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Exam 4: Analysis of Financial Statements

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Question 1

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Which of the following statements is CORRECT?

A) Other things held constant,the more debt a firm uses,the higher its operating margin will be.
B) Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.
C) Other things held constant,the more debt a firm uses,the higher its profit margin will be.
D) Other things held constant,the higher a firm's total debt to total capital ratio,the higher its TIE ratio will be.
E) Debt management ratios show the extent to which a firm's managers are attempting to reduce risk through the use of financial leverage.The higher the total debt to total capital ratio,the lower the risk.

F) C) and D)
G) D) and E)

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Question 2

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If a firm's fixed assets turnover ratio is significantly higher than the average for its industry,then it could be that the firm uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets.

A) True
B) False

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Question 3

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The return on invested capital (ROIC)differs from the return on assets (ROA).First,ROIC is based on total invested capital rather than total assets.Second,the numerator of the ROIC is after-tax operating income rather than net income.

Quigley Inc.is considering two financial plans for the coming year.Management expects sales to be $300,000,operating costs to be $265,000,assets (which is equal to its total invested capital) to be $200,000,and its tax rate to be 25%.Under Plan A it would finance the firm using 25% debt and 75% common equity.The interest rate on the debt would be 8.8%,but under a contract with existing bondholders the TIE ratio would have to be maintained at or above 3.9.Under Plan B,the maximum debt that met the TIE constraint would be employed.Assuming that sales,operating costs,assets,total invested capital,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? Do not round your intermediate calculations.

Exhibit 4.1 The balance sheet and income statement shown below are for Koski 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. ​ ​ ​ -Refer to Exhibit 4.1.What is the firm's ROA? Do not round your intermediate calculations.

Suppose you are analyzing two firms in the same industry.Firm A has a profit margin of 10% versus a margin of 8% for Firm B.Firm A's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is 70% versus 20% for Firm B.Based only on these two facts,you cannot reach a conclusion as to which firm is better managed,because the difference in debt,not better management,could be the cause of Firm A's higher profit margin.

Exhibit 4.1 The balance sheet and income statement shown below are for Koski 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. ​ ​ ​ -Refer to Exhibit 4.1.What is the firm's days sales outstanding? Assume a 365-day year for this calculation.Do not round your intermediate calculations.

Wie Corp's sales last year were $250,000,and its year-end total assets were $355,000.The average firm in the industry has a total assets turnover ratio (TATO) of 2.4.The firm's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales.By how much must the assets be reduced to bring the TATO to the industry average,holding sales constant? Do not round your intermediate calculations.

Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable.This action had no effect on the company's total assets or operating income.Which of the following effects occurred as a result of this action?

Taggart Technologies is considering issuing new common stock and using the proceeds to reduce its outstanding debt.The stock issue would have no effect on total assets,the interest rate Taggart pays,EBIT,or the tax rate.Which of the following is likely to occur if the company goes ahead with the stock issue?

Exhibit 4.1 The balance sheet and income statement shown below are for Koski 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. ​ ​ ​ -Refer to Exhibit 4.1.What is the firm's total debt to total capital ratio? Do not round your intermediate calculations.

The profit margin measures net income per dollar of sales.

Considered alone,which of the following would increase a company's current ratio?

Song Corp's stock price at the end of last year was $28.50 and its earnings per share for the year were $1.30.What was its P/E ratio?

Jordan Inc has the following balance sheet and income statement data: ​ The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average,2.70,without affecting either sales or net income.Assuming that inventories are sold off and not replaced to get the current ratio to the target level,and that the funds generated are used to buy back common stock at book value,by how much would the ROE change? Do not round your intermediate calculations.

Last year Rennie Industries had sales of $280,000,assets of $175,000 (which equals total invested capital) ,a profit margin of 5.3%,and an equity multiplier of 1.2.The CFO believes that the company could reduce its assets by $51,000 without affecting either sales or costs.The firm finances using only debt and common equity.Had it reduced its assets by this amount,and had the debt/total invested capital ratio,sales,and costs remained constant,how much would the ROE have changed? Do not round your intermediate calculations.

Which of the following statements is CORRECT?

Faldo Corp sells on terms that allow customers 45 days to pay for merchandise.Its sales last year were $300,000,and its year-end receivables were $60,000.If its DSO is less than the 45-day credit period,then customers are paying on time.Otherwise,they are paying late.By how much are customers paying early or late? Base your answer on this equation: DSO - Credit Period = Days early or late,and use a 365-day year when calculating the DSO.A positive answer indicates late payments,while a negative answer indicates early payments.Assume all sales to be on credit.Do not round your intermediate calculations.

River Corp's total assets at the end of last year were $320,000 and its net income was $32,750.What was its return on total assets?

Other things held constant,a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin.