Corporate Finance A Focused Approach 5th Edition By Ehrhardt, Michael C. – Test Bnak
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Sample Test
CHAPTER 3—ANALYSIS OF FINANCIAL STATEMENTS
TRUE/FALSE
1. Ratio
analysis involves analyzing financial statements in order to appraise a firm’s financial
position and strength.
ANS:
T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-1
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Ratio
analysis
KEY: Bloom’s: Knowledge
2. The
current ratio and inventory turnover ratios both help us measure the firm’s
liquidity. The current ratio measures the relationship of a firm’s current
assets to its current liabilities, while the inventory turnover ratio gives us
an indication of how long it takes the firm to convert its inventory into cash.
ANS:
T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-2
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Liquidity
ratios
KEY: Bloom’s: Knowledge
3. Although
a full liquidity analysis requires the use of a cash budget, the current and
quick ratios provide fast and easy-to-use measures of a firm’s liquidity
position.
ANS:
T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-2
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Liquidity
ratios
KEY: Bloom’s: Knowledge
4. High
current and quick ratios always indicate that a firm is managing its liquidity
position well.
ANS:
F
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-2
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Current ratio
KEY: Bloom’s: Knowledge
5. The
inventory turnover ratio and days sales outstanding (DSO) are two ratios that
are used to assess how effectively a firm is managing its assets.
ANS:
T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-3
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Asset management
ratios
KEY: Bloom’s: Knowledge
6. A
decline in a firm’s inventory turnover ratio suggests that it is managing its
inventory more efficiently and also that its liquidity position is improving,
i.e., it is becoming more liquid.
ANS:
F
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-3
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Inventory turnover
ratio
KEY: Bloom’s: Knowledge
7. Debt
management ratios show the extent to which a firm’s managers are attempting to
magnify returns on owners’ capital through the use of financial leverage.
ANS: T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-4
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Debt management ratios
KEY: Bloom’s: Knowledge
8. The
times-interest-earned ratio is one, but not the only, indication of a firm’s
ability to meet its long-term and short-term debt obligations.
ANS:
T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-4
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: TIE
ratio
KEY: Bloom’s: Knowledge
9. Profitability
ratios show the combined effects of liquidity, asset management, and debt
management on operating results.
ANS:
T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-5
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Profitability
ratios
KEY: Bloom’s: Knowledge
10.
Market value ratios provide management with an indication of how
investors view the firm’s past performance and especially its future prospects.
ANS:
T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-6
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial statements,
analysis, forecasting, and cash flows
LOC:
TBA
TOP: Market value
ratios
KEY: Bloom’s: Knowledge
11.
Determining whether a firm’s financial position is improving or
deteriorating requires analyzing more than the ratios for a given year. Trend
analysis is one method of measuring changes in a firm’s performance over time.
ANS:
T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-7
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Trend
analysis
KEY: Bloom’s: Knowledge
12.
The “apparent,” but not the “true,” financial position of a
company whose sales are seasonal can differ dramatically, depending on the time
of year when the financial statements are constructed.
ANS: T
Many of the ratios show sales over some past period such as the
last 12 months divided by an asset such as inventories as of a specific date.
Assets like inventories vary at different times of the year for a seasonal
business, thus leading to big changes in the ratio.
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-1
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Balance sheet changes
KEY: Bloom’s: Knowledge
13.
Significant variations in accounting methods among firms make
meaningful ratio comparisons between firms more difficult than if all firms
used similar accounting methods.
ANS:
T
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-1
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Limitations of ratio
analysis
KEY: Bloom’s: Knowledge
14.
The basic earning power ratio (BEP) reflects the earning power
of a firm’s assets after giving consideration to financial leverage and tax
effects.
ANS: F
BEP = EBIT/Assets. This is before the effects of leverage
(interest) and taxes, so the statement is false.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-5
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Basic earning power
ratio
KEY: Bloom’s: Knowledge
15.
The inventory turnover and current ratio are related. The
combination of a high current ratio and a low inventory turnover ratio,
relative to industry norms, suggests that the firm has an above-average
inventory level and/or that part of the inventory is obsolete or damaged.
ANS: T
A high current ratio is consistent with a lot of inventory. A
low inventory turnover is also consistent with a lot of inventory. If the CR
exceeds industry norms and the turnover is below the norms, then the firm has
more inventory than most other firms, given its sales. It could just be
carrying a lot of good inventory, but it might also have a normal amount of
“good” inventory plus some “bad” inventory that has not been written off. So
the statement is true.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-3
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA TOP:
Inventory turnover
ratio
KEY: Bloom’s: Comprehension
16.
It is appropriate to use the fixed assets turnover ratio to
appraise firms’ effectiveness in managing their fixed assets if and only if all
the firms being compared have the same proportion of fixed assets to total
assets.
ANS: F
The FA turnover is Sales/FA, and it gives an indication of how
effectively the firm utilizes its FA. The proportion of FA to TA is not
relevant to this usage.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-3
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Fixed assets
turnover
KEY: Bloom’s: Comprehension
17.
Since the ROA measures the firm’s effective utilization of
assets (without considering how these assets are financed), two firms with the
same EBIT must have the same ROA.
ANS: F
EBIT = Sales revenues - Operating
costs
Net income = EBIT -
Interest -
Taxes = (EBIT -
Interest) ´ (1 - T)
ROA = Net income after taxes/Assets
Two firms could have identical EBITs but very different amounts
of interest, different tax rates, and different assets, and thus very different
ROAs.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-5
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC: TBA
TOP: ROA
KEY: Bloom’s: Comprehension
18.
Suppose firms follow similar financing policies, face similar
risks, have equal access to capital, and operate in competitive product and
capital markets. Under these conditions, then firms that have high profit
margins will tend to have high asset turnover ratios, and firms with low profit
margins will tend to have low turnover ratios.
ANS: F
Think about the DuPont equation: ROE = PM ´ TATO ´ Equity multiplier.
Similar financing policies will lead to similar Equity multipliers. Moreover,
competition in the capital markets will cause ROEs to be similar, because
otherwise capital would flow to industries with high ROEs and drive returns
down toward the average, given similar risks. To have similar ROEs, firms with
relatively high PMs must have relatively low TATOs, and vice versa. Therefore,
the statement is false.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-8
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: DuPont
equation
KEY: Bloom’s: Comprehension
19.
Even though Firm A’s current ratio exceeds that of Firm B, Firm
B’s quick ratio might exceed that of A. However, if A’s quick ratio exceeds
B’s, then we can be certain that A’s current ratio is also larger than that of
B.
ANS: F
This question can be answered by thinking carefully about the
ratios:
Demonstration that the first sentence is true:
CR =
A > B QR =
B > A
A:
1.67
0.67
QR(B) > QR(A)
B:
1.50
1.00
Demonstration that second sentence is false:
CR =
A > B QR =
B > A
A:
1.0
0.67
QR(B) < QR(A)
B:
1.5
0.50
The key is inventory, which is in the CR but not in the QR. The
firm with more inventory can have the higher CR but the lower QR.
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-2
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Liquidity
ratios
KEY: Bloom’s: Comprehension
20.
Firms A and B have the same current ratio, 0.75, the same amount
of sales and cost of goods sold, and the same amount of current liabilities.
However, Firm A has a higher inventory turnover ratio than B. Therefore, we can
conclude that A’s quick ratio must be smaller than B’s.
ANS: F
Firm A has the higher inventory turnover, so given the same cost
of goods, it must have less inventory. Thus, since the two firms have the same
CR, then A must have the higher QR, not the lower one. Therefore, the statement
is false.
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-2
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA TOP:
Liquidity
ratios
KEY: Bloom’s: Comprehension
21.
Suppose a firm wants to maintain a specific TIE ratio. It knows
the amount of its debt, the interest rate on that debt, the applicable tax
rate, and its operating costs. With this information, the firm can calculate
the amount of sales required to achieve its target TIE ratio.
ANS: T
TIE = EBIT/Interest = (Sales - Op
cost)/(Debt ´
Interest rate). If we know the op. costs, the amount of debt, and the interest
rate, then we can solve for the sales level required to achieve the target TIE.
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-4
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: TIE
ratio
KEY: Bloom’s: Comprehension
22.
Suppose Firms A and B have the same amount of assets, pay the
same interest rate on their debt, have the same basic earning power (BEP), and
have the same tax rate. However, Firm A has a higher debt ratio. If BEP is
greater than the interest rate on debt, Firm A will have a higher ROE as a
result of its higher debt ratio.
ANS: T
The easiest way to think about this is to realize that you can
borrow at a cost of 10% and invest the proceeds to earn 11%, you’ll earn a
surplus. If you were previously earning an ROE of 10%, then after raising and
investing additional funds, your income will be higher, your equity will be the
same, and thus your ROE will increase. Similarly, if a firm earns more on
assets than the interest rate, there will be a surplus after paying interest on
the debt that will go to the equity, thus increasing the ROE. So, if BEP >
rd, then the firm can increase its expected ROE by using more debt leverage.
The answer can also be seen by working out an example. The one
below shows that leverage increases ROE if BEP > rd, but it could be varied
to show no difference in ROE if interest rates and BEP are the same, and a
reduction in ROE if the interest rate exceeds the BEP.
Firm A Firm B
Assets 100%
Assets 100%
Debt
60%
Debt 0%
Equity 40%
Equity 100%
BEP
15%
BEP 15%
Interest rate,
rd
10% Interest rate, rd
10%
Tax
rate
40% Tax
rate
40%
EBIT = BEP ´
Assets
15.0 EBIT = BEP ´
Assets 15.0
Interest
6.0
Interest
0
Taxable
income
9.0 Taxable
income
15.0
Taxes
3.6
Taxes 6.0
NI
5.4
NI 9.0
ROE 13.50%
ROE 9.00%
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-5
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: BEP and
ROE
KEY: Bloom’s: Comprehension
23.
If a firm finances with only debt and common equity, and if its
equity multiplier is 3.0, then its debt ratio must be 0.667.
ANS: T
Equity multiplier = Assets/Equity = 3.0, so Assets/Equity =
1/3.0 = 0.333.
By definition, Equity/Assets + Debt/Assets = 1.00, so
0.333 + Debt/Assets = 1.0.
Therefore, Debt/Assets = 1.0 -
0.333 = 0.667. Thus, the statement is true.
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-8
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Equity
multiplier
KEY: Bloom’s: Comprehension
24.
One problem with ratio analysis is that relationships can be
manipulated. For example, if our current ratio is greater than 1.5, then
borrowing on a short-term basis and using the funds to build up our cash
account would cause the current ratio to increase.
ANS: F
The key here is to recognize that if the CR is greater than 1.0,
then a given increase in both current assets and current liabilities would lead
to a decrease in the CR. The reverse would hold if the initial CR were less
than 1.0. Here the initial CR is greater than 1.0, so borrowing on a short-term
basis to build the cash account would lower the CR. For example:
Original
New
Old New
CA/CL Plus $1 CA/CL
CR CR
3/2
1/1
4/3
1.50
1.33 CR falls if initial CR is
greater than 1.0
2/3
1/1
3/4
0.67
0.75 CR rises if initial CR is less
than 1.0
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-1
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Limitations of ratio
analysis
KEY: Bloom’s: Comprehension
25.
One problem with ratio analysis is that relationships can be
manipulated. For example, we know that if our current ratio is less than 1.0,
then using some of our cash to pay off some of our current liabilities would
cause the current ratio to increase and thus make the firm look stronger.
ANS: F
The key here is to recognize that if the CR is less than 1.0,
then a given reduction in both current assets and current liabilities would
lead to a decrease in the CR. The reverse would hold if the initial CR were
greater than 1.0. In the question, the initial CR is less than 1.0, so using
cash to reduce current liabilities would lower the CR. If the CR were greater
than 1.0, the statement would have been true. Here’s an illustration:
Original
New
Old New
CA/CL Less $1 CA/CL
CR CR
2/3 -1/-1
1/2
0.67
0.50 CR falls if initial CR is less
than 1.0
3/2 -1/-1
2/1
1.5
2.0 CR rises if initial
CR is greater than 1.0
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-1
NAT: BUSPROG: Reflective Thinking
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Limitations of ratio
analysis
KEY: Bloom’s: Comprehension
MULTIPLE CHOICE
26.
Considered alone, which of the following would increase a
company’s current ratio?
27.
An increase in accounts payable.
28.
An increase in net fixed assets.
29.
An increase in accrued liabilities.
30.
An increase in notes payable.
31.
An increase in accounts receivable.
ANS:
E
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-2
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Current ratio
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
27.
Which of the following would, generally, indicate an improvement
in a company’s financial position, holding other things constant?
28.
The total assets turnover decreases.
29.
The TIE declines.
30.
The DSO increases.
31.
The EBITDA coverage ratio increases.
32.
The current and quick ratios both decline.
ANS:
D
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-2
NAT: BUSPROG: Analytic
STA: DISC: Financial statements,
analysis, forecasting, and cash flows
LOC:
TBA
TOP: Current ratio
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
28.
A firm wants to strengthen its financial position. Which of the
following actions would increase its current ratio?
29.
Use cash to increase inventory holdings.
30.
Reduce the company’s days’ sales outstanding to the industry
average and use the resulting cash savings to purchase plant and equipment.
31.
Use cash to repurchase some of the company’s own stock.
32.
Borrow using short-term debt and use the proceeds to repay debt
that has a maturity of more than one year.
33.
Issue new stock and then use some of the proceeds to purchase
additional inventory and hold the remainder as cash.
ANS: E
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-2
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Current ratio
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
29.
Which of the following statements is CORRECT?
30.
If a firm increases its sales and cost of goods sold while
holding its inventories constant, then, other things held constant, its
inventory turnover ratio will decrease.
31.
A reduction in inventories held would have no effect on the
current ratio.
32.
An increase in inventories would have no effect on the current
ratio.
33.
If a firm increases its sales and cost of goods sold while
holding its inventories constant, then, other things held constant, its
inventory turnover ratio will increase.
34.
A reduction in the inventory turnover ratio will generally lead
to an increase in the ROE.
ANS:
D
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-3
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP:
Inventories
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
30.
Companies A and C each reported the same earnings per share
(EPS), but Company A’s stock trades at a higher price. Which of the following
statements is CORRECT?
31.
Company A trades at a higher P/E ratio.
32.
Company A probably has fewer growth opportunities.
33.
Company A is probably judged by investors to be riskier.
34.
Company A must have a higher market-to-book ratio.
35.
Company A must pay a lower dividend.
ANS:
A
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-6
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Financial statement
analysis
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
31.
Which of the following statements is CORRECT?
32.
If a firm has the highest price/earnings ratio of any firm in
its industry, then, other things held constant, this suggests that the board of
directors should fire the president.
33.
If a firm has the highest market/book ratio of any firm in its
industry, then, other things held constant, this suggests that the board of
directors should fire the president.
34.
Other things held constant, the higher a firm’s expected future
growth rate, the lower its P/E ratio is likely to be.
35.
The higher the market/book ratio, then, other things held
constant, the higher one would expect to find the Market Value Added (MVA).
36.
If a firm has a history of high Economic Value Added (EVA)
numbers each year, and if investors expect this situation to continue, then its
market/book ratio and MVA are both likely to be below average.
ANS:
D
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-6
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Market value
ratios
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
32.
Which of the following statements is CORRECT?
33.
“Window dressing” is any action that improves a firm’s
fundamental, long-run position and thus increases its intrinsic value.
34.
Borrowing by using short-term notes payable and then using the
proceeds to retire long-term debt is an example of “window dressing.” Offering
discounts to customers who pay with cash rather than buy on credit and then
using the funds that come in quicker to purchase additional inventories is
another example of “window dressing.”
35.
Borrowing on a long-term basis and using the proceeds to retire
short-term debt would improve the current ratio and thus could be considered to
be an example of “window dressing.”
36.
Offering discounts to customers who pay with cash rather than
buy on credit and then using the funds that come in quicker to purchase
additional inventories is an example of “window dressing.”
37.
Using some of the firm’s cash to reduce long-term debt is an
example of “window dressing.”
ANS:
C
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-1
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Window
dressing
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
33.
The Cavendish Company recently issued new common stock and used
the proceeds to pay off some of its short-term notes payable. This action had
no effect on the company’s total assets or operating income. Which of the
following effects would occur as a result of this action?
34.
The company’s debt ratio increased.
35.
The company’s current ratio increased.
36.
The company’s times interest earned ratio decreased.
37.
The company’s basic earning power ratio increased.
38.
The company’s equity multiplier increased.
ANS:
B
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-6
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Miscellaneous
ratios
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
34.
A firm’s new president wants to strengthen the company’s
financial position. Which of the following actions would make it financially stronger?
35.
Increase inventories while holding sales and cost of goods sold
constant.
36.
Increase accounts receivable while holding sales constant.
37.
Increase EBIT while holding sales constant.
38.
Increase accounts payable while holding sales constant.
39.
Increase notes payable while holding sales constant.
ANS:
C
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Miscellaneous
ratios
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
35.
If the CEO of a large, diversified, firm were filling out a
fitness report on a division manager (i.e., “grading” the manager), which of
the following situations would be likely to cause the manager to receive a
better grade? In all cases, assume that other things are held constant.
36.
The division’s DSO (days’ sales outstanding) is 40, whereas the
average for its competitors is 30.
37.
The division’s basic earning power ratio is above the average of
other firms in its industry.
38.
The division’s total assets turnover ratio is below the average
for other firms in its industry.
39.
The division’s debt ratio is above the average for other firms
in the industry.
40.
The division’s inventory turnover is 6, whereas the average for
its competitors is 8.
ANS:
B
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Miscellaneous
ratios
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
36.
Which of the following would indicate an improvement in a
company’s financial position, holding other things constant?
37.
The current and quick ratios both increase.
38.
The inventory and total assets turnover ratios both decline.
39.
The debt ratio increases.
40.
The profit margin declines.
41.
The EBITDA coverage ratio declines.
ANS:
A
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Miscellaneous
ratios
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
37.
If a bank loan officer were considering a company’s request for
a loan, which of the following statements would you consider to be CORRECT?
38.
Other things held constant, the lower the current ratio, the
lower the interest rate the bank would charge the firm.
39.
The lower the company’s EBITDA coverage ratio, other things held
constant, the lower the interest rate the bank would charge the firm.
40.
Other things held constant, the higher the debt ratio, the lower
the interest rate the bank would charge the firm.
41.
Other things held constant, the lower the debt ratio, the lower
the interest rate the bank would charge the firm.
42.
The lower the company’s TIE ratio, other things held constant,
the lower the interest rate the bank would charge the firm.
ANS:
D
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-4
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Miscellaneous
ratios
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
38.
Which of the following statements is CORRECT?
39.
All else equal, increasing the debt ratio will increase the ROA.
40.
The use of debt financing will tend to lower the basic earning
power ratio, other things held constant.
41.
A firm that employs financial leverage will have a higher equity
multiplier than an otherwise identical firm that has no debt in its capital
structure.
42.
If two firms have identical sales, interest rates paid,
operating costs, and assets, but differ in the way they are financed, the firm
with less debt will generally have the higher expected ROE.
43.
Holding bonds is better than holding stock for investors because
income from bonds is taxed on a more favorable basis than income from stock.
ANS:
C
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-8
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Effects of
leverage
KEY: Bloom’s: Comprehension
MSC: TYPE: Multiple Choice: Conceptual
39.
A firm wants to strengthen its financial position. Which of the
following actions would increase its quick ratio?
40.
Issue new common stock and use the proceeds to acquire
additional fixed assets.
41.
Offer price reductions along with generous credit terms that
would (1) enable the firm to sell some of its excess inventory and (2) lead to
an increase in accounts receivable.
42.
Issue new common stock and use the proceeds to increase
inventories.
43.
Speed up the collection of receivables and use the cash
generated to increase inventories.
44.
Use some of its cash to purchase additional inventories.
ANS:
B
PTS:
1
DIF: Difficulty: Moderate
OBJ: LO: 3-2
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Quick
ratio
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
40.
Amram Company’s current ratio is 1.9. Considered alone, which of
the following actions would reduce the company’s current ratio?
41.
Use cash to reduce accounts payable.
42.
Borrow using short-term notes payable and use the proceeds to
reduce accruals.
43.
Borrow using short-term notes payable and use the proceeds to reduce
long-term debt.
44.
Use cash to reduce accruals.
45.
Use cash to reduce short-term notes payable.
ANS: C
a is false, given that the initial CR > 1.0.
b would leave the CR unchanged.
c would indeed reduce the CR.
d is false, given that the initial CR > 1.0.
e is false, given that the initial CR > 1.0.
Original
New
Old New
CA/CL Minus
.5
CA/CL
CR CR
1.9/1
0/0.5 1.9/1.5
1.90
1.27 CR falls if initial CR is
greater than 1.0
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-2
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Current ratio
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
41.
Which of the following statements is CORRECT?
42.
If a firm increases its sales while holding its accounts
receivable constant, then, other things held constant, its days’ sales
outstanding will decline.
43.
If a security analyst saw that a firm’s days’ sales outstanding
(DSO) was higher than the industry average and was also increasing and trending
still higher, this would be interpreted as a sign of strength.
44.
If a firm increases its sales while holding its accounts
receivable constant, then, other things held constant, its days’ sales
outstanding (DSO) will increase.
45.
There is no relationship between the days’ sales outstanding
(DSO) and the average collection period (ACP). These ratios measure entirely
different things.
46.
A reduction in accounts receivable would have no effect on the
current ratio, but it would lead to an increase in the quick ratio.
ANS:
A
PTS:
1
DIF: Difficulty: Moderate
OBJ: LO: 3-3
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Accounts
receivable
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
42.
Which of the following statements is CORRECT?
43.
If two firms differ only in their use of debt¾i.e., they have
identical assets, sales, operating costs, and tax rates¾but one firm has a
higher debt ratio, the firm that uses more debt will have a higher profit
margin on sales.
44.
If one firm has a higher debt ratio than another, we can be
certain that the firm with the higher debt ratio will have the lower TIE ratio,
as that ratio depends entirely on the amount of debt a firm uses.
45.
A firm’s use of debt will have no effect on its profit margin on
sales.
46.
If two firms differ only in their use of debt¾i.e., they have
identical assets, sales, operating costs, interest rates on their debt, and tax
rates¾but
one firm has a higher debt ratio, the firm that uses more debt will have a
lower profit margin on sales.
47.
The debt ratio as it is generally calculated makes an adjustment
for the use of assets leased under operating leases, so the debt ratios of
firms that lease different percentages of their assets are still comparable.
ANS: D
a is incorrect. The reverse is true.
b is false, because the TIE also depends on the interest rate
and EBIT.
c is false, because interest affects the profit margin.
d is correct, because the more interest the lower the profits,
hence the lower the profit margin.
e is simply incorrect.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-4
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Leverage effects | Debt management
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Conceptual
43.
Which of the following statements is CORRECT?
44.
If Firms X and Y have the same net income, number of shares
outstanding, and price per share, then their market-to-book ratios must also be
the same.
45.
If Firms X and Y have the same P/E ratios, then their
market-to-book ratios must also be the same.
46.
If Firms X and Y have the same net income, number of shares
outstanding, and price per share, then their P/E ratios must also be the same.
47.
If Firms X and Y have the same earnings per share and
market-to-book ratio, they must have the same price earnings ratio.
48.
If Firm X’s P/E ratio exceeds that of Firm Y, then Y is likely
to be less risky and also to be expected to grow at a faster rate.
ANS: C
No reason for a to be true.
No reason for b to be true.
c must be true, as EPS and P will be the same.
No reason for d to be true.
e is wrong, because high risk and low growth lead to low P/Es.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-6
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Market value
ratios
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
44.
Which of the following statements is CORRECT?
45.
Suppose a firm’s total assets turnover ratio falls from 1.0 to
0.9, but at the same time its profit margin rises from 9% to 10%, and its debt
increases from 40% of total assets to 60%. Under these conditions, the ROE will
decrease.
46.
Suppose a firm’s total assets turnover ratio falls from 1.0 to
0.9, but at the same time its profit margin rises from 9% to 10% and its debt
increases from 40% of total assets to 60%. Under these conditions, the ROE will
increase.
47.
Suppose a firm’s total assets turnover ratio falls from 1.0 to
0.9, but at the same time its profit margin rises from 9% to 10% and its debt
increases from 40% of total assets to 60%. Without additional information, we
cannot tell what will happen to the ROE.
48.
The modified DuPont equation provides information about how
operations affect the ROE, but the equation does not include the effects of
debt on the ROE.
49.
Other things held constant, an increase in the debt ratio will
result in an increase in the profit margin on sales.
ANS: B
PM ´
TATO ´
Eq
mult.
= ROE
Old
9%
1.0
1.666667
15%
New
10%
0.9
2.5
23%
We see that b is true, thus c must be false.
We can also see that d, e, and a are all false.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-8
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: DuPont
analysis
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
45.
You observe that a firm’s ROE is above the industry average, but
its profit margin and debt ratio are both below the industry average. Which of
the following statements is CORRECT?
46.
Its total assets turnover must equal the industry average.
47.
Its total assets turnover must be above the industry average.
48.
Its return on assets must equal the industry average.
49.
Its TIE ratio must be below the industry average.
50.
Its total assets turnover must be below the industry average.
ANS: B
Thinking through the DuPont equation, we can see that if the firm’s
PM and Equity multiplier are below the industry average, the only way its ROE
can exceed the industry average is if its equity multiplier exceeds the
industry average. The following data illustrate this point:
ROE
=
PM ´
TATO ´
Eq
mult.
ROA
Firm
30%
9%
2.0
1.67 18%
Industry
25%
10%
1
2.50 10%
The above demonstrates that b is correct, and that makes e and a
incorrect.
Now consider the following:
NI/Assets = NI/Sales ´
Sales/Assets
ROA = PM ´ TATO
If its ROA were equal to the industry average, then with its low
debt ratio (hence low equity multiplier) its ROE would also be below the
industry average. So c is incorrect. With its debt ratio below the industry
average, its interest charges should also be low, which would increase its TIE
ratio, making d incorrect.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-8
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: DuPont
analysis
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
46.
Companies Heidee and Leaudy are virtually identical in that they
are both profitable, and they have the same total assets (TA), Sales (S),
return on assets (ROA), and profit margin (PM). However, Company Heidee has the
higher debt ratio. Which of the following statements is CORRECT?
47.
Company Heidee has a lower operating income (EBIT) than Company
LD.
48.
Company Heidee has a lower total assets turnover than Company
Leaudy.
49.
Company Heidee has a lower equity multiplier than Company
Leaudy.
50.
Company Heidee has a higher fixed assets turnover than Company
Leaudy.
51.
Company Heidee has a higher ROE than Company Leaudy.
ANS: E
Rule out all answers except e because they are false.
Alternative answer explanation using the DuPont equation:
ROE = PM ´ TATO
´ Eq
mult.
ROE = NI/S ´ S/TA
´
TA/Equity
The first two terms are the same, but KB has higher equity
multiplier, hence higher ROE.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-8
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC: TBA
TOP: DuPont
analysis
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
47.
Cordelion Communications is considering issuing new common stock
and using the proceeds to reduce its outstanding debt. The stock issue would
have no effect on total assets, the interest rate Cordelion pays, EBIT, or the
tax rate. Which of the following is likely to occur if the company goes ahead
with the stock issue?
48.
The times interest earned ratio will decrease.
49.
The ROA will decline.
50.
Taxable income will decrease.
51.
The tax bill will increase.
52.
Net income will decrease.
ANS: D
a The TIE will increase, not decrease.
b is false because reducing debt will lower interest, raise
income, and thus raise ROA.
c is false for the above reason.
d is true for the above reason.
e is false.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Financial statement
analysis
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
48.
Which of the following statements is CORRECT?
49.
An increase in a firm’s debt ratio, with no changes in its sales
or operating costs, could be expected to lower the profit margin.
50.
The ratio of long-term debt to total capital is more likely to
experience seasonal fluctuations than is either the DSO or the inventory
turnover ratio.
51.
If two firms have the same ROA, the firm with the most debt can
be expected to have the lower ROE.
52.
An increase in the DSO, other things held constant, could be
expected to increase the total assets turnover ratio.
53.
An increase in the DSO, other things held constant, could be
expected to increase the ROE.
ANS: A
1. More
debt would mean more interest, hence a lower NI, given a constant EBIT. This
would lower the profit margin = NI/Sales.
2. Sales
fluctuations would have more effects on the DSO and S/Inventory ratios.
3. ROE =
ROA ´
Equity multiplier, so more debt, higher ROE for given ROA.
4. DSO =
Receivables/Sales per day. With sales constant, an increase in DSO would mean
an increase in receivables, hence a decline, not a rise, in the TATO.
5. An
increase in the DSO might increase or decrease ROE, depending on how it
affected sales and costs.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Financial statement
analysis
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
49.
Heidee Corp. and Leaudy Corp. have identical assets, sales,
interest rates paid on their debt, tax rates, and EBIT. However, Heidee uses
more debt than Leaudy. Which of the following statements is CORRECT?
50.
Heidee would have the higher net income as shown on the income
statement.
51.
Without more information, we cannot tell if Heidee or Leaudy
would have a higher or lower net income.
52.
Heidee would have the lower equity multiplier for use in the
DuPont equation.
53.
Heidee would have to pay more in income taxes.
54.
Heidee would have the lower net income as shown on the income
statement.
ANS: E
More debt would mean more interest, hence a lower NI, given a
constant EBIT, so e is correct. Also, we can rule out b and a, and Heidee would
also have the higher multiplier, which rules out c. And with more interest,
Heidee would have to pay less taxes, not more.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-8
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Financial statement
analysis
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
50.
Other things held constant, which of the following alternatives
would increase a company’s cash flow for the current year?
51.
Increase the number of years over which fixed assets are
depreciated for tax purposes.
52.
Pay down the accounts payables.
53.
Reduce the days’ sales outstanding (DSO) without affecting sales
or operating costs.
54.
Pay workers more frequently to decrease the accrued wages
balance.
55.
Reduce the inventory turnover ratio without affecting sales or
operating costs.
ANS: C
1. Lengthening
depreciable lives would lower depreciation, increase taxable income and taxes,
and thus lower cash flow.
2. Paying
down accounts payable would use cash and thus reduce cash flow.
3. Reducing
the DSO would require collecting receivables faster, which would indeed
increase cash flow.
4. Decreasing
accruals would lower cash flow.
5. Reducing
inventory turnover would mean increasing inventories, which would use cash.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-3
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Cash
flows KEY:
Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
51.
Companies Heidee and Leaudy have the same sales, tax rate,
interest rate on their debt, total assets, and basic earning power. Both
companies have positive net incomes. Company Heidee has a higher debt ratio
and, therefore, a higher interest expense. Which of the following statements is
CORRECT?
52.
Company Heidee has more net income.
53.
Company Heidee pays less in taxes.
54.
Company Heidee has a lower equity multiplier.
55.
Company Heidee has a higher ROA.
56.
Company Heidee has a higher times interest earned (TIE) ratio.
ANS: B
Under the stated conditions, Heidee would have more interest
charges, thus lower taxable income and taxes. Thus, b is correct. All of the
other statements are incorrect.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-8
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Leverage, taxes, and
ratios
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
52.
Companies Heidee and Leaudy have the same tax rate, sales, total
assets, and basic earning power. Both companies have positive net incomes.
Company Heidee has a higher debt ratio and, therefore, a higher interest
expense. Which of the following statements is CORRECT?
53.
Company Heidee has a lower times interest earned (TIE) ratio.
54.
Company Heidee has a lower equity multiplier.
55.
Company Heidee has more net income.
56.
Company Heidee pays more in taxes.
57.
Company Heidee has a lower ROE.
ANS: A
Heidee has higher interest charges. Basic earning power equals
EBIT/Assets, and since assets are equal, EBIT must also be equal. TIE =
EBIT/Interest. Therefore, Heidee higher interest charges means that its TIE
must be lower. Thus, a is correct. All of the other statements are incorrect.
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-8
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Leverage, taxes, and
ratios
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
53.
Lincoln Industries’ current ratio is 0.5. Considered alone,
which of the following actions would increase the company’s current ratio?
54.
Use cash to reduce long-term bonds outstanding.
55.
Borrow using short-term notes payable and use the cash to
increase inventories.
56.
Use cash to reduce accruals.
57.
Use cash to reduce accounts payable.
58.
Use cash to reduce short-term notes payable.
ANS: B
The key here is to recognize that if the CR is less than 1.0,
then a given increase in both current assets and current liabilities would lead
to an increase in the CR. The reverse would hold if the initial CR were greater
than 1.0. Here the initial CR is less than 1.0, so borrowing on a short-term
basis to build inventories would increase the CR. For example:
Original
New Old
New
CA/CL Plus $1 CA/CL
CR CR
1/2
1/1
2/3
0.50
0.67 CR rises if initial CR is less
than 1.0
All of the other statements are incorrect, although c, d, and e
would be correct if the initial CR had been >1.0.
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-2
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Current ratio
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
54.
Lofland’s has $20 million in current assets and $10 million in
current liabilities, while Smaland’s current assets are $10 million versus $20
million of current liabilities. Both firms would like to “window dress” their
end-of-year financial statements, and to do so each plans to borrow $10 million
on a short-term basis and to then hold the borrowed funds in their cash
accounts. Which of the statements below best describes the results of these
transactions?
55.
The transaction would improve both firms’ financial strength as
measured by their current ratios.
56.
The transactions would raise Lofland’s financial strength as
measured by its current ratio but lower Smaland’s current ratio.
57.
The transactions would lower Lofland’s financial strength as
measured by its current ratio but raise Smaland’s current ratio.
58.
The transaction would have no effect on the firm’ financial
strength as measured by their current ratios.
59.
The transaction would lower both firm’ financial strength as
measured by their current ratios.
ANS: C
The key here is to recognize that if the CR is less than 1.0,
then a given increase to both current assets and current liabilities will
increase the CR, while the reverse will hold if the initial CR is greater than
1.0. Thus, the transaction would make Smaland look stronger but Lofland look
weaker. Here’s an illustration:
Original
New
Old New
CA/CL Plus
$10
CA/CL CR
CR
Lofland 20/10
10/10 30/20
2.00
1.50 CR falls because initial CR is
greater than 1.0
Original
New
Old New
CA/CL Plus
$10
CA/CL
CR CR
Smaland
10/20 10/10
20/30 0.50
0.67 CR rises because initial CR is
less than 1.0
All of the statements except c are incorrect.
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-2
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Current ratio
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
55.
Companies Heidee and Leaudy have the same total assets, sales,
operating costs, and tax rates, and they pay the same interest rate on their
debt. However, company Heidee has a higher debt ratio. Which of the following
statements is CORRECT?
56.
If the interest rate the companies pay on their debt is less
than their basic earning power (BEP), then Company Heidee will have the higher
ROE.
57.
Given this information, Leaudy must have the higher ROE.
58.
Company Leaudy has a higher basic earning power ratio (BEP).
59.
Company Heidee has a higher basic earning power ratio (BEP).
60.
If the interest rate the companies pay on their debt is more
than their basic earning power (BEP), then Company Heidee will have the higher
ROE.
ANS: A
The companies have the same EBIT and assets, hence the same BEP
ratio. If the interest rate is less than the BEP, then using more debt will
raise the ROE. Therefore, statement a is correct. The others are all incorrect.
PTS:
1
DIF: Difficulty:
Challenging OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Effects of financial
leverage
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Conceptual
56.
Arshadi Corp.’s sales last year were $52,000, and its total
assets were $22,000. What was its total assets turnover ratio (TATO)?
57.
2.03
58.
2.13
59.
2.25
60.
2.36
61.
2.48
ANS: D
Sales $52,000
Total assets $22,000
TATO 2.36
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-3
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Total assets
turnover
KEY: Bloom’s: Application
MSC: TYPE: Multiple Choice: Problem
57.
Hutchinson Corporation has zero debt¾it is financed only
with common equity. Its total assets are $410,000. The new CFO wants to employ
enough debt to bring the debt/assets ratio to 40%, using the proceeds from the
borrowing to buy back common stock at its book value. How much must the firm
borrow to achieve the target debt ratio?
58.
$155,800
59.
$164,000
60.
$172,200
61.
$180,810
62.
$189,851
ANS: B
Total assets $410,000
Target debt
ratio
40%
Debt to achieve target ratio = amount
borrowed
$164,000
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-4
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Debt ratio: find the debt, given the D/A
ratio
KEY: Bloom’s:
Application
MSC: TYPE: Multiple Choice: Problem
58.
Orono Corp.’s sales last year were $435,000, its operating costs
were $362,500, and its interest charges were $12,500. What was the firm’s times
interest earned (TIE) ratio?
59.
4.72
60.
4.97
61.
5.23
62.
5.51
63.
5.80
ANS: E
Sales $435,000
Operating
costs
362,500
Operating income
(EBIT)
72,500
Interest charges
$ 12,500
TIE
ratio
5.80
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-4
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Times interest
earned
KEY: Bloom’s: Application
MSC: TYPE: Multiple Choice: Problem
59.
Rappaport Corp.’s sales last year were $320,000, and its net
income after taxes was $23,000. What was its profit margin on sales?
60.
6.49%
61.
6.83%
62.
7.19%
63.
7.55%
64.
7.92%
ANS: C
Sales $320,000
Net income $23,000
Profit margin 7.19%
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Profit margin on
sales
KEY: Bloom’s: Application
MSC: TYPE: Multiple Choice: Problem
60.
Branch Corp.’s total assets at the end of last year were
$315,000 and its net income after taxes was $22,750. What was its return on
total assets?
61.
7.22%
62.
7.58%
63.
7.96%
64.
8.36%
65.
8.78%
ANS: A
Total assets $315,000
Net income $22,750
ROA 7.22%
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Return on total assets (ROA)
KEY: Bloom’s: Application
MSC: TYPE: Multiple Choice: Problem
61.
Chambliss Corp.’s total assets at the end of last year were
$305,000 and its EBIT was 62,500. What was its basic earning power (BEP)?
62.
18.49%
63.
19.47%
64.
20.49%
65.
21.52%
66.
22.59%
ANS: C
Total assets $305,000
EBIT $62,500
BEP 20.49%
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Basic earning power
(BEP)
KEY: Bloom’s: Application
MSC: TYPE: Multiple Choice: Problem
62.
Nikko Corp.’s total common equity at the end of last year was
$305,000 and its net income after taxes was $60,000. What was its ROE?
63.
16.87%
64.
17.75%
65.
18.69%
66.
19.67%
67.
20.66%
ANS: D
Common
equity
$305,000
Net income $60,000
ROE 19.67%
PTS:
1
DIF: Difficulty: Easy
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Return on equity (ROE)
KEY: Bloom’s: Application
MSC: TYPE: Multiple Choice: Problem
63.
An investor is considering starting a new business. The company
would require $475,000 of assets, and it would be financed entirely with common
stock. The investor will go forward only if she thinks the firm can provide a
13.5% return on the invested capital, which means that the firm must have an
ROE of 13.5%. How much net income must be expected to warrant starting the
business?
64.
$52,230
65.
$54,979
66.
$57,873
67.
$60,919
68.
$64,125
ANS: E
Assets = equity $475,000
Target ROE
13.5%
Required net income $64,125
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-5
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Return on equity (ROE): finding net income
KEY: Bloom’s:
Application
MSC: TYPE: Multiple Choice: Problem
64.
Vang Corp.’s stock price at the end of last year was $33.50 and
its earnings per share for the year were $2.30. What was its P/E ratio?
65.
13.84
66.
14.57
67.
15.29
68.
16.06
69.
16.86
ANS: B
Stock
price $33.50
EPS $2.30
P/E 14.57
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-6
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Price/Earnings ratio
(P/E)
KEY: Bloom’s: Application
MSC: TYPE: Multiple Choice: Problem
65.
Lindley Corp.’s stock price at the end of last year was $33.50,
and its book value per share was $25.00. What was its market/book ratio?
66.
1.34
67.
1.41
68.
1.48
69.
1.55
70.
1.63
ANS: A
Stock
price $33.50
Book value per share $25.00
M/B ratio
1.34
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-6
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Price/Earnings ratio
(P/E)
KEY: Bloom’s: Application
MSC: TYPE: Multiple Choice: Problem
66.
Northwest Lumber had a profit margin of 5.25%, a total assets
turnover of 1.5, and an equity multiplier of 1.8. What was the firm’s ROE?
67.
12.79%
68.
13.47%
69.
14.18%
70.
14.88%
71.
15.63%
ANS: C
Profit margin 5.25%
TATO 1.50
Equity
multiplier
1.80
ROE 14.18%
PTS:
1
DIF: Difficulty:
Easy
OBJ: LO: 3-8
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: DuPont equation: basic
calculation
KEY: Bloom’s: Application
MSC: TYPE: Multiple Choice: Problem
67.
Bostian, Inc. has total assets of $625,000. Its total debt
outstanding is $185,000. The Board of Directors has directed the CFO to move
towards a debt-to-assets ratio of 55%. How much debt must the company add or
subtract to achieve the target debt ratio?
68.
$158,750
69.
$166,688
70.
$175,022
71.
$183,773
72.
$192,962
ANS: A
Total assets $625,000
Present debt $185,000
Target debt
ratio
55%
Target amount of debt $343,750
Change in amount of debt outstanding $158,750
PTS: 1
DIF: Difficulty:
Moderate
OBJ: LO: 3-4
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Debt
ratio
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem
68.
Emerson Inc.’s would like to undertake a policy of paying out
45% of its income. Its latest net income was $1,250,000, and it had 225,000
shares outstanding. What dividend per share should it declare?
69.
$2.14
70.
$2.26
71.
$2.38
72.
$2.50
73.
$2.63
ANS: D
Net income $1,250,000
Shares
outstanding 225,000
Payout ratio 45%
EPS $5.56
DPS $2.50
PTS:
1
DIF: Difficulty: Moderate
OBJ: LO: 3-6
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: EPS, DPS, and payout
KEY: Bloom’s: Analysis
MSC: TYPE: Multiple Choice: Problem
69.
Aziz Industries has sales of $100,000 and accounts receivable of
$11,500, and it gives its customers 30 days to pay. The industry average DSO is
27 days, based on a 365-day year. If the company changes its credit and
collection policy sufficiently to cause its DSO to fall to the industry
average, and if it earns 8.0% on any cash freed-up by this change, how would
that affect its net income, assuming other things are held constant?
70.
$267.34
71.
$281.41
72.
$296.22
73.
$311.81
74.
$328.22
ANS: E
Rate of return on cash
generated
8.0%
Sales $100,000
A/R $11,500
Days in year 365
Sales/day
$273.97
Company DSO 42.0
Industry DSO
27.0
Excess DSO 15.0
Cash flow from reducing the DSO
$4,102.74
Alternative calculation:
A/R at industry DSO
$7,397.26
Change in A/R $4,102.74
Additional Net Income $328.22
PTS:
1
DIF: Difficulty:
Moderate
OBJ: LO: 3-3
NAT: BUSPROG: Analytic
STA: DISC: Financial
statements, analysis, forecasting, and cash flows
LOC:
TBA
TOP: Effect of lowering the DSO on net income
KEY: Bloom’s:
Analysis
MSC: TYPE: Multiple Choice: Problem
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