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Chapter 2 – Analysis of Financial Statements
62. Bubbles Soap Corporation has a quick ratio of 1.0 and a current ratio of 2.0 implying that
a. the value of current assets is equal to the value of inventory.
b. the value of current assets is equal to the value of current liabilities.
c. the value of current liabilities is equal to the value of inventory.
d. All of the above.
e. None of the above.
63. Which of the following statements is most correct?
a. firms with relatively low debt ratios have higher expected returns when the business is good.
b. firms with relatively low debt ratios are exposed to risk of loss when the business is poor.
c. firms with relatively high debt ratios have higher expected returns when the business is bad.
d. firms with relatively high debt ratios have higher expected returns when the business is good.
e. none of the above.
64. All other things constant, an increase in a firm’s profit margin would
a. increase the additional funds needed for financing a growth in operations.
b. decrease the additional funds needed for financing a growth in operations.
c. have no effect on the additional funds needed for financing a growth in operations.
d. decrease its taxes.
e. none of the above.
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Chapter 2 – Analysis of Financial Statements
65. Which of the following statements is correct?
a. If Company A has a higher debt ratio that Company B, then we can be sure that A will have a lower times-
interest-earned ratio than B.
b. Suppose two companies have identical operations in terms of sales, cost of goods sold, interest rate on debt,
and assets. However, Company A used more debt than Company B; that is, Company A has a higher debt
ratio. Under these conditions, we would expect B’s profit margin to be higher than A’s.
c. The ROE of any company which is earning positive profits and which has a positive net worth (or common
equity) must exceed the company’s ROA.
d. Statements a, b, and c are all true.
e. Statements a, b, and c are all false.
66. Pepsi Corporation’s current ratio is 0.5, while Coke Company’s current ratio is 1.5. Both firms want to “window
dress” their coming end–of-year financial statements. As part of their window dressing strategy, each firm will
double its current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of
the statements below best describes the actual results of these transactions?
a. The transactions will have no effect on the current ratios.
b. The current ratios of both firms will be increased.
c. The current ratios of both firms will be decreased.
d. Only Pepsi Corporation’s current ratio will be increased.
e. Only Coke Company‘s current ratio will be increased.
CFIN4
Chapter 2 – Analysis of Financial Statements
67. The Charleston Company is a relatively small, privately owned firm. Last year the company had after-tax income of
$15,000 and 10,000 shares were outstanding. The owners were trying to determine the market value for the stock,
prior to taking the company public. A similar firm which is publicly traded had a price/earnings ratio of 5.0. Using
only the information given, estimate the market value of one share of Charleston‘s stock.
a. $10.00
b. $7.50
c. $5.00
d. $2.50
e. $1.50
68. 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
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Chapter 2 – Analysis of Financial Statements
69. A firm has a profit margin of 15 percent on sales of $20,000,000. If the firm has debt of $7,500,000, total assets of
$22,500,000, and an after-tax interest cost on total debt of 5 percent, what is the firm’s ROA?
a. 8.4%
b. 10.9%
c. 12.0%
d. 13.3%
e. 15.1%
CFIN4
Chapter 2 – Analysis of Financial Statements
70. Collins Company had the following partial balance sheet and complete income statement information for last year:
Balance Sheet:
Cash
$ 20
A/R
1,000
Inventories
2,000
Total current assets
$ 3,020
Net fixed assets
2,980
Total assets
$ 6,000
Income
Statem
$10,000
Cost of goods sold
9,200
EBIT
$ 800
Interest (10%)
400
EBT
$ 400
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%
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Chapter 2 – Analysis of Financial Statements
71. 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
72. Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10 percent annually on its bank
loan. Alumbat’s annual sales are $3,200,000; its average tax rate is 40 percent; and its net profit margin on sales is 6
percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and
bankruptcy will result. What is Alumbat’s current TIE ratio?
a. 2.4
b. 3.4
c. 3.6
d. 4.0
e. 5.0
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Chapter 2 – Analysis of Financial Statements
73. Determine the increase or decrease in cash for Rinky Supply Company for last year, given the following information.
(Assume no other changes occurred during the past year.)
Decrease in marketable securities
=
$25
Increase in accounts receivables
=
$50
Increase in notes payable
=
$30
Decrease in accounts payable
=
$20
Increase in accrued wages and taxes
=
$15
Increase in inventories
=
$35
Retained earnings
a. −$50
=
$ 5
b. +$40
c. −$30
d. +$20
e. −$10
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Chapter 2 – Analysis of Financial Statements
74. Cannon Company has enjoyed a rapid increase in sales in recent years, following a decision to sell on credit.
However, the firm has noticed a recent increase in its collection period. Last year, total sales were $1 million, and
$250,000 of these sales were on credit. During the year, the accounts receivable account averaged $41,664. It is
expected that sales will increase in the forthcoming year by 50 percent, and, while credit sales should continue to be
the same proportion of total sales, it is expected that the days sales outstanding will also increase by 50 percent. If
the resulting increase in accounts receivable must be financed by external funds, how much external funding will
Cannon need?
a. $41,664
b. $52,086
c. $47,359
d. $106,471
e. $93,750
75. The Meryl Corporation’s common stock currently is selling at $100 per share, which represents a P/E ratio of 10. If
the firm has 100 shares of common stock outstanding, a return on equity of 20 percent, and a debt ratio of 60
percent, what is its return on total assets (ROA)?
a. 8.0%
b. 10.0%
c. 12.0%
d. 16.7%
e. 20.0%
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Chapter 2 – Analysis of Financial Statements
76. Selzer Inc. sells all its merchandise on credit. It has a profit margin of 4 percent, days sales outstanding equal to 60
days, receivables of $150,000, total assets of $3 million, and a debt ratio of 0.64. What is the firm’s return on equity
(ROE)?
a. 7.1%
b. 33.3%
c. 3.3%
d. 71.0%
e. 8.1%
77. You are given the following information about a firm: The growth rate equals 8 percent; return on assets (ROA) is
10 percent; the debt ratio is 20 percent; and the stock is selling at $36. What is the return on equity (ROE)?
a. 14.0%
b. 12.5%
c. 15.0%
d. 2.5%
e. 13.5%
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Chapter 2 – Analysis of Financial Statements
78. Assume Meyer Corporation is 100 percent equity financed. Calculate the return on equity, given the following
information:
(1) Earnings before taxes = $1,500;
(2) Sales = $5,000;
(3) Dividend payout ratio = 60%;
(4) Total assets turnover = 2.0;
(5) Applicable tax rate = 30%.
a. 25%
b. 30%
c. 35%
d. 42%
e. 50%
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Chapter 2 – Analysis of Financial Statements
79. The Amer Company has the following characteristics:
Sales: $1,000
Total Assets: $1,000
Total Debt/Total Assets: 35%
EBIT: $ 200
Tax rate: 40%
Interest rate on total debt: 4.57%
What is Amer’s ROE?
a. 11.04%
b. 12.31%
c. 16.99%
d. 28.31%
e. 30.77%
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Chapter 2 – Analysis of Financial Statements
80. Aurillo Equipment Company (AEC) projected that its ROE for next year would be just 6%. However, the financial
staff has determined that the firm can increase its ROE by refinancing some high interest bonds currently
outstanding. The firm’s total debt will remain at $200,000 and the debt ratio will hold constant at 80%, but the interest
rate on the refinanced debt will be 10%. The rate on the old debt is 14%. Refinancing will not affect sales which are
projected to be $300,000. EBIT will be 11% of sales, and the firm’s tax rate is 40%. If AEC refinances its high
interest bonds, what will be its projected new ROE?
a. 3.0%
b. 8.2%
c. 10.0%
d. 15.6%
e. 18.7%
81. Savelots Stores’ current financial statements are shown below:
Inventories
$ 500
Accounts payable
$ 100
Other current assets
400
Short-term notes payable
370
Fixed assets
370
Common equity
800
Total assets
$1,270
Total liab. and equity
$1,270
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Chapter 2 – Analysis of Financial Statements
Sales
$2,000
Operating costs
1,843
EBIT
157
Less: Interest
37
EBT
120
Less: Taxes (40%)
48
Net income
72
A recently released report indicates that Savelots’ current ratio of 1.9 is in line with the industry average. However,
its accounts payable, which have no interest cost and which are due entirely to purchases of inventories, amount to
only 20% of inventory versus an industry average of 60%. Suppose Savelots took actions to increase its accounts
payable to inventories ratio to the 60% industry average, but it (1) kept all of its assets at their present levels (that is,
the asset side of the balance sheet remains constant) and (2) also held its current ratio constant at 1.9. Assume that
Savelots‘ tax rate is 40%, that its cost of short-term debt is 10%, and that the change in payments will not affect
operations. In addition, common equity would not change. With the changes, what would be Savelots’ new ROE?
a. 10.5%
b. 7.8%
c. 9.0%
d. 13.2%
e. 12.0%
82. Harvey Supplies Inc. has a current ratio of 3.0, a quick ratio of 2.4, and an inventory turnover ratio of 6. Harvey’s
total assets are $1 million and its debt ratio is 0.20. The firm has no long–term debt. What is Harvey‘s sales figure if
the total cost of goods sold is 75% of sales?
a. $960,000
b. $720,000
c. $1,620,000
d. $120,000
e. $540,000
83. Given the following information, calculate the market price per share of WAM Inc.
Earnings after interest and taxes = $200,000
Earnings per share = $2.00
Stockholders’ equity = $2,000,000
Market/Book ratio = 0.20
a. $20.00
b. $8.00
c. $4.00
d. $2.00
e. $1.00
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Chapter 2 – Analysis of Financial Statements
84. On its December 31st balance sheet, LCG Company reported gross fixed assets of $6,500,000 and net fixed assets
of $5,000,000. Depreciation for the year was $500,000. Net fixed assets a year earlier on December 31st, had been
$4,700,000. What figure for “Cash Flows Associated with Long-Term Investments (Fixed Assets)” should LCG
report on its Statement of Cash Flows for the current year?
a. $500,000
b. $600,000
c. $700,000
d. $800,000
e. $900,000
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Chapter 2 – Analysis of Financial Statements
85. Lombardi Trucking Company has the following data:
Assets:
$10,000
Profit margin:
3.0%
Debt ratio:
60.0%
Interest rate:
10.0%
Tax rate:
40%
Total asset turnover:
2.0
What is Lombardi’s TIE ratio?
a. 0.95
b. 1.75
c. 2.10
d. 2.67
e. 3.45
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Chapter 2 – Analysis of Financial Statements
86. Retailers Inc. and Computer Corp. each have assets of $10,000 and a return on common equity equal to 15%.
Retailers has twice as much debt and twice as many sales relative to Computer Corp. Retailers‘ net income equals
$750, and its total asset turnover is equal to 3. What is Computer Corp.’s profit margin?
a. 2.50%
b. 5.00%
c. 7.50%
d. 10.00%
e. 12.50%