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Principles of Finance, 6e
Besley/Brigham
Chapter 07
Cengage Learning Testing, Powered by Cognero
Page 1
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1. Other things held constant, which of the following will not affect the quick ratio? (Assume that current assets equal
current liabilities.)
a.
Fixed assets are sold for cash.
b.
Cash is used to purchase inventories.
c.
Cash is used to pay off accounts payable.
d.
Accounts receivable are collected.
e.
Long-term debt is issued to pay off a short-term bank loan.
ANSWER:
d
RATIONALE:
The quick ratio is calculated as follows: The only action that
doesn't affect the quick ratio is statement d. While this action decreases receivables (a
current asset), it increases cash (also a current asset). The net effect is no change in the
quick ratio.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-3 - Comprehension
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Quick Ratio
2. Changes in balance sheet accounts are necessary for
a.
A typical ratio analysis.
b.
Pro forma balance sheet construction.
c.
Statement of cash flows construction.
d.
Profit and loss analysis.
e.
Pro forma income statement construction.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Statement of Cash Flows
3. Which of the following would be classified as a use of cash?
a.
An increase in accounts payable.
b.
A decrease in marketable securities.
c.
A decrease in accounts receivable.
d.
An increase in retained earnings.
e.
An increase in inventories.
ANSWER:
e
Principles of Finance, 6e
Besley/Brigham
Chapter 07
Cengage Learning Testing, Powered by Cognero
Page 3
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
c.
Accounts receivable are collected.
d.
Cash is used to pay off accounts payable.
e.
A bank loan is obtained, and the proceeds are credited to the firm's checking account.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-3 - Comprehension
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Current Ratio
7. Which of the following statements is correct?
a.
In a reverse split, a company reduces the number of shares outstanding in order to stabilize and provide a floor
for a rapidly declining stock price.
b.
In theory, dividends are determined as a residual item. Therefore, in order to conserve earnings for better
future earnings opportunities, the poorer the firm's investment opportunities, the lower its dividend payments
should be.
c.
The farther to the right the IOS is the higher a firm's dividend payout ratio, other things held constant.
d.
Even if a stock split has no information content, and even if the dividend per share adjusted for the split does
not increase, there can still be a real benefit (i.e., a higher value for shareholders) from such a split, but any
such benefit is probably small.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Miscellaneous
8. A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts?
a.
Cash.
b.
Common stock.
c.
Paid-in capital.
d.
Retained earnings.
e.
None of the above.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
Principles of Finance, 6e
Besley/Brigham
Chapter 07
Cengage Learning Testing, Powered by Cognero
Page 5
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ACCREDITING STANDARDS:
Blooms Taxonomy-3 - Comprehension
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Stock Dividends
12. Which of the following statements is most correct?
a.
An increase in a firm's debt ratio, with no changes in its sales and operating costs, could be expected to lower
its profit margin on sales.
b.
An increase in the DSO, other things held constant, would generally lead to an increase in the total asset
turnover ratio.
c.
An increase in the DSO, other things held constant, would generally lead to an increase in the ROE.
d.
In a competitive economy, where all firms earn similar returns on equity, one would expect to find lower profit
margins for airlines, which require a lot of fixed assets relative to sales, than for fresh fish markets.
e.
It is more important to adjust the Debt/Assets ratio than the inventory turnover ratio to account for seasonal
fluctuations.
ANSWER:
a
RATIONALE:
Statement a is true because, if a firm takes on more debt, its interest expense will rise,
and this will lower its profit margin. Of course, there will be less equity than there would
have been, hence the ROE might rise even though the profit margin fell.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-3 - Comprehension
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Financial Statement Analysis
13. Which of the following statements is most correct? If a company lowers its DSO, but no changes occur in sales or
operating costs, then
a.
the company might well end up with a higher debt ratio.
b.
the company might well end up with a lower debt ratio.
c.
the company would probably end up with a higher ROE.
d.
the company's total asset turnover ratio would probably decline.
e.
none of the above is a correct statement.
ANSWER:
b
RATIONALE:
Accounts receivable would decline. Cash would initially increase, but it would soon be
redeployed. The cash generated could be used for a number of things, including paying
off debt, repurchasing stock, or increasing assets. Of the choices available in the answer,
only paying off debt, which would lower the debt ratio, is available.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-3 - Comprehension
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Principles of Finance, 6e
Besley/Brigham
Chapter 07
Cengage Learning Testing, Powered by Cognero
Page 7
b.
The debt ratio measures that portion of fixed assets which is supported by common equity.
c.
High inflation can seriously distort firms' balance sheets, and since inflation also affects depreciation and
inventory costs, profits can also be affected.
d.
Financial statement analysis is important from the investor's viewpoint in assessing past performance and
predicting future performance. However, from a management perspective, financial statement analysis
measures history and is merely a reporting requirement. It is not useful for planning future actions because it
does not help determine future cash flows.
e.
When an action is taken at one point in time, but its full effects cannot be accurately measured until later, this
has the potential to affect the firm's financial statements. However, as long as the firm keeps the same standard
accounting period this timing problem can be avoided.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Financial Statements
17. A firm's current ratio has steadily increased over the past 5 years, from 1.9 five years ago to 3.8 today. What would a
financial analyst be most justified in concluding?
a.
The firm's fixed assets turnover probably has improved.
b.
The firm's liquidity position probably has improved.
c.
The firm's stock price probably has increased.
d.
Each of the above is likely to have occurred.
e.
The analyst would be unable to draw any conclusions from this information.
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Liquidity Ratios
18. Recently the M&M Company has been having problems. As a result, its financial situation has deteriorated. M&M
approached the First National Bank for a badly needed loan, but the loan officer insisted that the current ratio (now 0.5) be
improved to at least 0.8 before the bank would even consider granting the credit. Which of the following actions would do
the most to improve the ratio in the short run?
a.
Using some cash to pay off some current liabilities.
b.
Collecting some of the current accounts receivable.
c.
Paying off some long-term debt.
d.
Selling some of the existing inventory at cost.
e.
Purchasing additional inventory on credit (accounts payable).
Principles of Finance, 6e
Besley/Brigham
Chapter 07
Cengage Learning Testing, Powered by Cognero
Page 8
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Current Ratio
19. Which of the following actions will cause an increase in the quick ratio in the short run?
a.
$1,000 worth of inventory is sold, and an account receivable is created. The receivable exceeds the inventory
by the amount of profit on the sale, which is added to retained earnings.
b.
A small subsidiary which was acquired for $100,000 two years ago and which was generating profits at the
rate of 10 percent is sold for $100,000 cash. (Average company profits are 15 percent of assets.)
c.
Marketable securities are sold at cost.
d.
All of the above.
e.
Answers a and b above.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Quick Ratio
20. Which of the following statements is correct?
a.
In the text, depreciation is regarded as a use of cash because it reduces fixed assets, which then must be
replaced.
b.
If a company uses some of its cash to pay off short-term debt, then its current ratio will always decline, given
the way the ratio is calculated, other things held constant.
c.
During a recession, it is reasonable to think that most companies' inventory turnover ratios will change while
their fixed asset turnover ratios will remain fairly constant.
d.
During a recession, we can be confident that most companies' DSOs (or ACPs) will decline because their sales
will probably decline.
e.
Each of the above statements is false.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Miscellaneous
Principles of Finance, 6e
Besley/Brigham
Chapter 07
end balance sheet?
a.
$20.75
b.
$15.00
c.
$15.96
d.
$19.95
e.
$18.75
ANSWER:
d
RATIONALE:
Construct a summary of the common stockholders' equity accounts: (In millions)
This Year
Last Year
Common stock (10 million authorized,
8 million outstanding, $1.00 par value)
$ 8.0
$ 8.0
Additional paid-in capital
18.0
18.0
Retained earnings
133.6
124.0
Total common stockholders' equity
$159.6
$150.0
Addition to RE = $16,000,000 − 0.40($16,000,000) = $9,600,000. Calculate the book
value per share: Book value per share = $159.6/8 million shares = $19.95.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-b - 10 min.
TOPICS:
Book Value Per Share
24. Borg Security Systems is considering the sale of 12,000 shares of stock to finance development of a new security
product. The firm has 40,000 shares of common stock outstanding, par value of $1.00 per share. The firm has $60,000 in
additional paid-in capital and $80,000 in retained earnings. Borg's investment bankers estimate that new shares will bring
in $5.15 per share. If Borg goes ahead with the new stock issue, what will be the change in book value per share?
a.
−$1.00
b.
+$0.15
c.
+$0.56
d.
+$1.00
e.
$0
ANSWER:
b
RATIONALE:
Construct a summary of common equity accounts: Before sale of stock:
Common stock (40,000 shares outstanding, $1.00 par)
$ 40,000
Additional paid-in capital
60,000
Retained earnings
80,000
Total stockholders' equity
$180,000
Book value per share = $180,000/40,000 shares = $4.50. After sale of additional 12,000
Principles of Finance, 6e
Besley/Brigham
Chapter 07
Cengage Learning Testing, Powered by Cognero
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© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
e.
$1.50
ANSWER:
b
RATIONALE:
EPS
= $15,000/10,000 = $1.50.
P/E
= 5.0 = P/$1.50.
P
= $7.50.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Market Price Per Share
29. You are given the following information: Stockholders' equity = $1,250; price/earnings ratio = 5; shares outstanding =
25; 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
ANSWER:
b
RATIONALE:
Total market value = $1,250(1.5) = $1,875. Market value per share = $1,875/25 = $75.
Alternative solution: Book value per share = $1,250/25 = $50. Market value per share =
$50(1.5) = $75.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-a - 5 min.
TOPICS:
Market Price Per Share
30. If Boyd Corporation has sales of $2 million per year (all credit) and days sales outstanding of 35 days, what is its
average amount of accounts receivable outstanding (assume a 360 day year)?
a.
$194,444
b.
$57,143
c.
$5,556
d.
$97,222
e.
$285,714
ANSWER:
a
RATIONALE:
A/R = (Sales/360)(DSO) = (($2,000,000)/(360))(35) = $194,444.
POINTS:
1
DIFFICULTY:
Easy
Principles of Finance, 6e
Besley/Brigham
Chapter 07
33. Velcraft Company has 20,000,000 shares of common stock authorized, but to date, has only 12,000,000 shares
outstanding, each with a $1.00 par value. The company has $24,000,000 in additional paid-in capital and retained earnings
are $96,000,000. What is Velcraft's current book value per share?
a.
$1.00
b.
$3.00
c.
$11.00
d.
$6.60
e.
$9.00
ANSWER:
c
RATIONALE:
Construct a summary of the common stockholders' equity accounts:
Account balance
Common stock (20 million authorized, 12 million
outstanding, $1.00 par value)
$ 12,000,000
Additional paid-in capital
24,000,000
Retained earnings
96,000,000
Total common stockholders' equity
$132,000,000
Calculate the book value per share: Book value per share = $132,000,000/12,000,000 =
$11.00.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-b - 10 min.
TOPICS:
Book Value Per Share
34. Ducheyne Electric recently declared a 15 percent stock dividend. On the date of the stock dividend Ducheyne had 16
million shares outstanding priced at $46 per share in the market. An accounting entry was required on the balance sheet
transferring some retained earnings to the common stock account. If retained earnings were $280 million prior to the
transaction, what was the dollar amount of retained earnings after the transfer?
a.
$280.0 million
b.
$110.4 million
c.
$234.0 million
d.
$277.6 million
e.
$169.6 million
ANSWER:
e
RATIONALE:
Amount of transfer: 16,000,000 shares × 0.15 × $46.00 = $110,400,000.
Before stock dividend: RE
=
$280.0 million
Less: transfer
(110.4 million)
RE after transfer
$169.6 million
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
Chapter 07
Taxes (40%)
160
Net Income
$ 240
The industry average DSO is 30 (360-day basis). Collins plans to change its credit policy so as to cause its DSO to equal
the industry average, and this change 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 which has a 10%
interest rate), what will Collins' debt ratio (Total debt/Total assets) be after the change in DSO is reflected in the balance
sheet?
a.
33.33%
b.
45.28%
c.
52.75%
d.
60.00%
e.
65.71%
ANSWER:
e
RATIONALE:
Industry average DSO = 30 days. Reduce
receivables by Debt = $400/0.10 = $4,000.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-b - 10 min.
TOPICS:
Financial Statement Analysis
37. 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 asset turnover: 3.0
What is Lone Star's EBIT?
a.
$3,200
b.
$12,000
c.
$18,000
d.
$30,000
e.
$33,200
ANSWER:
e
RATIONALE:
Write down equations with given data, then find unknowns:
Principles of Finance, 6e
Besley/Brigham
Chapter 07
Cengage Learning Testing, Powered by Cognero
Page 19
Time Estimate-b - 10 min.
TOPICS:
TIE Ratio
39. A firm has total interest charges of $10,000 per year, sales of $1 million, a tax rate of 40 percent, and a net profit
margin of 6 percent. What is the firm's times-interest-earned ratio?
a.
16 times
b.
10 times
c.
7 times
d.
11 times
e.
20 times
ANSWER:
d
RATIONALE:
NI
= $1,000,000(0.06) = $60,000.
EBT
= $60,000/0.6 = $100,000.
EBIT
= $100,000 + $10,000 = $110,000.
TIE
= EBIT/I = $110,000/$10,000 = 11 times.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
Time Estimate-b - 10 min.
TOPICS:
TIE Ratio
40. Nolan Inc. has cost of goods sold of $1,000,000 and an inventory turnover of 10.0. The firm's current ratio is 3.0,
while its quick ratio is 2.5. What are Nolan's current assets?
a.
$200,000
b.
$300,000
c.
$400,000
d.
$500,000
e.
$600,000
ANSWER:
e
RATIONALE:
Inventory
= (CGS/Inventory turnover ratio)
= $1,000,000/10.0 = $100,000.
Quick ratio
= (CA − Inventory)/CL
2.5
= (CA − $100,000)/CL
CA/CL
= 3.0; therefore, CL = CA/3.0
2.5
= (CA − $100,000)/(CA/3.0).
Therefore, CA = $600,000.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-07 - Finance Function
