Which One of the Following Will Increase the Profit Margin of a Firm, All Else Held Constant

Chapter 04 Test Bank 1. The sustainable growth rate is defined as the maximum rate at which company sales can increase. FALSE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 2. The sustainable growth rate is the only growth rate in sales that is consistent with stable values of the profit margin, retention rate, asset turnover, and leverage (assets/equitybop). TRUE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 3. A company experiencing balanced growth does not generate cash surpluses or cash deficits. TRUE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 4. If a company seeks to maximize firm value, it should never grow at a rate above its sustainable growth rate. FALSE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 5. The only way a company can grow at a rate above its current sustainable growth rate is by increasing leverage. FALSE Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 6. In recent years, U.S. companies as a whole have repurchased more equity than they have issued. TRUE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 7. Share repurchases usually decrease earnings per share. FALSE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 4-1 8. Issue costs of equity are high relative to those of debt. TRUE Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 9. One way to manage an actual growth rate above the sustainable growth rate is to decrease prices. FALSE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 10. One way to manage an actual growth rate below the sustainable growth rate is to repurchase shares. TRUE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 11. Which one of the following will increase the sustainable rate of growth a corporation can achieve? A. avoidance of external equity financing B. increase in corporate tax rates C. reduction in the retention ratio D. decrease in the dividend payout ratio E. decrease in sales given a positive profit margin F. None of the options are correct. Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 12. Which of these ratios are the determinants of a firm’s sustainable growth rate? I. Assets-to-equity ratio II. Profit margin III. Retention ratio IV. Asset turnover ratio A. I and III only B. II and III only C. II, III, and IV only D. I, II, and III only E. I, II, III, and IV F. None of the options are correct 4-2 Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 13. The retention ratio is A. equal to net income divided by the change in total equity. B. the percentage of net income available to the firm to fund future growth. C. equal to one minus the asset turnover ratio. D. the change in retained earnings divided by the dividends paid. E. the dollar increase in net income divided by the dollar increase in sales. F. None of the options are correct. Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 14. Which of the following statements is true? A. Rapid growth spurs increases in market share and profits and thus, is always a blessing. B. Firms that grow rapidly very rarely encounter financial problems. C. The cash flows generated in a given time period are equal to the profits reported. D. Profits provide assurance that cash flow will be sufficient to maintain solvency. E. Due to required cash investments in current assets, fast-growing and profitable companies can literally "grow broke". F. None of the options are correct. Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 15. Which one of the following correctly defines the retention ratio? A. one plus the dividend payout ratio B. additions to retained earnings divided by net income C. additions to retained earnings divided by dividends paid D. net income minus additions to retained earnings E. net income minus cash dividends F. None of the options are correct. Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 16. Which one of the following policies most directly affects the projection of the retained earnings balance to be used on a pro forma statement? A. net working capital policy B. capital structure policy C. dividend policy D. capital budgeting policy E. capacity utilization policy F. None of the options are correct. 4-3 Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 17. Which of the following questions are appropriate to address upon conducting sustainable growth analysis and the financial planning process? I. Should the firm merge with a competitor? II. Should additional equity be sold? III. Should a particular division be sold? IV. Should a new product be introduced? A. I, II, and III only B. I, II, and IV only C. I, III, and IV only D. II, III, and IV only E. I, II, III, and IV F. None of the options are correct Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 18. The sustainable growth rate of a firm is best described as the A. minimum growth rate achievable, assuming a 100 percent retention ratio. B. minimum growth rate achievable if the firm maintains a constant equity multiplier. C. maximum growth rate achievable, excluding external financing of any kind. D. maximum growth rate achievable, excluding any external equity financing while maintaining a constant debt-equity ratio. E. maximum growth rate achievable with unlimited debt financing. F. None of the options are correct. 19. The sustainable growth rate A. assumes there is no external financing of any kind. B. assumes no additional long-term debt is available. C. assumes the debt-equity ratio is constant. D. assumes the debt-equity ratio is 1.0. E. assumes all income is retained by the firm. F. None of the options are correct. Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 20. Which of the following can affect a firm's sustainable rate of growth? I. Asset turnover ratio II. Profit margin III. Dividend policy IV. Financial leverage A. III only B. I and III only C. II, III, and IV only D. I, II, and IV only E. I, II, III, and IV F. None of the options are correct 4-4 Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 21. Gujarat Corporation doubled its shareholders’ equity during the year 2017. Gujarat did not issue any new equity, repurchase any equity, or pay out any dividends during the year. What is Gujarat’s sustainable growth rate for 2017? A. 50% B. 100% C. 150% D. 200% If equity doubled, then g* = change in equity/equity bop = 100%. For example, if equity bop was 25, the change in equity must also be 25 in order to double equity. Accessibility: Keyboard Navigation Difficulty: 3 Hard Gradable: automatic 22. Hayesville Corporation had net income of $5 million this year on net sales of $125 million per year. At the beginning of this year, its debt-to-equity ratio was 1.5 and it held $75 million in total liabilities. It paid out $2 million in dividends for the year. What is Hayesville Corporation’s sustainable growth rate? A. 3% B. 4% C. 5% D. 6% ROEbop × Retention ratio = (5/50) × 0.6 = 6% Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 23. Milano Corporation has experienced growth of 20% for each of the last 5 years. Over this 5-year period, Milano’s return on equity has never exceeded 15%, its profit margin has held steady at 5%, and its total asset turnover has not changed. Over the 5-year period, Milano paid no dividends and issued no new equity. Based on this information, which of the following can you most likely infer about Milano’s performance over the past 5 years? A. Milano’s leverage has decreased. B. Milano’s leverage has remained constant. C. Milano’s leverage has increased. D. None of the options are correct. Note first that g > g* because g = 20% and g*<15%. With g > g* one of PRAT must increase. P has held steady at 5%, R has remained at 100%, A has not changed. Thus T (leverage) must have increased. Accessibility: Keyboard Navigation Difficulty: 3 Hard Gradable: automatic 24. Which of the following would increase a company’s need for external finance, all else equal? A. An increase in the dividend payout ratio B. A decrease in sales growth C. An increase in profit margin D. A decrease in the collection period 4-5 Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 25. You constructed a pro forma balance sheet for next year and found that external financing required was negative (i.e., the company projected a financing surplus). Which of the following options, all else equal, would NOT correct the projected imbalance? A. A stock repurchase B. A decrease in accounts payable C. An increase in cash and marketable securities D. An increase in the retention ratio Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 26. The sustainable growth rate A. is the highest growth rate attainable for a firm that pays no dividends. B. is the highest growth rate attainable for a firm without issuing new stock. C. can never be greater than the return on equity. D. can be increased by decreasing leverage. Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 27. Wax Music expects sales of $437,500 next year. The profit margin is 4.8 percent, and the firm has a 30 percent dividend payout ratio. What is the projected increase in retained earnings? A. $14,700 B. $17,500 C. $18,300 D. $20,600 E. $21,000 F. None of the options are correct. Change in retained earnings = $437,500 × 0.048 × (1 − 0.30) = $14,700 Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 28. Komatsu has a 4.5 percent profit margin and a 15 percent dividend payout ratio. The asset turnover ratio is 1.6, and the assets-to-equity ratio (using beginning-of-period equity) is 1.77. What is Komatsu’s sustainable rate of growth? A. 1.91% B. 6.12% C. 10.83% D. 11.26% E. 12.74% F. None of the options are correct. Sustainable growth = PRAT = 0.045 × (1 − 0.15) × 1.6 × 1.77 = 10.83% 4-6 Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 29. A firm has a retention ratio of 40 percent and a sustainable growth rate of 6.2 percent. Its asset turnover ratio is 0.85, and its assets-to-equity ratio (using beginning-of-period equity) is 1.80. What is its profit margin? A. 3.79% B. 5.69% C. 6.75% D. 10.13% E. 18.24% 0.062 = PRAT = profit margin × 0.40 × 0.85 × 1.80 profit margin= 0.062/(0.40 × 0.85 × 1.80) = 10.13% Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 30. Westcomb, Inc. had equity of $150,000 at the beginning of the year. At the end of the year, the company had total assets of $195,000. During the year, the company sold no new equity. Net income for the year was $72,000, and dividends were $44,640. What is Westcomb’s sustainable growth rate? A. 15.32 percent B. 15.79 percent C. 17.78 percent D. 18.01 percent E. 18.24 percent Change in Equity = Retained earnings = $72,000 − $44,640 = $27,360 Sustainable growth rate = g* = Change in Equity/Equity bop = $27,360/$150,000 = 18.24% Alternative: g* = R × ROEbop = 72,000 − 44,640)/72,000 × 72,000/150,000 = 0.38 × 0.48 = 0.1824 Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic [The following information applies to the questions displayed below.] Boss Stores, Inc. Selected financial information ($ millions) 2014 Sales $ 287.31 Net income 11.22 Total assets 268.58 Equity 180.63 2015 $ 339.19 16.48 275.30 191.90 2016 $ 411.78 19.70 318.43 211.03 2017 $ 446.84 12.23 451.32 222.57 Dividends 5.21 0.58 0.69 0.00 31. Please refer to the selected financial information for Boss Stores above. What is the retention ratio for 2016? A. 0.32 B. 0.68 C. 0.97 D. 1.00 E. None of the options are correct. 1 − (0.58/19.70) = 0.97 4-7 Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 32. Please refer to the selected financial information for Boss Stores above. What is the actual sales growth rate for 2016? A. −17.6% B. −7.9% C. 8.51% D. 21.4% E. None of the options are correct. (411.78 − 339.19)/339.19 = 0.214 33. Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic Please refer to the selected financial information for Boss Stores above. What is the sustainable growth rate for 2016? A. −17.6% B. −7.9% C. 9.97% D. 10.27% E. 12.23% F. 21.40% Sustainable growth = g* = Change in Equity/Equitybop = (211.03 − 191.90)/191.90 = 9.97% Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 34. Please refer to the selected financial information for Boss Stores above. What is the difference between Boss’s sustainable growth rate and its actual growth rate for 2017? A. −11.40% B. −7.09% C. −3.04% D. 5.47% E. 13.98% F. 21.40% Sustainable growth = g* = PRAT = 0.0274 × 0.94 × 0.99 × 2.14 = 5.47% Alternatively, g* = Change in Equity/Equitybop = (222.57 − 211.03)/211.03 = 5.47% Actual growth = g = Change in Sales/Sales bop = (446.84 − 411.78)/411.78 = 8.51% g* − g = 5.47% − 8.51% = − 3.04% Accessibility: Keyboard Navigation Difficulty: 3 Hard Gradable: automatic 4-8 35. Which of the following actions would help a firm’s growth problem if its actual sales growth exceeds its sustainable rate of growth? I. Increase prices II. Decrease financial leverage III. Decrease dividends IV. Prune away less-profitable products A. I and II only B. I and III only C. I, II, and IV only D. I, III, and IV only E. I, II, III, and IV F. None of the options are correct Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic 36. Which of the following is NOT a reason for why U.S. corporations haven’t issued more equity in recent years? A. Managers usually believe that their stock is overvalued. B. Companies in the aggregate had sufficient funds through profits and new debt. C. Equity is relatively expensive to issue. D. Managers try to avoid dilution of earnings per share. E. Managers perceive the stock market to be an unreliable funding source. Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic 37. Why do financial managers need to understand the implications of the sustainable rate of growth? Working capital, fixed assets, and external financing must coordinate with and be able to support a firm’s sales growth. If, for example, a projected increase in sales requires external financing when no such financing is available, then the firm cannot grow at the desired rate. Understanding the implications of the sustainable growth rate helps managers understand the need to manage growth so that the firm does not attempt to outgrow its resources. Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: manual [The following information applies to the questions displayed below.] Law Specialists, Inc. Selected financial information 4-9 Profit margin (%) Retention ratio (%) Asset turnover (X) Financial leverage (X) 2013 6.89 100.00 2.78 1.69 Growth rate in sales (%) 22.89 2014 4.94 100.00 2.47 1.38 - 10.05 2015 0.11 100.00 2.03 1.16 2016 0.32 100.00 2.00 1.32 2017 5.25 78.27 2.23 1.52 - 28.76 3.55 26.19 38. Use Law Specialists’s selected financial information above to answer the following questions: A. Calculate Law Specialists’s sustainable growth rate in each year. b. Comparing the company’s sustainable growth rate with its actual growth rate in sales, what growth problems did the company face over this period? A. Law Specialists’s sustainable growth rates (these are the product of the first four rows of financial information): Sustainable growth rate (%) 2013 2014 2015 2016 32.37 16.84 0.26 0.84 2017 13.9 3 b. From 2010 through 2012, Law Specialists’s actual growth (or decline) in sales was well below its sustainable growth rate. In 2013 and 2014, the company’s growth problems reversed, with actual growth modestly exceeding sustainable growth in 2013, and doubling sustainable growth in 2014. Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: manual 39. Please refer to the selected financial information for Law Specialists, Inc. above. Law Specialists paid its first dividends in 2017. As an analyst, assess the company’s decision to pay dividends. Dividends are typically the hallmark of a maturing industry. The growth rates between 2014 and 2016 indicate slowing growth for the staffing services business. In this context, the company’s decision makes sense. However, in 2017 the company resumed rapid growth. Persistent growth rates above sustainable growth could jeopardize its ability to pay dividends on an ongoing basis. Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: manual [The following information applies to the questions displayed below.] Sales Net income Total assets Equity Dividen ds 4-10 $ Hard Knock Doors Selected financial information ($ thousands) 2011 2012 2013 2014 2015 792.0 477.8 $ 491.62 706.52 $ $ 876.52 4 1 - 43.27 26.31 - 477.06 648.42 - 346.32 372.63 - - - 28.58 664.2 6 400.4 1 0.8 2017 $ 1,088.46 34.84 25.76 697.16 982.63 433.6 457.14 1.65 2.22 40. Please refer to the selected financial information for Hard Knock Doors above. Calculate the actual and sustainable growth rates for Hard Knock Doors for each year, 2013–2016. Hard Knock Doors 2013 2014 Profit margin Retention ratio Asset turnover Financial leverage Sustainable growth (g* = PRAT) OR g* = ΔEquity/Equitybop Actual growth 3.72 1 1.09 % 1.87 3.61 0.97 1.19 2015 % 3.97 0.95 1.26 1.78 2016 % 2.37 0.91 1.11 1.74 % 2.27 7.6 % 7.46 % 8.29 % 5.43 % 7.6 % 7.46 % 8.29 % 5.43 % 43.71 % 12.1 % 10.67 % 24.18 % Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: manual 41. Please refer to the selected financial information for Hard Knock Doors above. Do you think Hard Knock Doors is having a problem financing its growth? If so, what is it doing to address the problem? Hard Knock’s actual growth has exceeded its sustainable growth rate every year. The company has financed its rapid growth by increasing its asset turnover, and in 2016, its financial leverage. Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: manual 42. Please refer to the selected financial information for Hard Knock Doors above. Is the increase in dividends between 2013 and 2016 a good idea for Hard Knock Doors? The initiation and increase in dividend payments, although modest, have exacerbated its sustainable growth problems by decreasing the retention ratio. Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: manual 4-11 Chapter 04 Test Bank Summary Category Accessibility: Keyboard Navigation Difficulty: 1 Easy Difficulty: 2 Medium Difficulty: 3 Hard Gradable: automatic Gradable: manual 4-12 # of Question s 42 21 18 3 36 6