PROBLEM SOLVING QUESTIONS (4 points per question)
1. Below are the 2007 and 2008 year-end balance sheets for Tran Enterprises:
Total current assets
Net fixed assets
Liabilities and equity:
Total current liabilities
Total common equity
Total liabilities and equity
The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt in 2007. As of the end of 2008, none of the principal on this debt had been repaid. Assume that the company’s sales in 2007 and 2008 were the same. Which of the following statements must be CORRECT?
The firm increased its short-term bank debt in 2008.
The firm issued long-term debt in 2008.
The firm issued new common stock in 2008.
The firm had negative net income in 2008.
2. Consider the following balance sheet, for Games Inc. Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000.
Cash $ 50,000 Accounts payable $ 100,000 Inventory 200,000 Accruals 100,000 Accounts receivable 250,000 Total CL $ 200,000 Total CA $ 500,000 Debt 200,000 Net fixed assets $ 900,000 Common stock 200,000 Retained earnings 800,000 Total assets $1,400,000 Total L & E $1,400,000
A) True B) False
3. Jordan Inc has the following balance sheet and income statement data:
Cash $ 14,000 Accounts payable $ 42,000
Receivables 70,000 Other current liab. 28,000
Inventories 280,000 Total CL $ 70,000
Total CA $364,000 Long-term debt 140,000
Net fixed assets 126,000 Common equity 280,000
Total assets $490,000 Total liab. and equity $490,000
Net income $ 21,000
The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.75, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change?
Current ratio= Current assets/ Current Liabilities
ROE = Net Income / Shareholder’s Equity
ΔROE = ROE2 - ROE1
Current Ratio= 364000/70000=5.2%
ROE1=21000/280000=0,075 or 7,5%
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