Chapter 3 & 4

Question 1

A firm’s liquidity is measured with which one of the following ratios?
A. Market-to-book ratio
B. Current ratio
C. Debt-equity ratio
D. Net profit margin
E. Net working capital ratio

Answer 1

B. Current ratio

Current assets/current liabilities

Question 2

3. Ratios that measure a firm’s liquidity are known as ______ ratios.
   A. asset management
   B. long-term solvency
   C. short-term solvency
   D. profitability
   E. book value

Answer 2

C. short-term solvency

Short-term solvency ratios provide information about a firm’s liquidity

Question 3

All other things beings equal, and assuming all ratios have positive values, an increase in current liabilities will:
A. increase the cash ratio.
B. increase the net working capital to total assets ratio.
C. decrease the cash coverage ratio.
D. decrease the quick ratio.
E. increase the current ratio.

Answer 3

D. decrease the quick ratio.

quick ratio = current assets-inventory/current liabilities

Question 4

Ratios that measure how efficiently a firm manages its assets and operations to generate net income are referred to as ______ ratios.
A. asset management
B. long-term solvency
C. short-term solvency
D. profitability
E. Turnover

Answer 4

D. profitability

Question 5

Which one of the following accurately lists the three components of the DuPont identity?
A. Equity multiplier, net profit margin, and total asset turnover
B. Debt-equity ratio, capital intensity ratio, and net profit margin
C. Operating efficiency, equity multiplier, and profitability ratio
D. Return on assets, net profit margin, and equity multiplier
E. Financial leverage, operating efficiency, and profitability ratio

Answer 5

A. Equity multiplier, net profit margin, and total asset turnover

ROE= Profit margin (PM) x total assets turnover (TAT) x Equity multiplier (EM)

Question 6

Financial planning:
A. focuses solely on the short-term outlook for a firm.
B. is a process that firms employ only when major changes to a firm’s operations are anticipated.
C. is a process that firms undergo once every five years.
D. considers multiple options and scenarios.
E. provides minimal benefits for firms that are highly responsive to economic changes.

Answer 6

D. considers multiple options and scenarios.

Question 7

The financial planning process includes:
I. determining asset requirements.
II. developing contingency plans.
III. establishing priorities.
IV. analyzing funding options.
A. I and III only
B. II and IV only
C. I, III, and IV only
D. I, II, and III only
E. I, II, III, and IV

Answer 7

E. I, II, III, and IV

Question 8

The financial planning process tends to place the least emphasis on a firm’s:
A. growth limitations.
B. capacity utilization.
C. market value.
D. capital structure.
E. dividend policy.

Answer 8

C. market value.

The financial planning process is directly involved with operational and strategic decisions.

Question 9

The need for external financing:
A. will limit growth if unfunded.
B. is unaffected by the dividend payout ratio.
C. must be funded by long-term debt.
D. ignores any changes in retained earnings.
E. considers only the required increase in fixed assets.

Answer 9

A. will limit growth if unfunded.

Question 10

Wei Bridal is a profitable firm with a dividend payout ratio of 25 percent. The firm does not want to issue additional equity shares nor increase its long-term debt.
Which one of the following defines the maximum rate at which this firm can currently grow?
A. Internal growth rate × (1 − .25)
B. Sustainable growth rate × (1 − .25)
C. Internal growth rate
D. Sustainable growth rate
E. Zero percent

Answer 10

C. Internal growth rate

Question 11

The sustainable growth rate of a firm is best described as the ______ growth rate achievable ______.
A. minimum; assuming a 100 percent retention ratio
B. minimum; if the firm maintains a constant equity multiplier
C. maximum; excluding external financing of any kind
D. maximum; excluding any external equity financing, while maintaining a constant debt-equity ratio
E. maximum; with unlimited debt financing

Answer 11

D. maximum; excluding any external equity financing, while maintaining a constant debt-equity ratio

Question 12

All else constant, if a firm decreases its operating costs, which one of the following will also decrease?
A. Return on equity
B. Return on assets
C. Net profit margin
D. Total asset turnover
E. Price-earnings ratio

Answer 12

E. Price-earnings ratio

Question 13

Hulsey Outdoor had a return on assets of 15 percent and a return on equity of 15 percent. Given this information, the firm:
A. may have short-term, but not long-term debt.
B. is using its assets as efficiently as possible.
C. has no net working capital.
D. has a debt-equity ratio of 1.0.
E. has an equity multiplier of 1.0.

Answer 13

E. has an equity multiplier of 1.0.

ROE = ROA x equity multiplier

Question 14

The relationship between the return on assets and the return on equity is identified by the:
A. net profit margin.
B. profitability determinant.
C. balance sheet multiplier.
D. DuPont identity.
E. debt-equity ratio.

Answer 14

D. DuPont identity.

Question 15

Which one of the following is a correct formula for computing the return on equity?
A. Net profit margin × ROA
B. ROA × Equity multiplier
C. Net profit margin × Total asset turnover × Debt-equity ratio
D. Net income/Total assets
E. Debt-equity ratio × ROA

Answer 15

B. ROA × Equity multiplier

Question 16

All else constant, a(n) ______ will increase the internal rate of growth.
A. decrease in the retention ratio
B. decrease in net income
C. increase in the dividend payout ratio
D. decrease in total assets
E. increase in cost of goods sold

Answer 16

D. decrease in total assets

Question 17

Financial plans generally tend to ignore:
A. dividend policy.
B. managers’ goals and objectives.
C. risks associated with cash flows.
D. operating capacity levels.
E. capital structure policy.

Answer 17

C. risks associated with cash flows.

Question 18

The financial planning process is least apt to:
A. involve internal negotiations among divisions.
B. quantify senior manager’s goals.
C. consider the development of future technologies.
D. reconcile a company’s activities across divisions.
E. consider factors that currently provide a negative rate of growth.

Answer 18

C. consider the development of future technologies.

Question 19

Financial planning is a(n) _____ process.
A. one time
B. iterative
C. static
D. inert

Answer 19

B. iterative

Question 20

One advantage to well-executed financial planning is that the firm can _____.
A. get out ahead of the competition
B. be sure of final outcomes of investments
C. correct past mistakes
D. avoid surprises

Answer 20

D. avoid surprises

Question 21

The ___________growth rate is the maximum rate of growth a firm can maintain without increasing its financial leverage

Answer 21

sustainable

Question 22

Which of the following are often left out of most financial planning models?
A. Equity growth, cash flow, and financial leverage
B. Profit margins, financial leverage, and turnover
C. Sales growth, asset growth, and equity growth
D. Cash flow size, risk, and timing

Answer 22

D. Cash flow size, risk, and timing

Question 23

If a firm maintains a constant debt-equity ratio and does not use any new external equity financing, the firm can grow at a rate no greater than its _____.

A. return on equity
B. internal growth rate
C. return on assets
D. sustainable growth rate

Answer 23

D. sustainable growth rate

Question 24

The _____________growth rate tells us the maximum growth rate that can be achieved with no external financing of any kind.

Answer 24

internal

Question 25

What does a current ratio of 1.2 mean?

A. The firm has $1.20 in current assets for every $1 in current liabilities.
B. The firm has $1.20 in current liabilities for every $1 in long-term debt.
C. The firm has $1.20 in current liabilities for every $1 in current assets.
D. The firm has $1.20 in current assets for every $1 in fixed assets.

Answer 25

A. The firm has $1.20 in current assets for every $1 in current liabilities.

Question 26

Which of the following is the correct representation of the total debt ratio?

A. Total equity/Total long-term debt
B. (Total assets - Total equity)/(Total assets)
C. Long-term debt/Total assets

Answer 26

B. (Total assets - Total equity)/(Total assets)

Question 27

The inventory ____________ is calculated as the COGS divided by the inventory.

Answer 27

turnover

Question 28

The profit margin is equal to net income divided by ______.

A. total assets
B. operating income
C. net working capital
D. sales

Answer 28

D. Sales

Question 29

How is market-to-book ratio measured?

A. Market value of bonds/Book value of bonds
B. Market value of sales/Book value of costs
C. Book value per share/Market value per share
D. Market value per share/Book value per share

Answer 29

D. Market value per share/Book value per share

Question 30

What will happen to the current ratio if current assets increase, while everything else remains unchanged?

A. It will decrease.
B. It may either increase or decrease.
C. It will increase.
D. It will not be affected.

Answer 30

C. It will increase.

Question 31

Which one of the following does not affect ROE according to the DuPont identity?

A. Asset use efficiency
B. Investor sentiment
C. Operating efficiency
D. Financial leverage

Answer 31

B. Investor sentiment

Question 32

The information needed to compute the profit margin can be found on the ___________
A. income statement
B. balance sheet
C. statement of cash flow

Answer 32

A. income statement

Question 33

The _________ identity can help to explain why two firms with the same return on equity may not be operating in the same way.
A. dilution
B. ratio
C. Bourne
D. DuPont

Question 34

An increase in which one of the following will increase a firm’s quick ratio without affecting its cash ratio?

Accounts payable

Cash

Inventory

Accounts receivable

Fixed assets

Answer 34

Accounts receivable

Question 35

Mario’s Home Systems has sales of $2,870, costs of goods sold of $2,210, inventory of $514, and accounts receivable of $435. How many days, on average, does it take Mario’s to sell its inventory?

Multiple Choice
83.73 days
55.32 days
84.89 days
65.37 days
71.84 days

Answer 35

84.89 days

Inventory Turnover = cost of goods sold/inventory

days in inventory = 365/inventory turnover

Inventory turnover = 2210/514=4.3
days in inventory = 365/4.3=84.89

Question 36

Jupiter Explorers has $7,400 in sales. The profit margin is 5 percent. There are 4,100 shares of stock outstanding, with a price of $1.60 per share. What is the company’s price-earnings ratio?

17.73 times

45.12 times

8.87 times

13.60 times

14.44 times

Answer 36

17.73 times

Earnings per share = ($7,400 × .05)/4,100 = $.09024

Price-earnings ratio = $1.60/$.09024 = 17.73 times

Question 37

A firm has a return on equity of 20 percent. The total asset turnover is 2.8 and the profit margin is 7 percent. The total equity is $6,000. What is the net income?

$1,200
$429
$1,176
$3,360
$420

Answer 37

$1,200

Net income = .20 × $6,000 = $1,200

Question 38

If Roten Rooters, Incorporated, has an equity multiplier of 1.44, total asset turnover of 1.39, and a profit margin of 8.50 percent. What is its ROE?

15.31%
16.33%
-5.20%
18.71%
17.01%

Answer 38

17.01%

ROE = (PM)(TAT)(EM)
ROE = (0.085)(1.39)(1.44)
ROE = 0.1701, or 17.01%

Question 39

7. The Green Giant has a 7 percent profit margin and a 33 percent dividend payout ratio. The total asset turnover is 1.5 times and the equity multiplier is 1.5 times. What is the sustainable rate of growth?
   A. 2.25%
   B. 17.70%
   C. 15.75%
   D. 10.61%
   E. 11.80%

Answer 39

E. 11.80%

ROE = .07 x 1.5 x 1.5 = .158
Sustainable growth rate = [.158 x (1-.33)]/{1-[.158 x (1-.33)]}

Sustainable growth rate = ROE x b/1 - ROE x b
ROE = PM (profit margin) *TAT (total equity turnover) * EM (equity multiplier)
ROE = NI(net income)/TE(total equity)
B = plowback ratio (retention ratio)
retention ratio = addition to retained earnings/Net Income
also = to 1 minus the dividend payout ratio
Dividend payout ratio = cash dividends/net income

Question 40

8. The Green Giant has a 6 percent profit margin and a 32 percent dividend payout ratio. The total asset turnover is 1.4 times and the equity multiplier is 1.5 times. What is the sustainable rate of growth?
   A. 14.06%
   B. 9.37%
   C. 12.60%
   D. 2.10%
   E. 11.20%

Answer 40

B. 9.37%

See notes in question 7

ROE = .06 x 1.4 x 1.5 = .126
b = 1-.32 = .68
Sustainable rate of growth = .126 x .68/1 - (.126 x .68)

Question 41

9. A firm wants a sustainable growth rate of 2.13 percent while maintaining a dividend payout ratio of 30 percent and a profit margin of 4 percent. The firm has a capital intensity ratio of 2. What is the debt-equity ratio that is required to achieve the firm’s desired rate of growth?
   A. .70 times
   B. .74 times
   C. .49 times
   D. .51 times
   E. .21 times

Answer 41

C. .49 times

Sustainable growth rate ROE x b / 1 - ROE x b
Dividend payout ratio = cash dividends/net income
ROE = PM x TAT x EM
plowback ratio (b) = 1 minus dividend payout ratio
total asset turnover = Sales/total assets
capital intensity ratio = Total average assets/revenue
Debt equity ratio = equity multiplier - 1

If we know sustainable growth rate and b, we can calculate ROE
Sustainable growth rate = 2.13
b = 1 - dividend payout ratio (1-.3) = .7
If we know the ROE, PM, and TAT we can calculate the EM
If we know the capital intensity ratio, we can calculate TAT since TAT = 1/capital intensity ratio
If we know the EM, we can calculate the Debt-Equity ratio
Debt equity ratio = Equity multiplier (EM) - 1

.0213 = .7ROE/1-.7ROE
.0213(1-.7ROE) = .7ROE
.0213 - .01491ROE = .7ROE (add .01491ROE to both sides)
.0213 = .71491ROE (divide by .71491)
ROE = .02979

PM = .04
TAT = 1/capital intensity ratio (2) = 1/2

.02979 = .04 x .5 x EM
.02979 = .02EM
EM = 1.49

Debt equity ratio = 1.49 - 1 = .49
ANSWER .49

Question 42

All else constant, if a firm decreases its operating costs, which one of the following will also decrease?

Return on equity

Return on assets

Net profit margin

Total asset turnover

Price-earnings ratio

Answer 42

Price-earnings ratio

Question 43

Humphries has cash of $10,000, accounts receivable of $2,500, accounts payable of $900, and inventory of $1,200. What is the value of the quick ratio?

13.89
14.22
12.89
15.22
9.12

Answer 43

13.89

Quick ratio = ($10,000 + 2,500)/$900
Quick ratio = 13.89

Question 44

Which of the following questions should be considered when developing a corporation’s financial plan?

I. How much net working capital will be needed?
II. Will additional fixed assets be required?
III. Will dividends be paid to shareholders?
IV. How much new debt must be obtained?

I and IV only

II and III only

I, III, and IV only

II, III, and IV only

I, II, III, and IV

Answer 44

I, II, III, and IV

Question 45

Financial plans:

concentrate solely on income and expense items.

often contain alternative options based on economic developments.

frequently contain conflicting goals.

assume that firms obtain no additional external financing.

are based on a single set of economic assumptions.

Answer 45

often contain alternative options based on economic developments.

Question 46

The internal growth rate of a firm is best described as the ______ growth rate achievable ______.

minimum; assuming a retention ratio of 100 percent

minimum; if the firm maintains a constant equity multiplier

maximum; excluding external financing of any kind

maximum; excluding any external equity financing, while maintaining a constant debt-equity ratio

maximum; with unlimited debt financing

Answer 46

maximum; excluding external financing of any kind

Question 47

A firm wants a sustainable growth rate of 2.93 percent while maintaining a dividend payout ratio of 23 percent and a profit margin of 7 percent. The firm has a capital intensity ratio of 2. What is the debt-equity ratio that is required to achieve the firm’s desired rate of growth?

.53 times

.06 times

.77 times

.94 times

.18 times

Answer 47

.06 times

Sustainable growth rate = .0293 = [ROE × (1 − .23)]/{1 − [ROE × (1 − .23)]}

ROE = .03697

ROE = .03697 = .07 × (1/2) × Equity multiplier

Equity multiplier = 1.06

Debt-equity ratio = 1.06 − 1 = .06 times

Question 48

Logano Driving School’s 2017 balance sheet showed net fixed assets of $3.6 million, and the 2018 balance sheet showed net fixed assets of $5.5 million. The company’s 2018 income statement showed a depreciation expense of $915,000. What was net capital spending for 2018?

$1,900,000

$2,815,000

$-1,900,000

$-985,000

$985,000

Answer 48

$2,815,000

Net capital spending = NFAend − NFAbeg + Depreciation
Net capital spending = $5,500,000 − 3,600,000 + 915,000
Net capital spending = $2,815,000

Question 49

Which one of the following is an agency cost?

Accepting an investment opportunity that will add value to the firm

Investing in a new project that creates firm value

Increasing the quarterly dividend

Hiring outside accountants to audit the company’s financial statements

Closing a division of the firm that is operating at a loss

Answer 49

Hiring outside accountants to audit the company’s financial statements