PRACTICE EXERCISES
1. Below is the common equity section (in millions) of Timeless Technology’s
last two year–end balance sheets:
2011 2010
Common stock $2,000 $1,000
Retained earnings 2,000 2,340
Total common equity $4,000 $3,340
The firm has never paid a dividend to its common stockholders. Which
of the following statements is CORRECT?
a. The company’s net income in 2011 was higher than in 2010.
b. The firm issued common stock in 2011.
c. The market price of the firm’s stock doubled in 2011.
d. The firm had positive net income in both 2010 and 2011, but its net
income in 2011 was lower than it was in 2010.
e. The company has more equity than debt on its balance sheet.
i
2. 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.
3. 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.
a. True
b. False
4. 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.
a. True
b. False
5. 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.
a. True
b. False
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6. 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
7. 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
8. 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
