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Exam 3: Analysis of Financial Statements Part 2 Fixed Income Securities

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Question 41

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Suppose firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. Under these conditions, then firms that have high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.

A) True
B) False

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Question 42

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Branch Corp.'s total assets at the end of last year were $315,000 and its net income after taxes was $22,750. What was its return on total assets?

A) 7.22%
B) 7.58%
C) 7.96%
D) 8.36%
E) 8.78%

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

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Question 43

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The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its assets.

(The following data apply to Problems 87 through 105.) The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $) Assets 2010 Cash and securities $1,554.0 Accounts receivable 9,660.0 Inventories 13,440.0 Total current assets $24,654.0 Net plant and equipment 17,346.0 Total assets $42,000.0 Liabilities and Equity Accounts payable $7,980.0 Notes payable 5,880.0 Accruals 4,620.0 Total current liabilities $18,480.0 Long-term bonds 10,920.0 Total debt $29,400.0 Common stock 3,360.0 Retained earnings 9,240.0 Total common equity $12,600.0 Total liabilities and equity $42,000.0 Income Statement (Millions of $) 2010 Net sales $58,800.00 Operating costs except depr'n $54,978.0 Depreciation $1,029.0 Earnings bef int and taxes (EBIT) $2,793.0 Less interest 1,050.0 Earnings before taxes (EBT) $1,743.0 Taxes $610.1 Net income $1,133.0 Other data: Shares outstanding (millions) 175.00 Common dividends $509.83 Int rate on notes payable & L-T bonds 6.25% Federal plus state income tax rate 35% Year-end stock price $77.69 -What is the firm's profit margin?

Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be $301,770, operating costs to be $266,545, assets to be $200,000, and its tax rate to be 35%. Under Plan A it would use 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but the TIE ratio would have to be kept at 4.00 or more. Under Plan B the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure?

LeCompte Corp. has $312,900 of assets, and it uses only common equity capital (zero debt) . Its sales for the last year were $620,000, and its net income after taxes was $24,655. Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15%. What profit margin would LeCompte need in order to achieve the 15% ROE, holding everything else constant?

Last year Urbana Corp. had $197,500 of assets, $307,500 of sales, $19,575 of net income, and a debt-to-total-assets ratio of 37.5%. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $33,000. Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE?

Walter Industries' current ratio is 0.5. Considered alone, which of the following actions would increase the company's current ratio?

Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Company HD has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?

A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger?

If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?

(The following data apply to Problems 87 through 105.) The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $) Assets 2010 Cash and securities $1,554.0 Accounts receivable 9,660.0 Inventories 13,440.0 Total current assets $24,654.0 Net plant and equipment 17,346.0 Total assets $42,000.0 Liabilities and Equity Accounts payable $7,980.0 Notes payable 5,880.0 Accruals 4,620.0 Total current liabilities $18,480.0 Long-term bonds 10,920.0 Total debt $29,400.0 Common stock 3,360.0 Retained earnings 9,240.0 Total common equity $12,600.0 Total liabilities and equity $42,000.0 Income Statement (Millions of $) 2010 Net sales $58,800.00 Operating costs except depr'n $54,978.0 Depreciation $1,029.0 Earnings bef int and taxes (EBIT) $2,793.0 Less interest 1,050.0 Earnings before taxes (EBT) $1,743.0 Taxes $610.1 Net income $1,133.0 Other data: Shares outstanding (millions) 175.00 Common dividends $509.83 Int rate on notes payable & L-T bonds 6.25% Federal plus state income tax rate 35% Year-end stock price $77.69 -What is the firm's current ratio?

(The following data apply to Problems 87 through 105.) The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $) Assets 2010 Cash and securities $1,554.0 Accounts receivable 9,660.0 Inventories 13,440.0 Total current assets $24,654.0 Net plant and equipment 17,346.0 Total assets $42,000.0 Liabilities and Equity Accounts payable $7,980.0 Notes payable 5,880.0 Accruals 4,620.0 Total current liabilities $18,480.0 Long-term bonds 10,920.0 Total debt $29,400.0 Common stock 3,360.0 Retained earnings 9,240.0 Total common equity $12,600.0 Total liabilities and equity $42,000.0 Income Statement (Millions of $) 2010 Net sales $58,800.00 Operating costs except depr'n $54,978.0 Depreciation $1,029.0 Earnings bef int and taxes (EBIT) $2,793.0 Less interest 1,050.0 Earnings before taxes (EBT) $1,743.0 Taxes $610.1 Net income $1,133.0 Other data: Shares outstanding (millions) 175.00 Common dividends $509.83 Int rate on notes payable & L-T bonds 6.25% Federal plus state income tax rate 35% Year-end stock price $77.69 -What is the firm's dividends per share?

Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used similar accounting methods.

Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?

(The following data apply to Problems 87 through 105.) The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $) Assets 2010 Cash and securities $1,554.0 Accounts receivable 9,660.0 Inventories 13,440.0 Total current assets $24,654.0 Net plant and equipment 17,346.0 Total assets $42,000.0 Liabilities and Equity Accounts payable $7,980.0 Notes payable 5,880.0 Accruals 4,620.0 Total current liabilities $18,480.0 Long-term bonds 10,920.0 Total debt $29,400.0 Common stock 3,360.0 Retained earnings 9,240.0 Total common equity $12,600.0 Total liabilities and equity $42,000.0 Income Statement (Millions of $) 2010 Net sales $58,800.00 Operating costs except depr'n $54,978.0 Depreciation $1,029.0 Earnings bef int and taxes (EBIT) $2,793.0 Less interest 1,050.0 Earnings before taxes (EBT) $1,743.0 Taxes $610.1 Net income $1,133.0 Other data: Shares outstanding (millions) 175.00 Common dividends $509.83 Int rate on notes payable & L-T bonds 6.25% Federal plus state income tax rate 35% Year-end stock price $77.69 -What is the firm's BEP?

One problem with ratio analysis is that relationships can be manipulated. For example, we know that if our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.

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.

Which of the following statements is CORRECT?

Last year Rosenberg Corp. had $195,000 of assets, $18,775 of net income, and a debt-to-total-assets ratio of 32%. Now suppose the new CFO convinces the president to increase the debt ratio to 48%. Sales and total assets will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged. By how much would the change in the capital structure improve the ROE?