problem 1: The ROE ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher ROE ratios as being less risky and/or more likely to enjoy higher growth in the future.
problem 2: Which of the following statements is CORRECT?
a) The annual report is an internal document prepared by a firm's managers solely for the use of its creditors/lenders.
b) The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and statement of stockholders' equity.
c) Prior to the Enron scandal in the early 2000s, companies would put verbal information in their annual reports, along with the financial statements. That verbal information was often misleading, so today annual reports can contain only quantitative information--audited financial statements.
d) Assets other than cash are expected to produce cash over time, and the amounts of cash they eventually produce should be exactly the same as the amounts at which the assets are carried on the books.
e) The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.
problem 3: Chang Corp. has $375,000 of assets, and it uses only common equity capital (zero debt).
Its sales for the last year were $595,000, and its net income was $25,000. Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15.0%. What profit margin would the firm need in order to achieve the 15% ROE, holding everything else constant?
problem 4: Mantle Corporation is considering two equally risky investments:
- A $5,000 investment in preferred stock that yields 7%.
- A $5,000 investment in a corporate bond that yields 10%.
What is the break-even corporate tax rate that makes the company indifferent between the two investments?
problem 5: Brookman Inc's latest EPS was $2.75, its book value per share was $22.75, it had 315,000 shares outstanding, and its debt/assets ratio was 44%. How much debt was outstanding based on Book Value?
problem 6: Hartzell Inc. had the following data for 2010, in millions: Net income = $600; after-tax operating income [EBIT(1 - T)] = $700; and Total assets = $2,000. Information for 2011 is as follows: Net income = $825; after-tax operating income [EBIT(1 - T)] = $925; and Total assets = $2,500. How much free cash flow did the firm generate during 2011?
problem 7: C. F. Lee Inc. has the following income statement. How much after-tax operating income does the firm have?
EBIT $ 808.00
Interest expense 285.00
EBT $ 523.00
Taxes (35%) 183.05
Net income $ 339.95
problem 8: A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?
a) Reduce the company’s days’ sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
b) Use cash to repurchase some of the company’s own stock.
c) Issue new stock, then use some of the proceeds to purchase additional inventory and hold the remainder as cash.
d) Use cash to increase inventory holdings.
e) Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
problem 9: To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue.
problem 10: Last year Hamdi Corp. had sales of $500,000, operating costs of $450,000, and year-end assets of $395,000. The debt-to-total-assets ratio was 17%, the interest rate on the debt was 7.5%, and the firm's tax rate was 35%. The new CFO wants to see how the ROE would have been affected if the firm had used a 50% debt ratio. Assume that sales, operating costs, total assets, and the tax rate would not be affected, but the interest rate would rise to 8.0%. By how much would the ROE change in response to the change in the capital structure?