1. a.
A company's capital structure refers to the relative proportion of the assets financed by debt and by stockholders' equity.
2. c.
Financial risk refers to the relative proportion of assets financed by debt and by equity.
3 d.
The denominator for computing earnings per share is based on the average number of shares outstanding for the accounting period. This is the best estimate of the share ownership during the accounting period.
4. c.
The inventory methods used by the purchaser or the seller is of no consequence to the other person in a merchandise sale transaction.
5 c.
The effective interest rate is computed by diving 365 by the number of days from the last payment date (10th day) and the end of the credit period (30th day) and multiplying the result by the discount rate. Thus, the effective rate is 365 ¸20 = 18.25 times 1% discount = 18.25%
6. c.
Interest is deductible for income tax purposes, not dividends. This is a major advantage of issuing bonds instead of stock.
7. b.
Par value of common stock is usually set at the time of incorporation by the board of directors. Bonds do not have par value.
8. c.
ROE would be 23.3% computed as follows: $1,000,000 existing income level, less 30% income tax = $700,000 divided by $3,000,000 = 23.3%
9. a.
The income before income and taxes remains the same at $3,000,000 but the interest is now $600,000, leaving $2,400,000 as taxable income. The income tax rate of 30% results in $720,000 of income tax, leaving $1,680,000 net income ($2,400,000 - $720,000).
10. d.
The new net income is $1,680,000 ($3,000,000 - $600,000 interest - $720,000 taxes = $1,680,000). The new stockholders' equity is $4,000,000. $1,680,000 ¸$4,000,000 = 42.00%.
11. b.
The interest expense for the debt would be $100,000 ´ 10% or $10,000. The net income is $413,000 ($600,000 - $10,000 interest - $177,000 taxes = $413,000). The number of shares outstanding under the debt alternative is 10,000 so the earnings per share would be $413,000 ¸10,000 = $41.30 per share.
12. a.
The net income is $420,000 ($600,000 - $180,000 taxes = $420,000). The number of shares outstanding under this alternative would be 11,000 (the original 10,000 plus the 1,000 additional shares) so the earnings per share would be $420,000 ¸11,000 = $38.18 per share.