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Exam 4: Statement Analysis

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Question 21

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Your sister is thinking about starting a new business. The company would require $375,000 of assets, and it would be financed entirely with common stock. She will go forward only if she thinks the firm can provide a 13.5% return on the invested capital, which means that the firm must have an ROE of 13.5%. How much net income must be expected to warrant starting the business?

A) $41,234
B) $43,405
C) $45,689
D) $48,094
E) $50,625

F) C) and D)
G) B) and E)

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Question 22

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What is the firm's profit margin?

A) 1.51%
B) 1.67%
C) 1.86%
D) 2.07%
E) 2.27%

F) B) and C)
G) A) and D)

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Question 23

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High current and quick ratios always indicate that the firm is managing its liquidity position well.

If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline.

What is the firm's ROA?

Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength.

Amram Company's current ratio is 2.0. Considered alone, which of the following actions would lower the current ratio?

Han Corp's sales last year were $425,000, and its year-end receivables were $52,500. The firm sells on terms that call for customers to pay 30 days after the purchase, but some delay payment beyond Day 30. On average, how many days late do customers pay? Base your answer on this equation: DSO - Allowed credit period = Average days late, and use a 365-day year when calculating the DSO.

The return on common equity (ROE) is generally regarded as being less significant, from a stockholder's viewpoint, than the return on total assets (ROA).

The profit margin measures net income per dollar of sales.

Last year Hamdi Corp. had sales of $500,000, operating costs of $450,000, and year-end assets of $395,000. The debt-to-total-assets ratio was 17%, the interest rate on the debt was 7.5%, and the firm's tax rate was 35%. The new CFO wants to see how the ROE would have been affected if the firm had used a 50% debt ratio. Assume that sales, operating costs, total assets, and the tax rate would not be affected, but the interest rate would rise to 8.0%. By how much would the ROE change in response to the change in the capital structure?

River Corp's total assets at the end of last year were $415,000 and its net income was $32,750. What was its return on total assets?

The times-interest-earned ratio is one, but not the only, indication of a firm's ability to meet its long-term and short-term debt obligations.

In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock.

Other things held constant, the more debt a firm uses, the lower its profit margin will be.

If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.

What is the firm's equity multiplier?

The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be $300,000, operating costs to be $265,000, assets (capital) to be $200,000, and its tax rate to be 35%. Under Plan A it would use 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but under a contract with existing bondholders the TIE ratio would have to be maintained at or above 4.0. Under Plan B, the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure?

HD Corp and LD Corp have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, HD uses more debt than LD. Which of the following statements is CORRECT?