Multiple Choice

1. Which of the following statements is CORRECT?

a. If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses.
b. A firm's use of debt will have no effect on its profit margin on sales.
c. If two firms differ only in their use of debt--i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates--but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.
d. The debt ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable.
e. If two firms differ only in their use of debt--i.e., they have identical assets, sales, operating costs, and tax rates--but one firm has a higher debt ratio, the firm that uses more debt will have a higher profit margin on sales.

2. HD Corp. and LD Corp. have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, HD uses more debt than LD. Which of the following statements is CORRECT?

a. Without more information, we cannot tell if HD or LD would have a higher or lower net income.
b. HD would have the lower equity multiplier for use in the DU Pont equation.
c. HD would have to pay more in income taxes.
d. HD would have the lower net income as shown on the income statement.
e. HD would have the higher net income as shown on the income statement.

3. Which of the following statements is CORRECT?

a. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be the same.
b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.
c. If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price earnings ratio.
d. If Firm X's P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and also to be expected to grow at a faster rate.
e. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same.

4. Companies HD and LD are both profitable, and they have the same total assets (TA), Sales (s), return on assets (ROA), and profit margin (PM). However, Company HD has the higher debt ratio. Which of the following statements is CORRECT?

a. Company HD has a lower total assets turnover than Company LD.
b. Company HD has a lower equity multiplier than Company LD
c. Company HD has a higher Fixed assets turnover than Company B.
d. Company HD has a higher ROE than Company LD.
e. Company HD has a lower operating income (EBIT) than Company LD.

5. Other things held constant, which of the following alternatives would increase a company's cash flow for the current year?

a. Increase the number of years over which fixed assets are depreciated for tax purposes.
b. Pay down the accounts payables.
c. Reduce the days' sales outstanding (DSO) without affecting sales or operating costs.
d. Pay workers more frequently to decrease the accrued wages balance.
e. Reduce the inventory turnover ratio without affecting sales or operating costs.

6. 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.

7. Taggart Technologies is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Taggart pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?

a. The ROA will decline
b. Taxable income will decrease.
c. The tax bill will increase.
d. Net income will decrease.
e. The times interest earned ratio will decrease.