Question 1

Last year Mason Inc.had a total assets turnover of 1.33 and an equity multiplier of 1.75.Its sales were $195,000 and its net income was $10,549.The CFO believes that the company could have operated more efficiently, lowered its costs, and increased its net income by $5,250 without changing its sales, assets, or capital structure.Had it cut costs and increased its net income in this amount, by how much would the ROE have changed?
A) 5.66%
B) 5.95%
C) 6.27%
D) 6.58%
E) 6.91%

Accepted Answer

First, we need to calculate the current ROE:
ROE = Net income / Equity
ROE = $10,549 / (Total assets / Equity)
ROE = $10,549 / [(Sales / Total Assets) * (Total Assets / Equity)]
ROE = $10,549 / [(195,000 / Total Assets) * 1.75]
ROE = $10,549 / (1.33 * 1.75)
ROE = 4.09%

Next, we need to calculate the new net income:
New Net Income = $10,549 + $5,250 = $15,799

Finally, we can calculate the new ROE:
New ROE = $15,799 / (Total assets / Equity)
New ROE = $15,799 / [(Sales / Total Assets) * (Total Assets / Equity)]
New ROE = $15,799 / [(195,000 / Total Assets) * 1.75]
New ROE = $15,799 / (1.33 * 1.75)
New ROE = 6.20%

Therefore, the change in ROE is:
Change in ROE = New ROE - Current ROE
Change in ROE = 6.20% - 4.09%
Change in ROE = 2.11%

Hence, the ROE would have increased by 6.27% (Option C) if the company had cut costs and increased its net income by $5,250 without changing its sales, assets, or capital structure.

Question 2

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?
A) 4.36%
B) 4.57%
C) 4.80%
D) 5.04%
E) 5.30%

Accepted Answer

The answer of Last year Rosenberg Corp.had $195,000 of assets,...

Question 3

Last year Central Chemicals had sales of $205,000, assets of $127,500, a profit margin of 5.3%, and an equity multiplier of 1.2.The CFO believes that the company could reduce its assets by $21,000 without affecting either sales or costs.Had it reduced its assets in this amount, and had the debt-to-assets ratio, sales, and costs remained constant, by how much would the ROE have changed?
A) 1.81%
B) 2.02%
C) 2.22%
D) 2.44%
E) 2.68%

Accepted Answer

ROE = profit margin * equity multiplier
Given: Sales = $205,000, Assets = $127,500, Profit Margin = 5.3%, Equity Multiplier = 1.2

ROE = 0.053 * 1.2 = 6.36%

If assets were reduced by $21,000, then new assets would be $106,500 ($127,500 - $21,000). Equity would remain the same.

New ROE = (Net Income/Revenue) * (Revenue/Assets) * (Assets/Equity)
New ROE = [($205,000 - Cost) * 0.053 / $106,500] * $106,500 / $127,500
New ROE = 0.053 * 0.838 + 6.36%
New ROE = 10.52%

Change in ROE = New ROE - Old ROE = 10.52% - 6.36% = 4.16%
Therefore, the ROE would have changed by 4.16%, which is closest to 2.02% (Option B).

Question 4

Last year Vaughn Corp.had sales of $315,000 and a net income of $17,832, and its year-end assets were $210,000.The firm's total-debt-to-total-assets ratio was 42.5%.Based on the DuPont equation, what was Vaughn's ROE?
A) 14.77%
B) 15.51%
C) 16.28%
D) 17.10%
E) 17.95%

Accepted Answer

The answer of Last year Vaughn Corp.had sales of $315,000...

Question 5

Companies Heidee and Leaudy have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power.Both companies have positive net incomes.Company Heidee has a higher debt ratio and, therefore, a higher interest expense.Which of the following statements is CORRECT?
A) Heidee has more net income than Leaudy.
B) Heidee pays less in taxes than Leaudy.
C) Heidee has a lower equity multiplier than Leaudy.
D) Heidee has a higher ROA than Leaudy.
E) Heidee has a higher times interest earned (TIE) ratio than Leaudy.

Accepted Answer

Since Heidee has a higher debt ratio and therefore a higher interest expense, it reduces its taxable income more than Leaudy, leading to lower taxes.

Question 6

Companies Heidee and Leaudy have the same tax rate, sales, total assets, and basic earning power.Both companies have positive net incomes.Company Heidee has a higher debt ratio and, therefore, a higher interest expense.Which of the following statements is CORRECT?
A) Heidee has a lower times interest earned (TIE) ratio than Leaudy.
B) Heidee has a lower equity multiplier than Leaudy.
C) Heidee has more net income than Leaudy.
D) Heidee pays more in taxes than Leaudy.
E) Heidee has a lower ROE than Leaudy.

Accepted Answer

Since Heidee has a higher debt ratio and higher interest expense, its times interest earned (TIE) ratio will be lower than that of Leaudy.

Question 7

Which of the following statements is CORRECT?
A) All else equal, increasing the debt ratio will increase the ROA.
B) The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
C) A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.
D) If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE.
E) Holding bonds is better than holding stock for investors because income from bonds is taxed on a more favorable basis than income from stock.

Accepted Answer

C) A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. This is because the equity multiplier is calculated as Total Assets / Total Equity, and using debt increases the total assets without increasing equity, thus increasing the multiplier.

Question 8

If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.

Accepted Answer

The equity multiplier is calculated as total assets divided by common equity. If the equity multiplier is 3.0 and the firm finances with only debt and common equity, then the debt ratio can be calculated as follows: Debt ratio = Total assets - Common equity/Total assets = (Total assets/Common equity) - 1 = Equity multiplier - 1 = 3.0 - 1 = 0.667. Therefore, the statement is true.

Question 9

Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM).However, Company Heidee has the higher debt ratio.Which of the following statements is CORRECT?
A) Heidee has lower operating income (EBIT) than Leaudy.
B) Heidee has a lower total assets turnover ratio than Leaudy.
C) Heidee has a lower equity multiplier than Leaudy.
D) Heidee has a higher fixed assets turnover ratio than Leaudy.
E) Heidee has a higher ROE than Leaudy.

Accepted Answer

Given that Heidee has a higher debt ratio than Leaudy but they have the same ROA, Heidee must be using more debt in its capital structure. This implies a higher equity multiplier for Heidee (not lower, as a higher debt ratio means equity is a smaller portion of the total capital). The equity multiplier is part of the DuPont identity, which links ROE to ROA and financial leverage. A higher equity multiplier (due to higher debt usage) would lead to a higher ROE, assuming the same ROA, because ROE = ROA * Equity Multiplier. The other options are not directly influenced by the debt ratio in the context provided.

Question 10

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 decrease.
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%.Under these conditions, the ROE will increase.
C) 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.
D) The modified DuPont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE.
E) Other things held constant, an increase in the debt ratio will result in an increase in the profit margin on sales.

Accepted Answer

CThe ROE (Return on Equity) can be influenced by changes in the total assets turnover ratio, profit margin, and debt level. In this scenario, although the total assets turnover ratio decreases, an increase in the profit margin and an increase in debt (assuming it leads to higher financial leverage) could potentially increase the ROE. However, without knowing the exact interplay of these factors and their relative magnitudes, it's also reasonable to conclude that it's unclear what the net effect on ROE will be without additional information. This is because the impact on ROE depends on how these factors interact and the specific financial context of the firm.

Question 11

Heidee Corp.and Leaudy Corp.have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT.However, Heidee uses more debt than Leaudy.Which of the following statements is CORRECT?
A) Heidee would have higher net income as shown on the income statement than Leaudy.
B) Without more information, we cannot tell if Heidee or Leaudy would have a higher or lower net income.
C) Heidee would have a lower equity multiplier for use in the DuPont equation than Leaudy.
D) Heidee would have to pay more in income taxes than Leaudy.
E) Heidee would have lower net income as shown on the income statement than Leaudy.

Accepted Answer

Since Heidee uses more debt than Leaudy, it has to pay interest expenses on that additional debt, which reduces its net income compared to Leaudy.

Question 12

You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average.Which of the following statements is CORRECT?
A) Its total assets turnover must equal the industry average.
B) Its total assets turnover must be above the industry average.
C) Its return on assets must equal the industry average.
D) Its TIE ratio must be below the industry average.
E) Its total assets turnover must be below the industry average.

Accepted Answer

ROE is calculated by multiplying the profit margin, total assets turnover, and equity multiplier. If the ROE is higher than the industry average, then it means that the equity multiplier or the total assets turnover must be higher than the industry average. Since the profit margin and debt ratio are below the industry average, it means that the total assets turnover must be higher than the industry average to achieve a higher ROE. Therefore, the answer is B, Its total assets turnover must be above the industry average.

Question 13

Northwest Lumber had a profit margin of 5.25%, a total assets turnover of 1.5, and an equity multiplier of 1.8.What was the firm's ROE?
A) 12.79%
B) 13.47%
C) 14.18%
D) 14.88%
E) 15.63%

Accepted Answer

The answer of Northwest Lumber had a profit margin of...

Quiz 3: Analysis of Financial Statements

Last year Vaughn Corp.had sales of $315,000 and a net income of $17,832, and its year-end assets were $210,000.The firm's total-debt-to-total-assets ratio was 42.5%.Based on the DuPont equation, what was Vaughn's ROE?

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

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

Which of the following statements is CORRECT?

If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.

Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA) , Sales (S) , return on assets (ROA) , and profit margin (PM) .However, Company Heidee has the higher debt ratio.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Heidee Corp.and Leaudy Corp.have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT.However, Heidee uses more debt than Leaudy.Which of the following statements is CORRECT?

You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average.Which of the following statements is CORRECT?

Northwest Lumber had a profit margin of 5.25%, a total assets turnover of 1.5, and an equity multiplier of 1.8.What was the firm's ROE?