ANALYSIS OF CHAPTER

FINANCIAL3 STATEMENTS Multiple

Choice:
Conceptual

Easy:
Current ratio Answer: a Diff: E
1
. All else being equal, which of the following will increase a company’s current ratio?
a. An increase in accounts receivable.
b. An increase in accounts payable.
c. An increase in net fixed assets.
d. Statements a and b are correct.
e. All of the statements above are correct.
Current ratio Answer: d Diff: E
2
. Pepsi Corporation’s current ratio is 0.5, while Coke Company’s current ratio is 1.5. Both firms want to “window
dress” their coming end-of-year financial statements. As part of its window dressing strategy, each firm will double its
current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the
statements below best describes the actual results of these transactions?
a. The transactions will have no effect on the current ratios.
b. The current ratios of both firms will be increased.
c. The current ratios of both firms will be decreased.
d. Only Pepsi Corporation’s current ratio will be increased.
e. Only Coke Company’s current ratio will be increased.
Cash flows Answer: a Diff: E
3
. Which of the following alternatives could potentially result in a net increase in a company’s cash flow for the current
year?
a. Reduce the days sales outstanding ratio.
b. Increase the number of years over which fixed assets are depreciated.
c. Decrease the accounts payable balance.
d. Statements a and b are correct.
e. All of the statements above are correct.
Leverage and financial ratios Answer: d Diff: E
4
. Stennett Corp.’s CFO has proposed that the company issue new debt and use the proceeds to buy back common stock.
Which of the following are likely to occur if this proposal is adopted? (Assume that the proposal would have no effect
on the company’s operating income.)
a. Return on assets (ROA) will decline.
b. The times interest earned ratio (TIE) will increase.
c. Taxes paid will decline.
d. Statements a and c are correct.
e. None of the statements above is correct.
Leverage and profitability ratios Answer: e Diff: E
5
. Amazon Electric wants to increase its debt ratio, which will also increase its interest expense. Assume that the higher
debt ratio will have no effect on the company’s operating income, total assets, or tax rate. Also, assume that the basic
earning power ratio exceeds the before-tax cost of debt financing. Which of the following will occur if the company
increases its debt ratio?
a. Its ROA will fall.
b. Its ROE will increase.
c. Its basic earning power (BEP) will stay unchanged.
d. Statements a and c are correct.
e. All of the statements above are correct.
EVA Answer: b Diff: E N
6
. Which of the following statements is most correct?
a. A company that has positive net income must also have positive EVA.
b. If a company’s ROE is greater than its cost of equity, its EVA is positive.
c. If a company increases its EVA, its ROE must also increase.
d. Statements a and b are correct.
e. All of the above statements are correct.
ROE and EVA Answer: e Diff: E
7
. Which of the following statements is most correct about Economic Value Added (EVA)?
a. If a company has no debt, its EVA equals its net income.
b. If a company has positive ROE, its EVA must also be positive.
c. A company’s EVA will be positive whenever the cost of equity exceeds the ROE.
d. All of the statements above are correct.
e. None of the statements above is correct.
ROE and EVA Answer: b Diff: E
8
. Devon Inc. has a higher ROE than Berwyn Inc. (17 percent compared to 14 percent), but it has a lower EVA than
Berwyn. Which of the following factors could explain the relative performance of these two companies?

a. Devon is much larger than Berwyn.

b. Devon is riskier, has a higher WACC, and a higher cost of equity.
c. Devon has a higher operating income (EBIT).
d. Statements a and b are correct.
e. All of the statements above are correct.
Ratio analysis Answer: b Diff: E
9
. Bedford Hotels and Breezewood Hotels both have $100 million in total assets and a 10 percent return on assets
(ROA). Each company has a 40 percent tax rate. Bedford, however, has a higher debt ratio and higher interest
expense. Which of the following statements is most correct?

a. The two companies have the same basic earning power (BEP).
b. Bedford has a higher return on equity (ROE).
c. Bedford has a lower level of operating income (EBIT).
d. Statements a and b are correct.
e. All of the statements above are correct.
Financial statement analysis Answer: a Diff: E
10
. Company J and Company K each recently reported the same earnings per share (EPS). Company J’s stock, however,
trades at a higher price. Which of the following statements is most correct?
a. Company J must have a higher P/E ratio.
b. Company J must have a higher market to book ratio.
c. Company J must be riskier.
d. Company J must have fewer growth opportunities.
e. All of the statements above are correct.
Financial statement analysis Answer: e Diff: E
11
. Company A’s ROE is 20 percent, while Company B’s ROE is 15 percent. Which of the following statements is most
correct?
a. Company A must have a higher ROA than Company B.
b. Company A must have a higher EVA than Company B.
c. Company A must have a higher net income than Company B.
d. All of the statements above are correct.
e. None of the statements above is correct.
Financial statement analysis Answer: e Diff: E
12
. Company A and Company B have the same total assets, return on assets (ROA), and profit margin. However,
Company A has a higher debt ratio and interest expense than Company B. Which of the following statements is most
correct?
a. Company A has a higher ROE (return on equity) than Company B.
b. Company A has a higher total assets turnover than Company B.
c. Company A has a higher operating income (EBIT) than Company B.
d. Statements a and b are correct.
e. Statements a and c are correct.
Financial statement analysis Answer: d Diff: E N
13
. Nelson Company is thinking about issuing new common stock. The proceeds from the stock issue will be used to
reduce the company’s outstanding debt and interest expense. The stock issue will have no effect on the company’s
total assets, EBIT, or tax rate. Which of the following is likely to occur if the company goes ahead with the stock
issue?
 a. The company’s net income will increase.
b. The company’s times interest earned ratio will increase.
c. The company’s ROA will increase.
d. All of the above statements are correct.
e. None of the above statements is correct.
Miscellaneous ratios Answer: a Diff: E
14
. Companies A and B have the same profit margin and debt ratio. However, Company A has a higher return on assets
and a higher return on equity than Company B. Which of the following can explain these observed ratios?
a. Company A must have a higher total assets turnover than Company B.
b. Company A must have a higher equity multiplier than Company B.
c. Company A must have a higher current ratio than Company B.
d. Statements b and c are correct.
e. All of the statements above are correct.
Miscellaneous ratios Answer: e Diff: E R
15
. Bichette Furniture Company recently issued new common stock and used the proceeds to reduce its short-term notes
payable and accounts payable. This action had no effect on the company’s total assets or operating income. Which of
the following effects did occur as a result of this action?
a. The company’s current ratio decreased.
b. The company’s basic earning power ratio increased.
c. The company’s time interest earned ratio decreased.
d. The company’s debt ratio increased.
e. The company’s equity multiplier decreased.
Medium:
Current ratio Answer: d Diff: M
16
. Van Buren Company has a current ratio = 1.9. Which of the following actions will increase the company’s current
ratio?
a. Use cash to reduce short-term notes payable.
b. Use cash to reduce accounts payable.
c. Issue long-term bonds to repay short-term notes payable.
d. All of the statements above are correct.
e. Statements b and c are correct.
Current ratio Answer: e Diff: M
17
. Which of the following actions can a firm take to increase its current ratio?
a. Issue short-term debt and use the proceeds to buy back long-term debt with a maturity of more than one year.
b. Reduce the company’s days sales outstanding to the industry average and use the resulting cash savings to
purchase plant and equipment.
c. Use cash to purchase additional inventory.
d. Statements a and b are correct.
e. None of the statements above is correct.
Ratio analysis Answer: c Diff: M
18
. As a short-term creditor concerned with a company’s ability to meet its financial obligation to you, which one of the
following combinations of ratios would you most likely prefer?
Current Debt
ratio TIE ratio
a. 0.5 0.5 0.33
b. 1.0 1.0 0.50
c. 1.5 1.5 0.50
d. 2.0 1.0 0.67
e. 2.5 0.5 0.71
Ratio analysis Answer: c Diff: M N
19
. Drysdale Financial Company and Commerce Financial Company have the same total assets, the same total assets
turnover, and the same return on equity. However, Drysdale has a higher return on assets than Commerce. Which of
the following can explain these ratios?
a. Drysdale has a higher profit margin and a higher debt ratio than Commerce.
b. Drysdale has a lower profit margin and a lower debt ratio than Commerce.
c. Drysdale has a higher profit margin and a lower debt ratio than Commerce.
 d. Drysdale has lower net income but more common equity than Commerce.
e. Drysdale has a lower price earnings ratio than Commerce.
Ratio analysis Answer: a Diff: M
20
. You are an analyst following two companies, Company X and Company Y. You have collected the following
information:
 The two companies have the same total assets.
 Company X has a higher total assets turnover than Company Y.
 Company X has a higher profit margin than Company Y.
 Company Y has a higher inventory turnover ratio than Company X.
 Company Y has a higher current ratio than Company X.
Which of the following statements is most correct?
a. Company X must have a higher net income.
b. Company X must have a higher ROE.
c. Company Y must have a higher ROA.
d. Statements a and b are correct.
e. Statements a and c are correct.
Effects of leverage Answer: a Diff: M
21
. Which of the following statements is most correct?
a. A firm with financial leverage has a larger equity multiplier than an otherwise identical firm with no debt in its
capital structure.
b. The use of debt in a company’s capital structure results in tax benefits to the investors who purchase the
company’s bonds.
c. All else equal, a firm with a higher debt ratio will have a lower basic earning power ratio.
d. All of the statements above are correct.
e. Statements a and c are correct.
Financial statement analysis Answer: a Diff: M
22
. Which of the following statements is most correct?
a. An increase in a firm’s debt ratio, with no changes in its sales and operating costs, could be expected to lower its
profit margin on sales.
b. An increase in the DSO, other things held constant, would generally lead to an increase in the total assets turnover
ratio.
c. An increase in the DSO, other things held constant, would generally lead to an increase in the ROE.
d. In a competitive economy, where all firms earn similar returns on equity, one would expect to find lower profit
margins for airlines, which require a lot of fixed assets relative to sales, than for fresh fish markets.
e. It is more important to adjust the debt ratio than the inventory turnover ratio to account for seasonal fluctuations.
Financial statement analysis Answer: d Diff: M N
23
. Harte Motors and Mills Automotive each have the same total assets, the same level of sales, and the same return on
equity (ROE). Harte Motors, however, has less equity and a higher debt ratio than does Mills Automotive. Which of
the following statements is most correct?
a. Mills Automotive has a higher net income than Harte Motors.
b. Mills Automotive has a higher profit margin than Harte Motors.
c. Mills Automotive has a higher return on assets (ROA) than Harte Motors.
d. All of the statements above are correct.
e. None of the statements above is correct.
Leverage and financial ratios Answer: e Diff: M
24
. Company A and Company B have the same total assets, tax rate, and net income. Company A, however, has a lower
profit margin than Company B. Company A also has a higher debt ratio and, therefore, higher interest expense than
Company B. Which of the following statements is most correct?
a. Company A has a higher total assets turnover.
b. Company A has a higher return on equity.
c. Company A has a higher basic earning power ratio.
d. Statements a and b are correct.
e. All of the statements above are correct.
Leverage and financial ratios Answer: d Diff: M N
25
. Company A and Company B have the same tax rate, total assets, and basic earning power. Both companies have positive
net incomes. Company A has a higher debt ratio, and therefore, higher interest expense than Company B. Which of the
following statements is true?
a. Company A has a higher ROA than Company B.
b. Company A has a higher times interest earned (TIE) ratio than Company B.
c. Company A has a higher net income than Company B.
d. Company A pays less in taxes than Company B.
e. Company A has a lower equity multiplier than Company B.
Du Pont equation Answer: b Diff: M R
26
. You observe that a firm’s profit margin is below the industry average, while its return on equity and debt ratio exceed
the industry average. What can you conclude?
a. Return on assets must be above the industry average.
b. Total assets turnover must be above the industry average.
c. Total assets turnover must be below the industry average.
d. Statements a and b are correct.
e. None of the statements above is correct.
ROE and EVA Answer: d Diff: M
27
. Huxtable Medical’s CFO recently estimated that the company’s EVA for the past year was zero. The company’s cost
of equity capital is 14 percent, its cost of debt is 8 percent, and its debt ratio is 40 percent. Which of the following
statements is most correct?
a. The company’s net income was zero.
b. The company’s net income was negative.
c. The company’s ROA was 14 percent.
d. The company’s ROE was 14 percent.
e. The company’s after-tax operating income was less than the total dollar cost of capital.
ROE and EVA Answer: b Diff: M
28
. Which of the following statements is most correct?
a. If two firms have the same ROE and the same level of risk, they must also have the same EVA.
b. If a firm has positive EVA, this implies that its ROE exceeds its cost of equity.
c. If a firm has positive ROE, this implies that its EVA is also positive.
d. Statements b and c are correct.
e. All of the statements above are correct.
Miscellaneous ratios Answer: b Diff: M
29
. Which of the following statements is most correct?
a. If Firms A and B have the same earnings per share and market to book ratio, they must have the same price
earnings ratio.
b. Firms A and B have the same net income, taxes paid, and total assets. If Firm A has a higher interest expense, its
basic earnings power ratio (BEP) must be greater than that of Firm B.
c. Firms A and B have the same net income. If Firm A has a higher interest expense, its return on equity (ROE) must
be greater than that of Firm B.
d. All of the statements above are correct.
e. None of the statements above is correct.
Miscellaneous ratios Answer: e Diff: M
30
. Reeves Corporation forecasts that its operating income (EBIT) and total assets will remain the same as last year, but
that the company’s debt ratio will increase this year. What can you conclude about the company’s financial ratios?
(Assume that there will be no change in the company’s tax rate.)
a. The company’s basic earning power (BEP) will fall.
b. The company’s return on assets (ROA) will fall.
c. The company’s equity multiplier (EM) will increase.
d. All of the statements above are correct.
e. Statements b and c are correct.
Miscellaneous ratios Answer: d Diff: M
31
. Company X has a higher ROE than Company Y, but Company Y has a higher ROA than Company X. Company X
also has a higher total assets turnover ratio than Company Y; however, the two companies have the same total assets.
Which of the following statements is most correct?
 a. Company X has a lower debt ratio than Company Y.
b. Company X has a lower profit margin than Company Y.
c. Company X has a lower net income than Company Y.
d. Statements b and c are correct.
e. All of the statements above are correct.
Tough:
ROE and EVA Answer: a Diff: T
32
. Division A has a higher ROE than Division B, yet Division B creates more value for shareholders and has a higher
EVA than Division A. Both divisions, however, have positive ROEs and EVAs. What could explain these performance
measures?
a. Division A is riskier than Division B.
b. Division A is much larger (in terms of equity capital employed) than Division B.
c. Division A has less debt than Division B.
d. Statements a and b are correct.
e. All of the statements above are correct.
Ratio analysis Answer: d Diff: T
33
. You have collected the following information regarding Companies C and D:
 The two companies have the same total assets.
 The two companies have the same operating income (EBIT).
 The two companies have the same tax rate.
 Company C has a higher debt ratio and interest expense than Company D.
 Company C has a lower profit margin than Company D.
On the basis of this information, which of the following statements is most correct?
a. Company C must have a higher level of sales.
b. Company C must have a lower ROE.
c. Company C must have a higher times interest earned (TIE) ratio.
d. Company C must have a lower ROA.
e. Company C must have a higher basic earning power (BEP) ratio.
Ratio analysis Answer: d Diff: T
34
. An analyst has obtained the following information regarding two companies, Company X and Company Y:
 Company X and Company Y have the same total assets.
 Company X has a higher interest expense than Company Y.
 Company X has a lower operating income (EBIT) than Company Y.
 Company X and Company Y have the same return on equity (ROE).
 Company X and Company Y have the same total assets turnover (TATO).
 Company X and Company Y have the same tax rate.
On the basis of this information, which of the following statements is most correct?
a. Company X has a higher times interest earned (TIE) ratio.
b. Company X and Company Y have the same debt ratio.
c. Company X has a higher return on assets (ROA).
d. Company X has a lower profit margin.
e. Company X has a higher basic earning power (BEP) ratio.
Ratio analysis and Du Pont equation Answer: d Diff: T
35
. Lancaster Co. and York Co. both have the same return on assets (ROA). However, Lancaster has a higher total assets
turnover and a higher equity multiplier than York. Which of the following statements is most correct?
a. Lancaster has a lower profit margin than York.
b. Lancaster has a lower debt ratio than York.
c. Lancaster has a higher return on equity (ROE) than York.
d. Statements a and c are correct.
e. All of the statements above are correct.
Leverage and financial ratios Answer: d Diff: T
36
. Blair Company has $5 million in total assets. The company’s assets are financed with $1 million of debt and $4
million of common equity. The company’s income statement is summarized below:
Operating income (EBIT) $1,000,000
Interest 100,000
Earnings before taxes (EBT) $ 900,000
Taxes (40%) 360,000
 Net income $ 540,000
The company wants to increase its assets by $1 million, and it plans to finance this increase by issuing $1 million in
new debt. This action will double the company’s interest expense but its operating income will remain at 20 percent of
its total assets, and its average tax rate will remain at 40 percent. If the company takes this action, which of the
following will occur:
a. The company’s net income will increase.
b. The company’s return on assets will fall.
c. The company’s return on equity will remain the same.
d. Statements a and b are correct.
e. All of the statements above are correct.
Miscellaneous ratios Answer: c Diff: T
37
. Some key financial data and ratios are reported in the table below for Hemmingway Hotels and for its competitor,
Fitzgerald Hotels:

Ratio Hemmingway Hotels Fitzgerald Hotels

Profit margin 4% 3%
ROA 9% 8%
Total assets $2.0 billion $1.5 billion
BEP 20% 20%
ROE 18% 24%
On the basis of the information above, which of the following statements is most correct?
a. Hemmingway has a higher total assets turnover than Fitzgerald.
b. Hemmingway has a higher debt ratio than Fitzgerald.
c. Hemmingway has higher net income than Fitzgerald.
d. Statements a and b are correct.
e. All of the statements above are correct.
Multiple Choice: Problems
Easy:
Financial statement analysis Answer: a Diff: E
38
. Russell Securities has $100 million in total assets and its corporate tax rate is 40 percent. The company recently
reported that its basic earning power (BEP) ratio was 15 percent and its return on assets (ROA) was 9 percent. What
was the company’s interest expense?

a. $ 0 c. $ 6,000,000 e. $18,000,000
b. $ 2,000,000 d. $15,000,000
Market price per share Answer: b Diff: E
39
. You are given the following information: Stockholders’ equity = $1,250; price/earnings ratio = 5; shares outstanding =
25; and market/book ratio = 1.5. Calculate the market price of a share of the company’s stock.
a. $ 33.33 c. $ 10.00 e. $133.32
b. $ 75.00 d. $166.67
Market price per share Answer: c Diff: E
40
. Given the following information, calculate the market price per share of WAM Inc.:
Net income $200,000.00
Earnings per share $2.00
Stockholders’ equity $2,000,000.00
Market/Book ratio 0.20
a. $20.00 c. $ 4.00 e. $ 1.00
b. $ 8.00 d. $ 2.00
Market/book ratio Answer: c Diff: E
41
. Meyersdale Office Supplies has common equity of $40 million. The company’s stock price is $80 per share and its
market/book ratio is 4.0. How many shares of stock does the company have outstanding?
a. 500,000 c. 2,000,000 e. Insufficient
b. 125,000 d. 800,000,000 information.
Market/book ratio Answer: e Diff: E N
42
. Strack Houseware Supplies Inc. has $2 billion in total assets. The other side of its balance sheet consists of $0.2 billion
in current liabilities, $0.6 billion in long-term debt, and $1.2 billion in common equity. The company has 300 million
shares of common stock outstanding, and its stock price is $20 per share. What is Strack’s market/book ratio?
a. 1.25 c. 3.15 e. 5.00
b. 2.65 d. 4.40
ROA Answer: d Diff: E
43
. A firm has a profit margin of 15 percent on sales of $20,000,000. If the firm has debt of $7,500,000, total assets of
$22,500,000, and an after-tax interest cost on total debt of 5 percent, what is the firm’s ROA?
a. 8.4% c. 12.0% e. 15.1%
b. 10.9% d. 13.3%
TIE ratio Answer: b Diff: E
44
. Culver Inc. has earnings after interest but before taxes of $300. The company’s times interest earned ratio is 7.00.
Calculate the company’s interest charges.
a. $42.86 c. $40.00 e. $57.93
b. $50.00 d. $60.00
ROE Answer: c Diff: E
45
. Tapley Dental Supply Company has the following data:
Net income $240
Sales $10,000
Total assets $6,000
Debt ratio 75%
TIE ratio 2.0
Current ratio 1.2
BEP ratio 13.33%
If Tapley could streamline operations, cut operating costs, and raise net income to $300 without affecting sales or the
balance sheet (the additional profits will be paid out as dividends), by how much would its ROE increase?
a. 3.00% c. 4.00% e. 5.50%
b. 3.50% d. 4.25%
Profit margin Answer: c Diff: E
46
. Your company had the following balance sheet and income statement information for 2002:
Balance Sheet:
Cash $ 20
A/R 1,000
Inventories 5,000
Total current assets $6,020 Debt $4,000
Net fixed assets 2,980 Equity 5,000
Total assets $9,000 Total claims $9,000

Income Statement:
Sales $10,000
Cost of goods sold 9,200
EBIT $ 800
Interest (10%) 400
EBT $ 400
Taxes (40%) 160
Net income $ 240
The industry average inventory turnover is 5. You think you can change your inventory control system so as to cause
your turnover to equal the industry average, and this change is expected to have no effect on either sales or cost of goods
sold. The cash generated from reducing inventories will be used to buy tax-exempt securities that have a 7 percent rate
of return. What will your profit margin be after the change in inventories is reflected in the income statement?
a. 2.1% c. 4.5% e. 6.7%
b. 2.4% d. 5.3%
Du Pont equation Answer: a Diff: E
47
. The Wilson Corporation has the following relationships:
Sales/Total assets 2.0
Return on assets (ROA) 4.0%
Return on equity (ROE) 6.0%
 Using only the information given, estimate the market value of one share of Charleston’s stock.
What is Wilson’s profit margin and debt ratio?c. $ 5.00
a. $10.00 e. $ 1.50
b. $ 7.50 d. $ 2.50
P/E ratio and stock price Answer: e Diff: E
49
. Cleveland Corporation has 100,000 shares of common stock outstanding, its net income is $750,000, and its P/E is 8.
What is the company’s stock price?
a. $20.00 c. $40.00 e. $60.00
b. $30.00 d. $50.00
Current ratio and inventory Answer: b Diff: E N
50
.Iken Berry Farms has $5 million in current assets, $3 million in current liabilities, and its initial inventory level is $1
million. The company plans to increase its inventory, and it will raise additional short-term debt (that will show up as
notes payable on the balance sheet) to purchase the inventory. Assume that the value of the remaining current assets
will not change. The company’s bond covenants require it to maintain a current ratio that is greater than or equal to
1.5. What is the maximum amount that the company can increase its inventory before it is restricted by these
covenants?
a. $0.50 million c. $1.33 million e. $2.33 million
b. $1.00 million d. $1.66 million
Medium:
Accounts receivable increase Answer: b Diff: M R
51
. Cannon Company has enjoyed a rapid increase in sales in recent years, following a decision to sell on credit. However, the
firm has noticed a recent increase in its collection period. Last year, total sales were $1 million, and $250,000 of these sales
were on credit. During the year, the accounts receivable account averaged $41,096. It is expected that sales will increase in
the forthcoming year by 50 percent, and, while credit sales should continue to be the same proportion of total sales, it is
expected that the days sales outstanding will also increase by 50 percent. If the resulting increase in accounts receivable
must be financed externally, how much external funding will Cannon need? Assume a 365-day year.
a. $ 41,096 c. $ 47,359 e. $ 92,466
b. $ 51,370 d. $106,471
Accounts receivable Answer: a Diff: M R
52
. Ruth Company currently has $1,000,000 in accounts receivable. Its days sales outstanding (DSO) is 50 days. The
company wants to reduce its DSO to the industry average of 32 days by pressuring more of its customers to pay their
bills on time. The company’s CFO estimates that if this policy is adopted the company’s average sales will fall by 10
percent. Assuming that the company adopts this change and succeeds in reducing its DSO to 32 days and does lose 10
percent of its sales, what will be the level of accounts receivable following the change? Assume a 365-day year.
a. $576,000 c. $750,000 e. $966,667
b. $633,333 d. $900,000
ROA Answer: a Diff: M
53
. A fire has destroyed a large percentage of the financial records of the Carter Company. You have the task of piecing
together information in order to release a financial report. You have found the return on equity to be 18 percent. If
sales were $4 million, the debt ratio was 0.40, and total liabilities were $2 million, what would be the return on assets
(ROA)?
a. 10.80% c. 1.25% e. Insufficient
b. 0.80% d. 12.60% information.
ROA Answer: e Diff: M
54
. Humphrey Hotels’ operating income (EBIT) is $40 million. The company’s times interest earned (TIE) ratio is 8.0, its
tax rate is 40 percent, and its basic earning power (BEP) ratio is 10 percent. What is the company’s return on assets
(ROA)?
a. 6.45% c. 4.33% e. 5.25%
b. 5.97% d. 8.56%
ROA Answer: c Diff: M N
55
. Viera Company has $500,000 in total assets. The company’s basic earning power (BEP) is 10 percent, its times
interest earned (TIE) ratio is 5, and the company’s tax rate is 40 percent. What is the company’s return on assets
(ROA)?
a. 3.2% c. 4.8% e. 7.2%
b. 4.0% d. 6.0%
ROE Answer: c Diff: M R
56
. Selzer Inc. sells all its merchandise on credit. It has a profit margin of 4 percent, days sales outstanding equal to 60
 days, receivables of $150,000, total assets of $3 million, and a debt ratio of 0.64. What is the firm’s return on equity
(ROE)? Assume a 365-day year.
a. 7.1% c. 3.4% e. 8.1%
b. 33.4% d. 71.0%
ROE Answer: b Diff: M
57
. A firm has a debt/equity ratio of 50 percent. Currently, it has interest expense of $500,000 on $5,000,000 of total
debt outstanding. Its tax rate is 40 percent. If the firm’s ROA is 6 percent, by how many percentage points is the
firm’s ROE greater than its ROA?
a. 0.0% c. 5.2% e. 9.0%
b. 3.0% d. 7.4%
ROE Answer: d Diff: M
58
. Assume Meyer Corporation is 100 percent equity financed. Calculate the return on equity, given the following
information:
Earnings before taxes $1,500
Sales $5,000
Dividend payout ratio 60%
Total assets turnover 2.0
Tax rate 30%
a. 25% c. 35% e. 50%
b. 30% d. 42%
ROE Answer: c Diff: M
59
. The Amer Company has the following characteristics:
Sales $1,000
Total assets $1,000
Total debt/Total assets 35.00%
Basic earning power (BEP) ratio 20.00%
Tax rate 40.00%
Interest rate on total debt 4.57%
What is Amer’s ROE?
a. 11.04% c. 16.99% e. 30.77%
b. 12.31% d. 28.31%
Equity multiplier Answer: d Diff: M
60
. A firm that has an equity multiplier of 4.0 will have a debt ratio of
a. 4.00 c. 1.00 e. 0.25
b. 3.00 d. 0.75
TIE ratio Answer: e Diff: M
61
. Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10 percent annually on its bank
loan. Alumbat’s annual sales are $3,200,000, its average tax rate is 40 percent, and its net profit margin on sales is 6
percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and
bankruptcy will result. What is Alumbat’s current TIE ratio?
a. 2.4 c. 3.6 e. 5.0
b. 3.4 d. 4.0
TIE ratio Answer: b Diff: M N
62
. Moss Motors has $8 billion in assets, and its tax rate is 40 percent. The company’s basic earning power (BEP) ratio is
12 percent, and its return on assets (ROA) is 3 percent. What is Moss’ times interest earned (TIE) ratio?
a. 2.25 c. 1.00 e. 2.50
b. 1.71 d. 1.33
TIE ratio Answer: b Diff: M
63
. Lancaster Motors has total assets of $20 million. Its basic earning power is 25 percent, its return on assets (ROA) is
10 percent, and the company’s tax rate is 40 percent. What is Lancaster’s TIE ratio?
a. 2.5 c. 1.5 e. 0.6
b. 3.0 d. 1.2
TIE ratio Answer: d Diff: M N
64
. Roll’s Boutique currently has total assets of $3 million in operation. Over this year, its performance yielded a basic
earning power (BEP) of 25 percent and a return on assets (ROA) of 12 percent. The firm’s earnings are subject to a
35 percent tax rate. On the basis of this information, what is the firm’s times interest earned (TIE) ratio?
a. 1.84 c. 2.83 e. 4.17
b. 1.92 d. 3.82
EBITDA coverage ratio Answer: a Diff: M N
65
. Peterson Packaging Corp. has $9 billion in total assets. The company’s basic earning power (BEP) ratio is 9 percent,
and its times interest earned ratio is 3.0. Peterson’s depreciation and amortization expense totals $1 billion. It has
$0.6 billion in lease payments and $0.3 billion must go towards principal payments on outstanding loans and long-
term debt. What is Peterson’s EBITDA coverage ratio?
a. 2.06 c. 2.25 e. 2.77
b. 1.52 d. 1.10
Debt ratio Answer: c Diff: M
66
. Kansas Office Supply had $24,000,000 in sales last year. The company’s net income was $400,000, its total assets
turnover was 6.0, and the company’s ROE was 15 percent. The company is financed entirely with debt and common
equity. What is the company’s debt ratio?
a. 0.20 c. 0.33 e. 0.66
b. 0.30 d. 0.60
Profit margin Answer: a Diff: M
67
. The Merriam Company has determined that its return on equity is 15 percent. Management is interested in the various
components that went into this calculation. You are given the following information: total debt/total assets = 0.35 and
total assets turnover = 2.8. What is the profit margin?
a. 3.48% c. 6.96% e. 12.82%
b. 5.42% d. 2.45%
Financial statement analysis Answer: e Diff: M R
68
. Collins Company had the following partial balance sheet and complete income statement information for 2002:
Partial Balance Sheet:
Cash $ 20
A/R 1,000
Inventories 2,000
Total current assets $ 3,020
Net fixed assets 2,980
Total assets $ 6,000
Income Statement:
Sales $10,000
Cost of goods sold 9,200
EBIT $ 800
Interest (10%) 400
EBT $ 400
Taxes (40%) 160
Net income $ 240
The industry average DSO is 30 (assuming a 365-day year). Collins plans to change its credit policy so as to cause
its DSO to equal the industry average, and this change is expected to have no effect on either sales or cost of goods
sold. If the cash generated from reducing receivables is used to retire debt (which was outstanding all last year and
has a 10 percent interest rate), what will Collins’ debt ratio (Total debt/Total assets) be after the change in DSO is
reflected in the balance sheet?
a. 33.33% c. 52.75% e. 65.65%
b. 45.28% d. 60.00%
Financial statement analysis Answer: b Diff: M R
69
. Taft Technologies has the following relationships:
Annual sales $1,200,000.00
Current liabilities $ 375,000.00
Days sales outstanding (DSO) (365-day year) 40.00
Inventory turnover ratio 4.80
Current ratio 1.20
 The company’s current assets consist of cash, inventories, and accounts receivable. How much cash does Taft have on
its balance sheet?
a. -$ 8,333 c. $125,000 e. $316,667
b. $ 68,493 d. $200,000
Basic earning power Answer: d Diff: M
70
. Aaron Aviation recently reported the following information:
Net income $500,000
ROA 10%
Interest expense $200,000
The company’s average tax rate is 40 percent. What is the company’s basic earning power (BEP)?
a. 14.12% c. 17.33% e. 22.50%
b. 16.67% d. 20.67%
P/E ratio and stock price Answer: e Diff: M
71
. Dean Brothers Inc. recently reported net income of $1,500,000. The company has 300,000 shares of common stock, and
it currently trades at $60 a share. The company continues to expand and anticipates that one year from now its net
income will be $2,500,000. Over the next year the company also anticipates issuing an additional 100,000 shares of
stock, so that one year from now the company will have 400,000 shares of common stock. Assuming the company’s
price/earnings ratio remains at its current level, what will be the company’s stock price one year from now?
a. $55 c. $65 e. $75
b. $60 d. $70
Current ratio and DSO Answer: a Diff: M
72
. Parcells Jets has the following balance sheet (in millions):
Cash $ 100 Notes payable $ 100
Inventories 300 Accounts payable 200
Accounts receivable 400 Accruals 100
Total current assets $ 800 Total current liabilities $ 400
Net fixed assets 1,200 Long-term bonds 600
Total debt $1,000
______ Total common equity 1,000
Total assets $2,000 Total liabilities and equity $2,000
Parcells’ DSO (on a 365-day basis) is 40, which is above the industry average of 30. Assume that Parcells is able to
reduce its DSO to the industry average without reducing sales, and the company takes the freed-up cash and uses it to
reduce its outstanding long-term bonds. If this occurs, what will be the new current ratio?
a. 1.75 c. 2.33 e. 1.67
b. 1.33 d. 1.25
Current ratio Answer: c Diff: M N
73
. Cartwright Brothers has the following balance sheet (all numbers are expressed in millions of dollars):

Cash $ 250 Accounts payable $ 300

Accounts receivable 250 Notes payable 300
Inventories 250 Long-term debt 600
Net fixed assets 1,250 Common stock 800
Total assets $2,000 Total claims $2,000

Cartwright’s average daily sales are $10 million. Currently, Cartwright’s days sales outstanding (DSO) is well above
the industry average of 15. Cartwright is implementing a plan that is designed to reduce its DSO to 15 without
reducing its sales. If successful the plan will free up cash, half of which will be used to reduce notes payable and the
other half will be used to reduce accounts payable. What will be the current ratio if Cartwright fully succeeds in
implementing this plan?
a. 1.00 c. 1.30 e. 1.50
b. 0.63 d. 1.25
Current ratio Answer: b Diff: M N
74
. Jefferson Co. has $2 million in total assets and $3 million in sales. The company has the following balance sheet:
Cash $ 100,000 Accounts payable $ 200,000
Accounts receivable 200,000 Accruals 100,000
Inventories 500,000 Notes payable 200,000
Net fixed assets 1,200,000 Long-term debt 700,000
 Inventories 190,000
Accounts receivable 125,000 Common
Long-termequity
debt 800,000
300,000
Net fixed assets 360,000 Total
Commonliabilities
equity 200,000
Total
Total assets
assets $2,000,000
$700,000 and equity
Total claims $2,000,000
$700,000
Jefferson
The company wantshas
to improve its inventory
been advised that theirturnover ratio so
credit policy is that it equals the
too generous andindustry
that theyaverage
shouldofreduce
10.0.their
Thedays
company
sales
would like to accomplish this goal without reducing sales. If successful, the company would
outstanding to 36 days (assume a 365-day year). The increase in cash resulting from the decrease in accounts take the freed-up cash
from the reduction in inventories and use half of it to reduce notes payable and the other half to reduce
receivable will be used to reduce the company’s long-term debt. The interest rate on long-term debt is 10 percent and common equity.
What will be Jefferson’s
the company’s tax rate iscurrent ratio, if
30 percent. Theit istighter
able to accomplish
credit policy isitsexpected
goal of improving its inventory
to reduce the company’smanagement?
sales to $730,000
and result in EBIT of $70,000. What is the company’s expected ROE after the change in credit policy?
a. 14.88% c. 15.86% e. 16.25%
b. 16.63% d. 18.38%
Du Pont equation Answer: d Diff: M
76
. Austin & Company has a debt ratio of 0.5, a total assets turnover ratio of 0.25, and a profit margin of 10 percent.
The Board of Directors is unhappy with the current return on equity (ROE), and they think it could be doubled. This
could be accomplished (1) by increasing the profit margin to 12 percent and (2) by increasing debt utilization. Total
assets turnover will not change. What new debt ratio, along with the new 12 percent profit margin, would be required
to double the ROE?
a. 55% c. 65% e. 75%
b. 60% d. 70%
Sales and extended Du Pont equation Answer: a Diff: M
77
. Shepherd Enterprises has an ROE of 15 percent, a debt ratio of 40 percent, and a profit margin of 5 percent. The
company’s total assets equal $800 million. What are the company’s sales? (Assume that the company has no
preferred stock.)
a. $1,440,000,000 c. $ 120,000,000 e. $ 960,000,000
b. $2,400,000,000 d. $ 360,000,000
Net income and Du Pont equation Answer: c Diff: M N
78
. Samuels Equipment has $10 million in sales. Its ROE is 15 percent and its total assets turnover is 3.5 . The
company is 100 percent equity financed. What is the company’s net income?
a. $1,500,000 c. $ 428,571 e. $ 52,500
b. $2,857,143 d. $2,333,333
Tough:
ROE Answer: c Diff: T
79
. Roland & Company has a new management team that has developed an operating plan to improve upon last year’s
ROE. The new plan would place the debt ratio at 55 percent, which will result in interest charges of $7,000 per year.
EBIT is projected to be $25,000 on sales of $270,000, it expects to have a total assets turnover ratio of 3.0, and the
average tax rate will be 40 percent. What does Roland & Company expect its return on equity to be following the
changes?
a. 17.65% c. 26.67% e. 51.25%
b. 21.82% d. 44.44%
ROE Answer: d Diff: T
80
. Georgia Electric reported the following income statement and balance sheet for the previous year:
Balance Sheet:
Cash $ 100,000
Inventories 1,000,000
Accounts receivable 500,000
Current assets $1,600,000
Total debt $4,000,000
Net fixed assets 4,400,000 Total equity 2,000,000
Total assets $6,000,000 Total claims $6,000,000

Income Statement:
Sales $3,000,000
Operating costs 1,600,000
Operating income (EBIT) $1,400,000
Interest 400,000
Taxable income (EBT) $1,000,000
 Inventories $ 500 Accounts payable $ 100
Other current assets Taxes (40%) 400 Short-term notes400,000
payable 370
Fixed assets Net income 370 $ 600,000
Common equity 800
The
Totalcompany’s
assets interest cost is 10 percent, so the company’s
$1,270 Total interest
liab. andexpense
equity each year is 10 percent
$1,270of its total debt.
While the company’s financial performance is quite strong, its CFO (Chief Financial Officer) is always looking for
ways to improve. The CFO has Statement:
Income noticed that the company’s inventory turnover ratio is considerably weaker than the
industry average, which isSales 6.0. As an exercise,$2,000
the CFO asks what would the company’s ROE have been last year if
the following had occurred: Operating costs 1,843
 The company maintained EBIT the same sales, $but was able to reduce inventories enough to achieve the industry
157
average inventory turnover
Interestratio. 37
 The cash that was generated EBT from the reduction
$ 120 in inventories was used to reduce part of the company’s
outstanding debt. So, the (40%)
Taxes company’s total debt48would have been $4 million less the freed-up cash from the
improvement in inventoryNet income The company’s
policy. $ 72 interest expense would have been 10 percent of new total
debt.
A recently
Assume equityreport
released does not change.
indicates that(The company
Savelots’ paysratio
current all net income
of 1.9 is in as
linedividends.)
with the industry average. However, its
Under this scenario, what would have been the company’s ROE last year?
accounts payable, which have no interest cost and are due entirely to purchases of inventories, amount to only 20 percent
of inventories versus an industry average of 60 percent. Suppose Savelots took actions to increase its accounts payable
to inventories ratio to the 60 percent industry average, but it (1) kept all of its assets at their present levels (that is, the
asset side of the balance sheet remains constant) and (2) also held its current ratio constant at 1.9. Assume that Savelots’
tax rate is 40 percent, that its cost of short-term debt is 10 percent, and that the change in payments will not affect
operations. In addition, common equity will not change. With the changes, what will be Savelots’ new ROE?
a. 10.5% c. 9.0% e. 12.0%
b. 7.8% d. 13.2%
ROE and refinancing Answer: d Diff: T
82
. Aurillo Equipment Company (AEC) projected that its ROE for next year would be just 6 percent. However, the
financial staff has determined that the firm can increase its ROE by refinancing some high interest bonds currently
outstanding. The firm’s total debt will remain at $200,000 and the debt ratio will hold constant at 80 percent, but the
interest rate on the refinanced debt will be 10 percent. The rate on the old debt is 14 percent. Refinancing will not
affect sales, which are projected to be $300,000. EBIT will be 11 percent of sales and the firm’s tax rate is 40 percent.
If AEC refinances its high interest bonds, what will be its projected new ROE?
a. 3.0% c. 10.0% e. 18.7%
b. 8.2% d. 15.6%
TIE ratio Answer: d Diff: T
83
. Lombardi Trucking Company has the following data:
Assets $10,000
Profit margin 3.0%
Tax rate 40%
Debt ratio 60.0%
Interest rate 10.0%
Total assets turnover 2.0
What is Lombardi’s TIE ratio?
a. 0.95 c. 2.10 e. 3.45
b. 1.75 d. 2.67
Current ratio Answer: e Diff: T
84
. Victoria Enterprises has $1.6 million of accounts receivable on its balance sheet. The company’s DSO is 40 (based on
a 365-day year), its current assets are $2.5 million, and its current ratio is 1.5. The company plans to reduce its DSO
from 40 to the industry average of 30 without causing a decline in sales. The resulting decrease in accounts receivable
will free up cash that will be used to reduce current liabilities. If the company succeeds in its plan, what will
Victoria’s new current ratio be?
a. 1.50 c. 1.26 e. 1.66
b. 1.97 d. 0.72
P/E ratio and stock price Answer: b Diff: T
85
. XYZ’s balance sheet and income statement are given below:

Balance Sheet:
Cash $ 50 Accounts payable $ 100
A/R 150 Notes payable 0
Inventories 300 Long-term debt (10%) 700
 Fixed assets 500 Common equity (20 shares) 200
Total assets $1,000 Total liabilities and equity $1,000

Income Statement:
Sales $1,000
Cost of goods sold 855
EBIT $ 145
Interest 70
EBT $ 75
Taxes (33.333%) 25
Net income $ 50
The industry average inventory turnover is 5, the interest rate on the firm’s long-term debt is 10 percent, 20 shares are
outstanding, and the stock sells at a P/E of 8.0. If XYZ changed its inventory methods so as to operate at the industry
average inventory turnover, if it used the funds generated by this change to buy back common stock at the current
market price and thus to reduce common equity, and if sales, the cost of goods sold, and the P/E ratio remained
constant, by what dollar amount would its stock price increase?
a. $ 3.33 c. $ 8.75 e. $12.50
b. $ 6.67 d. $10.00
Du Pont equation and debt ratio Answer: e Diff: T
86
. Company A has sales of $1,000, assets of $500, a debt ratio of 30 percent, and an ROE of 15 percent. Company B
has the same sales, assets, and net income as Company A, but its ROE is 30 percent. What is B’s debt ratio? (Hint:
Begin by looking at the Du Pont equation.)
a. 25.0% c. 50.0% e. 65.0%
b. 35.0% d. 52.5%
Financial statement analysis Answer: a Diff: T
87
. A company has just been taken over by new management that believes it can raise earnings before taxes (EBT) from
$600 to $1,000, merely by cutting overtime pay and reducing cost of goods sold. Prior to the change, the following
data applied:
Total assets $8,000
Debt ratio 45%
Tax rate 35%
BEP ratio 13.3125%
EBT $600
Sales $15,000
These data have been constant for several years, and all income is paid out as dividends. Sales, the tax rate, and the
balance sheet will remain constant. What is the company’s cost of debt? (Hint: Work only with old data.)
a. 12.92% c. 13.51% e. 14.00%
b. 13.23% d. 13.75%
EBIT Answer: e Diff: T
88
. Lone Star Plastics has the following data:
Assets $100,000
Profit margin 6.0%
Tax rate 40%
Debt ratio 40.0%
Interest rate 8.0%
Total assets turnover 3.0

What is Lone Star’s EBIT?

a. $ 3,200 c. $18,000 e. $33,200
b. $12,000 d. $30,000
Sales increase needed Answer: b Diff: T N
89
. Ricardo Entertainment recently reported the following income statement:
Sales $12,000,000
Cost of goods sold 7,500,000
EBIT $ 4,500,000
Interest 1,500,000
EBT $ 3,000,000
Debt ratio and Du Pont analysis
Taxes (40%) 1,200,000 Answer: c Diff: M N
90
. What is Fama’s debt Net income
ratio? $ 1,800,000
a. 14.29% c. 28.57% e. 71.43%
The company’s CFO, Fred Mertz, wants to see
b. 28.00% d. a 55.56%
25 percent increase in net income over the next year. In other words,
his target
Profit margin andforDu
next year’s
Pont net income is $2,250,000. Mertz has made the following
analysis observations:
Answer: a Diff: E N
91
. What is Fama’soperating
 Ricardo’s profit margin?
margin (EBIT/Sales) was 37.5 percent this past year. Mertz expects that next year this
a. 2.00%
margin will c. 4.33% increase e. to6.00%
b. 4.00%
40 percent. d. 5.33%
(The following
 Ricardo’s interest expense information
is expected to remainapplies to the next two problems.)
constant.
 Ricardo’srecently
Miller Technologies tax rate is expected
reported theto following
remain at 40 percent.
balance sheet in its annual report (all numbers are in millions of
dollars):
On the basis of these numbers, what is the percentage increase in sales that Ricardo needs in order to meet Mertz’s
Cash target for net income? $ 100 Accounts payable $ 300
Accounts receivable 300 Notes payable 500
Inventory 500 Total current liabilities $ 800
Total current assets $ 900 Long-term debt 1,500
Total debt $2,300
Common stock 500
Retained earnings 400
Net fixed assets 2,300 Total common equity $ 900
Total assets $3,200 Total liabilities and equity $3,200

Miller also reported sales revenues of $4.5 billion and a 20 percent ROE for this same year.
ROA Answer: d Diff: M N
92
. What is Miller’s ROA?
a. 2.500% c. 4.625% e. 7.826%
b. 3.125% d. 5.625%
Current ratio Answer: b Diff: M N
93
. Miller Technologies is always looking for ways to expand their business. A plan has been proposed that would entail
issuing $300 million in notes payable to purchase new fixed assets (for this problem, ignore depreciation). If this plan
were carried out, what would Miller’s current ratio be immediately following the transaction?
a. 0.455 c. 1.091 e. 1.800
b. 0.818 d. 1.125
(The following information applies to the next three problems.)
Dokic, Inc. reported the following balance sheets for year-end 2001 and 2002 (dollars in millions):

2002 2001
Cash $ 650 $ 500
Accounts receivable 450 700
Inventories 850 600
Total current assets $1,950 $1,800
Net fixed assets 2,450 2,200
Total assets $4,400 $4,000

Accounts payable $ 680 $ 300

Notes payable 200 600
Wages payable 220 200
Total current liabilities $1,100 $1,100
Long-term bonds 1,000 1,000
Common stock 1,500 1,200
Retained earnings 800 700
Total common equity $2,300 $1,900
Total liabilities and equity $4,400 $4,000
Miscellaneous concepts Answer: e Diff: E N
94
. Which of the following statements is most correct?
a. The company’s current ratio was higher in 2002 than it was in 2001.
 b. The company’s debt ratio was higher in 2002 than it was in 2001.
c. The company issued new common stock during 2002.
d. Statements a and b are correct.
e. Statements a and c are correct.

Net income Answer: b Diff: E N

95
. The total dividends paid to the company’s common stockholders during 2002 was $50 million. What was the
company’s net income during the year 2002?
a. $ 50 million c. $250 million e. $450 million
b. $150 million d. $350 million
Sales, DSO, and inventory turnover Answer: b Diff: M N
96
. When reviewing the company’s performance for 2002, its CFO observed that the company’s inventory turnover ratio
was below the industry average inventory turnover ratio of 6.0. In addition, the company’s DSO (days sales
outstanding, calculated on a 365-day basis) was less than the industry average of 50 (that is, DSO < 50). On the basis
of this information, what is the most likely estimate of the company’s sales (in millions of dollars) for 2002?
a. $ 2,940 c. $ 7,250 e. $30,765
b. $ 5,038 d. $10,863
(The following information applies to the next two problems.)

Below are the 2001 and 2002 year-end balance sheets for Kewell Boomerangs:
2002 2001
Cash $ 100,000 $ 85,000
Accounts receivable 432,000 350,000
Inventories 1,000,000 700,000
Total current assets $1,532,000 $1,135,000
Net fixed assets 3,000,000 2,800,000
Total assets $4,532,000 $3,935,000

Accounts payable $ 700,000 $ 545,000

Notes payable 800,000 900,000
Total current liabilities $1,500,000 $1,445,000
Long-term debt 1,200,000 1,200,000
Common stock 1,500,000 1,000,000
Retained earnings 332,000 290,000
Total common equity $1,832,000 $1,290,000
Total liabilities and equity $4,532,000 $3,935,000
Kewell Boomerangs has never paid a dividend on its common stock. Kewell issued $1,200,000 of long-term debt in 1997.
This debt was non-callable and is scheduled to mature in 2027. As of the end of 2002, none of the principal on this debt has
been repaid. Assume that 2001 and 2002 sales were the same in both years.
Financial statement analysis Answer: a Diff: E N
97
. Which of the following statements is most correct?
a. Kewell’s current ratio in 2002 was higher than it was in 2001.
b. Kewell’s inventory turnover ratio in 2002 was higher than it was in 2001.
c. Kewell’s debt ratio in 2002 was higher than it was in 2001.
d. All of the statements above are correct.
e. None of the statements above is correct.
Current ratio Answer: c Diff: M N
98
. During 2002, Kewell’s days sales outstanding (DSO) was 40 days. The industry average DSO was 30 days. Assume
instead that in 2002, Kewell had been able to achieve the industry-average DSO without reducing its sales, and that
the freed-up cash would have been used to reduce accounts payable. If this reduction in DSO had successfully
occurred, what would have been Kewell’s new current ratio in 2002? (Assume Kewell uses a 365-day accounting
year.)
a. 1.018
b. 1.021
c. 1.023
d. 1.027
e. 1.033
 CHAPTER 3
1

2
3
4
5
6

7
8

9
10

11
12
13
14
15
16
17

18
19
20
21
22
23
24
25
26

27
28
29
30
31

32
33

34

35
36
37
38 ANSWERS AND SOLUTIONS
. Financial statement analysis Answer: a Diff: E

BEP = EBIT/TA
0.15 = EBIT/$100,000,000
EBIT = $15,000,000.

ROA = NI/TA
0.09 = NI/$100,000,000
NI = $9,000,000.
EBT = NI/(1 - T)
EBT = $9,000,000/0.6
EBT = $15,000,000.
Therefore interest expense = $0.

39. Market price per share Answer: b Diff: E

Total market value = $1,250(1.5) = $1,875.

Market value per share = $1,875/25 = $75.
Alternative solution:
Book value per share = $1,250/25 = $50.
Market value per share = $50(1.5) = $75.

40. Market price per share Answer: c Diff: E

Number of shares = $200,000/$2.00 = 100,000.

Book value per share = $2,000,000/100,000 = $20.
Market value = 0.2(Book value) = 0.2($20) = $4.00 per share.

41
. Market/book ratio Answer: c Diff: E

M Price per share  shares


B BV
$80  shares
4.0 
$40,000,000
$160,000,000  $80  shares
2,000,000  shares.

42. Market/book ratio Answer: e Diff: E N

TA = $2,000,000,000; CL = $200,000,000; LT debt = $600,000,000; CE =

$1,200,000,000; Shares outstanding = 300,000,000; P0 = $20; M/B = ?

$1,200,000,000
Book value = = $4.00.
300,000,000

$20.00
M/B = = 5.0.
$4.00

43. ROA Answer: d Diff: E

Net income = 0.15($20,000,000) = $3,000,000.

ROA = $3,000,000/$22,500,000 = 13.3%.

44. TIE ratio Answer: b Diff: E

 TIE = EBIT/INT
7 = ($300 + INT)/INT
7INT = $300 + INT
6INT = $300
INT = $50.

45. ROE Answer: c Diff: E

Equity = 0.25($6,000) = $1,500.

NI $240
Current ROE = = = 16%.
E $1,500
$300
New ROE = = 0.20 = 20%.
$1,500
ROE = 20% - 16% = 4%.

46. Profit margin Answer: c Diff: E

S $10,000
Current inventory turnover = = = 2.
Inv $5,000
S S $10,000
New inventory turnover = = 5; Inv = = = $2,000.
Inv 5 5
Freed cash = $5,000 - $2,000 = $3,000.
Increase in NI = 0.07($3,000) = $210.
NI $240 + $210
New Profit margin = = = 0.0450 = 4.5%.
Sales $10,000

47. Du Pont equation Answer: a Diff: E

First, calculate the profit margin, which equals NI/Sales:

ROA = NI/TA = 0.04.
Sales/Total assets = S/TA = 2.
PM = (NI/TA)(TA/S) = 0.04(0.5) = 0.02. [TA/S = 1/2 = 0.5.]

Next, find the debt ratio by finding the equity ratio:

E/TA = (E/NI)(NI/TA). [ROE = NI/E and ROA = NI/TA.]
E/TA = (1/ROE)(ROA) = (1/0.06)(0.04) = 0.667, or 66.7% equity.
Therefore, D/TA must be 0.333 = 33.3%.

48. P/E ratio and stock price Answer: b Diff: E

EPS = $15,000/10,000 = $1.50.

P/E = 5.0 = P/$1.50.
P = $7.50.

49. P/E ratio and stock price Answer: e Diff: E

EPS = $750,000/100,000 = $7.50.

P/E = Price/EPS = 8.
Thus, Price = 8  $7.50 = $60.00.

50. Current ratio and inventory Answer: b Diff: E N

With the numbers provided, we can see that Iken Berry Farms has a current
ratio of 1.67 (CA/CL = $5/$3 = 1.67). If notes payable are going to be raised
to buy inventories, both the numerator and the denominator of the ratio will
increase. We can increase current liabilities $1 million before the current
 ratio reaches 1.5.

CA  X
 1.5
CL  X
$5,000,000  X
 1.5
$3,000,000  X
$5,000,000  X  $4,500,000  1.5X
$500,000  0.5X
$1,000,000  X
X  $1,000,000.

51. Accounts receivable increase Answer: b Diff: M R

DSO = $41,096/($250,000/365) = 60 days.

New A/R = [($250,000)(1.5)/(365)](60)(1.5) = $92,466.
Hence, increase in receivables = $92,466 - $41,096 = $51,370.

52. Accounts receivable Answer: a Diff: M R

First solve for current annual sales using the DSO equation as follows: 50 =
$1,000,000/(Sales/365) to find annual sales equal to $7,300,000.
If sales fall by 10%, the new sales level will be $7,300,000(0.9) =
$6,570,000. Again, using the DSO equation, solve for the new accounts
receivable figure as follows: 32 = AR/($6,570,000/365) or AR = $576,000.

53. ROA Answer: a Diff: M

Equity multiplier = 1/(1 - D/A) = 1/(1 - 0.4) = 1.67.

ROE = ROA  Equity multiplier
18% = (ROA)(1.67)
ROA = 10.8%.

54. ROA Answer: e Diff: M

Step 1: We must find TA. We are given BEP and EBIT.

EBIT EBIT
BEP = and TA = .
TA BEP
Therefore, TA = $40,000,000/0.1, or $400 million.

Step 2: NI/TA = ROA, so now we need to find net income. Net income is found
by working through the income statement (in millions):

EBIT $40
Interest 5 (from TIE ratio: 8 = EBIT/Int)
EBT $35
Taxes (40%) 14
NI $21

Step 3: ROA = $21/$400 = 0.0525 = 5.25%.

55 . ROA

Answer: c Diff: M N

BEP = EBIT/TA = 0.10, so EBIT = 0.10  $500,000 = $50,000.

 TIE = EBIT/INT = 5, so INT = $50,000/5 = $10,000.

EBIT $50,000
Int -10,000
EBT $40,000
Taxes (40%) -16,000
NI $24,000

ROA = NI/TA = $24,000/$500,000 = 0.048, or 4.8%.

56. ROE Answer: c Diff: M R

(Sales per day)(DSO) = A/R

(Sales/365)(60) = $150,000
Sales = $912,500.

Profit margin = Net income/Sales.

Net income = 0.04($912,500) = $36,500.
Debt ratio = 0.64 = Total debt/$3,000,000.
Total debt = $1,920,000.
Total equity = $3,000,000 - $1,920,000 = $1,080,000.
ROE = $36,500/$1,080,000 = 3.38%  3.4%.

57. ROE Answer: b Diff: M

Total equity = ($5,000,000)(2) = $10,000,000.

Total assets = $5,000,000 + $10,000,000 = $15,000,000.
Net income = (0.06)($15,000,000) = $900,000.
ROE = $900,000/$10,000,000 = 9%.
ROE - ROA = 9% - 6% = 3%.

58. ROE Answer: d Diff: M

Profit margin = ($1,500(1 - 0.3))/$5,000 = 21%.

Equity multiplier = 1.0 since firm is 100% equity financed.

ROE = (Profit margin)(Assets turnover)(Equity multiplier)

= (21%)(2.0)(1.0) = 42%.

59. ROE Answer: c Diff: M

Calculate debt, equity, and EBIT:

Debt = D/A  TA = 0.35($1,000) = $350.
Equity = TA - Debt = $1,000 - $350 = $650.
EBIT = TA  BEP = $1,000(0.20) = $200.

Calculate net income and ROE:

Net income = (EBIT - I)(1 - T) = [$200 - 0.0457($350)](0.6) = $110.4.
ROE = $110.4/$650 = 16.99%.

60. Equity multiplier Answer: d Diff: M

Equity multiplier = 4.0 = Total assets/Total equity = 4/1.

Assets = Debt + Equity

4 = Debt + 1
Debt = 3.
 Debt/Assets = 3/4 = 0.75.

61. TIE ratio Answer: e Diff: M

TIE = EBIT/I, so find EBIT and I.

Interest = $800,000  0.1 = $80,000.
Net income = $3,200,000  0.06 = $192,000.
Pre-tax income = $192,000/(1 - T) = $192,000/0.6 = $320,000.
EBIT = $320,000 + $80,000 = $400,000.
TIE = $400,000/$80,000 = 5.0.

62. TIE ratio Answer: b Diff: M N

TA = $8,000,000,000; T = 40%; EBIT/TA = 12%; ROA = 3%; TIE ?

EBIT
 0.12
$8,000,000,000
EBIT  $960,000,000.
NI
 0.03
$8,000,000,000
NI  $240,000,000.

Now use the income statement format to determine interest so you can calculate
the firm’s TIE ratio.

INT = EBIT – EBT

EBIT $960,000,000 See above. = $960,000,000 - $400,000,000
INT 560,000,000
EBT $400,000,000 EBT = $240,000,000/0.6
Taxes (40%) 160,000,000
NI $240,000,000 See above.

TIE = EBIT/INT
= $960,000,000/$560,000,000
= 1.7143  1.71.

63. TIE ratio Answer: b Diff: M

Remember, TIE = EBIT/Interest. We need to find EBIT and Interest.

TA = $20,000,000; BEP = 25%; ROA = 10%; T = 40%.

BEP = EBIT/TA
25% = EBIT/$20,000,000
$5,000,000 = EBIT.

ROA = NI/TA
10% = NI/$20,000,000
$2,000,000 = NI.

NI = (EBIT - I)(1 - T)
$2,000,000 = ($5,000,000 - I)(1 - 0.4)
$2,000,000 = ($5,000,000 - I)(0.6)
$3,333,333 = $5,000,000 - I
$1,666,667 = I.

Therefore, TIE = EBIT/I

 = $5,000,000/$1,666,667
= 3.0.

64. TIE ratio Answer: d Diff: M N

The times interest earned (TIE) ratio is calculated as the ratio of EBIT and
interest expense. We can find EBIT from the BEP ratio and total assets given
in the problem.

EBIT
BEP =
TA
EBIT
25% =
$3,000,000
EBIT = $750,000.

Interest expense can be obtained from the income statement by simply working
your way up the income statement. To do this, however, we must first
calculate net income from the data given for ROA.

NI
ROA =
TA
NI
12% =
$3,000,000
NI = $360,000.

Solving for EBT and then interest, we find:

NI
EBT =
(1 - T)
$360,000
EBT =
(1  0.35)
EBT = $553,846.

EBIT – INT = EBT

$750,000 – INT = $553,846
INT = $196,154.

We can now calculate the TIE as follows:

EBIT
TIE =
INT
$750,000
TIE =
$196,154
TIE = 3.82.

65. EBITDA coverage ratio Answer: a Diff: M N

TA = $9,000,000,000; EBIT/TA = 9%; TIE = 3; DA = $1,000,000,000; Lease

payments = $600,000,000; Principal payments = $300,000,000; EBITDA coverage
= ?

EBIT/$9,000,000,000 = 0.09
EBIT = $810,000,000.
 3 = EBIT/INT
3 = $810,000,000/INT
INT = $270,000,000.

EBITDA = EBIT + DA
= $810,000,000 + $1,000,000,000
= $1,810,000,000.

EBITDA  Lease payments

EBITDA coverage ratio =
INT  Princ. pmts  Lease pmts
$1,810,000,000  $600,000,000
=
$270,000,000  $300,000,000  $600,000,000
$2,410,000,000
= = 2.0598  2.06.
$1,170,000,000

66. Debt ratio Answer: c Diff: M

Debt ratio = Debt/Total assets.

Sales/Total assets = 6
Total assets = $24,000,000/6 = $4,000,000.

ROE = NI/Equity
Equity = NI/ROE = $400,000/0.15 = $2,666,667.

Debt = Total assets - Equity = $4,000,000 - $2,666,667 = $1,333,333.

Debt ratio = $1,333,333/$4,000,000 = 0.3333.

67. Profit margin Answer: a Diff: M

Equity multiplier = 1/(1 - 0.35) = 1.5385.

ROE = (Profit margin)(Assets utilization)(Equity multiplier)

15% = (PM)(2.8)(1.5385)
PM = 3.48%.

68. Financial statement analysis Answer: e Diff: M R

$1,000
Current DSO = = 36.5 days. Industry average DSO = 30 days.
$10,000/365
 $10,000 
Reduce receivables by (36.5 – 30)   = $178.08.
 365 
Debt = $400/0.10 = $4,000.
TD $4,000 - $178.08
= = 65.65%.
TA $6,000 - $178.08

69. Financial statement analysis Answer: b Diff: M R

First, find the amount of current assets:

Current ratio = Current assets/Current liabilities
Current assets = (Current liabilities)(Current ratio)
= $375,000(1.2) = $450,000.
 Next, find the accounts receivables:
DSO = AR/(Sales/365)
AR = DSO(Sales)(1/365)
= (40)($1,200,000)(1/365) = $131,506.85.

Next, find the inventories:

Inventory turnover = Sales/Inventory
Inventory = Sales/Inventory turnover
= $1,200,000/4.8 = $250,000.

Finally, find the amount of cash:

Cash = Current assets - AR - Inventory
= $450,000 - $131,506.85 - $250,000 = $68,493.15  $68,493.

70. Basic earning power Answer: d Diff: M

Given ROA = 10% and net income of $500,000, total assets must be $5,000,000.
NI
ROA =
A
$500,000
10% =
TA
TA = $5,000,000.

To calculate BEP, we still need EBIT. To calculate EBIT construct a partial

income statement:

EBIT $1,033,333 ($200,000 + $833,333)

Interest 200,000 (Given)
EBT $ 833,333 $500,000/0.6
Taxes (40%) 333,333
NI $ 500,000
EBIT
BEP =
TA
$1,033,333
=
$5,000,000
= 0.2067 = 20.67%.

71. P/E ratio and stock price Answer: e Diff: M

The current EPS is $1,500,000/300,000 shares or $5. The current P/E ratio is
then $60/$5 = 12. The new number of shares outstanding will be 400,000. Thus,
the new EPS = $2,500,000/400,000 = $6.25. If the shares are selling for 12
times EPS, then they must be selling for $6.25(12) = $75.

72 . Current ratio and DSO

Answer: a Diff: M

Step 1: Determine average daily sales using the old DSO.

Receivables
DSO = .
Average Daily Sales

If DSO changes while sales remain the same, then receivables must
change.
 $400
40 =
Average Daily Sales
$10 = Average Daily Sales.

Step 2: Determine the new level of receivables required for Parcells to

achieve the industry average DSO.
Receivables
30 =
$10
$300 = Receivables.

Step 3: Calculate the new current ratio.

Receivables decline by $100, so current assets declined by $100.
Therefore, the new level of current assets is $800 - $100 = $700. Since
the $100 cash freed up is used to reduce long-term bonds, cur-rent
liabilities remain at $400. Current ratio = $700/$400 = 1.75.

73. Current ratio Answer: c Diff: M N

Currently:
DSO = AR/Average Daily Sales
= $250/$10
= 25 days.

Now, Cartwright wants to reduce DSO to 15. The firm needs to reduce accounts
receivable because it doesn’t want to reduce average daily sales. So, we can
calculate the new AR balance as follows:
DSO = AR/Average Daily Sales
15 = AR/$10
$150 million = AR.

If the firm reduces its DSO to the industry average, its AR will be $150
million, reduced by $100 million. Therefore, there must be an equal reduction
on the right side of the balance sheet. Half of this $100 million of freed-up
cash will be used to reduce notes payable, and the other half will be used to
reduce accounts payable. Therefore, notes payable will fall by $50 million to
$250 million, and accounts payable will fall by $50 million to $250 million.

Therefore, we can now calculate the firm’s new current ratio:

Current Ratio = CA/CL
= (Cash + AR + Inv.)/(Notes Payable + Accounts Payable)
= ($250 + $150 + $250)/($250 + $250)
= $650/$500
= 1.30.
74. Current ratio Answer: b Diff: M N

Step 1: Calculate the firm’s current inventory turnover.

Inv. turnover = Sales/Inv.
= $3,000,000/$500,000
= 6.0.

New Inv. turnover = 10.0 (but sales stay the same).

Step 2: Calculate what the firm’s inventory balance should be if the firm
maintains the industry average inventory turnover.
Inv. turnover = Sales/Inv.
10 = $3 million/Inv.
$300,000 = Inv.
 The new inventory level will be $300,000, so inventories will be reduced by
$200,000 from the old level. This means that current assets will decrease by
$200,000.

Step 3: Calculate the firm’s new current assets level.

CA = Cash + Inv. + A/R
= $100,000 + $300,000 + $200,000
= $600,000.

Half of the $200,000 that is freed up will be used to reduce notes payable, and
the other half will be used to reduce common equity. Therefore, notes payable
will be reduced by $100,000 to a new level of $100,000.

Step 4: Calculate the firm’s new liabilities level.

CL = A/P + Accruals + Notes payable
= $200,000 + $100,000 + $100,000
= $400,000.

Step 5: Calculate the firm’s new current ratio with the improved inventory
management.
CR = CA/CL
= $600,000/$400,000
= 1.5.

75. Credit policy and ROE Answer: c Diff: M R

Use the DSO formula to calculate accounts receivable under the new policy as
36 = AR/($730,000/365) or AR = $72,000. Thus, $125,000 - $72,000 = $53,000 is
the cash freed up by reducing DSO to 36 days. Retiring $53,000 of long-term
debt leaves $247,000 in long-term debt. Given a 10% interest rate, interest
expense is now $247,000(0.1) = $24,700. Thus, EBT = EBIT - Interest = $70,000
- $24,700 = $45,300. Net income is $45,300(1 - 0.3) = $31,710. Thus, ROE =
$31,710/$200,000 = 15.86%.

76. Du Pont equation Answer: d Diff: M

Before: Equity multiplier = 1/(1 - D/A) = 1/(1 - 0.5) = 2.0.

ROE = (PM)(Assets turnover)(EM) = (10%)(0.25)(2.0) = 5%.

After: [ROE = 2(5%) = 10%]:

10% = (12%)(0.25)(EM)
EM = 3.33 = A/E.

E/A = 1/3.33 = 0.3.

D/A = 1 – 0.3 = 0.7 = 70%.

77. Sales and extended Du Pont equation Answer: a Diff: M

NI/E = 15%; D/A = 40%; E/A = 60%; A/E = 1/0.6 = 1.6667; NI/S = 5%.

Step 1: Determine total assets turnover from the extended Du Pont equation:
NI/S  S/TA  A/E = ROE
(5%)(S/TA)(1.6667) = 15%
0.0833 S/TA = 15%
S/TA = 1.8.
 Step 2: Determine sales from the total assets turnover ratio:
S/TA = 1.8
S/$800 = 1.8
S = $1,440 million.

78. Net income and Du Pont equation Answer: c Diff: M N

Step 1: Calculate total assets from information given.

Sales = $10 million.

3.5 = Sales/TA
$10,000,000
3.5 =
Assets
Assets = $2,857,142.8571.

Step 2: Calculate net income.

There is no debt, so Assets = Equity = $2,857,142.8571.

ROE = NI/S  S/TA  TA/E

0.15 = NI/$10,000,000  3.5  1
3.5NI
0.15 =
$10,000,000
$1,500,000 = 3.5NI
$428,571.4286 = NI.

79. ROE Answer: c Diff: T

Given: New D/A = 0.55 Interest = $7,000

EBIT = $25,000 Tax rate = 40%
Sales = $270,000 TATO = 3.0

Recall the Du Pont equation: ROE = (PM)(TATO)(EM).

ROE = (ROA)(EM).
ROE = NI/Equity.
EBIT $25,000
Interest 7,000 (Given)
EBT $18,000
Taxes (40%) 7,200 ($18,000  40%)
NI $10,800

TATO = Sales/Total assets

Total assets = Sales/TATO = $270,000/3 = $90,000.

Equity = [1 - (D/A)](Total assets)

Equity = [1 - 0.55](Total assets)
Equity = 0.45($90,000) = $40,500.

ROE = NI/Equity = $10,800/$40,500 = 26.67%.

80. ROE Answer: d Diff: T

Industry average inventory turnover = 6 = Sales/Inventories.

To match this level: Inventories = Sales/6
$3,000,000/6 = $500,000.

Current inventories = $1,000,000. Reduction in inventories = $1,000,000 -

 $500,000 = $500,000. This $500,000 is to be used to reduce debt.

New debt level = $4,000,000 - $500,000 = $3,500,000.

Interest on this level of debt = $3,500,000  0.1 = $350,000.

Look at the income statement to determine net income:

EBIT $1,400,000
Interest 350,000
EBT $1,050,000
Taxes (40%) 420,000
NI $ 630,000

ROE = Net income/Equity = $630,000/$2,000,000 = 0.3150 or 31.50%.

81. ROE and financing Answer: a Diff: T

The firm is not using its “free” trade credit (that is, accounts payable
(A/P)) to the same extent as other companies. Since it is financing part of
its assets with 10% notes payable, its interest expense is higher than
necessary.

Calculate the increase in payables:

Current (A/P)/Inventories ratio = $100/$500 = 0.20.
Target A/P = 0.60(Inventories) = 0.60($500) = $300.
Increase in A/P = $300 - $100 = $200.

Since the current ratio and total assets remain constant, total liabilities
and equity must be unchanged. The increase in accounts payable must be
matched by an equal decrease in interest-bearing notes payable. Notes payable
decline by $200. Interest expense decreases by $200  0.10 = $20.
Construct comparative Income Statements:
Old New
Sales $2,000 $2,000
Operating costs 1,843 1,843
EBIT $ 157 $ 157
Interest 37 17
EBT $ 120 $ 140
Taxes (40%) 48 56
Net income (NI) $ 72 $ 84

ROE = NI/Equity = $72/$800 = 9%. $84/$800 = 10.5%.

New ROE = 10.5%.

82. ROE and refinancing Answer: d Diff: T

Relevant information: Old ROE = NI/Equity = 0.06 = 6%.

Sales = $300,000; EBIT = 0.11(Sales) = 0.11($300,000) = $33,000.
Debt = $200,000; D/A = 0.80 = 80%.
Tax rate = 40%.
Interest rate change: Old bonds 14%; new bonds 10%.

Calculate total assets and equity amounts:

Since debt = $200,000, total assets = $200,000/0.80 = $250,000.
Equity = 1 - D/A = 1 - 0.80 = 0.20.
Equity = E/TA  TA = 0.20  $250,000 = $50,000.

Construct comparative Income Statements from EBIT, and calculate new ROE:
 Old New
EBIT $33,000 $33,000
Interest 28,000 20,000
EBT $ 5,000 $13,000
Taxes (40%) 2,000 5,200
Net income $ 3,000 $ 7,800

New ROE = NI/Equity = $7,800/$50,000 = 0.1560 = 15.6%.

83. TIE ratio Answer: d Diff: T

EBIT
TIE = = ?
I
TA Turnover = S/A = 2
S/$10,000 = 2
S = $20,000.
TD
= 0.6;
TA
TD = 0.6($10,000)
ebt = $6,000.

I = $6,000(0.1) = $600.

NI
PM = = 3%
S
NI
PM = = 0.03
$20,000
NI = $600.

$600
EBT = = $1,000.
(1 - 0.4)

EBIT $1,600
Interest 600
EBT $1,000
Taxes (40%) 400
NI $ 600

TIE = $1,600/$600 = 2.67.

84. Current ratio Answer: e Diff: T

Old DSO = 40; CA = $2,500,000; CA/CL = 1.5; AR = $1,600,000.

Step 1: Calculate average daily sales:

DSO = AR/Average daily sales
40 = $1,600,000/Average daily sales
$40,000 = Average daily sales.

Step 2: Calculate the new level of accounts receivable when DSO = 30:
30 = AR/$40,000
$1,200,000 = AR.
So, the change in receivables will be $1,600,000 – $1,200,000 =
$400,000.
 Step 3: Calculate the old level of current liabilities:
Current ratio = CA/CL
1.5 = $2,500,000/CL
$1,666,667 = CL.

Step 4: Calculate the new current ratio:

The change in receivables will cause a reduction in current assets of
$400,000 and a reduction in current liabilities of $400,000.
CA new = $2,500,000 - $400,000 = $2,100,000.
CL new = $1,666,667 - $400,000 = $1,266,667.
CR new = $2,100,000/$1,266,667 = 1.66.

85. P/E ratio and stock price Answer: b Diff: T

Here are some data on the initial situation:

EPS = $50/20 = $2.50.
Stock price = $2.50(8) = $20.
If XYZ had the industry average inventory turnover, its inventory balance
would be:
Sales $1,000
Turnover = 5 = =
Inv Inv
Inv = $1,000/5 = $200.
Therefore, inventories would decline by $100.
The income statement would remain at the initial level. However, the company
could now repurchase and retire 5 shares of stock:
Funds available $100
= = 5 shares.
Price/share $20
Thus, the new EPS would be:
Net income $50
New EPS = = = $3.33.
Shares outstanding 20 - 5
The new stock price would be:
New price = New EPS(P/E) = $3.33(8) = $26.67.
Stock price increase = $26.67 - $20.00 = $6.67.
86. Du Pont equation and debt ratio Answer: e Diff: T

NI S A
  = ROE.
S A EQ

Data for A:
NI $1,000 $500
  = 0.15
$1,000 $500 0.7($500)
NI
= 0.15 = NI = $52.50.
0.7($500)
NI $52.50
ROE = = = 0.0525 = 5.25%.
S $1,000

Data for B:
NI S A
  = 0.30
S A EQ
 $500
0.0525  2  = 0.30
EQ
$500
0.1050  = 0.30
EQ
$500
= 2.8571
EQ
Equity = $175.

Debt = $500 - $175 = $325.

Therefore, D/A = $325/$500 = 0.65 or 65%.

87. Financial statement analysis Answer: a Diff: T

Sales $15,000
Cost of goods sold _______
EBIT $ 1,065
Interest 465
EBT $ 600
Taxes (35%) 210
NI $ 390

EBIT EBIT
BEP = = = 0.133125; EBIT = $1,065.
TA $8,000

Now fill in: EBIT = $1,065.

Interest = EBIT - EBT = $1,065 - $600 = $465.

D D
= = 0.45; D = 0.45($8,000) = $3,600.
A $8,000
Interest $465
Interest rate = = = 0.1292 = 12.92%.
Debt $3,600

88. EBIT Answer: e Diff: T

Write down equations with given data, then find unknowns:

NI
Profit margin = = 0.06.
S
D D
Debt ratio = = = 0.4; D = $40,000.
A $100,000
S S
TA turnover = = 3.0 = = 3; S = $300,000.
A $100,000

Now plug sales into profit margin ratio to find NI:

NI
= 0.06; NI = $18,000.
$300,000

Now set up an income statement:

Sales $300,000
Cost of goods sold ________
EBIT $ 33,200 (EBIT = EBT + Interest)
Interest 3,200 ($40,000(0.08) = $3,200)
EBT $ 30,000 (EBT = $18,000/(1 - T) = $30,000)
Taxes (40%) 12,000
 NI $ 18,000

89. Sales increase needed Answer: b Diff: T N

You need to work backwards through the income statement to solve this problem.

The new NI will be: ($1,800,000)(1.25) = $2,250,000.

Now find EBT:

(EBT)(1 - T) = NI
EBT = NI/(1 - T)
= $2,250,000/(1 - 0.4)
= $3,750,000.

Now find EBIT:

EBIT - I = EBT
EBIT = EBT + I
EBIT = $3,750,000 + $1,500,000
= $5,250,000.

Now find Sales:

(Sales)(Operating Margin) = EBIT
Sales = EBIT/Operating Margin
= $5,250,000/0.4
= $13,125,000.

Therefore, sales need to rise to $13,125,000. How much of an increase is

this?

$13,125,000/$12,000,000 = 1.09375. Therefore, sales have gone up by 9.375%

(rounded to 9.38%).
90. Debt ratio and Du Pont analysis Answer: c Diff: M N

The Du Pont analysis of return on equity gives us:

ROE = ROA  EM
14% = 10%  EM
1.4 = EM.

From the equity multiplier (A/E), we can calculate the debt ratio:

1.4 = A/E
E/A = 1/1.4
E/A = 0.7143.

D/A = 1 – E/A
D/A = 1 – 0.7143
D/A = 0.2857 = 28.57%.

91. Profit margin and Du Pont analysis Answer: a Diff: E N

Using the Du Pont analysis again, we can calculate the profit margin.

ROE = PM  TATO  EM
14% = PM  5  1.4
14% = PM  7
2% = PM.
92. ROA Answer: d Diff: M N

ROA = NI/Assets. Total assets = $3,200,000,000 (from the balance sheet).

We, know ROE = NI/Common equity = 0.20, with Common equity = $900,000,000
(from the balance sheet).

0.20 = NI/$900,000,000
NI = $180,000,000.

So, ROA = $180,000,000/$3,200,000,000 = 0.05625, or 5.625%.

93. Current ratio Answer: b Diff: M N

Recall the current ratio is CA/CL = $900,000,000/$800,000,000 = 1.125.

The plan looks like this: Debit Fixed assets $300,000,000

Credit Notes payable $300,000,000

So, current liabilities increase by $300 million, while current assets do not
change.

So, the new current ratio is $900,000,000/($800,000,000 + $300,000,000) =

$900,000,000/$1,100,000,000 = 0.818.

94. Miscellaneous concepts Answer: e Diff: E N

The correct answer is statement e. The current ratio in 2002 was 1.77, while the
current ratio in 2001 was 1.64. Hence, the current ratio was higher in 2002.
The debt ratio was 0.4773 in 2002 and 0.5250 in 2001, so the debt ratio decreased
from 2001 to 2002. The firm issued $300 million in new common stock in 2002.

95. Net income Answer: b Diff: E N

To determine 2002 net income, use the following equation:

Ending retained earnings = Beginning RE + NI – Dividends paid
$800,000,000 = $700,000,000 + NI – $50,000,000
$150,000,000 = NI.

96. Sales, DSO, and inventory turnover Answer: b Diff: M N

Step 1: One of our initial conditions is that inventory turnover (S/Inv.) <
6.0, hence:
Sales/Inventory < 6.0
Sales/$850,000,000 < 6.0
Sales < $5,100,000,000.
Step 2: Our second initial condition is that DSO < 50, hence:
AR/(Sales/365) < 50.0
$450,000,000/(Sales/365) < 50.0
[($450,000,000)(365)]/Sales < 50.0
($450,000,000)365 < 50(Sales)
[($450,000,000)(365)]/50 < Sales
Sales > $3,285,000,000.
So, the most likely estimate of the firm’s 2002 sales would fall between
$3,285,000,000 and $5,100,000,000. Only statement b meets this requirement.
97 . Financial statement analysis

Answer: a Diff: E N

The correct answer is statement a. The current ratio in 2002 is 1.02, while
in 2001 it is 0.785. So, statement a is correct. For statement b, assume
that sales are X. The inventory turnover ratio for 2002 is X/$1,000,000 and
X/$700,000 in 2001. So, the inventory turnover ratio for 2001 is higher than
in 2002. (If that’s not clear, try X = $500,000 or any other number.) Thus,
statement b is incorrect. The debt ratio in 2002 is 0.596, while in 2001 it’s
0.672, so statement c is incorrect.

98 . Current ratio

Answer: c Diff: M N

Step 1: Determine actual 2002 sales:

DSO = AR/(Sales/365)
40 = $432,000/(Sales/365)
40(Sales)/365 = $432,000
40(Sales) = $157,680,000
Sales = $3,942,000.

Step 2: Determine new accounts receivable balance if DSO = 30 and sales

remain the same:
30 = AR/($3,942,000/365)
30 = AR/$10,800
AR = $324,000.

Step 3: Determine the amount of freed-up cash and the new level of accounts
payable.
Freed-up cash = $432,000 - $324,000 = $108,000.
New AP = $700,000 - $108,000 = $592,000.
Step 4: Determine the new current ratio:
CR = ($100,000 + $324,000 + $1,000,000)/($592,000 + $800,000)
= $1,424,000/$1,392,000
= 1.023.