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,
_
"apital ,perating
Supplied ) /nvestor +otal
*A"" .
34 59A B 6/ S 3%
S
5quity4.
3-4 59A B 3.,5 ) %
S
4 5quity.
Since 0evon has a higher .,5, but its 59A is lower, the only things that
could explain this is if 314 its %
s
were higher or 34 its equity 3or si7e4
were lower.
Since statement a would have the opposite effect 3increasing 0evons 59A4,
statement a is false. /f the %
S
were higher, then 3.,5 ) %
S
4 would be
lower, and 59A would be lower. +herefore, statement b is true. A higher
5&/+ would lead to a higher 59A, so statement c is false.
< - Ratio analysis
Answer: b Diff: E
&edford B 0I &ree7ewood B O.
+A
0
B +A
O
I .,A
0
B .,A
O
I +
0
B +
O
I 0AA
0
R 0AA
O
I /6+
0
R /6+
O
I .,A B 6/A+A.
/f both companies have the same .,A and total assets, then they must both
have the same net incomes. +herefore, 6/
0
B 6/
O
.
2irst, compare &5!s. &5! B 5&/+A+A. *or% bac%ward up the income statement.
/f both companies have the same 6/ and tax rate, then they must both have
the same 5&+. =owever, &edford has higher interest payments, so its 5&/+
must be higher than &ree7ewoods. 3.ememberF 5&+ T / B 5&/+.4 +herefore,
statement c is false. /n addition, &edfords &5! is higher than
&ree7ewoods, so statements a, d, and e are all false. Statement b must be
true for the following reason. "ompare .,5s. .,5 B
.,A 5H and 5H B
A A 0 1
1
.
&edford has a higher 0AA ratio than &ree7ewoodI therefore, it has a higher
5H than &ree7ewood. /f its 5H is higher and its .,A is the same, then
&edfords .,5 must be higher than &ree7ewoods.
1#- inancial state!ent analysis Answer: a Diff: E
11- inancial state!ent analysis Answer: e Diff: E
.,5 B 6/A5quityI .,A B 6/A+AI 59A B 6/ ) %
s
5quity.
*e %now nothing about the debt ratio or equity multiplier of either
company. .emember, .,A B .,5A5H 35H B equity multiplier4. Since we dont
have 5H, we dont have enough information to say anything about .,A.
+herefore, statement a is false. *e dont %now anything about the %
s
or the
amount of equity of either company. +herefore, we dont %now enough to
determine which companys 59A is higher. +herefore, statement b is false.
*e %now that As .,5 is higher than &s. =owever, we dont %now how much
equity either one has, so we cannot say which one has a higher net income.
+herefore, statement c is false. Since statements a, b, and c are false,
the correct choice must be statement e.
1- inancial state!ent analysis Answer: e Diff: E
2rom the first sentence, both firms have the same net income, sales, and
assets. Since A has more debt, it must have less equity. +hus, its .,5
3calculated as 6et incomeA5quity4 is higher than &s. So statement a is
correct. Since the two firms have the same total assets and sales, their
total assets turnover ratios must be the same. So statement b is false. /f
A has higher interest expense than & but the same net income, this means
that A must have higher operating income 35&/+4 than &. +herefore statement
c is correct. Since statements a and c are correct, the correct choice is
statement e.
1-- inancial state!ent analysis Answer: d Diff: E N
+he correct answer is statement d. Although 5&/+ is unchanged, interest
expense will go down, so 6/ will increase. +herefore, statement a is
correct. /f 5&/+ is unchanged, but interest expense goes down, the +/5
ratio 35&/+A/6+4 will increase. +herefore, statement b is correct. /f the
stoc% issue has no effect on the companys total assets, but 6/ has
increased 3see statement a4, then .,A 36/A+A4 will increase. +herefore,
statement c is also correct.
11- "iscellaneous ratios Answer: a Diff: E
+he 0u !ont equation statesF .,5 B !H +A+, 5H.
+he firms have the same profit margin and equity multiplier. +he equity
multiplier is the same because both companies have the same debt ratio. /f
"ompany A has a higher .,5 than &, then from the 0u !ont equation "ompany A
also has a higher total assets turnover ratio than &. +he current ratio
does not explain the ratios discussed. +herefore, only statement a
explains the observed ratios.
1$- "iscellaneous ratios Answer: e Diff: E R
"urrent ratio B "urrent assetsA"urrent liabilities. +his transaction will
reduce current liabilities, which results in a higher current ratio. So
statement a is false. +he basic earning power ratio B 5&/+A+A. Since
neither the firms operating income 35&/+4 or total assets have changed,
its &5! ratio remains unchanged. So statement b is false. +/5 B
5&/+A/nterest. 5&/+ will be unaffected, but we may see interest costs fall
due to the firm having less debt. +his will result in an increase in the
+/5 ratio. So statement c is false. Statement d is also false for the
same reasons as statements a and b. +otal debt is reduced but total assets
remain the same. +he firm now has more equity, so the equity multiplier
3AssetsA5quity4 will decrease, so statement e is correct.
18- Current ratio Answer: d Diff: "
Statement d is the correct answer. 2or statements a and b a reduction in
the numerator and denominator by the same amount will increase the current
ratio because the current ratio is greater than 1. /n statement c only the
denominator goes down 3long)term bonds are not in the current ratio4, so
the current ratio will increase.
1:- Current ratio Answer: e Diff: "
1;- Ratio analysis Answer: c Diff: "
1<- Ratio analysis Answer: c Diff: " N
+A
0
B +A
"
.
+A+,
0
B +A+,
"
so, SA+A
0
B SA+A
"
.
.,5
0
B .,5
"
.
.,A
0
R .,A
"
.
Since +A+, is the same for both, and since +A is the same for both, sales
must be the same for both 3since +A+, B SalesA+A4. .emember the 0u !ont
equationF .,5 B !H +A+, 5H. 0rysdale and "ommerce have the same +A+,.
So, if 0rysdale has a higher !H and a higher 5H 3if the debt ratio is
higher, the 5H is higher4, then its .,5 must be higher. =owever, the problem
states that the companies have the same .,5. +herefore, statement a is
incorrect. /f 0rysdales !H and debt ratio are lower than "ommerces and
both have the same +A+,, 0rysdale would have a lower .,5. +he problem states
that the companies have the same .,5, so statement b is incorrect. Joo%ing
again at the 0u !ont equationF .,5 B !H +A+, 5H. /f the .,5s are the
same and the +A+,s are the same, then 3!H 5H4 must be the same for the two
companies. /f 0rysdale has a higher !H and a lower 5H, then 3!H 5H4 could
be the same for both. +herefore, statement c could explain the ratios in
the problem. /f 0rysdale has lower 6/ and more common equity 3higher +54,
then its .,5 would be lower. +herefore, statement d is incorrect. +he !A5
ratio is irrelevant. +he stoc% price cannot explain what is going on with
the two companies ratios.
#- Ratio analysis Answer: a Diff: %
Statement a is correctI the others are false. /f "ompany E has a higher
total assets turnover 3SalesA+A4 but the same total assets, it must have
higher sales than D. /f E has higher sales and also a higher profit margin
36/ASales4 than D, it must follow that E has a higher net income than D.
Statement b is false. .,5 B 6/A5U or .,5 B .,A 5quity multiplier. /n
either case we need to %now the amount of equity that both firms have. +his
is impossible to determine given the information in the question. +herefore,
we cannot say that E must have a higher .,5 than D. Statement c is false.
.emember from the 0u !ont equation that .,A B !rofit margin +otal assets
turnover B 6/AS SA+A. Since "ompany E has both a higher profit margin and
total assets turnover than "ompany D, Es .,A must also be higher than Ds.
1- Effects of leverage Answer: a Diff: "
Statement a is correct. +he other statements are false. +he use of debt
provides tax benefits to the corporations that issue debt, not to the
investors who purchase debt 3in the form of bonds4. +he basic earning
power ratio would be the same if the only thing that differed between the
firms were their debt ratios.
- inancial state!ent analysis Answer: a Diff: "
Statement a is true because, if a firm ta%es on more debt, its interest
expense will rise, and this will lower its profit margin. ,f course, there
will be less equity than there would have been, hence the .,5 might rise
even though the profit margin declined.
- - inancial state!ent analysis
Answer: d Diff: " N
+he correct answer is statement d. Start with the 0u !ont equationF
6/AS SA+A +AA5 B .,5. *e %now SA+A and .,5 are the same for both.
Since the equity of Hills is higher than =arte, its 6/ must also be higher
to %eep .,5 the same. So, statement a is correct. +he other statements
are then also true. Liven Hills higher net income, both the profit margin
and the .,A for Hills are also higher than =artes.
1- Leverage and financial ratios Answer: e Diff: "
+A+, B SalesA+A. &oth companies have the same total assets. =owever,
since A has a lower profit margin than & and its net income is the same as
&s, it must have higher salesI thus, A has a higher total assets turnover
ratio than &. +herefore, statement a is true. .,5 B 6/A5quity. &oth
companies have the same total assets and net income, but A has more debt
and thus less equity than &. +herefore, A has a higher .,5 than &.
+herefore, statement b is true. &5! B 5&/+A+A. *e %now that A has higher
interest payments than & but the same net income as &. +herefore, A must
have a higher 5&/+ than & to cover this extra interest. +hus, A must have
a higher basic earning power ratio than &. +herefore, statement c is true.
Since statements a, b, and c are true, the correct choice is statement e.
$- Leverage and financial ratios Answer: d Diff: " N
/f &5! and total assets are equal, we %now that 5&/+ is equal. "ompany A
has a higher debt ratio and higher interest expense than "ompany &.
Since "ompany A has lower net income, it must have a lower .,A 3since total
assets are the same4. /f 5&/+ is the same for both A and & and "ompany A
has higher interest expense, "ompany A must have a lower +/5 ratio than
"ompany &. "ompany A has a lower 5&+ and lower net income than "ompany &.
/f A has lower 5&+, then "ompany A pays less in taxes than "ompany &.
+here is a positive relationship between the debt ratio and the equity
multiplier, which means that "ompany A has a higher equity multiplier than
& because As debt ratio is higher than &s. +herefore, the correct choice
is statement d.
8- Du #ont e$uation Answer: b Diff: " R
+he 0u !ont equationF .,5 B 3!H43+A+,435H4. .,5 is above average. !H is
below average. 5H is above average because a high debt ratio implies a
high 5H. +herefore, +A+, must be higher for the equation to hold. 6ote
that the firms .,A does not have to be higher than the industry .,A for
this equation to hold.
:- ROE and EVA Answer: d Diff: "
59A B 6/ S 3%
s
5quity4. %
s
5quity cannot be 7ero, therefore, net income
must be positive if 59A is 7ero. So statements a and b are false. .,A B
6/A+A. +his equation really does not have anything to do with the 59A
calculation. Statement c is only correct if the firm has 7ero debt, which
we %now not to be correct. 3*e are given information in the question
stating that the firms debt ratio is 1# percent.4 +herefore, statement c
is also false. .,5 B 6/A5quity. .ewrite the 59A equation by substituting
into it 59A B #, and you getF 6/ B %
s
5quity. 0ivide both sides by 5quity
and you obtain the following equationF 6/A5quity B %
s
. +hus .,5 B 11K.
Statement e would give a negative 59A and the problem states that the firms
59A is 7ero, so it is false.
;- ROE and EVA Answer: b Diff: "
Statement a is falseI 59A depends upon the amount of equity invested, which
could be different for the two firms. Statement b is correctI for positive
59A, the .,5 must exceed the cost of equity. Statement c is falseI it is
very plausible to have a firm with positive .,5 and a higher cost of
equity, resulting in negative 59A.
<- "iscellaneous ratios Answer: b Diff: "
Statement b is correct. 5&/+ B 5&+ T /nterest. Statement c is incorrect
because higher interest expense doesnt necessarily imply greater debt. 2or
this statement to be correct, As amount of debt would have to be greater
than &s.
-#- "iscellaneous ratios Answer: e Diff: "
Statements b and c are correct. .,A B 6/A+A. An increase in the debt ratio
will result in an increase in interest expense, and a reduction in 6/. +hus
.,A will fall. 5H B AssetsA5quity. As debt increases, the amount of equity
in the denominator decreases, thus causing the equity multiplier 35H4 to
increase. +herefore, statement e is the correct choice.
-1- "iscellaneous ratios Answer: d Diff: "
Since E has a lower .,A 36/A+A4 than D and both firms have the same assets,
E must have a lower net income than D. So statement c is correct. E has a
higher .,5 36/A5U4 than D, even though its net income is lower.
"onsequently, E must have less equity than D, and therefore, more debt than
D. So statement a is false. Since E has a higher total assets turnover
ratio 3SalesA+A4 than D and both firms have the same assets, Es sales must
be higher than Ds. +his fact, combined with Es lower net income, means
that E must have a lower profit margin 36/ASales4 than D, so statement b is
correct. +hus, statements b and c are both correct. So, the correct
choice is statement d.
-- ROE and EVA Answer: a Diff: %
+he following formula will ma%e this question much easierF 59A B 3.,5 ) %
s
4
+otal equity. /f 0ivision A is ris%ier than 0ivision &, then As cost of
equity capital will be higher than &s. /f %
s
is higher, 59A will be lower.
So, statement a is true. /f A is larger than & in terms of equity, then the
term 3.,5 ) %
s
4 will be multiplied by a much larger number for 0ivision A.
Since As .,5 is also higher than &s, then its 59A would be higher than
&s. +herefore, statement b is false. /f A has less debt, then its
interest payments will be lower than &s, so its 5&/+ will be higher.
Another way to write the 59A formula is 59A B 5&/+ 31 S +4 S V"ost of
capital /nvestor)supplied capital employedW. So, a higher 5&/+ will lead
to a higher 59A. /n addition, a lower level of debt will ma%e A less ris%y
than &, so As cost of equity will be lower than &s. 2rom the other 59A
formula, we can see that this would cause a higher 59A, not a lower one.
So, statement c is false.
--- Ratio analysis Answer: d Diff: %
Statement d is correctI the others are false. .,A B 6/A+A. "ompany " has
higher interest expense than "ompany 0I therefore, it must have lower net
income. Since the two firms have the same total assets, .,A
"
P .,A
0
.
Statement a is falseI we cannot tell what sales are. 2rom the facts as
stated above, they could be the same or different. Statement b is falseI
"ompany " must have lower equity than "ompany 0, which could lead it to
have a higher .,5 because its equity multiplier would be greater than
company 0Qs. Statement c is false as +/5 B 5&/+A/nterest, and " has higher
interest than 0 but the same 5&/+I therefore, +/5
"
P +/5
0
. Statement e is
falseI they have the same &5! B 5&/+A+A from the facts as given in this
problem.
-1- Ratio analysis Answer: d Diff: %
*e can conclude that E has a lower 6/, because it has a lower 5&/+ and
higher interest than D, but the same tax rate as D. Sales for each company
are the same because they have the same total assets and the same total
assets turnover ratio 3+A+, B SalesA+A4. +herefore, since E has a lower 6/
and same sales as D, it must follow that it has a lower profit margin
36/ASales4.
-$ - Ratio analysis and Du #ont e$uation
Answer: d Diff: %
.,A
J
B .,A
D
I SA+A
J
R SA+A
D
I 5H
J
R 5H
D
, or AA5
J
R AA5
D
.
2rom the 0u !ont equation we %now that .,A B !rofit margin +otal assets
turnover. /f the firms .,As are equal, but Jancasters total assets
turnover is greater than Dor%s then Jancasters profit margin must be lower
than Dor%s. +herefore, statement a is true. +he debt ratio is calculated
as 1 ) 1A5quity multiplier. So, if Jancaster has a higher equity multiplier
than Dor%, its debt ratio must be higher too. So, statement b is false.
2rom the extended 0u !ont equation we %now that .,5 B !rofit margin +otal
assets turnover 5quity multiplier. *e also %now that .,A B !rofit margin
+otal assets turnover. Since we %now the
firms .,As are equal and Jancaster has a higher equity multiplier it must
have a higher .,5 too. +herefore, statement c is true. Since statements a
and c are true, the correct choice is statement d.
-8- Leverage and financial ratios Answer: d Diff: %
+he new income statement will be as followsF
,perating income 35&/+4 >1,##,### #. >8,###,###
/nterest expense ##,###
5arnings before taxes 35&+4 >1,###,###
+axes 31#K4 1##,###
6et income > 8##,###
.,A
,ld
B
1#.;K B
>$,###,###
>$1#,###
Assets
6/
I
6ew
.,5
B
1#K. B
>8,###,###
>8##,###
+herefore, .,A falls.
.,5
,ld
B
1-.$K
>1,###,###
>$1#,###
5quity
6/
I .,5
6ew
B
1$.#K.
>1,###,###
>8##,###
Since net income increases, .,A falls and .,5 increases, statement d is the
correct choice.
-:- "iscellaneous ratios Answer: c Diff: %
Step 1F Cse the ratios and data to arrive at alternative relationships to
answer the questionF
+A+, B SalesA+A
B 6/A+A SA6/
B .,A 1A!H.
0AA B +0A+A
B 3+A ) 5U4A+A
B 3+AA+A4 ) 35UA+A4
B 1 ) 35UA6/4 36/A+A4
B 1 ) 3.,AA.,54.
.,A B 6/A+A
6/ B +A .,A.
Step F Substitute the data given with the alternative relationships
obtained in Step 1F
=emmingway 2it7gerald
+A+, B .,AA!H B #.#<A#.#1 B #.#;A#.#-
B .$X. B .8:X.
0AA B 1 ) 3.,AA.,54 B 1 ) 3#.#<A#.1;4 B 1 ) 3#.#;A#.14
B #.$. B #.88:.
6/ B +A .,A B #.#< B 1.$ #.#;
B >#.1; billion. B >#.1 billion.
2rom the calculations above, statement c is the correct choice.
-;- inancial state!ent analysis Answer: a Diff: E
&5! B 5&/+A+A
#.1$ B 5&/+A>1##,###,###
5&/+ B >1$,###,###.
.,A B 6/A+A
#.#< B 6/A>1##,###,###
6/ B ><,###,###.
5&+ B 6/A31 ) +4
5&+ B ><,###,###A#.8
5&+ B >1$,###,###.
+herefore interest expense B >#.
-<- "ar&et price per share Answer: b Diff: E
+otal mar%et value B >1,$#31.$4 B >1,;:$.
Har%et value per share B >1,;:$A$ B >:$.
Alternative solutionF
&oo% value per share B >1,$#A$ B >$#.
Har%et value per share B >$#31.$4 B >:$.
1#- "ar&et price per share Answer: c Diff: E
6umber of shares B >##,###A>.## B 1##,###.
&oo% value per share B >,###,###A1##,### B >#.
Har%et value B #.3&oo% value4 B #.3>#4 B >1.## per share.
11
- "ar&et'boo& ratio Answer: c Diff: E
shares. ,###,###
shares ;# > ## >18#,###,#
# >1#,###,##
shares ;# >
# . 1
&9
shares share per !rice
&
H
+ +
+
+
+
+
$1- Accounts receivable increase Answer: b Diff: " R
0S, B >11,#<8A3>$#,###A-8$4 B 8# days.
6ew AA. B V3>$#,###431.$4A3-8$4W38#431.$4 B ><,188.
=ence, increase in receivables B ><,188 ) >11,#<8 B >$1,-:#.
$- Accounts receivable Answer: a Diff: " R
2irst solve for current annual sales using the 0S, equation as followsF $#
B >1,###,###A3SalesA-8$4 to find annual sales equal to >:,-##,###.
/f sales fall by 1#K, the new sales level will be >:,-##,###3#.<4 B
>8,$:#,###. Again, using the 0S, equation, solve for the new accounts
receivable figure as followsF - B A.A3>8,$:#,###A-8$4 or A. B >$:8,###.
$-- ROA Answer: a Diff: "
5quity multiplier B 1A31 ) 0AA4 B 1A31 ) #.14 B 1.8:.
.,5 B .,A 5quity multiplier
1;K B 3.,A431.8:4
.,A B 1#.;K.
$1- ROA Answer: e Diff: "
Step 1F *e must find +A. *e are given &5! and 5&/+.
&5! B
+A
5&/+
and +A B
&5!
5&/+
.
+herefore, +A B >1#,###,###A#.1, or >1## million.
Step F 6/A+A B .,A, so now we need to find net income. 6et income is
found by wor%ing through the income statement 3in millions4F
5&/+ >1#
/nterest $ 3from +/5 ratioF ; B 5&/+A/nt4
5&+ >-$
+axes 31#K4 11
6/ >1
Step -F .,A B >1A>1## B #.#$$ B $.$K.
$$ - ROA
Answer: c Diff: " N
&5! B 5&/+A+A B #.1#, so 5&/+ B #.1# >$##,### B >$#,###.
+/5 B 5&/+A/6+ B $, so /6+ B >$#,###A$ B >1#,###.
5&/+ >$#,###
/nt )1#,###
5&+ >1#,###
+axes 31#K4 )18,###
6/ >1,###
.,A B 6/A+A B >1,###A>$##,### B #.#1;, or 1.;K.
$8- ROE Answer: c Diff: " R
3Sales per day430S,4 B AA.
3SalesA-8$438#4 B >1$#,###
Sales B ><1,$##.
!rofit margin B 6et incomeASales.
6et income B #.#13><1,$##4 B >-8,$##.
0ebt ratio B #.81 B +otal debtA>-,###,###.
+otal debt B >1,<#,###.
+otal equity B >-,###,### ) >1,<#,### B >1,#;#,###.
.,5 B >-8,$##A>1,#;#,### B -.-;K -.1K.
$:- ROE Answer: b Diff: "
+otal equity B 3>$,###,###434 B >1#,###,###.
+otal assets B >$,###,### T >1#,###,### B >1$,###,###.
6et income B 3#.#843>1$,###,###4 B ><##,###.
.,5 B ><##,###A>1#,###,### B <K.
.,5 ) .,A B <K ) 8K B -K.
$;- ROE Answer: d Diff: "
!rofit margin B 3>1,$##31 ) #.-44A>$,### B 1K.
5quity multiplier B 1.# since firm is 1##K equity financed.
.,5 B 3!rofit margin43Assets turnover435quity multiplier4
B 31K43.#431.#4 B 1K.
$<- ROE Answer: c Diff: "
"alculate debt, equity, and 5&/+F
0ebt B 0AA +A B #.-$3>1,###4 B >-$#.
5quity B +A ) 0ebt B >1,### ) >-$# B >8$#.
5&/+ B +A &5! B >1,###3#.#4 B >##.
"alculate net income and .,5F
6et income B 35&/+ ) /431 ) +4 B V>## ) #.#1$:3>-$#4W3#.84 B >11#.1.
.,5 B >11#.1A>8$# B 18.<<K.
8#- E$uity !ultiplier Answer: d Diff: "
5quity multiplier B 1.# B +otal assetsA+otal equity B 1A1.
Assets B 0ebt T 5quity
1 B 0ebt T 1
0ebt B -.
0ebtAAssets B -A1 B #.:$.
81- %(E ratio Answer: e Diff: "
+/5 B 5&/+A/, so find 5&/+ and /.
/nterest B >;##,### #.1 B >;#,###.
6et income B >-,##,### #.#8 B >1<,###.
!re)tax income B >1<,###A31 ) +4 B >1<,###A#.8 B >-#,###.
5&/+ B >-#,### T >;#,### B >1##,###.
+/5 B >1##,###A>;#,### B $.#.
8- %(E ratio Answer: b Diff: " N
+A B >;,###,###,###I + B 1#KI 5&/+A+A B 1KI .,A B -KI +/5 ?
. ### , ### , <8# > 5&/+
1 . #
,### >;,###,###
5&/+
6ow use the income statement format to determine interest so you can
calculate the firms +/5 ratio.
5&/+ ><8#,###,### See above.
/6+ $8#,###,###
5&+ >1##,###,### 5&+ B >1#,###,###A#.8
+axes 31#K4 18#,###,###
6/ >1#,###,### See above.
/6+ B 5&/+ S 5&+
B ><8#,###,### ) >1##,###,###
+/5 B 5&/+A/6+
B ><8#,###,###A>$8#,###,###
B 1.:11- 1.:1.
8-- %(E ratio Answer: b Diff: "
.emember, +/5 B 5&/+A/nterest. *e need to find 5&/+ and /nterest.
+A B >#,###,###I &5! B $KI .,A B 1#KI + B 1#K.
&5! B 5&/+A+A
$K B 5&/+A>#,###,###
>$,###,### B 5&/+.
.,A B 6/A+A
1#K B 6/A>#,###,###
>,###,### B 6/.
6/ B 35&/+ ) /431 ) +4
>,###,### B 3>$,###,### ) /431 ) #.14
>,###,### B 3>$,###,### ) /43#.84
>-,---,--- B >$,###,### ) /
>1,888,88: B /.
+herefore, +/5 B 5&/+A/
B >$,###,###A>1,888,88:
B -.#.
81- %(E ratio Answer: d Diff: " N
+he times interest earned 3+/54 ratio is calculated as the ratio of 5&/+
and interest expense. *e can find 5&/+ from the &5! ratio and total assets
given in the problem.
&5! B
+A
5&/+
$K B
>-,###,###
5&/+
5&/+ B >:$#,###.
/nterest expense can be obtained from the income statement by simply
wor%ing your way up the income statement. +o do this, however, we must
first calculate net income from the data given for .,A.
.,A B
+A
6/
1K B
>-,###,###
6/
6/ B >-8#,###.
Solving for 5&+ and then interest, we findF
5&+ B
+4 ) 31
6/
5&+ B
4 -$ . # 1 3
### , -8# >
5&+ B >$$-,;18.
5&/+ S /6+ B 5&+
>:$#,### S /6+ B >$$-,;18
/6+ B >1<8,1$1.
*e can now calculate the +/5 as followsF
+/5 B
/6+
5&/+
+/5 B
1$1 , 1<8 >
### , :$# >
+/5 B -.;.
8$- E)(%DA coverage ratio Answer: a Diff: " N
+A B ><,###,###,###I 5&/+A+A B <KI +/5 B -I 0A B >1,###,###,###I Jease
payments B >8##,###,###I !rincipal payments B >-##,###,###I 5&/+0A coverage
B ?
5&/+A><,###,###,### B #.#<
5&/+ B >;1#,###,###.
- B 5&/+A/6+
- B >;1#,###,###A/6+
/6+ B >:#,###,###.
5&/+0A B 5&/+ T 0A
B >;1#,###,### T >1,###,###,###
B >1,;1#,###,###.
5&/+0A coverage ratio B
pmts Jease pmts !rinc. /6+
payments Jease 5&/+0A
+ +
+
B
### , ### , 8## > ### , ### , -## > ### , ### , :# >
### , ### , 8## > ### , ### , ;1# , 1 >
+ +
+
B
### , ### , 1:# , 1 >
### , ### , 11# , >
B .#$<; .#8.
88- Debt ratio Answer: c Diff: "
0ebt ratio B 0ebtA+otal assets.
SalesA+otal assets B 8
+otal assets B >1,###,###A8 B >1,###,###.
.,5 B 6/A5quity
5quity B 6/A.,5 B >1##,###A#.1$ B >,888,88:.
0ebt B +otal assets ) 5quity B >1,###,### ) >,888,88: B >1,---,---.
0ebt ratio B >1,---,---A>1,###,### B #.----.
8:- #rofit !argin Answer: a Diff: "
5quity multiplier B 1A31 ) #.-$4 B 1.$-;$.
.,5 B 3!rofit margin43Assets utili7ation435quity multiplier4
1$K B 3!H43.;431.$-;$4
!H B -.1;K.
8;- inancial state!ent analysis Answer: e Diff: " R
"urrent 0S, B
$ >1#,###A-8
>1,###
B -8.$ days. /ndustry average 0S, B -# days.
.educe receivables by 3-8.$ S -#4
,
_
-8$
>1#,###
B >1:;.#;.
0ebt B >1##A#.1# B >1,###.
+A
+0
B
>1:;.#; ) >8,###
>1:;.#; ) >1,###
B 8$.8$K.
8<- inancial state!ent analysis Answer: b Diff: " R
2irst, find the amount of current assetsF
"urrent ratio B "urrent assetsA"urrent liabilities
"urrent assets B 3"urrent liabilities43"urrent ratio4
B >-:$,###31.4 B >1$#,###.
6ext, find the accounts receivablesF
0S, B A.A3SalesA-8$4
A. B 0S,3Sales431A-8$4
B 31#43>1,##,###431A-8$4 B >1-1,$#8.;$.
6ext, find the inventoriesF
/nventory turnover B SalesA/nventory
/nventory B SalesA/nventory turnover
B >1,##,###A1.; B >$#,###.
2inally, find the amount of cashF
"ash B "urrent assets ) A. ) /nventory
B >1$#,### ) >1-1,$#8.;$ ) >$#,### B >8;,1<-.1$ >8;,1<-.
:#- )asic earning power Answer: d Diff: "
Liven .,A B 1#K and net income of >$##,###, total assets must be >$,###,###.
.,A B
A
6/
1#K B
+A
>$##,###
+A B >$,###,###.
+o calculate &5!, we still need 5&/+. +o calculate 5&/+ construct a
partial income statementF
5&/+ >1,#--,--- 3>##,### T >;--,---4
/nterest ##,### 3Liven4
5&+ > ;--,--- >$##,###A#.8
+axes 31#K4 ---,---
6/ > $##,###
&5! B
+A
5&/+
B
>$,###,###
>1,#--,---
B #.#8: B #.8:K.
:1- #'E ratio and stoc& price Answer: e Diff: "
+he current 5!S is >1,$##,###A-##,### shares or >$. +he current !A5 ratio
is then >8#A>$ B 1. +he new number of shares outstanding will be 1##,###.
+hus, the new 5!S B >,$##,###A1##,### B >8.$. /f the shares are selling
for 1 times 5!S, then they must be selling for >8.$314 B >:$.
: - Current ratio and D*O
Answer: a Diff: "
Step 1F 0etermine average daily sales using the old 0S,.
0S, B
Sales 0aily Average
s .eceivable
.
/f 0S, changes while sales remain the same, then receivables must
change.
1# B
Sales 0aily Average
1## >
>1# B Average 0aily Sales.
Step F 0etermine the new level of receivables required for !arcells to
achieve the industry average 0S,.
-# B
>1#
s .eceivable
>-## B .eceivables.
Step -F "alculate the new current ratio.
.eceivables decline by >1##, so current assets declined by >1##.
+herefore, the new level of current assets is >;## ) >1## B >:##.
Since the >1## cash freed up is used to reduce long)term bonds, cur)
rent liabilities remain at >1##. "urrent ratio B >:##A>1## B 1.:$.
:-- Current ratio Answer: c Diff: " N
"urrentlyF
0S, B A.AAverage 0aily Sales
B >$#A>1#
B $ days.
6ow, "artwright wants to reduce 0S, to 1$. +he firm needs to reduce
accounts receivable because it doesnt want to reduce average daily sales.
So, we can calculate the new A. balance as followsF
0S, B A.AAverage 0aily Sales
1$ B A.A>1#
>1$# million B A..
/f the firm reduces its 0S, to the industry average, its A. will be >1$#
million, reduced by >1## million. +herefore, there must be an equal
reduction on the right side of the balance sheet. =alf of this >1##
million of freed)up cash will be used to reduce notes payable, and the
other half will be used to reduce accounts payable. +herefore, notes
payable will fall by >$# million to >$# million, and accounts payable will
fall by >$# million to >$# million.
+herefore, we can now calculate the firms new current ratioF
"urrent .atio B "AA"J
B 3"ash T A. T /nv.4A36otes !ayable T Accounts !ayable4
B 3>$# T >1$# T >$#4A3>$# T >$#4
B >8$#A>$##
B 1.-#.
:1- Current ratio Answer: b Diff: " N
Step 1F "alculate the firms current inventory turnover.
/nv. turnover B SalesA/nv.
B >-,###,###A>$##,###
B 8.#.
6ew /nv. turnover B 1#.# 3but sales stay the same4.
Step F "alculate what the firms inventory balance should be if the firm
maintains the industry average inventory turnover.
/nv. turnover B SalesA/nv.
1# B >- millionA/nv.
>-##,### B /nv.
+he new inventory level will be >-##,###, so inventories will be reduced by
>##,### from the old level. +his means that current assets will decrease
by >##,###.
Step -F "alculate the firms new current assets level.
"A B "ash T /nv. T AA.
B >1##,### T >-##,### T >##,###
B >8##,###.
=alf of the >##,### that is freed up will be used to reduce notes payable,
and the other half will be used to reduce common equity. +herefore, notes
payable will be reduced by >1##,### to a new level of >1##,###.
Step 1F "alculate the firms new liabilities level.
"J B AA! T Accruals T 6otes payable
B >##,### T >1##,### T >1##,###
B >1##,###.
Step $F "alculate the firms new current ratio with the improved inventory
management.
". B "AA"J
B >8##,###A>1##,###
B 1.$.
:$- Credit policy and ROE Answer: c Diff: " R
Cse the 0S, formula to calculate accounts receivable under the new policy
as -8 B A.A3>:-#,###A-8$4 or A. B >:,###. +hus, >1$,### ) >:,### B
>$-,### is the cash freed up by reducing 0S, to -8 days. .etiring >$-,###
of long)term debt leaves >1:,### in long)term debt. Liven a 1#K interest
rate, interest expense is now >1:,###3#.14 B >1,:##. +hus, 5&+ B 5&/+ )
/nterest B >:#,### ) >1,:## B >1$,-##. 6et income is >1$,-##31 ) #.-4 B
>-1,:1#. +hus, .,5 B >-1,:1#A>##,### B 1$.;8K.
:8- Du #ont e$uation Answer: d Diff: "
&eforeF 5quity multiplier B 1A31 ) 0AA4 B 1A31 ) #.$4 B .#.
.,5 B 3!H43Assets turnover435H4 B 31#K43#.$43.#4 B $K.
AfterF V.,5 B 3$K4 B 1#KWF
1#K B 31K43#.$435H4
5H B -.-- B AA5.
5AA B 1A-.-- B #.-.
0AA B 1 S #.- B #.: B :#K.
::- *ales and e+tended Du #ont e$uation Answer: a Diff: "
6/A5 B 1$KI 0AA B 1#KI 5AA B 8#KI AA5 B 1A#.8 B 1.888:I 6/AS B $K.
Step 1F 0etermine total assets turnover from the extended 0u !ont
equationF
6/AS SA+A AA5 B .,5
3$K43SA+A431.888:4 B 1$K
#.#;-- SA+A B 1$K
SA+A B 1.;.
Step F 0etermine sales from the total assets turnover ratioF
SA+A B 1.;
SA>;## B 1.;
S B >1,11# million.
:;- Net inco!e and Du #ont e$uation Answer: c Diff: " N
Step 1F "alculate total assets from information given.
Sales B >1# million.
-.$ B SalesA+A
-.$ B
Assets
### , ### , 1# >
Assets B >,;$:,11.;$:1.
Step F "alculate net income.
+here is no debt, so Assets B 5quity B >,;$:,11.;$:1.
.,5 B 6/AS SA+A +AA5
#.1$ B 6/A>1#,###,### -.$ 1
#.1$ B
### , ### , 1# >
6/ $ . -
>1,$##,### B -.$6/
>1;,$:1.1;8 B 6/.
:<- ROE Answer: c Diff: %
LivenF 6ew 0AA B #.$$ /nterest B >:,###
5&/+ B >$,### +ax rate B 1#K
Sales B >:#,### +A+, B -.#
.ecall the 0u !ont equationF .,5 B 3!H43+A+,435H4.
.,5 B 3.,A435H4.
.,5 B 6/A5quity.
5&/+ >$,###
/nterest :,### 3Liven4
5&+ >1;,###
+axes 31#K4 :,## 3>1;,### 1#K4
6/ >1#,;##
+A+, B SalesA+otal assets
+otal assets B SalesA+A+, B >:#,###A- B ><#,###.
5quity B V1 ) 30AA4W3+otal assets4
5quity B V1 ) #.$$W3+otal assets4
5quity B #.1$3><#,###4 B >1#,$##.
.,5 B 6/A5quity B >1#,;##A>1#,$## B 8.8:K.
;#- ROE Answer: d Diff: %
/ndustry average inventory turnover B 8 B SalesA/nventories.
+o match this levelF /nventories B SalesA8
>-,###,###A8 B >$##,###.
"urrent inventories B >1,###,###. .eduction in inventories B >1,###,### )
>$##,### B >$##,###. +his >$##,### is to be used to reduce debt.
6ew debt level B >1,###,### ) >$##,### B >-,$##,###.
/nterest on this level of debt B >-,$##,### #.1 B >-$#,###.
Joo% at the income statement to determine net incomeF
5&/+ >1,1##,###
/nterest -$#,###
5&+ >1,#$#,###
+axes 31#K4 1#,###
6/ > 8-#,###
.,5 B 6et incomeA5quity B >8-#,###A>,###,### B #.-1$# or -1.$#K.
;1- ROE and financing Answer: a Diff: %
+he firm is not using its 'free( trade credit 3that is, accounts payable
3AA!44 to the same extent as other companies. Since it is financing part
of its assets with 1#K notes payable, its interest expense is higher than
necessary.
"alculate the increase in payablesF
"urrent 3AA!4A/nventories ratio B >1##A>$## B #.#.
+arget AA! B #.8#3/nventories4 B #.8#3>$##4 B >-##.
/ncrease in AA! B >-## ) >1## B >##.
Since the current ratio and total assets remain constant, total liabilities
and equity must be unchanged. +he increase in accounts payable must be
matched by an equal decrease in interest)bearing notes payable. 6otes
payable decline by >##. /nterest expense decreases by >## #.1# B >#.
"onstruct comparative /ncome StatementsF
,ld 6ew
Sales >,### >,###
,perating costs 1,;1- 1,;1-
5&/+ > 1$: > 1$:
/nterest -: 1:
5&+ > 1# > 11#
+axes 31#K4 1; $8
6et income 36/4 > : > ;1
.,5 B 6/A5quity B >:A>;## B <K. >;1A>;## B 1#.$K.
6ew .,5 B 1#.$K.
;- ROE and refinancing Answer: d Diff: %
.elevant informationF ,ld .,5 B 6/A5quity B #.#8 B 8K.
Sales B >-##,###I 5&/+ B #.113Sales4 B #.113>-##,###4 B >--,###.
0ebt B >##,###I 0AA B #.;# B ;#K.
+ax rate B 1#K.
/nterest rate changeF ,ld bonds 11KI new bonds 1#K.
"alculate total assets and equity amountsF
Since debt B >##,###, total assets B >##,###A#.;# B >$#,###.
5quity B 1 ) 0AA B 1 ) #.;# B #.#.
5quity B 5A+A +A B #.# >$#,### B >$#,###.
"onstruct comparative /ncome Statements from 5&/+, and calculate new .,5F
,ld 6ew
5&/+ >--,### >--,###
/nterest ;,### #,###
5&+ > $,### >1-,###
+axes 31#K4 ,### $,##
6et income > -,### > :,;##
6ew .,5 B 6/A5quity B >:,;##A>$#,### B #.1$8# B 1$.8K.
;-- %(E ratio Answer: d Diff: %
+/5 B
/
5&/+
B ?
+A +urnover B SAA B
SA>1#,### B
S B >#,###.
+A
+0
B #.8I
+0 B #.83>1#,###4
0ebt B >8,###.
/ B >8,###3#.14 B >8##.
!H B
S
6/
B -K
!H B
>#,###
6/
B #.#-
6/ B >8##.
5&+ B
#.14 ) 31
>8##
B >1,###.
5&/+ >1,8##
/nterest 8##
5&+ >1,###
+axes 31#K4 1##
6/ > 8##
+/5 B >1,8##A>8## B .8:.
;1- Current ratio Answer: e Diff: %
,ld 0S, B 1#I "A B >,$##,###I "AA"J B 1.$I A. B >1,8##,###.
Step 1F "alculate average daily salesF
0S, B A.AAverage daily sales
1# B >1,8##,###AAverage daily sales
>1#,### B Average daily sales.
Step F "alculate the new level of accounts receivable when 0S, B -#F
-# B A.A>1#,###
>1,##,### B A..
So, the change in receivables will be >1,8##,### S >1,##,### B
>1##,###.
Step -F "alculate the old level of current liabilitiesF
"urrent ratio B "AA"J
1.$ B >,$##,###A"J
>1,888,88: B "J.
Step 1F "alculate the new current ratioF
+he change in receivables will cause a reduction in current assets
of >1##,### and a reduction in current liabilities of >1##,###.
"A new B >,$##,### ) >1##,### B >,1##,###.
"J new B >1,888,88: ) >1##,### B >1,88,88:.
". new B >,1##,###A>1,88,88: B 1.88.
;$- #'E ratio and stoc& price Answer: b Diff: %
=ere are some data on the initial situationF
5!S B >$#A# B >.$#.
Stoc% price B >.$#3;4 B >#.
/f EDO had the industry average inventory turnover, its inventory balance
would beF
+urnover B $ B
/nv
Sales
B
/nv
>1,###
/nv B >1,###A$ B >##.
+herefore, inventories would decline by >1##.
+he income statement would remain at the initial level. =owever, the
company could now repurchase and retire $ shares of stoc%F
e !riceAshar
available 2unds
B
>#
>1##
B $ shares.
+hus, the new 5!S would beF
6ew 5!S B
g outstandin Shares
income 6et
B
$ ) #
>$#
B >-.--.
+he new stoc% price would beF
6ew price B 6ew 5!S3!A54 B >-.--3;4 B >8.8:.
Stoc% price increase B >8.8: ) >#.## B >8.8:.
;8- Du #ont e$uation and debt ratio Answer: e Diff: %
5U
A
A
S
S
6/
B .,5.
0ata for AF
#.:3>$##4
>$##
>$##
>1,###
>1,###
6/
B #.1$
#.:3>$##4
6/
B #.1$ B 6/ B >$.$#.
.,5 B
S
6/
B
>1,###
>$.$#
B #.#$$ B $.$K.
0ata for &F
5U
A
A
S
S
6/
B #.-#
#.#$$
5U
>$##
B #.-#
#.1#$#
5U
>$##
B #.-#
5U
>$##
B .;$:1
5quity B >1:$.
0ebt B >$## ) >1:$ B >-$.
+herefore, 0AA B >-$A>$## B #.8$ or 8$K.
;:- inancial state!ent analysis Answer: a Diff: %
Sales >1$,###
"ost of goods sold MMMMMMM
5&/+ > 1,#8$
/nterest 18$
5&+ > 8##
+axes 3-$K4 1#
6/ > -<#
&5! B
+A
5&/+
B
>;,###
5&/+
B #.1--1$I 5&/+ B >1,#8$.
6ow fill inF 5&/+ B >1,#8$.
/nterest B 5&/+ ) 5&+ B >1,#8$ ) >8## B >18$.
A
0
B
>;,###
0
B #.1$I 0 B #.1$3>;,###4 B >-,8##.
/nterest rate B
0ebt
/nterest
B
>-,8##
>18$
B #.1< B 1.<K.
;;- E)(% Answer: e Diff: %
*rite down equations with given data, then find un%nownsF
!rofit margin B
S
6/
B #.#8.
0ebt ratio B
A
0
B
>1##,###
0
B #.1I 0 B >1#,###.
+A turnover B
A
S
B -.# B
>1##,###
S
B -I S B >-##,###.
6ow plug sales into profit margin ratio to find 6/F
>-##,###
6/
B #.#8I 6/ B >1;,###.
6ow set up an income statementF
Sales >-##,###
"ost of goods sold MMMMMMMM
5&/+ > --,## 35&/+ B 5&+ T /nterest4
/nterest -,## 3>1#,###3#.#;4 B >-,##4
5&+ > -#,### 35&+ B >1;,###A31 ) +4 B >-#,###4
+axes 31#K4 1,###
6/ > 1;,###
;<- *ales increase needed Answer: b Diff: % N
Dou need to wor% bac%wards through the income statement to solve this
problem.
+he new 6/ will beF 3>1,;##,###431.$4 B >,$#,###.
6ow find 5&+F
35&+431 ) +4 B 6/
5&+ B 6/A31 ) +4
B >,$#,###A31 ) #.14
B >-,:$#,###.
6ow find 5&/+F
5&/+ ) / B 5&+
5&/+ B 5&+ T /
5&/+ B >-,:$#,### T >1,$##,###
B >$,$#,###.
6ow find SalesF
3Sales43,perating Hargin4 B 5&/+
Sales B 5&/+A,perating Hargin
B >$,$#,###A#.1
B >1-,1$,###.
+herefore, sales need to rise to >1-,1$,###. =ow much of an increase is
this?
>1-,1$,###A>1,###,### B 1.#<-:$. +herefore, sales have gone up by <.-:$K
3rounded to <.-;K4.
<#- Debt ratio and Du #ont analysis Answer: c Diff: " N
+he 0u !ont analysis of return on equity gives usF
.,5 B .,A 5H
11K B 1#K 5H
1.1 B 5H.
2rom the equity multiplier 3AA54, we can calculate the debt ratioF
1.1 B AA5
5AA B 1A1.1
5AA B #.:11-.
0AA B 1 S 5AA
0AA B 1 S #.:11-
0AA B #.;$: B ;.$:K.
<1- #rofit !argin and Du #ont analysis Answer: a Diff: E N
Csing the 0u !ont analysis again, we can calculate the profit margin.
.,5 B !H +A+, 5H
11K B !H $ 1.1
11K B !H :
K B !H.
<- ROA Answer: d Diff: " N
.,A B 6/AAssets. +otal assets B >-,##,###,### 3from the balance sheet4.
*e, %now .,5 B 6/A"ommon equity B #.#, with "ommon equity B ><##,###,###
3from the balance sheet4.
#.# B 6/A><##,###,###
6/ B >1;#,###,###.
So, .,A B >1;#,###,###A>-,##,###,### B #.#$8$, or $.8$K.
<-- Current ratio Answer: b Diff: " N
.ecall the current ratio is "AA"J B ><##,###,###A>;##,###,### B 1.1$.
+he plan loo%s li%e thisF 0ebit 2ixed assets >-##,###,###
"redit 6otes payable >-##,###,###
So, current liabilities increase by >-## million, while current assets do
not change.
So, the new current ratio is ><##,###,###A3>;##,###,### T >-##,###,###4 B
><##,###,###A>1,1##,###,### B #.;1;.
<1- "iscellaneous concepts Answer: e Diff: E N
+he correct answer is statement e. +he current ratio in ## was 1.::, while
the current ratio in ##1 was 1.81. =ence, the current ratio was higher in
##. +he debt ratio was #.1::- in ## and #.$$# in ##1, so the debt ratio
decreased from ##1 to ##. +he firm issued >-## million in new common stoc%
in ##.
<$- Net inco!e Answer: b Diff: E N
+o determine ## net income, use the following equationF
5nding retained earnings B &eginning .5 T 6/ S 0ividends paid
>;##,###,### B >:##,###,### T 6/ S >$#,###,###
>1$#,###,### B 6/.
<8- *ales, D*O, and inventory turnover Answer: b Diff: " N
Step 1F ,ne of our initial conditions is that inventory turnover 3SA/nv.4
P 8.#, henceF
SalesA/nventory P 8.#
SalesA>;$#,###,### P 8.#
Sales P >$,1##,###,###.
Step F ,ur second initial condition is that 0S, P $#, henceF
A.A3SalesA-8$4 P $#.#
>1$#,###,###A3SalesA-8$4 P $#.#
V3>1$#,###,###43-8$4WASales P $#.#
3>1$#,###,###4-8$ P $#3Sales4
V3>1$#,###,###43-8$4WA$# P Sales
Sales R >-,;$,###,###.
So, the most li%ely estimate of the firms ## sales would fall between
>-,;$,###,### and >$,1##,###,###. ,nly statement b meets this requirement.
<: - inancial state!ent analysis
Answer: a Diff: E N
+he correct answer is statement a. +he current ratio in ## is 1.#,
while in ##1 it is #.:;$. So, statement a is correct. 2or statement b,
assume that sales are E. +he inventory turnover ratio for ## is EA
>1,###,### and EA>:##,### in ##1. So, the inventory turnover ratio for
##1 is higher than in ##. 3/f thats not clear, try E B >$##,### or any
other number.4 +hus, statement b is incorrect. +he debt ratio in ## is
#.$<8, while in ##1 its #.8:, so statement c is incorrect.
<; - Current ratio
Answer: c Diff: " N
Step 1F 0etermine actual ## salesF
0S, B A.A3SalesA-8$4
1# B >1-,###A3SalesA-8$4
1#3Sales4A-8$ B >1-,###
1#3Sales4 B >1$:,8;#,###
Sales B >-,<1,###.
Step F 0etermine new accounts receivable balance if 0S, B -# and sales
remain the sameF
-# B A.A3>-,<1,###A-8$4
-# B A.A>1#,;##
A. B >-1,###.
Step -F 0etermine the amount of freed)up cash and the new level of
accounts payable.
2reed)up cash B >1-,### ) >-1,### B >1#;,###.
6ew A! B >:##,### ) >1#;,### B >$<,###.
Step 1F 0etermine the new current ratioF
". B 3>1##,### T >-1,### T >1,###,###4A3>$<,### T >;##,###4
B >1,11,###A>1,-<,###
B 1.#-.