Question

1. Company A has Return On Equity (ROE) of 25%. The company just declared a dividend payment. What will ROE be after the declaration?

a.	More than 25%.
b.	Less than 25%.
c.	25%.
d.	Unable to determine without more information.

1. Firms with high levels of operating leverage experience which of the following in comparison to firms with low levels of operating leverage

a.	Higher levels of risk in operations.
b.	Lower expected rates of return.
c.	Lower variability in returns on assets.
d.	Higher sales.

1. The management of company A increased the estimated salvage value of the company’s PP&E. What effect will that change have on the interest coverage ratio?

a.	Increase.
b.	Decrease.
c.	No effect.
d.	Unable to determine without more information.

Answer 1

Ans 1 A

More than 25%

Logic:-

ROE = Net Income/ Equity

The dividend declaration will reduce the equity because of a decrease in retained earnings. Hence, ROE will increase.

Ans 2 A

Higher levels of risk in their operations

Logic:-

Operating leverage measures the percentage of total cost as fixed cost and variable cost. High operating leverage means that the percentage of fixed cost is higher than the percentage of variable cost and vice versa. Therefore, the firm with high operating leverage will have higher levels of risk in their operations because they have to bear the fixed cost irrespective of volume sales.

Ans 3 A

Increase

Logic:-

Interest coverage ratio = EBIT/Interest expenses.

The higher the scrap value of an asset, the less is the depreciation. Lower depreciation will increase EBIT. Hence interest coverage ratio will increase.

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