FINANCIAL MANAGEMENT B: Short-term interest rates have traditionally been more stable than long-term interest rates.

1
. Net working capital is the difference between C: A firm that borrows heavily long-term is more apt to be unable to repay the debt than a
A: Current assets and current liabilities. firm that borrows heavily short-term.
B: Fixed assets and fixed liabilities. D: Financing requirements remain constant.
C: Total assets and total liabilities.
D: Shareholders' investment and cash. Cash & Marketable Securities Management
7
. A compensating balance
2
. If a firm increases its cash balance by issuing additional shares of common stock, working A: Compensates a financial institution for services rendered by providing it with deposits of
capital funds.
A: Remains unchanged and the current ratio remains unchanged. B: Is used to compensate for possible losses on a marketable securities portfolio.
B: Increases and the current ratio remains unchanged. C: Is a level of inventory held to compensate for variations in usage rate and lead time.
C: Increases and the current ratio decreases. D: Is the amount of prepaid interest on a loan.
D: Increases and the current ratio increases.
8
. What is the major advantage of a zero-balance account system?
Operating Cycle & Cash Conversion Cycle A: It helps insure that cash is available for contingencies.
3
. The cash conversion is accurately illustrated by which of the following expressions? B: It maximizes the amount of interest earned on demand deposits.
A. Inventory conversion period + Receivables conversion period -- Payables deferral period C: It maximizes the float involved in cash disbursements.
B. Inventory conversion period -- Receivables conversion period -- Payables deferral period D: It maximizes the float involved in cash receipts.
C. Inventory conversion period + Receivables conversion period + Payables deferral period
D. Inventory conversion period -- Receivables conversion period -- Payables deferral period .
9
Which of the following effects would a lockbox most likely provide for receivables
+ Long-term financing period management?
A: Minimized collection float. C: Minimized disbursement float.
4
. A growing company is assessing current working capital requirements. An average of 58 days B: Maximized collection float. D: Maximized disbursement float.
is required to convert raw materials into finished goods and to sell them. Then an average of
32 days is required to collect on receivables. If the average time the company takes to pay for 10
. A firm has daily cash receipts of $100,000 and collection time of 2 days. A bank has offered to
its raw materials is 15 days after they are received, then the total cash conversion cycle for this reduce the collection time on the firm’s deposits by 2 days for a monthly fee of $500. If money
company would be market rates are expected to average 6% during the year, the net annual benefit (loss) from
A: 11 days. C: 75 days. having this service is
B: 41 days. D: 90 days. A: $ 3,000 C: $0
B: $12,000 D: $ 6,000
Working Capital Policy
5
. Financing some current assets with long-term debt is considered to be 11
. Kemple is a newly established janitorial firm, and the owner is deciding what type of checking
A: An unsound financing policy. account to open. Kemple is planning to keep a $500 minimum balance in the account for
B: A conservative financing policy. emergencies and plans to write roughly 80 checks per month. The bank charges $10 per
C: An aggressive financing policy. month plus a $0.10 per check charge for a standard business checking account with no
D: A policy used to maximize net income. minimum balance. Kemple also has the option of a premium business checking account that
requires a $2,500 minimum balance but has no monthly fees or per check charges. If
6
. Why would a firm generally choose to finance temporary assets with short-term debt? Kemple’s cost of funds is 10%, which account should Kemple choose?
A: Matching the maturities of assets and liabilities reduces risk. A: Standard account, because the savings is $34 per year.
 B: Premium account, because the savings is $34 per year. August 900 170
C: Standard account, beause the savings is $16 per year. September 500 80
D: Premium account, because the savings is $16 per year. The percentage of receivables in the 31-to-60-day age group at the end of September is
A: 21.43% C: 48.57%
12
. When managing cash and short-term investments, a corporate treasurer is primarily B: 28.57% D: 71.43%
concerned with
A: Maximizing rate of return. . A firm sells on terms of 2/10 net 60. It sells 1,000 units per day at a unit price of $10. On 60%
18

B: Minimizing taxes. of sales, customers take the cash discount. On the remaining 40% of sales, customers pay,
C: Investing in Treasury bonds since they have no default risk. on average, in 70 days. What would be the impact on the balance of accounts receivable if
D: Liquidity and safety. the firm initiates a more aggressive collection policy and is able to reduce the average
payment period to 60 days for those customers not taking the cash discount? (Assume sales
Receivables Management levels are unaffected by the change in policy.)
13
. Which of the following ratios is appropriate for the evaluation of accounts receivable? A: Decrease by $4,000. C: Decrease by $240,000.
A: Days' sales outstanding. C: Collection to debt ratio. B: Decrease by $40,000. D: Decrease by $280,000
B: Return on total assets. D: Current ratio.
19
. A company sells 10,000 skateboards a year at $66 each. All sales are on credit, with terms of
14
. The average collection period for a firm measures the number of days 3/10, net 30, which means 3% discount if payment is made within 10 days; otherwise full
A: After a typical credit sale is made until the firm receives the payment. payment is due at the end of 30 days. One half of the customers are expected to take
B: For a typical check to "clear" through the banking system. advantage of the discount and pay on day 10. The other half are expected to pay on day 30.
C: Beyond the end of the credit period before a typical customer payment is received. Sales are expected to be uniform throughout the year for both types of customers.
D: Before a typical account becomes delinquent. What is the expected average collection period for the company?
A: 10 days. C: 20 days.
15
. Which of the following represents a firm’s average gross receivables balance? B: 15 days. D: 30 days.
I. Days’ sales in receivables x Accounts receivable turnover.
II. Average daily sales x Average collection period . A company sells 10,000 skateboards a year at $66 each. All sales are on credit, with terms of
20

III. Net sales ÷ Average gross receivables 3/10, net 30, which means 3% discount if payment is made within 10 days; otherwise full
A: I only. C: II only. payment is due at the end of 30 days. One half of the customers are expected to take
B: I and II only. D: II and III only. advantage of the discount and pay on day 10. The other half are expected to pay on day 30.
Sales are expected to be uniform throughout the year for both types of customers.
16
. Amicable Wireless, Inc. offers credit terms of 2/10, net 30 for its customers. Sixty percent of Assume that the average collection period is 25 days. After the credit policy is well
Amicable’s customers take the 2% discount and pay on day 10. The remainder of Amicable’s established, what is the expected average accounts receivable balance for the company at
customers pay on day 30. How many days’ sales are in Amicable’s accounts receivable? any point in time, assuming a 365-day year?
A: 6 C: 18 A: $ 684.93 C: $27,123.30
B: 12 D: 20 B: $ 1,808.22 D: $45,205.48
17
. At the end of September a company has outstanding accounts receivable of $350 on third- Inventory Management
quarter credit sales, composed as follows: 21
. Which of the following is critical to effective supply chain management?
Month Credit sales Still outstanding at the end of September A: A large number of suppliers. C: Sharing of information.
July $600 $100 B: A large number of customers. D: A complex production process.
 B. Denominator Numerator
22
. All of the following are features of just-in-time (JIT) systems except C. Denominator Denominator
A: Reduction of inventories, ideally to zero. D. Not used Denominator
B: Immediate incoming inspection of materials to eliminate defective parts.
C: Simplification of production activities by eliminating non-value-added activities. . A company sells 1,500 units of a particular item each year and orders the items in equal
28

D: All of the above are features of JIT. quantities of 500 units at a price of $5 per unit. No safety stocks are held. If the company has
a cost of capital of 12%, its annual cost of carrying inventory is
23
. A manufacturing company is attempting to implement a just-in-time (JIT) purchase policy A: $150 C: $300
system by negotiating with its primary suppliers to accept long-term purchase orders which B: $180 D: $900
result in more frequent deliveries of smaller quantities of raw materials. If the JIT purchase
policy is successful in reducing the total inventory costs of the manufacturing company, which . In computing the reorder point for an item of inventory, which of the following is used?
29

of the following combinations of cost changes would be most likely to occur? I. Cost
Cost category to increase Cost category to decrease II. Usage per day
A. Purchasing costs Stockout costs III. Lead time
B. Purchasing costs Quality costs A: I and II. B: II and III.
C. Quality costs Ordering costs C: I and III. D: I, II, and III.
D. Stockout costs Carrying costs
30
. The Polly Company wishes to determine the amount of safety stock that it should maintain for
. Spotech Co.’s budgeted sales and budgeted cost of sales for the coming year are
24 Product D that will result in the lowest cost. The following information is available:
$212,000,000 and $132,500,000, respectively. Short-term interest rates are expected to Stockout cost $80 per occurrence 
average 5%. If Spotech could increase inventory turnover from its current 8.0 times per year Carrying cost of safety stock $ 2 per unit
to 10.0 times per year, its expected cost savings in the current year would be Number of purchase orders 5 per year
A: $ 165,625 C: $3,312,500 The available options open to Polly are as follows:
B: $0 D: $ 828,125 Units of safety stock Probability of running out of safety stock
10 50%
25
. Which of the following inventory management approaches orders at the point where carrying 20 40%
costs equate nearest to restocking costs in order to minimize total inventory cost? 30 30%
A: Economic order quantity. C: Materials requirements planning. 40 20%
B: Just-in-time. D: ABC. 50 10%
55 5%
26
. Which of the following assumptions is associated with the economic order quantity formula? The number of units of safety stock that will result in the lowest cost is
A: The carrying cost per unit will vary with quantity ordered. A: 20 C: 50
B: The cost of placing an order will vary with quantity ordered. B: 40 D: 55
C: Periodic demand is known.
D: The purchase cost per unit will vary based on quantity discounts. Trade Credit
31
. If a firm purchases raw materials from its supplier on a 2/10, net 40, cash discount basis, the
27
. How would the following be used in the economic order quantity formula? equivalent annual interest rate (using a 360-day year) of forgoing the cash discount and
Inventory carrying cost Cost per purchase order making payment on the 40th day is
A. Numerator Numerator A: 2% C: 24.49%
 B: 18.36% D: 36.72% C: Makes rent payments which are actually installment payments constituting a payment of
both principal and interest only under a capital lease.
Short-term Loans D: Finances the transaction through the leased asset only under a capital lease.
32
. Which one of the following responses is not an advantage to a corporation that uses the
commercial paper market for short-term financing? Bond financing
A: This market provides more funds at lower rates than other methods provide. 37
. What would be the primary reason for a company to agree to a debt covenant limiting the
B: The borrower avoids the expense of maintaining a compensating balance with a percentage of its long-term debt?
commercial bank. A: To cause the price of the company's stock to rise.
C: There are no restrictions as to the type of corporation that can enter into this market. B: To lower the company's bond rating.
D: This market provides a broad distribution for borrowing. C: To reduce the risk for existing bondholders.
D: To reduce the interest rate on the bonds being sold.
33
. The credit instrument known as a banker’s acceptance
A: Calls for immediate payment upon delivery of the shipping documents to the bank's . Which one of the following statements correctly compares bond financing alternatives?
38

customer and acceptance of goods by the bank. A: A bond with a call provision typically has a lower yield to maturity than a similar bond
B: Involves an invoice being signed by the banker upon receipt of goods, after which both without a call provision.
the banker and the seller record the transaction on their respective books. B: A convertible bond must be converted to common stock prior to its maturity.
C: Is a time draft payable on a specified date and guaranteed by the bank. C: A call provision is usually considered detrimental to the investor.
D: Is a method of sales financing in which the bank retains title to the goods until the buyer D: A sinking fund prohibits the firm from redeeming a bond issue prior to its final maturity.
has completed the payment.
39
. Serial bonds are attractive to investors because
34
. Newman Products has received proposals from several banks to establish a lockbox system to A: All bonds in the issue mature on the same date.
speed up receipts. Newman receives an average of 700 checks per day averaging $1,800 B: The yield to maturity is the same for all bonds in the issue.
each, and its cost of short-term funds is 7% per year. Assuming that all proposals will produce C: Investors can choose the maturity that suits their financial needs.
equivalent processing results and using a 360-day year, which one of the following proposals D: The coupon rate on these bonds is adjusted to the maturity date.
is optimal for Newman?
A: A $0.50 fee per check. C: A fee of 0.03% of the amount collected. . A bond backed by fixed assets is a(n)
40

B: A flat fee of $125,000 per year. D: A compensating balance of $1,750,000. A: Income bond. C: Debenture.
B: Subordinated debenture. D: Mortgage bond.
35
. A company has an outstanding one-year bank loan of $500,000 at a stated interest rate of 8%.
The company is required to maintain a 20% compensating balance in its checking account. . The best reason corporations issue Eurobonds rather than domestic bonds is that
41

The company would maintain a zero balance in this account if the requirement did not exist. A: These bonds are denominated in the currency of the country in which they are issued.
What is the effective interest rate of the loan? B: These bonds are normally a less expensive form of financing because of the absence of
A: 8% C: 20% government regulation.
B: 10% D: 28% C: Foreign buyers more readily accept the issues of both large and small US corporations
than do domestic investors.
Leases D: Eurobonds carry no foreign exchange risk.
36
. Capital and operating leases differ in that the lessor
A: Only obtains use of the asset under a capital lease. . Zero-coupon bonds
42

B: Is using the lease as a source of financing only under an operating lease.

 A: Sell for a small fraction of their face value because their yield is much lower than the . Bander Co. is determining how to finance some long-term projects. Bander has decided it
47

market rate. prefers the benefits of no fixed charges, no fixed maturity date, and an increase in the
B: Increase in value each year as they approach maturity, providing the owner with the total creditworthiness of the company. Which of the following would best meet Bander’s financing
payoff at maturity. requirements?
C: Are redeemable in measures of a commodity such as barrels of oil, tons of coal, or A: Bonds. C: Long-term debt.
ounces of rare metal (e.g., silver). B: Common stock. D: Short-term debt.
D: Are high-interest-rate, high-risk, unsecured bonds which have been used extensively to
finance leveraged buyouts. Capital Structure
48
. A firm must select from among several methods of financing arrangements when meeting its
43
. Bonds payable issued with scheduled maturities at various dates are called capital requirements. To acquire additional growth capital while attempting to maximize
A. B. C. D. earnings per share, a firm should normally
Serial bonds No No Yes Yes A: Attempt to increase both debt and equity in equal proportions, which preserves a stable
Term bonds Yes No No Yes capital structure and maintains investor confidence.
B: Select debt over equity intitially, even though increased debt is accompanied by interest
. Which of the following types of bonds is most likely to maintain a constant market value?
44 costs and a degree of risk.
A: Zero-coupon. C: Callable. C: Select equity over debt initially, which minimizes risk and avoids interest costs.
B: Floating-rate. D: Convertible. D: Discontinue dividends and use current cash flow, which avoids the cost and risk of
increased debt and the dilution of EPS through increased equity.
45
. Assume a company has gone bankrupt and will be liquidated. After liquidating the assets and 49
covering tax liabilities, administration fees, and wage expenses, the following claims remain: . Which one of the following factors might cause a firm to increase the debt in its financial
Notes payable $10,000,000 structure?
Unsecured bank loans 4,000,000 A: An increase in the corporate income tax rate.
Subordinated debentures 6,000,000 B: Increased economic uncertainty.
There is only $10,000,000 available to pay these claims. How much will be allocated to C: An increase in the federal funds rate.
subordinated debentures? D: An increase in the price-earnings ratio.
A: $0 C: $4,000,000 50
B: $3,000,000 D: $6,000,000 . A firm’s target or optimal capital structure is consistent with which one of the following?
A: Maximum earnings per share.
Stocks B: Minimum cost of debt.
46
. Preferred and common stock differ in that C: Minimum cost of equity.
A: Failure to pay dividends on common stock will not force the firm into bankruptcy, while D: Minimum weighted-average cost of capital.
failure to pay dividends on preferred stock will force the firm into bankruptcy. 51
B: Common stock dividends are a fixed amount, while preferred stock dividends are not. . In which stage of a firm’s development is it most likely to seek and obtain external equity
C: Preferred stock has a higher priority than common stock with regard to earnings and financing in the form of venture capital?
assets in the event of bankruptcy. A: Formation. C: Growth to maturity.
D: Preferred stock dividends are deductible as an expense for tax purposes while common B: Rapid growth. D: Maturity and industry decline.
stock dividends are not. 52
. The benefits of debt financing over equity financing are likely to be highest in which of the
following situations?
 A: High marginal tax rates and few noninterest tax benefits. D: Investors have shorter expected holding periods.
B: Low marginal tax rates and few noninterest tax benefits.
C: High marginal tax rates and many noninterest tax benefits. . In comparison to the capital asset pricing model, the arbitrage pricing model
58

D: Low marginal tax rates and many noninterest tax benefits. A: Involves a more precise measurement of systematic risk.
B: Involves a more precise measurement of unsystematic risk.
53
. A company currently has 1,000 shares of common stock outstanding with zero debt. It has the C: Is only useful for pricing preferred stock.
choice of raising an additional $100,000 by issuing 9% long-term debt, or issuing 500 shares D: Does not consider risk.
of common stock. The company has a 40% tax rate. What level of earnings before interest
and taxes (EBIT) would result in the same earnings per share (EPS) for the two financing . Which of the following is the most expensive form of additional capital?
59

options? A: New debt. C: Retained earnings.

A: An EBIT of $27,000 would result in EPS of $10.80 for both. B: New preferred stock. D: New common stock.
B: An EBIT of $27,000 would result in EPS of $7.20 for both.
C: An EBIT of ($18,000) would result in EPS of ($7.20) for both. . The optimal capitalization for an organization usually can be determined by the
60

D: An EBIT of ($10,800) would result in EPS of ($7.92) for both. A: Maximum degree of financial leverage (DFL).
B: Maximum degree of total leverage (DTL).
Cost of Capital C: Lowest total weighted-average cost of capital (WACC).
54
. The theory underlying the cost of capital is primarily concerned with the cost of D: Intersection of the marginal cost of capital and the marginal efficiency of investment.
A: Long-term funds and old funds.
B: Short-term funds and new funds. . The capital structure of a firm includes bonds with a coupon rate of 12% and an effective
61

C: Long-term funds and new funds. interest rate is 14%. The corporate tax rate is 30%. What is the firm’s net cost of debt?
D: Any combination of old or new, short-term or long-term funds. A: 8.4% C: 12.0%
B: 9.8% D: 14.0%
55
. When calculating the cost of capital, the cost assigned to retained earnings should be
A: Zero. . By using the dividend growth model, estimate the cost of equity capital for a firm with a stock
62

B: Lower than the cost of external common equity. price of $30, an estimated dividend at the end of the first year of $3 per share, and an
C: Equal to the cost of external common equity. expected growth rate of 10%.
D: Higher than the cost of external common equity. A: 21.1% C: 11.0%
B: 12.2% D: 20.0%
56
. Assume that nominal interest rates just increased substantially but that the expected future
dividends for a company over the long run were not affected. As a result of the increase in . A company has $650,000 of 10% debt outstanding and $500,000 of equity financing. The
63

nominal interest rates, the company’s stock price should required return of the equity holders is 15% and there are no retained earnings currently
A: Increase. C: Stay constant. available for investment purposes. If new outside equity is raised, it will cost the firm 16%.
B: Decrease. D: Change, but in no obvious direction. New debt would have before-tax cost of 9%, and the corporate tax rate is 50%. When
calculating the marginal cost of capital, the company should assign a cost of <List A> to equity
57
. The market value of a firm’s outstanding common shares will be higher, everything else equal, capital and <List B> to the after-tax cost of debt financing.
if A B. C. D.
A: Investors have a lower required return on equity. List A 15% 15% 16% 16%
B: Investors expect lower dividend growth. List B 4.5% 5.0% 4.5% 5.0%
C: Investors have longer expected holding periods.
64
. Assume that a firm has a 40% tax rate and the following capital structure:
Amount Cost before tax . The Capital Asset Pricing Model (CAPM) computes the expected return on a security by
68

Debt $10,000,000 6% adding the risk-free rate of return to the incremental yield of the expected market return, which
Preferred equity 5,000,000 6% is adjusted by the company's beta. Compute DQZ's expected rate of return on equity.
Common equity 25,000,000 10% A: 9.20% C: 7.20%
  $40,000,000 B: 12.20% D: 12.00%
What is the firm’s weighted-average cost of capital?
A: 7% C: 8.5% . Assume that the after-tax cost of debt is 7% and the cost of equity is 12%. Determine the
69

B: 7.9% D: 10% weighted-average cost of capital.

A: 10.50% C: 9.50%
65
. ABC Co. had debt with a market value of $1 million and an after-tax cost of financing of 8%. B: 8.50% D: 6.30%
ABC also had equity with a market value of $2 million and a cost of equity capital of 9%.
ABC’s weighted-average cost of capital would be . A company has the following financial information:
70

A: 8.0% C: 8.7% Source of capital Proportion of capital structure Cost of capital

B: 8.5% D: 9.0% Long-term debt 60% 7.1%
Preferred stock 20% 10.5%
66
. A company with a combined federal and state tax rate of 30% has the following capital Common stock 20% 14.2%
structure: To maximize shareholder wealth, the company should accept projects with returns greater
Weight Instrument Cost of capital than what percent?
40% Bonds 10% A: 7.1% C: 10.6%
50% Common stock 10% B: 9.2% D: 14.2%
10% Preferred stock 20%
What is the weighted-average after-tax cost of capital for this company? Retained Earnings Breakpoint
A: 3.3% C: 8.2% 71
. A company has $1,500,000 of outstanding debt and $1,000,000 of outstanding common
B: 7.7% D: 9.8% equity. Management plans to maintain the same proportions of financing from each source if
additional projects are undertaken. If the company expects to have $60,000 of retained
Questions 1 thru 3 are based on the following information. earnings available for reinvestment in new projects in the coming year, what dollar amount of
DQZ Telecom is considering a project for the coming year that will cost $50,000,000. DQZ plans to new investments can be undertaken without issuing new equity?
use the following combination of debt and equity to finance the investment: A: $0 C: $ 90,000
• Issue $15,000,000 of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation B: $ 24,000 D: $150,000
costs of 1.5% of par. The after-flotation cost yield is 8.08%.
• Use $35,000,000 of funds generated from earnings. Dividend Policy
• The equity market is expected to earn 12%. US Treasury bonds are currently yielding 5%. 72
. In practice, dividends
The beta coefficient for DQZ is estimated to be .60. DQZ is subject to an effective corporate A: Usually exhibit greater stability than earnings.
income tax rate of 40%. B: Fluctuate more widely than earnings.
C: Tend to be a lower percentage of earnings for mature firms.
67
. The before-tax cost of DQZ’s planned debt financing, net of flotation costs, in the first year is D: Are usually set as a fixed percentage of earnings.
A: 8.08% C: 7.92%
B: 10.00% D: 8.00%
73
. Which of the following types of dividends do not reduce the shareholders’ equity in the B: Common stockholders are worse off than they would have been if the firm was not as
corporation? heavily leveraged.
A: Cash dividends. C: Liquidating dividends. C: The extent of financial leverage is not relevant to the well-being of common stockholders.
B: Property dividends. D: Stock dividends. D: It is impossible to determine the effect without knowing the operating leverage.
74
. Which of the following statements is correct regarding the declaration of a stock dividend by a
corporation having only one class of par value stock?
A: A stock dividend has the same legal and practical significance as a stock split.
B: A stock dividend increases a stockholder’s proportionate share of corporate ownership.
C: A stock dividend causes a decrease in the assets of the corporation.
D: A stock dividend is a corporation’s ratable distribution of additional shares of stock to its
stockholders.

Leverage
75
. The degree of operating leverage (DOL) is
A: Constant at all levels of sales.
B: A measure of the change in earnings available to common stockholders associated with a
given change in operating earnings.
C: A measure of the change in operating income resulting from a given change in sales.
D: Lower if the degree of total leverage is higher, other things held constant.
76
. The purchase of treasury stock with a firm’s surplus cash
A: Increases a firm's assets.
B: Increases a firm's financial leverage.
C: Increases a firm's interest coverage ratio.
D: Dilutes a firm's earnings per share.
77
. If two companies, company X and company Y, are alike in all respects except that company X
employs more debt financing and less equity financing than company Y does, which of the
following statements is true?
A: Company X has more net earnings variability than company Y.
B: Company X has more operating earnings variability than company Y.
C: Company X has less operating earnings variability than company Y.
D: Company X has less financial leverage than company Y.
78
. Which of the following is accurate regarding a company with a high degree of financial
leverage and significant losses for the period?
A: Common stockholders are better off than they would have been if the firm was not as
heavily leveraged.
1
.Answer A is correct. Net working capital is equal to current assets minus current liabilities.
2
.Answer D is correct. Issuance of common stock increases cash and equity. Since cash is increased the current ratio is
also increased.
3
.Answer A is correct. The cash conversion cycle measures the time period from the time the firm pays for its materials
and labor to the time it collects its cash from sales.
4
.Answer C is correct. The cash conversion cycle is the length of time between paying for purchases and receiving cash
from the sale of finished goods. It is calculated as follows: Cash conversion cycle = Inventory conversion period +
Receivables collection period – Payables deferral period = 58 days + 32 days – 15 days = 75 days.
Answer A is incorrect. This solution subtracts, rather than adds, the receivables collection period: Cash conversion
cycle = Inventory conversion period – Receivables collection period – Payables deferral period = 58 days – 32 days – 15
days = 11 days. Answer B is incorrect. This solution subtracts, rather than adds, the receivables collection period and
also adds, rather than subtracts, the payables deferral period: Cash conversion cycle = Inventory conversion period –
Receivables collection period + Payables deferral period = 58 days – 32 days + 15 days = 41 days. Answer D is
incorrect. This calculation omits the subtraction of the payables deferral period: Cash conversion cycle = Inventory
conversion period + Receivables collection period = 58 days + 32 days = 90 days.
5
.Answer B is correct. Financing permanent working capital with long-term debt is considered to be a conservative
policy.
Answer D is incorrect. Long-term financing is typically more expensive than short-term financing.
6
.Answer A is correct because an important financial strategy involves matching maturities of assets and liabilities to
reduce risk.
Answer B is incorrect because long-term rates have traditionally been more stable than short-term rates. Answer C is
incorrect because short-term debt is more difficult to repay than long-term because it is due within one year. Answer D
is incorrect because short-term financing requirements change more frequently than long-term requirements.
7
.Answer A is correct. A compensating balance compensates the financial institution for services.
8
.Answer C is correct. By using regional banks and not transferring funds until the checks are presented, the float on
disbursements is maximized.
Answer A is incorrect. There is no money on deposit in the account. Answer B is incorrect. There is no money on
deposit in the account. Answer D is incorrect. This technique does not affect the float on cash receipts.
9
.Answer A is correct because in a lockbox system payments are sent directly to the company’s financial institution.
Therefore, collection float is minimized.
Answer B is incorrect because a lockbox minimizes float. Answer C is incorrect because a lockbox does not affect
disbursement float. Answer D is incorrect because a lockbox does not affect disbursement float.
10
.Answer D is correct. A reduction of 2 days of collection time on receipts of $100,000 would increase the firm’s average
cash balance by $200,000 (2 × $100,000). This would save the firm interest in the amount of $12,000 ($200,000 × 6%).
The net benefit is the interest savings, $12,000, less the fee, $6,000, or $6,000.
11
.Answer D is correct. The standard account will cost $10 per month plus $8 in check charges (80 x $0.10) = $18, or
$216 per year. The premium account will have no fee but will require an additional $2,000 ($2,500 – 500) of funds on
deposit. The interest cost on $2,000 for the year is $200 ($2,000 x 10%). Therefore, the cost of the premium checking
is less by $16.
12
.Answer D is correct. Short-term investments must be liquid and safe to provide funds when needed.
13
.Answer A is correct. The requirement is to identify the ratio that is appropriate for evaluation of accounts receivable.
Answer A is correct because days’ sales outstanding provides a measure of the average age of accounts receivable.
Answer B is incorrect because it represents a profitability measure. Answer C is incorrect because it is not a commonly
used ratio. Answer D is incorrect because it is a measure of liquidity.
14
.Answer A is correct. The collection period is the average time it takes from sale to collection.
Answer B is incorrect. This is the float. Answer C is incorrect.  Refer to the correct answer explanation. Answer D is
incorrect.  Refer to the correct answer explanation.
15
.Answer C is correct. Average daily sales times average collection period would equal the average receivables balance.
16
.Answer C is correct. The requirement is to calculate the number of days’ sales in accounts receivable. Answer C is
correct because 60% of the company’s customers pay in 10 days and 40% pay in 30 days. Therefore, the days’ sales is
equal to 18 days [(.60 × 10) + (.4 × 30)].
Answer A is not the appropriate result. Answer B is not the appropriate result. Answer D is not the appropriate result.
17
.Answer C is correct. Receivables on August sales still outstanding at the end of September are in the 31-to-60-day age
group. As a proportion of total receivables, the 31-to-60-day age group represents 170 / 350 = 48.57%.
Answer A is incorrect. This is the proportion of receivables in the 0-to-30-day age group at the end of September
incorrectly calculated using 75 instead of 80 as the outstanding receivables. Receivables on September sales still
outstanding at the end of September are in the 0-to-30-day age group and represent 75 / 350 = 21.43% of total
outstanding receivables at that time. Answer B is incorrect. This is the proportion of receivables in the 61-to-90-day age
group at the end of September. Receivables on July sales still outstanding at the end of September are in the 61-to-90-
day age group and represent 100 / 350 = 28.57% of total outstanding receivables at that time. Answer D is incorrect.
This is the proportion of outstanding receivables that are from 0 to 60 days old and that arose from both August and
September sales. As a proportion of total receivables, those that are 0 to 60 days old represent (170 + 80) / 350 = 250 /
350 = 71.43%
18
.Answer B is correct. On the 40% of sales to customers not taking the cash discount, a 10-day reduction in the average
collection period will reduce the accounts receivable balance as follows: .4 x Daily unit sales x Unit price x Reduction in
days outstanding = .4 x 1,000 x $10 x 10 = $40,000.
Answer A is incorrect. This solution does not multiply the unit sales volume by the price per unit and calculates the
reduction in account receivable as: .4 x Daily unit sales x Reduction in days outstanding = .4 x 1,000 x 10 = $4,000.
Answer C is incorrect. This is the total balance of accounts receivable under the new collection policy: .4 x Daily unit
sales x Unit price x Average collection period = .4 x 1,000 x $10 x 60 days = $240,000. Answer D is incorrect. This is
the total balance of accounts receivable under the old collection policy: .4 x Daily unit sales x Unit price x Average
collection period = .4 x 1,000 x $10 x 70 days = $280,000.
19
.Answer C is correct. The average collection period is calculated as: .5(10 days) + .5(30 days) = 5 + 15 = 20 days.
Answer A is incorrect. It is based on 100% of the customers taking the discount. Answer B is incorrect. It is based on
half of the customers paying on day 30 but ignores the remaining half of the customers who are paying on day 10.
Answer D is incorrect. It is based on 100% of the customers paying on day 30.
20
.Answer D is correct. The average accounts receivable balance is calculated as: Credit sales per day x Average
collection period = (10,000 units x $66 unit price) / 365 x 25 days = $45,205.48.
Answer A is incorrect. It is based on credit sales of $10,000 per annum rather than 10,000 x $66 ($10,000 / 365) x 25 =
$684.93. Answer B is incorrect. It is the credit sales per day: (10,000 x $66) / 365 = $1808.22. Answer C is incorrect.
The calculation is based on a 15-day average collection period: $1808.22 x 15 = $27,123.30.
21
.Answer C is correct. The key aspect of supply chain management is the sharing of information about forecasted
production needs with suppliers, who share it with their suppliers, etc.
22
.Answer B is correct. Incoming inspection of goods is not a feature of JIT. Instead, vendors inspect their own goods
and guarantee that they are free of defects, thus eliminating the need for incoming inspection by the purchaser.
Answer A is incorrect. Reduction of inventories is a feature of JIT. Answer C is incorrect. Simplification of production
activities is a feature of JIT. Answer D is incorrect.  Refer to the correct answer explanation.
23
.Answer A is incorrect. While the supplier may ask for a concession in its selling price which would raise the
manufacturer’s purchasing costs, the manufacturing company will be receiving fewer materials at any point in time
increasing the likelihood of stockout, thereby resulting in an increase in stockout costs. Answer B is incorrect. While the
supplier may ask for a concession in its selling price which would raise the manufacturer’s purchasing costs, the cost of
quality would not necessarily be affected by the JIT purchasing system. Answer C is incorrect. With fewer purchase
orders being processed by the manufacturer, the ordering costs are likely to decrease. However, the cost of quality
would not necessarily be affected by the JIT purchasing system.
Answer D is correct. In this situation, the company will be receiving fewer materials at any point in time, increasing the
likelihood of stockout; at the same time, the average inventory will be less, resulting in a reduction in the carrying costs.
24
.Answer A is correct. If cost of sales is $132,500,000 and inventory turnover is 8 times per year, average inventory is
$16,562,500 ($132,500,000/8) If turnover increases to 10 times, average inventory would decrease to $13,250,000
($132,500,000/10). Average inventory would decrease by $3,312,500 ($16,562,500 – $13,250,000), which would save
Spotech $165,625 ($3,312,500 x 5%) in interest.
25
.Answer A is correct. The economic order quantity model minimizes the sum of ordering and carrying costs.
Answer B is incorrect. Just-in-time attempts to reduce inventory levels to near zero. Answer C is incorrect. Materials
requirements planning is a manufacturing planning system. Answer D is incorrect. ABC is a costing system.
26
.Answer C is correct.  The requirement is to identify the assumption that is associated with the economic order quantity
formula. Periodic demand must be assumed to use the economic quantity formula.
Answer A is incorrect because carrying costs are assumed to be constant, not variable. Answer B is incorrect because
the cost of placing an order is assumed to be constant, not variable. Answer D is incorrect because the purchase cost
per unit is assumed to be constant, not variable.
27
.Answer B is correct. The economic order quantity formula is

 
In the above equation, a = cost of placing one order, D = annual demand in units, and K = annual cost of carrying one
unit in inventory for 1 year (i.e., inventory carrying cost). With this information it is easy to see that inventory carrying
cost is used in the denominator and cost per purchase order in the numerator.
28
.Answer A is correct. The annual cost of carrying inventory is the average inventory level times the cost per unit of
inventory times the cost of capital. It is calculated as follows: Average inventory level x Unit cost x Cost of capital =
(order size / 2) x $5 x .12 = (500 / 2) x $5 x .12 = $150.
Answer B is incorrect. This answer is obtained by using the total annual quantity rather than the average inventory level
and by neglecting to multiply by the unit price: = Annual quantity x .12 = 1,500 x .12 = 180. Answer C is incorrect. This
answer is obtained by using the order size rather than the average inventory level: = Order size x $5 x .12 = 500 x $5 x .
12 = $300. Answer D is incorrect. This answer is obtained by using the total annual quantity rather than the average
inventory level: = 1,500 x $5 x .12 = $900.
29
.Answer B is correct. The lead time multiplied by the usage per day expected during lead time yields the reorder point.
The most common approach to setting the optimum safety-stock level is to examine previous lead time periods to
determine the probabilities of running out of stock (a stockout) for different assessed levels of safety stock. Cost is used
to determine the amount to be ordered, known as the economic order quantity, not when to reorder.
30
.Answer D is correct. The solutions approach is to compute the total cost for each of the four answer choices as
illustrated below. The carrying cost is $2 for each unit of safety stock. The stockout cost per year equals the probability
 of running out of inventory times $80 per stockout times five orders per year. The lowest total cost of carrying safety
stock and stockouts is $130 [(55 units x $2/unit) + ($80 x 5% x 5 reorders)]. Thus, 55 units of safety stock should be
maintained.
Safety stock Carrying cost Stockout cost/5 orders Total cost
20 $ 40 $160 $200
40 $ 80 $ 80 $160
50 $100 $ 40 $140
55 $110 $ 20 $130
31
.Answer C is correct. The buyer is receiving 2% of the face for paying the account 30 days before it is due. The formula
to calculate the nominal rate is shown below.
= 2% x 360 days
Nominal interest rate
100% – 2% 40 days – 10 days
         
  = 24.49%    
32
.Answer C is correct. Only very creditworthy firms can issue commercial paper.
33
.Answer C is correct. A banker’s acceptance is a time draft, payable on a specified future date, with the bank
guaranteeing the payment.
Answer A is incorrect. The description is of a sight draft, except that with a sight draft it is the buyer that accepts the
goods, not the bank. Answer B is incorrect. The description is of an open account for any buyer/seller relationship.
Answer D is incorrect. The description is of a conditional sales contract except that with a conditional sales contract it is
the seller, not the bank, that retains title to the goods until the buyer has completed the payment.
34
.Answer D is correct. The cost of proposal a. is $252,000 (700 x 360 x $0.50). The cost of proposal b. is $125,000.
The cost of proposal c. is $136,080 (0.03% x 700 x $1,800 x 360). The cost of proposal d. is $122,500 (7% x
$1,750,000). Therefore, D is the best alternative.
35
.Answer B is correct.  The requirement is to calculate the effective interest on the loan. The effective rate is calculated
by dividing the interest amount by the outstanding balance less the compensating balance requirement. The annual
interest amount is equal to $40,000 (8% × $500,000) and the compensating balance amount is equal to $100,000 (20%
× $500,000). The effective interest rate is equal to 10% [$40,000 ÷ ($500,000 – $100,000)].
36
.Answer D is correct. In a capital lease transaction, the lessee is using the lease as a financing source and the lessor is
financing the transaction (providing the investment capital) through the leased asset.
Answer A is incorrect. It is the lessee that obtains use of the asset in a lease transaction, whether it is an operating or a
capital lease Answer B is incorrect. It is the lessee that uses the lease as a source of financing, but under a capital
lease rather than under an operating lease. Answer C is incorrect. It is the lessee that makes payments to the lessor.
These payments are actually installment payments under a capital lease.
37
.Answer D is correct. The requirement is to identify the most likely reason to agree to a debt covenant restricting the
percentage of long-term debt. Answer D is correct because such a covenant would reduce the interest rate on the debt
being issued.
Answer A is incorrect because it is difficult to determine the effect on share price. Answer B is incorrect because it
would likely raise the company’s bond rating, if anything. Answer C is incorrect because it has no effect on the risk of
existing bondholders.
38
.Answer C is correct. A call provision allows the corporation to call the bond even if the bondholder does not want to
dispose of the investment.
39
.Answer C is correct. Serial bonds mature on varying dates allowing an investor to choose a maturity date.
40
.Answer D is correct. A bond secured by property is referred to as a mortgage bond.
41
.Answer B is correct. Eurobonds are subject to less stringent registration requirements making them less costly to issue.
Answer A is incorrect. Eurobonds are not denominated in local currency. Answer C is incorrect. Foreign buyers do not
necessarily more readily accept Eurobonds. Answer D is incorrect. Eurobonds do carry foreign exchange risk to the
investor.
42
.Answer B is correct. This is one of the features that make zero-coupon bonds attractive to the issuer.
Answer A is incorrect. Deep discount and zero-coupon bonds sell for a small fraction of their face value but deep
discount bonds pay interest (based on an interest rate that is significantly below the market rate) while zero-coupon
bonds do not. Answer C is incorrect. This is the definition for “commodity-backed” bonds, which are also called “asset-
linked” bonds. Answer D is incorrect. This is the definition for “junk bonds.”
43
.Answer C is correct. Serial bonds are bond issues that mature in installments (i.e., on the same date each year over a
period of years). Term bonds, on the other hand, are bond issues that mature on a single date.
44
.Answer B is correct.  The requirement is to identify the types of bonds that are most likely to maintain a constant market
value. A bond with a floating rate will generally hold a steady market value because its value will not change due to
changes in prevailing interest rates.
Answer A is incorrect because a zero-coupon rate bond increases in value as it approaches its maturity. Answer C is
incorrect because a callable bond has a fixed interest rate and its market value fluctuates with changes in prevailing
interest rates. Answer D is incorrect because a convertible bond has a fixed interest rate and is convertible into stock.
Therefore its market value fluctuates with both changes in prevailing interest rates and changes in the value of the stock.
45
.Answer A is correct. The subordinated debentures are unsecured and subordinated to other liabilities.
46
.Answer C is correct. Preferred stock has a higher priority than common stock for both dividend payment and assets in
the event of bankruptcy.
47
.Answer B is correct because the issuance of common stock involves no fixed charges, no fixed maturity dates and will
increase the creditworthiness of the company.
48
.Answer B is correct. Debt financing is the least costly and using it would tend to maximize earnings per share.
49
.Answer A is correct. Interest is tax-deductible. Therefore, an increase in income tax rate would reduce the after-tax
cost of debt as a form of financing.
Answer B is incorrect. If economic uncertainty increases, management should not assume more debt. Answer C is
incorrect. An increase in the federal funds rate will increase the cost of debt. Answer D is incorrect. An increase in the
price-earnings ratio decreases the cost of equity.
50
.Answer D is correct. Optimal capital structure results in the least weighted-average cost of capital.
51
.Answer B is correct. At the rapid growth stage, if a company is reasonably profitable it will experience financing needs
in excess of funds available either internally or from trade credit or bank credit. Additional debt financing would often
result in an unreasonable amount of financial leverage at this stage of development and public equity financing is not yet
available to the company. This is the stage at which the company is most likely to seek and obtain venture capital
financing.
Answer A is incorrect. During the formation stage, personal savings, trade credit, and government agencies are the
main sources of financing. Prior to demonstrating initial success, a company is not likely to easily attract venture capital
financing. Answer C is incorrect. In the growth to maturity stage of development, the company is able to access formal
markets for debt and equity because it has a track record of success and a better balance between cash in- and
outflows than it had in the rapid growth stage. Formal capital markets provide financing at lower cost than venture
capitalists, so venture capital is not likely to be sought at this stage. Answer D is incorrect. The decline phase is
 characterized by more than adequate cash flows, relative to available investment opportunities, so venture capital is not
likely to be sought at this stage of development.
52
.Answer A is correct. The requirement is to identify the circumstances in which the benefits of debt financing over equity
financing are likely to be the highest. Answer A is correct because when the marginal tax rate is high and the company
has few noninterest tax benefits, the deduction for interest on debt is maximized.
Answer B is incorrect because a low marginal tax rate minimizes the tax benefits of debt financing. Answer C is
incorrect because many noninterest tax benefits reduces the potential benefit of debt financing. Answer D is incorrect
because a low marginal tax rate minimizes the tax benefits of debt financing.
53
.Answer A is correct.  The requirement is to determine the level of earnings before interest and taxes that would result in
the same earnings per share under the two financing options. Answer A is correct as calculated below.
Alternative 1—issuing long-term debt
Interest = $9,000 ($100,000 × 9%)
Earnings before taxes = $18,000 ($27,000 EBIT – $9,000 interest)
(EBT)
Taxes = $7,200 (40% $18,000 EBT)
Net earnings = $10,800 ($18,000 EBT – $7,200 taxes)
EPS = $10.80 (net earnings $10,800 ÷ 1,000 shares
outstanding)
Alternative 2—issue additional stock
Net earnings = $16,200 [$27,000 EBIT – taxes $10,800 (40% × $27,000)]
EPS = $10.80 (net earnings $16,200 ÷ 1,500 shares
outstanding)
54
.Answer C is correct. The theory underlying cost of capital is related to existing long-term financing and obtaining new
long-term financing.
55
.Answer B is correct. New common equity has floatation costs that increase its cost above retained earnings.
56
.Answer B is correct. If the nominal rate of interest increases, investors will expect a higher yield from all investments.
Therefore, the stock price will decline.
57
.Answer A is correct. Investors value common shares more highly if they have a lower required return because then
they apply a lower discount rate to the expected future dividend stream of the company.
Answer B is incorrect. Lower expected dividend growth would reduce, not increase, the market value of the outstanding
common shares of the company. Answer C is incorrect. Expected holding periods of investors are not relevant to
market valuation of the outstanding common shares of the company. Answer D is incorrect. Expected holding periods
of investors are not relevant to market valuation of the outstanding common shares of the company.
58
.Answer A is correct. The arbitrage pricing model includes a series of systematic risk factors to estimate systematic risk.
CAPM only includes one.
Answer B is incorrect. Unsystematic risk is assumed to be diversified away. Answer C is incorrect. It is used for pricing
common stock. Answer D is incorrect. The model does consider risk.
59
.Answer D is correct. Common stock is the most expensive form of financing and because of floatation costs new
common stock is more expensive than retained earnings.
60
.Answer C is correct because the optimal capital structure for an organization is when it minimizes its weighted-average
cost of capital.
Answer A is incorrect because the maximum degree of financial leverage does not minimize the cost of capital. Answer
B is incorrect because the maximum degree of total leverage does not minimize the cost of capital. Answer D is
incorrect because this relationship does not deal with appropriate capital structure.
61
.Answer B is correct. The requirement is to compute the cost of debt. Answer B is correct because the cost of debt is
equal to the effective rate less the tax advantage, or 9.8% [14% × (1–.3)].
Answer A is incorrect because it uses the coupon rate. Answer C is incorrect because it uses the coupon rate. Answer
D is incorrect because it does not adjust for the tax benefit.
62
.Answer D is correct.
ks = D1 + Expected g =
P0 $3.00 / $30.00

63
.Answer C is correct. The marginal cost of equity financing is 16% and the after-tax cost of new debt financing is 9% x
(1 – .5), or 4.5%.
Answer A is incorrect. 15% is the cost of existing equity financing. Answer B is incorrect. These are the costs of
existing debt and equity financing and the question asks for the incremental costs of both financing sources. Answer D
is incorrect. 5% is the after-tax cost of existing debt financing.
64
.Answer B is correct. 7.9% = [6% x (1 – .4)] x $10,000,000 / 40,000,000 + (6% x $5,000,000 / 40,000,000) + (10% x
$25,000,000 / $40,000,000).
65
.The requirement is to compute the weighted-average cost of capital. Answer C is correct as calculated below:
Cost of capital Weight Weighted
average
Debt 8% 33 1/3% 2.667%
Equity 9% 66 2/3% 6.000%
      8.667%
66
.Answer D is correct. The requirement is to calculate the weighted-average after-tax cost of capital. The after-tax cost
of capital for the bonds is equal to 7% [10% × (100% – 30% tax rate)], and the weighted-average cost of capital for the
company is equal to 9.8% as calculated below.
Weight Cost of capital Weighted cost
Bonds 40% 7% 2.8%
Common stock 50% 10% 5.0%
Preferred stock 10% 20% 2.0%
Weighted-avg. 9.8%
67
.Answer A is correct. The cost of debt before tax is the bond yield to maturity, 8.08%.
68
.Answer A is correct. CAPM is calculated as ks (CAPM) = kRF + (kM – kRF)bi, which is the risk-free interest rate + (the
market rate – risk-free interest rate) x beta. This is equal to 9.20% [(5% + (12% – 5%) x .60].
69
.Answer A is correct. The cost of debt and equity is weighted in proportion to its percentage of the total financing. $15
million or 30% of the financing is coming from debt and $35 million or 70% is coming from equity. Therefore, the
weighted-average cost of capital is 10.5% = (30% x 7%) + (70% x 12%).
70
.Answer B is correct.  The requirement is to determine the return that would maximize shareholder wealth. The
weighted-average cost of capital is equal to 9.2% and taking projects in excess of that percentage would maximize
shareholder return. The weighted-average cost of capital is calculated as 9.2% [(7.1% × 60%) + (10.5% × 20%) +
(14.2% × 20%)].
71
.Answer D is correct. The proportion of equity in the financial structure of the firm is the value of outstanding equity
divided by the total value of all financing sources.
Value of equity = 1,000,000 = .40
Value of debt + Value of equity 1,000,000 + 1,500,000
 Since the question states that the firm will maintain the same weight of each financing source, each dollar invested is
composed of 40 cents of equity and 60 cents of debt. The first $60,000 of equity used in financing new projects is
sourced from retained earnings. This source of equity is exhausted when the firm reaches an investment level of
$60,000 / .4 = $150,000. When the level of investment exceeds this amount, equity financing must be raised externally.
Answer A is incorrect. The company has retained earnings to use as one source of project financing. Answer B is
incorrect. This answer multiplies, rather than divides by, the weight equity represents in the financial structure (see D.
for the correct calculation). This solution is calculated as: $60,000 x .40 = $24,000. Answer C is incorrect. This answer
calculates the proportion of equity financing incorrectly as: Value of equity / value of debt = 1,000,000 / 1,500,000 = .
667 so the investment level at which retained earnings would be exhausted is $60,000 / .667 = $90,000. See solution
D. for the correct calculation.
72
.Answer A is correct. Firms tend to establish a stable dividend policy and are hesitant to decrease dividends.
73
.Answer D is correct. Stock dividends involve issuing stock in the form of the firm’s own shares. They do not involve
distribution of assets.
74
.Answer D is correct because a stock dividend involves a ratable distribution of additional shares to common
stockholders.
Answer A is incorrect because a stock split alters the par value of stock and a stock dividend does not. Answer B is
incorrect because a stock dividend results in stockholders having the same proportionate share of ownership in the
corporation. Answer C is incorrect because declaration of a stock dividend has no effect on the assets of the
corporation. It is paid in stock of the corporation not in cash.
75
.Answer C is correct. The degree of operating leverage (DOL) is a measure of the change in earnings available to
common stockholders associated with a given change in operating earnings. It is calculated, for a particular level of
sales, as
Percentage change in operating income
Percentage change in sales volume
Answer A is incorrect. DOL is specific to the initial sales level and varies with the initial sales level. Answer B is
incorrect. The statement describes the degree of financial leverage (DFL), not the degree of operating leverage (DOL).
Answer D is incorrect. The degree of total leverage is the multiple of the degree of operating leverage and the degree of
financial leverage. Other things equal, DOL is higher if the degree of total leverage is higher.
76
.Answer B is correct. Purchase of treasury stock decreases the firm’s assets and stockholders’ equity. Therefore it
increases the firm’s financial leverage.
77
.Answer A is correct. Since company X has more debt financing, it has greater fixed financing charges than company Y.
Interest payments are fixed financing charges while dividends are not. As a result, company X will have a more volatile
net income stream than company Y, all else equal.
Answer B is incorrect. The level of fixed financing charges does not affect operating income variability. Answer C is
incorrect. The level of fixed financing charges does not affect operating income variability. Answer D is incorrect.
Company X has greater, not less, financial leverage than company Y. Greater use of debt financing means that a
company has greater financial leverage.
78
.Answer B is correct. When the firm performs poorly, common stockholders are better off with less financial leverage.