Chapter 04: Analysis of Financial Statements
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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?
a. The transactions would improve 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 transactions would have no effect on the firms’ financial strength as measured by their current ratios.
d. The transactions would lower both firms’ financial strength as measured by their current ratios.
e. The transactions would improve both firms’ financial strength as measured by their current ratios.
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82. 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. Both firms finance using only debt and common equity, and total assets equal total invested capital.
However, company HD has a higher total debt to total capital ratio. Which of the following statements is CORRECT?
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.
83. Which of the following statements is CORRECT?
a. 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.
b. 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.
c. 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.
d. 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.
e. Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, no debt and therefore an
equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow funds using long-term debt, use
the funds to buy back stock, and raise the equity multiplier to 2.0. The size of the firm (assets) would not change. 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 not be a good move, as it would decrease the ROE from 7.5% to 6.5%.
Chapter 04: Analysis of Financial Statements
Chapter 04: Analysis of Financial Statements
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85. Beranek Corp has $625,000 of assets (which equal total invested capital), and it uses no debt—it is financed only with
common equity. The new CFO wants to employ enough debt to raise the total debt to total capital 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. $195,000
b. $250,000
c. $202,500
d. $262,500
e. $212,500
86. Ajax Corp’s sales last year were $510,000, its operating costs were $362,500, and its interest charges were $12,500.
What was the firm’s times-interest-earned (TIE) ratio?
a. 11.80
b. 9.32
c. 10.50
d. 14.75
e. 9.56
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c. 10.23%
d. 7.68%
e. 9.72%
89. X-1 Corp’s total assets at the end of last year were $365,000 and its EBIT was $52,500. What was its basic earning
power (BEP) ratio?
a. 14.10%
b. 14.67%
c. 17.40%
d. 13.23%
e. 14.38%
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90. Zero Corp’s total common equity at the end of last year was $510,000 and its net income was $70,000. What was its
ROE?
a. 16.33%
b. 13.73%
c. 16.06%
d. 11.39%
e. 16.61%
91. Your sister is thinking about starting a new business. The company would require $355,000 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. $44,091
b. $53,676
c. $45,529
d. $47,925
e. $51,759
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92. Herring Corporation has operating income of $275,000 and a 25% tax rate. The firm has short-term debt of $143,000,
long-term debt of $323,000, and common equity of $466,000. What is its return on invested capital?
a. 20.88%
b. 21.46%
c. 22.13%
d. 23.38%
e. 24.23%
93. Song Corp’s stock price at the end of last year was $28.50 and its earnings per share for the year were $1.30. What was
its P/E ratio?
a. 22.58
b. 18.85
c. 21.48
d. 21.92
e. 20.39
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96. Meyer Inc’s total invested capital is $670,000, and its total debt outstanding is $185,000. The new CFO wants to
establish a total debt to total capital ratio of 55%. The size of the firm will not change. How much debt must the company
add or subtract to achieve the target debt to capital ratio?
a. $194,510
b. $183,500
c. $170,655
d. $187,170
e. $227,540
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107. 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-capital ratio was 47.5%. The firm finances using only debt and common equity, and its total
assets equal total invested capital. Based on the DuPont equation, what was the ROE? Do not round your intermediate
calculations.
a. 17.08%
b. 11.29%
c. 14.48%
d. 14.91%
e. 13.03%
108. Last year Rennie Industries had sales of $280,000, assets of $175,000 (which equals total invested capital), 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. The firm finances using only debt and common equity. Had it reduced its assets by
this amount, and had the debt/total invested capital ratio, sales, and costs remained constant, how much would the ROE
have changed? Do not round your intermediate calculations.
a. 4.23%
b. 3.26%