Question

1. If Debt Ratio decreased from 36% to 33%, it means,

   	a.	financial risk decreases
   	b.	leverage will not be affected
   	c.	leverage increases
   	d.	financial risk increases
   	e.	the company may have increased its long-term debt

 

Question 6

1. Mermaid Enterprises, a manufacturing firm, is considering investing $420,000 in a new machine. It is estimated that the net cash flow per year will be $150,000 and the machine will have a 5-year useful life. The residual value expected at the end of the 5-year life is $80,000. The accounting rate of return is:

   	a.	19.5%
   	b.	60%
   	c.	Unable to be determined from the information given
   	d.	35.7%
   	e.	32.8%

Answer 1

Correct Answer:

Option (a) or financial risk decreases is correct answer because decreased in debt ratio indicates that total liabilities are decreased as compared to total assets. So this lead to less claim of assets from the company's creditors and therefore the burden of financial risk decreases.

Incorrect answers:

Option ( b) or leverages will not affected is incorrect answer the because due to decreased in debt ratio indicates that total liabilities are decreased. So there is a less leverage.

Option ( c) or leverages increases is incorrect answer because due to decreased in debt ratio indicates that total liabilities are decreased as compared to total assets. So leverage decreases and not increases.

Option ( d) or financial risk increases is incorrect answer because as debt ratio decreased,the amount of liabilities are also decreases and therefore, there is less financial risk.

Option ( e) or the company may have increased its long-term debt is incorrect answer because the debt ratio is decreased and therefore there is a decreased in total liabilities including its long-term debt.

So correct answer is option (a) or financial risk decreases

Question 6

The accounting rate of return is calculated below:

Accounting rate of return = Annual Net Income / Annual Average Investment*100

Annual Net Income = Annual Net Cash Flow - Depreciation

Depreciation = (Cost - Salvage Value) / Useful Life

= ($420,000 - $80,000) / 5

= $68,000

Annual Net Income =  $150,000 - $68,000

= $82,000

Annual Average Investment = (Cost of Assets + Salvage Value)/2

= ($420,000 + $80,000)/2

= $500,000/2  

= $250,000

Accounting rate of return = $82,000/ $250,000*100

= $32.8%

So Correct answer is option (e) or $32.8%