Everything else being equal, a highly leveraged firm will have earnings per share.
Answer (C) is correct. Earnings per share is less volatile in less highly leveraged firms. Lower fixed costs result in less variable earnings when sales fluctuate.
If the ratio of total liabilities to equity increases, a ratio that must also increase is
Answer (B) is correct. Because total assets will be the same as the sum of liabilities and equity, an increase in the liabilities to equity ratio will simultaneously increase the liabilities to assets ratio.
A measure of long-term debt-paying ability is a companyís
Answer (D) is correct. The times interest earned ratio is one measure of a firmís ability to pay the interest on its debt obligations out of current earnings. This ratio equals earnings before interest and taxes divided by interest expense.
All of the following financial indicators are measures of liquidity and activity except the
Answer (D) is correct. Liquidity ratios measure a firmís ability to pay its obligations in the short term and thus to continue operations. Examples include the current ratio and acid test (quick) ratio. Activity ratios measure the firmís use of assets to generate revenue and income. Examples include inventory turnover, average collection period, and receivables turnover Times interest earned is a ratio that measures the firmís ability to cover its interest burden.
A bondholder would be most concerned with which one the following ratios?
Answer (B) is correct. The times interest earned ratio is an income statement approach to evaluating a firmís ongoing ability to meet the interest payments on its debt obligations It equals earnings before interest and taxes divided by interest expense. A bondholder, being a creditor of the firm would be most interested in how thoroughly the firmís earnings cover the periodic interest payments on the bond.
In general, as a company increases the amount of short-term financing relative to long-term financing, the
Answer (A) is correct. An increase in the proportion of short-term financing will not affect a companyís degree of leverage, but risk is increased because of the need for frequent refinancing. Because the debtor company will be forced to meet principal and interest payments quickly, perhaps before expected funds from a new project, the danger of default is increased. Also, future interest rates are difficult to predict.
Which one of the following factors would likely cause a firm to increase its use of debt financing as measured by the debt to total capital ratio?
Answer (D) is correct. Debt financing usually has a lower cost than equity financing because interest payments are tax deductible. If tax rates rise, debt becomes even more desirable because the tax shield becomes more valuable. The disadvantages of debt include the increase in fixed payments (interest). Thus, in an unstable economy, debt represents a greater risk to a firm than equity financing.
Which of the outcomes represented in the following table would result from a companyís retirement of debt with excess cash?
Total Assets Turnover Ratio
Following Periodís Times Interest Earned Ratio
Answer (A) is correct. Because total assets will decline without any impact on sales, the total assets turnover ratio (sales ų total assets) will increase. In addition, a reduced debt level should cause a reduction in annual interest payments, so the times interest earned ratio [(net income + interest + taxes) ų interest] should increase.
A company issued long-term bonds and used the proceeds to repurchase 40% of the
outstanding shares of its stock. This financial transaction will likely cause the
Answer (C) is correct. The times interest earned ratio equals earnings before interest and taxes divided by interest expense. If bonds replace some equity in the capital structure, interest expense will increase in the denominator, which has the effect of reducing the ratio.
Stanford Company leased some special-purpose equipment from Vincent, Inc., under a long-term lease that was treated as an operating lease by Stanford. After the financial statements for the year had been issued, it was discovered that the lease should have been treated as a capital lease by Stanford. All of the following measures relating to Stanford would be affected by this discovery except the
Answer (B) is correct. Whether the lease is classified as operating or capital, it represents an obligation on Stanfordís part No receivable on Stanfordís books is involved