1.

An increase in the market price of a company’s common stock will immediately affect its:
a. dividend yield ratio. c. earnings per share of common stock.
b. debt-to-equity ratio. d. dividend payout ratio.

2. Which of the following is true regarding the calculation of return on total assets?
a. The numerator of the ratio consists only of net income.
b. The denominator of the ratio consists of the balance of total assets at the end of the period under consideration.
c. The numerator of the ratio consists of net income plus interest expense times the tax rate.
d. The numerator of the ratio consists of net income plus interest expense times one minus the tax rate.

3. Financial leverage is negative when:

a. the return on total assets is less than the rate of return on common stockholders' equity.
b. total liabilities are less than stockholders' equity.
c. total liabilities are less than total assets.
d. the return on total assets is less than the rate of return demanded by creditors.

4. If a company's bonds bear an interest rate of 8%, the tax rate is 30%, and the company's assets are generating an after-tax return
of 7%, then the leverage would be:
a. positive.
b. negative.
c. neither positive or negative.
d. impossible to determine without knowing the return on common stockholders' equity.

5. Allen Company's average collection period for accounts receivable was 40 days last year, but increased to 60 days this year.
Which of the following would most likely account for this change?
a. a decrease in accounts receivable relative to sales.
b. a decrease in sales.
c. a relaxation of credit policies.
d. an increase in sales.

6. Starrs Company has current assets of P300,000 and current liabilities of P200,000. Which of the following transactions would
increase its working capital?
a. Prepayment of P50,000 of next year’s rent.
b. Refinancing P50,000 of short-term debt with long-term debt.
c. Acquisition of land valued at P50,000 by issuing new common stock.
d. Purchase of P50,000 of marketable securities for cash.

7. 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.

8. 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.

9. 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.
 10. 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.

11. 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.

12. 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.

13. 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 P2.0 billion P1.5 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.

14. A limitation in calculating ratios in financial statement analysis is that

a. it requires a calculator.
b. no one other than the management would be interested in them.
c. some account balances may reflect atypical data at year end.
d. they seldom identify problem areas in a company.

15. Which of these statements is false?

a. Many companies will not clearly fit into any one industry.
b. A financial service uses its best judgment as to which industry the firm best fits.
c. The analysis of an entity's financial statements can be more meaningful if the results are compared with industry averages
and with results of competitors.
d. A company comparison should not be made with industry averages if the company does not clearly fit into any one industry.

Problem Solving (NRX 2): Supply the requirements of each problem.

A. The net accounts receivable for Andante Company were P150,000 at the beginning of the most recent year and P190,000 at the
end of the year. If the accounts receivable turnover for the year was 8.5, and 15% of total sales were cash sales, then the total
sales for the year were: 1,700,000
Credit sales = 8.5*(150,000 + 190,000)/2 = 1,445,000. Sales = 1,445,000/(1 - .15)
 B. Selected data from Sheridan Corporation’s year-end financial statements are presented below. The difference between average
and ending inventory is immaterial.
Current ratio ............ 2.0 Inventory turnover ....... 8 times
Acid-test ratio .......... 1.5 Gross profit margin ...... 40%
Current liabilities ...... P120,000
Sheridan's sales for the year was: 800,000
Inventory = CA - QA = 120,000*2 - 120,000*1.5 = 60,000.Sales = (60,000*8)/(1 - .40)

C. Cameron Company had 50,000 shares of common stock issued and outstanding during the year just ended. The following
information pertains to these shares:
Price originally issued ................... P40
Book value at end of current year ......... P70
Market value, beginning of current year ... P85
Market value, end of current year ......... P90
The total dividend on common stock for the year was P400,000. Cameron Company's dividend yield ratio for the year was:
8.89% (400,000/50,000)/90
D. Selected year-end data for the Brayer Company are presented below:
Current liabilities ........ P600,000
Acid-test ratio ............ 2.5 to 1
Current ratio .............. 3.0 to 1
Cost of goods sold ......... P500,000
The company has no prepaid expenses and inventories remained unchanged during the year. Based on these data, the company's
inventory turnover ratio for the year was closest to: 1.67

E. Marcy Corporation's current ratio is currently 1.75 to 1. The firm’s current ratio cannot fall below 1.5 to 1 without violating
agreements with its bondholders. If current liabilities are presently P250 million, the maximum new short-term debt that can
be issued to finance an equivalent amount of inventory expansion is 125,000,000

F. Tapley Dental Supply Company has the following data:

Net income P240 TIE ratio 2.0
Sales P10,000 Current ratio 1.2
Total assets P6,000 BEP ratio 13.33%
Debt ratio 75%
If Tapley could streamline operations, cut operating costs, and raise net income to P300 without affecting sales or the balance
sheet (the additional profits will be paid out as dividends), by how much would its ROE increase? 4%

G. 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 P1 million, and P250,000 of these sales
were on credit. During the year, the accounts receivable account averaged P41,096. 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. _51,370

H. 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 P7,000 per year. EBIT is projected
to be P25,000 on sales of P270,000, 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? 26.67%

I. Company A has sales of P1,000, assets of P500, 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? 65.0%

J. 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 pesos) for 2002? 5,038

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.

K. 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 P200,000 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 P300,000.
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? 15.6%

L. Georgia Electric reported the following income statement and balance sheet for the previous year:

Balance Sheet:
Cash P 100,000 Total debt P4,000,000
Inventories 1,000,000
Accounts receivable 500,000
Current assets P1,600,000
Net fixed assets 4,400,000 Total equity 2,000,000
Total assets P6,000,000 Total claims P6,000,000
Income Statement:
Sales P3,000,000
Operating costs 1,600,000
Operating income (EBIT) P1,400,000
Interest 400,000
Taxable income (EBT) P1,000,000
Taxes (40%) 400,000
Net income P 600,000
The company’s interest cost is 10 percent, so the company’s interest expense each year is 10 percent of 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 noticed that the company’s inventory turnover ratio is considerably weaker than the industry average, which is 6.0.
As an exercise, the CFO asks what would the company’s ROE have been last year if the following had occurred:
• The company maintained the same sales, but was able to reduce inventories enough to achieve the industry average
inventory turnover ratio.
• The cash that was generated from the reduction in inventories was used to reduce part of the company’s outstanding
debt. So, the company’s total debt would have been P4 million less the freed-up cash from the improvement in
inventory policy. The company’s interest expense would have been 10 percent of new total debt.
• Assume equity does not change. (The company pays all net income as dividends.)
Under this scenario, what would have been the company’s ROE last year? 31.5%
M. Savelots Stores’ current financial statements are shown below:
Balance Sheet:
Inventories P 500 Accounts payable P 100
Other current assets 400 Short-term notes payable 370
Fixed assets 370 Common equity 800
Income Statement:
Sales P2,000 Interest 37
Operating costs 1,843 Taxes (40%) 48

A recently released report indicates that Savelots’ current ratio of 1.9 is in line with the industry average. However, its 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? 10.5%
N. Ricardo Entertainment recently reported the following income statement:
Sales P12,000,000
Cost of goods sold 7,500,000
Interest 1,500,000
Taxes (40%) 1,200,000
Net income P 1,800,000
The company’s CFO, Fred Mertz, wants to see a 25 percent increase in net income over the next year. In other words, his
target for next year’s net income is P2,250,000. Mertz has made the following observations:
• Ricardo’s operating margin (EBIT/Sales) was 37.5 percent this past year. Mertz expects that next year this margin
will increase to 40 percent.
• Ricardo’s interest expense is expected to remain constant.
• Ricardo’s tax rate is expected to remain at 40 percent.
On the basis of these numbers, what is the percentage increase in sales that Ricardo needs in order to meet Mertz’s target for
net income? _9.38%