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FIN 5219 Financial Management Tools Prof.

Nadia Vozlyublennaia

Name _________________________ Section ________

Financial Ratios and Planning Practice test 2


You have 1 hour 20 minutes to complete the exam. You may use a calculator (not a financial or programmable calculator), cheat sheet with formulae, and scratch paper. Please make sure to write your name on the scantron and on exam. You need to submit both the scantron and exam. Find the best option in the available multiple choice answers. Keep in mind that there may be some rounding errors. Good luck! ____ 1. ____ indicate the firm's capacity to meet its debt obligations, both short-term and long-term. a. Liquidity ratios b. Activity ratios c. Financial leverage ratios d. Profitability ratios 2. The retained earnings figure represents a. a pool of cash readily available to the firm and its stockholders b. an accounting of that portion of a firm's assets that were financed from past earnings c. a permanent part of the firm's equity base d. a deferred liability owed to preferred stockholders 3. The following policy that is consistent with an increase in a firm's return on total assets is: a. costs increase more than revenues b. the firm's net working capital (current assets minus current liabilities) position declines c. the firm sells off some unused assets and pays the proceeds to existing stockholders in the form of an extra dividend d. the firm's net working capital (current assets minus current liabilities) position declines, and the firm sells off some unused assets and pays the proceeds to existing stockholders in the form of an extra dividend 4. If a firm's return on investment, i.e., earnings after taxes divided by total assets, is 7%, and the firm has no preferred stock financing, it is a. possible that its return on stockholders' equity is 10%. b. possible that its return on stockholders' equity is 5%. c. not possible for its debt-to-equity ratio to be 1.0. d. not possible for its net profit margin to be 7%. 5. Firms with ____ growth rates would be expected to have ____ payout ratios. a. high, low b. high, high c. low, low d. low, high 6. A firm's current ratio is 1.5 and its quick ratio is 1.0. If its current liabilities are $10,000, what are its inventories? a. $ 5,000 b. $10,000 c. $15,000 d. $20,000

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7. If a firm has interest expenses of $10,000 per year, sales of $700,000, a tax rate of 40%, and a net profit margin of 7%, what is the firm's times interest earned ratio? a. 8.17 b. 4.90 c. 13.25 d. 9.17 8. AK, Inc. is considering issuing additional long-term debt to finance an expansion. The company currently has $20 million in 5% debt outstanding. Its earnings after-tax (EAT) are $3.0 million, and its marginal and average tax rate is 40 percent. The company is required by the debt holders to maintain its times interest earned ratio at 3.0 or greater. How much additional 10 percent debt can the company issue now and maintain its times interest earned ratio at 3.0? Assume for this calculation that earnings before interest and taxes remains at its present level. a. $10 million b. $ 6 million c. $ 1 million d. $5 million 9. Greg is interested in investing in a small company, and he thinks Good Buy Co. might be a good investment. He has been given the following information and would like to know the return on stockholder's equity. Assume Good Buys marginal tax rate is 40%. Earning before taxes Net profit margin Total liabilities Total stockholder's equity a. b. c. d. 12% 20% 15% 18% $3 million 3.6% $15.0 million $10.0 million

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____ 10. Pro forma financial statements are used to: a. find the contribution margin b. show the results of some assumed event c. predict the sensitivity of different output variables d. show the results of an actual event ____ 11. ECG Monitors is forecasting that sales next year will be $8,640,000, a 20 percent increase over current sales. ECG has total assets of $3,840,000 and all assets will increase proportionately with sales. Of the current liabilities, only accounts payable (now $740,000) will increase with sales. What total financing will be needed by ECG to support the expected sales increase? a. $317,600 b. $620,000 c. $465,600 d. $840,400

____ 12. ICU has current assets of $800,000 and net fixed assets of $1,400,000. The firm expects its sales to climb 25 percent next year from its current level of $3,500,000. ICU's only current liability is accounts payable of $1,200,000. If both current assets and current liabilities will increase proportionately with sales, what additional financing will be needed by ICU next year? Assume ICU has a net profit margin of 6 percent. An increase in net fixed assets of $500,000 will be required. The firm pays out 50 percent of its earnings as dividends. a. $400,000 b. $358,750 c. $178,750 d. $268,750 ____ 13. Great Subs believes it can increase sales by 50 percent without any increase in net fixed assets. Earnings after tax are expected to be $2,000. The company pays no dividends. What additional financing will Subs need to finance this growth? Subs balance sheet currently is as follows: Cash Accounts Rec. Inventory Fixed assets, net a. b. c. d.
$ 2,500 4,400 6,000 47,700 $60,600

Accounts payable Notes payable Long-term debt Stockholder's equity

$ 5,600 10,000 15,000 30,000 $60,600

$3,350 surplus--no additional financing needed $1,650 $3,650 None of the above are correct

____ 14. In 20X3, the Fillmore Company's sales were $12.0 million. Its balance sheet at year end 20X3 is shown below. Fillmore's 20X4 sales are expected to be $15 million and its 20X5 sales are expected to be $18 million. Earnings after tax in both years is expected to be 5.0% of sales, and annual dividends of $250,000 are expected to be paid in both 20X4 and 20X5. The company presently has excess plant and equipment capacity. As a result, assume that the net fixed asset figure on the balance sheet will remain constant for both 20X4 and 20X5. Assuming that the ratios of assets (except fixed assets, net) to sales and accounts payable to sales in 20X3 remain the same in 20X4 and 20X5, calculate the total amount, i.e., one number, of external financing required during the 2 year period from 20X4 through 20X5, using the percentage of sales method. Fillmore Co. Balance Sheet (December 31, 20X3) ($ millions) Current liabilities: $0.2 Accts. payable 1.2 Notes payable 2.0 Long-term debt 2.6 Stockholders' equity
$6.0

Current assets: Cash Accts. Rec. Inventory Fixed assets, net a. b. c. d. $ 750,000 $ 250,000 $1,000,000 None of the above

$0.6 0.7 1.5 2.2 $6.0

____ 15. The Danville Company is considering a $50 million expansion (capital expenditure) program next year. The company wants to determine approximately how much additional financing will be needed if the expansion program is undertaken. Next year the company expects to earn $25 million after interest and taxes. The company also plans to increase its dividends from $5 million to $7 million. If the expansion program is accepted, the company expects working capital requirements to increase by approximately $8 million next year. Long-term debt retirement obligations total $3 million next year and depreciation is expected to be $13 million. No fixed assets are expected to be sold next year. a. $30 million b. $43 million c. $32 million d. $22 million ____ 16. Calculate Uniteds total assets if the firm expects sales to grow by 15% this year and the earnings after tax will be $50,000. Current liabilities in the last year were 40,000. United paid $20,000 in dividends last year and expects to increase dividends 10% this year. The firm will need additional financing of $25,000 to finance the expected growth. a. $393,333 b. $590,000 c. $226,667 d. $616,000 ____ 18. The Hudson River Line Company has a balance sheet as of the end of the year as follows: Cash $ 5,000 Accounts Payable $ 15,000 Accounts Receivable 20,000 Notes Payable 10,000 Inventories 40,000 Total Current Liab. 25,000 Total Current Assets $ 65,000 Long-term Debt 30,000 Fixed Assets, net 50,000 Stockholders Equity 60,000 Total Assets $115,000 Total Liabilities & Equity $115,000 Last year, the firm had sales of $148,750. This year the company expects sales to increase 25%, to generate earnings after tax of $16,000, and to pay a dividend of $5,000. Hudson operated its fixed assets at 85% capacity last year. What additional financing will be needed to support the sales increase? a. $2,125 b. $4,625 c. $1,500 d. $375 surplus -- no financing needed. ____ 18. Which of the following statements is/are correct about deferred taxes? I. Deferred taxes can occur because of geographical problems with the location of corporate headquarters. II. Deferred taxes can occur because some companies use the straight-line depreciation method to calculate income reported to stockholders and accelerated depreciation to calculate taxable income. This practice reduces taxes owed. a. I only b. II only c. Both I and II d. Neither I nor II ____ 19. ____ ratios indicate how efficiently a firm is using its assets to generate sales. a. Liquidity b. Asset management c. Financial leverage d. Equity

____ 20. The ____ ratio is a more severe measure of a firm's ability to meet fixed financial obligations than is the times interest earned ratio. a. acid test b. debt c. fixed charge coverage d. debt to equity ____ 21. Firms with a positive economic value added (EVA): a. have increasing growth in earnings b. have an increasing rate of return on investment c. have a return on capital greater than their cost of capital d. have a high return on book value ____ 22. All the following current liabilities normally vary directly with the sales except: a. accounts payable b. notes payable c. accrued wages d. accrued taxes ____ 23. The ____ is (are) used to forecast the amount of additional financing (i.e., cash) a company will need in some future period. a. percentage of sales forecasting method b. pro forma statement of cash flows c. a and b d. none of the above ____ 24. Jones Company sales last year were $25 million and its total assets were $8 million. Accounts payable were $2 million and common stock and retained earnings were $5 million. Jones sales are forecasted to be $30 million this year, earnings after tax are expected to be 3% of sales, and dividends of $250,000 are expected to be paid. Assuming that the ratio of assets to sales and current liabilities to sales remain the same this year as last year, determine the amount of additional financing required. a. $550,000 b. $1,200,000 c. $300,000 d. none of the above

Answer Section
1. ANS: C 2. 3. 4. 5. 6. ANS: B ANS: D ANS: A ANS: A ANS: A Solution: 1.5 = current assets / $10,000 Current assets = $15,000 1.0 = ($15,000 - inventories) / $10,000 Inventories = $5,000

7. ANS: D Solution: EAT = $700,000(0.07) = $49,000; EBT = $49,000/0.6 = $81,667 EBIT = $81,667 + $10,000 = $91,667; TIE = $91,667/$10,000 = 9.17 8. ANS: A Solution: EBT = $3.0 / (1 - 0.40) = $5.0 EBIT = $5.0 + $1.0 = $6.0 Interest permitted = EBIT / T.I.E. = $6.0 / 3.0 = $2.0 Additional interest = $2.0 - $1.0 = $1.0 Additional debt = $1.0 / 0.1 = $10, or $10 million 9. ANS: D Solution: EAT = 3,000,000(1-.4) = $1,800,000 NPM = EAT/sales = 0.036 so Sales = 1,800,000/.036 = $50,000,000 E.M. = TA/ Equity = 25/10 = 2.5 R.O.E. = NPM Total asset turnover Equity multiplier R.O.E. = 0.036 50/25 2.5 = 0.18 or 18% 10. ANS: B 11. ANS: B Solution: S = $8,640,000/1.2 = $7,200,000 TFN = (3,840,000/$7,200,000) ($1,440,000) -($740,000/$7,200,000)($1,440,000) = $620,000 12. ANS: D Solution: AFN = $500,000 + $800,000(0.25) - $1,200,000(0.25) - $3,500,000 (1.25)(0.06)(0.5) = $268,750

13. ANS: B Solution: AFN = ($12,900 / S )(.5S) - ( $5,600 / S)(.5S) - $2,000 = 6,450 - 2,800 - 2000 = $1,650 14. ANS: B Solution: Assets that are expected to vary proportionately with sales = $6.0 - $2.6 = $3.4 million External financing needed = [($3.4/$12)($6) - ($0.6/$12)($6)] - [0.05($15 + $18) - 2($0.25)] = $0.25 million, or $250,000 15. ANS: A Solution: Financing needed = $50 million capital expenditure - $25 million EAT + $7 million dividends + $8 million working capital increase + $3 million debt retirement - $13 million depreciation = $30 million 16. ANS: A Solution: $25,000 = (A/S)(.15S) - ($40,000/S)(.15S) - ($50,000 - $22,000) A = $393,333 17. ANS: B Solution: Full capacity sales = $148,750/0.85 = $175,000 New Sales = $148,750(1.25) = $185,938 $50,000 net fixed assets will support $175,000 in sales. Hence net fixed assets must increase by 50/175, or 0.2857 times sales in excess of capacity, or 0.2857($185,938 - $175,000) = $3,125 AFN = $65,000(0.25) + $3,125 - $15,000(0.25) - ($16,000 - $5,000) = $16,250 + $3,125 - $3,750 - $11,000 = $4,625 18. 19. 20. 21. 22. 23. ANS: ANS: ANS: ANS: ANS: ANS: D B C C B C

24. ANS: A Solution: AFN = [(A/S) S - (CL/S) S] - [CF - D] = [($8,000,000/$25,000,000) ($5,000,000) - ($2,000,000/$25,000,000)($5,000,000)] - [0.03

$30,000,000 - $250,000] = $550,000

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