Fin 534: week 2 homework assignment (chapter 3) (latest update)

1. Which of the following statements is CORRECT?

a. The ratio of long-term debt to total capital is more likely to experience seasonal 

fluctuations than is either the DSO or the inventory turnover ratio.

b. If two firms have the same ROA, the firm with the most debt can be expected to have the

lower ROE.

c. An increase in the DSO, other things held constant, could be expected to increase the 

total assets turnover ratio.

d. An increase in the DSO, other things held constant, could be expected to increase the

ROE.

e. An increase in a firm’s debt ratio, with no changes in its sales or operating costs, could be

expected to lower the profit margin.

 

2. Companies HD and LD have the same tax rate, sales, total assets, and basic earning power.

Both companies have positive net incomes. Company HD has a higher debt ratio and, therefore, 

a higher interest expense. Which of the following statements is CORRECT?

a. Company HD has a lower equity multiplier.

b. Company HD has more net income. 

c. Company HD pays more in taxes.

d. Company HD has a lower ROE.

e. Company HD has a lower times interest earned (TIE) ratio.

3. Companies HD and LD have the same total assets, sales, operating costs, and tax rates, and 

they pay the same interest rate on their debt. However, company HD has a higher debt ratio. 

Which of the following statements is CORRECT?

a. Given this information, LD must have the higher ROE.

b. Company LD has a higher basic earning power ratio (BEP). 

c. Company HD has a higher basic earning power ratio (BEP).

d. If the interest rate the companies pay on their debt is more than their basic earning power

(BEP), then Company HD will have the higher ROE.

e. If the interest rate the companies pay on their debt is less than their basic earning power

(BEP), then Company HD will have the higher ROE.

 

4. MuscarellaInc. has the following balancesheet and incomestatementdata:

Cash $ 14,000 Accounts payable $ 42,000

Receivables 70,000 Other current liabilities 28,000

Inventories 210,000 Total CL $ 70,000

Total CA $294,000 Long-term debt 70,000

Net fixed assets 126,000 Common equity 280,000

Total assets $420,000 Total liab. and equity $420,000

Sales $280,000

Net income $ 21,000FIN 534 – Homework Chapter 3

 

 

The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the 

current ratio to equal the industry average, 2.70, without affecting either sales or net income. 

Assuming that inventories are sold off and not replaced to get the current ratio to the target level, 

and that the funds generated are used to buy back common stock at book value, by how much 

would the ROE change?

a. 4.28%

b. 4.50%

c. 4.73%

d. 4.96%

e. 5.21%

 

5. Quigley Inc. is considering two financial plans for the coming year. Management expects sales to 

be $301,770, operating costs to be $266,545, assets to be $200,000, and its tax rate to be 35%. 

Under Plan A it would use 25% debt and 75% common equity. The interest rate on the debt 

would be 8.8%, but the TIE ratio would have to be kept at 4.00 or more. Under Plan B the 

maximum debt that met the TIE constraint would be employed. Assuming 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. 3.83%

b. 4.02%

c. 4.22%

d. 4.43%

e. 4.65%

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