Name: ________________________ Class: ___________________ Date: __________ ID: A

Sample Questions for Mini-Test 1

Multiple Choice
Identify the letter of the choice that best completes the statement or answers the question.

____ 1. Which of the following is likely to encourage a firm's managers to make decisions that are in the best interest
of shareholders?
a. Executive compensation comes primarily in the form of stock options.
b. The state legislature recently passed a law that makes it more difficult to successfully
complete a hostile takeover.
c. Institutional investors such as mutual funds and pension funds hold large amounts of the
firm's stock.
d. Statements a and b are correct.
e. Statements a and c are correct.
____ 2. Last year, Owen Technologies reported negative net cash flow and negative free cash flow. However, its cash
on the balance sheet increased. Which of the following could explain these changes in its cash position?
a. The company had a sharp increase in its depreciation and amortization expenses.
b. The company had a sharp increase in its inventories.
c. The company issued new common stock.
d. Statements a and b are correct.
e. Statements a and c are correct.
____ 3. At the end of 2001, Scaringe Medical Supply had $275 million of retained earnings on its balance sheet.
During 2002, Scaringe paid a per-share dividend of $0.25 and produced earnings per share of $0.75. Scaringe
has 20 million shares of stock outstanding. What was the level of retained earnings that Scaringe had on its
balance sheet at the end of 2002?
a. $255 million
b. $265 million
c. $275 million
d. $285 million
e. $295 million
____ 4. Nelson Company is thinking about issuing new common stock. The proceeds from the stock issue will be
used to reduce the company's outstanding debt and interest expense. The stock issue will have no effect on
the company's total assets, EBIT, or tax rate. Which of the following is likely to occur if the company goes
ahead with the stock issue?
a. The company's net income will increase.
b. The company's times interest earned ratio will increase.
c. The company's ROA will increase.
d. All of the above statements are correct.
e. None of the above statements is correct.

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Name: ________________________ ID: A

Dokic, Inc.
Dokic, Inc. reported the following balance sheets for year-end 2001 and 2002 (dollars in millions):

2002 2001
Cash $ 650 $ 500
Accounts receivable 450 700
Inventories 850 600
Total current assets $1,950 $1,800
Net fixed assets 2,450 2,200
Total assets $4,400 $4,000

Accounts payable $ 680 $ 300

Notes payable 200 600
Wages payable 220 200
Total current liabilities $1,100 $1,100
Long-term bonds 1,000 1,000
Common stock 1,500 1,200
Retained earnings 800 700
Total common equity $2,300 $1,900
Total liabilities and equity $4,400 $4,000

____ 5. Refer to Dokic, Inc. Which of the following statements is most correct?
a. The company's current ratio was higher in 2002 than it was in 2001.
b. The company's debt ratio was higher in 2002 than it was in 2001.
c. The company issued new common stock during 2002.
d. Statements a and b are correct.
e. Statements a and c are correct.
____ 6. Which of the following statements is most correct?
a. A mission statement is a condensed version of a firm's strategic plans.
b. Both mission statements and strategic plans usually begin with a statement of the overall
corporate purpose.
c. A firm's corporate scope defines a firm's lines of business and geographic area of
operations.
d. Both statements b and c are correct.
e. All of the statements above are correct.

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Name: ________________________ ID: A

Gourmet Kitchens Incorporated

Gourmet Kitchens Incorporated recently reported the following 2002 income statement (in millions of
dollars):

Sales $1,225
Operating costs 875
EBIT $ 350
Interest 70
EBT $ 280
Taxes (40%) 112
Net income $ 168

Dividends (33.333%) $ 56
Addition to retained earnings $ 112

The company is forecasting a 30 percent increase in 2003 sales, and it expects that its year-end operating
costs will equal 75 percent of sales. Gourmet's tax rate, interest expense, and dividend payout ratio are all
expected to remain constant.

____ 7. Refer to Gourmet Kitchens Incorporated. What is the expected growth rate in Gourmet's dividends?
a. 5.00%
b. 12.50%
c. 17.20%
d. 20.33%
e. 22.75%

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 ID: A

Sample Questions for Mini-Test 1

Answer Section

MULTIPLE CHOICE

1. ANS: E
The correct answer is statement e. If compensation comes primarily from stock options, then the managers
will be shareholders and will share the same concerns as other shareholders. Therefore, they will make
decisions that are in the best interests of shareholders, so statement a is correct. If it is more difficult for
hostile takeovers to take place, managers will have less fear of being thrown out of their jobs. Therefore, they
will be less concerned with the interests of shareholders. Statement b is incorrect. If institutional investors
hold a large amount of the firm's stock, they will like to have more say in the management of the company.
(Some may even make sure that they get board seats.) Since they are shareholders and have more influence,
they will ensure that managers act in the best interests of shareholders, so statement c is true.
2. ANS: C
The correct answer is statement c. Recall Net cash flow = NI + DEP and AMORT. Free cash flow = EBIT(1 -
T) + Depreciation and amortization - Capital expenditures - NOWC.

An increase in depreciation and amortization expenses increases both NCF and FCF, and may reduce taxes.
This does not explain why NCF and FCF are negative with an increase in cash flow. So, statement a is not
correct. An increase in inventories is paid either in cash or accounts payable. This suggests cash either
decreases or remains the same. So, statement b is incorrect. By issuing new stock, cash does increase. And
this has no impact on either NCF or FCF, so statement c is the correct response.
3. ANS: D
2001 Ret. earnings $275,000,000 (given)
2002 Net income + 15,000,000 ($ 0.75 20,000,000)
2002 Dividends - 5,000,000 ($ 0.25 20,000,000)
2002 Ret. earnings $285,000,000
4. ANS: D
The correct answer is statement d. Although EBIT is unchanged, interest expense will go down, so NI will
increase. Therefore, statement a is correct. If EBIT is unchanged, but interest expense goes down, the TIE
ratio (EBIT/INT) will increase. Therefore, statement b is correct. If the stock issue has no effect on the
company's total assets, but NI has increased (see statement a), then ROA (NI/TA) will increase. Therefore,
statement c is also correct.
5. ANS: E
The correct answer is statement e. The current ratio in 2002 was 1.77, while the current ratio in 2001 was
1.64. Hence, the current ratio was higher in 2002. The debt ratio was 0.4773 in 2002 and 0.5250 in 2001, so
the debt ratio decreased from 2001 to 2002. The firm issued $300 million in new common stock in 2002.
6. ANS: E
The correct answer is statement e. Statements a, b, and c are all verbatim statements from the text.
7. ANS: C
From the first question we know that the new dividend amount is $65.63.
Dividends = ($65.63 $56.00)/$56.00 = 0.1720 = 17.20%.