Finance Problems
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1. Why is interest expense said to cost the firm substantially less than the actual expense, while dividends cost it 100 percent of the outlay?
2. If the accounts receivable turnover ratio is decreasing, what will be happening to the average collection period?
3. Griffey Junior Wear, Inc. has $800,000 in assets and $200,000 of debt. It reports net income of $100,000.
a. What is the return on assets?
b. What is the return on stockholders' equity?
4. How would you define efficient security markets?
5. Why does float exist and what effect do electronic funds transfer systems have on float?
6. Big Co., Inc.
(in millions)
Income Statement 2006 2005
Net Sales $10,500 $9,700
Cost of Sales 8,200 7,500
Selling, administrative, and general
Expenses 900 800
Interest Expense 300 400
Net Income 1,100 1,000
Balance Sheet
Cash $ 1,000 $900
Inventory 2,000 1,500
Accounts Receivables 1,200 1,100
Equipment and Furnishings 5,000 5,100
Total Assets 9,200 8,600
Accounts Payable 1,500 1,200
Long Term Debt 2,500 2,500
Shareholder's Equity 2,200 1,900
a) What is the current ratio for 2006?
b) What is the Quick Ratio for 2006
c) Which year had the highest profit margin?
d) What is the Return on Equity for 2006?
e) Which of the two years had the best inventory turnover?
f) Looking at the balance sheet, name a use of cash from 2005 to 2006. In other words, what was a change that consumed cash?
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1. Why is interest expense said to cost the firm substantially less than the actual expense, while dividends cost it 100 percent of the outlay?
This is because the interest expense is before tax and dividend is after tax. Since the interest expense is before tax, the income before tax decreases and so the tax paid is reduced because of the interest expense. The net cost to the firm is the interest expense - the savings in tax. As an example
EBIT 100
Interest 0
EBT 100
Tax (40%) 40
Net Income 60
If the firm has 30 of interest we get
EBIT 100
Interest 30
EBT 70
Tax (40%) 28
Net income 42
Even with interest expense of 30, the net income decreases only by 18 since 12 is the savings in tax. The actual cost of interest is interest X (1-tax rate).
Dividends are paid from net income and so there is no tax benefit and the cost is 100% of the outlay.
2. If the accounts receivable turnover ratio is decreasing, what will be happening to the average collection period?
Average Collection Period = 365/Accounts Receivable Turnover
If the AR turnover is decreasing, the average collection period will increase
3. ...
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