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d. Net income will decrease.
e. The times-interest-earned ratio will decrease.
68. Which of the following statements is CORRECT?
a. The ratio of long-term debt to total capital is more likely to
experience seasonal fluctuations than is either the DSO or the
inventory turnover ratio.
b. If two firms have the same ROA, the firm with the most debt can be
expected to have the lower ROE.
c. An increase in the DSO, other things held constant, could be
expected to increase the total assets turnover ratio.
d. An increase in the DSO, other things held constant, could be
expected to increase the ROE.
e. An increase in a firm’s debt ratio, with no changes in its sales or
operating costs, could be expected to lower its profit margin.
69. HD Corp and LD Corp have identical assets, sales, interest rates paid
on their debt, tax rates, and EBIT. However, HD uses more debt than LD.
Which of the following statements is CORRECT?
a. Without more information, we cannot tell if HD or LD would have a
higher or lower net income.
b. HD would have the lower equity multiplier for use in the DuPont
equation.
c. HD would have to pay more in income taxes.
d. HD would have the lower net income as shown on the income statement.
e. HD would have the higher operating margin.
70. Companies HD and LD have the same sales, tax rate, interest rate on
their debt, total assets, and basic earning power. Both companies have
positive net incomes. Company HD has a higher debt ratio and,
therefore, a higher interest expense. Which of the following
statements is CORRECT?
a. Company HD pays less in taxes.
b. Company HD has a lower equity multiplier.
c. Company HD has a higher ROA.
d. Company HD has a higher times-interest-earned (TIE) ratio.
e. Company HD has more net income.
71. Companies HD and LD have the same tax rate, sales, total assets, and
basic earning power. Both companies have positive net incomes. Company
HD has a higher debt ratio and, therefore, a higher interest expense.
Which of the following statements is CORRECT?
a. Company HD has a lower equity multiplier.
b. Company HD has more net income.
c. Company HD pays more in taxes.
d. Company HD has a lower ROE.
e. Company HD has a lower times-interest-earned (TIE) ratio.
72. Which of the following statements is CORRECT?
a. If a firm has high current and quick ratios, this always indicate
that the firm is managing its liquidity position well.
b. If a firm sold some inventory for cash and left the funds in its bank
account, its current ratio would probably not change much, but its
quick ratio would decline.
c. If a firm sold some inventory on credit, its current ratio would
probably not change much, but its quick ratio would decline.
d. If a firm sold some inventory on credit as opposed to cash, there is
no reason to think that either its current or quick ratio would
change.
e. The inventory turnover ratio and days sales outstanding (DSO) are two
ratios that are used to assess how effectively a firm is managing
its current assets.
73. Which of the following statements is CORRECT?
a. A decline in a firm's inventory turnover ratio suggests that it is
improving both its inventory management and its liquidity position,
i.e., that it is becoming more liquid.
b. In general, it's better to have a low inventory turnover ratio than a
high one, as a low one indicates that the firm has an adequate stock
of inventory relative to sales and thus will not lose sales as a
result of running out of stock.
c. If a firm's fixed assets turnover ratio is significantly lower than
its industry average, this could indicate that it uses its fixed
assets very efficiently or is operating at over capacity and should
probably add fixed assets.
d. The more conservative a firm's management is, the higher its debt
ratio is likely to be.
e. The days sales outstanding ratio tells us how long it takes, on
average, to collect after a sale is made. The DSO can be compared
with the firm's credit terms to get an idea of whether customers are
paying on time.
74. Which of the following statements is CORRECT?
a. Other things held constant, the more debt a firm uses, the higher its
operating margin will be.
b. Debt management ratios show the extent to which a firm's managers are
attempting to magnify returns on owners' capital through the use of
financial leverage.
c. Other things held constant, the more debt a firm uses, the higher its
profit margin will be.
d. Other things held constant, the higher a firm's debt ratio, the
higher its TIE ratio will be.
e. Debt management ratios show the extent to which a firm's managers are
attempting to reduce risk through the use of financial leverage.
The higher the debt ratio, the lower the risk.
75. Which of the following statements is CORRECT?
a. Other things held constant, the less debt a firm uses, the lower its
return on total assets will be.
b. The advantage of the basic earning power ratio (BEP) over the return
on total assets for judging a company's operating efficiency is that
the BEP does not reflect the effects of debt and taxes.
c. The return on common equity (ROE) is generally regarded as being
less significant, from a stockholder's viewpoint, than the return on
total assets (ROA).
d. The price/earnings (P/E) ratio tells us how much investors are
willing to pay for a dollar of current earnings. In general,
investors regard companies with higher P/E ratios as being more
risky and/or less likely to enjoy higher future growth.
e. Suppose you are analyzing two firms in the same industry. Firm A
has a profit margin of 10% versus a margin of 8% for Firm B. Firm
A's debt ratio is 70% versus 20% for Firm B. Based only on these
two facts, you cannot reach a conclusion as to which firm is better
managed, because the difference in debt, not better management,
could be the cause of Firm A's higher profit margin.
76. Which of the following statements is CORRECT?
a. In general, if investors regard a company as being relatively risky
and/or having relatively poor growth prospects, then it will have
relatively high P/E and M/B ratios.
b. The basic earning power ratio (BEP) reflects the earning power of a
firm's assets after giving consideration to financial leverage and
tax effects.
c. The “apparent,” but not necessarily the “true,” financial position
of a company whose sales are seasonal can change dramatically during
a given year, depending on the time of year when the financial
statements are constructed.
d. The market/book (M/B) ratio tells us how much investors are willing
to pay for a dollar of accounting book value. In general, investors
regard companies with higher M/B ratios as being more risky and/or
less likely to enjoy higher future growth.
e. It is appropriate to use the fixed assets turnover ratio to appraise
firms' effectiveness in managing their fixed assets if and only if
all the firms being compared have the same proportion of fixed
assets to total assets.
77. Walter Industries’ current ratio is 0.5. Considered alone, which of
the following actions would increase the company’s current ratio?
a. Borrow using short-term notes payable and use the cash to increase
inventories.
b. Use cash to reduce accruals.
c. Use cash to reduce accounts payable.
d. Use cash to reduce short-term notes payable.
e. Use cash to reduce long-term bonds outstanding.
78. Safeco’s current assets total to $20 million versus $10 million of
current liabilities, while Risco’s current assets are $10 million
versus $20 million of current liabilities. Both firms would like to
“window dress” their end-of-year financial 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 firm’ financial strength
as measured by their current ratios.
d. The transactions would lower both firm’ financial strength as
measured by their current ratios.
e. The transactions would improve both firms’ financial strength as
measured by their current ratios.
79. 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.
However, company HD has a higher debt 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.
80. 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, a zero debt ratio and therefore an equity
multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the
firm borrow money, use it to buy back stock, and raise the debt
ratio to 50% and the equity multiplier to 2.0. 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%.
Multiple Choice: Problems
A good bit of relatively simple algebra is involved in these problems, and although the
calculations are simple, it will take students some time to set up the problems and do the
arithmetic. We allow for this when assigning problems for a timed test. Also, note that students
must know the definitions of a number of ratios to answer the questions. We provide our
students with a formula sheet on exams, using the relevant sections of Appendix C at the end of
the text. Otherwise, they spend too much time trying to memorize things rather than trying to
understand the issues.
The difficulty of the problems depends on (1) whether or not students are provided with a
formula sheet and (2) the amount of time they have to work the problems. Our difficulty
assessments assume that they have a formula sheet and a “reasonable” amount of time for the
test. Note that a few of the problems are trivially easy if students have formula sheets.
To work some of the problems, students must transpose equations and solve for items that
are normally inputs. For example, the equation for the profit margin is given as Profit margin =
Net income/Sales. We might have a problem where sales and the profit margin are given and
then require students to find the firm's net income. We explain to our students in class before the
exam that they will have to transpose terms in the formulas to work some problems.
Problems 81 to 109 are all stand-alone problems with individualized data. Problems 110
through 127 are all based on a common set of financial statements, and they require students to
calculate ratios and find items like EPS, TIE, and the like using this data set. The financial
statements can be changed algorithmically, and this changes the calculated ratios and other items.
81. Ryngard Corp's sales last year were $38,000, and its total assets were
$16,000. What was its total assets turnover ratio (TATO)?
a. 2.04
b. 2.14
c. 2.26
d. 2.38
e. 2.49
82. Beranek Corp has $720,000 of assets, and it uses no debt--it is
financed only with common equity. The new CFO wants to employ enough
debt to raise the debt/assets 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. $273,600
b. $288,000
c. $302,400
d. $317,520
e. $333,396
83. Ajax Corp's sales last year were $435,000, its operating costs were
$362,500, and its interest charges were $12,500. What was the firm's
times-interest-earned (TIE) ratio?
a. 4.72
b. 4.97
c. 5.23
d. 5.51
e. 5.80
84. Royce Corp's sales last year were $280,000, and its net income was
$23,000. What was its profit margin?
a. 7.41%
b. 7.80%
c. 8.21%
d. 8.63%
e. 9.06%
85. River Corp's total assets at the end of last year were $415,000 and its
net income was $32,750. What was its return on total assets?
a. 7.89%
b. 8.29%
c. 8.70%
d. 9.14%
e. 9.59%
86. X-1 Corp's total assets at the end of last year were $405,000 and its
EBIT was 52,500. What was its basic earning power (BEP) ratio?
a. 11.70%
b. 12.31%
c. 12.96%
d. 13.61%
e. 14.29%
87. Zero Corp's total common equity at the end of last year was $405,000
and its net income was $70,000. What was its ROE?
a. 14.82%
b. 15.60%
c. 16.42%
d. 17.28%
e. 18.15%
88. Your sister is thinking about starting a new business. The company
would require $375,000 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. $41,234
b. $43,405
c. $45,689
d. $48,094
e. $50,625
89. Song Corp's stock price at the end of last year was $23.50 and its
earnings per share for the year were $1.30. What was its P/E ratio?
a. 17.17
b. 18.08
c. 18.98
d. 19.93
e. 20.93
90. Hoagland Corp's stock price at the end of last year was $33.50, and its
book value per share was $25.00. What was its market/book ratio?
a. 1.34
b. 1.41
c. 1.48
d. 1.55
e. 1.63
91. Precision Aviation had a profit margin of 6.25%, a total assets turnover
of 1.5, and an equity multiplier of 1.8. What was the firm's ROE?
a. 15.23%
b. 16.03%
c. 16.88%
d. 17.72%
e. 18.60%
92. Meyer Inc's assets are $625,000, and its total debt outstanding is
$185,000. The new CFO wants to establish a debt/assets ratio of 55%.
The size of the firm does not change. How much debt must the company
add or subtract to achieve the target debt ratio?
a. $158,750
b. $166,688
c. $175,022
d. $183,773
e. $192,962
93. Helmuth Inc's latest net income was $1,250,000, and it had 225,000
shares outstanding. The company wants to pay out 45% of its income.
What dividend per share should it declare?
a. $2.14
b. $2.26
c. $2.38
d. $2.50
e. $2.63
94. Garcia Industries has sales of $200,000 and accounts receivable of
$18,500, and it gives its customers 25 days to pay. The industry
average DSO is 27 days, based on a 365-day year. If the company
changes its credit and collection policy sufficiently to cause its DSO
to fall to the industry average, and if it earns 8.0% on any cash
freed-up by this change, how would that affect its net income, assuming
other things are held constant?
a. $241.45
b. $254.16
c. $267.54
d. $281.62
e. $296.44
95. Faldo Corp sells on terms that allow customers 45 days to pay for
merchandise. Its sales last year were $325,000, and its year-end
receivables were $60,000. If its DSO is less than the 45-day credit
period, then customers are paying on time. Otherwise, they are paying
late. By how much are customers paying early or late? Base your
answer on this equation: DSO - Credit Period = Days early or late, and
use a 365-day year when calculating the DSO. A positive answer
indicates late payments, while a negative answer indicates early
payments.
a. 21.27
b. 22.38
c. 23.50
d. 24.68
e. 25.91
96. Han Corp's sales last year were $425,000, and its year-end receivables
were $52,500. The firm sells on terms that call for customers to pay
30 days after the purchase, but some delay payment beyond Day 30. On
average, how many days late do customers pay? Base your answer on this
equation: DSO - Allowed credit period = Average days late, and use a
365-day year when calculating the DSO.
a. 12.94
b. 13.62
c. 14.33
d. 15.09
e. 15.84
97. Wie Corp's sales last year were $315,000, and its year-end total assets
were $355,000. The average firm in the industry has a total assets
turnover ratio (TATO) of 2.4. The firm's new CFO believes the firm has
excess assets that can be sold so as to bring the TATO down to the
industry average without affecting sales. By how much must the assets
be reduced to bring the TATO to the industry average, holding sales
constant?
a. $201,934
b. $212,563
c. $223,750
d. $234,938
e. $246,684
98. A new firm is developing its business plan. It will require $615,000
of assets, and it projects $450,000 of sales and $355,000 of operating
costs for the first year. Management is reasonably sure of these
numbers because of contracts with its customers and suppliers. It can
borrow at a rate of 7.5%, but the bank requires it to have a TIE of at
least 4.0, and if the TIE falls below this level the bank will call in
the loan and the firm will go bankrupt. What is the maximum debt ratio
(measured as debt/assets) the firm can use? (Hint: Find the maximum
dollars of interest, then the debt that produces that interest, and
then the related debt ratio.)
a. 41.94%
b. 44.15%
c. 46.47%
d. 48.92%
e. 51.49%
99. Chang Corp. has $375,000 of assets, and it uses only common equity
capital (zero debt). Its sales for the last year were $595,000, and
its net income was $25,000. Stockholders recently voted in a new
management team that has promised to lower costs and get the return on
equity up to 15.0%. What profit margin would the firm need in order to
achieve the 15% ROE, holding everything else constant?
a. 9.45%
b. 9.93%
c. 10.42%
d. 10.94%
e. 11.49%
Page 122 M/C Problems Chapter 4: Statement Analysis
100. Last year Ann Arbor Corp had $155,000 of assets, $305,000 of sales,
$20,000 of net income, and a debt-to-total-assets ratio of 37.5%. The
new CFO believes a new computer program will enable it to reduce costs
and thus raise net income to $33,000. Assets, sales, and the debt
ratio would not be affected. By how much would the cost reduction
improve the ROE?
a. 11.51%
b. 12.11%
c. 12.75%
d. 13.42%
e. 14.09%
101. Brookman Inc's latest EPS was $2.75, its book value per share was
$22.75, it had 315,000 shares outstanding, and its debt/assets ratio was
44%. How much debt was outstanding?
a. $4,586,179
b. $4,827,557
c. $5,081,639
d. $5,349,094
e. $5,630,625
102. 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-assets ratio was 45.0%. Based on the DuPont equation, what
was the ROE?
a. 13.82%
b. 14.51%
c. 15.23%
d. 16.00%
e. 16.80%
103. Last year Rennie Industries had sales of $305,000, assets of $175,000,
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. Had it reduced its assets by this
amount, and had the debt/assets ratio, sales, and costs remained
constant, how much would the ROE have changed?
a. 4.10%
b. 4.56%
c. 5.01%
d. 5.52%
e. 6.07%
Chapter 4: Statement Analysis M/C Problems Page 123
104. Last year Blease Inc had a total assets turnover of 1.33 and an equity
multiplier of 1.75. Its sales were $295,000 and its net income was
$10,600. The CFO believes that the company could have operated more
efficiently, lowered its costs, and increased its net income by $10,250
without changing its sales, assets, or capital structure. Had it cut
costs and increased its net income by this amount, how much would the
ROE have changed?
a. 6.55%
b. 7.28%
c. 8.09%
d. 8.90%
e. 9.79%
105. Last year Jandik Corp. had $295,000 of assets, $18,750 of net income,
and a debt-to-total-assets ratio of 37%. Now suppose the new CFO
convinces the president to increase the debt ratio to 48%. Sales and
total assets will not be affected, but interest expenses would
increase. However, the CFO believes that better cost controls would be
sufficient to offset the higher interest expense and thus keep net
income unchanged. By how much would the change in the capital
structure improve the ROE?
a. 2.13%
b. 2.35%
c. 2.58%
d. 2.84%
e. 3.12%
106. Last year Kruse Corp had $305,000 of assets, $403,000 of sales, $28,250
of net income, and a debt-to-total-assets ratio of 39%. The new CFO
believes the firm has excessive fixed assets and inventory that could
be sold, enabling it to reduce its total assets to $252,500. Sales,
costs, and net income would not be affected, and the firm would
maintain the same debt ratio (but with less total debt). By how much
would the reduction in assets improve the ROE?
a. 2.85%
b. 3.00%
c. 3.16%
d. 3.31%
e. 3.48%
Page 124 M/C Problems Chapter 4: Statement Analysis
107. Jordan Inc has the following balance sheet and income statement data:
Cash $ 14,000 Accounts payable $ 42,000
Receivables 70,000 Other current liab. 28,000
Inventories 280,000 Total CL $ 70,000
Total CA $364,000 Long-term debt 140,000
Net fixed assets 126,000 Common equity 280,000
Total assets $490,000 Total liab. and equity $490,000
Sales $280,000
Net income $21,000
The new CFO thinks that inventories are excessive and could be lowered
sufficiently to cause the current ratio to equal the industry average,
2.75, without affecting either sales or net income. Assuming that
inventories are sold off and not replaced to get the current ratio to
the target level, and that the funds generated are used to buy back
common stock at book value, by how much would the ROE change?
a. 11.26%
b. 11.85%
c. 12.45%
d. 13.07%
e. 13.72%
108. Last year Hamdi Corp. had sales of $500,000, operating costs of
$450,000, and year-end assets of $395,000. The debt-to-total-assets
ratio was 17%, the interest rate on the debt was 7.5%, and the firm's
tax rate was 35%. The new CFO wants to see how the ROE would have been
affected if the firm had used a 50% debt ratio. Assume that sales,
operating costs, total assets, and the tax rate would not be affected,
but the interest rate would rise to 8.0%. By how much would the ROE
change in response to the change in the capital structure?
a. 1.71%
b. 1.90%
c. 2.11%
d. 2.34%
e. 2.58%
109. Quigley Inc. is considering two financial plans for the coming year.
Management expects sales to be $300,000, operating costs to be
$265,000, assets (capital) to be $200,000, and its tax rate to be 35%.
Under Plan A it would use 25% debt and 75% common equity. The interest
rate on the debt would be 8.8%, but under a contract with existing
bondholders the TIE ratio would have to be maintained at or above 4.0.
Under Plan B, the maximum debt that met the TIE constraint would be
employed. Assuming that sales, operating costs, assets, the interest
rate, and the tax rate would all remain constant, by how much would the
ROE change in response to the change in the capital structure?
a. 3.71%
b. 4.08%
c. 4.48%
Chapter 4: Statement Analysis M/C Problems Page 125
d. 4.93%
e. 5.18%
Multiple Part:
(The following information applies to Problems 110 through 127.)
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.
Balance Sheet (Millions of $)
Assets 2012
Cash and securities $ 2,500
Accounts receivable 11,500
Inventories 16,000
Total current assets $30,000
Net plant and equipment $20,000
Total assets $50,000
Liabilities and Equity
Accounts payable $ 9,500
Notes payable 7,000
Accruals 5,500
Total current liabilities $22,000
Long-term bonds $15,000
Total debt $37,000
Common stock $ 2,000
Retained earnings 11,000
Total common equity $13,000
Total liabilities and equity $50,000
Income Statement (Millions of $) 2012
Net sales $87,500
Operating costs except depreciation 81,813
Depreciation 1,531
Earnings bef interest and taxes (EBIT) $ 4,156
Less interest 1,375
Earnings before taxes (EBT) $ 2,781
Taxes 973
Net income $ 1,808
Other data:
Shares outstanding (millions) 500.00
Common dividends $632.73
Int rate on notes payable & L-T bonds 6.25%
Federal plus state income tax rate 35%
Year-end stock price $43.39
110. What is the firm's current ratio?
a. 0.99
b. 1.10
c. 1.23
d. 1.36
Page 126 M/C Problems Chapter 4: Statement Analysis
e. 1.50
Chapter 4: Statement Analysis M/C Problems Page 127
111. What is the firm's quick ratio?
a. 0.51
b. 0.64
c. 0.76
d. 0.92
e. 1.10
112. What is the firm's days sales outstanding? Assume a 365-day year for
this calculation.
a. 39.07
b. 41.13
c. 43.29
d. 45.57
e. 47.97
113. What is the firm's total assets turnover?
a. 1.12
b. 1.40
c. 1.75
d. 2.10
e. 2.52
114. What is the firm's inventory turnover ratio?
a. 5.47
b. 5.74
c. 6.03
d. 6.33
e. 6.65
115. What is the firm's TIE?
a. 2.20
b. 2.45
c. 2.72
d. 3.02
e. 3.33
116. What is the firm's debt/assets ratio?
a. 48.55%
b. 53.95%
c. 59.94%
d. 66.60%
Page 128 M/C Problems Chapter 4: Statement Analysis
e. 74.00%
