Exam 8: Analysis of Financial Statements

Aurillo Equipment Company (AEC) projected that its ROE for next year would be just 6 percent. However, the financial staff has determined that 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 percent, but the interest rate on the refinanced debt will be 10 percent. The rate on the old debt is 14 percent. Refinancing will not affect sales which are projected to be $300,000. EBIT will be 11 percent of sales, and the firm's tax rate is 40 percent. If AEC refinances its high interest bonds, what will be its projected new ROE?

Stennett Corp.'s CFO has proposed that the company issue new debt and use the proceeds to buy back common stock. Which of the following are likely to occur if this proposal is adopted? (Assume that the proposal would have no effect on the company's operating earnings.)

Profitability ratios show the combined effects of liquidity, asset management, and debt management on operations.

The current ratio and inventory turnover ratio measure the liquidity of a firm. The current ratio measures the relationship of a firm's current assets to its current liabilities and the inventory turnover ratio measures how rapidly a firm turns its inventory back into a "quick" asset or cash.

Company A has sales of $1,000, assets of $500, a debt ratio of 30 percent, and an ROE of 15 percent. Company B has the same sales, assets, and net income, but its ROE is 30 percent. What is B's debt ratio? (Hint: Begin by looking at the Du Pont equation.)

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

Company R and Company S each have the same operating income (EBIT) and basic earning power (BEP) ratio. Company S, however, has a lower times-interest-earned (TIE) ratio. Which of the following statements is most correct?

Which of the following statements is most correct?

Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10 percent annually on its bank loan. Alumbat's annual sales are $3,200,000; its average tax rate is 40 percent; and its net profit margin on sales is 6 percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy will result. What is Alumbat's current TIE ratio?

The fixed charge coverage ratio recognizes that firms often lease equipment under contract and thus, some firms must meet more than just their scheduled interest payments out of earnings. Therefore, the fixed charge coverage is more inclusive than the TIE ratio.

Huxtable Medical's CFO recently estimated that the company's EVA for the past year was zero. The company's cost of equity capital is 14 percent, its cost of debt is 8 percent, and its debt ratio is 40 percent. Which of the following statements is most correct?

Humphrey Hotels' operating income (EBIT) is $40 million. The company's times-interest-earned (TIE) ratio is 8.0, its tax rate is 40 percent, and its basic earning power (BEP) ratio is 10 percent. What is the company's return on assets (ROA)?

Which of the following statements is most correct?

A decline in the inventory turnover ratio suggests that the firm's liquidity position is improving.

Van Buren Company has a current ratio = 1.9. Which of the following actions will increase the company's current ratio?

Ratio analysis involves a comparison of the relationships between financial statement accounts so as to analyze the financial position and strength of a firm.

Which of the following alternatives could potentially result in a net increase in a company's free cash flow for the current year?

A firm has total interest charges of $10,000 per year, sales of $1 million, a tax rate of 40 percent, and a net profit margin of 6 percent. What is the firm's times-interest-earned ratio?

Which of the following statements is correct?

If a company increases its debt ratio, but leaves its operating income (EBIT) and total assets unchanged, which of the following is most likely to occur: