[i]. 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
Common
equity 800,000
Total liabilities
Total assets $2,000,000 and equity $2,000,000
Jefferson wants to improve its inventory turnover to the
industry average of 10.0´. The change is not expected to
have an effect on sales. If successful,
the company would use the freed-up cash from the reduction in inventories and
use half of it to reduce notes payable and the other half to reduce common
equity. If successful, what will be Jefferson’s current ratio?
a.1.43
b.1.50
c.2.50
d.2.00
e.1.20
[ii]. Daggy
Corporation has the following simplified balance sheet:
Cash $ 25,000 Current liabilities $200,000
Inventories 190,000
Accounts receivable 125,000 Long-term debt 300,000
Net fixed assets
360,000 Common equity 200,000
Total assets $700,000 Total
claims $700,000
The company has been advised to tighten their
credit policy and reduce their days sales outstanding to 36 days. The increase in cash resulting from the decrease
in accounts receivable will be used to reduce the company’s long-term
debt. The interest rate on long-term
debt is 10% and the company’s tax rate is 30%.
The new credit policy is expected to reduce the company’s sales to
$730,000 and EBIT to $70,000. What is
the company’s expected ROE after the change in credit policy?
a.14.88%
b.16.63%
c.15.86%
d.18.38%
e.16.25%
[iii]. Austin
& Company has a debt ratio of 0.5, a total assets turnover ratio of 0.25,
and a profit margin of 10%. 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% and (2) by increasing
debt utilization. Total assets turnover
will not change. What new debt ratio,
along with the new 12% profit margin, would be required to double the ROE?
a.55%
b.60%
c.65%
d.70%
e.75%
[iv]. Shepherd
Enterprises has an ROE of 15%, a debt ratio of 40%, and a profit margin of
5%. 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
b.$2,400,000,000
c.$
120,000,000
d.$
360,000,000
e.$
960,000,000
[v]. Samuels
Equipment has $10 million in sales. Its
ROE is 15% and its total assets turnover is 3.5´. The
company is 100% equity financed. What is
the company’s net income?
a.$1,500,000
b.$2,857,143
c.$ 428,571
d.$2,333,333
e.$ 52,500
[vi]. 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
Taxes (40%) 400,000
Net income $ 600,000
The company’s interest cost is 10%, so the
company’s interest expense each year is 10% of its total debt.
While
the company’s financial performance is quite strong, its CFO 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 the company’s ROE would have been last year if the following
had occurred:
·
The company maintained the same sales, but
reduced inventories enough to achieve the industry average inventory turnover
ratio.
·
Cash generated from the inventory reduction was
used to reduce the company’s outstanding debt.
So, the company’s total debt would have been $4 million less the
freed-up cash from the improvement in inventory policy.
·
Assume equity does not change and all earnings
are paid out as dividends.
Under this
scenario, what would have been the company’s ROE last year?
a.27.0%
b.29.5%
c.30.3%
d.31.5%
e.33.0%
[vii]. Roland
& Company has a new management team that has developed an operating plan to
improve upon last year’s ROE. The new
plan would make the debt ratio 55%, 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%.
What does Roland & Company expect its ROE to be?
a.17.65%
b.21.82%
c.26.67%
d.44.44%
e.51.25%
[viii].Savelots
Stores’ current financial statements are shown below:
Balance Sheet:
Inventories $ 500 Accounts
payable $ 100
Other current assets 400 Short-term
notes payable 370
Fixed assets 370 Common
equity 800
Total assets $1,270 Total
liab. and equity $1,270
Income
Statement:
Sales $2,000
Operating
costs 1,843
EBIT $
157
Interest 37
EBT $ 120
Taxes
(40%) 48
Net income $ 72
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% of inventories versus an industry average of 60%. Suppose Savelots increased its accounts
payable-to-inventories ratio to the 60% industry average, but it (1) kept all
of its assets at their present levels and (2) held its current ratio at
1.9. Assume that Savelots’ tax rate is
40%, that its cost of short-term debt is 10%, and that the change in payments
does not affect operations. In addition,
common equity will not change. What will
be Savelots’ new ROE?
a.10.5%
b. 7.8%
c. 9.0%
d.13.2%
e.12.0%
[ix]. Aurillo
Equipment Company (AEC) projected next year’s ROE to be 6%. However, 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%, but the interest rate on the
refinanced debt will be 10%. The rate on
the old debt is 14%. Refinancing will
not affect sales, which are projected to be $300,000. The basic earning power will be 11% and the
firm’s tax rate is 40%. If AEC
refinances, what will be its projected new ROE?
a. 3.0%
b. 8.2%
c.10.0%
d. 9.0%
e.18.7%
[x]. 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
b.1.75
c.2.10
d.2.67
e.3.45
[xi]. Victoria
Enterprises has $1.6 million of accounts receivable.The company’s DSO is 40, its
current assets are $2.5 million, and its current ratio is 1.5. The company plans to reduce its DSO to the
industry average of 30 without causing a decline in sales. The freed-up
cash will be used to reduce current liabilities.If the company succeeds, what
will Victoria’s new current ratio be?
a.1.50
b.1.97
c.1.26
d.0.72
e.1.66
[xii]. 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%, 20 shares are outstanding,
and the stock’s P/E is 8.0. If XYZ
increased its inventory turnover to the industry average, if it used freed up
funds 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
b.$ 6.67
c.$ 8.75
d.$10.00
e.$12.50
Du Pont equation and debt ratio Answer: e
[xiii].Company A
has sales of $1,000, assets of $500, a debt ratio of 30%, and an ROE of
15%. Company B has the same sales,
assets, and net income as Company A, but its ROE is 30%. What is B’s debt ratio? (Hint: Begin by looking at the Du Pont
equation.)
a.25.0%
b.35.0%
c.50.0%
d.52.5%
e.65.0%
[xiv]. 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?
a.12.92%
b.13.23%
c.13.51%
d.13.75%
e.14.00%
[xv]. 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
b.$12,000
c.$18,000
d.$30,000
e.$33,200
[xvi]. 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
Taxes (40%) 1,200,000
Net income $ 1,800,000
The
company’s CFO, Fred Mertz, wants to see a 25% increase in net income over the
next year. In other words, his target
for next year’s net income is $2,250,000.
Mertz has made the following observations:
·
Ricardo’s
operating margin (EBIT/Sales) was 37.5% this past year. Mertz expects that next year this margin will
increase to
40%.
·
Ricardo’s
interest expense is expected to remain constant.
·
Ricardo’s tax
rate is expected to remain at 40%.
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?
a.72.92%
b. 9.38%
c. 2.50%
d.48.44%
e.25.00%
Multiple Part:
(The
following information applies to the next two problems.)
Fama’s French Bakery has a return on assets (ROA) of 10%
and a return on equity (ROE) of 14%.
Fama’s total assets equal total debt plus common equity (that is, there
is no preferred stock). Furthermore, we
know that the firm’s total assets turnover is 5.
[xvii].What is Fama’s debt ratio?
a.14.29%
b.28.00%
c.28.57%
d.55.56%
e.71.43%
[xviii]. What is Fama’s profit margin?
a.2.00%
b.4.00%
c.4.33%
d.5.33%
e.6.00%
(The following information applies to the
next two problems.)
Miller Technologies recently reported the following
balance sheet in its annual report (all numbers are in millions of dollars):
Cash $
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% ROE for this same year.
[xix]. What is Miller’s ROA?
a.2.500%
b.3.125%
c.4.625%
d.5.625%
e.7.826%
[xx]. Miller Technologies is considering 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
b.0.818
c.1.091
d.1.125
e.1.800
(The following information
applies to the next three problems.)
Dokic, Inc. reported the
following balance sheets for year-end 2004 and 2005 (dollars in millions):
2005 2004
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
[xxi]. Which of the following statements is NOT
correct?
a.The
company’s current ratio was higher in 2005 than it was in 2004.
b.The company’s debt ratio was
higher in 2005 than it was in 2004.
c.The company
issued new common stock during 2005.
d.If the company
paid no dividends, it must have had a positive net income.
e.The company’s
net working capital declined between 2004 and 2005.
[xxii].The total
dividends paid to the company’s common stockholders during 2005 was $50
million. What was the company’s net
income during the year 2005?
a.$
50 million
b.$150 million
c.$250 million
d.$350 million
e.$450 million
[xxiii]. When
reviewing the company’s performance for 2005, its CFO observed that the
company’s inventory turnover ratio was below the industry average inventory
turnover ratio of 6.0. In addition, the
company’s DSO was less than the industry average of 50. What is the most likely estimate of the company’s
sales (in millions of dollars) for 2005?
a.$
2,940
b.$ 5,038
c.$ 7,250
d.$10,863
e.$30,765
(The following information
applies to the next two problems.)
Below are the 2004 and 2005
year-end balance sheets for Kewell Boomerangs:
2005 2004
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 2005, none of the principal
on this debt has been repaid. Assume
that 2004 and 2005 sales were the same in both years.
[xxiv].Which of the following statements is most
correct?
a.Kewell’s
current ratio in 2005 was higher than it was in 2004.
b.Kewell’s inventory turnover ratio in 2005 was
higher than it was in 2004.
c.Kewell’s debt
ratio in 2005 was higher than it was in 2004.
d.Since retained
earnings increased, the company must have paid no dividends.
e.Because fixed
assets turnover increased slower than total assets, the total assets turnover
is greater than the fixed assets turnover.
[xxv]. During
2005, Kewell’s days sales outstanding was 40 days. The industry average DSO was 30 days. Assume instead that in 2005, 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 DSO were reduced, what would have been
Kewell’s current ratio in 2005?
a.1.018
b.1.021
c.1.023
d.1.027
e.1.033