1. An increase in financial leverage generally results in a higher return on equity (ROE).
Reasoning: It may or may not increase ROE, depending upon the level of leverage and the interest cost of debt.
2. Leverage and liquidity generally rise or fall together.
3. It is possible for a company to grow faster than its sustainable growth rate.
4. Which of the following ratios uses sales in the denominator?
o Days in inventory
o Receivables turnover
o Cash ratio
o Average collection period
5. For a levered firm, EBIT is equivalent to:
o Net income
o Pro forma earnings
o Operating profit
o Net income before taxes
6. Common-size financial statements are constructed in order to:
o Adjust for inflation and risk
o Facilitate comparisons of different-sized companies
o To comply with SEC requirements
o All of the above
7. A firm has $100 of average inventory, operating profit of $500 and sales of $1,500. Its days in inventory is:
o 36.5 days
o 24.3 days
o 73.0 days
o Not enough information
8. For which of the following generic businesses would you expect a combination of high asset turnover and low profit margins?
o Software developers
9. Analysis of a company’s financial statements: Below are simplified versions of the balance sheet and income statement for Toys by Tom, Inc. Use this information to answer question 9.
Toys by Tom, Inc. has a current ratio of ____, suggesting ________.
o 9.6; reasonable ability to cover interest expense
o 0.57; potential illiquidity
o 0.21; potential collection problems
o 1.75; reasonable liquidity
10. Analysis of a company’s financial statements: Below are simplified versions of the balance sheet and income statement for Toys by Tom, Inc. Use this information to answer question 10.
What is Toys by Tom, Inc. return on assets (ROA)?
o ANSWER: NONE- OF THE ABOVE (EXPLANATION GIVEN BELOW)
11. Operating cash flow is generated by a company’s daily operations related to production and sales of goods and/or services.
12. In general, the reduction of an asset is a source of funds.
13. The sustainable growth rate is the maximum growth rate achievable over an extended period of time.
14. The cash conversion cycle is calculated as:
o Days in Inventory + Collection Period
o Days in Inventory – Payables Period
o Days in Inventory + Collection Period – Payables Period
o None of the above
15. A company can shorten its cash cycle by:
o Reducing inventory turnover
o Reducing account payables
o Reducing days receivable
o None of the above
16. A company has a retention rate of 50%, sales of $25,000, beginning equity of $50,000 and profit margins of 10%, an asset turnover ratio of .75 and debt of $10,000. What is its sustainable growth rate?
o Not enough information given
17. Scenario analysis is a way of testing forecasts by changing one assumption at a time.
18. Biases can and should always be eliminated in financial forecasts.
19. Which of the following is commonly used in preparing pro forma statements:
o Historical financial statements
o Projected sales
o Efficiency ratios
o All of the above
20. Pro forma statements are:
o Summaries of historical financial statements
o Government-mandated analyses of financial statements
o Projected statements used in financial planning
o Estimated tax liabilities
21. Selecting investment projects according to rules based either on project NPV or IRR results in maximizing firm value.
22. A dollar today is worth more than a dollar tomorrow.
23. The NPV rule, which says companies should invest in projects for which NPV is greater than 0, depends on the assumption of value maximization.
24. If you invest $2,000 today for three years at 5% interest paid annually, you will earn a total of $______ in interest. Assume you re-invest all interest.
25. The amount by which a project increases the value of the firm is given by which of the following?
o The project’s accounting rate of return
o The project’s net present value (NPV).
o The project’s internal rate of return (IRR).
o The project’s present value
26. Which items are necessary in calculating the net present value of a project?
I. Investment outlays
II. Discount rate
III. Incremental cash flow
IV. Time period for the project
o I, II and IV
o I, II and III
o II, III and IV
o All of the above
27. Compute the net present value of an investment with 5 years of annual cash inflows of $100 and two cash outflows, one today of $100 and one at the beginning of the second year of $50. Use a discount rate of 10 percent.
Year PV factor Cash PV of cash
at 10% flows flows
0 1 -100 -100.00
1 0.909091 -50 -45.45
1 0.909091 100 90.91
2 0.826446 100 82.64
3 0.751315 100 75.13
4 0.683013 100 68.30
5 0.620921 100 62.09
PV of cash flows = 233.62
28. Suppose a riskless project requires an initial investment of $10 and will generate a one-time cash inflow of $30 two years later. Assuming a risk-free interest rate of 5%, which of the following statements about the project is NOT true?
o The net present value of the project is positive
o The IRR is greater than 50 percent.
o The accounting rate of return on the project is positive.
o The payback period is less than 2 years.
29. What is the present value of a perpetuity of $100 given a discount rate of 5%?
o $ 2,000
o $ 3,000
o $ 1,500
o $ 500
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