1.

Companies HD and LD have the same tax rate, sales, total assets, and basic earning
power. Both companies have positive net incomes. Company HD has a higher debt
ratio and, therefore, a higher interest expense. Which of the following statements is
CORRECT?
a. Company HD has a lower equity multiplier.
b. Company HD has more net income.
c. Company HD pays more in taxes.
d. Company HD has a lower ROE.
e. Company HD has a lower times interest earned (TIE) ratio.

2. Walter Industries’ current ratio is 0.5. Considered alone, which of the following actions
would increase the company’s current ratio?
a. Borrow using short-term notes payable and use the cash to increase inventories.
b. Use cash to reduce accruals.
c. Use cash to reduce accounts payable.
d. Use cash to reduce short-term notes payable.
e. Use cash to reduce long-term bonds outstanding.

3. Van Buren Company has a current ratio = 1.9. Which of the following actions will increase the
company’s current ratio?
a. Use cash to reduce short-term notes payable.
b. Use cash to reduce accounts payable.
c. Issue long-term bonds to repay short-term notes payable.
d. All of the statements above are correct.
e. Statements b and c are correct.

4. Which of the following actions can a firm take to increase its current ratio?
a. Issue short-term debt and use the proceeds to buy back long-term debt with a maturity of more than
one year.
b. Reduce the company’s days sales outstanding to the industry average and use the resulting cash
savings to purchase plant and equipment.
c. Use cash to purchase additional inventory.
d. Statements a and b are correct.
e. None of the statements above is correct.

5. Drysdale Financial Company and Commerce Financial Company have the same total assets, the
same total assets turnover, and the same return on equity. However, Drysdale has a higher
return on assets than Commerce. Which of the following can explain these ratios?
a. Drysdale has a higher profit margin and a higher debt ratio than Commerce.
b. Drysdale has a lower profit margin and a lower debt ratio than Commerce.
c. Drysdale has a higher profit margin and a lower debt ratio than Commerce.
d. Drysdale has lower net income but more common equity than Commerce.
e. Drysdale has a lower price earnings ratio than Commerce.

6. Which of the following statements is most correct?

a. A firm with financial leverage has a larger equity multiplier than an otherwise identical firm with no
debt in its capital structure.
b. The use of debt in a company’s capital structure results in tax benefits to the investors who purchase
the company’s bonds.
c. All else equal, a firm with a higher debt ratio will have a lower basic earning power ratio.
d. All of the statements above are correct.
e. Statements a and c are correct.