A firm’s ROE is equal to 9% and its ROA is equal to 6%. The firm finances only with
short-term debt, long-term debt, and common equity, so assets equal total invested
capital. The firm’s total debt to total capital ratio must be 50%.
a.True
b.False
Bell Brothers has $3,000,000 in sales. Fixed costs are estimated to be $100,000 and
variable costs are equal to 50% of sales. The company has $1,000,000 in debt
outstanding at a before-tax cost of 10%. If Bell Brothers’ sales were to increase by 20%,
how much of a percentage increase would you expect in the company’s net income?
a.18.80%
b.19.79%
c.20.83%
d.21.92%
e.23.08%
Which of the following statements is CORRECT?
a.One disadvantage of organizing a business as a corporation rather than a partnership is
that the equity investors in a corporation are exposed to unlimited liability.
b.Using restrictive covenants in debt agreements is an effective way to reduce conflicts
between stockholders and managers.
c.Managers generally welcome hostile takeovers since the “raider” generally offers a
price for the stock that is higher than the price before the takeover action started.
d.The managers of established, stable companies sometimes attempt to get their state
legislatures to impose rules that make it more difficult for raiders to succeed with
hostile takeovers.
e.Most business in the U.S. is conducted by corporations, and corporations’ popularity
results primarily from their favorable tax treatment.
Other things held constant, which of the following events would be most likely to
encourage a firm to increase the amount of debt in its capital structure?
a.Its sales are projected to become less stable in the future.
b.The bankruptcy laws are changed in a way that would make bankruptcy more costly
to the firm and its stockholders.
c.Management believes that the firm’s stock is currently overvalued.
d.The firm decides to automate its factory with specialized equipment and thus increase
its use of operating leverage.
e.The corporate tax rate is increased.
Which of the following statements is CORRECT?
a.Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time
its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets
to 60%. The firm finances using only debt and common equity and total assets equal
total invested capital. Under these conditions, the ROE will increase.
b.Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time
its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to
60%. The firm finances using only debt and common equity and total assets equal total
invested capital. Without additional information, we cannot tell what will happen to the
ROE.
c.The DuPont equation provides information about how operations affect the ROE, but
the equation does not include the effects of debt on the ROE.
d.Other things held constant, an increase in the total debt to total capital ratio will result
in an increase in the profit margin.
e.Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time
its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets
to 60%. The firm finances using only debt and common equity and total assets equal
total invested capital. Under these conditions, the ROE will decrease.
The amount shown on the December 31, 2015, balance sheet as “retained earnings” is
equal to the firm’s net income for 2015 minus any dividends it paid.
a.True
b.False
Which of the following statements is most CORRECT?
a.The acquiring firm’s required rate of return in most horizontal mergers will not be
affected, because the two firms will have similar betas.
b.The goal of merger valuation is to value the target firm’s total capital at the target
firm’s weighted average cost of capital because a firm is acquired from all of its
investors–both shareholders and creditors.
c.The basic rationale for any financial merger is synergy and, thus, the estimation of pro
forma cash flows is the single most important part of the analysis.
d.In most mergers, the benefits of synergy and the premium the acquirer pays over the
market price are summed and then divided equally between the shareholders of the
acquiring and target firms.
e.The primary rationale for most operating mergers is synergy.
Romano Inc. has the following data. What is the firm’s cash conversion cycle?
a.33 days
b.37 days
c.41 days
d.45 days
e.49 days
Over the past 88 years, we have observed that investments with the highest average
annual returns also tend to have the highest standard deviations of annual returns. This
observation supports the notion that there is a positive correlation between risk and
return. Which of the following answers correctly ranks investments from highest to
lowest risk (and return), where the security with the highest risk is shown first, the one
with the lowest risk last?
a.Small-company stocks, long-term corporate bonds, large-company stocks, long-term
government bonds, U.S. Treasury bills.
b.Large-company stocks, small-company stocks, long-term corporate bonds, U.S.
Treasury bills, long-term government bonds.
c.Small-company stocks, large-company stocks, long-term corporate bonds, long-term
government bonds, U.S. Treasury bills.
d.U.S. Treasury bills, long-term government bonds, long-term corporate bonds,
small-company stocks, large-company stocks.
e.Large-company stocks, small-company stocks, long-term corporate bonds, long-term
government bonds, U.S. Treasury bills.
Exhibit 4.1
The balance sheet and income statement shown below are for Koski Inc. Note that the
firm has no amortization charges, it does not lease any assets, none of its debt must be
retired during the next 5 years, and the notes payable will be rolled over.
Refer to Exhibit 4.1. What is the firm’s return on invested capital?
a.4.25%
b.5.67%
c.7.72%
d.9.33%
e.11.87%
You were hired as the CFO of a new company that was founded by three professors at
your university. The company plans to manufacture and sell a new product, a cell phone
that can be worn like a wrist watch. The issue now is how to finance the company, with
equity only or with a mix of debt and equity. The price per phone will be $250.00
regardless of how the firm is financed. The expected fixed and variable operating costs,
along with other data, are shown below. How much higher or lower will the firm’s
expected ROE be if it uses 60% debt rather than only equity, i.e., what is ROEL –
ROEU?
a.5.68%
b.5.94%
c.6.22%
d.6.52%
e.6.83%
Stromburg Corporation makes surveillance equipment for intelligence organizations. Its
sales are $75,000,000. Fixed costs, including research and development, are
$40,000,000, while variable costs amount to 30% of sales. Stromburg plans an
expansion which will generate additional fixed costs of $15,000,000, decrease variable
costs to 25% of sales, and also permit sales to increase to $100,000,000. What is
Stromburg’s degree of operating leverage at the new projected sales level?
a.3.7500
b.3.9375
c.4.1344
d.4.3411
e.4.5581
Which of the following statements is CORRECT?
a.In general, a firm with low operating leverage also has a small proportion of its total
costs in the form of fixed costs.
b.There is no reason to think that changes in the personal tax rate would affect firms’
capital structure decisions.
c.A firm with a relatively high business risk is more likely to increase its use of
financial leverage than a firm with low business risk, assuming all else equal.
d.If a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always
reduce its WACC by increasing its use of debt.
e.Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to
the point where it is at its optimal capital structure will decrease the costs of both debt
and equity.