مسائل محاسبية مع حلولها

[Bishara]

An analyst has collected the following data about a firm:

• Receivables turnover = 10 times

• Inventory turnover = 8 times

• Payables turnover = 12 times

What is the cash conversion cycle?

A. 111 days.

B. Not enough information is given.

C. 51 days.

D. 41 days.

C

Cash conversion cycle = receivables collection period + inventory processing period – payables payment period.

Receivables collection period = 360/10 = 36

Inventory processing period = 360/8 = 45

Payables payment period = 360/12 = 30

Cash conversion cycle = 36 + 45 – 30 = 51

[Bishara]

Given the following information about a company:

• Receivables turnover = 10 times

• Payables turnover = 12 times

• Inventory turnover = 8 times

What are the average receivables collection period, the average payables payment period, and the average inventory processing period respectively?

A. Average Receivables Average Payables Average Inventory

Collection Period Payment Period Processing Period

31 30 28

B. Average Receivables Average Payables Average Inventory

Collection Period Payment Period Processing Period

37 30 52

C. Average Receivables Average Payables Average Inventory

Collection Period Payment Period Processing Period

37 45 46

D. Average Receivables Average Payables Average Inventory

Collection Period Payment Period Processing Period

37 30 46

D

Ave. receivables collection period = 365/10 = 36.5 or 37

Ave. payables payment period = 365/12 = 30.4 or 30

Ave. inventory processing period = 365/8 = 45.6 or 46

[Bishara]

When the return on equity equation (ROE) is decomposed, what three ratios comprise the components of ROE?

A. Net profit margin, asset turnover, asset multiplier.

B. Net profit margin, asset turnover, equity multiplier.

C. Net profit margin, inventory turnover, equity multiplier.

D. Gross profit margin, asset turnover, equity multiplier.

B

The three ratios can be further decomposed as follows:

Net profit margin = net income/sales

Asset turnover = sales/assets

Equity multiplier = assets/equity

[Bishara]

An analyst has gathered the following information about a company:

Balance Sheet

Assets

Cash 100

Accounts Receivable 750

Marketable Securities 300

Inventory 850

Property, Plant & Equip 900

Accumulated Depreciation (150)

Total Assets 2750

Liabilities and Equity

Accounts Payable 300

Short-Term Debt 130

Long-Term Debt 700

Common Equity 1000

Retained Earnings 620

Total Liab. and Stockholder's equity 2750

Income Statement

Sales 1500

COGS 1100

Gross Profit 400

SG&A 150

Operating Profit 250

Interest Expense 25

Taxes 75

Net Income 150

What is the ROE?

A. 10.9%.

B. 9.3%.

C. 9.9%.

D. 10.7%.

B

ROE = 150(NI)/[1000(common) + 620(RE)] = 150/1620 = 0.0926 or 9.3%

[Bishara]

The equity multiplier for a firm with a total debt ratio equal to 45 percent is:

A. 1.8182 times.

B. 0.5495 times.

C. 2.2222 times.

D. 0.6897 times.

A

Given: L/A = 0.45. Restating as L = 0.45A and substituting into the basic accounting equation A = L + E . A = 0.45A + E, or 0.55 A = E. From this, the equity multiplier, A/E, can be stated as: A/E = 1 / 0.55 = 1.8182.

[Bishara]

The two major types of risk affecting a firm are:

A. business risk and collection risk.

B. financial risk and cash flow risk.

C. bankruptcy risk and cash flow risk.

D. business risk and financial risk.

D

Business risk is the uncertainty regarding the operating income of a company. Financial risk refers to the uncertainty caused by the fixed cost associated with borrowed money.

[Bishara]

Cash that normally would have been used to pay the firm's accounts payable is used instead to pay off some of the firm's long-term debt. This will cause the firm's:

A. cash conversion cycle to lengthen.

B. current ratio to rise.

C. payables turnover to rise.

D. quick ratio to fall.

D

The quick ratio = (cash + receivables) / current liabilities, thus if cash is reduced the numerator will decrease as will the ratio.

[Bishara]

If a company has a net profit margin of 15 percent, an asset turnover ratio of 4.5 and a ROE of 18 percent, what is the equity multiplier?

A. 2.667.

B. .267.

C. .523.

D. 3.135.

B

There are many different ways to illustrate ROE one of which is:

ROE = (net profit margin)(asset turnover)(equity multiplier)

.18 = (.15)(4.5)(equity multiplier)

.18/[(.15)(4.5)]=equity multiplier

.18/0.675 = equity multiplier

.18/0.675 = 0.267

[Bishara]

If a firm has a profit margin of .05, an asset turnover of 1.465, and an equity multiplier of 1.66, what is the firm's ROE?

A. 3.18%.

B. 12.16%.

C. 5.87%.

D. 5.66%.

B

One of the many ways to express ROE = profit margin *asset turnover* equity multiplier = ROE = (0.05)(1.465)(1.66) = .1216

[Bishara]

Assume that Q-Tell Incorporated is in the communications industry, which has an average receivables turnover ratio of 16 times. If the Q-Tell’s receivables turnover is less than that of the industry, Q-Tell’s average receivables collection period is most likely:

A. 12 days.

B. 16 days.

C. 20 days.

D. 25 days.

D

Average receivables collection period = 365 / receivables turnover, which is 22.81 days for the industry (= 365/16). If Q-Tell’s receivables turnover is less than 16, its average days collection period must be greater that 22.81 days.

[Bishara]

Q-Tell Incorporated is in the communications industry and has the same absolute dollar level of current liabilities as the average firm in the industry. The current ratio and quick ratio for Q-Tell and the communications industry are as follows:

Industry: Current Ratio of 3.0, Quick Ratio of 2.5

Q-Tell: Current Ratio of 3.0, Quick Ratio of 2.1

Relative to the communications industry Q-Tell is most likely to have:

A. less inventory.

B. more inventory.

C. more payables.

D. more cash, marketable securities, and receivables.

B

The current ratio is current assets divided by current liabilities, (CA/CL), where current assets include cash, marketable securities, receivables, and inventory. The quick ratio is (CA – inventory) / current liabilities. Since current ratio and current liabilities are given as the same for both the industry and Q-Tell, (CA – inventory) for Q-Tell must be less than (CA – inventory) for the industry. This means that Q-Tell either has more inventory or less in cash and cash equivalents, and receivables.

[Bishara]

Which of the following best explains why a firm's ratio of "long-term debt to total capital" and its ratio of "income before interest and taxes to debt interest charges" are both lower than the industry average? The firm:

A. pays lower interest on its long-term debt than average.

B. has a high ratio of "current assets to current liabilities."

C. has a high ratio of "total cash flow to total long-term debt."

D. has more short-term debt than average.

D

If the interest coverage = earnings before interest and taxes / interest expense is lower than the industry, the firm is taking on more debt.

[Bishara]

Common size income statements express all income statement items as a percentage of:

A. sales.

B. assets.

C. net income.

D. industry averages.

A

Common size income statements express all income statement items as a percentage of sales. Note that common size balance sheets express all balance sheet accounts as a percentage of total assets.

[Bishara]

Common size balance sheets express all balance sheet items as a percentage of:

A. assets.

B. industry averages.

C. equity.

D. sales.

A

Common size balance sheets express all balance sheet items as a percentage of assets. Note that common size income statements express all income statement items as a percentage of sales.

[Bishara]

An analyst has gathered the following information about a company:

• Net profit margin of 15%

• Asset turnover ratio of 4.5

• Equity multiplier of 0.267

• Dividend payout ratio of 30%

• What is the company’s growth rate?

A. 12.6%

B. 36.6%

C. 14.8%

D. 18.6%

A

g = (retention rate)(ROE)

ROE = (net profit margin)(asset turnover)(equity multiplier)

= (.15)(4.5)(0.267) = 0.180

g = (1-.3)(0.180) = (.7)(0.18) = 0.126 or 12.6%

[Bishara]

Which of the following best explains a ratio of "net sales to average net fixed assets" that exceeds the industry average? The firm:

A. uses straight line depreciation.

B. expanded its plant and equipment in the past few years.

C. makes less than efficient use of its assets than competing firms.

D. has a substantial amount of old plant and equipment.

D

If a firm has a high fixed asset turnover = net sales/net fixed assets, it can be implied that the firm has not built or purchased many new assets such as plant and equipment. If the firm had recently purchased a new plant and equipment the net fixed asset number would be smaller.

[Bishara]

Which of the following best explains a ratio of "net sales to average net fixed assets" that exceeds the industry average? The firm:

A. uses straight line depreciation.

B. expanded its plant and equipment in the past few years.

C. makes less than efficient use of its assets than competing firms.

D. has a substantial amount of old plant and equipment.

D

If a firm has a high fixed asset turnover = net sales/net fixed assets, it can be implied that the firm has not built or purchased many new assets such as plant and equipment. If the firm had recently purchased a new plant and equipment the net fixed asset number would be smaller.

[Bishara]

Assume that the exercise price of an option is $5, and the average market price of the stock is $8. Assuming 816 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the diluted EPS?

A. 306.

B. 510.

C. 272.

D. 816.

A

(816)(5) = $4,080. $4,080 / $8 = 510 shares. 816 - 510 = 306 new shares.

[Bishara]

If a firm has a great deal of inventory built up which of the following ratios would be the largest?

A. Current Ratio.

B. Gross profit margin ratio.

C. Cash ratio.

D. Quick ratio.

A

The current ratio is the only one out of the current, cash, and quick ratios that has current assets in the numerator making it the largest of the three ratios.

[Bishara]

Which of the following is NOT one of the major areas where financial ratios are used?

A. Stock valuation.

B. Capital budgeting.

C. Bankruptcy.

D. Systematic risk.

B

Besides using ratios to determine systematic risk, stock valuation, and forecasting bankruptcy, they are also used in creating bond ratings.

[Bishara]

The standard equation for computing basic earnings per share (EPS) is:

A. Basis EPS = [Net Income – Preferred Dividends]/Weighted Average Number of Common Shares Outstanding.

B. [Net Income - Common Dividends] / Weighted Average Number of Common Shares Outstanding.

C. Total Assets – Total Liabilities + Stockholder’s Equity.

D. [sales - Cost of Goods Sold] / Number of Preferred Shares Outstanding.

A

[Bishara]

At the beginning of 2000, the Alaska Corporation had 2 million shares of common stock outstanding and no preferred stock. At the end of August, 2000, Alaska issued 600,000 new shares of common stock. If Alaska reported net income equal to $8.8 million, what was the firm’s earnings per share for 2000?

A. $4.40.

B. $3.67.

C. $4.00.

D. $3.38.

C

EPS = earnings available to common shareholders divided by the weighted average number of common shares outstanding. With no preferred shareholders, all of net income is available to the common shareholders. The weighted average number of shares outstanding equals the original 2 million shares plus 4/12 of the additional 600,000 shares. The 4/12 weight is used because the new shares were only outstanding 4 months of the year. Thus, EPS = $8.8 million / [2 million + (4/12)(600,000)] = 8.8/2.2 = $4.00.

[Bishara]

An analyst has gathered the following information about a company:

• 110,000 shares of common outstanding at the beginning of the year.

• The company repurchases 20,000 of its own common shares on July 1.

• Earnings are $300,000 for the year.

• 10,000 shares of existing 10 percent cumulative $100 par preferred outstanding that is not in arrears at the beginning or ending of the year.

• The company also has $1 million in 10 percent callable bonds outstanding.

• The company has declared a $0.50 dividend on the common.

What is the company's basic Earnings Per Share?

A. $1.00.

B. $1.40.

C. $2.00.

D. $3.00.

C

Interest is already deducted from earnings. (300000 – 100000)/100,000

[Bishara]

Last year, the AKB Company had net income equal to $5 million. Combined state and local taxes were 45 percent. The firm paid $1 million to its 1 million common shareholders and $250,000 to 100,000 preferred shareholders. What was AKB's earnings per share (EPS) last year?

A. $3.75.

B. $4.75.

C. $2.50.

D. $2.25.

B

EPS = earnings available to common shareholders divided by the weighted average number of common shares outstanding. Earnings available to common shareholders is net income minus preferred dividends, or $4,750,000 (= $5 million – 250,000) for AKB.

[Bishara]

The ZZT Company went public on June 1, 1999, by issuing 25 million shares of common stock. In 2000, the firm raised additional capital by issuing 2 million shares of preferred stock. What is the weighted average number of common shares outstanding for the year ending December 31, 2000?

A. 15,750,000.

B. 14,583,333.

C. 10,416,667.

D. 25,000,000.

D

The weighted average number of common shares outstanding is the number of shares outstanding during the year weighted by the portion of the year they were outstanding. Since no new common shares were issued in 2000, and there were 25 million shares at the end of 1999, there are 25 million shares at the end of 2000. Note that the preferred stock shares do not affect the common shares outstanding.

[Bishara]

At the beginning of 2001, Osami Corporation had 1.4 million shares of common stock outstanding and no preferred stock. At the end of August 2001, Osami issued 1.2 million new shares of common stock. If Osami reported net income equal to $7.2 million, what were its earnings per share (EPS) for 2001?

A. $2.77.

B. $4.00.

C. $1.66.

D. $3.33.

B

Basic EPS = earnings available to common shareholders divided by the weighted average number of common shares outstanding. With no preferred shareholders, all of net income is available to the common shareholders. The weighted average number of shares outstanding equals the original 1.4 million shares plus 4/12 of the additional 1.2 million shares. The 4/12 weighting on the new shares is because the new shares were only outstanding 4 months of the year. Thus, the weighted average number of shares outstanding is [1.4 + (4/12)(1.2)] million = 1.8 million shares. So basic EPS = $7.2 million / 1.8 million = $4.00.

[Bishara]

Robinson Company had 1 million shares outstanding at the beginning of the year. On April 1, Robinson issued an additional 300,000 shares. On July 1, Robinson issued 200,000 more shares. What is Robinson's weighted average number of shares outstanding for the calculation of earnings per share?

A. 1,200,000 shares.

B. 1,500,000 shares.

C. 1,325,000 shares.

D. 1,000,000 shares.

C

Wtd. avg. shares = 1,000,000 + (0.75) 300,000 + (0.5) 200,000 = 1,325,000 shares

[تالي الليل]

جزاك الله خيرا ابو بدر

[Bishara]

2.: Discounted Cash Flow Applications

a: Calculate the net present value and internal rate of return of a capital investment project.

Example: Calculate the NPV of an investment project with an initial cost of $5 million (CF0 = -5 million), and positive cash flows of CF1 = 1.6 million at the end of year 1, CF2 = 2.4 million at the end of year 2, and CF3 = 2.8 million at the end of year 3. Use 12% as the discount rate.

NPV = [-5 + 1.6 / (1.12)] +[ 2.4 / (1.12)2] + [2.8 / (1.12)3] = $332,130

Example: Using the same investment project, calculate IRR.

0 = -5 + [1.6 / (1 + IRR)] + [2.4 / (1 + IRR)2] + [2.8 / (1 + IRR)3] = 15.52%

[Bishara]

1.A: Analysis of Inventories

a: Compute ending inventory balances and cost of goods sold using the LIFO, FIFO, and average cost methods to account for product inventory.

Example: Given the following inventory data:

January 1 (beginning inventory): 2 units @ $2 per unit = $ 4

January 7 purchase: 3 units @ $3 per unit = $9

January 19 purchase: 5 units @ $5 per unit = $25

Cost of goods available (BI + P): 10 units = $38

Units sold during January: 7 units

FIFO cost of goods sold (value the 7 units sold at unit cost of last units purchased). Start at the top and work down:

From beginning inventory: 2 units @ $2 per unit = $4

From first purchase: 3 units @ $3 per unit = $ 9

From second purchase: 2 units @ $5 per unit = $10

FIFO cost of goods sold: 7 units = $23

Ending inventory: 3 units @ $5 = $15

LIFO cost of goods sold (value the 7 units sold at unit cost of first units purchased). Start at the bottom and work up:

From second purchase: 5 units @ $5 per unit = $25

From first purchase: 2 units @ $3 per unit = $6

LIFO cost of goods sold: 7 units = $31

Ending inventory: 2 @ $2 + 1 @ $3 = $7

Average cost of goods sold (value the 7 units sold at the average unit cost of goods available).

Average unit cost = $38 / 10 = $3.80 per unit

Weighted average cost of goods sold = 7 @ $3.80 = $26.60

Ending inventory = 3 @ $3.80 = $11.40

[komi_2004m]

جزاك الله خيرا على المعلومات المفيدة

[Bishara]

Which of the following statements is TRUE? Income tax expense:

A. and income tax paid are similar.

B. is the reported net of deferred tax assets and liabilities.

C. is the amount of taxes due to the government.

D. includes taxes payable and deferred income tax expense.

D

Income tax expense is defined as expense resulting from current period pretax income. It includes taxes payable and deferred income tax expense. Income tax paid is the actual cash flow for income taxes, including payments or refunds for other years and may differ from income tax expense. Taxes payable are the amount of taxes due the government.

[Bishara]

Which of the following statements is a CORRECT description of valuation allowance? Reserve:

A. created when deferred tax assets are greater than deferred tax liabilities.

B. against deferred tax liabilities based on the likelihood that those liabilities will be paid.

C. against deferred tax assets based on the likelihood that those assets will be realized.

D. created when deferred tax liabilities are greater than deferred tax assets.

C

Valuation allowance is a reserve against deferred tax assets based on the likelihood that those assets will be realized. Deferred tax assets reflect the difference in tax expense and taxes payable that are expected to be recovered from future operations.

[Bishara]

A tax loss carryforward is the:

A. net taxable loss that can be used to refund paid taxes from the previous year.

B. difference of deferred tax liabilities and deferred tax assets.

C. net taxable loss that can be used to reduce taxable income in the future.

D. difference of taxes payable and income tax paid.

C

difference of taxes payable and income tax paid.

[Bishara]

The difference in income tax expense and taxes payable is a:

A. deferred tax asset.

B. deferred income tax expense.

C. timing difference.

D. deferred tax liability.

B

Taxes payable is defined as the taxes due the government as determined by taxable income and the tax rate, while income tax expense is the amount actually recognized on the balance sheet. Deferred income tax expense is defined as the difference in income tax expense and taxes payable. Each individual deferred item is expected to be paid (or recovered) in future years.

[Bishara]

Accelerated depreciation results in:

A. lower taxes in the early years that are not reversed in the future.

B. higher taxes in the early years that are then reversed in the future.

C. higher taxes in the early years that are not reversed in the future.

D. lower taxes in the early years that are then reversed in the future

d.

[Bishara]

The following information is regarding as asset a firm purchased for $100,000.

• The asset has a 5-year useful life and no salvage value.

• The asset generates $30,000 of annual revenue for 5-years

• Tax rate is 35 percent.

• The business depreciates the asset over 4 years on a straight-line basis.

Taxes payable in year 5 are?

A. $5250.

B. $1750.

C. $10500.

D. $8750.

B

$30,000 revenue - $25,000 depreciation = $5,000 income

($5,000 income)(.35 tax rate) = $1750 taxes payable

[Bishara]

When firms are deferring their tax liability what type of depreciation is present?

A. Straight line.

B. Depleted.

C. Illegal.

D. Accelerated.

D

[Bishara]

1: Analysis of Financial Statements

a: Calculate, interpret, and discuss the uses of measures of a company's internal liquidity, operating performance, risk profile, growth potential, and external liquidity.

Measures of a company’s internal liquidity

These ratios are the:

1. Current ratio = current assets / current liabilities.

2. Quick ratio = [cash + marketable securities + receivable] / current liabilities.

3. Cash ratio = [cash + marketable securities] / current liabilities.

The current, quick, and cash ratios differ only in the liquidity of the current assets that the analyst projects will be used to pay off the current liabilities. Other ratios ask:

1. Does the company collect its receivables on a timely basis?

a. Receivables turnover = sales / average receivables

b. Average receivables collection period = 365 / receivables turnover

2. How fast does the company move its inventory through the system?

a. Inventory turnover = cost of goods sold / average inventory

b. Average inventory processing period = 365 / inventory turnover

3. Does the company pay its current bills?

a. Payables turnover = cost of goods sold / average accounts payable

b. Average payment period = 365 / payables turnover

The cash cycle is the time period that exists from when the firm pays out money for the purchase of raw materials to when it gets the money back from the purchasers of the firm’s finished goods.

Cash conversion cycle = collection period + inventory period - payment period.

Example: Receivables turnover = 9, days receivables out (collection period) = 41 days, inventory turnover = 6, days inventory in stock (inventory period) = 61 days, payables turnover = 11, and days payables out (payment period) = 33 days. Cash conversion cycle = 41 days + 61 days - 33 days = 69 days.

________________________________________

[Bishara]

Measures of a company’s operating performance

Operating efficiency ratios question how efficiently management is using the assets they have at their disposal. Efficiency ratios are all sales to balance sheet item ratios.

• total asset turnover = sales / total assets

• fixed asset turnover = sales / fixed assets

• equity turnover = sales / equity

Operating profitability ratios look at how good management is at turning their efforts into profits.

Gross profit margin = gross profits / sales.

Operating profit margin = operating profit / sales, this ratio is also written as EBIT / sales

Net profit margin = EAT / sales, also know the before tax profit margin = EBT / sales

Return on total capital = [EAT + interest] / capital

Return on owners equity = ROE = EAT / equity

[Bishara]

Measures of a company’s risk profile

Business risk is related to the firm’s industry, the variability of sales due to the firm’s products, customers and method of doing business.

1. Business risk = [standard deviation of operating income] / [mean operating income]

2. Sales variability = coefficient of variation of sales, sales variability = [standard deviation of sales] / [mean sales]

3. Operating leverage =[ave % change in operating earn]/[ave % change in sales]

Financial risk occurs on top of business risk. Financial risk is related to the uncertainty caused by the fixed cost associated with borrowed money.

Leverage ratios show where the money comes from:

a. debt to equity ratio = total long-term debt / equity

b. assets to equity ratio = assets / equity also called the financial leverage multiplier

c. debt to capital ratio = total long-term debt / total long-term capital

d. total debt ratio = [long-term + short-term debt] / total capital.

Earnings or cash flow ratios are designed to show the earnings or cash that is available to meet the required interest and lease payments. Debt service ratios.

a. Interest coverage = operating profit / interest expense = EBIT / I

b. Total fixed charge coverage = [EBIT + lease payments]/[interest + lease payments + (preferred dividends/{1-tax rate})]

c. Cash flow / interest expense

d. Cash flow coverage = (cash flow + interest expense) / interest expense

e. Cash flow / long-term debt.

[Bishara]

Measures of a company’s growth potential

Growth analysis: Investors and creditors are interested in the firm’s growth potential. Investors because high growth means high stock prices, and creditors because high growth means the firm’s ability to repay its obligations is improved.

1. Sustainable growth (g) = (earnings retention rate)(ROE), Where: the earnings retention rate = [1 - (dividends/net income)]

2. ROE = [EAT/sales][sales/assets][assets/equity]

Example: A firm has a predictable dividend payout ratio of 40%, a net profit margin of 12%, an asset turnover of 1.3 and an equity multiplier leverage measure of 1.4. Estimate the firm’s sustainable growth rate.

g = (earnings retention rate)(ROE) = (1 - dividend payout)(EAT/S)(S/A)(A/Eq)

g = (1 - .4)(.12)(1.3)(1.4) = .13 or 13%

[Bishara]

Measures of a company’s external liquidity

External liquidity is the relative speed at which you can trade your shares with little impact on the price. The most important determinant of external market liquidity is the number of shares traded during the time period. Other measures of liquidity are:

• The size of the bid-ask spread. The smaller the spread the greater the liquidity.

• The total market value of the outstanding securities.

• The number of shareholders.

• The trading turnover (shares traded during the period)/(number of shares outstanding).

b: Calculate the various components of the company's return on equity using the traditional and extended duPont systems.

Ratio analysis using the duPont system is an important tool of the analyst. The duPont system is the method of breaking down return ratios into their components. There are many variants of this breakdown.

Traditional version of the duPont equation:

• Start with the basic ROE ratio, (net income / equity).

• Multiplying the ROE by sales / sales gives ROE = (net income / sales)(sales / equity). Therefore, ROE = (net profit margin)(equity turnover).

• Expanding the equation further by incorporating financial leverage gives us ROE = (net income / sales)(sales / equity).

• Multiplying by assets / assets and rearranging the denominator gives us ROE = (net income / sales)(sales / assets)(assets / equity).

• Finally, we end up at (net profit margin)(asset turnover)(equity multiplier).

Extended version of the duPont equation:

• From the income statement you will notice that EAT = EBT(1 - t), where t is the firm's average tax rate. Substituting EBT(1 - t) for EAT in the expanded ROE equation gives us ROE = (EBT / sales)(sales / assets)(assets / equity)(1 - t).

• Now look at the income statement. The relationship between EBT and EBIT is EBT = EBIT - I, where I equals the firm's total interest expense. Substituting (EBIT - I) into the ROE equation for EBT gives us ROE = [(EBIT / sales)(sales / assets) - (interest expense / assets)] (assets / equity) (1 - t).

• Restated in accounting terms: ROE = [(operating profit margin)(total asset turnover) - (interest expense rate)](financial leverage multiplier)(tax retention rate).

[Bishara]

Q1. Define a contract and explain the essential elements of a valid contract.

Ans. The word "contract" derives from Latin words meaning "to draw together." Essentially, a contract does just that--it draws together the essential elements of an oral or written agreement. Unlike a gratuitous promise or a non-binding agreement, a valid contract is recognized at law and a party can be sued for not fulfilling the terms of the contract. As a result, contracts can just as easily draw people together into the courtroom.

The very fact that the word "contract" comes from Latin reflects that people have been negotiating for a very long time. As a result, the study of contracts is quite detailed. Law students often spend two years studying the principles of contracts. Some lawyers devote their practices to the interpretation, enforcement, and dissolution of contracts. Although a short article can hardly explore the intricacies of contracts, some generalities about contracts can be outlined.

Essentials of Valid Contracts

In determining whether or not a valid contract exists, courts usually look to three factors:

1. Was there an offer and an acceptance?

2. Was there consideration for the contract?

3. Are there any defenses to the contract?

Offer and Acceptance

An offer from a person reflects a willingness to enter into a contract on the basis of the offered terms (such as, "I will sell you this book for $4.00"). The more definite and certain a statement is, the more likely that a court will consider it an offer, rather than just negotiations that may lead to an offer ("Can I buy this painting for $50" versus "What's the lowest amount you will take for this painting?").

An acceptance is another party's agreement to the terms of the offer. Like an offer, an acceptance should be definite and can be as simple as the word "yes." In addition, the method of acceptance must usually be in the same manner of the offer or in an agreed upon manner. For example, a person offering ties for sale on the street would not expect an acceptance by telegram several days later.

Once a person receives notice that an offer is no longer valid, it is usually too late to accept the offer. A common example is when an item for sale is sold out. However, many lawsuits hinge on whether an offer was revoked timely and properly.

Consideration

Consideration simply means that each party to the contract is giving up something in return for obtaining something else. For example, if a new car part costs $80, one person is giving up $80 while gaining the car part and the other person is giving up the car part to obtain $80. Consideration is often referred to as a "bargained-for-exchange" and is essential to a valid contract.

Consideration gives a court the terms by which to enforce the agreement as a contract. When there is no consideration, a court may have to consider the transaction a gratuitous gift, rather than a contract. Consider the situation in which someone promises to give you a piece of jewelry. If the person changes her mind, a court will not enforce the gift because there was no consideration. If, however, you had contracted to buy the jewelry for cash (consideration), a court could enforce the terms of the contract.

Defenses

Even is a court finds an offer, acceptance, and consideration in a transaction, no contract exists if there are certain defenses. A defense simply means that there was a defect regarding the transaction or the parties involved so that no contract was created. For example, the fact that an item no longer exists is a mutual mistake that prevents a contract from being formed. Similarly, an agreement that has an illegal purpose, such as hiring someone to kill a person, will not be considered an enforceable contract.

To Write or Not to Write

There's an old saying that "An oral contract isn't worth the paper it's written on." Even so, an oral contract is valid in most instances. However, North Carolina has required by statute that certain contracts must be in writing to be enforceable. If an agreement falls under this "Statute of Frauds," a court will not require a party to fulfill the contract unless there is some type of written document signed by the party to be compelled.

The Statute of Frauds requires many documents to be in writing, including the following:

 A promise which by its very terms cannot be performed with one year.

 A promise which creates an interest in land, such as for the sale of real property.

 A lease with a term of more than one year.

 A mortgage.

 A promise which limits a person's right to do business in the state, such as a covenant not to compete signed by an employee.

Just because an agreement falls under the Statute of Frauds does not mean that a lengthy and complicated contract is required in all situations. The statute only requires that every "essential term" be in some written form. This language has usually been interpreted to require at least the following information:

(1) The identity of the parties;

(2) The subject matter of the contract;

(3) The terms and conditions of the agreement;

(4) The consideration given and received;

(5) The signature of the parties.

As long as some document, note, or combination of papers contain this essential information, a court will enforce the contract. A related rule states that if there is a writing no oral agreement will be entertained to contradict the written agreement.

Written Contact Essentials:

 Names of the parties

 Subject matter

 Terms and conditions

 Consideration, or money, exchanged

 Signatures of parties

SCDL - PGDBA - Finance - Sem 1- Business Law.doc

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