Cebu Institute of Technology University

Acctg235 | Financial Management

Final Summative Assessment – Study Material | December 2020

1. The acquisition of land by issuing common stock is

A. a noncash transaction which is not reported in the body of a statement of cash flows.
B. a cash transaction and would be reported in the body of a statement of cash flows.
C. a non cash transaction and would be reported in the body of a statement of cash flows.
D. only reported if the statement of cash flows is prepared using the direct method.
Proforma entry: debit land credit common stock. Walang cash na affected

The correct answer is letter A. Letter B is incorrect because first and foremost, issuing a common stock for land
acquisition is a noncash consideration and it affects only in the shareholder’s equity and not in statement of
cash flows. Obviously from the name itself “STATEMENT OF CASH FLOWS”, only the cash items will be
considered. Letter C is also incorrect because though it stated that it is non cash however, it further stated that
it is reported in the statement of cash flows which is not based on what I said a while ago. Also, letter D is
wrong because only cash items will be reported in cash flows in whatever circumstances whether it will be
prepared in direct method or indirect method. Thus, A is the correct answer—issuing a common stock for land
acquisition is non cash and not reported in the statement of cash flows.

2. Yong Importers, an Asian import company, is evaluating two mutually exclusive projects, A and B. The relevant cash
flows for each project are given in the table below. The cost of capital for use in evaluating each of these equally risky
projects is 10 percent.
Project A Project B
P350,000 P425,000 Initial
Investment
Year Cash Inflows (CF)
1 P140,000 P175,000
2 165,000 150,000
3 190,000 125,000
4 100,000
5 75,000
6 50,000
What is the annualized NPV for Project A and Project B, respectively, and which should be
accepted? A. P22,673 and P11,673; Project A should be accepted. B. P18,795 and P15,844;
Project B should be accepted. C. P22,673 and P21,828; Project A should be accepted.
D. P38,227 and P21,828; Project A should be accepted.
The item asked for the annualized NPV for both project and which project to accept. First, the formula of
annualized NPV is NPV divided by PVIFA or present value interest factor of annuity. We already know how to
solve the NPV and the concern here is on PVIFA. The formula of this is 1-(1 + r) to the power of –n over
(divided by) r. The r here represents the interest rate and n is the number of periods. Since it will take time to
narrate the whole computation, we’ll jump directly to the final answer and we were able to get 22,673
annualized npv for project A and 21,828 for project B. since project A has higher annualized npv then, project A
should be accepted.

3. In calculating net cash provided by operating activities using the indirect method, an increase in prepaid expenses
during a period is
A. deducted from net income. C. ignored because it does not affect income.
B. added to net income. D. ignored because it does not affect expenses.
An increase in prepaid expenses is deducted from net income. Obviously, it is an expense which means that
there is disbursement. Furthermore, it also stated that it increases thus there is an additional cash
disbursement for that certain expense. The remaining letters are incorrect because increase in prepaid
expenses shouldn’t be ignored in computing the net cash flows because they affect both income and expenses.
Also, this shouldn’t be added to income because basically it is an expense and must be deducted.

4. Suppose you are comparing two firms in the steel industry. One firm is large and the other is small. Which type of
numbers would be most meaningful for statement analysis?
A. Absolute numbers would be most meaningful for both the large and small firm.
B. Absolute numbers would be most meaningful in the large firm; relative numbers would be most meaningful in the
small firm.
C. Relative numbers would be most meaningful for the large firm; absolute numbers would be most meaningful for
the small firm.
D. Relative numbers would be most meaningful for both the large and small firm, especially for interfirm
comparisons.
First, we’ll have to define absolute number and relative number. Absolute value, or also called intrinsic value
refers to a form of business valuation that uses the discounted cash flow analysis to assess financial value of a
company. This focuses on the intrinsic aspect. On the other hand, relative number or the relative valuation
model is a business valuation that compares a company’s value to its competitors or industry peers to assess
the firm’s financial worth. Now, in relation to the question, we were supposed to compare a large and small
steel industry. Thus, relative numbers would be most meaningful for statement analysis because it involves
comparison of two things which fits for the purpose and definition of relative valuation model.
5. Dixie Tours Inc. buys on terms of 2/15, net 30 days. It does not take discounts, and it typically pays 35 days after the
invoice date. Net purchases amount to P720,000 per year. What is the nominal annual cost of its non-free trade
credit? (Assume a 365-day year.)
A. 17.2% B. 23.6% C. 26.1% D. 37.2%
What is being asked in the problem is the nominal annual cost of its non-free trade credit. First and foremost,
the formula for this is “discount rate/(1-discount rate) multiplied to 365/(full payment days minus discount
period). Upon calculating these figures, we were able to get an answer of 37.2%. The significance of this is that
it calculates the cost if you don't take the trade discount. Let's say your company is offered terms of trade of
2/15, net 30 but is not able to take the 2% discount. In other words, you don't have the cash flow to pay the bill
and receive the discount within 15 days, what is this going to cost you? So based on the answer, 37.2% is the
cost of not taking the discount.

6. Denver Dynamics has net income of P2,000,000. Oakland Enterprises has net income of P2,500,000. Which of the
following best compares the profitability of Denver and Oakland?
A. Oakland Enterprises is 25% more profitable than Denver Dynamics.
B. Oakland Enterprises is more profitable than Denver Dynamics, but the comparison can't be quantified.
C. Oakland Enterprises is only more profitable if it is smaller than Denver Dynamics.
D. Further information is needed for a reasonable comparison.
This item compares the profitability of two companies. So, this has something to do with profitability ratios.
There are different profitability ratios which need the figures of net income, sales, total assets, common equity,
as well as the total invested capital in order to determine a specific profitability ratio, however in the problem,
only the net income is presented. This became impossible for us to determine which one is more profitable
thus, further information is needed for a reasonable comparison.
7. Return on assets cannot fall under which of the following circumstances?

First, we’ll have to determine the formula of the different ratios provided such as ROA, Net profit Margin as well
as the total asset turnover. So in order to find relativity or connections of the three ratios, we establish a formula
of ROA = profit margin ratio x asset turnover ratio. When we put some figures on it, obviously the return on
assets will not FALL if the two ratios will rise. Also, these two must increase or rise because if the other one will
decrease, there is a possibility that the ROA will also decrease or fall. So the correct answer is letter C.

A. B. C. D.
Net profit margin Decline Rise Rise Decline
 Total asset turnover Rise Decline Rise Decline
8. Which of the following statements is CORRECT?
A. If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this
suggests that the board of directors should fire the president.
B. If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this
suggests that the board of directors should fire the president.
C. Other things held constant, the higher a firm’s expected future growth rate, the lower its P/E ratio is likely to be.
D. The higher the market/book ratio, then, other things held constant, the higher one would expect to find the
Market Value Added (MVA).
The correct answer is letter D. Letter A is incorrect because a higher price/earnings ratio is actually significant
towards the company because it shows that investors are willing to pay a higher share price today because of
growth expectations in the future. Thus, the President shouldn’t be fired. Letter B is also incorrect because the
ratio of a stock’s market price to its book value gives another indication of how investors regard the company.
Companies that are well regarded by investors have high Market/Book ratios so the president shouldn’t be fired
as well. Letter C is also incorrect because basically the price/earning ratio will increase. Letter D is correct
because market/book ratio and market value added are directly proportional. So the higher the market/book
ratio, the higher market value added would be.

9. Cross Collectibles currently fills mail orders from all over the U.S. and receipts come in to headquarters
in Little Rock, Arkansas. The firm’s average accounts receivable (A/R) is P2.5 million and is
financed by a bank loan with 11 percent annual interest. Cross is considering a regional lockbox
system to speed up collections that it believes will reduce A/R by 20 percent. The annual cost of
the system is P15,000. What is the estimated net annual savings to the firm from implementing
the lockbox system?
A. P500,000 B. P 30,000 C. P 60,000 D. P 40,000
Here, we are being asked for the net annual savings to the firm from implementing the lockbox system.
So first, we’ll have to calculate the cost of the loan which is 2.5 million multiplied to 11% interest rate. This
equaled to 275,000. Upon considering the new system, they expected that the AR will decrease by 20%
so its cost as well will decrease to 220,000. Also, we consider the cost of the system which is 15,000 so
220,000 + 15,000 is equals to 235,000 and this will be our new cost. In order to determine the savings, we
have to find the difference between the old and new cost which is 275,000-235,000 is equals to 40,000.
40,000 is actually our net annual savings.
10. Assume you have a choice between two deposit accounts. Account A has an annual percentage rate
of 7.55 percent but with interest compounded monthly. Account B has an annual percentage rate of
7.45 percent with interest compounded continuously. Which account provides the highest effective
annual return?
A. Account A. C. Both provide the same effective annual return.
B. Account B. D. We don’t have sufficient information to make a choice.
In order to visualize which has the highest effective annual return, we’ll assume a 100,000 deposit on both
accounts. The formula for calculating monthly compounded interest is principal X (1+interest rate/12) to the
power of the number of months. Then, we get a return of 7,817. On the other hand, the formula for calculating
continuous compounded interest is FV = PV x e (i x t), where e is the mathematical constant approximated as
2.7183. Here, we were able to derive 7,735 returns. Thus, account A provides the highest effective annual
return.

11. Z Co. is considering an investment in a machine that would reduce annual labor costs by P30,000.
The machine has an expected life of 10 years with no salvage value. The machine would be
depreciated according to the straight-line method over its useful life. The company’s marginal tax rate
is 30%. Assume that the company will invest in the machine if it generates a pre-tax internal rate of
return of 16%. What is the maximum amount the company can pay for the machine and still meet the
internal rate of return criterion (PVFA is 4.833)?
A. P180,000 B. P118,704 C. P187,500 D. P144,996
From buying the new machine, the company will get the following benefits:
(a) Saving in annual labor cost by P30,000 pre tax

(b) Tax benefit of 30% of annual depreciation amount

Now let's assume the total cost of the machine is 'X'. The annual depreciation shall be 1/10th of 'X', since the company
will depreciate the cost of machine in 10 years on Straight line method.

Total annual post tax savings from the machine shall be derived as under:

(1-tax rate) x Savings in annual labor cost + Annual depreciation x tax rate

= (1-30%) * P30,000 + (1/10) * X * 30%

=0.70%*P30,000 + 0.03X

=P21,000 + 0.03X

The above saving shall be derived every year till 10years. The internal rate of return of the company is 16%. Let’s assume
that all the savings from the machine shall arrive at the end of the year. We shall use the Present value of the annuity for
10years at 16% interest rate which was already given in the problem.

PV of annuity of 1 at 16% p.a. for 10 years = 4.833

The company can pay the maximum amount for the machine equal to the present value of the benefits to be received
from the machine.

Maximum cost for the machine = PV of the post-tax annual benefits from the machine

X = 4.833*(P21,000 + 0.03X)

X = P101,493 + 0.14499X

(X - 0.14499X) = P101,493

0.85501 X = P101,493

X = P101,493/0.85501 = P118,703.8748 or P118,704

Hence, the company can pay maximum amount of P118,704 for the machine. Letter B is correct in the given problem.
12. 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.
The correct answer is letter B. Letter A is incorrect because having the same Price to Earning ratio doesn’t
mean that they will also have the same market to book ratios since the two ratios have different factors for
calculation. The same thing that happens to letter C. Letter D is also incorrect because a higher P/E ratio
means it expected to grow faster. Thus, If Firm X’s P/E ratio exceeds that of Firm Y, then X is likely to grow
faster. Only letter B is correct because the factors and considerations presented satisfies the calculations for
price/earnings ratios.
13. Youngsten Electric is contemplating new projects for the next year that will require P30,000,000 of new financing. In
keeping with its capital structure, Youngsten plans to use debt & equity financing as follows:
• Issue P10,000,000 of 20-year bonds at a price of 101.5, with a coupon of 10%, and flotation costs of 2.5% of par
value.
• Use internal funds generated from earnings of P20,000,000.
The equity market is expected to earn 15%. U.S. treasury bonds currently are yielding 9%. The beta coefficient for
Youngsten's common stock is estimated to be .8. Youngsten is subject to a 40% corporate income tax rate. Youngsten
has a price/earnings ratio of 10, a constant dividend payout ratio of 40%, and an expected growth rate of 12%. Assume
Youngsten has an after-tax cost of debt of 9% and an after-tax cost of equity of 15%. Youngsten's weighted average cost
of capital is:
A. 11.0% B. 13.0% C. 12.0% D. 11.8%
The correct answer is letter B. The weighted average cost of capital is computed by multiplying the required
returns on equity and debt by the percentage of equity and debt used to finance that particular project.
Youngsten will use 33% debt ($10 million of $30 million total project cost) and 67% equity ($20 million of $30
million total project cost). Therefore:
WACC = 9% (33%) + 15% (67%)
= 2.97% + 10.05%
= 13.02% or 13.0% (rounded)
Choices a, c, and d are incorrect as per the calculation presented.
14. Compared to other firms in the industry, a company that maintains a conservative working capital policy will tend to
have a
A. Greater percentage of short-term financing.
B. Greater risk of needing to sell current assets to repay debt.
C. Higher ratio of current assets to fixed assets.
D. Higher total asset turnover.
The correct answer is letter C. Letters A and B are incorrect because maintaining a conservative working
capital doesn’t pose a greater percentage of short-term financing because you have enough fund for your
current operations and need not to sell your current assets to repay debt. Moreover, letter D is also incorrect
because this seems irrelevant to working capital because it has something to do with your earnings or net
income. Thus, the only correct answer is letter C
15. A firm has an operating cycle of 170 days, an average payment period of 50 days, and an average age of inventory of
145 days. The firm’s average collection period is _________ days.
A. 25 B. 75 C. 95 D. 120
The operating cycle formula may be used to solve the average collection period which is operating cycle is
equal to average age of inventories plus average collection period. Thus, operating cycle (170) minus average
age of inventories (145) will result to the average collection period of 25 days
16. The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of carrying the
chemical in inventory is 50 cents per gallon per year, and the cost of ordering the chemical is P150 per order. The
firm uses the chemical at a constant rate throughout the year. The chemical’s economic order quantity is
A. 32,863 gallons. B. 11,619 gallons. C. 9,487 gallons. D. 1,900 gallons.
EOQ will be 32863 gallons
So option (a) will be the correct answer.
We have given that company uses 150000 gallons of hydrochloric acid per month, ordering cost is $150,
and the holding cost is $0.5. We know that 1 year is equal to 12 months; this means that to get the
annual demand we have to multiply 150,000 to 12 months which is equal to 1,800,000.
We have to find the economic order quantity EOQ
Using this formula:

This means that the optimal amount of gallons of hydrochloric acid that should be ordered annually
should be 32,863 gallons; this amount would maintain a cost efficient supply chain for the company.

17. The working capital financing policy that subjects the firm to the greatest risk of being unable to meet the firm’s
maturing obligations is the policy that finances
A. Fluctuating current assets with long-term debt. C. Permanent current assets with short-term debt.
 B. Permanent current assets with long-term debt. D. Fluctuating current assets with short-term debt.

Answer (C) is correct. Fluctuating current assets can often be financed with short-term debt because the
periodic liquidation of the assets provides funds to pay off the debt. However, financing permanent current
assets with short-term debt is a risky strategy because the assets may not be liquidated in time to pay off the
debt at maturity. A and B is incorrect because interests on long term borrowing are more stable than the short
term which is fluctuating widely and are more risky.

18. In assessing the loan value of inventory, a banker will normally be concerned about the portion of inventory that is
work-in-process because
A. WIP inventory is relatively easy to sell because it does not represent a raw material or a finished product.
B. WIP inventory usually has the highest loan value of the different inventory types.
C. WIP generally has the lowest marketability of the various types of inventories.
D. WIP represents a lower investment by a corporation as opposed to other types of inventories.
The correct answer is option C because WIP is cost of unfinished goods, which, if used to secure a loan may not be as
beneficial in the part of the banker. The option A is wrong simply because Work in process inventory is the total cost of
unfinished currently in production process, which in sense, cannot be relatively sold. Option B is also incorrect because
work in process inventory does not have the highest loan value. Banks usually view inventory financing as a type of
unsecured loan because if the business can't sell its inventory the bank may not be able to either, hence, not the most
optimal or highest loan value among the firm’s asset. Lastly, option D is also incorrect because WIP has the highest
investment among the other types of inventories. A corporation must have to purchase raw materials, enhance their
manpower and invest in their machines in order to finished goods that are still in process hence making this statement
false.
19. Your firm buys on credit terms of 2/10, net 45 days, and it always pays on Day 45. If you calculate that this policy
effectively costs your firm P159,621 each year, what is the firm’s average accounts payable balance? (Hint: Use the
nominal cost of trade credit and carry its cost out to 6 decimal places.)
A. P1,234,000 B. P 75,000 C. P 157,500 D. P 750,000
What is being asked in the problem is the firm’s average accounts payable balance which is discussed on
Chapter 16 of this course. We have learned that in calculating the nominal annual cost of its non-free trade
credit, the formula is “discount rate/(1-discount rate) multiplied to 365/(full payment days minus discount
period). Upon calculating these figures, we were able to get an answer of 21.28279853%. Afterwards, we’ll
have to divide the amount of 159,621 by 21.28279853% in order to get the requirement. Thus, the firm’s
average accounts payable balance is 750,000. This is useful in the firm because we will be able to assess
if the credit we are opting for is feasible or efficient for the overall impact of the company.
20. Accounts receivable turnover will normally decrease as a result of
A. The write-off of an uncollectible account (assume the use of the allowance for doubtful accounts method).
B. A significant sales volume decrease near the end of the accounting period.
C. An increase in cash sales in proportion to credit sales.
D. A change in credit policy to lengthen the period for cash discounts.
Accounts receivable turnover will normally decrease as a result of A change in credit policy to lengthen the
period for cash discounts. As what we have learned from Chapter 4 and further discussed on Chapter 16 of
this course, the formula for A/R Turnover is Net Credit Sales/Average Accounts Receivable, this is in line to
the formula for Asset Turnover Ratio. Which means that, if the company lengthens the credit period or the
discount period, it will decrease the Accounts Receivable Turnover as the denominator (Average Accounts
Receivable) will increase as receivables are held for a longer time. Hence, the correct answer is D, Accounts
receivable turnover will normally decrease as a result of a change in credit policy to lengthen the period for
cash discounts.
21. The use of safety stock by a firm will:
A. reduce inventory costs C. have no effect on inventory costs B. increase inventory costs D. none of the above
The use of safety stock by a firm will increase inventory cost. As what we have learned, there are firms
that need safety stock or what we call buffer stock to avoid or lessen the risk of a stock out situation.
Holding on to that safety stock entails inventory costs for the company as there would be expenses in
warehouse and even insurance for the merchandise being stored. Hence, safety stocks, even while they
are being still stored are incurring costs which are to be covered by the company’s expenses, therefore,
increasing inventory cost.
22. The following information is available for Rothenberg, Inc.:
Balance sheet
Current assets P 500,000
Property, plant, and equipment 4,000,000
Total assets P4,500,000
Current liabilities P 30,000
Long-term debt 2,500,000
Common stock 200,000
Retained earnings 1,770,000
Total liabilities and SHE P4,500,000

Budget income information 100,000 units 105,000 units

Sales P3,000,000 P3,150,000
Expenses (2,800,000) (2,850,000)
Operating income (EBIT) P 200,000 P 300,000
Earnings per share (EPS) P 0.20 P 1.20
What is the degree of operating leverage, degree of financial leverage, and degree of total leverage, respectively?
A. 10, 10, 100 C. 10, 2.5, 25
B. 7, 10, 70 D. 7, 10, 25
Degree of Operating Leverage (DOL)

DOL = (Percent change in EBIT)/(Percent change in unit volume)

In this case, the percent change in EBIT(earnings before interest and taxes) is equal to 50% [($300,000 -
$200,000) ÷ $200,000], and the percent change in unit volume is equal to 5% [(105,000 - 100,000) ÷
100,000 units]. Thus, the DOL is equal to 10 (50% ÷ 5%).

Degree of Financial Leverage (DFL)

= Percentage Change in EPS (earnings per share) / Percentage Change in EBIT

Degree of Financial Leverage

= New EPS - Old EPS / Old EPS divided by

New EBIT - Old EBIT / Old EBIT

In this case, the percent change in earnings per share or EPS is 5% [(1.20 - 0.20) ÷ 0.20], and the percent
change in earnings before income and taxes or EBIT is equal to 50% [(300,000 - 200,000) ÷ $200,000].
Thus, the DOL is equal to 10 (50% ÷ 5%).

Degree of Total Leverage

= Degree of Operating Leverage (DOL) x Degree of Financial Leverage (DFL) which is 100
In this case, the DTL is equal to 100 (10 x 10). Therefore, the correct answer is letter A having the
amounts of 10, 10 and 100 respectively.
23. With credit terms of 3/8, n/30, what is the customer’s payment decision date?
A. Three days after the invoice is received. C. Anytime during the period, 8th to the 30th.
B. The 8th day is the customer’s decision date. D. The 30th day is the primary decision date.
The correct answer is letter B because the customer needs to pay within 8 days in order to avail or enjoy
the 3% discount. Option A is wrong because 3 is indicated as 3% discount. Option C and D are also
wrong because the customer must either choose to pay within 8 days in order to enjoy the 3% discount or
pay the full amount within 30 days since 30th day is the date when payment is normally due.
24. Relative to cash flows affecting net working capital, all of the following are true EXCEPT
A. cash inflows are generally more predictable than cash outlays.
B. cash outlays for current liabilities are relatively predictable.
C. the more predictable the cash inflows, the less net working capital a firm needs.
D. because most firms are unable to match cash inflows to outflows with certainty, current assets that more than cover
outflows for current liabilities are necessary.
The correct answer is letter A because cash outlay is easily predictable from past experience whereas
cash inflows are less predictable since it depends upon future circumstances. Option B is wrong because
the value of current liabilities are certain. Option C is wrong because working capital is the difference of
current assets and current liabilities. Thus, it can be kept at lower side as much as possible. Option D is
wrong because this statement is true.
25. A firm is analyzing a relaxation of credit standards that is expected to increase sales 10 percent. The firm is currently
selling 400 units at an average sale price per unit of P575, and the variable cost per unit is P400 at the current
sales volume. The average cost per unit is P425. What is the additional profit contribution from sales if credit
standards are relaxed?
A. P23,000 B. P16,000 C. P6,000 D. P7,000
The question in this case is the additional profit contribution from sales if credit standards are relaxed. In order to get the
answer, we shall have the formula of sales volume under proposed plan that is 400 times 1.10 less sales volume under
present plan that is 400 to have the difference of increase on sales volumes. The difference shall then be multiplied to the
profit contribution that is sales price of 575 minus variable cost of 400 hence, the answer of 7,000 as the additional profit
contribution found in letter D.
26. 1/15 net 30 date of invoice translates as
A. a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the balance is due in 30 days
after the middle of the month.
B. a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the balance is due 30 days
after the invoice date.
C. a 1 percent cash discount may be taken if paid in 15 days; if no cash discount is taken, the balance is due 30 days
after the end of the month.
D. a 1 percent discount may be taken on 15 percent of the purchase if the account is paid within 30 day s after the end of
the month.
Firms generally publish a statement of their credit period and discount policy called the credit terms. 1/15 net 30 is what a
firm offers to the customers in order to motivate and take advantage of the early payment. Thus, 1/15 net 30 means that
there shall be an either discount of 1% if payment is received within 15 days or pay the full amount that is due in 30 days.
For instance, if a customer pays within 15 days, he shall obtain the 1% discount; otherwise, he can make a normal
payment in 30 days and by normal, it means no discount at all. Therefore, the correct answer is letter B.
27. A firm has just ended the calendar year making a sale in the amount of P200,000 of merchandise purchased during
the year at a total cost of P150,500. Although the firm paid in full for the merchandise during the year, it has yet to
collect at year end from the customer. One possible problem this firm may face is
A. low profitability. B. insolvency. C. inability to receive credit. D. high leverage.
The firm in the question could face some liquidity issues. Even though the firm generates a large profit margin, if the cash
flow is all tied up then it could damage the business's reputation. Here, the company has a net profit of $49,500 from the
difference between $200,000 and $150,500 but the cash flow is of negative $150,500 from this sale for the year when we
subtracted the total cost from its net profit. Hence, the firm may experience insolvency that is cash flow insolvency in
which a company had accounts receivables or the money owed by the customers that is not being paid in time to settle
bills.
28. Below is the equity portion (in millions) of the year-end balance sheet that Glenn Technology has reported for the last
two years:
2016 2015
Preferred stock P 80 P 80
Common stock 2,000 1,000
Retained earnings 2,000 2,340
Total equity P4,080 P3,420
Glenn does not pay a dividend to its common stockholders. Which of the following statements is most correct?
A. Glenn issued preferred stock in both 2015 and 2016.
B. Glenn issued common stock in 2016.
C. Glenn had positive net income in both 2015 and 2016, but the company’s net income in 2016 was lower than it
was in 2015.
The correct answer is option b. Option a is wrong because if Glenn had issued preferred stock, the dollar value of
preferred stock would have increased. Option c is also wrong. Glenn’s net income during 2016 is negative because if a
company has positive net income, it pays a dividend first but it was stated that dividend is equal to $0, and whenever
there is left over it will be added to retained earnings. But the retained earnings declined, from 2,340 to 2,300, and no
dividends were paid, net income must have been negative in 2002. So, the correct answer is option b since the amount of
common stock did increase between 2015 and 2016. Statements b and c are correct.

29. If net income is P115,000 and interest expense is P30,000 for 2016, and the market price is P30, What is the price
earnings ratio on common stock for 2016. (round to one decimal point)?
A. 17.0 B. 12.1 C. 12.4 D. 15.9
The formula to get the price/earnings ratio is to divide market share per ratio by earnings per share. But we need to get
first the earnings per share and it is calculated by dividing the income available to common shares by the common shares
outstanding. And to get the income available to common shares, it is calculated by deducting preferred dividends from net
income. Thus, the net income of 2016 is 115,000 deducted by preferred dividends of 9,000 so the income available to
common shares would be 106,000. The earnings per share is 1.77 (computed as 106,000 divided by 60,000). The answer
for the question, what is the price per earnings ratio, we need to divide 30 (the market share price) by the earnings per
share we calculated earlier, 1.766. That led us to an answer of 17. So, letter A is correct.
30. The following data are related to Samba stock:
Required return on Samba common 15 percent
Beta coefficient 1.5
Risk-free rate 9.0 percent
The required market return is
A. 13.0 percent C. 25.0 percent B. 18.0 percent D. 16.0 percent
The answer is letter A. To get the required market return, we need to put the figures in their respective spaces in this
formula—

Required rate of return= Risk free rate + Beta coefficient * (required market return – risk free rate)
.15= .09 + 1.5 * (y- .09)

So, now we will multiply 1.5 to (y - .09). The answer would be 1.5y - .135

.15= .09 + 1.5y - .135

We will now transfer y from right to the left side.

1.5y= .15 - .09 + .135
1.5y= .195 divide both side to 1.5
1.5 = 1.5
y= .13 or 13%.
Therefore, letter A is the correct answer.
31. One reason that a common-size statement is a useful tool in financial analysis is that it enables the user to
A. judge the relative potential of two companies of similar size in different industries.
b. determine which companies in a single industry are of the same value.
c. determine which companies in a single industry are of the same size.
d. make a better comparison of two companies of different sizes in the same industry.
Creating common size financial statements makes it easier to analyze a company over time and compare it with its rivals.
Investors can monitor whether the debt level is too high, excess cash is being retained on the balance sheet, or
inventories are growing too high
32. Analysts who follow Sierra Nevada Inc. recently noted that, relative to the previous year, the company’s net cash flow
was larger but cash on the firm’s balance sheet had declined. What factors could explain these changes?
A. The company sold a division and received cash in return.
B. The company cut its dividend.
C. The company made a large investment in new plant and equipment.
D. Statements a and b are correct.
Net Cash Flow = Net Income + DEP and AMORT. If the company had sold a division and received cash, cash on the firm’s
balance sheet would have increased. Therefore, statement a is false. If the company cut its dividend, it would have more
cash left over from net income, so cash on the firm’s balance sheet would have increased. Therefore, statement b is false.
If the company made a large investment in new plant and equipment, it would have larger depreciation expense, so net
cash flow would increase. In addition, it had to pay for the equipment somehow, so cash on the balance sheet would
decline. Therefore, statement c is true.

33. Below are the 2015 and 2016 year-end balance sheets for Kewell Boomerangs:

Assets: 2016 2015

Cash P 100,000 P
85,000
Accounts receivable 432,000 350,000
Inventories 1,000,000 700,00
0
Total current assets P1,532,000 P1,135,0
00
Net fixed assets 3,000,000 2,800,00
0
Total assets P4,532,000 P3,935,0
Liabilities and equity: 00
Accounts payable P 700,000 P
545,000
Notes payable 800,000 900,00
0
Total current liabilities P1,500,000 P1,445,0
00
Long-term debt 1,200,000 1,200,000
Common stock 1,500,000 1,000,000
Retained earnings 332,000 290,00
0
Total common equity P1,832,000 P1,290,0
00
Total liabilities and equity P4,532,000 P3,935,0
00
Kewell Boomerangs has never paid a dividend on its common stock. Kewell issued P1,200,000 of long-term debt in 2012.
This debt was non-callable and is scheduled to mature in 2041. As of the end of 2016, none of the principal on this debt
has been repaid. Assume that 2015 and 2016 sales were the same in both years. Which of the following statements is
most correct?
A. Kewell had negative net income in 2016. C. Kewell issued long-term debt in 2016.
B. Kewell issued new common stock in 2016. D. Statements a and b are correct.
The correct answer is statement b. Since its retained earnings increased, net income had to be positive in 2016, so
statement a is incorrect. Statement c is incorrect since outstanding long-term debt did not change from 2015 to 2016.
Statement b, then, is the only correct answer.
34. Phranklin Pharms Inc. purchases merchandise from a company that gives sales terms of 2/15, net 40 days. Phranklin
Pharms has gross purchases of P819,388 per year. What is the maximum amount of costly trade credit Phranklin
could get, assuming it abides by the supplier’s credit terms? (Assume a 365-day year.)
A. P88,000 B. P33,000 C. P55,000 D. P50,000
A is the correct answer because to identify the maximum amount of costly trade credit that Phranklin could get, first you
need to divide the gross purchase of P819,388 to 365 days to get the daily purchase amount which will be equal to 2,245
daily. Then multiply it by 40days to get the net purchases as of 40 days which will be equal to 89,796. Assuming Phranklin
abides the supplier’s credit terms, so it has 2% discount amounting to 1,796. So, P89,796 minus 1,796 is equal to 88,000.

35. Bedford Hotels and Breezewood Hotels both have P100 million in total assets and a 10 percent return on assets
(ROA). Each company has a 40 percent tax rate. Bedford, however, has a higher debt ratio and higher interest
expense.
Which of the following statements is most correct?
A. The two companies have the same basic earning power (BEP).
B. Bedford has a higher return on equity (ROE).
C. Bedford has a lower level of operating income (EBIT).
D. Statements a and b are correct.
Bedford Hotels has a higher return on their equity because ROE is a measure of the profitability of a business in relation to
the equity. Bedford has a higher ROE because also they have a high total asset and with a 10% ROA. Even they have a
high debt ratio or a high interest expense which gives an idea of how the firm has financed its assets as well as the firm’s
ability to repay its long-term debt. A high ROE depends on maintaining liquidity, on efficient asset management, and on
the proper use of debt.
36. A company has P650,000 of 10% debt outstanding and P500,000 of equity financing. The required return of the
equity holders is 15%, and there are no retained earnings currently available for investment purposes. If new outside
equity is raised, it will cost the firm 16%. New debt would have a before-tax cost of 9%, and the corporate tax rate is
50%. When calculating the marginal cost of capital, the company should assign a cost of <List A> to equity capital
and <List B> to the after-tax cost of debt financing.

A. B. C. D
.
List A 15% 15% 16% 16
%
List B 4.5% 5.0% 4.5% 5.0
%
LIST A:16% will be the cost for a newly raised outside equity.
LIST B: After-tax cost of debt = rd(1 - T) cost of debt (1-tax)
= [50%(1-9%)](10%)
=4.5%
37. A firm has an average age of inventory of 101 days, an average collection period of 49 days, and an average payment
period of 60 days. The firm’s inventory turnover is _________.
A. 3.2 B. 4.0 C. 2.5 D. 3.6
The answer is letter D. 3.6. Here we simply divide 101 days from 365 days.
This means that the firm sold or turn its inventory 3.6 times during the year. Inventory is usually faster in some industries
such as grocery stores than in other such as department stores, comparatively low inventory turnover means that a
company has a poor sales or too much inventory. While high inventory turnover can indicate strong sales, but it can also
indicate that the company doesn't have an effective inventory purchasing plan in place. For many businesses the ideal
turnover ratio is about 4 to 6. And in the given problem the answer resulted to 3.6 which implies that rate in which the
item is restocked is not that balanced with sales.
38. Pepsi Corporation’s current ratio is 0.5, while Coke Company’s current ratio is 1.5. Both firms want to “window dress”
their coming end-of-year financial statements. As part of its window dressing strategy, each firm will double its
current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the
statements below best describes the actual results of these transactions? A. The transactions will have no effect on
the current ratios.
B. The current ratios of both firms will be increased.
C. The current ratios of both firms will be decreased.
D. Only Pepsi Corporation’s current ratio will be increased.
The answer is letter D. only pepsi corporation’s current ratio will be increased. Why? Because Coke Company’s current
ratio of 1.5 fall within the ideal current ratio which is 1.2 to 2, which means that the business has 2 times more current
assets than liabilities to cover its debts, while for Pepsi which has a current ratio of below 1, this means that the company
should increase its current ratio to cover its short-term liabilities since it doesn’t have enough liquid assets for it.
39. What type of analysis is indicated by the following?
Increase (Decrease*) 2017 2016 Amount Percent
Current assets P 380,000 P 500,000 P120,000* 24%*
Fixed assets 1,680,000 1,500,000 180,000 12%
A. vertical analysis B. horizontal analysis C. liquidity analysis D. common-size analysis
The type of analysis indicated in this number is horizontal analysis letter B. There are 2 years shown here which is 2017
and 2016 with its corresponding categories of current assets and fixed assets. There amount difference is shown in the
amount section: For current assets it is 120,000 and for fixed assets it is 180,000 and we divide that horizontally with its
corresponding amount in its base year in (2016), we get 24% for current assets and 12% for fixed assets. This implies
that the firm's current assets decreased from 2016 to 2017 of 24% but an increase of fixed assets of 12% from 2016 to
2017
40. An increase in inventory holding costs will
A. Decrease the economic order quantity. C. Increase the economic order quantity.
B. Have no effect on the economic order quantity. D. Decrease the number of orders issued per year.
Letter A. Holding costs refer to all the costs associated with holding additional inventory on hand. Ordering a large amount
of inventory increases a company's holding costs thus decreasing the economic order quantity due to a consideration of
minimizing inventory costs. Economic Order Quantity (ECQ) refers to the ideal order quantity a company should purchase
in order to minimize its inventory costs. Therefore, a company should ensure that a right amount of inventory is ordered
within a specified period so as to limit or minimize the holding costs that is associated with it which means that if the
holding cost is high, then the quantity ordered will be decreased to avoid additional expenses that might affect the
company’s profit.
41. Missile Company has correctly computed its economic order quantity as 500 units. However, management feels it
would rather order quantities of 600 units. How should Missile’s total annual purchase-order costs and total annual
carrying cost for an order quantity of 600 units compare to the respective amounts for an order quantity of 500 units?
A. Higher purchase-order cost and lower carrying cost. C. Lower purchase-order cost and higher carrying cost.
B. Higher purchase-order cost and higher carrying cost. D. Lower purchase-order cost and lower carrying cost.
The correction answer is Letter C, the economic order quantity is 500, it is the point where the carrying costs
are minimal. If the company will lift this quantity to 600 units, the purchasing cost per order will be reduced as
they order inventory in less number of orders when compared to previous order and carrying costs will be
increased compared to previous order quantity because we need to manage more inventory. “Larger order size
results in lower order costs because fewer orders need to be placed to cover the annual demand. This however
results in higher holding costs because of the increase in inventory levels”. Therefore, increasing order quantity
from 500 units to 600 units will reduced order cost and increase carrying cost.
42. The following information applies to Lott Enterprises:

Operating income (EBIT) P300,000 Shares 120,000

outstanding
Debt P100,000 EPS P1.45
Interest expense P 10,000 Stock price P17.40
Tax rate 40%
The company is considering a recapitalization where it would issue P348,000 worth of new debt and use the proceeds to
buy back P348,000 worth of common stock. The buyback will be undertaken at the pre-recapitalization share price
(P17.40). The recapitalization is not expected to have an effect on operating income or the tax rate. After the
recapitalization, the company’s interest expense will be P50,000. Assume that the recapitalization has no effect on the
company’s price earnings (P/E) ratio. What is the expected price of the company’s stock following the recapitalization?
A. P15.30 B. P17.75 C. P18.00 D. P19.03
The correct answer is letter C. The expected price of the company’s stock following the recapitalization is P18.00.

EBIT P300,000
Interest (50,000)
EBT 250,000
Tax (40%) (100,00)
NI 150,000
Shares 100,000 shares *120,000 – (348,000/17.40)

EPS 150,000/100,000 = 1.50

P/E (price-earning ratio) 17.40/ 1.45 = 12
Expected price of the company’s stock after recapitalization is = 12 x 1.50 = P18.00
43. Which of the following is NOT relevant in calculating annual net cash flows for an investment?
A. Interest payments on funds borrowed to finance the project.
B. Depreciation on fixed assets purchased for the project.
C. The income tax rate.
D. Lost contribution margin if sales of the product invested in will reduce sales of other products.
correct answer is letter A. Interest received or paid are classified in a consistent manner as either operating,
investing or financing cash activities. However, in this case, it is part of financing activities. Cash flow
from financing activities is a section of a company’s cash flow statement, which shows the net flows of
cash that are used to fund the company. The cash flow from financing activities are the funds that the
business took in or paid to finance its activities. On the other hand, cash flow for an investment reflects a
company's purchases and sales of capital assets. Therefore, interest payments on funds borrowed to
finance the project is NOT relevant in calculating annual net cash flows for an investment.

44. Jumpdisk Company writes checks averaging P15,000 a day, and it takes five days for these checks to clear.
The firm also receives checks in the amount of P17,000 per day, but the firm loses three days while its
receipts are being deposited and cleared. What is the firm’s net float in pesos?
A. P126,000 B. P 75,000 C. P 32,000 D. P 24,000
The correct answer is letter D. To get the net float we simply subtract the cash float from the disbursement float. But
before that, let us first compute for the disbursement float by multiplying 15000 by 5, so that would be equal to 75,000
and the collection float by multiplying 17000 by 3, and that would be equal to 51,000. After that, let us subtract 51000
from 75000. So, the firm’s net float is 24,000.
45. Chadmark Corporation’s budgeted monthly sales are P3,000. Forty percent of its customers pay in the first month and
take the 2 percent discount. The remaining 60 percent pay in the month following the sale and don’t receive a
discount. Chadmark’s bad debts are very small and are excluded from this analysis. Purchases for next month’s
sales are constant each month at P1,500. Other payments for wages, rent, and taxes are constant at P700 per
month. Construct a single month’s cash budget with the information given. What is the average cash gain or
(loss) during a typical month for Chadmark Corporation?
A. P2,600 B. P 800 C. P 776 D. P 740
The correct answer is letter C. To get the average cash gain or loss, what we have to do is to subtract the purchases and
other payments from the monthly sales. First, let us compute for the monthly sales, since only 40% of the customers take
the 2% discount each month, let us multiply 3000 by 40%, so that would be 1,200. Next let us multiply 1,200 by 0.98, so
that would be 1176. After that, let us add the 60% of the 3,000, so the total monthly sale is 2,976. After that, let us
subtract the purchases which amounted to 1500 and other payments which amounted to 700. Thus, the final answer is
776.

46. Through the effects of financial leverage, when EBIT increases, earnings per share will
A. increase. B. decrease. C. remain unchanged. D. change in an undetermined direction.
The correct answer is letter A, an increase in earnings per share. We all know that Financial leverage, also known as
equity leverage or equity investing, it refers to the use of debt to gain additional assets.
Using financial leverage to manage a larger amount of assets (by borrowing money) would increase the return on the
owner's cash investment.
if EBIT increases, then the EBT and net income also increase and so the Earning per share also increase
if the EBIT increase then the Earning per share also increase, because if numerator increase, the ratio also increases
Earnings before interest and taxes calculate all income before interest and tax payments are made, which divides the
capital structure and focuses primarily on how well a business makes a profit.
EBIT is one of the most widely used metrics for calculating the profitability of a company and is frequently used
interchangeably with "operating income."
Option A is wrong because if the numerator in the earning per share the ratio doesn't increase
option C & D is also wrong, because isn't related to financial leverage, it relates to operating leverage
Operating leverage = Contribution / EBIT
operating leverage is the concept of using fixed cost to its maximum potential level to bring down the total cost per unit of
a product, if EBIT increase or decrees, it doesn't affect the operating fixed cost

47. Which of the following describes the annual returns that are discounted in determining the NPV of an investment?
A. Net incomes expected to be earned by the project. B. Pre-tax cash flows expected from
the project.
C. After-tax cash flows expected from the project.
D. After-tax cash flows adjusted for the time value of money.
The correct answer is letter C, the after-tax cash flows expected from the project. The present value of cash flow after
taxes can be calculated to decide whether an investment in a business is worthwhile. Cash Flow After Tax is important for
investors and analysts because it gauges a corporation's ability to meet its cash obligations such as an increase in working
capital and payroll to support growth, make cash investments in fixed assets, or eventually and in the long run, make cash
dividends or distributions. The NPV is a measure that can assess whether an investment opportunity is a good financial
decision. NPV is the present value (PV) of all cash flows (with inflows being positive cash flows and outflows being
negative), which means that the NPV can be called a revenue minus expense formula. If the NPV is positive, this means
that the value of the income (cash inflow) is greater than the expense (cash outflows).
48. The board of directors of Aggressive Company was unhappy with the current return on common equity. Though
the return on sales (profit margin) was impressively good at 12.5 percent, the asset turnover was only 0.75. The
present debt ratio is 0.40.
Ms. Sylvia Moreno, the vice-president of corporate planning, presented a proposal as follows:
• Profit margin should be raised to 15 percent.
• The new capital structure will be revised by raising debt component.
• The asset turnover will be maintained at 0.75.
The proposed adjustment is estimated to raise return on equity by 50 percent.
What debt ratio did Ms. Moreno propose in order to raise the return on equity (ROE) to 150 percent of the present
level?
A. 0.52 C. 0.61
B. 0.68 D. 0.72
Return on Assets = Asset Turnover ratio x Return on Sales
=.125 x 0.75
=0.09375
Current Return on Equity= 9.375 /0 .60
= 15.625
Target ROE = 15.625 x 1.50
= 23.4375%
Let x = Debt ratio
0.234375 = (15 x 75) / 1 – x
X= 52%

First, get the ROA , multiply the Asset Turnover Ratio with your Return on Sale. After getting the ROA, we will proceed on
computing the current Return on Equity by dividing the ROA by 0.60 (1-0.40) which results to 23.4375%. To finally get the
debt ratio, we will let x = debt ratio . (refer to the equation above) 0.23475 is equal to 15 multiplied by 75 over 1 minus x. X
then will be equals to 52%

49. When income taxes are considered in capital budgeting, the cash flows related to a company's advertising expense
would be correctly figured by taking the cash paid for advertising and: A. adding the result of multiplying
(advertising expense x tax rate).
B. adding the tax rate.
C. adding the result of multiplying [advertising expense x (1 - tax rate)].
D. subtracting the result of multiplying (advertising expense x tax rate).
The correct answer is letter D since the effects of income taxes on cash flows must be considered in capital budgeting
decisions when an organization is subject to income taxes. Advertising expenses which are incurred to stimulate current
sales are considered as business expenses. As such, these could be claimed as income tax deduction in the period when
they are actually incurred. Tax deductible expenses decrease the company's net taxable income and reduce the taxes the
company must pay.
50. A bank lends a firm P1,000,000 for one year at 12 percent on a discounted basis and requires compensating
balances of 10 percent of the face value of the loan. The effective annual interest rate associated with this loan is
A. 12 percent. B. 13.3 percent. C. 13.6 percent. D. 15.4 percent.
Interest rate= 12% or 0.12
Amount of loan= 1000000
Interest deducted on loan =1000000*0.12= 120,000
Compensating balance = 10% of face value = 10%*1,000,000= 100,000
Effective loan rate on Discount Loan with compensating balance = Interest /((Amount- interest deducted-Compensating
balance)*100
= 120,000/ (1,000,000-120,000-100,000)*100
= 15.38461538
So, effective rate is 15.4%
51. Assume that a capital project is being analyzed by a discounted-cash-flow approach, and an employee first assumes
no income taxes and then later assumes a 30% income tax rate. How would depreciation expense be incorporated in
the analysis?
30% Income
No Income Taxes Tax Rate
A. Considered Considered
B. Considered Ignored
C. Ignored Considered
D. Ignored Ignored
The correct answer is letter C because wherein it should be ignored if there are no income taxes and it should be
considered if there is a 30% income tax rate. It is because discounted cash flow is a valuation method used to estimate
the value of an investment based on its expected future cash flows. The purpose of the analysis is to find the present
value of the expected future cash flow by using the discount rate, so the 30% income tax rate should really be considered
since it is the main point on why the discounted- cash-flow-approach is used.
52. The primary advantages of the average rate of return method are its ease of computation and the fact that:
A. It is especially useful to managers whose primary concern is liquidity
B. There is less possibility of loss from changes in economic conditions and obsolescence when the commitment is
short-term
C. It emphasizes the amount of income earned over the life of the proposal
D. Rankings of proposals are necessary
.The correct answer is letter C. It emphasizes the amount of income earned over the life of the proposal. It is because the
average rate of return method allows for a simple comparison between different types of investments. Since it results in a
single percentage, investors can investment's returns if it produces its average rate of return in the future. Letter A is
incorrect because the average rate of return is useful to investors to learn about their options before deciding to commit
money to a particular investment. Letter B is also incorrect because it is not an advantage of the average rate of return
method as it talks about the economic life not the average rate of return method the same as well in Letter D as it doesn't
relate to average rate of return method. Thus, letter C is the correct answer
53. Colt Inc. is planning to use retained earnings to finance anticipated capital expenditures. The beta coefficient for Colt's
stock is 1.15, the risk-free rate of interest is 8.5 percent, and the market return is estimated at 12.4%. If a new issue
of common stock was used in this model, the flotation costs would be 7%. By using the Capital Asset Pricing Model,
the cost of using retained earnings to finance the capital expenditures is:
A. 13.96 percent. B. 12.99 percent. C. 14.26 percent. D. 13.21 percent.
The Capital Asset Pricing Model can be calculated using the CAPM formula:
E(Ri)= Rf + Bi (E(Rm) - Rf)

E(Ri) - capital asset expected return

Rf - risk-free rate of interest
Bi- sensitivity
E(Rm) - expected return of the market

E(Ri)= Rf + Bi (E(Rm) - Rf)

E(Ri) = 8.5% + 1.15 (12.4% - 8.5%)
= 8.5% + 1.15 ( 3.9%)
12.99%
So, the cost of using retained earnings to finance the capital expenditures is 12.99 percent
54. Consider the following statements:
Statement A - In capital budgeting, the preferred approaches in assessing whether a project is acceptable are those that
integrate time value procedures, risk and return considerations, and valuation concepts.
Statement B - In the case of annuity cash inflows, the payback period can be found by dividing the initial investment by
the annual cash inflow.
Statement C - The payback period is the exact amount of time required for the firm to recover the installed cost of a new
asset.
Statement D - The payback period is generally viewed as an unsophisticated capital budgeting technique, because it does
not explicitly consider the time value of money by discounting cash flows to find present value.
Statement E - One weakness of payback is its failure to recognize cash flows that occur after the payback period.
Statement F - The major weakness of payback period in evaluating projects is that it cannot specify the appropriate
payback period in light of the wealth maximization goal.
Statement G - If the payback period is less than the maximum acceptable payback period, we would reject a project.
Which of the statements above are not true?
A. Statements D and G only. C. Statements C , F, and G only.
B. Statements C and G only. D. Statements D, F, and G only.
The correct answer is letter B. Among the seven statements, only statement C and G are not true. Statement C states that
the payback period is the exact amount of time required for the firm to recover the installed cost of a new asset. Well in
fact, payback period disregards the time value of money. It is determined by counting the number of years it takes to
recover the funds invested.
On the other hand, statement G is incorrect as well. It should be that if the payback period is less than the maximum
acceptable payback period, we should accept the project and if it is greater than the maximum acceptable payback period,
we should reject the project. The reason is that the project with a shortest payback period has less risk than with the
project with longer payback period. An investment with a shorter payback period is considered to be better, since the
investor's initial outlay is at risk for a shorter period of time.
55. On average, a firm sells P2,000,000 in merchandise a month. It keeps inventory equal to one-half of its monthly
sales on
hand at all times. If the firm analyzes its accounts using a 365-day year, what is the firm’s inventory conversion period?
A. 365.0 days B. 182.5 days C. 30.3 days D. 15.2 days
The answer is letter D which is 15.2 days, in order to arrived with this answer we must first recall the formula in order to
get the inventory conversion period which is Sales divided by its inventory or what we called Inventory Turnover then the
number of days in a year is divided by the Inventory Turnover.

So in this problem, the monthly sales of 2M will be multiplied by 12 months so it will become 24M then divide it by 1M
since it's stated here that inventory is equal to one-half of the sales at ALL TIMES which is 2M. So the Inventory turnover
would be 24 times. Finally, to get the inventory conversion period we will divide 365 days which is given in the problem
with 24 as Inventory turnover, then it will result in 15.2 days.
56. A financial manager usually prefers to issue preferred stock rather than debt because A. Payments to
preferred stockholders are not considered fixed payments.
B. The cost of fixed debt is less expensive since it is tax deductible even if a sinking fund is required to retire the
debt.
C. The preferred dividend is often cumulative, whereas interest payments are not.
D. In a legal sense, preferred stock is equity; therefore, dividend payments are not legal obligations.
The answer is letter D which is because in a legal sense, preferred stock is equity; therefore, dividend payments are not
legal obligations. The reason for being considered as Equity is that, this preferred stock gives the holders a percentage
share of the company's profit, and ownership of the company's assets which aren't present in debt. Also, preferred stock
doesn't mature unlike debt and it simply get fixed interest payments along with repayment of principal. Thus, this serves a
good way to finance the company's project because some investors want more consistent dividends and stronger
bankruptcy protections.
57. When calculating the cost of capital, the cost assigned to retained earnings should be
A. Zero C. Equal to the cost of external common equity
B. Lower than the cost of external common equity D. Higher than the cost of external common equity
To complete this statement, it should be letter b. lower than the cost of external equity. The reason for this is that the
only cost incurred when these retained earnings are reinvested back into the company is the Opportunity cost. It should
be lower because this opportunity cost shows the rate in which the stockholders can earn in buying other similar stocks
with the same risks so this serves as their basis whether to reinvest back to the company or not. Moreover, the cost of
external equity involves flotation cost which lowers the amount of capital that a company can raise.
58. The dividend growth model, when used, assumes that the total return on a share of common stock is comprised of a:
A. capital gains yield and a dividend growth rate. C. dividend yield and the expected price next
year.
B. capital gains growth rate and a dividend growth rate. D. dividend yield and a capital gains yield.
The correct answer is D because when the dividend growth model is used the total rate of return is assumed to be
composed of dividend yield and capital gains yield because common stockholders receive their returns in dividend income
and capital appreciation. Dividend income puts cash in their pockets while capital appreciation means stock price increases
over time. Most stock returns come from capital appreciation, but the dynamic between growth and income changes over
time.
59. The capital asset pricing model (CAPM) states that:
A. The expected risk premium on an investment is proportional to its beta.
B. The expected rate of return on an investment is proportional to its beta.
C. The expected rate of return on an investment depends on the risk-free rate and the market rate of return.
D. The expected rate of return on an investment is dependent on the risk-free rate.
The correct answer is A because The Capital Asset Pricing Model (CAPM) describes the relationship between systematic
risk and expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities
and generating expected returns for assets given the risk of those assets and cost of capital. The CAPM definition is that it
precisely determines the expected return from an asset’s beta. In other words, it is the stock's sensitivity to market risk.
For instance, if a company's beta is equal to 1.5 the security has 150% of the volatility of the market average. However, if
the beta is equal to 1, the expected return on a security is equal to the average market return
60. The drawback of the CAPM is that it:
A. Ignores the return on the market portfolio C. Ignores risk-free return
B. Requires a single measure of systematic risk D. Utilizes too many factors
The correct answer is B because the CAPM takes into account systematic risk (beta), which is left out of other return
models, such as the dividend discount model (DDM). Systematic or market risk is an important variable because it is
unforeseen and, for that reason, often cannot be completely mitigated. The issue with using this input is that the yield
changes daily, creating volatility. In order to use the CAPM, values need to be assigned to the risk-free rate of return, the
return on the market, or the equity risk premium and the equity beta. The yield on short-term government debt which is
used as a substitute for the risk-free rate of return, is not fixed but changes on a daily basis according to the economic
circumstances. A short-term average value can be used to smooth out its volatility.

61. Which of the following factors is inherent in a firm's operations if it utilizes only equity financing?
A. Financial risk. B. Business risk. C. Interest rate risk. D. Marginal risk.
Letter A, Financing risk, is incorrect since it does not include possibility of losing money on an investment or business
venture. Then letter C, Interest rate risk, is also incorrect since the company does not have debt it does not face interest
rate risk, the potential for investment losses that result from a change in interest rates does not evolve. And letter D,
Marginal risk, is incorrect because it is not a typical business term. Thus, the correct answer is letter B, Business risk. A
firm that utilizes only equity financing would face business risk. Business risk derives from the broad, macro-risk a firm
faces largely as a result of the relationship between the firm and the environment in which it operates. The extent of that
risk would depend on the susceptibility of the firm to changes in the overall economic climate.
62. An advantage of the use of long-term debt as opposed to short-term debt to finance current assets is
A. It decreases the risk of the firm. C. It generally places fewer restrictions on the firm.
B. It generally is less costly than short-term debt. D. It is easy to repay.
An advantage of the use of long-term debt as opposed to short-term debt to finance current assets is it decreases the risk
of the firm. Long-term, fixed-rate financing minimizes the refinancing risk that comes with shorter-term debt maturities,
due to its fixed interest rate, thus decreasing a company’s interest rate and balance sheet risk. Letter B is incorrect since
the maturity associated with long-term financing better coordinates with the typical lifespan of assets purchased. Letter C
is also incorrect, as Long-term financing provides greater flexibility and resources to fund various capital needs, and
reduces dependence on any one capital source. Letter D is incorrect as Long-term financing enables a company to align its
capital structure with its long-term strategic goals, affording the business more time to realize a return on an investment.
63. Which of the following is an advantage of equity financing in comparison to debt financing?
A. Issuance costs are greater than for debt.
B. Ownership is given up with respect to the issuance of common stock.
C. Dividends are not tax deductible by the corporation whereas interest is tax deductible.
D. The company has no firm obligation to pay dividends to common shareholders.
The requirement is to identify the advantage of equity financing in comparison to debt financing. First is “issuance costs
are greater than for debt”, it is incorrect because it is a disadvantage of equity financing. Next is, “ownership is given up
with respect to the issuance of common stock”, it is considered a disadvantage of equity financing. Also, “dividends are
not tax deductible by the corporation whereas interest is tax deductible” belongs to the disadvantage of equity financing.
Thus, the correct answer is letter D. It is correct because the lack of a firm obligation to pay dividends to common
shareholders is an advantage of equity financing.
64. An increase in fixed operating costs will result in _________ in the degree of operating leverage.
A. a decrease B. an increase C. no change D. an undetermined change
Letter B is the correct answer which is an increase in the degree of operating leverage, because operating leverage
primarily tackles the degree measurement of which a company can increase operating income by increasing revenue.
Hence, this also pertains to the fixed operating costs in relation to the variable operating costs of the company since
income and cost has an indirect relationship. Consequently, increasing the fixed costs shall lead to a higher or an increase
degree of operating leverage and a higher degree of O.L then creates an additional change in its revenue.
65. The Altman Company has a debt ratio of 33.33 percent, and it needs to raise P100,000 to expand. Management feels
that an optimal debt ratio would be 16.67 percent. Sales are currently P750,000, and the total assets turnover is 7.5.
How should the expansion be financed so as to produce the desired debt ratio?
A. 100% equity C. 20 percent debt, 80 percent equity B. 100% debt
D. 40 percent debt, 60 percent equity

So we are being asked as to how we can finance the expansion as to the production of the desired debt ratio. In getting
the answer, we firstly solve the current debt level by multiplying 100k by 0.3333 and that is 33,330. Second is to check
the achieved debt ratio of 16.67% by having (debt + 33,330) / 200k which is 0.1667 as a result. The total asset is
increased to 200k because we received financing for the project. Thus, solving the equation yields debt to zero. Which
means that in doing the entire financing equity requires 100% of its equity itself. And that is letter a from the question.

66. Assume that Company A and Company B are alike in all respects except that Company A utilizes more debt financing
and less equity financing than does Company B. Which of the following statements is true?
A. Company A has more net earnings variability than Company B.
B. Company A has more operating earnings variability than Company B.
C. Company A has less operating earnings variability than Company B.
d. Company A has less financial leverage than Company B.
In this item, letter a is the correct answer because company A is more highly leveraged. It has greater fixed charges in the
form of interest. Thus, it will have more volatile net earnings than company B. Letters b and c are incorrect, because the
level of fixed financing charges does not affect operating earnings variability. The operating income is computed before
interest expense. Also, letter d is incorrect because comp. A has greater, not less, financial leverage than comp. B.

67. Which of the following factors generally does not impact management’s capital structure strategy?
A. Business risk. B. Tax position. C. Management aggressiveness. D. Expected return on assets.
The requirement is to identify the factor that does not affect management's judgment about the firm's capital structure.
Answer (d) is correct because the expected return on assets is not a factor that affects management's judgment about the
firm's capital structure. Answer (a) is incorrect because the greater the inherent risk of a business, the lower the optimal
debt to equity ratio. Answer (b) is incorrect because a major advantage of debt is the tax deductibility of interest
payments. Answer (c) is incorrect because a firm's target capital structure will be affected by the risk tolerance of
management. More aggressive management may take on more debt.
68. After satisfying obligations to creditors, the government, and preferred stockholders, any remaining earnings will most
likely be allocated to any of the following EXCEPT
A. common shareholders as cash dividends.
B. common shareholders as stock dividends.
C. retained by the firm for future investment.
D. a combination of retained earnings and cash dividends.
Letter (a)(c)(d) are the best answer but the requirement is except of the following so the correct answer is (b). Letter (a)
common shareholders as cash dividends in which a cash dividend is the distribution of funds or money paid to
stockholders generally as part of the corporation's current earnings or accumulated profits. Cash dividends are paid
directly in money, as opposed to being paid as a stock dividend or other form of value. Letter (c) retained by the firm for
future investment which is the retained earnings (RE) is the amount of net income left over for the business after it has
paid out dividends to its shareholders. A business generates earnings that can be positive (profits) or negative (losses).
Letter (d) is a combination of retained earnings and cash dividends ,when the dividends are paid, the effect on the
balance sheet is a decrease in the company's retained earnings and its cash balance. In other words, retained earnings
and cash are reduced by the total value of the dividend. Thus, letter (b) is the answer which is the common shareholders
as stock dividends, A stock dividend, a method used by companies to distribute wealth to shareholders, is a dividend
payment made in the form of shares rather than cash. Stock dividends are primarily issued in lieu of cash dividends when
the company is low on liquid cash on hand. The board of directors decides on when to declare a (stock) dividend and in
what form the dividend will be paid.
69. The inexpensive nature of long-term debt in a firm’s capital structure is due to the fact that A. the equity holders are
the true owners of the firm.
B. equity capital has a fixed return.
C. creditors have a higher position in the priority of claims.
D. dividend payments are tax-deductible.
Answer (c) is the correct answer because creditors have the highest priority and paid first before stockholders. Answer (a)
is incorrect because a corporation is considered by the law to be a person with rights and therefore it can't be owned by a
person. What actually an equity stockholders owned are stocks and not the corporation itself. Answer (b) is incorrect
because equity capital is for perpetuity and not returned. Answer (d) is incorrect because dividends payment is not tax
deductible because these are distribution of profits not interest payments
70. As debt is substituted for equity in the capital structure and the debt ratio increases, all of the following statements
about the component costs of capital are true EXCEPT A. the cost of equity continually increases.
B. the cost of debt continually increases.
C. the overall cost of capital first declines, reaches a minimum, and then rises again.
D. the overall cost of capital continually increases.
D is the correct answer since this is the only exception. Since increases in debt, results in the reduction of the cost of
capital because of tax deductibility.

A and B are not the answer for both are true. Since there is a substitution there is an increase of the volatility of dividend
payment to shareholders. If the financial risk to shareholders increases, they will require a greater return to compensate
them for this increased risk, thus the cost of equity will increase. The cost of debt increases as the cost of equity also
starts to increase. Since there is an increase in the financial risk, shareholders want a higher return so there is increased
cost of financial distress at higher debt levels.

And C is true since eventually, the rate at which creditors and investors increase their required rates of return accelerates
and dominates the weighting toward debt, pushing the cost of capital back upward. The result is that the cost of capital
declines with debt and reaches a minimum point before rising again.
71. Poor capital structure decisions can result in _________ the cost of capital, resulting in _________ acceptable
investments. Effective capital structure decisions can _________ the cost of capital, resulting in _________
acceptable investments.
A. increasing; fewer; lower; more C. increasing; more; lower, fewer
B. decreasing; more; higher; fewer D. decreasing; fewer; higher; more
A is the correct answer since assuming a perfect market is how a firm designs its capital structure. A poor capital structure
may result in a higher cost of capital and, consequently, lower firm value. A healthy capital structure reflects low levels of
debt and a high amount of equity thus creating a positive sign of investment quality.

B, C, and D are not correct since it doesn’t navigate to the correct results of each feedback. Investors are more on putting
off their money to firm’s with a secured balance sheet. Thus, there is a need for effective capital structure decisions for it
should reflect lower levels of debt but higher levels of equity
72. A firm is analyzing two possible capital structures—30 and 50 percent debt ratios. The firm has total assets of
P5,000,000 and common stock valued at P50 per share. The firm has a marginal tax rate of 40 percent on ordinary
income. The number of common shares outstanding for each of the capital structures would
be A. 30 percent debt ratio: 30,000 shares and 50 percent debt ratio: 50,000 shares. B. 30
percent debt ratio: 50,000 shares and 50 percent debt ratio: 70,000 shares.
 C. 30 percent debt ratio: 70,000 shares and 50 percent debt ratio: 100,000 shares.
D. 30 percent debt ratio: 70,000 shares and 50 percent debt ratio: 50,000 shares.
D is the correct answer since by getting the number of common shares outstanding we have to multiply the value of total
assets to the respective debt ratio and divide by the value per share . To get the value of equity at 30% debt ratio the
value of total assets of 5 million should be multiplied to 70%; and for the 50% debt ratio the total assets of 5 million
should still be multiplied by 50%. Each is divided by the common stock value at P50 per share respectively. Thus resulting
in 70,000 shares outstanding at 30% debt ratio and 50,000 shares outstanding at 70% debt ratio. Calculating a firm’s
outstanding shares is relevant since it also allows the company to calculate its earnings per share which is a measurement
of how much money a company makes for each share of its stock.
73. A firm has interest expense of P145,000, preferred dividends of P25,000, and a tax rate of 40 percent. The firm’s
financial breakeven point is
A. P 25,000. B. P170,000. C. P186,667. D. P145,000.
The correct answer is letter C because the formula in getting the financial breakeven point is preferred dividends divided
by 1 less tax rate plus interest expense. And the result of the calculation is 186,666.6666 or 186,667. Additionally,
financial break-even point is a point defining the level before EBIT at which the earnings per share of the company is
equal to zero
74. A firm with a higher degree of operating leverage when compared to the industry average implies that the
A. Firm has higher variable costs.
B. Firm’s profits are more sensitive to changes in sales volume.
C. Firm is more profitable.
D. Firm is less risky.
The correct answer is letter B. Since operating leverage is a measure of how much debt a company uses to finance its
ongoing operations, the changes in sales volume really affects the firm’s profits since in sales the company can get money
to pay its debt. Letter a is incorrect because higher leveraged firms have less variable costs because a firm that has high
operating leverage should cover a larger amount of fixed cost each month. Letter C is incorrect because the firm may or
may not be more profitable since it depends on the sales volume and letter d is incorrect because a firm with high
leverage is more risky.
75. Eagle Sporting Goods has P2.5 million in inventory and P2 million in accounts receivable. Its average daily sales are
P100,000. The firm’s payables deferral period is 30 days and average daily cost of sales are P50,000. What is the length
of the firm’s cash conversion period?
A. 100 days. B. 60 days. C. 50 days. D. 40 days.
The correct answer is letter D. And in computing this problem, the first step to take is to calculate the inventory
conversion period which is inventory divided by cost of goods sold per day which is 50 days. Next one is the average
collection period which is computed by sales per day divided to receivables which results to 20 days. Next step is getting
the payables deferral period which is payables divided by purchases per day and since the deferral period is already given
which is 30 days, it will only be subtracted to the sum of 50 and 20 days and the result is 40 days.

Nothing follows.
Acctg235 :: Final Assessment Study Material :: December 2020

1
A
2
C
3
A
4
D
5
D
6
D
7
C
8
D
9
D
10
A
11
B
12
B
13
B 14
C
15
A
16
A
17
C
18
C
19
D
20
D
21
B 22
A 23
B
24
A
25
D
26
B
27
B
28
B
29
A
30
A
31
D
32
C
33
B 34

A
35
B
36
C
37
D
38
D
39
B
40
A
41
C
42
C
43
A
44
D
45
C
46
A
47
C
48
A
49
D
50
D
51
C
52
C
53
B
54
B
55
D
56
D
57
B

58
D
59
A
60
B
61
B
62
A
63
D
64
B 65

A
66
A
67
D
68
B 69
C
70
D
71
A
72
D
73
C 74
B
75
D