Course name: Foundations of Financial Management (10248) – Fall I, 2013
Assignment name: Week 2 Questions/Problems
1. Which of the following statements is CORRECT?
a. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.
b. The statement of cash flows shows where the firm’s cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit.
c. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock.
d. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital.
e. The statement of cash flows shows how much the firm’s cash?the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)?increased or decreased during a given year.
2. Personal After-Tax Yield
Corporate bonds issued by Johnson Corporation currently yield 8%. Municipal bonds of equal risk currently yield 5.5%. At what tax rate would an investor be indifferent between these two bonds? Round your answer to two decimal places.
Corporate After-Tax Yield
3. The Shrieves Corporation has $5,000 that it plans to invest in marketable securities. It is choosing among AT&T bonds, which yield 7.5%, state of Florida muni bonds, which yield 4.5% (but are not taxable), and AT&T preferred stock, with a dividend yield of 6%. Shrieves’s corporate tax rate is 40%, and 70% of the dividends received are tax exempt. Find the after-tax rates of return on all three securities. Round your answers to two decimal places.
A-T rate of return on AT&T bond %
A-T rate of return on Florida muni bonds %
A-T rate of return on AT&T preferred stock %
4. Little Books Inc. recently reported $3.75 million of net income. Its EBIT was $7.75 million, and its tax rate was 40%. What was its interest expense? (Hint: Write out the headings for an income statement and then fill in the known values. Then divide $3.75 million net income by (1 – T) = 0.6 to find the pre-tax income. The difference between EBIT and taxable income must be the interest expense. Use this same procedure to work some of the other problems.) Round your answer to the nearest whole dollar and enter your answer as a dollar amount.
Net Cash Flow
5. Kendall Corners Inc. recently reported net income of $4.5 million and depreciation of $765,000. What was its net cash flow? Assume it had no amortization expense.
Balance Sheet Analysis
6. Complete the balance sheet and sales information in the table that follows for Hoffmeister Industries using the following financial data:
Debt ratio: 45%
Quick ratio: 0.90
Total assets turnover: 1.2
Days sales outstanding: 36 days*
Gross profit margin on sales: (Sales – Cost of goods sold)/Sales = 25%
Inventory turnover ratio: 3.0
* Calculation is based on a 365-day year.
Round your answers to the nearest whole dollar.
Accounts payable $
Accounts receivable $
Long-term debt $ 60,000
Common stock $
Fixed assets $
Retained earnings $ 97,500
Total assets $ 300,000 Total liabilities and equity $
Cost of goods sold $
7. Which of the following statements is CORRECT?
a. The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC).
b. The income statement for a given year, say 2007, is designed to give us an idea of how much the firm earned during that year.
c. The focal point of the income statement is the cash account, because that account cannot be manipulated by “accounting tricks.”
d. The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP).
e. If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be identical to its reported net cash flow.
8. Companies HD and LD are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company HD has the higher debt ratio. Which of the following statements is CORRECT?
a. Company HD has a higher fixed assets turnover than Company LD.
b. Company HD has a lower total assets turnover than Company LD.
c. Company HD has a lower equity multiplier than Company LD.
d. Company HD has a higher ROE than Company LD.
e. Company HD has a lower operating income (EBIT) than Company LD.
9. Vigo Vacations has an equity multiplier of 1.9. The company’s assets are financed with some combination of long-term debt and common equity. What is the company’s debt ratio? Round your answer to two decimal places.
10. Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined. Which of the following could explain this performance?
a. The company’s cost of goods sold increased.
b. The company’s depreciation and amortization expenses declined.
c. The company’s interest expense increased.
d. The company’s operating income declined.
e. The company’s expenditures on fixed assets declined.
Current and Quick Ratios
11. Ace Industries has current assets equal to $7 million. The company’s current ratio is 2.0, and its quick ratio is 1.5.
1. What is the firm’s level of current liabilities?
2. What is the firm’s level of inventories?
12. A company has an EPS of $1.20, a cash flow per share of $4.40, and a price/cash flow ratio of 5.0. What is its P/E ratio? Round your answer to two decimal places.
13. Which of the following statements is CORRECT?
a. Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will increase.
b. Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Without additional information, we cannot tell what will happen to the ROE.
c. The modified Du Pont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE.
d. Other things held constant, an increase in the debt ratio will result in an increase in the profit margin on sales.
e. Suppose a firm’s total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will decrease.
14. Last year, Tucker Technologies had (1) a negative net cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation?
a. The company made a large capital investment early in the year.
b. The company sold a new issue of common stock.
c. The company had a sharp increase in its inventories.
d. The company had a sharp increase in its accrued liabilities.
e. The company had a sharp increase in its depreciation and amortization expenses.
15. Amram Company’s current ratio is 1.9. Considered alone, which of the following actions would reduce the company’s current ratio?
a. Borrow using short-term notes payable and use the proceeds to reduce accruals.
b. Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
c. Use cash to reduce accruals.
d. Use cash to reduce short-term notes payable.
e. Use cash to reduce accounts payable.