AEC 205 – EXAM 1 1-21-22 PSBA

TEST I – THEORIES
1. 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.

2. The income statement shows the difference between a firm's income and its costs--i.e.,
its profits--during a specified period of time. However, not all reported income comes in
the form of cash, and reported costs likewise may not be consistent with cash outlays.
Therefore, there may be a substantial difference between a firm's reported profits and its
actual cash flow for the same period.

3. Free cash flow (FCF) is, essentially, the cash flow that is available for interest and
dividends after the company has made the investments in current and fixed assets that
are necessary to sustain ongoing operations.

4. If a firm is reporting its income in accordance with generally accepted accounting

principles, then its net income as reported on the income statement should be equal to its
free cash flow.

5. Both interest and dividends paid by a corporation are deductible operating expenses,
hence they decrease the firm's taxes.

6. Assume that two firms are both following generally accepted accounting principles. Both
firms commenced operations two years ago with P1million of identical fixed assets, and
neither firm sold any of those assets or purchased any new fixed assets. The two firms
would be required to report the same amount of net fixed assets on their balance sheets
as those statements are presented to investors.

7. Net operating working capital is equal to current assets minus the difference between
current liabilities and notes payable. This definition assumes that the firm has no "excess"
cash.

8. An increase in accounts payable represents an increase in net cash provided by operating

activities just like borrowing money from a bank. An increase in accounts payable has an
effect similar to taking out a new bank loan. However, these two items show up in different
sections of the statement of cash flows to reflect the difference between operating and
financing activities.

9. Which of the following statements is CORRECT?

 a. The balance sheet for a given year is designed to give us an idea of what happened
to the firm during that year.
b. The balance sheet for a given year tells us how much money the company earned
during that year.
c. The difference between the total assets reported on the balance sheet and the liabilities
reported on this statement tells us the current market value of the stockholders' equity,
assuming the statements are prepared in accordance with generally accepted
accounting principles (GAAP).
d. If a company's statements were prepared in accordance with generally accepted
accounting principles (GAAP), the market value of the stock equals the book value of
the stock as reported on the balance sheet.
e. The assets section of a typical company's balance sheet begins with cash, then lists
the assets in the order in which they will probably be converted to cash, with the longest
lived assets listed last.

10. Considered alone, which of the following would increase a company's current ratio?
a. An increase in net fixed assets.
b. An increase in accrued liabilities.
c. An increase in notes payable.
d. An increase in accounts receivable.
e. An increase in accounts payable.

11. Companies E and P each reported the same earnings per share (EPS), but Company E's
stock trades at a higher price. Which of the following statements is CORRECT?
a. Company E probably has fewer growth opportunities.
b. Company E is probably judged by investors to be riskier.
c. Company E must have a higher market-to-book ratio.
d. Company E must pay a lower dividend.
e. Company E trades at a higher P/E ratio.

12. If a bank loan officer were considering a company's loan request, which of the following
statements would you consider to be CORRECT?
a. The lower the company's inventory turnover ratio, other things held constant, the lower
the interest rate the bank would charge the firm.
b. Other things held constant, the higher the days sales outstanding ratio, the lower the
interest rate the bank would charge.
c. Other things held constant, the lower the total debt to total capital ratio, the lower the
interest rate the bank would charge.
d. The lower the company's TIE ratio, other things held constant, the lower the interest
rate the bank would charge.
e. Other things held constant, the lower the current ratio, the lower the interest rate the
bank would charge the firm.

13. Which of the following statements is CORRECT?

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

14. You observe that a firm's ROE is above the industry average, but both its profit margin
and equity multiplier are below the industry average. Which of the following statements is
CORRECT?
a. Its total assets turnover must be above the industry average.
b. Its return on assets must equal the industry average.
c. Its TIE ratio must be below the industry average.
d. Its total assets turnover must be below the industry average.
e. Its total assets turnover must equal the industry average.

15. Which of the following statements is CORRECT?

a. The ratio of long-term debt to total capital is more likely to experience seasonal
fluctuations than is either the DSO or the inventory turnover ratio.
b. If two firms have the same ROA, the firm with the most debt can be expected to have
the lower ROE.
c. An increase in the DSO, other things held constant, could be expected to increase the
total assets turnover ratio.
d. An increase in the DSO, other things held constant, could be expected to increase the
ROE.
e. An increase in a firm's total debt to total capital ratio, with no changes in its sales or
operating costs, could be expected to lower its profit margin.

TEST II – PROBLEM SOLVING

Problem 1
Brown Fashions Inc.'s December 31, 2014, balance sheet showed total common equity of
P4,050,000 and 200,000 shares of stock outstanding. During 2014, the firm had P450,000 of net
income, and it paid out P100,000 as dividends.
 16. What was the book value per share at 12/31/14, assuming no common stock was either
issued or retired during 2014?
a. P20.90
b. P22.00
c. P23.10
d. P24.26
e. P25.47

Problem 2
Prezas Company's balance sheet showed total current assets of P4,250, all of which were
required in operations. Its current liabilities consisted of P975 of accounts payable, P600 of 6%
short-term notes payable to the bank, and P250 of accrued wages and taxes.

17. What was its net operating working capital?

a. 2,874
b. 3,025
c. 3,176
d. 3,335
e. 3,502

Problem 3
Brown Office Supplies recently reported P15,500 of sales, P8,250 of operating costs other than
depreciation, and P1,750 of depreciation. It had P9,000 of bonds outstanding that carry a 7.0%
interest rate, and its income tax rate was 40%.

18. How much was the firm's earnings before taxes (EBT)?
a. P4,627
b. P4,870
c. P5,114
d. P5,369
e. P5,638

Problem 4
Over the years, O'Brien Corporation's stockholders have provided P20,000,000 of capital, when
they purchased new issues of stock and allowed management to retain some of the firm's
earnings. The firm now has 1,000,000 shares of common stock outstanding, and it sells at a
price of P38.50 per share.

19. How much value has O'Brien's management added to stockholder wealth over the
years, i.e., what is O'Brien's MVA?
a. P18,500,000
b. P18,870,000
c. P19,247,400
d. P19,632,348
e. P20,024,995
Problem 5

The following are extracted from Antonio’s financial data for the years December 31, 2020 and
2021:

2021 2020
Cash P170,000 P90,000
Accounts receivable (net) 450,000 400,000
Merchandise inventory 540,000 420,000
Short-term marketable securities 80,000 40,000
Land and building (net) 1,000,000 1,000,000
Mortgage payable – current portion 60,000 50,000
Accounts payable and accrued liabilities 240,000 220,000
Short-term notes payable 100,000 140,000

Net credit sales totaled to P3,000,000 and P2,000,000 for the years ended December 31, 2021
and 2020, respectively.

20. At December 31, 2021, what was Antonio’s current ratio? (Input your answer to 2
decimal places e. g. 5.12)

21. At December 31, 2021, what was Antonio’s quick asset ratio? (Input your answer to 2
decimal places e. g. 5.12)

22. For 2021, what was Antonio’s accounts receivable turnover? (Input your answer to 2
decimal places e. g. 5.12)

Problem 6
The following are extracted from Tony’s financial data for 2021:

Operating income P900,000

Interest expense 100,000
Income before tax 800,000
Income tax expense 320,000
Net Income 480,000
Preferred stock dividends 200,000
Net income available to common stockholders P280,000
Common stock dividends P120,000

23. What was the times interest earned ratio? (Input your answer to 1 decimal place e. g. 5.1
if your answer is with decimal, if not, input e. g. 8)

24. What was the times preferred dividend ratio? (Input your answer to 1 decimal place e. g.
5.1 if your answer is with decimal, if not, input e. g. 8)

25. What is the basic EPS assuming there are 10,000 outstanding common shares? (No sign
of peso for the answer)