A) Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's.
B) Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required to achieve its target TIE ratio.
C) Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed, two firms with the same EBIT must have the same ROA.
D) Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.
E) Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, a zero debt ratio and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow money, use it to buy back stock, and raise the debt ratio to 50% and the equity multiplier to 2.0. She thinks that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would probably not be a good move, as it would decrease the ROE from 7.5% to 6.5%.
G) B) and E)
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A) Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.
B) Issue new common stock and use the proceeds to increase inventories.
C) Speed up the collection of receivables and use the cash generated to increase inventories.
D) Use some of its cash to purchase additional inventories.
E) Issue new common stock and use the proceeds to acquire additional fixed assets.
G) A) and E)
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B) False
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A) Other things held constant, the less debt a firm uses, the lower its return on total assets will be.
B) 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.
C) 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) .
D) The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In general, investors regard companies with higher P/E ratios as being more risky and/or less likely to enjoy higher future growth.
E) Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a margin of 8% for Firm B. Firm A's debt ratio is 70% versus 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A's higher profit margin.
G) C) and E)
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A) 0.87
B) 1.02
C) 1.21
D) 1.42
E) 1.67
G) A) and E)
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A) $201,934
B) $212,563
C) $223,750
D) $234,938
E) $246,684
G) B) and E)
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A) If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses.
B) A firm's use of debt will have no effect on its profit margin.
C) If two firms differ only in their use of debt--i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates--but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales and a lower return on assets.
D) The debt ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable.
E) If two firms differ only in their use of debt--i.e., they have identical assets, sales, operating costs, and tax rates--but one firm has a higher debt ratio, the firm that uses more debt will have a higher operating margin and return on assets.
G) B) and D)
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A) 7.50%
B) 7.90%
C) 8.31%
D) 8.73%
E) 9.16%
G) A) and E)
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B) False
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A) 21.27
B) 22.38
C) 23.50
D) 24.68
E) 25.91
G) A) and E)
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A) 0.51
B) 0.64
C) 0.76
D) 0.92
E) 1.10
G) A) and B)
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A) 17.17
B) 18.08
C) 18.98
D) 19.93
E) 20.93
G) D) and E)
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B) False
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A) Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will increase.
B) Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Without additional information, we cannot tell what will happen to the ROE.
C) The DuPont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE.
D) Other things held constant, an increase in the debt ratio will result in an increase in the profit margin.
E) Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will decrease.
G) B) and D)
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A) The TIE declines.
B) The DSO increases.
C) The quick ratio increases.
D) The current ratio declines.
E) The total assets turnover decreases.
G) C) and E)
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A) Company E probably has fewer growth opportunities.
B) Company E is probably judged by investors to be riskier.
C) Company E must have a higher market-to-book ratio.
D) Company E must pay a lower dividend.
E) Company E trades at a higher P/E ratio.
G) B) and E)
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A) Company HD has a lower equity multiplier.
B) Company HD has more net income.
C) Company HD pays more in taxes.
D) Company HD has a lower ROE.
E) Company HD has a lower times-interest-earned (TIE) ratio.
G) B) and C)
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A) $158,750
B) $166,688
C) $175,022
D) $183,773
E) $192,962
G) A) and E)
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A) 12.0
B) 12.6
C) 13.2
D) 13.9
E) 14.6
G) B) and D)
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A) Company HD has a lower total assets turnover than Company LD.
B) Company HD has a lower equity multiplier than Company LD.
C) Company HD has a higher fixed assets turnover than Company LD.
D) Company HD has a higher ROE than Company LD.
E) Company HD has a lower operating income (EBIT) than Company LD.
G) A) and E)
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