Question 1

Pettijohn Inc.
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.
 
-Refer to the data for Pettijohn Inc.What is the firm's book value per share?
A) $61.73
B) $64.98
C) $68.40
D) $72.00
E) $75.60

Accepted Answer

BVPS = Common equity/Shares outstanding = $72.00

Question 2

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

$\begin{array}{lr}
\text { Sales } & \$ 315,000 \
\text { Assets } & \$ 210,000 \
\text { Net income } & \$ 17,832 \
\text { Debt ratio } & 42.5 \% \
\text { Debt } & \$ 89,250 \
\text { Equity } & \$ 120,750 \
\text { Profit margin } & 5.66 \% \
\text { TATO } & 1.50 \
\text { Equity multiplier } & 1.74 \
\text { ROE } & \mathbf{1 4 . 7 7 \%}
\end{array}$

Question 3

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

The equity multiplier measures the amount of assets a firm controls with each dollar of equity, and the use of debt financing increases this multiplier. Therefore, a firm that employs financial leverage (i.e., uses debt financing) will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. This statement is true.

Question 4

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

Thinking through the DuPont equation, we can see that if the firm's PM and Equity multiplier are below the industry average, the only way its ROE can exceed the industry average is if its equity multiplier exceeds the industry average. The following data illustrate this point:
 $$\begin{array} { c c c c c c c c } 
&\mathrm { ROE } & = & \text { PM } & \text { x } & \text { TATO } & & \text { Eq mult } && \text { ROA } \
\text { Firm } & 30 \% & &9 \% && 2.0 && 1.67 & &18 \% \
\text { Industry } & 25 \% & &10 \% && 1 && 2.50 & &10 \%
\end{array}$$ 
The above demonstrates that b is correct, and that makes e and a incorrect. Now consider the following: NI/Assets = NI/Sales × Sales/Assets ROA = PM × TATO If its ROA were equal to the industry average, then with its low debt ratio (hence low equity multiplier) its ROE would also be below the industry average. So c is incorrect. With its debt ratio below the industry average, its interest charges should also be low, which would increase its TIE ratio, making d incorrect.

Question 5

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) company heidee has a lower times interest earned (tie) ratio.
B) company heidee has a lower equity multiplier.
C) company heidee has more net income.
D) company heidee pays more in taxes.
E) company heidee has a lower roe.

Accepted Answer

Heidee has higher interest charges. Basic earning power equals EBIT/Assets, and since assets are equal, EBIT must also be equal. TIE = EBIT/Interest. Therefore, Heidee higher interest charges means that its TIE must be lower. Thus, a is correct. All of the other statements are incorrect.

Question 6

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.

Accepted Answer

Think about the DuPont equation: ROE = PM × TATO × Equity multiplier. Similar financing policies will lead to similar Equity multipliers. Moreover, competition in the capital markets will cause ROEs to be similar, because otherwise capital would flow to industries with high ROEs and drive returns down toward the average, given similar risks. To have similar ROEs, firms with relatively high PMs must have relatively low TATOs, and vice versa. Therefore, the statement is false.

Question 7

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) company heidee has a lower operating income (ebit) than company ld.
B) company heidee has a lower total assets turnover than company leaudy.
C) company heidee has a lower equity multiplier than company leaudy.
D) company heidee has a higher fixed assets turnover than company leaudy.
E) company heidee has a higher roe than company leaudy.

Accepted Answer

Rule out all answers except e because they are false. Alternative answer explanation using the DuPont equation: ROE = PM × TATO × Eq mult. ROE = NI/S × S/TA × TA/Equity The first two terms are the same, but KB has higher equity multiplier, hence higher ROE.

Question 8

Pettijohn Inc.
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.
 
-Refer to the data for Pettijohn Inc.What is the firm's EPS?
A) $5.84
B) $6.15
C) $6.47
D) $6.80
E) $7.14

Accepted Answer

EPS = Net income/common shares outstanding = $6.47

Question 9

Stewart Inc.'s latest EPS was $3.50, its book value per share was $22.75, it had 215,000 shares outstanding, and its debt-to-assets ratio was 46%. How much debt was outstanding?
A) $3,393,738
B) $3,572,356
C) $3,760,375
D) $3,958,289
E) $4,166,620

Accepted Answer

$\begin{array}{lr}
\text { EPS } & \$ 3.50 \
\text { BVPS } & \$ 22.75 \
\text { Shares outstanding } & 215,000 \
\text { Debt ratio } & 46.0 \% \
\text { Total equity } & \$ 4,891,250 \
\text { Total assets } & \$ 9,057,870 \
\text { Total debt } & \$ 4,166,620
\end{array}$

Question 10

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

Equity multiplier = Assets/Equity = 3.0, so Assets/Equity = 1/3.0 = 0.333. By definition, Equity/Assets + Debt/Assets = 1.00, so 0.333 + Debt/Assets = 1.0. Therefore, Debt/Assets = 1.0 -0.333 = 0.667. Thus, the statement is true.

Question 11

Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of measuring changes in a firm's performance over time.

Accepted Answer

Trend analysis involves analyzing a firm's performance over multiple years to identify patterns and changes in financial position, which can help determine whether the firm is improving or deteriorating.

Question 12

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) company heidee has more net income.
B) company heidee pays less in taxes.
C) company heidee has a lower equity multiplier.
D) company heidee has a higher roa.
E) company heidee has a higher times interest earned (tie) ratio.

Accepted Answer

Under the stated conditions, Heidee would have more interest charges, thus lower taxable income and taxes. Thus, b is correct. All of the other statements are incorrect.

Question 13

Vang Corp.'s stock price at the end of last year was $33.50 and its earnings per share for the year were $2.30. What was its P/E ratio?
A) 13.84
B) 14.57
C) 15.29
D) 16.06
E) 16.86

Accepted Answer

$\begin{array}{lr}
\text {Stock price } & \$ 33.50 \
\text { EPS } &\$ 2.30 \
\text { P/E} & 14.57\
\end{array}$

Question 14

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 the higher net income as shown on the income statement.
B) without more information, we cannot tell if heidee or leaudy would have a higher or lower net income.
C) heidee would have the lower equity multiplier for use in the dupont equation.
D) heidee would have to pay more in income taxes.
E) heidee would have the lower net income as shown on the income statement.

Accepted Answer

More debt would mean more interest, hence a lower NI, given a constant EBIT, so e is correct. Also, we can rule out b and a, and Heidee would also have the higher multiplier, which rules out c. And with more interest, Heidee would have to pay less taxes, not more.

Question 15

Pettijohn Inc.
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.
 
-Refer to the data for Pettijohn Inc.What is the firm's market-to-book ratio?
A) 0.56
B) 0.66
C) 0.78
D) 0.92
E) 1.08

Accepted Answer

Market/book ratio (M/B) = Price per share/BVPS = 1.08

Question 16

Emerson Inc.'s would like to undertake a policy of paying out 45% of its income. Its latest net income was $1,250,000, and it had 225,000 shares outstanding. What dividend per share should it declare?
A) $2.14
B) $2.26
C) $2.38
D) $2.50
E) $2.63

Accepted Answer

$\begin{array}{lr}
\text { Net income } & \$ 1,250,000 \
\text { Shares outstanding } & 225,000 \
\text { Payout ratio } & 45 \% \
\text { EPS } & \$ 5.56 \
\text { DPS } & \$ 2,50
\end{array}$

Question 17

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

$\begin{array}{r}
\text {Profit margin}& 5.25 \% \
\text {TATO}&1.50 \
\text {Equity multiplier}&1.80 \
\text {ROE}&14.18\%
\end{array}$

Question 18

Pettijohn Inc.
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.
 
-Refer to the data for Pettijohn Inc.What is the firm's P/E ratio?
A) 12.0
B) 12.6
C) 13.2
D) 13.9
E) 14.6

Accepted Answer

P/E ratio = Price per share/Earnings per share = 12.0

Question 19

Lindley Corp.'s stock price at the end of last year was $33.50, and its book value per share was $25.00. What was its market/book ratio?
A) 1.34
B) 1.41
C) 1.48
D) 1.55
E) 1.63

Accepted Answer

$\begin{array}{lr}
\text {Stock price } & \$ 33.50 \
\text { Book value per share } &\$ 25.00 \
\text { M/B  ratio} & 1.34\
\end{array}$

Question 20

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

$\begin{array}{lcccc}
&&PM&x&TATO&x&\text { Eq mult. }&=&ROE\
 \text { Old } && 9 \% && 1.0 && 1.666667 && 15 \% \
 \text { New }&& 10 \% && 0.9 && 25 && 20 \%
\end{array}$ 
We see that b is true, thus c must be false. We can also see that d, e, and a are all false.

Quiz 7: 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?

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?

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?

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?

Stewart Inc.'s latest EPS was $3.50, its book value per share was $22.75, it had 215,000 shares outstanding, and its debt-to-assets ratio was 46%. How much debt was outstanding?

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.

Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of measuring changes in a firm's performance over time.

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?

Vang Corp.'s stock price at the end of last year was $33.50 and its earnings per share for the year were $2.30. What was its P/E ratio?

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?

Emerson Inc.'s would like to undertake a policy of paying out 45% of its income. Its latest net income was $1,250,000, and it had 225,000 shares outstanding. What dividend per share should it declare?

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?

Lindley Corp.'s stock price at the end of last year was $33.50, and its book value per share was $25.00. What was its market/book ratio?

Which of the following statements is CORRECT?