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31. The following information is available for ABC company: Debt-to-equity 50% Operating liabilities $1,500,000 Interest expense $300,000 Total debt outstanding $3,500,000 Tax rate 40% ROA 5% The difference between the firm’s ROA and its ROE is closest to: A. 2.0%. B. 2.5%. C. 3.6%.

Ans: C. Debt-to-equity==0.5 and debt= $3,500,000 Then the equity= $7,000,000 Total assets= operating liabilities +debt + equity                    =$1,500,000 + 3,500,000 + 7,000,000                    =$12,000,000 ROA==0.05 So NI= $12,000,000 x 0.05 = $600,000 ROE===8.6% ROE-ROA=8.6%-5%=3.6%

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32. Sun Group, Inc. (SGI) uses LIFO inventory costing under U.S.GAAP. During fiscal 2012, the company had net sales of $15.0 million. SGI began the year with no inventory and made purchase at a rate of 100,000 units per quarter. The effective corporate tax rate was 40%. Additional information is as follows: SGI 2012 Unit sales price $50/unit SG&A expense 1,300,000 Interest expense 500,000 Inventory purchases Period Unit price Q1 $17 Q2 $21 Q3 $24 Q4 $27 SGI’s net profit margin for 2012 was closest to: A. 24%. B. 31%. C. 40%.

Ans: A. Unite sales: $15,000,000/$50= 300,000 units COGS (LIFO): Units Cost LIFO 100,000 $21 $2,100,000 100,000 24 2,400,000 100,000 27 2,700,000 300,000 $7,200,000 Net profit margin ($000): Sales $15,000 COGS (7,200) Gross margin $7,800 SG7A (1,300) Interest expense (500) Pre-tax income $6,000 Tax @40% (2,400) Net profit (income) $3,600 Net profit margin = $ 3,600 / $15,000 = 24%

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33. An analyst has summarized the following key financial information for a firm: Year 2012 Gross margin 60% Net margin 15% Gross sales $52,000 Net sales 50,000 Interest 3,000 Taxes 5,000 Preferred dividends paid 2,500 Retention rate 50% The EBIT margin for year 2012 is closest to: A. 26.0%. B. 31.0%. C. 42.2%.

Ans: B. The EBIT margin (operating profit margin) is derived from the following: Since net income (NI)= EBIT – interest expense – taxes Then EBIT = NI + interest expense + taxes == The calculation becomes =31.0%

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34. Selected information for a company and the common size data for its industry are provided below. Company (￡) Common Size Industry Data (% of sales) EBIT 76,000 28.0 Pretax profit 66,400 19.6 Net income 44,500 13.1 Sales 400,000 100.0 Total assets 524,488 140.0 Total equity 296,488 74.0 ROE 15% 17.7% Which of the following is most likely a contributor to the company’s inferior ROE compared to that of the industry? The company’s: A. Tax burden ratio. B. Interest burden ratio. C. EBIT margin.

Ans. C. Calculation Company Industry Tax burden ratio Net Inc/EBT 44,500/66,400= 0.67 13.1/19.6=0.67 EBIT margin EBIT/sales 76,000/400,000=0.19 28.0/100=0.28 Interest burden ratio EBT/EBIT 66,400/76,000= 0.87 19.6/28.0=0.70 The company has a higher interest burden ratio but a lower EBIT margin than the industry, and the same tax burden ratio, the lower EBIT margin relative to the industry is the cause of the company’s poor relative performance. EBT: Pretax profit (earnings before tax) Net Inc: Net income

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		Ans. C. Calculation Company Industry Tax burden ratio Net Inc/EBT 44,500/66,400= 0.67 13.1/19.6=0.67 EBIT margin EBIT/sales 76,000/400,000=0.19 28.0/100=0.28 Interest burden ratio EBT/EBIT 66,400/76,000= 0.87 19.6/28.0=0.70 The company has a higher interest burden ratio but a lower EBIT margin than the industry, and the same tax burden ratio, the lower EBIT margin relative to the industry is the cause of the company’s poor relative performance. EBT: Pretax profit (earnings before tax) Net Inc: Net income
35. Given the following information about a company: (all figures in $ millions) 2012 2011 Short-term borrowings $2,240 $5,400 Current portion of long-term interest-bearing debt 2,000 1,200 Long-term interest-bearing debt 12,000 9,000 Total shareholders’ equity 23,250 21,175 EBIT 3,850 3,800 Interest payments 855 837 Operation lease payments 800 800 What is the most appropriate conclusion an analyst can make about the solvency of the company? Solvency has: A. Improved because the debt-to-equity ratio decreased. B. Deteriorated because the debt-to-equity ratio increased. C. Improved because the fixed charge coverage ratio increased.		Ans: A. The debt-to-equity ratio decreased thereby improving solvency; the fixed charge coverage ratio remained the same. 2012 2011 comments debt-to-equity (total debt/equity) =70% =74% Ratio decreased; company has less financial risk; is more solvent. Fixed charge coverage ratio= =2.81 =2.81 No change in FCC ratio

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36. The following information is taken from a company’s annual report (all figures in millions): Total assets $250 Total debt 150 Total equity 100 Net income 25 During the year the Company entered into a 20-year tak-or-pay contract that requires us to purchase a minimum of $0.750 of hydro-electrical power annually, stating next year. The company’s average cost of long-term borrowing is 7%. If an analyst were to include the take-or-pay contract in his analysis, the company’s debt-to-equity ratio and return-on-assets, respectively, will be closest to: A. 1.58; 10.0%. B. 1.65; 9.4%. C. 1.65; 10.0%.

Ans: B. The total sum of the payments should be added to both liabilities and assets. The revised debt-to-equity==1.65. The revised ROA==9.4%.

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37. Selected financial information for a company as of the end of the current year is presented below. Accounts receivable 513,347 Cash and marketable securities $520 Cash ratio 0.03 Current assets $23,100 Daily cash expenditures $277 Gross profit margin 0.28 Inventory turnover 4.7 Number of days of payables 87 Quick ratio 0.80 Revenues $41,500 Total asset turnover 0.82 Total liabilities $44,000 If last year the current ratio, defensive interval, and operating cycle were 1.22, 54 days and 208 days, receptively, which of the following statements is most accurate? The company’s: A. Current ratio has decreased. B. Defensive interval increased. C. Operating cycle has decreased.

Ans: C. Cash ratio= So CL=(Cash + marketable securities) / cash ratio           =$520/0.03           =$17,333 Currentratio==$23,100/$17,333=1.33   (higher: increased from 1.22) DSO ====117 DOH===78 Operating cycle = DSO+DOH=117+78=195 (shorter: decreased from 208) Defensive interval=                                  ==50days (shorter: decreased from 54 days)

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38. To gain insight into what portion of the company’s assets is liquid, an analyst will most likely use: A. the cash ratio. B. the current ratio. C. common-size balance sheets.

Ans: C. A common-size balance sheet expresses all balance sheet accounts as a percentage of total assets. Common-size statements normalize balance sheets and allow the analyst to more easily compare performance across firms and for a single firm over time. Also, common-size analysis is appropriate for quickly viewing certain financial ratios. A and B are incorrect. Both cash ratio and current ratio are liquidity ratios that can be employed by analysts to determine the firm’s ability to pay its short-term liabilities. But they cannot help the analysts to gain insight into what portion of the company’s assets is liquid.

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39. Two manufacturing companies operating in the sale industry have different net fixed asset turnover ratios. The difference most likely occurs because the company with the higher ratio: A. had significantly lower amortization expense for the year. B. was operating with older equipment that had a low cost basis. C. recently invested a substantial amount in new plant and equipment.

Ans: B. A company operating with old, low-cost equipment that is likely to be fully depreciated would tend to have a high fixed asset turnover ratio because average total assets are low. Fixed asset turnover=

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40. A junior analyst wants to understand the underlying components of the DuPont method to better see what changes are driving the changes in ROE. Which of the following items is a direct component of the original (three-part) DuPont equation? A. Asset turnover. B. Gross profit margin. C. Debt-to-equity ratio. A. ating theese  leverage to 1.5, but the increased borrowing costs would reduce the ef

Ans: A. The three-part DuPont approach is as follows: net profit margin x asset turnover x leverage ratio where the leverage ratio is assets-to-equity.