Bus 320: Quiz 1 Solutions – White Version

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True/False Questions: Circle the correct response. (2 points each)

1. T F If a sole proprietorship fails, the owner may lose whatever was invested in the business, but the owner’s personal assets are not at risk.
2. T F A company that has an increase in its return on assets, but no noticeable change in asset turnover, has most likely experienced an increase in financial leverage.
3. T F If a firm is not operating at full capacity, assuming assets grow with sales will likely overstate the firms funding needs.
4. T F A firm with many growth opportunities would likely have a book value less than its market value.
5. T F Joel (the owner) at Dave’s Cosmic Subs decides to get a diamond-encrusted sandwich toaster. This would be an example of an indirect agency cost.
6. T F A grocery store will likely have a higher days’ sales in inventory than a car dealer.
7. T F A Stakeholder is a group or individual who benefits from or is harmed by corporate actions.
8. T F Many software firms capitalize (treat as an asset) the development costs associated with creating new software products. One motivation for doing this is because it increases accounting earnings.
9. T F If a firm sells part of its inventory at a loss, its quick ratio will increase.
10. T F A firm wants to boost sales and reduce inventory so they lower the price of
their product. All else equal, this will likely lower their profit margin and

decrease total asset turnover.
11. T F Tech firms tend to have higher market-to-book ratios than brick-and-mortar firms.
12. T F If a firm uses accounts payable to purchase a new fixed asset, this will make the current ratio move away from one.
13. T F Manufacturing firms will likely have smaller differences between their Times

Interest Earned and Cash Coverage Ratios than consulting firms.
14. T F In the secondary market, investors trade previously-issued securities without the involvement of the issuing companies.
15. T F If a firm’s growth in sales is higher than its sustainable growth rate, it will either need to raise money from equity or accept a higher level of financial risk (leverage).
16. T F If a firm pays off accounts payable using cash, this will result in a decrease in its net working capital.
17. T F It’s uncommon for firms to have P/E Ratios above 200.
18. T F Initial Public Offerings take place in the primary market.
19. T F For firms with no debt, the sustainable growth rate and the internal growth rate will both be zero.
20. T F You are interested in purchasing stock in a publicly traded company. You (or your broker) would most likely purchase the shares in the primary market.

Multiple Choice Questions: Circle the correct response. (4 points each)

21.

A firm has a book value of assets of $117 billion, 10.3 billion shares outstanding, and a market price of $38 per share. The firm has $16 billion in cash, and total debt equal to $47 billion. What is the firm’s market to book ratio?

  1. a.               0.18 b.               0.30
  1. c.                 3.35 d.                 5.59 e.                 6.48 f.                 7.25

22.

A firm has a profit margin of 13% and return on equity equal to 27%. The firm’s debt to equity ratio is 0.72, and its total assets are $43,940. Compute the firm’s level of sales.

a. $ 15,232.53
b. $ 36,388.83
c. $ 53,058.14
d. $ 78,988.56
  1. 23. A firm’s ROE last year was 8%. A new plan calls for a Total Debt Ratio of 40%, which will result in interest charges of $10,000 per year. Management projects an EBIT of $24,000 on Sales of $280,000 and it expects to have a Total Asset Turnover ratio of 1.8. Under these conditions, the average tax rate will be 34%. What will the ROE be this year?
  1. a) 3.06% b) 5.94% c) 9.00% d) 9.90% e) 15.00% f) 31.43%

24.

This year, a firm had earnings per share of $8 and dividends per share of $2. The addition to retained earnings was $12 million during the year, while book value of equity per share at year-end was $40. If year-end total debt was $120 million, and no new common stock was issued during the year, what was the company’s year-end total debt ratio?

  1. a.       0.47 b.       0.54 c.       0.57 d.       0.60 e.       0.72 f.       0.75 g.     0.87

25.

Highland Bakery maintains an inventory of flour worth $644. It has sales of $164,000 and a total bill for flour over the course of the year of $16,744. How old on average is the flour in the bread it sells its customers?

  1. a.     14 days b.     16 days c.     18 days d.     20 days
  1. 22 days f.     24 days g.     26 day
  1. 26. (20 points) The managers of Icona Inc. have made the following predictions for 2014.
  • Sales will grow at a rate of 32% during 2014
  • Operating costs and cash balances will also grow with sales.
  • They would like to manage their inventory more efficiently by reducing day’s sales in inventory to 180 (use a 360-day year for your calculation)
  • A purchase of $28,800 in new fixed assets are required to accomodate the growth in sales.
  • Accounts payable and Accounts Receivable will grow with sales
  • The interest rate on short-term debt is 10% and the interest rate on long-term debt is 12%. The tax rate is 34%.
  • The managers would like dividends to increase by 8% relative to the previous year.
  • The managers prefer new external financing to come from Notes Payable, then Bonds if necessary, and then Equity as a last resort. Their bankers have insisted that for 2014 the current ratio not fall below 1.6 and the total debt ratio not exceed 0.46 (assume these Prepare Pro Forma Statements for 2014. Round to penni
  1. 27. (14 points) ABC Tech Corp has 6.5 billion shares outstanding and a share price of $1 The company is considering developing a new software product in-house at a cost of $500 million. Alternatively, the firm can acquire a firm that already has the technology for $900 million worth (at the current price) of ABC stock. Suppose that absent the expense of the new technology, ABC will have EPS of $0.80.
  1. a) Suppose the firm develops the product in house. What impact would the development cost have on the ABC’s EPS? Assume all costs are incurred this year and are treated as R&D expense; ABC’s tax rate is 35%, and the number of shares outstanding is unchanged.
  1. b) Suppose ABC does not develop the product but instead acquires the techn What effect would the acquisition have on ABC’s EPS this year? Note that the acquisition expenses do not appear on the income statement, and assume the acquired firm has no revenues or expenses of its own, so the only effect on EPS is due to the change in number of shares outstanding.
  1. c) Which method of acquiring the technology has smaller impact on earnings? Is this method cheaper? Explain (one or two sentences is fine).
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