1. Which one of the following statements related to liquidity is correct?

I. Liquid assets tend to earn a high rate of return.

a) I and II only.
b) II and III only.
c) I, II and III only.
d) II and IV only.
e) III and IV only.

2. What is the average tax rate for a firm with a taxable income of $309,750?

a) 33.6%
b) 33.3%
c) 32.9%
d) 34.2%
e) 35.0%

Use the financial statements provide on page 6 to answer questions 3 – 13. Use end of the year
figures for balance sheet items for all questions.

3. What is the Galaxy Interior’s payout ratio for 2008?

a) 48%
b) 52%
c) 58%
d) 35%
e) 100%

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4. What is the change in the net working capital from 2007 to 2008 (include ALL current
liabilities)?

a) -$1,194
b) $1,306
c) $1,887
d) $4,780
e) $5,172

5. What is the amount of the net capital spending for 2008?

a) -$382
b) $1,229
c) $1,804
d) $2,375
e) $2,516

6. What is the cash flow from assets for 2008?

a) $1,732
b) $2,247
c) $2,961
d) $3,915
e) $4,267

7. What is the cash flow to creditors for 2008 (exclude any current liabilities)?

a) -$353
b) -$210
c) $300
d) $432
e) $527

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8. What can you say about Galaxy Interior’s Days Sales Outstanding?

a) In 2008, the firm is collecting its accounts receivables quicker because the Days Sales
Outstanding increased from 12.88 to 14.02.
b) In 2008, the firm is collecting its accounts receivables quicker because the Days Sales
Outstanding decreased from 28.34 to 26.03.
c) In 2008, the firm is collecting its accounts receivables slower because the Days Sales
Outstanding increased from 12.88 to 14.02.
d) In 2008, the firm is collecting its accounts receivables slower because the Days Sales
Outstanding decreased from 28.34 to 26.03.
e) It appears the firm has a lot of bad debt.

9. What is the Galaxy Interior’s return on equity for 2008?

a) 15.12%
b) 25.16%
c) 24.09%
d) 11.62%
e) 14.17%

10. (7 points) Did ROE improve in 2008? Using Dupont Analysis, explain the change in ROE
for Galaxy Interiors.

Use the space below for calculations.

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Suppose the Galaxy Interior is currently operating at 90% capacity and a 10% increase in Sales is
projected for 2009. The firm will not issue or retire any of its existing debt (that is, any changes
in capital structure will happen through common stockholders’ equity). The firm’s marginal tax
rate is 35% and its payout ratio will remain constant.

11. Using these forecasts, create a pro forma income statement for 2009:

12. Using these forecasts create a pro forma balance sheet for 2009:

13. What is the External Financing needed to support the projected sales increase?

a) $921
b) $390
c) -$390
d) -$921
e) $1,246
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14. (19 points) Phone Home, Inc. is considering a new 4-year expansion project that requires an
initial fixed asset investment of $3 million. The fixed asset will be depreciated straight-line to a
zero book value over its 4-year tax life. The firm expects to be able to sell these assets for
$231,000 at the end of the project. It is expected that this project will generate new sales of
$2,640,000. The firm is also expecting to lose sales of approximately $420,000 each year from a
competing product during the life of this project. The project requires an initial investment in net
working capital of $330,000, all of which will be recovered at the end of the project. The firm’s
average tax rate is 32% and the marginal tax rate is 35%. The required return for this project is
15%. What is the net present value of this project? Should the project be accepted? Why or why
not?

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 Galaxy Interiors
Consolidated Income Statement
($ in millions)
2007 2008
Net Sales $20,750 $21,415
Cost of Goods Sold 15,900 16,408
Depreciation 1,650 1,611
EBIT 3,200 3,396
Interest 1,480 1,282
EBT $1,720 $2,114
Taxes Paid 602 739.9
Net Income $1,118 $1,374

Galaxy Interiors
Consolidated Balance Sheets
($ in millions)
2007 2008 2007 2008
Cash $668 $297 Accounts Payable $1,694 $1,532
Accounts Receivable 1,611 1,527 Notes Payable 2,500 0
Inventory 3,848 2,947 Total Current Liabilities $4,194 $1,532
Total Current Assets $6,127 $4,771 Long-term debt 9,800 10,650
Net Fixed Asset 17,489 17,107 Common stock 7,500 7,000
Retained Earnings 2,122 2,696
Total Assets $23,616 $21,878 Total Liab. & Owners' Equity $23,616 $21,878

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Answers
1. E
2. A
3. C
4. B
5. B
6. A
7. D
8. B
9. E
10. ROE increases because the increase in profit margin and total asset turnover outweighed
the decrease in leverage (equity multiplier)
11. See spreadsheet
12. See spreadsheet.
Note: maximum sales = $23,794. No additional fixed assets are needed, therefore NFA will not
change and DEP will not change. INT also will not change because you are told the firm will not
increase borrowing.
13. C