Business Risk and ROE Variability Quiz

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What does the current ratio (1.5) indicate about the company's liquidity?

The company is likely to have weak liquidity and cash flow problems.
The company may face cash problems despite having a strong current ratio. (correct)
The current ratio indicates nothing about the company's liquidity.
The company has strong liquidity and no cash flow issues.

What is the total equity of the company?

$40
$25
$50 (correct)
$20

What are the short-term debt obligations of the company?

$25
$20
$50
$30 (correct)

Which financial statement ratio does not provide information on the timing of cash flows?

Current ratio (B) Signup and view all the answers

What can be inferred about the company's working capital based on the text?

It is difficult to infer working capital based on the provided information. (B) Signup and view all the answers

What potential issue does the company face despite having a strong current ratio?

Excessive short-term debt (B) Signup and view all the answers

What effect does borrowing have on a firm's risk?

Borrowing increases a firm's financial risk (A) Signup and view all the answers

What is the impact of changes in EBIT on firm D's ROE?

It causes firm D's ROE to vary widely (C) Signup and view all the answers

What does ROE stand for in the context of the text?

Return on Equity (A) Signup and view all the answers

How is the Weighted Average Cost of Capital (WACC) calculated?

By adding the cost of debt and cost of equity (C) Signup and view all the answers

What does EVA stand for in the context of the text?

Economic Value Added (A) Signup and view all the answers

What is the purpose of the Invested Capital mentioned in the text?

To evaluate the company's total capital employed (C) Signup and view all the answers

What does the negative EVA imply?

Value destruction (B) Signup and view all the answers

Why is the growth of WCR concerning in this scenario?

It indicates inefficient management of working capital (A) Signup and view all the answers

What does the negative historical return spread imply?

Value destruction (C) Signup and view all the answers

Why is Mr. Bobson accused of overinvesting in working capital?

To raise profits and increase his bonus (D) Signup and view all the answers

What is the assumption made about management in the financial leverage table?

Management earns an operating profit of 10% on every dollar (D) Signup and view all the answers

What is the ROE before tax for Firm C in the financial leverage table?

8% (C) Signup and view all the answers

What is the leverage effect for Firm F in the financial leverage table?

positive (A) Signup and view all the answers

What is the interest amount for Firm B in the financial leverage table?

$50 (C) Signup and view all the answers

What is the ROIC before tax for Firm E in the financial leverage table?

13% (C) Signup and view all the answers

What is the cost of debt for Firm F in the financial leverage table?

$64 (A) Signup and view all the answers

What is the earnings before tax for Firm E in the financial leverage table?

$52 (D) Signup and view all the answers

What is the invested capital for Firm D in the financial leverage table?

$1000 million (D) Signup and view all the answers

What is the assumption made about management in the effect of financing on profitability table?

Management earns an operating profit of 10% on every dollar. (A) Signup and view all the answers

What is the profitability of the firm with 20% Equity (F) in the effect of financing on profitability table?

2% ROICBT, -22% ROEBT (A) Signup and view all the answers

What is the profitability of the firm with 50% Equity (D) in the effect of financing on profitability table?

10% ROICBT, 12% ROEBT (D) Signup and view all the answers