Dr. Sudhakar Raju
FN 6450
PRACTICE MULTIPLE CHOICE QUESTIONS FOR EXAM 1
1. The JoHickum Corporation has released the following year-end financial data:
Sales
Interest Expense
Net Income
Total Assets
Total Liabilities
Tax Rate
$300,000
$7,200
$42,000
$240,000
$80,000
30%
Based on the information above, the company’s operating profit margin (i.e. EBIT/Sales)and
return on equity respectively are closest to:
a.
b.
c.
d.
20.0%
20.0%
22.4%
22.4%
17.5%
26.3%
26.3%
17.5%
2. An analyst applies the traditional DuPont system of financial analysis to the following data
for a company:
Equity turnover [Sales /TE]
4.2
Total asset turnover
2.0
Sales
$1.0 million
Profit margin
5.5%
Dividend payout ratio
31.8%
The company’s ROE is closest to:
a. 1.7%
b. 11.0%
c. 23.1%
d. 46.2%
3. Orange Tree Pharmaceuticals has a ratio of total debt to total assets that is above the
industry average and a ratio of long-term debt to equity that is below the industry average. This
situation suggests that the company:
a. Has a relatively low dividend payout ratio.
b. Has high current liabilities.
c. Efficiently utilizes its assets.
d. Maintains a low current ratio.
1
4. A bank loan officer is considering a short-term loan to XYZ Company. Which of the following
combinations of ratios would be preferable?
Current Ratio
Times Interest Earned
Debt Ratio
a.
0.5
0.5
0.33
b.
1.5
1.5
0.50
c.
2.0
1.0
0.60
d.
2.5
0.5
0.75
5. Ric Barrymore Productions is 100% equity financed. Current year EBIT is $1,500; sales are
$5,000; the tax rate is 30%; the dividend payout ratio is 60%; and total asset turnover is 2.0. The
firm’s return on equity is closest to:
a.
b.
c.
d.
35%
40%
42%
48%
6. Hershey Manufacturing has an accounts receivable balance of $600,000. If the average
collection period is 36.5 days what is the firm’s sales?
a. $6,000,000
b. $8,000,000
c. $18,000,000
d. $22,000,000
Use the following data to answer the next 2 questions:
Spartacus Corporation
Balance Sheet
Assets
12/31/2001 12/31/2000
Cash
$120,000
$36,000
Accounts Receivable
240,000
360,000
Inventory
720,000
480,000
Property, Plant & Equipment
1,680,000
1,764,000
Total Assets
$2,760,000 $2,640,000
Liabilities and Shareholders’ Equity
Accounts Payable
$453,600
Mortgage Payable
960,000
Common Stock (250 shares)
720,000
Retained Earnings
626,400
Total Liabilities & Shareholders’ Equity
$2,760,000
2
$600,000
996,000
720,000
324,000
$2,640,000
Spartacus Corporation
Income Statement
For the Year Ended December 31, 2001
Net Sales
Less Expenses:
Cost of Goods Sold
SG&A Expenses
Depreciation Expense
Interest Expense
Total Expenses
Pre-Tax Income
Income Tax Expense (30%)
Net Income
7.
a.
b.
c.
d.
$2,160,000
$1,200,000
396,000
84,000
48,000
1,728,000
432,000
129,000
$302,400
The company’s return on common equity for 2001 is:
22.46%
35.6%
40.2%
42.0%
8. What is the dividend payout ratio in 2001?
a. 0%
b. 15%
c. 50%
d. 100%
9. The sustainable growth rate of a firm is best described as the:
a. minimum growth rate achievable if the firm maintains a constant equity multiplier.
b. maximum growth rate achievable without external financing of any kind.
c. maximum growth rate achievable without using any external equity financing while
maintaining a constant debt-equity ratio.
d. maximum growth rate achievable without any limits on the level of debt financing.
10. A firm is currently operating at full capacity. Net working capital, costs, and all assets vary
directly with sales. The firm does not wish to obtain any additional equity financing. The
dividend payout ratio is constant at 40 percent. If the firm has a positive EFN, that need will be
met by:
a. accounts payable.
b. long-term debt.
c. fixed assets.
d. retained earnings.
3
Use the following data to answer the next 2 questions:
Franklin Corp.
Balance Sheet
Dec. 31, 2001
$ 60,000
550,000
690,000
1,300,000
1,300,000
$2,600,00
$270,000
580,000
850,000
900,000
1,750,000
250,000
600,000
$2,600,000
Cash
Accounts Receivable
Inventory
Total Current Assets
Fixed Assets
Total Assets
Accounts Payable
Wages Payable
Total Current Liabilities
Long-term Liabilities
Total Liabilities
Common Stock*
Retained Earnings
Total Liabilities& Equity
Dec. 31, 2000
$ 50,000
500,000
620,000
1,170,000
1,230,000
$2,400,000
$250,000
500,000
750,000
1,000,000
1,750,000
250,000
400,000
$2,400,000
*There are 25,000 common shares outstanding
Franklin Corp.
Income Statement for the Period Ending
December 31, 2001
Net Sales
Cost of Goods sold
SG&A
EBIT (Earnings Before Interest & Taxes)
Interest Expense
Pretax Profit
Income Tax Expense
Net Earnings
$4,000,000
3,040,000
430,000
530,000
160,000
370,000
148,000
$ 222,000
11. If the price of Franklin’s common stock is currently $177, what is Franklin’s P/E ratio?
a. 5
b. 10
c. 15
d. 20
4
12. Franklin’s equity multiplier in 2001 is:
a. 1.5
b. 2.8
c. 3.06
d. 4.91
13. Which of the following most accurately describes the balance sheet?
a. The items on the balance sheet are primarily based on market values.
b. The items represent actual amounts, not judgments and/or estimates.
c. There could be some items that are of financial value which are not included.
d. In certain situations, a firm’s assets may be greater than the sum of its total liabilities and
shareholders’ equity.
14. A company with 5,000,000 common shares outstanding decides to split its shares 5 for 1.
Prior to the split, the shares are selling for $0.60 per share. What is the change in retained
earnings for the company as a result of this stock split?
a.
b.
c.
d.
$0
$3,000,000
$12,000,000
$15,000,000
15. If a firm has a profit margin of 21%, which of the following is closest to the equity turnover
ratio [Sales/TE] required to achieve an 14% return on equity?
a.
b.
c.
d.
67%
78%
149%
294%
Use the information below to answer the next two questions
Profit Margin:
Total Asset Turnover:
Total Debt Ratio:
Payout Ratio:
8.5%
1.50
60%
40%
5
16. What is the IGR?
a. 8.28%
b. 12.67%
c. 6.36%
d. None of the above
17. What is the SGR?
a. 19.65%
b. 23.65%
c. 16.81%
d. None of the above
18. During 2007, a firm paid $10,000 in interest expense and its long-term debt decreased from
$75,000 to $45,000. What is the 2007 cash flow to creditors?
a. –$30,000
b. –$20,000
c. $10,000
d. $40,000
19. Alpha and Beta are two firms that are equal in every way except for their dividend payout
ratios. Alpha has a 30 percent payout ratio while Beta has a 40 percent payout ratio. Given this
difference:
a. Alpha's profit margin next year will exceed the Beta's profit margin.
b. Alpha and Beta will continue to grow at the same rate over the next five years assuming
neither firm utilizes any external financing.
c. Alpha's plowback ratio is less than Beta's plowback ratio.
d. Alpha has higher internal rate of growth than does Beta.
e. Alpha has a lower sustainable rate of growth than does Beta
20. All else equal, the internal growth rate increases when the:
a. retention ratio decreases.
b. dividend payout ratio increases.
c. net income decreases.
d. total assets decrease.
e. plowback ratio decreases
[ANSWER KEY ON THE NEXT PAGE]
6
Answer Key
1. C
2. C
3. B
4. B
5. C
6. A
7. A
8. A
9. C
10. B
11. D
12. C
13.C
14. A
15. A
16. A
17. B
18. D
19. D
20. D
Worked Out Solutions to Practice Exam1 for FN 6450
1) NI = EBT – Taxes
$42,000 = EBT – (Tax Rate) (EBT)
$42,000 = EBT [1 - .30]
EBT = [$42,000/.70] = $60,000
EBIT = EBT + Interest Expense
= $60,000 + $7,200
= $67,200
The operating profit margin is given by [EBIT/Sales] = [$67,200/$300,000] = 22.40%
TE = TA – TL = $240,000 - $80,000 = $160,000
ROE = NI/TE = $42,000/$160,000 = 26.25%
7
2) ROE = PM x TAT x EM
= [NI/Sales] x [Sales/TA] x [TA/TE]
= .0550 x [Sales/TE] (Note that TA’s in the last two terms will cancel out)
= .0550 x 4.2
= 23.10%
3) TD = CL + L-T Debt
If L-T Debt is low the reason why TD is high is because CL is very high.
4) Choice A has a current ratio that is too low.
Choice D has a debt ratio that is too high.
Between choices B and C, B is a better choice since it has a higher TIE ratio and a lower
debt ratio while also having an adequate current ratio.
5) EBIT =
Interest =
EBT
Taxes (30%)
NI
$1500
-$0
1500
-450
1050
Note that 100% equity financed implies that:
a.) TA = TE
b.) Interest expense is zero.
TAT = Sales/TA
2 = $5000/TA
TA = $2500. Since TA = TE, TE is also $2500
ROE = PM x TAT x EM
= [NI/Sales] x 2 x [TA/TE]
= [1050/5000] x 2 x [$2500/$2500]
ROE = .42 or 42%
6) ACP = AC Receivable
Sales/365
36.50 = $600,000
Sales/365
8
Sales = $600,000 x 365
36.50
Sales = $6 million
7) TE = C.S. + R.E. = 720,000 + 626,400 = 1,346,400
ROE = NI/TE = $302,400/$1,346,400 = 22.46%
8) The ARE (Addition to Retained Earnings) is given by the change in RE from 2000 to 2001
or $626,400 - $324,000 or $302,400. Since this value is equal to Net Income, 100% of
Net Income must have been retained leading to a dividend payout of 0%.
9) Choice C
10) Choice B
11) EPS = NI/Shares = [$222,000/25,000] = $8.88
P/E = $177/$8.88 = 19.93 or 20.
12) EM = 1 + TD/TE = 1+ $1,750,000
$250,000 + $600,000
= 1 + ($1,750,000/$850,000) = 3.06
13) C
14) Value of Equity before split = $.60 x 5m
= $3m
After the split, the stock price is 1/5th of its previous value or $.60/5 = $.12. The number
of shares after the stock split is [5 million x 5] or 25 million shares. The new value of
equity after the split is thus equal to $.12 x 25 million = $3 million. Thus, the split has not
changed the value of equity in any real sense. Hence, choice A.
15) ROE = PM x TAT x EM
.14 = .21 x [Sales/TA] x [TA/TE]
9
Note that TA’s in the last two terms will cancel out leaving Sales/TE = Equity Turnover.
The required equity turnover is then given by:
.14/.21 = .67 or 67%
16) RR = 1 – Payout Ratio – 1 - .40 = .60
ROA = PM x TAT
= .0850 x 1.50
= .1275
IGR = RR x ROA =
1 – (RR x ROA)
.60 x .1275 =
1 – (.60 x .1275)
.0765
.9235
= 8.28%
17) ROE = PM x TAT x EM
= .0850 x 1.50 x TA/TE
Note that since the TD ratio is 60% this must mean that TE ratio is 40%.
Also, TA = TD + TE = .60 + .40 = 1
Thus, TA/TE = 1/.40 = 2.50
Thus, EM = 2.50 which implies that ROE = .31875 or 31.875%
SGR = RR x ROE =
1 – (RR x ROE)
.60 x .31875 =
1 – (.60 x .31875)
.19125
.80875
= 23.65%
18) CF to Creditors = Interest Expense – [Net New Debt]
= $10,000 – [$45,000 - $75,000]
= $10,000 – [-$30,000]
= $40,000
19) Assume some simple values. Assume that the ROA and ROE of both firms is equal to
20%. The RR (Plowback Ratio) of Alpha is 70% and RR of Beta is 60%. If you compute the
IGR and SGR of both firms you will find that the IGR and SGR of Firm Alpha is higher than
the IGR and SGR of Firm Beta [IGR and SGR value of 16.28% for Alpha compared to
13.64% for Beta]. The basic intuition here is that higher the RR, higher the growth rate.
10
20) IGR will increase if the RR increases or dividend payout increases. If IGR increases, total
assets would have to increase. The basic intuition here is that higher the level of growth,
greater the level of total assets.
11