PART II: FINANCIAL RATIO

1) Which one of the following ratios is a measure of a firm's liquidity?

A) Cash coverage ratio
B) Profit margin
C) Debt-equity ratio
D) Quick ratio
E) NWC turnover

Explanation: Quick ratio (acid – test ratio) (CA – Inventory)/CL: is one of liquidity ratios,
besides current ratio (CA/CL), cash ratio (Cash & cash equivalents/CL), operating cash flow
ratio (Operating cash flow/CL), and NWC.
The quick ratio assesses a company's ability to meet its short-term obligations using its most
liquid assets.

More: The quick ratio is a stricter test of liquidity than the current ratio. It only considers
certain current assets. It considers more liquid assets such as cash, accounts receivable, and
marketable securities. It leaves out current assets such as inventory and prepaid expenses
because the two are less liquid. So, the quick ratio is more of a true test of a company’s ability
to cover its short-term obligations.

The quick ratio excludes inventory because inventory is often considered less liquid than other
current assets. Here are a few reasons for this exclusion:
- Liquidity Concerns: Inventory may not be easily converted into cash in the short term.
It requires selling, which can take time and may not guarantee immediate cash flow.
- Valuation Issues: The valuation of inventory can fluctuate based on market demand,
making it less reliable as a liquid asset compared to cash or receivables.
- Operational Factors: Companies may have varying levels of inventory turnover. A firm
with a high amount of slow-moving inventory might not be able to liquidate it quickly,
impacting its ability to meet short-term obligations.

2) An increase in current liabilities will have which one of the following effects, all else
held constant? Assume all ratios have positive values.
A) Increase in the cash ratio
B) Increase in the net working capital to total assets ratio
C) Decrease in the quick ratio
D) Decrease in the cash coverage ratio
E) Increase in the current ratio

Explanation: When current liabilities increase and current assets remain constant, the
denominator increases, leading to a lower quick ratio.
A, B, E: increase -> decrease

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3) An increase in which one of the following will increase a firm's quick ratio without
affecting its cash ratio?
A) Accounts payable
B) Cash
C) Inventory
D) Accounts receivable
E) Fixed assets

4) A supplier, who requires payment within 10 days, should be most concerned with
which one of the following ratios when granting credit?
A) Current
B) Cash
C) Debt-equity
D) Quick
E) Total debt

Explanation: The cash ratio specifically assesses a company's ability to cover its current
liabilities (including short-term obligations like those to suppliers) with its liquid cash and cash
equivalents. This ratio provides insight into how quickly a company can pay its short-term
obligations, which is critical for suppliers extending credit.

5) 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

Explanation: These ratios assess a company's ability to meet its short-term obligations.

6) If a firm has a debt-equity ratio of 1.0, then its total debt ratio must be which one of
the following?
A) 0
B) 0.5
C) 1.0
D) 1.5
E) 2.0

Explanation:
Debt – equity ratio = Total debt/Total equity
If the debt – equity ratio equals 1.0, it means that total debt = total equity
Total debt ratio = Total debt/Total assets
Because total debt = total equity, total assets, which equals the sum of total debt and total
equity, can be represented as total debt + total debt, or:
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Total assets = 2 x Total debt
Total debt ratio = Total debt/2 x Total debt = ½ = 0.5

7) The cash coverage ratio directly measures the ability of a company to meet its
obligation to pay:
A) an invoice to a supplier.
B) wages to an employee.
C) interest to a lender.
D) principal to a lender.
E) a dividend to a shareholder.

Explanation: Cash coverage ratio = Total cash/Interest expense

This ratio assesses how well a company can cover its interest expenses with its available cash
and cash flow from operations.

8) 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

Explanation: The asset turnover ratio measures the value of a company's sales or revenues
relative to the value of its assets. The asset turnover ratio indicates the efficiency with which a
company is using its assets to generate revenue.
The higher the asset turnover ratio, the more efficient a company is. Conversely, if a company
has a low asset turnover ratio, it means it is not efficiently using its assets to create revenue.
Assets turnover ratio = Net sales/Average total assets

9) If a company produces a return on assets of 14 percent and also a return on equity of

14 percent, then 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.

Explanation: The equity multiplier is a financial ratio that measures a company's financial
leverage. It indicates how much of a company's assets are financed by its shareholders' equity.
A higher equity multiplier suggests that a larger portion of assets is financed through debt.
Equity multiplier = Total assets/Total equity = ROE/ROA
If both ROA and ROE are equal (14% in this case), it implies that the equity multiplier is 1.0.
This indicates that the company is entirely financed by equity, with no debt.
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10) Which one of the following will decrease if a firm can decrease its operating costs, all
else constant?
A) Return on equity
B) Return on assets
C) Profit margin
D) Total asset turnover
E) Price-earnings ratio

Explanation: If a firm can decrease its operating costs, all else constant, the following financial
metrics are affected:
- Return on equity (ROE): This is calculated as Net Income / Shareholder's Equity.
Decreasing operating costs will increase net income, which typically increases ROE,
not decreases it.
- Return on assets (ROA): This is calculated as Net Income / Total Assets. With lower
operating costs, net income increases, which usually increases ROA, not decreases it.
- Profit margin: This is calculated as Net Income / Sales. Lower operating costs increase
net income while sales remain the same, which typically increases the profit margin,
not decreases it.
- Total asset turnover: This is calculated as Sales / Total Assets. Decreasing operating
costs does not directly affect sales or total assets, so this ratio would generally not
decrease as a result of decreased operating costs.
- Price-earnings ratio (P/E ratio): This is calculated as Stock Price / Earnings Per Share
(EPS). Although decreased operating costs lead to increased net income (and possibly
higher EPS), the P/E ratio could decrease if the stock price does not increase
proportionally or if investors expect less growth in the future.
Among the choices, E) Price-earnings ratio is the one that could potentially decrease if a firm
decreases its operating costs, due to possible effects on stock price expectations.

11) Al's has a price-earnings ratio of 18.5. Ben's also has a price-earnings ratio of 18.5.
Which one of the following statements must be true if Al's has a higher PEG ratio than
Ben's?
A) Al's has more net income than Ben's.
B) Ben's is increasing its earnings at a faster rate than Al's.
C) Al's has a higher market value per share than does Ben's.
D) Ben's has a lower market-to-book ratio than Al's.
E) Al's has a higher earnings growth rate than Ben's.

Explanation:
Price-Earnings (P/E) Ratio: This is calculated as the market price per share divided by the
earnings per share (EPS). It indicates how much investors are willing to pay per dollar of
earnings.
Price-Earnings-Growth (PEG) Ratio: This is calculated as the P/E ratio divided by the earnings
growth rate. It provides insight into the valuation of a company's stock in relation to its
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earnings growth.
Given that both Al's and Ben's have the same P/E ratio of 18.5, the PEG ratio formula is:
PEG Ratio = P/E Ratio/Earnings Growth Rate
Since Al's has a higher PEG ratio than Ben's, and the P/E ratios are the same, it means that the
earnings growth rate of Al's must be lower than that of Ben's. This is because a higher PEG
ratio implies a lower growth rate when the P/E ratio is constant.

12) Mortgage lenders probably have the most interest in the ________ ratios.
A) return on assets and profit margin
B) long-term debt and times interest earned
C) price-earnings and debt-equity
D) market-to-book and times interest earned
E) return on equity and price-earnings

Explanation: Mortgage lenders are primarily concerned with the ability of borrowers to meet
their debt obligations over the long term. Therefore, they focus on ratios that assess the
borrower’s ability to manage and repay debt.
Among the options given:
A) Return on assets and profit margin: These ratios are more relevant to assessing a company's
profitability and efficiency rather than its debt repayment capability.
B) Long-term debt and times interest earned: These ratios are directly related to a company's
ability to manage long-term debt and cover interest payments, which are crucial for mortgage
lenders who are interested in understanding the borrower's ability to service long-term debt.
C) Price-earnings and debt-equity: The price-earnings ratio is more relevant to investors and
stock valuation, while the debt-equity ratio relates to leverage and debt levels.
D) Market-to-book and times interest earned: The market-to-book ratio is more relevant to
valuation, while times interest earned is relevant to debt servicing.
E) Return on equity and price-earnings: These ratios are more focused on profitability and
valuation rather than debt management.
Therefore, the ratios that mortgage lenders would be most interested in are:
B) Long-term debt and times interest earned
These ratios help assess how well a borrower can manage and service their long-term debt,
which is a critical consideration for lenders.

13) DL Farms currently has $600 in debt for every $1,000 in equity. Assume the company
uses some of its cash to decrease its debt while maintaining its current equity and net
income. Which one of the following will decrease as a result of this action?
A) Equity multiplier
B) Total asset turnover
C) Profit margin
D) Return on assets
E) Return on equity

Explanation: The effects on each of the given metrics:

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 - Equity Multiplier: This is calculated as total assets divided by total equity. It can also be
expressed as 1 + Debt-to-Equity Ratio. When debt decreases and equity remains the
same, the equity multiplier will decrease because total assets (which include debt) will
be lower relative to equity.
- Total Asset Turnover: This ratio is calculated as net sales divided by total assets. Since
the reduction in debt means a decrease in total assets (assuming the cash used to pay off
debt reduces assets), the impact on total asset turnover will depend on whether net sales
remain constant or change.
- Profit Margin: This is net income divided by net sales. Since net income and net sales
are not directly affected by the change in debt, the profit margin should remain constant
if net income and sales stay the same.
- Return on Assets (ROA): This is net income divided by total assets. With a decrease in
total assets (due to paying down debt) and assuming net income remains the same, the
ROA will likely increase because the denominator (total assets) is smaller.
- Return on Equity (ROE): This is net income divided by total equity. Since equity is
unchanged and net income remains the same, ROE should stay constant, assuming no
other changes in the business operations.

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

15) At the beginning of the year, Brick Makers had cash of $183, accounts receivable of
$392, accounts payable of $463, and inventory of $714. At year end, cash was $167,
accounts payables was $447, inventory was $682, and accounts receivable was $409. What
is the amount of the net source or use of cash by working capital accounts for the year?
A) Net use of $16 cash
B) Net use of $17 cash
C) Net source of $17 cash
D) Net source of $15 cash
E) Net use of $15 cash

Change in NWC = Ending NWC – Beginning NWC = ($167 + 682 + 409 – 447) – ($183 + 392
+ 714 – 463) = -$15
Or = Change in CA – Change in CL = (167 – 183 + 409 – 392 + 682 – 714) – (447 – 463)
Decrease in NWC is a source of cash.

16) Lani's generated net income of $911, depreciation expense was $47, and dividends
paid were $25. Accounts payables increased by $15, accounts receivables increased by
$28, inventory decreased by $14, and net fixed assets decreased by $8. There was no
interest expense. What was the net cash flow from operating activity?
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A) $776
B) $865
C) $959
D) $922
E) $985

CF from operations = Net income + Non-cash items + Changes in working capital

Net cash flow from operating activities = Net income + Depreciation +
Increase in accounts payable − Increase in accounts receivable + Decrease in inventory
= $911 + 47 + 15 – 28 + 14 = $959

17) Williamsburg Market is an all-equity firm that has net income of $96,200,
depreciation expense of $6,300, and an increase in net working capital of $2,800. What is
the amount of the net cash from operating activity?
A) $91,300
B) $99,700
C) $93,400
D) $105,300
E) $113,700

Net cash from operating activities = $96,200 + 6,300 – 2,800 = $99,700

18) The accounts payable of a company changed from $136,100 to $104,300 over the
course of a year. This change represents a:
A) use of $31,800 of cash as investment activity.
B) source of $31,800 of cash as an operating activity.
C) source of $31,800 of cash as a financing activity.
D) source of $31,800 of cash as an investment activity.
E) use of $31,800 of cash as an operating activity.

Explanation: A decrease in accounts payables is a use of cash as operating activity.

19) Oil Creek Auto has sales of $3,340, net income of $274, net fixed assets of $2,600, and
current assets of $920. The firm has $430 in inventory. What is the common-size
statement value of inventory?
A) 12.22 percent
B) 44.16 percent
C) 16.54 percent
D) 13.36 percent
E) 46.74 percent

Total assets = 2,600 + 920 = 3,520

Common-size statement value of inventory = 430/3,520 = 12.22%

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20) Duke's Garage has cash of $68, accounts receivable of $142, accounts payable of $235,
and inventory of $318. What is the value of the quick ratio?
A) 2.25
B) .53
C) .71
D) .89
E) 1.35

Quick ratio = (Current assets – Inventory)/Current liabilities

= (68 + 142 + 318 – 318)/235 = 0.89

21) Uptown Men's Wear has accounts payable of $2,214, inventory of $7,950, cash of
$1,263, fixed assets of $8,400, accounts receivable of $3,907, and long-term debt of $4,200.
What is the value of the net working capital to total assets ratio?
A) .31
B) .42
C) .47
D) .51
E) .56

NWC to total assets ratio = (CA – CL)/TA

CA – CL = 7,950 + 1,263 + 3,907 – 2,214 = 10,906
TA = CA + FA = 7,950 + 1,263 + 3,907 + 8,400 = 21,520
=> NWC to total assets ratio = 10,906/21,520 = 0.51

22) DJ's has total assets of $310,100 and net fixed assets of $168,500. The average daily
operating costs are $2,980. What is the value of the interval measure?
A) 31.47 days
B) 47.52 days
C) 56.22 days
D) 68.05 days
E) 104.62 days

Interval measure = Current assets/Average daily operating costs

= (310,100 – 168,500)/2,980 = 47.52 days

More: The interval measure is a liquidity ratio that allows a company to understand the money
it needs for its operations. It also helps in understanding how much funds a company needs for
operations to help in the long-term survival of the company.
The interval measure ratio helps a business get an idea of how long it would survive using the
available working capital. Or, we can say this ratio helps determine the number of days a firm
can operate using just the funds it has on its hands without accessing the long-term assets.
Because in the short term, those long-term assets may not be easily converted to cash.

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23) Corner Books has a debt-equity ratio of .57. What is the total debt ratio?
A) .36
B) .30
C) .44
D) 2.27
E) 2.75

Total debt ratio = Total debt/Total assets = 0.57/(1+0.57) = 0.36

24) SS Stores has total debt of $4,910 and a debt-equity ratio of 0.52. What is the value of
the total assets?
A) $16,128.05
B) $7,253.40
C) $9,571.95
D) $11,034.00
E) $14,352.31

Total debt ratio = Total debt/Total assets = 0.52/(1+0.52) = 0.3421

=> Total assets = Total debt/0.34 = 4,910/0.34 = 14,352
Another way:
4,910/(Total assets – 4,910) = 0.52

25) JK Motors has sales of $96,400, costs of $53,800, interest paid of $2,800, and
depreciation of $7,100. The tax rate is 21 percent. What is the value of the cash coverage
ratio?
A) 15.21
B) 12.14
C) 17.27
D) 23.41
E) 12.68

Cash coverage ratio = (EBIT + Depreciation)/Interest expense

EBIT = 96,400 – 53,800 – 7,100 = 35,500
Cash coverage ratio = (35,500 + 7,100)/2,800 = 15.21

26) The Up-Towner has sales of $913,400, costs of goods sold of $579,300, inventory of
$123,900, and accounts receivable of $78,900. How many days, on average, does it take
the firm to sell its inventory assuming that all sales are on credit?
A) 74.19 days
B) 84.69 days
C) 78.07 days
D) 96.46 days
E) 71.01 days

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Inventory turnover ratio = COGS/Inventory
= 579,300/123,900 = 4.68
Days to sell inventory = 365/4.68 = 78.07 days

27) Flo's Flowers has accounts receivable of $4,511, inventory of $1,810, sales of $138,609,
and cost of goods sold of $64,003. How many days does it take the firm to sell its
inventory and collect the payment on the sale assuming that all sales are on credit?
A) 11.88 days
B) 22.20 days
C) 16.23 days
D) 14.50 days
E) 18.67 days

Inventory turnover ratio = 64,003/1,810 = 35.36

Acc receivable turnover ratio = Sales/Receivables = 138,609/4,511 = 30.802
Days to sell inventory = 365/35.36 = 10.32 days
Days to collect the payment = 365/30.802 = 11.85 days
=> Total = 22.2 days

28) TJ's has annual sales of $813,200, total debt of $171,000, total equity of $396,000, and
a profit margin of 5.78 percent. What is the return on assets?
A) 8.29 percent
B) 6.48 percent
C) 9.94 percent
D) 7.78 percent
E) 8.02 percent

Net income = Profit margin x Sales = 5.78% x 813,200 = 47,002.96

Total assets = 171,000 + 396,000 = 567,000
ROA = 47,002.96/567,000 = 8.29%

29) Hungry Lunch has net income of $73,402, a price-earnings ratio of 13.7, and earnings
per share of $.43. How many shares of stock are outstanding?
A) 13,520
B) 12,460
C) 165,745
D) 171,308
E) 170,702

Number of shares outstanding = Net income/EPS

= 73,402/0.43 = 170,702

30) Nielsen's has inventory of $29,406, accounts receivable of $46,215, net working capital
of $4,507, and accounts payable of $48,919. What is the quick ratio?
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A) 1.55
B) .49
C) 1.32
D) .94
E) .92

Current assets = Current liabilities + NWC

= 48,919 + 4,507 = 53,426
Quick ratio = (53,426 – 29,406)/48,919 = 0.49

31) The Strong Box has sales of $859,700, cost of goods sold of $648,200, net income of
$93,100, and accounts receivable of $102,300. How many days of sales are in receivables?
A) 57.60 days
B) 40.32 days
C) 54.53 days
D) 29.41 days
E) 43.43 days

Acc receivable turnover ratio = 859,700/102,300 = 8.4037

Days of sales in receivable = 365/8.4037 = 43.43 days

32) Corner Supply has a current accounts receivable balance of $246,000. Credit sales for
the year just ended were $2,430,000. How many days on average did it take for credit
customers to pay off their accounts during this past year?
A) 44.29 days
B) 55.01 days
C) 55.50 days
D) 36.95 days
E) 41.00 days

Acc receivable turnover ratio = Sales/Acc receivable = 2,430,000/246,000 = 9.878

Days to pay off = 365/9.878 = 36.95 days

33) BL Industries has ending inventory of $302,800, annual sales of $2.33 million, and
annual cost of goods sold of $1.41 million. On average, how long did a unit of inventory
sit on the shelf before it was sold?
A) 47.43 days
B) 22.18 days
C) 78.38 days
D) 61.78 days
E) 83.13 days

Inventory turnover ratio = 1,410,000/302,800 = 4.657

Days to sell inventory = 365/4.657 = 78.38 days
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34) Billings Inc. has net income of $161,000, a profit margin of 7.6 percent, and an
accounts receivable balance of $127,100. Assume that 66 percent of sales are on credit.
What is the days' sales in receivables?
A) 21.90 days
B) 27.56 days
C) 33.18 days
D) 35.04 days
E) 36.19 days

Sales = Net income/Profit margin = 161,000/7.6% = 2,118,421.053

Acc receivable turnover ratio = 2,118,421.053/127,100 = 16.67
Days’ sales in receivables = 365/16.67 = 21.9 days

35) Stone Walls has a long-term debt ratio of .6 and a current ratio of 1.2. Current
liabilities are $800, sales are $7,800, the profit margin is 6.5 percent and return on equity
is 15.5 percent. What is the amount of the firm's net fixed assets?
A) $8,880.15
B) $8,017.43
C) $7,666.67
D) $5,848.15
E) $8,977.43

Current assets = CL x Current ratio = 800 x 1.2 = 960

Net income = Sales x Profit margin = 7,800 x 6.5% = 507
Equity = Net income/ROE = 507/15.5% = 3,270.97
Long-term debt ratio = Long-term debt/Total assets
= Long-term debt/(Long-term debt + CL (?) + Equity)
= Long-term debt/(Long-term debt + 3,270.97)
=> Long-term debt = 4,906.46
Total assets = 4,906.46 + 800 + 3,270.97 = 8,977.43
Net fixed assets = 8,977.43 – 960 = 8,017.43

36) The Docksider has net income for the most recent year of $24,650 and a combined tax
rate of 24 percent. The firm paid $1,800 in total interest expense and deducted $2,900 in
depreciation expense. What was the cash coverage ratio for the year?
A) 20.48 times
B) 11.48 times
C) 19.39 times
D) 20.63 times
E) 13.69 times

EBT = 24,650/(1-24%) = 32,434.21

EBIT + Dep = 32,434.21 + 1,800 + 2,900 = 37,134.21
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Cash coverage ratio = 37,134.21/1,800 = 20.63 times

37) Beach Wear has current liabilities of $350,000, a quick ratio of 1.65, inventory
turnover of 4.7, and a current ratio of 2.9. What is the cost of goods sold?
A) $1,980,500
B) $1,760,750
C) $1,950,000
D) $2,056,250
E) $1,560,000

Current assets = CL x Current ratio = 350,000 x 2.9 = 1,015,000

(CA – Inventory)/CL = 1.65 => Inventory = 437,500
COGS = Inventory x Inventory turnover
= 437,500 x 4.7 = 2,056,250

38.Cooper Inc's latest EPS was $4.00, its book value per share was $20.00, it had 200,000
shares outstanding, and its debt ratio was 40%. How much debt was outstanding?
A) $2,333,333
B) $2,666,667
C) $3,000,000
D) $3,333,333
E) $3,666,667

Book value of equity = 20 x 200,000 = 4,000,000

Book value of debt = 4,000,000/60% x 40% = 2,666,667

39. Rangala Corp sells on terms that allow customers 30 days to pay for merchandise. Its
sales last year were $450,000, and its year-end receivables were $45,000. If its DSO is less
than the 30 day credit period, then customers are paying on time. Otherwise, they are
paying late. By how much are customers paying early or late? Base your answer on this
equation: DSO - Credit Period = days early or late, and use a 365 day year when
calculating the DSO. A positive answer indicates late payments.
A) 6.50
B) 6.75
C) 7.00
D) 7.25
E) 7.50

Days sales outstanding (DSO) measures the average number of days it takes for a company to
collect cash from credit purchases.
DSO = Receivables/Average daily sales
= Receivables/(Revenue/365 days)
= Receivables x 365 days/Revenue
= 45,000 x 365/450,000 = 36.5
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DSO – Credit period = 36.5 – 30 = 6.5 > 0 => late payments

40. Cooper Inc. expects sales next year to be $300,000 and operating costs to be $270,000.
The company will have $200,000 of assets, and under the current plan they will be financed
with 30% debt and 70% common equity. The interest rate on the debt will be 10%, but the
TIE ratio must be kept at 4.0 or more. The firm's tax rate is 40%. The new CFO wants to
see how the ROE would be affected if the firm increased its debt ratio to the maximum
consistent with the required TIE ratio. Assume that sales, operating costs, assets, the interest
rate, and the tax rate would all remain constant. By how much would the ROE change in
response to the change in the capital structure?
A) 0.33%
B) 0.51%
C) 0.82%
D) 1.17%
E) 1.39%

EBIT=Sales−Operating Costs=300,000−270,000=30,000
The TIE ratio is defined as: TIE=EBIT/Interest Expense
Given that the TIE ratio must be at least 4.0:
4.0=30,000/Interest Expense
So, the maximum interest expense can be calculated as:
Interest Expense=30,000/4.0=7,500

Since the interest rate on the debt is 10%, we can find the maximum debt:
Debt=Interest Expense/Interest Rate
=7,500/0.10=75,000

Total assets are $200,000, and with the new debt amount of $75,000, the equity will be:
Equity=Total Assets−Debt=200,000−75,000=125,000

The new interest expense remains $7,500 (as calculated above). Now, we need to calculate net
income:
Taxable Income=EBIT−Interest Expense=30,000−7,500=22,500
Taxes=Taxable Income×Tax Rate=22,500×0.40=9,000
Net Income=Taxable Income−Taxes=22,500−9,000=13,500
ROE=Net Income/Equity=13,500/125,000=0.108=10.8%

Under the old capital structure, the debt was 30% of $200,000:
Old Debt=0.30×200,000=60,000
Thus, the old equity is:
Old Equity=200,000−60,000=140,000
Calculate the old interest expense:
Old Interest Expense=60,000×0.10=6,000
Old Taxable Income=30,000−6,000=24,000
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Old Taxes=24,000×0.40=9,600Old Taxes=24,000×0.40=9,600
Old Net Income=24,000−9,600=14,400Old Net Income=24,000−9,600=14,400
Old ROE=14,400140,000=0.102857≈10.29%Old ROE=140,00014,400=0.102857≈10.29%

The the change in ROE:

Change in ROE=New ROE−Old ROE=10.8%−10.29%≈0.51%

41. Cleveland Corporation has 100,000 shares of common stock outstanding, its net income
is $750,000, and its P/E is 8. What is the company’s stock price?
A) $20.00
B) $30.00
C) $40.00
D) $50.00
E) $60.00

EPS = 750,000/100,000 = 7.5

Stock price = 7.5 x 8 = 60

42. Iken Berry Farms has $5 million in current assets, $3 million in current liabilities, and
its initial inventory level is $1 million. The company plans to increase its inventory, funded
by additional short-term debt (notes payable). Assume that the value of the remaining
current assets will not change. The company’s bond covenants require a current ratio
greater than or equal to 1.5. How much inventory can be purchased before the covenants
are violated?
A) $0.50 million
B) $1.00 million
C) $1.33 million
D) $1.66 million
E) $2.33 million

43. Aurillo Equipment Company (AEC) projected next year’s ROE to be 6%. However,
the firm can increase its ROE by refinancing some high interest bonds currently
outstanding. The firm’s total debt will remain at $200,000 and the debt ratio will hold
constant at 80%, but the interest rate on the refinanced debt will be 10%. The rate on the
old debt is 14%. Refinancing will not affect sales, which are projected to be $300,000. The
basic earning power will be 11% and the firm’s tax rate is 40%. If AEC refinances, what
will be its projected new ROE?
A) 3.0%
B) 8.2%
C) 10.0%
D) 15.6%
E) 18.7%

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