CHAPTER 1
1–1 What is finance? What types of decisions do people in finance make?
1–2 Why should persons who pursue careers in business have a basic understanding of finance even if
their jobs are in areas other than finance, such as marketing or information systems?
1–3 What does it mean to maximize the value of a corporation?
1–4 In general terms, how is value measured? What three factors determine value? How does each
factor affect value?
1–5 What is the difference between stock price maximization and profit maximization? Under what
conditions might profit maximization not lead to stock price maximization?
1–6 What are some actions stockholders can take to ensure that management’s interests and those of
stockholders coincide? What are some other factors that might influence management’s actions?
1–7 If you were the owner of a proprietorship, would you make decisions to maximize the value of
your business or your personal satisfaction?
1–8 Suppose you are the president of a large corporation located in Seattle, Washington. How do you
think the stockholders will react if you decide to increase the proportion of the company’s assets
that is financed with debt from 35 percent to 50 percent? In other words, what if the firm used
much more debt to finance its assets.
1–9 What is corporate governance? How does corporate governance affect the returns generated for
stockholders?
1–10 Why do U.S. corporations go international?
1–11 What are some factors that make financial decision making more complicated for firms that
operate in foreign countries than for purely domestic firms?
1–12 Describe the four general areas included in the study of finance. Why is it important for a person
who works in the financial markets to understand the responsibilities of a person who works in
managerial finance?
1–13 Describe the major differences among the three primary forms of business organization (a
proprietorship, a partnership, and a corporation).
1–14 Why do you think hybrid forms of business, such as limited liability partnerships (LLP) and
limited liability companies (LLC), have evolved over time?
1–15 What does it mean to be ethical in business dealings? Should unethical business behavior be
encouraged by business owners (stockholders) if such behavior increases the value of the stock
they own in the short term?
1–16 Can a firm sustain its operations by maximizing stockholders’ wealth at the expense of other
stakeholders?
1–17 Compared to the ownership structure of U.S. firms, which are “open” companies, what are some
advantages of the ownership structure of foreign firms, many of which are “closed” companies?
Can you think of any disadvantages?
1–18 Should stockholder wealth maximization be thought of as a long-term goal or a short-term goal?
Why?
1–19 Discuss the possibility of agency problems in a business that is a (a) proprietorship, (b) partnership
with five partners, and (c) corporation with 100,000 stockholders.
1–20 Discuss the validity of the following statement: “When a firm’s stock price falls, it is evidence that
the firm’s managers are not acting in the best interests of the shareholders.”
CHAPTER 2
2–1 What kind of financial information is a publicly traded company required to provide to its
stockholders? Which financial statement do you think provides the best information for investors?
2–2 Differentiate (compare) among the information that is provided in each of the following financial
statements: (1) balance sheet, (2) income statement, and (3) statement of cash flows.
2–3 Discuss some of the limitations associated with performing ratio (financial statement) analysis.
What is the most important ingredient (input) in completing ratio analysis? Explain why.
2–4 Robust Robots (RR) recently issued 100,000 shares of common stock at $7 per share. The stock
has a par value equal to $3 per share. What amount of the $700,000 that RR raised should be
reported in the “common stock at par” account, and what amount should be reported in the “Paid-
in capital” account?
2–5 Crooked Golf’s most recent income statement shows that net income was $90,000, depreciation
was $25,000, and taxes were $60,000. What was Crooked Golf’s net cash flow?
2–6 HighTech Wireless just published its current income statement, which shows net income equal to
$240,000. The statement also shows that operating expenses were $500,000 before including
depreciation, depreciation was $100,000, and the tax rate was 40 percent.
If HighTech has no debt, what were its sales revenues? What was its net cash flow?
2–7 Credit Card of America (CCA) has a current ratio of 3.5 and a quick ratio of 3.0. If its total current
assets equal $73,500, what are CCA’s (a) current liabilities and (b) inventory?
2–8 At the end of the year, Wrinkle Free Laundry (WFL) had $150,000 in total assets. (a) If WFL’s
total assets turnover was 2.0, what were its sales revenues? (b) If WFL’s return on assets was 6
percent, what were its net income and net profit margin?
2–9 The balance sheet for Panoramic Open Pictures (POP) shows $300,000 in total assets and
$200,000 in total liabilities. POP’s return on assets (ROA) is 5 percent. Compute POP’s (a) net
income for the year and (b) its return on equity (ROE). POP has no preferred stock.
2–10 Legacy Cleaning has a debt ratio equal to 40 percent, total assets equal to $750,000, return on
assets (ROA) at 6 percent, and total assets turnover of 3.0. (a) If it has no preferred stock, what
amount of common equity does Legacy have? (b) What is Legacy’s net profit margin?
2–11 At the end of the year, Water Works International (WWI) had $10,000 in total assets. Its total
assets turnover was 2.5, and its return on assets (ROA) was 4 percent. What were WWI’s (a) sales
revenues and (b) net profit margin?
2–12 Last year, Delightful Desserts had a quick ratio of 1.8, a current ratio of 5.0, an inventory turnover
of 7, total current assets of $340,000, and cash and equivalents of $43,000. If the cost of goods
sold equaled 80 percent of sales, what were Bailey’s annual sales and DSO?
2–13 Wiley’s Wilderness pays 6 percent interest on its outstanding debt, which equals $200,000. The
company’s sales are $540,000, its tax rate is 40 percent, and its net profit margin is 4 percent. (a)
What is Wiley’s TIE? (b) If Wiley’s wants to maintain a TIE equal to 6.0, what must its sales
equal?
2–14 The most recent balance sheet of Infinity Information Systems (IIS) shows that the company has
$35 million of common equity and 7 million shares of common stock outstanding. The company’s
common stock has a market value equal to $8 per share. IIS’s net income was $14 million. What
are IIS’s (a) P/E ratio and (b) M/B ratio?
2–15 Smitty’s Finger-Licking BBQ has a total asset turnover equal to 2.0, a return on equity (ROE)
equal to 15 percent, and a debt ratio equal to 60 percent. If Smitty’s is financed with debt and
common stock, what are its (a) return on assets (ROA) and (b) net profit margin?
2–16 Duncan Boutique’s total assets are $440,000, its return on assets (ROA) is 8 percent, and its debt
ratio is 20 percent. What are Duncan’s (a) net income and (b) return on equity (ROE)?
2–17 Horatio’s Hot Dogs’ current assets equal $260,000. The company’s return on assets (ROA) is 4
percent, its net income is $140,000, its long-term debt equals $1,755,000, and 35 percent of its
assets are financed with common equity. Horatio’s has no preferred stock. Compute the
company’s current ratio.
2–18 Fido’s Dog Spa’s financial statements show that its total assets equal $100,000, its return on assets
(ROA) is 3 percent, and its return on equity (ROE) is 5 percent. (a) Compute the company’s net
income. (b) What portion of total assets is financed with debt? Fido’s has no preferred stock.
2–19 Sixty (60) percent of Extreme Well Drilling’s assets are financed with common equity, which is
the only type of equity financing the company has. Extreme’s current ratio is 5.0, its total assets
turnover is 4.0, current assets equal $150,000, and its sales equal $1,800,000. What amount of
Extreme’s total liabilities is long term, and what amount is short term (current liabilities)?
2–20 North/South Airlines generated the following information from its financial statements: (1) P/E
ratio equals 15.0, (2) common stock market price per share is $30, (3) fixed assets turnover equals
8.0, (4) current ratio equals 5.0, (5) current liabilities equal $300,000, (6) net profit margin equals
4 percent, and (7) 60,000 shares of common stock are outstanding. What are North/South’s (a)
return on assets (ROA) and (b) total assets turnover?
CHAPTER 16
16–1 Midwest Mining (MWM) expects its sales to grow by 20 percent next year. Last year, when the
firm was operating at full capacity, MWM generated sales equal to $250,000 with assets of
$800,000. MWM’s current balance sheet shows that accounts payable and accruals are $150,000,
notes payable are $25,000, long-term debt is $100,000, common stock is $450,000, and retained
earnings are $75,000. Next year, MWM’s net profit margin is expected to be the same as this past
year, 5 percent, and the company plans to continue to pay 60 percent of earnings as dividends.
Estimate MWM’s additional funds needed (AFN) for next year.
16–2 Esther’s Egg Farm is constructing its pro forma financial statements for this year. At year end,
assets were $400,000 and accounts payable (the only current liabilities account) were $125,000.
Last year’s sales were $500,000. Esther’s expects to grow by 15 percent this year. Assets and
accounts payable are expected to grow proportionally to sales. Common stock currently equals
$140,000, and retained earnings are $98,000. Esther’s plans to sell $15,000 of new common stock
this year. The firm’s profit margin on sales is 6 percent, and 40 percent of earnings will be paid
out as dividends. How much new long-term debt financing will Esther’s need this year to finance
its expected growth? Esther’s is currently operating at full capacity.
16–3 In its most recent fiscal year, SynoCorp generated $810,000 in sales. The firm was operating at 90
percent capacity. How much more sales can SynoCorp generate before it is at full capacity?
16–4 TransCan Industries has been operating at 60 percent capacity the past few years. In each of these
years, TransCan generated sales of $5.4 million. By what percentage can TransCan increase its
sales before full capacity is reached?
16–5 Prime Colors (PC) sells one-gallon cans of house paint for $25 each. The variable cost to produce
each can is $17.50, and fixed operating costs are $1,500. PC normally sells 30,000 gallons of paint
each year, has an interest expense equal to $300, and its marginal tax rate is 40 percent. Given this
information, what is PC’s operating breakeven point?
16–6 Maxine’s Pumps (MP) sells bilge pumps for $250 each. Each pump costs $150 to produce, and
MP’s fixed operating costs equal $600,000. (a) What is MP’s operating breakeven point? (b) What
is MP’s operating income (NOI) when 10,000 pumps are sold?
16–7 Flash Gordon Memory (FGM) sells memory cards for $45 each. Fixed costs are $900,000 for
output up to 200,000 cards. Variable costs are $25 per card. (a) What is FGM’s operating income
at sales of 75,000 cards? (b) What is the operating breakeven point?
16–8 Last Chance Gaming manufactures slot machines that are sold to individuals for $575 each. Fixed
operating costs are $690,000, and each machine’s variable cost is 70 percent of its selling price.
What is the firm’s degree of operating leverage at sales equal to (a) 6,000 machines, (b) 9,000
machines, and (c) 12,000 machines?
16–9 Lost Time Watch (LTW) Company manufactures watches that are sold for $200 each. Fixed
operating costs are $640,000 and variable costs are $120 per watch.
(a) What is LTW’s operating breakeven point?
(b) What is LTW’s degree of operating leverage (DOL) at sales of 10,000 units?
(c) Everything else equal, what would happen to the operating breakeven point if the selling
price is raised to $220?
16–10 Open Door Manufacturing (ODM) and Closed Window Industries (CWI) have identical operating
cost structures. Both firms incur a fixed operating cost equal to $420,000, their variable cost ratio
is 80 percent of the unit selling price, and they sell their products for $1,400 each. ODM normally
sells 2,000 units per year, whereas CWI normally sells 2,500 units each year.
(a) Compute the firms’ operating breakeven point.
(b) Compute the degree of operating leverage (DOL) for each firm at their normal sales levels,
and show that ODM is operating closer to the operating breakeven point than CWI.
16–11 Mercury Air’s debt consists of $50,000 in accounts payable, $100,000 in 10 percent notes payable,
and $240,000 in 8 percent bonds. Mercury has no preferred stock. If its marginal tax rate is 35
percent, what is Mercury’s financial breakeven point?
16–12 Juniper Jams’(JJ) balance sheet shows that its outstanding debt consists of $15,000 in 9 percent
notes payable and $48,000 in 6 percent bonds. In addition, JJ has $60,000 preferred stock that pays
a 5 percent dividend. If its marginal tax rate is 40 percent, what is JJ’s financial breakeven point?
16–13 Nuance Art has only one type of debt outstanding: a long-term bond with a face value of $300,000
and a coupon rate of interest equal to 11 percent. Nuance expects this year’s EBIT to equal
$99,000, and its marginal tax rate is 30 percent.
(a) If Nuance has no preferred stock, what is its degree of financial leverage (DFL)?
(b) If Nuance has preferred stock that pays an annual dividend equal to $18,480, what is its
DFL?
16–14 Stumpy’s Gator Farm forecasts that its net income will be $46,800 this year. The firm’s marginal
tax rate is 35 percent, and it must pay $36,000 interest on outstanding debt. Stumpy’s has no
preferred stock. What is the firm’s degree of financial leverage (DFL)?
16–15 Debbie’s Sod Farm (DSF) expects its EBIT to be $2,250 this year. DSF’s marginal tax rate is 40
percent, it must pay $1,000 in interest this year, and it has 500 shares of common stock
outstanding. DSF has no preferred stock.
(a) Compute the EPS that DSF expects to generate this year.
(b) What is DSF’s degree of financial leverage (DFL)?
16–16 Beachcomber Treasures (BT) has determined that its degree of operating leverage (DOL) is 3.5
and its degree of financial leverage (DFL) is 2.0.
(a) What is BT’s degree of total leverage (DTL)?
(b) What impact will a 5 percent decrease in sales have on BT’s (i) EBIT and (ii) net income?
16–17 Ensured Insurance has a degree of financial leverage (DFL) equal to 4.0 and a degree of total
leverage (DTL) equal to 10.0. Ensured expects sales to be $600,000 this year, and its net profit
margin is 8 percent.
(a) What is Ensured’s degree of operating leverage (DOL)?
(b) If Ensured’s sales turn out to be 7 percent higher than expected, what will its net income be?
16–18 Analysts have evaluated the Wright Sign Company and discovered that when sales are $400,000,
EBIT equals $125,000, the company’s degree of operating leverage (DOL) is 2.0, its degree of
financial leverage (DFL) is 4.0, and EPS equals $2.50. According to this information, what will
Wright’s EBIT be if actual sales equal $360,000 rather than $400,000? What will the EPS be?
16–19 Callie Corporation’s products sell for $180 each. The variable cost of each product is $135, and
fixed operating costs are $371,250. Callie pays $61,875 interest on its outstanding debt each year,
and its marginal tax rate is 40 percent. If Callie expects to sell 11,000 units, what is its degree of
operating leverage (DOL), its degree of financial leverage (DFL), and its degree of total leverage
(DTL)? The firm has no preferred stock.
16–20 LPM Corporation sells its product for $10 each. Fixed operating costs equal $100,000, and
variable operating costs are 75 percent of the selling price. The firm pays $37,500 in interest, and
its marginal tax rate is 35 percent. LPM has no preferred stock.
(a) What are LPM’s operating breakeven point and financial breakeven point?
(b) If LPM expects to sell 65,000 units, what are its degree of operating leverage (DOL),
degree of financial leverage (DFL), and degree of total leverage (DTL)?
