depending on the time of year when
the financial statements are constructed.

22. Significant variations in accounting methods among firms make meaningful ratio comparisons
between firms more difficult than if all firms used the same or similar accounting methods.

23. 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 and/or that part of the inventory is obsolete or damaged.

24. 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.

25. Other things held constant, the more debt a firm uses, the lower its profit margin will be.

26. Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10%
versus a margin of 8% for Firm B. Firm A's debt ratio is 70% versus one of 20% for Firm B. Based
only on these two facts, you cannot reach a conclusion as to which firm is better managed,
because the difference in debt, not better management, could be the cause of Firm A's higher
profit margin.

27. Other things held constant, the more debt a firm uses, the lower its operating margin will be.

28. The advantage of the basic earning power ratio (BEP) over the return on total assets for judging
a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

29. Other things held constant, the more debt a firm uses, the lower its return on total assets will be.

30. 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.

31. Other things held constant, a decline in sales accompanied by an increase in financial leverage
must result in a lower profit margin.
 32. The return on common equity (ROE) is generally regarded as being less significant, from a
stockholder's viewpoint, than the return on total assets (ROA).

33. Market value ratios provide management with an indication of how investors view the firm's past
performance and especially its future prospects.

34. In general, if investors regard a company as being relatively risky and/or having relatively poor
growth prospects, then it will have relatively high P/E and M/B ratios.

35. The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current
earnings. In general, investors regard companies with higher P/E ratios as being less risky and/or
more likely to enjoy higher growth in the future.

36. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of
accounting book value. In general, investors regard companies with higher M/B ratios as being
less risky and/or more likely to enjoy higher growth in the future.

37. 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 examining changes in a
firm's performance over time.

38. Suppose all firms follow similar financing policies, face similar risks, have equal access to capital,
and operate in competitive product and capital markets. However, firms face different
operating conditions because, for example, the grocery store industry is different from the airline
industry. Under these conditions, firms with high profit margins will tend to have high asset
turnover ratios, and firms with low profit margins will tend to have low turnover ratios.

39. Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, a zero debt
ratio and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that
the firm borrow money, use it to buy back stock, and raise the debt ratio to 50% and the equity
multiplier to 2.0. She thinks that operations would not be affected, but interest on the new debt
would lower the profit margin to 4.5%. This would probably be a good move, as it would
increase the ROE from 7.5% to 13.5%.

40. 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 B's.

MULTIPLE CHOICE WITH ANSWERS (FS, CASHFLOW AND TAXES)

1. 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 must pay out in
interest during the year.
 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.

ANS: B PTS: 1 DIF: EASY NAT: Reflective thinking

2. Which of the following statements is CORRECT?

a. Assets other than cash are expected to produce cash over time, and the amounts
of cash they eventually produce should be exactly the same as the amounts at
which the assets are carried on the books.
b. 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.
c. The annual report is an internal document prepared by a firm's managers solely for
the use of its creditors/lenders.
d. The four most important financial statements provided in the annual report are the
balance sheet, income statement, cash budget, and statement of stockholders'
equity.
e. Prior to the Enron scandal in the early 2000s, companies would put verbal
information in their annual reports, along with the financial statements. That verbal
information was often misleading, so today annual reports can contain only
quantitative information--audited financial statements.

ANS: B PTS: 1 DIF: EASY NAT: Reflective thinking

3. 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
liabilities 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. If a company's statements were prepared in accordance with generally
accepted accounting principles (GAAP), the market value of the stock equals the
book value of the stock as reported on the balance sheet.
e. The assets section of a typical industrial company’s balance sheet begins with
cash, then lists the assets in the order in which they will probably be converted to
cash, with the longest lived assets listed last.

ANS: E PTS: 1 DIF: EASY NAT: Analytic skills

4. 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.

ANS: C PTS: 1 DIF: EASY NAT: Analytic skills

5. Which of the following items is NOT normally considered to be a current asset?
a. Accounts receivable.
b. Inventory.
c. Bonds.
d. Cash.
e. Short-term, highly-liquid, marketable securities.

ANS: C PTS: 1 DIF: EASY NAT: Analytic skills

6. 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.

ANS: D PTS: 1 DIF: EASY NAT: Analytic skills

7. 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 cash flow.
e. The income statement for a given year, say 2008, is designed to give us an idea of
how much the firm earned during that year.

ANS: E PTS: 1 DIF: EASY NAT: Analytic skills

8. Which of the following statements is most correct?

a. Corporations are allowed to exclude 70% of their interest income from corporate
taxes.
b. Corporations are allowed to exclude 70% of their dividend income from corporate
taxes.
c. Individuals pay taxes on only 30% of the income realized from municipal bonds.
d. Individuals are allowed to exclude 70% of their interest income from their taxes.
e. Individuals are allowed to exclude 70% of their dividend income from their taxes.

ANS: B PTS: 1 DIF: EASY | MEDIUM

9. A loss incurred by a corporation

a. Must be carried forward unless the company has had 2 loss years in a row.
b. Can be carried back 2 years, then carried forward up to 20 years following the
loss.
c. Can be carried back 5 years and forward 3 years.
 d. Cannot be used to reduce taxes in other years except with special permission
from the IRS.
e. Can be carried back 3 years or forward 10 years, whichever is more
advantageous to the firm.

ANS: B PTS: 1 DIF: EASY | MEDIUM

10. Below are the 2007 and 2008 year-end balance sheets for Tran Enterprises:The firm has never
paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-
term debt in 2007. As of the end of 2008, none of the principal on this debt had been repaid.
Assume that the company’s sales in 2007 and 2008 were the same. Which of the following
statements must be CORRECT?

Assets: 2008 2007

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

a. The firm increased its short-term bank debt in 2008.

b. The firm issued long-term debt in 2008.
c. The firm issued new common stock in 2008.
d. The firm repurchased some common stock in 2008.
e. The firm had negative net income in 2008.

ANS: C PTS: 1 DIF: MEDIUM NAT: Analytic skills

11. On its 12/31/08 balance sheet, Barnes Inc 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 2008, it must have paid dividends.
b. The company must have had zero net income in 2008.
c. The company must have paid out half of its 2008 earnings as dividends.
d. The company must have paid no dividends in 2008.
e. Dividends could have been paid in 2008, but they would have had to equal the
earnings for the year.
 ANS: E PTS: 1 DIF: MEDIUM NAT: Analytic skills

12. Below is the common equity section (in millions) of Timeless Technology’s last two year-end
balance sheets: The firm has never paid a dividend to its common stockholders. Which of the
following statements is CORRECT?

2008 2007
Common stock 2,000 1,000
Retained earnings 2,000 2,340
Total common equity $4,000 $3,340

a. The company’s net income in 2008 was higher than in 2007.

b. The firm issued common stock in 2008.
c. The market price of the firm's stock doubled in 2008.
d. The firm had positive net income in both 2007 and 2008, but its net income in 2008
was lower than it was in 2007.
e. The company has more equity than debt on its balance sheet.

ANS: B PTS: 1 DIF: MEDIUM NAT: Analytic skills

13. Which of the following statements is CORRECT?

a. Typically, a firm’s DPS should exceed its EPS.
b. Typically, a firm’s net income should exceed its EBIT.
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.

ANS: C PTS: 1 DIF: MEDIUM NAT: Analytic skills

14. 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 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 cash flow.
d. Operating income is derived from the firm's regular core business. Operating
income is calculated as Revenues less Operating costs. Operating costs do not
include interest or taxes.
e. Depreciation is not a cash charge, so it does not have an effect on a firm’s
reported profits.

ANS: D PTS: 1 DIF: MEDIUM NAT: Analytic skills

15. Which of the following factors could explain why Michigan Energy's cash balance increased
even though it had a negative cash flow last year?
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 depreciation expenses.
e. The company repurchased 20% of its common stock.

ANS: A PTS: 1 DIF: MEDIUM NAT: Analytic skills

16. Analysts who follow Howe Industries recently noted that, relative to the previous year, the
company’s net cash provided from operations 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 large investments in fixed assets.
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.

ANS: B PTS: 1 DIF: MEDIUM NAT: Analytic skills

17. Austin Financial recently announced that its net income increased sharply from the previous
year, yet its net cash provided from operations declined. Which of the following could explain
this performance?
a. The company’s dividend payment to common stockholders declined.
b. The company’s expenditures on fixed assets declined.
c. The company’s cost of goods sold increased.
d. The company’s depreciation expense declined.
e. The company’s interest expense increased.

ANS: D PTS: 1 DIF: MEDIUM NAT: Analytic skills

18. 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.

ANS: E PTS: 1 DIF: MEDIUM NAT: Reflective thinking

19. Which of the following statements is CORRECT?

 a. In the statement of cash flows, a decrease in accounts receivable is subtracted
from net income in the operating activities section.
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 subtracted from
net income in the operating activities section.
d. In the statement of cash flows, depreciation is subtracted from net income in the
operating activities section.
e. In the statement of cash flows, a decrease in inventories is subtracted from net
income in the operating activities section.

ANS: C PTS: 1 DIF: MEDIUM NAT: Analytic skills

20. Which of the following statements is CORRECT?

a. Most rapidly growing companies have positive free cash flows because cash flows
from existing operations generally exceed fixed asset purchases and changes to
net working capital.
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
- Capital expenditures required to sustain operations
- Required changes in net working capital.
d. Free cash flow (FCF) is defined as follows:
FCF = EBIT(1 - T) + Capital expenditures.
e. Managers should be less concerned with free cash flow than with accounting net
income. Accounting net income is the

ANS: C PTS: 1 DIF: MEDIUM NAT: Reflective thinking

21. 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 federal 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%.

ANS: B PTS: 1 DIF: MEDIUM NAT: Reflective thinking

22. 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, even though they report high
accounting profits.
b. All businesses, regardless of their legal form of organization, are taxed under the
Business Tax Provisions of the Internal Revenue Code.
c. Small corporations that qualify under the Tax Code can elect not to pay
corporate taxes, but then each stockholder must report his or her 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 corporation's income and stockholders were taxed again on this income
when it was paid to them as dividends.
e. All corporations other than non-profits are subject to corporate income taxes,
which are 15% for the lowest amounts of income and 38% for the highest amounts.

ANS: C PTS: 1 DIF: MEDIUM NAT: Reflective thinking

23. Which of the following statements is most correct?

a. Retained earnings, as reported on the balance sheet, represents the amount of
cash a company has available to pay out as dividends to shareholders.
b. 70% of the interest received by corporations is excluded from taxable income.
c. 70% of the dividends received by corporations is excluded from taxable income.
d. Because taxes on long-term capital gains are not paid until the gain is realized,
investors must pay the top individual tax rate on that gain.
e. The corporate tax system favors equity financing, as dividends paid are
deductible from corporate taxes.

ANS: C PTS: 1 DIF: MEDIUM NAT: Reflective thinking

24. Last year, Delip Industries had (1) negative 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 depreciation expenses.

ANS: C PTS: 1 DIF: MEDIUM NAT: Analytic skills

25. 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’ after-tax operating profits would decline.
b. Companies’ physical stocks of fixed assets would increase.
c. Companies’ cash flows would increase.
 d. Companies’ cash positions would decline.
e. Companies’ reported net incomes would decline.

ANS: D PTS: 1 DIF: MEDIUM NAT: Analytic skills

Multiple Choice with answers (BREAKEVEN ANALYSIS)

c 1. Which formula gives unit sales required to earn a target profit? (P = selling price, V =
variable cost per unit, F = total fixed costs, T = target profit)

a. F/(P - V)

b. (F + T)/P

c. (F + T)/(P - V)

d. (F + T)/V

c 2. Which formula gives the sales dollars required to earn a target profit? (P = selling price, V =
variable cost per unit, F = total fixed costs, T = target profit)

a. F/[(P - V)/P]

b. (F + T)/(P)

c. (F + T)/[(P - V)/P]

d. F + T/V

d 3. Over the relevant range, total revenues and total costs

a. increase, but at a decreasing rate.

b. decrease.

c. remain constant.

d. can be graphed as straight lines.

b 4. At the break-even point, total contribution margin is

a. zero.

b. equal to total fixed costs.

c. equal to total costs.

d. equal to total variable costs.

c 5. If a company is operating at a loss,

 a. fixed costs are greater than sales.

b. selling price is lower than variable cost per unit.

c. selling price is less than average total cost per unit.

d. fixed cost per unit is greater than variable cost per unit.

b 6. As volume increases, average cost per unit

a. increases.

b. decreases.

c. remains constant.

d. increases in proportion to the change in volume.

d 7. All else constant, if the selling price falls,

a. total variable costs will be lower than expected.

b. contribution margin percentage will be higher than expected.

c. total contribution margin will be higher than expected.

d. per-unit contribution margin will be lower than expected.

c 8. If all goes according to plan except that unit variable cost falls,

a. total contribution margin will be lower than expected.

b. the contribution margin percentage will be lower than expected.

c. profit will be higher than expected.

d. per-unit contribution margin will be lower than expected.

a 9. If all goes according to plan except that total fixed costs rise,

a. income will be lower than expected.

b. total contribution margin will be lower than expected.

c. total sales will be lower than expected.

d. income will be higher than expected.

a 10. Which of the following decreases per-unit contribution margin the most for a company
currently earning a profit?

a. A 10% decrease in selling price.

b. A 10% increase in variable cost per unit.

c. A 10% increase in fixed costs.

d. A 10% increase in fixed cost per unit.

c 11. If variable cost as a percentage of sales increases, the

a. contribution margin percentage increases.

b. selling price increases.

c. break-even point in dollars increases.

d. fixed costs decrease.

b 12. Which cost is most likely to be variable for a retailer?

a. Advertising.

b. Cost of goods sold.

c. Sales salaries.

d. Rent.
a 13. A cost-volume-profit graph reflects relationships

a. expected to hold over the relevant range.

b. of results over the past few years.

c. that the company's managers would like to have happen.

d. likely to prevail for the industry.

d 14. A multiproduct company

a. cannot use CVP analysis.

b. must use a separate CVP graph for each of its products.

c. can use CVP analysis only if the contribution margin percentages on each product are the
same.

d. could earn a higher-than-expected profit even though the total number of units sold was
less than expected.

a 15. If selling price, per-unit variable cost, and total fixed costs are constant,

a. the break-even point in units remains constant.

b. profit per unit remains constant for all levels of volume within the relevant range.

c. total variable costs equal total fixed costs.

d. total contribution margin equals total fixed costs.

MULTIPLE CHOICE with ANSWERS (RATIO ANALYSIS)

1. Ryngard Corp's sales last year were $27,000, and its total assets were $16,000. What was its total
assets turnover ratio (TATO)?
a. 1.57
b. 1.64
c. 1.49
d. 1.94
e. 1.69

ANS: E
Sales $27,000
Total assets $16,000
TATO = Sales/Total assets = 1.69

2. Beranek Corp has $665,000 of assets, and it uses no debt--it is financed only with common
equity. The new CFO wants to employ enough debt to raise the debt/assets ratio to 40%, using
the proceeds from borrowing to buy back common stock at its book value. How much must the
firm borrow to achieve the target debt ratio?
a. $303,240
b. $266,000
c. $324,520
d. $250,040
e. $252,700

ANS: B
Total assets $665,000
Target debt ratio 40%
Debt to achieve target ratio = Amount borrowed = Target% Assets = $266,000

3. Ajax Corp's sales last year were $460,000, its operating costs were $362,500, and its interest
charges were $12,500. What was the firm's times-interest-earned (TIE) ratio?
a. 7.80
b. 7.18
c. 8.19
d. 7.72
e. 9.75

ANS: A
Sales $460,000
Operating costs $362,500
Operating income $97,500
(EBIT)
Interest charges $12,500
 TIE ratio = EBIT/Interest = 7.80

4. Royce Corp's sales last year were $260,000, and its net income was $23,000. What was its profit
margin?
a. 7.61%
b. 7.25%
c. 8.85%
d. 8.58%
e. 10.97%

ANS: C
Sales $260,000
Net income $23,000
Profit margin = NI/Sales = 8.85%

5. River Corp's total assets at the end of last year were $380,000 and its net income was $32,750.
What was its return on total assets?
a. 6.98%
b. 7.15%
c. 8.62%
d. 10.77%
e. 10.43%

ANS: C
Total assets $380,000
Net income $32,750
ROA = NI/Assets = 8.62%

6. X-1 Corp's total assets at the end of last year were $380,000 and its EBIT was 52,500. What was its
basic earning power (BEP) ratio?
a. 11.88%
b. 11.19%
c. 16.44%
d. 16.16%
e. 13.82%

ANS: E
Total assets $380,000
EBIT $52,500
BEP = EBIT / Assets = 13.82%

7. Zero Corp's total common equity at the end of last year was $430,000 and its net income was
$70,000. What was its ROE?
a. 14.98%
 b. 16.28%
c. 12.70%
d. 15.79%
e. 12.21%

ANS: B
Common equity $430,000
Net income $70,000
ROE = NI/Equity = 16.28%

8. Your sister is thinking about starting a new business. The company would require $380,000 of
assets, and it would be financed entirely with common stock. She 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. $58,482
b. $45,144
c. $52,326
d. $51,300
e. $39,501

ANS: D
Assets = Equity $380,000
Target ROE 13.5%
Required net income = Target ROE Equity = $51,300

9. Song Corp's stock price at the end of last year was $27.75 and its earnings per share for the year
were $1.30. What was its P/E ratio?
a. 20.28
b. 26.47
c. 20.07
d. 21.35
e. 24.12

ANS: D
Stock price $27.75
EPS $1.30
P/E = Stock price / EPS 21.35

10. Hoagland Corp's stock price at the end of last year was $22.50, and its book value per share was
$25.00. What was its market/book ratio?
a. 0.85
b. 0.90
c. 0.86
 d. 0.97
e. 1.00

ANS: B
Stock price $22.50
Book value per share $25.00
M/B ratio = Stock price / Book value per share = 0.90

11. Precision Aviation had a profit margin of 4.75%, a total assets turnover of 1.5, and an equity
multiplier of 1.8. What was the firm's ROE?
a. 14.88%
b. 13.59%
c. 15.52%
d. 13.47%
e. 12.83%

ANS: E
Profit margin 4.75%
TATO 1.50
Equity multiplier 1.80
ROE = PM TATO Eq. Multiplier = 12.83%

12. Meyer Inc's assets are $745,000, and its total debt outstanding is $185,000. The new CFO wants
to establish a debt ratio of 55%. The size of the firm does not change. How much debt must the
company add or subtract to achieve the target debt ratio?
a. $168,563
b. $224,750
c. $191,038
d. $211,265
e. $271,948

ANS: B
Total assets $745,000
Old debt $185,000
Target debt ratio 55%
Target amount of debt = Target debt% Total assets = $409,750
Change in amount of debt outstanding = Target debt - Old debt = $224,750

13. Helmuth Inc's latest net income was $1,210,000, 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. $2.49
b. $2.06
c. $2.11
d. $2.69
e. $2.42
 ANS: E
Net income $1,210,000
Shares outstanding 225,000
Payout ratio 45%
EPS = NI / shares outstanding = $5.38
DPS = EPS Payout% = $2.42

14. Garcia Industries has sales of $167,500 and accounts receivable of $18,500, and it gives its
customers 25 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. $508.32
b. $405.68
c. $488.77
d. $386.13
e. $518.09

ANS: C
Rate of return on cash generated 8.0%
Sales $167,500
A/R $18,500
Days in Year 365
Sales/day = Sales / 365 = $458.90
Company DSO = Receivables / Sales per day = 40.3
Industry DSO 27.0
Difference = Company DSO - Industry DSO = 13.3
Cash flow from reducing the DSO = Difference Sales/day = $6,109.59
Additional Net Income = Return on cash Added cash flow = $488.77
Alternative Calculation:
A/R at industry DSO $12,390.41
Change in A/R $6,109.59
Additional Net Income $488.77

15. Faldo Corp sells on terms that allow customers 45 days to pay for merchandise. Its sales last year
were $435,000, 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. 5.18
b. 4.86
c. 5.29
d. 5.34
e. 5.40
 ANS: D
Credit period 45
Sales $435,000
Sales/day = Sales / 365 = $1,191.78
Receivables $60,000
Company DSO = Receivables / Sales per day = 50.34
Company DSO - Credit Period = Days early (-) or late (+) = 5.34

16. Han Corp's sales last year were $395,000, and its year-end receivables were $52,500. The firm
sells on terms that call for customers to pay 30 days after the purchase, but some 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. 15.92
b. 15.18
c. 13.88
d. 18.51
e. 14.07

ANS: D
Sales $395,000
Sales/day = Sales / 365 = $1,082.19
Receivables $52,500
Company DSO = Receivables / Sales per day = 48.51
Credit period 30
DSO - Credit period = Days late 18.51

17. Wie Corp's sales last year were $365,000, 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. The firm'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. $202,917
b. $221,179
c. $213,063
d. $160,304
e. $184,654

ANS: A
Sales $365,000
Actual total assets $355,000
Target TATO = Sales / Total assets = 2.40
Target assets = Sales / Target TATO = $152,083
Asset reduction = Actual assets - Target assets = $202,917
18. A new firm is developing its business plan. It will require $635,000 of assets, and it projects
$450,000 of sales and $355,000 of operating costs for the first year. Management is reasonably
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. 50.87%
b. 59.34%
c. 49.87%
d. 62.34%
e. 42.89%

ANS: C
Assets $635,000
Sales $450,000
Operating costs $355,000
Operating income $95,000
(EBIT)
Target TIE 4.00
Maximum interest expense = EBIT / Target TIE $23,750
Interest rate 7.50%
Max. debt = Max interest expense/Interest rate $316,667
Maximum debt ratio = Debt/Assets 49.87%

19. Chang Corp. has $375,000 of assets, and it uses only common equity capital (zero debt). Its
sales for the last year were $520,000, and its net income was $25,000. Stockholders recently
voted in a new management team that has promised to lower costs and get the return on
equity up to 15.0%. What profit margin would the firm need in order to achieve the 15% ROE,
holding everything else constant?
a. 10.71%
b. 9.41%
c. 10.82%
d. 8.11%
e. 12.66%

ANS: C
Total assets = Equity because zero $375,000
debt
Sales $520,000
Net income $25,000
Target ROE 15.00%
Net income req'd to achieve target ROE = Target ROE Equity = $56,250
Profit margin needed to achieve target ROE = NI / Sales = 10.82%
20. Last year Ann Arbor Corp had $300,000 of assets, $305,000 of sales, $20,000 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. 5.34%
b. 5.82%
c. 6.59%
d. 8.67%
e. 6.93%

ANS: E
Assets $300,000
Debt ratio 37.5%
Debt = Assets Debt% = $112,500
Equity = Assets - Debt = $187,500
Sales $305,000
Old net income $20,000
New net income $33,000
New ROE = New NI / Equity = 17.600%
Old ROE = Old NI / Equity = 10.667%
Increase in ROE = New ROE - Old ROE = 6.93%

21. Brookman Inc's latest EPS was $2.75, its book value per share was $22.75, it had 280,000 shares
outstanding, and its debt ratio was 44%. How much debt was outstanding?
a. $4,704,700
b. $5,355,350
c. $5,205,200
d. $4,054,050
e. $5,005,000

ANS: E
EPS $2.75
BVPS $22.75
Shares outstanding 280,000
Debt ratio 44.0%
Total equity = Shares outstanding BVPS = $6,370,000
Total assets = Total equity / (1 - Debt ratio) = $11,375,000
Total debt = Total assets - Equity = $5,005,000

22. Last year Harrington Inc. had sales of $325,000 and a net income of $19,000, and its year-end
assets were $250,000. The firm's total-debt-to-total-assets ratio was 67.5%. Based on the DuPont
equation, what was the ROE?
a. 21.98%
b. 18.94%
c. 23.38%
d. 22.68%
e. 22.22%
 ANS: C
Sales $325,000
Assets $250,000
Net income $19,000
Debt ratio 67.5%
Debt = Debt% Assets = $168,750
Equity = Assets - Debt = $81,250
Profit margin = NI / Sales = 5.85%
TATO 1.30
Equity multiplier = Assets / Equity = 3.08
ROE 23.38%

23. Last year Rennie Industries had sales of $240,000, assets of $175,000, a profit margin of 5.3%, and
an equity multiplier of 1.2. The CFO believes that the company could reduce its assets by
$51,000 without affecting either sales or costs. Had it reduced its assets by this amount, and had
the debt ratio, sales, and costs remained constant, how much would the ROE have changed?
a. 3.55%
b. 3.19%
c. 3.66%
d. 3.01%
e. 3.59%

ANS: E
Old New
Sales $240,000 $240,000
Original assets $175,000
Reduction in assets $51,000
New assets = Old assets - Reduction = $124,000
TATO = Sales / Assets = 1.37 1.94
Profit margin 5.30% 5.30%
Equity multiplier 1.20 1.20
ROE = PM TATO Eq Multiplier = 8.72% 12.31%
Change in ROE 3.59%

24. Last year Blease Inc had a total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales
were $320,000 and its net income was $10,600. The CFO believes that the company could have
operated more efficiently, lowered its costs, and increased its net income by $10,250 without
changing its sales, assets, or capital structure. Had it cut costs and increased its net income by
this amount, how much would the ROE have changed?
a. 5.82%
b. 9.10%
c. 7.31%
d. 8.87%
e. 7.46%

ANS: E
 Old New
Sales $320,000 $320,000
Original net income $10,600 $10,600
Increase in net $0 $10,250
income
New net income $10,600 $20,850
Profit margin = NI / Sales = 3.31% 6.52%
TATO 1.33 1.33
Equity multiplier 1.75 1.75
ROE = PM TATO Eq Multiplier = 7.71% 15.17%
Change in ROE 7.46%

25. Last year Jandik Corp. had $325,000 of assets, $18,750 of net income, and a debt-to-total-assets
ratio of 37%. 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. 2.19%
b. 1.67%
c. 1.57%
d. 1.94%
e. 2.17%

ANS: D
Assets $325,000
Old debt ratio 37%
Old debt = Assets Old debt% = $120,250
Old equity $204,750
New debt ratio 48%
New debt = Assets New debt% = $156,000
New Equity = Assets - New debt = $169,000
Net income $18,750
New ROE = New income / New Equity 11.09%
Old ROE = Old income / Old Equity 9.16%
Increase in ROE 1.94%