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It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all of the firms being compared have the same proportion of fixed assets to total assets.

A) True
B) False

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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.  Assets 2018 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity  Accounts payable $18,630 Accruals 8,370 Notes payable 6,000 Total current liabilities $33,000 Long-term bonds $9,000 Total liabilities $42,000 Common stock $5,040 Retained earnings 12,960 Total common equity $18,000 Total liabilities and equity $60,000\begin{array}{lc}\text { Assets } & 2018 \\\text { Cash and securities } & \$ 3,000 \\\text { Accounts receivable } & 15,000 \\\text { Inventories } & 18,000 \\\text { Total current assets } & \$ 36,000 \\\text { Net plant and equipment } & \$ 24,000 \\\text { Total assets } & \$ 60,000\\\text { Liabilities and Equity }\\\text { Accounts payable } & \$ 18,630 \\\text { Accruals } & 8,370 \\\text { Notes payable } & 6,000 \\\text { Total current liabilities } & \$ 33,000\\\\\text { Long-term bonds } & \$ 9,000 \\\text { Total liabilities } & \$ 42,000 \\\text { Common stock } & \$ 5,040 \\\text { Retained earnings } & 12,960 \\\text { Total common equity } & \$ 18,000\\\text { Total liabilities and equity }&\$60,000\end{array}  Income Statement (Millions of $ )  2018 Net sales $84,000 Operating costs except depreciation 78,120 Depreciation 1,680 Earnings before interest and taxes (EBIT)  $4,200 Less interest 900 Earnings before taxes (EBT)  $3,300 Taxes 1,320 Net income $1,980 Other data:  Shares outstanding (millions)  500.00 Common dividends (millions of $ )  $693.00 Int rate on notes payable & L-T bonds 6% Federal plus state income tax rate 40% Year-end stock price $47.52\begin{array}{lr}\text { Income Statement (Millions of } \$ \text { ) } & {2018} \\ \text { Net sales } & \$ 84,000 \\\text { Operating costs except depreciation } & 78,120 \\\text { Depreciation } & 1,680 \\\text { Earnings before interest and taxes (EBIT) } & \$ 4,200 \\\text { Less interest } & 900\\\text { Earnings before taxes (EBT) } &{\$ 3,300} \\\text { Taxes } & 1,320 \\\text { Net income } & \$ 1,980\\\\\text { Other data: }\\\text { Shares outstanding (millions) } & 500.00 \\\text { Common dividends (millions of } \$ \text { ) } & \$ 693.00 \\\text { Int rate on notes payable \& L-T bonds } & 6 \% \\\text { Federal plus state income tax rate } & 40 \% \\\text { Year-end stock price } & \$ 47.52\end{array} -Refer to Exhibit 4.1.What is the firm's ROA? Do not round your intermediate calculations.


A) 3.30%
B) 2.61%
C) 2.97%
D) 3.04%
E) 3.10%

F) D) and E)
G) B) and D)

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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.  Assets 2018 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity  Accounts payable $18,630 Accruals 8,370 Notes payable 6,000 Total current liabilities $33,000 Long-term bonds $9,000 Total liabilities $42,000 Common stock $5,040 Retained earnings 12,960 Total common equity $18,000 Total liabilities and equity $60,000\begin{array}{lc}\text { Assets } & 2018 \\\text { Cash and securities } & \$ 3,000 \\\text { Accounts receivable } & 15,000 \\\text { Inventories } & 18,000 \\\text { Total current assets } & \$ 36,000 \\\text { Net plant and equipment } & \$ 24,000 \\\text { Total assets } & \$ 60,000\\\text { Liabilities and Equity }\\\text { Accounts payable } & \$ 18,630 \\\text { Accruals } & 8,370 \\\text { Notes payable } & 6,000 \\\text { Total current liabilities } & \$ 33,000\\\\\text { Long-term bonds } & \$ 9,000 \\\text { Total liabilities } & \$ 42,000 \\\text { Common stock } & \$ 5,040 \\\text { Retained earnings } & 12,960 \\\text { Total common equity } & \$ 18,000\\\text { Total liabilities and equity }&\$60,000\end{array}  Income Statement (Millions of $ )  2018 Net sales $84,000 Operating costs except depreciation 78,120 Depreciation 1,680 Earnings before interest and taxes (EBIT)  $4,200 Less interest 900 Earnings before taxes (EBT)  $3,300 Taxes 1,320 Net income $1,980 Other data:  Shares outstanding (millions)  500.00 Common dividends (millions of $ )  $693.00 Int rate on notes payable & L-T bonds 6% Federal plus state income tax rate 40% Year-end stock price $47.52\begin{array}{lr}\text { Income Statement (Millions of } \$ \text { ) } & {2018} \\ \text { Net sales } & \$ 84,000 \\\text { Operating costs except depreciation } & 78,120 \\\text { Depreciation } & 1,680 \\\text { Earnings before interest and taxes (EBIT) } & \$ 4,200 \\\text { Less interest } & 900\\\text { Earnings before taxes (EBT) } &{\$ 3,300} \\\text { Taxes } & 1,320 \\\text { Net income } & \$ 1,980\\\\\text { Other data: }\\\text { Shares outstanding (millions) } & 500.00 \\\text { Common dividends (millions of } \$ \text { ) } & \$ 693.00 \\\text { Int rate on notes payable \& L-T bonds } & 6 \% \\\text { Federal plus state income tax rate } & 40 \% \\\text { Year-end stock price } & \$ 47.52\end{array} -Refer to Exhibit 4.1.What is the firm's ROE? Do not round your intermediate calculations.


A) 11.77%
B) 11.00%
C) 11.55%
D) 10.89%
E) 10.01%

F) B) and D)
G) B) and C)

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Which of the following statements is CORRECT?


A) The use of debt financing will tend to lower the basic earning power ratio,other things held constant.
B) 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.
C) 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.
D) The numerator used in the TIE ratio is earnings before taxes (EBT) .EBT is used because interest is paid with post-tax dollars,so the firm's ability to pay current interest is affected by taxes.
E) Other things held constant,increasing the total debt to total capital ratio will increase the ROA.

F) A) and E)
G) A) and D)

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Suppose Firms A and B have the same amount of assets,total assets are equal to total invested capital,pay the same interest rate on their debt,have the same basic earning power (BEP),finance with only debt and common equity,and have the same tax rate.However,Firm A has a higher debt to capital ratio.If BEP is greater than the interest rate on debt,Firm A will have a higher ROE as a result of its higher debt ratio.

A) True
B) False

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Firms A and B have the same current ratio,0.75,the same amount of sales,and the same amount of current liabilities.However,Firm A has a higher inventory turnover ratio than B.Therefore,we can conclude that A's quick ratio must be smaller than B's.

A) True
B) False

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Which of the following statements is CORRECT?


A) In general,if investors regard a company as relatively risky and/or having relatively poor growth prospects,then it will have relatively high P/E and M/B ratios.
B) The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.
C) The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year,depending on the time of year when the financial statements are constructed.
D) The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value.In general,investors regard companies with higher M/B ratios as more risky and/or less likely to enjoy higher future growth.
E) It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

F) B) and E)
G) A) and D)

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Chang Corp.has $375,000 of assets,and it uses only common equity capital (zero debt) .Its sales for the last year were $550,000,and its net income was $25,000.Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15%.What profit margin would the firm need in order to achieve the 15% ROE,holding everything else constant? Do not round your intermediate calculations.


A) 10.13%
B) 8.59%
C) 10.23%
D) 10.64%
E) 9.92%

F) B) and E)
G) A) and B)

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Last year Ann Arbor Corp had $250,000 of assets (which equals total invested capital) ,$305,000 of sales,$20,000 of net income,and a debt-to-total-capital ratio of 37.5%.The new CFO believes that a new computer program will enable the company to reduce costs and thus raise net income to $33,000.The firm finances using only debt and common equity.Assets,total invested capital,sales,and the debt to capital ratio would not be affected.By how much would the cost reduction improve the ROE? Do not round your intermediate calculations.


A) 8.15%
B) 8.57%
C) 8.82%
D) 6.74%
E) 8.32%

F) B) and C)
G) None of the above

Correct Answer

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Although a full liquidity analysis requires the use of a cash budget,the current and quick ratios provide fast and easy-to-use estimates of a firm's liquidity position.

A) True
B) False

Correct Answer

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Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects.These ratios include the Price/Earnings,the Market/Book,and Enterprise Value/EBITDA ratios.

A) True
B) False

Correct Answer

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Which of the following statements is CORRECT?


A) A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position,i.e. ,that it is becoming more liquid.
B) In general,it's better to have a low inventory turnover ratio than a high one,as a low one indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock.
C) If a firm's fixed assets turnover ratio is significantly lower 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.
D) The more conservative a firm's management is,the higher the firm's total debt to total capital ratio is likely to be.
E) The days sales outstanding ratio tells us how long it takes,on average,to collect after a sale is made.The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time.

F) A) and B)
G) A) and C)

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Which of the following statements is CORRECT?


A) The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio.
B) If two firms have the same ROA,the firm with the most debt can be expected to have the lower ROE.
C) An increase in the DSO,other things held constant,could be expected to increase the total assets turnover ratio.
D) An increase in the DSO,other things held constant,could be expected to increase the ROE.
E) An increase in a firm's total debt to total capital ratio,with no changes in its sales or operating costs,could be expected to lower its profit margin.

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

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The basic earning power ratio (BEP)reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.

A) True
B) False

Correct Answer

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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.  Assets 2018 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity  Accounts payable $18,630 Accruals 8,370 Notes payable 6,000 Total current liabilities $33,000 Long-term bonds $9,000 Total liabilities $42,000 Common stock $5,040 Retained earnings 12,960 Total common equity $18,000 Total liabilities and equity $60,000\begin{array}{lc}\text { Assets } & 2018 \\\text { Cash and securities } & \$ 3,000 \\\text { Accounts receivable } & 15,000 \\\text { Inventories } & 18,000 \\\text { Total current assets } & \$ 36,000 \\\text { Net plant and equipment } & \$ 24,000 \\\text { Total assets } & \$ 60,000\\\text { Liabilities and Equity }\\\text { Accounts payable } & \$ 18,630 \\\text { Accruals } & 8,370 \\\text { Notes payable } & 6,000 \\\text { Total current liabilities } & \$ 33,000\\\\\text { Long-term bonds } & \$ 9,000 \\\text { Total liabilities } & \$ 42,000 \\\text { Common stock } & \$ 5,040 \\\text { Retained earnings } & 12,960 \\\text { Total common equity } & \$ 18,000\\\text { Total liabilities and equity }&\$60,000\end{array}  Income Statement (Millions of $ )  2018 Net sales $84,000 Operating costs except depreciation 78,120 Depreciation 1,680 Earnings before interest and taxes (EBIT)  $4,200 Less interest 900 Earnings before taxes (EBT)  $3,300 Taxes 1,320 Net income $1,980 Other data:  Shares outstanding (millions)  500.00 Common dividends (millions of $ )  $693.00 Int rate on notes payable & L-T bonds 6% Federal plus state income tax rate 40% Year-end stock price $47.52\begin{array}{lr}\text { Income Statement (Millions of } \$ \text { ) } & {2018} \\ \text { Net sales } & \$ 84,000 \\\text { Operating costs except depreciation } & 78,120 \\\text { Depreciation } & 1,680 \\\text { Earnings before interest and taxes (EBIT) } & \$ 4,200 \\\text { Less interest } & 900\\\text { Earnings before taxes (EBT) } &{\$ 3,300} \\\text { Taxes } & 1,320 \\\text { Net income } & \$ 1,980\\\\\text { Other data: }\\\text { Shares outstanding (millions) } & 500.00 \\\text { Common dividends (millions of } \$ \text { ) } & \$ 693.00 \\\text { Int rate on notes payable \& L-T bonds } & 6 \% \\\text { Federal plus state income tax rate } & 40 \% \\\text { Year-end stock price } & \$ 47.52\end{array} -Refer to Exhibit 4.1.What is the firm's P/E ratio? Do not round your intermediate calculations.


A) 12.0
B) 12.6
C) 13.2
D) 13.9
E) 14.6

F) C) and D)
G) A) and B)

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One problem with ratio analysis is that relationships can be manipulated.For example,we know that if our current ratio is less than 1.0,then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.

A) True
B) False

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A firm wants to strengthen its financial position.Which of the following actions would increase its quick ratio?


A) Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.
B) Issue new common stock and use the proceeds to increase inventories.
C) Speed up the collection of receivables and use the cash generated to increase inventories.
D) Use some of its cash to purchase additional inventories.
E) Issue new common stock and use the proceeds to acquire additional fixed assets.

F) A) and E)
G) A) and B)

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A firm's new president wants to strengthen the company's financial position.Which of the following actions would make the company financially stronger?


A) Increase accounts receivable while holding sales constant.
B) Increase EBIT while holding sales and assets constant.
C) Increase accounts payable while holding sales constant.
D) Increase notes payable while holding sales constant.
E) Increase inventories while holding sales constant.

F) A) and D)
G) A) and E)

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Your sister is thinking about starting a new business.The company would require $300,000 of assets,and it would be financed entirely with common stock.She will go forward only if she thinks the firm can provide a 13.5% return on the invested capital,which means that the firm must have an ROE of 13.5%.How much net income must be expected to warrant starting the business?


A) $38,475
B) $44,145
C) $33,210
D) $40,500
E) $41,310

F) B) and E)
G) All of the above

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Which of the following would generally indicate an improvement in a company's financial position,holding other things constant?


A) The TIE declines.
B) The DSO increases.
C) The quick ratio increases.
D) The current ratio declines.
E) The total assets turnover decreases.

F) A) and C)
G) B) and C)

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