QUESTION I   

ABC Corp management has decided that the required rate of return for the company should be 8%. Total assets on the December 31, 2019 ABC Corp balance sheet are $500,000. If ABC’s Net Income for 2019 is $40,000, has the company met the required return of 8%? Use “residual income” to determine your answer.

QUESTION II

A. If the bank requires that a corporation keep the debt to total assets ratio at 45% maximum, determine the capital structure (in dollars of debt and equity) of a company that has total assets of $2,000,000.  

B. Why is a lower level of debt, in a corporation’s capital structure, considered a conservative financial structure?

QUESTION III

A. Briefly explain how EVA differs from “residual income” with regards to financial analysis.

B. Calculate EVA for AA Corp, considering that its Total Debt is $350,000 and Total Shareholders’ Equity is $750,000.  Net operating profit (after taxes) was $50,000 and its WACC is 4.5%. Explain your answer.

QUESTION IV

A. If the operating leverage for XYZ Inc is 4, and the company’s sales volume decreases from 100,000 units to 95,000 units, explain the impact on the income statement of this decrease in sales volume. Include a numeric (percentage) and a brief written answer.

B. Calculate the financial leverage, for XYZ Inc using the income statement data below.