Ratio and Accounts Analysis - CPA Diary



CPA REVIEW SCHOOL OF THE PHILIPPINES

Manila

MANAGEMENT ADVISORY SERVICES

FINANCIAL STATEMENT ANALYSIS

THEORY

1. When a balance sheet amount is related to an income statement amount in computing a ratio,

a. The income statement amount should be converted to an average for the year.

b. Comparisons with industry ratios are not meaningful.

c. The balance sheet amount should be converted to an average for the year.

d. The ratio loses its historical perspective because a beginning-of-the-year amount is combined with an end-of-the-year amount.

2. How are financial ratios used in decision making?

a. They can help identify the reasons for success and failure in business, but decision making requires information beyond the ratios.

b. They remove the uncertainty of the business environment.

c. They aren’t useful because decision making is too complex.

d. They give clear signals about the appropriate action to take.

3. A useful tool in financial statement analysis is the common-size financial statement. What does this tool enable the financial analyst to do?

a. Evaluate financial statements of companies within a given industry of approximately the same value.

b. Determine which companies in the same industry are at approximately the same stage of development.

c. Compare the mix of assets, liabilities, capital, revenue, and expenses within a company over time or between companies within a given industry without respect to relative size.

d. Ascertain the relative potential of companies of similar size in different industries.

4. Which of the following is not revealed on a common size balance sheet?

a. The debt structure of a firm.

b. The capital structure of a firm.

c. The peso amount of assets and liabilities.

d. The distribution of assets in which funds are invested.

5. If a transaction causes total liabilities to decrease but does not affect the owners’ equity, what change if any, will occur in total assets?

a. Assets will be increased. c. No change in total assets.

b. Assets will be decreased. d. None of the above.

6. Last year, a business had no long-term investments; this year long term investments amount to P100,000. In a horizontal analysis the change in long-term investments should be expressed as

a. An absolute value of P100,000, and an increase of 100%

b. An absolute value of P100,000 and an increase of 1,000%

c. An absolute value of P100,000 and no value for a percentage change

d. No change in any terms because there was no investment in the previous year.

7. In a set of comparative financial statements, you observed a gradual decline in the net of gross ratio, i.e., between net sales and gross sales. This indicates that:

a. There is a stiffening in the grant of discounts to the customers.

b. The discount period is being lengthened.

c. There is adherence to the collection policies of the company.

d. Sales volume is decreasing.

8. Which of these ratios are measures of a company’s profitability?

|1. Earnings per share |5. Return on assets |

|2. Current ratio |6. Inventory turnover |

|3. Return on sales |7. Receivables turnover |

|4. Debt-equity ratio |8. Price-earnings ratio |

a. All eight ratios. c. 1, 3, 5, 6, 7, and 8 only.

b. 1, 3, 5, and 8 only. d. 1, 3, and 5 only

9. Which ratio is most helpful in appraising the liquidity of current assets?

a. Current ratio. c. Debt ratio.

b. Acid-test ratio. d. Accounts receivable turnover.

10. Which one of the following ratios would provide a best measure of liquidity?

A. Sales minus returns to total debt.

B. Total assets minus goodwill to total equity.

C. Current assets minus inventories to current liabilities.

D. Net profit minus dividends to interest expense.

11. North Bank is analyzing Belle Corp.’s financial statements for a possible extension of credit. Belle’s quick ratio is significantly better than the industry average. Which of the following factors should North consider as possible limitation of using this ratio when evaluating Belle’s creditworthiness?

a. Fluctuating market prices of short-term investments may adversely affect the ratio.

b. Increasing market prices for Belle’s inventory may adversely affect the ratio.

c. Belle may need to sell its available-for-sale investments to meet its current obligations.

d. Belle may need to liquidate its inventory to meet its long-term obligations.

12. The ratio of analytical measurements which measures the productivity of assets regardless of capital structure is

a. Current ratio. c. Quick (acid test) ratio.

b. Debt ratio. d. Return on total assets.

13. How are the following used in the calculation of the dividend-pay-out ratio for a company with only common stock outstanding?

| |a. |b. |c. |d. |

|Dividends per share |Denominator |Denominator |Numerator |Numerator |

|Earnings per share |Numerator |Not used |Denominator |Not used |

|Book value per share |Not used |Numerator |Not used |Denominator |

14. An investor has been given several financial ratios for an enterprise but none of the financial reports. Which combination of ratios can be used to derive return on equity?

A. Market-to-book-value ratio and total-debt-to-total-assets ratio.

B. Price-to-earnings ratio, earnings per share, and net profit margin.

C. Price-to-earnings ratio and return-on-assets ratio.

D. Net profit margin, total assets turnover, and equity multiplier.

15. Which of the following actions will increase a company’s quick ratio?

a. Reduce inventories and use the proceeds to reduce long-term debt.

b. Reduce inventories and use the proceeds to reduce current liabilities.

c. Issue short-term debt and use the proceeds to purchase inventory.

d. Issue long-term debt and use the proceeds to purchase fixed assets.

e. Issue equity and use the proceeds to purchase inventory.

16. On December 31, 1991, Northpark Co. collected a receivable due from a major customer. Which of the following ratios would be increased by this transaction?

a. Inventory turnover ratio. c. Current ratio.

b. Receivable turnover ratio. d. Quick ratio.

17. Jack & Sons, Inc. has a 2 to 1 acid test (quick) ratio. This ratio would decrease to less than 2 to 1 if the company

a. Purchased inventory on open account.

b. Sold merchandise on open account that earned a normal gross margin.

c. Collected an account receivable.

d. Paid an account payable.

18. The ratio that measures a firm's ability to generate earnings from its resources is

A. Days' sales in inventory. C. Days' sales in receivables.

B. Sales to working capital. D. Asset turnover.

19. In comparing the current ratios of two companies, why is it invalid to assume that the company with the higher current ratio is the better company?

a. The current ratio includes assets other than cash.

b. A high current ratio may indicate inadequate inventory on hand.

c. A high current ratio may indicate inefficient use of various assets and liabilities.

d. The two companies may define working capital in different terms.

20. Mabuhay Corp. has current assets of P180,000 and current liabilities of P360,000. Which of the following transactions would improve Mabuhay’s current ratio?

a. Refinancing a P60,000 long-term mortgage with a short-term note.

b. Collecting P20,000 of short-term accounts receivable.

c. Purchasing P100,000 of merchandise inventory with a short-term accounts payable.

d. Paying P40,000 of short-term accounts payable.

21. A company has a current ratio of 2 to 1. The ratio will decrease if the company

a. Receives a 5% stock dividend on one of its marketable securities.

b. Sells merchandise for more than cost and records the sale using the perpetual inventory method.

c. Pays a large account payable which had been a current liability.

d. Borrow cash on a six-month note.

22. Recording cash dividend payment when declaration was recorded earlier would

a. Increase both current ratio and working capital

b. Decreases both current ratio and working capital

c. Have no effect on current ratio or earnings per share

d. Increase current ratio but no effect on working capital.

23. ABC Corporation has a current ratio of 2 to 1 and a quick ratio (acid test) of 1 to 1. A transaction that would change Bond's quick ratio but not its current ratio is the

A. payment of accounts payable.

B. sale of inventory on account at cost.

C. collection of accounts receivable.

D. sale of short-term marketable securities for cash that results in a profit.

24. A company’s current ratio is 2.2 to 1 and the quick ratio is 1.0 to 1 at the beginning of the year. At the end of the year, the company has a current ratio of 2.5 to 1 and a quick ratio of 0.8 to 0.1 Which of the following could help explain the divergence in the ratios from the beginning to the end of the year?

a. An increase in inventory levels during the year.

b. An increase in credit sales in relationship to sales

c. An increase in the use of payables during the current year.

d. An increase in the use of payables during the current year.

25. If the ratio of total liabilities to equity increases, a ratio that must also increase is

A. Times interest earned. C. Return on equity.

B. Total liabilities to total assets. D. The current ratio.

26. The market value of a firm's outstanding common shares will be higher, everything else equal, if

A. Investors have a lower required return on equity.

B. Investors expect lower dividend growth.

C. Investors have longer expected holding periods.

D. Investors have shorter expected holding periods.

27. In a comparison of 1992 to 1991, Neir Co.’s inventory turnover ratio increased substantially although sales and inventory amounts were essentially unchanged. Which of the following statements explains the increased inventory turnover ratio?

a. Cost of goods sold decreased.

b. Accounts receivable turnover increased.

c. Total asset turnover increased.

d. Gross profit percentage decreased.

28. Minix Co. has a high sales-to-working-capital ratio. This could indicate

a. The firm is undercapitalized.

b. The firm is likely to have liquidity problems.

c. Working capital is not profitably utilized.

d. The firm is not profitable.

29. If, just prior to the period of rising prices, a company changed its inventory measurement from FIFO to LIFO, the effect in the next period would be to

| |a. |b. |c. |d. |

|Current ratio |Increase |Decrease |Increase |Decrease |

|Inventory turnover |Increase |Decrease |Decrease |Increase |

30. When compared to a debt-to-assets ratio, a debt-to-equity ratio would

A. Be about the same as the debt-to-assets ratio.

B. Be higher than the debt-to-assets ratio.

C. Be lower than the debt-to-assets ratio.

D. Have no relationship at all to the debt-to-assets ratio.

31. Assume that a company's debt ratio is currently 50%. It plans to purchase fixed assets either by using borrowed funds for the purchase or by entering into an operating lease. The company's debt ratio as measured by the balance sheet will

A. Increase whether the assets are purchased or leased.

B. Increase if the assets are purchased, and remain unchanged if the assets are leased.

C. Increase if the assets are purchased, and decrease if the assets are leased.

D. Remain unchanged whether the assets are purchased or leased.

32. You observe that a firm’s profit margin and debt ratio are below the industry average, while its return on equity exceeds the industry average. What can you conclude?

a. Return on assets is above the industry average.

b. Total assets turnover is above the industry average.

c. Total assets turnover is below the industry average.

d. Statements a and b are correct.

33. The following situations are descriptive of SBD Corporation. Which would be considered as the most favorable for the common stockholders.

a. Book value per share of common stock is substantially higher than market value per share; return on common stockholders’ equity is less than the rate of interest paid to creditors.

b. Equity ratio is high; return on assets exceeds the cost of borrowing.

c. SBD stops paying dividends on its cumulative preferred stock; the price-earnings ratio of common stock is low.

d. Equity ratio is low; return on assets exceeds the cost of borrowing.

34. What would be the effect on book value per share and earnings per share if the corporation purchased its own shares in the open market at a price greater than book value per share?

| |A. |B. |C. |D. |

|Book value per share |No effect |Increase |Decrease |Decrease |

|Earnings per share |Increase |Increase |Decrease |Increase |

35. Which of the following statements is correct?

a. An increase in a firm’s inventories will call for additional financing unless the increase is offset by an equal or larger decrease in some other asset account.

b. A high quick ratio is always a good indication of a well-managed liquidity position.

c. A relatively low return on assets (ROA) is always an indicator of managerial incompetence.

d. A high degree of operating leverage lowers the risk by stabilizing the firm’s earnings stream.

36. A company issued long-term bonds and used the proceeds to repurchase 40% of the outstanding shares of its stock. This financial transaction will likely cause the

A. Total assets turnover ratio to increase. C. Times-interest-earned ratio to decrease.

B. Current ratio to decrease. D. Fixed charge coverage ratio to increase.

37. The company issued new common shares in a three-for-one stock split. Identify the statements that indicate the correct effect(s) of this transaction.

a. It reduced equity per share of common stock.

b. Share of each common stockholder is reduced.

c. The peso amount of capita stock is increased.

d. Working capital and current ratio are increased.

38. All of the following statements are valid except

a. The short term creditor is more interested in cash flows and in working capital management that he is in how much accounting net income is reported.

b. If the return on total assets is higher than the after-tax cost of long-term debt, then leverage is positive, and the common stockholders will benefit.

c. The results of financial statements analysis are of value only when viewed in comparison with the results of other periods or other firms.

d. The inventory turnover is computed by dividing sales by average inventory.

PROBLEMS

1. The net sales of Grand Manufacturing Co. in 1990 is total, P580,600. The cost of goods manufactured is P480,000. The beginning inventories of goods in process and finished goods are P82,000 and P65,000, respectively. The ending inventories are, goods in process, P75,000, finished goods, P55,000. The selling expenses is 5%, general and administrative expenses 2.5% of cost of sales, respectively. The net profit in the year 1990 is

a. P90,000 b. P45,725 c. P53,850 d. P83,000

2. In 19x5, MPX Corporation’s net income was P800,000 and in 19x6 it was P200,000. What percentage increase in net income must MPX achieve in 19x7 to offset the 19x6 decline in net income?

a. 60% b. 600% c. 400% d. 300%

3. Barr Co. has total debt of $420,000 and shareholders’ equity of $700,000. Barr is seeking capital to fund an expansion. Barr is planning to issue an additional $300,000 in common stock, and is negotiating with a bank to borrow additional funds. The bank is requiring a debt-to-equity rate of 0.75. What is the maximum additional amount Barr will be able to borrow?

A. $225,000 B. $330,000 C. $525,000 D. $750,000

4. Perry Technologies Inc. had the following financial information for the past year:

|Sales | $860,000 |Inventory turnover |8x |

|Quick ratio |1.5 |Current ratio | 1.75 |

What were Perry’s current liabilities?

a. $430,000 b. $500,000 c. $107,500 d. $ 61,429

5. A service company's working capital at the beginning of January of the current year was $70,000. The following transactions occurred during January:

|Performed services on account |$30,000 |

|Purchased supplies on account |5,000 |

|Consumed supplies |4,000 |

|Purchased office equipment for cash |2,000 |

|Paid short-term bank loan |6,500 |

|Paid salaries |10,000 |

|Accrued salaries |3,500 |

What is the amount of working capital at the end of January?

A. $90,000 B. $80,500 C. $50,500 D. $47,500

6. The working capital of Regalado Co. is P600,000 and its current ratio is 3 to 1. The amount of current assets is

a. P900,000 b. P1,200,000 c. P600,000 d. P1,800,000

7. Blasso Co.’s net accounts receivable were $500,000 at December 31, 2000 and $600,000 at December 31, 2001. Net cash sales for 2001 were $200,000. The accounts receivable turnover for 2001 was 5.0. What were Blasso’s total net sales for 2001?

a. $2,950,000 b. $3,000,000 c. $3,200,000 d. $5,500,000

8. During 1989, Rand Co. purchased $960,000 of inventory. The cost of goods sold for 1989 was $900,000, and the ending inventory at December 31, 1989 was $180,000. What was the inventory turnover for 1989?

a. 6.4 b. 6.0 c. 5.3 d. 5.0

9. Last year's asset turnover ratio for Wuerffel Airlines was 2.5. This year, sales increased by 20% and average total assets increased by 10%. What is the new asset turnover ratio?

A. 2.50 B. 2.59 C. 2.73 D. 3.00

10. The following information pertains to AL Corporation as of and for the year-ended December 31, 19x7.

|Liabilities |P 60,000 |

|Stockholders’ equity |P 500,000 |

|Shares of common stock issued and outstanding |10,000 |

|Net income |P 30,000 |

During 1997, AL officers exercised stock options for 1,000 shares of stock at an option price of P8 per share. What was the effect of exercising the stock option?

a. No ratios were affected. c. Debt to equity ratio decreased to 12%.

b. Asset turnover increased to 50.4% d. Earnings per share increased by P0.33

11. Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10 percent annually on its bank loan. Alumbat’s annual sales are $3,200,000, its average tax rate is 40 percent, and its net profit margin on sales is 6 percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy will result. What is Alumbat’s current TIE ratio?

a. 2.4 b. 3.4 c. 3.6 d. 5.0

12. OTW Corporation has current assets totaling P15 million and a current ratio of 2.5 to 1. What is OTW’s current ratio immediately after it has paid P2million of its accounts payable?

a. 3.75 to 1 b. 2.75 to 1 c. 3.25 to 1 d. 4.75 to 1

13. What would be a company’s “times interest earned ratio” if interest paid on loans amount to P9,000 and its net income after income tax is P99,000. (Assume a 25% income tax rate on first P100,000 of income and 35% income tax rate on income in excess of P100,000.)

a. 10 times b. 12 times c. 13 times d. 16.21 times

14. The average stockholders equity for ABC Company for 2000 was P2,000,000. Included in this figure is P200,000 par value of 8% preferred stock, which remained unchanged during the year. The return on common shareholders’ equity was 12.5% during the 2000. How much was the net income of the company in 2000?

a. P234,000 b. P241,000 c. P250,000 d. P225,000

15. Planners have determined that sales will increase by 25% next year, and that the profit margin will remain at 15% of sales. Which of the following statements is correct?

A. Profit will grow by 25%.

B. The profit margin will grow by 15%.

C. Profit will grow proportionately faster than sales.

D. Ten percent of the increase in sales will become net income.

16. Given the following information, calculate the market price per share of WAM Inc.

|Net income = $200,000 |Earnings per share = $2.00 |

|Stockholders’ equity = $2,000,000 |Market/Book ratio = 0.20 |

a. $20.00 b. $ 8.00 c. $ 4.00 d. $ 2.00

17. Associated Co. paid out one-half of its 1994 earnings by dividends. Its earnings increased by 20% and the amounts of its dividends increased by 15% in 1995. Associated’s dividend payout ratio for 1995 was

a. 51.5% b. 52.3% c. 75.0% d. 47.9%

18. Earnings per share amount to P10 and the price earnings ratio is 5. If the dividend yield is 8%,

a. Market price of the stock must be P40.

b. Market value of the stock cannot be determined.

c. The amount of dividend cannot be determined.

d. The dividend is P4 per share.

19. Victoria Enterprises has $1.6 million of accounts receivable on its balance sheet. The company’s DSO is 40 (based on a 360-day year), its current assets are $2.5 million, and its current ratio is 1.5. The company plans to reduce its DSO from 40 to the industry average of 30 without causing a decline in sales. The resulting decrease in accounts receivable will free up cash that will be used to reduce current liabilities. If the company succeeds in its plan, what will Victoria’s new current ratio be?

a. 1.50 b. 1.97 c. 0.72 d. 1.66

20. Ehrenburg Co. had net income of $5.3 million and earnings per share of common stock of $2.50. Included in the net income was $500,000 of bond interest expense related to its long-term debt. The income tax rate was 50%. Dividends on preferred stock were $300,000. The dividend payout ratio on common stock was 40%. What were the dividends on common stock?

a. $1,800,000 b. $1,900,000 c. $2,000,000 d. $2,120,000

21. Taft Technologies has the following relationships:

|Annual sales |$1,200,000 |Inventory turnover ratio | 4.8 |

|Current liabilities |$ 375,000 |Current ratio | 1.2 |

|Days sales outstanding (DSO) | 40 |(360-day year) | |

The company’s current assets consist of cash, inventories, and accounts receivable. How much cash does Taft have on its balance sheet?

a. -$ 8,333 b. $ 66,667 c. $125,000 d. $200,000

22. JC Goods, Inc. has a total assets turnover of 0.30 and a profit margin of 10%. The president is unhappy with the current return on assets, and he thinks it could be doubled. This could be accomplished (1) by increasing the profit margin to 15% and (2) by increasing total assets turnover. What new asset turnover ratio, along with the 15% profit margin, is required to double the return on assets?

a. 35% b. 45% c. 40% d. 50%

23. Rainier Inc. has $2 million in current assets, its current ratio is 1.6, and its quick ratio is 1.2. The company plans to raise funds as additional notes payable and to use these funds to increase inventory. By how much can Rainier’s short-term debt (notes payable) increase without pushing its quick ratio below 0.8?

a. $625,000 b. $556,000 c. $333,000 d. $278,000

24. Shepherd Enterprises has an ROE of 15 percent, a debt ratio of 40 percent, and a profit margin of 5 percent. 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. $ 360,000,000 d. $ 960,000,000

25. A fire has destroyed many of the financial records of R. Son & Co. You are assigned to put together a financial report. You have found the return on equity to be 12% and the debt ratio was 0.40. What was the return on assets?

a. 5.35% b. 8.40% c. 6.60% d. 7.20%

26. The following were reflected from the records of War Freak Company:

|Earnings before interest and taxes |P1,250,000 |

|Interest expense |250,000 |

|Preferred dividends |200,000 |

|Payout ratio |40% |

|Shares outstanding throughout 2003 | |

| Preferred |20,000 |

| Common |35,000 |

|Income tax ratio |40% |

|Price earnings ratio |5 times |

The dividend yield ratio is:

A. 0.50 B. 0.40 C. 0.12 D. 0.08

27. Selzer Inc. sells all its merchandise on credit. It has a profit margin of 4 percent, days sales outstanding equal to 60 days, receivables of $150,000, total assets of $3 million, and a debt ratio of 0.64. What is the firm’s return on equity (ROE)? Assume a 360-day year.

a. 7.1% b. 33.3% c. 8.1% d. 3.3%

28. Deb & Co. has a debt ratio of 0.50, a total assets turnover of 0.25, and a profit margin of 10%. The president is unhappy with the current return on equity, and he thinks it could be doubled. This could be accomplished (1) by increasing the profit margin to 14% and (2) increasing debt utilization. Total assets turnover will not change. What new debt ratio, along with the 14% profit margin, is required to double the return on equity?

a. 0.75 b. 0.70 c. 0.65 d. 0.55

29. Last year, Quayle Energy had sales of $200 million and its inventory turnover ratio was 5.0. The company’s current assets totaled $100 million and its current ratio was 1.2. What was the company’s quick ratio?

a. 1.20 b. 1.39 c. 0.72 d. 0.55

30. Oliver Incorporated has a current ratio equal to 1.6 and a quick ratio equal to 1.2. The company has $2 million in sales and its current liabilities are $1 million. What is the company’s inventory turnover ratio?

a. 5.0 b. 5.2 c. 5.5 d. 6.0

31. Vance Motors has current assets of $1.2 million. The company’s current ratio is 1.2, its quick ratio is 0.7, and its inventory turnover ratio is 4. The company would like to increase its inventory turnover ratio to the industry average, which is 5, without reducing its sales. Any reductions in inventory will be used to reduce the company’s current liabilities. What will be the company’s current ratio, assuming that it is successful in improving its inventory turnover ratio to 5?

a. 1.33 b. 1.67 c. 1.22 d. 0.75

32. The following ratios and data were computed from the 1997 financial statements of Star Co.:

|Current ratio |1.5 |

|Working capital |P20,000 |

|Debt/equity ratio |.8 |

|Return on equity |.2 |

If net income for 1997 is P40,000, the balance sheet at the end of 1997 total assets of

a. P340,000 b. P360,000 c. P300,000 d. P400,000

33. An enterprise has total asset turnover of 3.5 times and a total debt to total assets ratio of 70%. If the enterprise has total debt of $1,000,000, it has a sales level of

A. $5,000,000.00 B. $2,450,000.00 C. $408,163.26 D. $200,000.00

34. Selected information from the accounting records of the Blackwood Co. is as follows:

|Net A/R at December 31, 2000 |$ 900,000 |

|Net A/R at December 31, 2001 |$1,000,000 |

|Accounts receivable turnover |5 to 1 |

|Inventories at December 31, 2000 |$1,100,000 |

|Inventories at December 31, 2001 |$1,200,000 |

|Inventory turnover |4 to 1 |

What was the gross margin for 2001?

a. $150,000 b. $200,000 c. $300,000 d. $400,000

35. The Meryl Corporation’s common stock is currently selling at $100 per share, which represents a P/E ratio of 10. If the firm has 100 shares of common stock outstanding, a return on equity of 20 percent, and a debt ratio of 60 percent, what is its return on total assets (ROA)?

a. 8.0% b. 10.0% c. 12.0% d. 16.7%

36. A firm has total assets of $1,000,000 and a debt ratio of 30 percent. Currently, it has sales of $2,500,000, total fixed costs of $1,000,000, and EBIT of $50,000. If the firm’s before-tax cost of debt is 10 percent and the firm’s tax rate is 40 percent, what is the firm’s ROE?

a. 1.7% b. 2.5% c. 6.0% d. 8.3%

37. Dean Brothers Inc. recently reported net income of $1,500,000. The company has 300,000 shares of common stock, and it currently trades at $60 a share. The company continues to expand and anticipates that one year from now its net income will be $2,500,000. Over the next year the company also anticipates issuing an additional 100,000 shares of stock, so that one year from now the company will have 400,000 shares of common stock. Assuming the company’s price/earnings ratio remains at its current level, what will be the company’s stock price one year from now?

a. $55 b. $60 c. $70 d. $75

38. Southeast Packaging’s ROE last year was only 5 percent, but its management has developed a new operating plan designed to improve things. The new plan calls for a total debt ratio of 60 percent, which will result in interest charges of $8,000 per year. Management projects an EBIT of $26,000 on sales of $240,000, and it expects to have a total assets turnover ratio of 2.0. Under these conditions, the average tax rate will be 40 percent. If the changes are made, what return on equity will Southeast earn?

a. 9.00% b. 11.25% c. 17.50% d. 22.50%

39. Lone Star Plastics has the following data:

|Assets: |$100,000 |Interest rate: |8.0% |

|Debt ratio: |40.0% |Total assets turnover: |3.0 |

|Profit margin: |6.0% |Tax rate: |40% |

What is Lone Star’s EBIT?

b. $12,000 c. $18,000 d. $30,000 d. $33,200

40. A firm has a debt/equity ratio of 50 percent. Currently, it has interest expense of $500,000 on $5,000,000 of total debt outstanding. Its tax rate is 40 percent. If the firm’s ROA is 6 percent, by how many percentage points is the firm’s ROE greater than its ROA?

a. 0.0% b. 3.0% c. 5.2% d. 7.4%

41. Watson Corporation computed the following items from its financial records for the year just ended:

|Price-earnings ratio |12 |

|Payout ratio |.6 |

|Asset turnover |.9 |

The dividend yield on Watson's common stock is

A. 5.0% B. 7.2% C. 7.5% D. 10.8%

42. Lombardi Trucking Company has the following data:

|Assets: |$10,000 |Interest rate: |10.0% |

|Debt ratio: |60.0% |Total assets turnover: |2.0 |

|Profit margin: |3.0% |Tax rate: |40% |

What is Lombardi’s TIE ratio?

a. 0.95 b. 1.75 c. 2.10 d. 2.67

43. Miller and Rogers Partnership has $3 million in total assets, $1.65 million in equity, and a $500,000 capital budget. To maintain the same debt-equity ratio, how much debt should be incurred?

A. $50,000 B. $225,000 C. $275,000 D. $450,000

44. Standard Company's bonds have a provision which stipulates that the ratio of senior debt to total assets will never rise above 45%. The company is at the limit of that ratio and it wishes to issue still another $25 million in senior debt. How much additional equity capital must it raise to comply with this restrictive provision?

A. $11.25 million. B. $20.45 million. C. $30.56 million. D. $55.56 million.

45. India Oats pays dividends of $0.62 per quarter, and has annual earnings per share of $2.80. What is India Oats's dividend yield and dividend payout ratio for 2000, respectively, if its recent market price is $30.00 and its average market price was $28.00?

A. 8.27% and 88.6%. C. 8.86% and 88.6%.

B. 8.27% and 22.1%. D. 8.86% and 22.1%. Gleim

46. Assume Meyer Corporation is 100 percent equity financed. Calculate the return on equity, given the following information:

(1) Earnings before taxes = $1,500

(2) Sales = $5,000

(3) Dividend payout ratio = 60%

(4) Total assets turnover = 2.0

(5) Tax rate = 30%

a. 25% b. 30% c. 35% d. 42%

47. Beatnik Company has a current ratio of 2.5 and a quick ratio of 2.0. If the firm experienced $2 million in sales and sustains an inventory turnover of 8.0, what are the firm's current assets?

A. $1,000,000 B. $500,000 C. $1,500,000 D. $1,250,000

48. Hanson Corporation's present year ROE remained at last year's 14% level, while the profit margin was reduced from 8% to 4% and the leverage ratio increased from 1.2 to 1.5. The effects on asset turnover were to

A. Remain constant. C. Decease from 14.58 to 2.33.

B. Increase from 1.46 to 2.33. D. Increase from 4.76 to 9.60.

49. Landry Retailers has annual sales of $365 million. The company’s days sales outstanding (calculated on a 365-day basis) is 50, which is well above the industry average of 35. The company has $200 million in current assets, $150 million in current liabilities, and $75 million in inventories. The company’s goal is to reduce its DSO to the industry average without reducing sales. Cash freed up would be used to repurchase common stock. What will be the current ratio if the company accomplishes its goal?

a. 1.23 b. 1.33 c. 1.43 d. 0.73

50. Kansas Office Supply had $24,000,000 in sales last year. The company’s net income was $400,000, its total assets turnover was 6.0, and the company’s ROE was 15 percent. The company is financed entirely with debt and common equity. What is the company’s debt ratio?

a. 0.20 b. 0.30 c. 0.33 d. 0.60

51. Last year, Thomas Lumber Co. had a profit margin of 10 percent, total assets turnover of 0.5, and a debt ratio of 20 percent. (The company finances its assets with debt and common equity; it does not use preferred stock.) This year, the company’s CFO wants to double ROE. She expects the total assets turnover will remain at 0.5, while the profit margin and debt ratio will increase enough to double ROE. Assume that the profit margin is increased to 15 percent, what debt ratio will the company need in order to double its ROE?

a. 0.30 b. 0.33 c. 0.40 d. 0.45

52. The Intelinet Corporation and Comp Inc. have assets of $100,000 each and a return on common equity of 17%. Intelinet has twice the debt of Comp Inc., while Comp has half the sales of Intelinet. If Intelinet has net income of $10,000 and a total assets turnover ratio of 3.5, what is Comp Inc.'s profit margin?

A. 3.31% B. 7.71% C. 10.00% D. 13.50%

53. Selected data from the year-end financial statements of World Cup Corp. are presented below. The difference between average and ending inventories is immaterial.

|Current ratio |2.0 |

|Quick ratio |1.5 |

|Current liabilities |P600,000 |

|Inventory turnover (based on cost of sales) |8 times |

|Gross profit margin |40% |

World’s net sales for the year were

a. P2.4 million b. P4.0 million c. P1.2 million d. P6.0 million

54. Roland & Company has a new management team that has developed an operating plan to improve upon last year’s ROE. The new plan would place the debt ratio at 55 percent, 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 percent. What does Roland & Company expect its return on equity to be following the changes?

a. 17.65% b. 21.82% c. 26.67% d. 44.44%

55. White Knight Enterprises is experiencing a growth rate of 9% with a return on assets of 12%. If the debt ratio is 36% and the market price of the stock is $38 per share, what is the return on equity?

A. 7.68% B. 9.0% C. 12.0% D. 18.75%

56. Manufacturer’s Inc. estimates that its interest charges for this year will be $700 and its net income will be $3,000. Assuming its average tax rate is 30 percent, what is the company’s estimated times interest earned ratio?

a. 2.40 b. 4.25 c. 5.33 d. 7.12

Questions 57 through 59 are based on the following information.

The condensed balance sheet as of December 31, 1982 of San Matias Company is given below. Figures shown by a question mark (?) may be computed from the additional information given:

|ASSETS | |LIAB. & STOCKHOLDERS’ EQUITY |

|Cash |P 60,000 | |Accounts payable |P ? |

|Trade receivable-net |? | |Current notes payable |40,000 |

|Inventory |? | |Long-term payable |? |

|Fixed assets-net |252,000 | |Common stock |140,000 |

| | | |Retained earnings |? |

|Total Assets |P 480,000 | |Total L & SHE |P 480,000 |

Additional information:

|Current ratio (as of Dec. 31, 1982) |1.9 to 1 |

|Ratio of total liabilities to total stockholders’ equity |1.4 |

|Inventory turnover based on sales and ending inventory |15 times |

|Inventory turnover based on cost of goods sold and ending inventory |10 times |

|Gross margin for 1982 |P500,000 |

57. The balance of accounts payable of San Matias as of December 31, 1982 is

a. P40,000 b. P80,000 c. P95,000 d. P280,000

58. The balance of retained earnings of San Matias as of December 31, 1982 is

a. P60,000 b. P140,000 c. P200,000 d. P360,000

59. The balance of inventory of San Matias as of December 31, 1982 is

a. P68,000 b. P100,000 c. P168,000 d. P228,000

Questions 60 thru 63 are based on the following information.

You are requested to reconstruct the accounts of Angela Trading for analysis. The following data were made available to you:

Gross margin for 19x8 P472,500

Ending balance of merchandise inventory P300,000

Total stockholders’ equity as of December 31, 19x8 P750,000

Gross margin ratio 35%

Debt to equity ratio 0.8:1

Times interest earned 10

Quick ratio 1.3:1

Ratio of operating expenses to sales 18%

Long-term liabilities consisted of bonds payable with interest rate of 20%

Based on the above information,

60. What was the operating income for 19x8?

a. P472,500 b. P243,500 c. P205,550 d. P229,500

61. How much was the bonds payable?

a. P400,000 b. P200,750 c. P114,750 d. P370,500

62. Total current liabilities would amount to

a. P600,000 b. P714,750 c. P485,250 d. P550,00

63. Total current assets would amount to

a. P630,825 b. P780,000 c. P580,000 d. P930,825

Answer Key

Theory

|1. C |6. C |11. A |16. B |21. D |26. A |31. B |36. C |

|2. A |7. B |12. D |17. A |22. D |27. D |32. B |37. A |

|3. C |8. B |13. C |18. D |23. B |28. A |33. B |38. D |

|4. C |9. D |14. D |19. C |24. A |29. D |34. D | |

|5. B |10. C |15. B |20. C |25. B |30. B |35. A | |

Problem

|1. C |16. C |31. C |46. D |61. C |

|2. D |17. D |32. B |47. D |62. C |

|3. B |18. D |33. A |48. B |63. D |

|4. A |19. D |34. A |49. A | |

|5. B |20. C |35. A |50. C | |

|6. A |21. B |36. A |51. C | |

|7. A |22. C |37. D |52. B | |

|8. B |23. A |38. D |53. B | |

|9. C |24. A |39. D |54. C | |

|10. C |25. D |40. B |55. D | |

|11. D |26. D |41. A |56. D | |

|12. C |27. D |42. D |57. B | |

|13. D |28. C |43. B |58. A | |

|14. B |29. C |44. C |59. B | |

|15. A |30. A |45. A |60. D | |

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