Chapter 3 - Analysis of Financial Statements: True/False

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Chapter 3 - Analysis of Financial Statements

TRUE/FALSE

1. Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and
strength.

ANS: T PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

2. The current and inventory turnover ratios both help us measure a firm's liquidity. The current ratio
measures the relationship of the 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: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

3. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide
fast and easy-to-use estimates of a firm's liquidity position.

ANS: T PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

4. High current and quick ratios always indicate that the firm is managing its liquidity position well.

ANS: F
It might have too much liquidity. Liquid assets generally provide low returns.

PTS: 1 DIF: EASY NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

5. If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would
probably not change much, but its quick ratio would decline.

ANS: F PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

6. If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick
ratio would increase.

ANS: T PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

7. If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its
current or quick ratio would change.

ANS: F
The quick ratio would increase as receivables replaced inventory.

PTS: 1 DIF: EASY NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

8. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess
how effectively a firm is managing its current assets.

ANS: T PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

9. A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory
management and its liquidity position, i.e., that it is becoming more liquid.

ANS: F PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

10. In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio indicates
that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result
of running out of stock.

ANS: F PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

11. The days sales outstanding tells us how long it takes, on average, to collect after a sale is made. The
DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on
time.

ANS: T PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

12. If a firm's fixed assets turnover ratio is significantly higher than its industry average, this could
indicate that it uses its fixed assets very efficiently or is operating at over capacity and should probably
add fixed assets.

ANS: T PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

13. 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: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

14. The more conservative a firm's management is, the higher its debt ratio is likely to be.

ANS: F PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

15. Other things held constant, the higher a firm's debt ratio, the higher its TIE ratio will be.

ANS: F PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

16. 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: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

17. Profitability ratios show the combined effects of liquidity, asset management, and debt management on
a firm's operating results.

ANS: T PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

18. 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: EASY NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

19. The operating margin measures operating income per dollar of assets.

ANS: F PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

20. The profit margin measures net income per dollar of sales.

ANS: T PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

21. The "apparent," but not necessarily the "true," financial position of a company whose sales are
seasonal can change dramatically during a given year, 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: EASY NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

22. Significant variations in accounting methods among firms make meaningful ratio comparisons
between firms more difficult than if all firms used the same or similar accounting methods.

ANS: T PTS: 1 DIF: EASY


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

23. 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: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

24. 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: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

25. Other things held constant, the more debt a firm uses, the lower its profit margin will be.

ANS: T PTS: 1 DIF: MEDIUM


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

26. Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a
margin of 8% for Firm B. Firm A's debt ratio is 70% versus one of 20% for Firm B. Based only on
these two facts, you cannot reach a conclusion as to which firm is better managed, because the
difference in debt, not better management, could be the cause of Firm A's higher profit margin.

ANS: F
A's higher debt ratio would tend to lower its profit margin. Since its margin is already higher, this
indicates that A is the better managed company.

PTS: 1 DIF: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

27. Other things held constant, the more debt a firm uses, the lower its operating margin will be.
ANS: F PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

28. The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a
company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

ANS: T PTS: 1 DIF: MEDIUM


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

29. Other things held constant, the more debt a firm uses, the lower its return on total assets will be.

ANS: T PTS: 1 DIF: MEDIUM


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

30. 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
Two firms could have identical EBITs but different amounts of interest, tax rates, and different
amounts of assets, and thus different ROAs.

Example: A B
EBIT = Sales revenues - Operating costs = EBIT $ 100.0 $ 100.0
Interest differs. B has more debt: Interest 10.0 20.0
EBT $ 90.0 $ 80.0
Both have 35% rate: Taxes 31.5 28.0
AT Inc. $ 58.5 $ 52.0
Assets differ: Assets $ 200.0 $ 500.0
ROA 29.3 % 10.4 %

PTS: 1 DIF: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

31. Other things held constant, a decline in sales accompanied by an increase in financial leverage must
result in a lower profit margin.

ANS: F
PM = NI / Sales. A decline in sales would, other things held constant, increase the PM. An increase in
financial leverage would lead to higher interest charges, which would decrease net income, which
would decrease the PM. So, the net effect could be an increase or a decrease in the PM, or no change.

PTS: 1 DIF: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

32. The return on common equity (ROE) is generally regarded as being less significant, from a
stockholder's viewpoint, than the return on total assets (ROA).

ANS: F
Stockholders should--and generally do--consider the ROE as being probably the single most important
ratio based strictly on the financial statements.
PTS: 1 DIF: MEDIUM NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

33. 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: MEDIUM


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

34. In general, if investors regard a company as being relatively risky and/or having relatively poor growth
prospects, then it will have relatively high P/E and M/B ratios.

ANS: F PTS: 1 DIF: MEDIUM


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

35. The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current
earnings. In general, investors regard companies with higher P/E ratios as being less risky and/or more
likely to enjoy higher growth in the future.

ANS: T PTS: 1 DIF: MEDIUM


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

36. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting
book value. In general, investors regard companies with higher M/B ratios as being less risky and/or
more likely to enjoy higher growth in the future.

ANS: T PTS: 1 DIF: MEDIUM


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

37. 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 examining changes in a firm's
performance over time.

ANS: T PTS: 1 DIF: MEDIUM


NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

38. Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and
operate in competitive product and capital markets. However, firms face different operating conditions
because, for example, the grocery store industry is different from the airline industry. Under these
conditions, firms with 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: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

39. Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, a zero debt ratio
and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm
borrow money, use it to buy back stock, and raise the debt ratio to 50% and the equity multiplier to
2.0. She thinks that operations would not be affected, but interest on the new debt would lower the
profit margin to 4.5%. This would probably be a good move, as it would increase the ROE from 7.5%
to 13.5%.

ANS: T
DuPont equation: ROE = PM TATO Equity multiplier. Given the data, the statement is true.

PM X TATO X Eq Mult = ROE


5.0 % 1.5 1.0 7.5 %
4.5 % 1.5 2.0 13.5 %

PTS: 1 DIF: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

40. 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 B's.

ANS: F
This question can be answered by thinking carefully about the ratios:

C + A/R + Inv CR: A > B C + A/R B>A


Demonstration that the CR = CL QR = CL
first sentence is true: A: 1+1+3 = 1.67 1+ 1 0.67
QR(B) > QR(A) 3 3
B: 1+1+1 = 1.50 1+ 1 1.00
2 2

Demonstration that the C + A/R + Inv CR: A < B C + A/R B<A


second sentence CR = CL QR = CL
is false: A: 1+1+1 1.0 1+ 1 0.67
QR(B) < QR(A) 3 3
B: 1+1+4 1.5 1+ 1 0.50
4 4

The key is inventory, which is in the CR but not in the QR. The firm with more inventory can have the

PTS: 1 DIF: HARD NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.
41. Firms A and B have the same current ratio, 0.75, the same amount of sales, 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, S/I. So, given the same sales, A must have less inventory.
Since the two firms have the same CR, A must have the higher QR, not the lower one. Therefore, the
statement is false.

PTS: 1 DIF: HARD NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

42. 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: HARD NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

43. 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 problem is to realize that if 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 at 11%, 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: Uses Debt Firm B: No Debt


Assets $ 100Assets $ 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 $ 15.0EBIT = BEP Assets $ 15.0
Interest 6.0Interest 0
Taxable income 9.0Taxable income 15.0
Taxes 3.6Taxes 6.0
NI 5.4NI 9.0
ROE 13.50 %ROE 9.00 %

PTS: 1 DIF: HARD NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

44. 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 Equity/Assets = 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: HARD NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

45. One problem with ratio analysis is that relationships can sometimes 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 Plus $1 New CA/CL Old CR New CR


CA/CL
3 1 4 1.50 1.33 CR falls if initial CR
2 1 3 is greater than 1.0

2 1 3 0.67 0.75 CR rises if initial CR


3 1 4 is less than 1.0

PTS: 1 DIF: HARD NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

46. 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 Less $1 New CA/CL Old CR New CR


CA/CL
2 -1 1 0.67 0.50 CR falls if initial CR
3 -1 2 is less than 1.0

3 -1 2 1.5 2.0 CR rises if initial CR


2 -1 1 is greater than 1.0

PTS: 1 DIF: HARD NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

MULTIPLE CHOICE

1. Considered alone, which of the following would INCREASE a company’s current ratio?
a. An increase in net fixed assets.
b. An increase in accrued liabilities.
c. An increase in notes payable.
d. An increase in accounts receivable.
e. An increase in accounts payable.
ANS: D PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

2. Which of the following would, generally, indicate an IMPROVEMENT in a company’s financial


position, holding other things constant?
a. The TIE declines.
b. The DSO increases.
c. The quick ratio increases.
d. The current ratio declines.
e. The total assets turnover decreases.
ANS: C PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

3. A firm wants to strengthen its financial position. Which of the following actions would INCREASE
its current ratio?
a. Reduce the company’s days’ sales outstanding to the industry average and use the resulting
cash savings to purchase plant and equipment.
b. Use cash to repurchase some of the company’s own stock.
c. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of
more than one year.
d. Issue new stock, then use some of the proceeds to purchase additional inventory and hold
the remainder as cash.
e. Use cash to increase inventory holdings.
ANS: D PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

4. Which of the following statements is CORRECT?


a. A reduction in inventories would have no effect on the current ratio.
b. An increase in inventories would have no effect on the current ratio.
c. If a firm increases its sales while holding its inventories constant, then, other things held
constant, its inventory turnover ratio will increase.
d. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
e. If a firm increases its sales while holding its inventories constant, then, other things held
constant, its fixed assets turnover ratio will decline.
ANS: C PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

5. Companies E and P each reported the same earnings per share (EPS), but Company E’s stock trades at
a higher price. Which of the following statements is CORRECT?
a. Company E probably has fewer growth opportunities.
b. Company E is probably judged by investors to be riskier.
c. Company E must have a higher market-to-book ratio.
d. Company E must pay a lower dividend.
e. Company E trades at a higher P/E ratio.
ANS: E PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

6. Which of the following statements is CORRECT?


a. 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.”
b. 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."
c. Offering discounts to customers who pay with cash rather than buy on credit and then
using the funds that come in quicker to purchase fixed assets is an example of “window
dressing.”
d. Using some of the firm’s cash to reduce long-term debt is an example of “window
dressing.”
e. “Window dressing” is any action that does not improve a firm’s fundamental long-run
position and thus increases its intrinsic value.
ANS: B PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

7. Casey Communications 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?
a. The company’s current ratio increased.
b. The company’s times interest earned ratio decreased.
c. The company’s basic earning power ratio increased.
d. The company’s equity multiplier increased.
e. The company’s debt ratio increased.
ANS: A PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

8. A firm’s new president wants to strengthen the company’s financial position. Which of the following
actions would make it FINANCIALLY stronger?
a. Increase accounts receivable while holding sales constant.
b. Increase EBIT while holding sales and assets constant.
c. Increase accounts payable while holding sales constant.
d. Increase notes payable while holding sales constant.
e. Increase inventories while holding sales constant.
ANS: B PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

9. 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.
a. The division’s basic earning power ratio is above the average of other firms in its industry.
b. The division’s total assets turnover ratio is below the average for other firms in its industry.
c. The division’s debt ratio is above the average for other firms in the industry.
d. The division’s inventory turnover is 6, whereas the average for its competitors is 8.
e. The division’s DSO (days’ sales outstanding) is 40, whereas the average for its competitors
is 30.
ANS: A PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

10. Which of the following would indicate an IMPROVEMENT in a company’s financial position,
holding other things constant?
a. The inventory and total assets turnover ratios both decline.
b. The debt ratio increases.
c. The profit margin declines.
d. The times-interest-earned ratio declines.
e. The current and quick ratios both increase.
ANS: E PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

11. If a bank loan officer were considering a company’s loan request, which of the following statements
would you consider to be CORRECT?
a. The lower the company’s inventory turnover ratio, other things held constant, the lower the
interest rate the bank would charge the firm.
b. Other things held constant, the higher the days sales outstanding ratio, the lower the
interest rate the bank would charge.
c. Other things held constant, the lower the debt ratio, the lower the interest rate the bank
would charge.
d. The lower the company’s TIE ratio, other things held constant, the lower the interest rate
the bank would charge.
e. Other things held constant, the lower the current ratio, the lower the interest rate the bank
would charge the firm.
ANS: C PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

12. Which of the following statements is CORRECT?


a. The use of debt financing will tend to lower the basic earning power ratio, other things
held constant.
b. 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.
c. 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.
d. The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because
interest is paid with post-tax dollars, so the firm's ability to pay current interest is affected
by taxes.
e. All else equal, increasing the debt ratio will increase the ROA.
ANS: B PTS: 1 DIF: EASY
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

13. A firm wants to strengthen its financial position. Which of the following actions would INCREASE
its quick ratio?
a. 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.
b. Issue new common stock and use the proceeds to increase inventories.
c. Speed up the collection of receivables and use the cash generated to increase inventories.
d. Use some of its cash to purchase additional inventories.
e. Issue new common stock and use the proceeds to acquire additional fixed assets.
ANS: A PTS: 1 DIF: EASY | MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

14. Amram Company’s current ratio is 2.0. Considered alone, which of the following actions would
LOWER the current ratio?
a. Borrow using short-term notes payable and use the proceeds to reduce accruals.
b. Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
c. Use cash to reduce accruals.
d. Use cash to reduce short-term notes payable.
e. Use cash to reduce accounts payable.
ANS: B PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

15. Which of the following statements is CORRECT?


a. If a security analyst saw that a firm’s days’ sales outstanding (DSO) was higher than the
industry average, and was increasing and trending still higher, this would be interpreted as
a sign of strength.
b. A high average DSO indicates that none of its customers are paying on time. In addition, it
makes no sense to evaluate the firm's DSO with the firm's credit terms.
c. There is no relationship between the days’ sales outstanding (DSO) and the average
collection period (ACP). These ratios measure entirely different things.
d. A reduction in accounts receivable would have no effect on the current ratio, but it would
lead to an increase in the quick ratio.
e. If a firm increases its sales while holding its accounts receivable constant, then, other
things held constant, its days’ sales outstanding will decline.
ANS: E PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.
16. Which of the following statements is CORRECT?
a. 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.
b. A firm’s use of debt will have no effect on its profit margin.
c. If two firms differ only in their use of debt—i.e., they have identical assets, sales, operating
costs, interest rates on their debt, and tax rates—but one firm has a higher debt ratio, the
firm that uses more debt will have a lower profit margin on sales and a lower return on
assets.
d. 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.
e. If two firms differ only in their use of debt—i.e., they have identical assets, sales, operating
costs, and tax rates—but one firm has a higher debt ratio, the firm that uses more debt will
have a higher operating margin and return on assets.
ANS: C PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

17. Which of the following statements is CORRECT?


a. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be
equal.
b. 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.
c. If Firms X and Y have the same earnings per share and market-to-book ratio, they must
have the same price/earnings ratio.
d. If Firm X’s P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and/or be
expected to grow at a faster rate.
e. 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.
ANS: B PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

18. Which of the following statements is CORRECT?


a. 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.
b. 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.
c. The DuPont equation provides information about how operations affect the ROE, but the
equation does not include the effects of debt on the ROE.
d. Other things held constant, an increase in the debt ratio will result in an increase in the
profit margin.
e. 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.
ANS: A PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.
19. 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?
a. Its total assets turnover must be above the industry average.
b. Its return on assets must equal the industry average.
c. Its TIE ratio must be below the industry average.
d. Its total assets turnover must be below the industry average.
e. Its total assets turnover must equal the industry average.
ANS: A PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

20. Companies HD and LD are both profitable, and they have the same total assets (TA), Sales (S), return
on assets (ROA), and profit margin (PM). However, Company HD has the higher debt ratio. Which of
the following statements is CORRECT?
a. Company HD has a lower total assets turnover than Company LD.
b. Company HD has a lower equity multiplier than Company LD.
c. Company HD has a higher fixed assets turnover than Company LD.
d. Company HD has a higher ROE than Company LD.
e. Company HD has a lower operating income (EBIT) than Company LD.
ANS: D
Rule out all answers except d because they are false.
Alternative answer using the DuPont equation:
ROE = PM x TATO x Eq multiplier
ROE = NI/S x S/TA x TA/Equity
The first two terms are the same, but HD has a higher equity multiplier due to its higher debt, hence
higher ROE.

PTS: 1 DIF: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

21. Taggart Technologies 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 Taggart pays,
EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the
stock issue?
a. The ROA will decline.
b. Taxable income will decline.
c. The tax bill will increase.
d. Net income will decrease.
e. The times-interest-earned ratio will decrease.
ANS: C PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

22. Which of the following statements is CORRECT?


a. 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.
b. If two firms have the same ROA, the firm with the most debt can be expected to have the
lower ROE.
c. An increase in the DSO, other things held constant, could be expected to increase the total
assets turnover ratio.
d. An increase in the DSO, other things held constant, could be expected to increase the ROE.
e. An increase in a firm’s debt ratio, with no changes in its sales or operating costs, could be
expected to lower its net profit margin.
ANS: E PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

23. HD Corp and LD Corp have identical assets, sales, interest rates paid on their debt, tax rates, and
EBIT. However, HD uses more debt than LD. Which of the following statements is CORRECT?
a. Without more information, we cannot tell if HD or LD would have a higher or lower net
income.
b. HD would have the lower equity multiplier for use in the DuPont equation.
c. HD would have to pay more in income taxes.
d. HD would have the lower net income as shown on the income statement.
e. HD would have the higher operating margin.
ANS: D PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

24. Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic
earning power. Both companies have positive net incomes. Company HD has a higher debt ratio and,
therefore, a higher interest expense. Which of the following statements is CORRECT?
a. Company HD pays less in taxes.
b. Company HD has a lower equity multiplier.
c. Company HD has a higher ROA.
d. Company HD has a higher times-interest-earned (TIE) ratio.
e. Company HD has more net income.
ANS: A
Under the stated conditions, HD would have more interest charges, thus lower taxable income and
taxes.

PTS: 1 DIF: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

25. Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both
companies have positive net incomes. Company HD has a higher debt ratio and, therefore, a higher
interest expense. Which of the following statements is CORRECT?
a. Company HD has a lower equity multiplier.
b. Company HD has more net income.
c. Company HD pays more in taxes.
d. Company HD has a lower ROE.
e. Company HD has a lower times-interest-earned (TIE) ratio.
ANS: E
HD has higher interest charges. Basic earning power equals EBIT/Assets, and since assets and BEP
are equal, EBIT must also be equal. TIE = EBIT/Interest. Therefore, HD's higher interest charges
means that its TIE must be lower.

PTS: 1 DIF: MEDIUM NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

26. Which of the following statements is CORRECT?


a. If a firm has high current and quick ratios, this always indicate that the firm is managing its
liquidity position well.
b. If a firm sold some inventory for cash and left the funds in its bank account, its current
ratio would probably not change much, but its quick ratio would decline.
c. If a firm sold some inventory on credit, its current ratio would probably not change much,
but its quick ratio would decline.
d. If a firm sold some inventory on credit as opposed to cash, there is no reason to think that
either its current or quick ratio would change.
e. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used
to assess how effectively a firm is managing its current assets.
ANS: E PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

27. Which of the following statements is CORRECT?


a. A decline in a firm's inventory turnover ratio suggests that it is improving both its
inventory management and its liquidity position, i.e., that it is becoming more liquid.
b. In general, it's better to have a low inventory turnover ratio than a high one, as a low one
indicates that the firm has an adequate stock of inventory relative to sales and thus will not
lose sales as a result of running out of stock.
c. If a firm's fixed assets turnover ratio is significantly lower than its industry average, this
could indicate that it uses its fixed assets very efficiently or is operating at over capacity
and should probably add fixed assets.
d. The more conservative a firm's management is, the higher its debt ratio is likely to be.
e. The days sales outstanding ratio tells us how long it takes, on average, to collect after a
sale is made. The DSO can be compared with the firm's credit terms to get an idea of
whether customers are paying on time.
ANS: E PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

28. Which of the following statements is CORRECT?


a. Other things held constant, the more debt a firm uses, the higher its operating margin will
be.
b. 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.
c. Other things held constant, the more debt a firm uses, the higher its profit margin will be.
d. Other things held constant, the higher a firm's debt ratio, the higher its TIE ratio will be.
e. Debt management ratios show the extent to which a firm's managers are attempting to
reduce risk through the use of financial leverage. The higher the debt ratio, the lower the
risk.
ANS: B PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

29. Which of the following statements is CORRECT?


a. Other things held constant, the less debt a firm uses, the lower its return on total assets will
be.
b. The advantage of the basic earning power ratio (BEP) over the return on total assets for
judging a company's operating efficiency is that the BEP does not reflect the effects of debt
and taxes.
c. The return on common equity (ROE) is generally regarded as being less significant, from a
stockholder's viewpoint, than the return on total assets (ROA).
d. The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of
current earnings. In general, investors regard companies with higher P/E ratios as being
more risky and/or less likely to enjoy higher future growth.
e. Suppose you are analyzing two firms in the same industry. Firm A has a net profit margin
of 10% versus a margin of 8% for Firm B. Firm A's debt ratio is 70% versus 20% for Firm
B. Based only on these two facts, you cannot reach a conclusion as to which firm is better
managed, because the difference in debt, not better management, could be the cause of
Firm A's higher profit margin.
ANS: B PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

30. Which of the following statements is CORRECT?


a. In general, if investors regard a company as being relatively risky and/or having relatively
poor growth prospects, then it will have relatively high P/E and M/B ratios.
b. The basic earning power ratio (BEP) reflects the earning power of a firm's assets after
giving consideration to financial leverage and tax effects.
c. The "apparent," but not necessarily the "true," financial position of a company whose sales
are seasonal can change dramatically during a given year, depending on the time of year
when the financial statements are constructed.
d. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of
accounting book value. In general, investors regard companies with higher M/B ratios as
being more risky and/or less likely to enjoy higher future growth.
e. 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: C PTS: 1 DIF: MEDIUM
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

31. Walter Industries’ current ratio is 0.5. Considered alone, which of the following actions would
INCREASE the company’s current ratio?
a. Borrow using short-term notes payable and use the cash to increase inventories.
b. Use cash to reduce accruals.
c. Use cash to reduce accounts payable.
d. Use cash to reduce short-term notes payable.
e. Use cash to reduce long-term bonds outstanding.
ANS: A PTS: 1 DIF: HARD
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

32. Safeco’s current assets total to $20 million versus $10 million of current liabilities, while Risco’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 they tentatively plan 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?
a. The transactions would improve Safeco’s financial strength as measured by its current ratio
but lower Risco’s current ratio.
b. The transactions would lower Safeco’s financial strength as measured by its current ratio
but raise Risco’s current ratio.
c. The transactions would have no effect on the firm’ financial strength as measured by their
current ratios.
d. The transactions would lower both firm’ financial strength as measured by their current
ratios.
e. The transactions would improve both firms’ financial strength as measured by their current
ratios.
ANS: B
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 transactions would make Risco look stronger but Safeco look weaker. Here's an
illustration:

Original New
CA/CL Plus $10 CA/CL Old CR New CR
Safeco 20 10 30 2.00 1.50 CR falls because initial
10 10 20 CR is greater than 1.0

Original New
CA/CL Plus $10 CA/CL Old CR New CR
Risco 10 10 20 0.50 0.67 CR rises because initial
20 10 30 CR is less than 1.0

PTS: 1 DIF: HARD NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

33. Companies HD and LD have the same total assets, sales, operating costs, and tax rates, and they pay
the same interest rate on their debt. However, company HD has a higher debt ratio. Which of the
following statements is CORRECT?
a. Given this information, LD must have the higher ROE.
b. Company LD has a higher basic earning power ratio (BEP).
c. Company HD has a higher basic earning power ratio (BEP).
d. If the interest rate the companies pay on their debt is more than their basic earning power
(BEP), then Company HD will have the higher ROE.
e. If the interest rate the companies pay on their debt is less than their basic earning power
(BEP), then Company HD will have the higher ROE.
ANS: E
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 e is correct. The others
are all incorrect.

PTS: 1 DIF: HARD NAT: Analytic skills | Reflective thinking


LOC: Students will acquire knowledge of financial analysis and cash flows.

34. Which of the following statements is CORRECT?


a. 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 B's.
b. 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.
c. 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.
d. Suppose all firms follow similar financing policies, face similar risks, have equal access to
capital, and operate in competitive product and capital markets. However, firms face
different operating conditions because, for example, the grocery store industry is different
from the airline industry. Under these conditions, firms with high profit margins will tend
to have high asset turnover ratios, and firms with low profit margins will tend to have low
turnover ratios.
e. Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, a
zero debt ratio and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO
recommends that the firm borrow money, use it to buy back stock, and raise the debt ratio
to 50% and the equity multiplier to 2.0. She thinks that operations would not be affected,
but interest on the new debt would lower the profit margin to 4.5%. This would probably
not be a good move, as it would decrease the ROE from 7.5% to 6.5%.
ANS: B PTS: 1 DIF: HARD
NAT: Analytic skills | Reflective thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.

35. Ryngard Corp's sales last year were $27,000, and its total assets were $16,000. What was its total
assets turnover ratio (TATO)?
a. 1.57
b. 1.64
c. 1.49
d. 1.94
e. 1.69
ANS: E
Sales $27,000
Total assets $16,000
TATO = Sales/Total assets = 1.69

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

36. Beranek Corp has $665,000 of assets, and it uses no debt--it is financed only with common equity.
The new CFO wants to employ enough debt to raise the debt/assets ratio to 40%, using the proceeds
from borrowing to buy back common stock at its book value. How much must the firm borrow to
achieve the target debt ratio?
a. $303,240
b. $266,000
c. $324,520
d. $250,040
e. $252,700
ANS: B
Total assets $665,000
Target debt ratio 40%
Debt to achieve target ratio = Amount borrowed = Target% Assets = $266,000

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

37. Ajax Corp's sales last year were $460,000, its operating costs were $362,500, and its interest charges
were $12,500. What was the firm's times-interest-earned (TIE) ratio?
a. 7.80
b. 7.18
c. 8.19
d. 7.72
e. 9.75
ANS: A
Sales $460,000
Operating costs $362,500
Operating income $97,500
(EBIT)
Interest charges $12,500
TIE ratio = EBIT/Interest = 7.80

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

38. Royce Corp's sales last year were $260,000, and its net income was $23,000. What was its profit
margin?
a. 7.61%
b. 7.25%
c. 8.85%
d. 8.58%
e. 10.97%
ANS: C
Sales $260,000
Net income $23,000
Profit margin = NI/Sales = 8.85%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

39. River Corp's total assets at the end of last year were $380,000 and its net income was $32,750. What
was its return on total assets?
a. 6.98%
b. 7.15%
c. 8.62%
d. 10.77%
e. 10.43%
ANS: C
Total assets $380,000
Net income $32,750
ROA = NI/Assets = 8.62%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

40. X-1 Corp's total assets at the end of last year were $380,000 and its EBIT was 52,500. What was its
basic earning power (BEP) ratio?
a. 11.88%
b. 11.19%
c. 16.44%
d. 16.16%
e. 13.82%
ANS: E
Total assets $380,000
EBIT $52,500
BEP = EBIT / Assets = 13.82%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

41. Zero Corp's total common equity at the end of last year was $430,000 and its net income was $70,000.
What was its ROE?
a. 14.98%
b. 16.28%
c. 12.70%
d. 15.79%
e. 12.21%
ANS: B
Common equity $430,000
Net income $70,000
ROE = NI/Equity = 16.28%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

42. Your sister is thinking about starting a new business. The company would require $380,000 of assets,
and it would be financed entirely with common stock. She 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?
a. $58,482
b. $45,144
c. $52,326
d. $51,300
e. $39,501
ANS: D
Assets = Equity $380,000
Target ROE 13.5%
Required net income = Target ROE Equity = $51,300

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

43. Song Corp's stock price at the end of last year was $27.75 and its earnings per share for the year were
$1.30. What was its P/E ratio?
a. 20.28
b. 26.47
c. 20.07
d. 21.35
e. 24.12
ANS: D
Stock price $27.75
EPS $1.30
P/E = Stock price / EPS 21.35

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

44. Hoagland Corp's stock price at the end of last year was $22.50, and its book value per share was
$25.00. What was its market/book ratio?
a. 0.85
b. 0.90
c. 0.86
d. 0.97
e. 1.00
ANS: B
Stock price $22.50
Book value per share $25.00
M/B ratio = Stock price / Book value per share = 0.90

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

45. Precision Aviation had a profit margin of 4.75%, a total assets turnover of 1.5, and an equity multiplier
of 1.8. What was the firm's ROE?
a. 14.88%
b. 13.59%
c. 15.52%
d. 13.47%
e. 12.83%
ANS: E
Profit margin 4.75%
TATO 1.50
Equity multiplier 1.80
ROE = PM TATO Eq. Multiplier = 12.83%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

46. Meyer Inc's assets are $745,000, and its total debt outstanding is $185,000. The new CFO wants to
establish a debt ratio of 55%. The size of the firm does not change. How much debt must the
company add or subtract to achieve the target debt ratio?
a. $168,563
b. $224,750
c. $191,038
d. $211,265
e. $271,948
ANS: B
Total assets $745,000
Old debt $185,000
Target debt ratio 55%
Target amount of debt = Target debt% Total assets = $409,750
Change in amount of debt outstanding = Target debt - Old debt = $224,750

PTS: 1 DIF: EASY | MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

47. Helmuth Inc's latest net income was $1,210,000, and it had 225,000 shares outstanding. The company
wants to pay out 45% of its income. What dividend per share should it declare?
a. $2.49
b. $2.06
c. $2.11
d. $2.69
e. $2.42
ANS: E
Net income $1,210,000
Shares outstanding 225,000
Payout ratio 45%
EPS = NI / shares outstanding = $5.38
DPS = EPS Payout% = $2.42

PTS: 1 DIF: EASY | MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

48. Garcia Industries has sales of $167,500 and accounts receivable of $18,500, and it gives its customers
25 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?
a. $508.32
b. $405.68
c. $488.77
d. $386.13
e. $518.09
ANS: C
Rate of return on cash generated 8.0%
Sales $167,500
A/R $18,500
Days in Year 365
Sales/day = Sales / 365 = $458.90
Company DSO = Receivables / Sales per day = 40.3
Industry DSO 27.0
Difference = Company DSO - Industry DSO = 13.3
Cash flow from reducing the DSO = Difference Sales/day = $6,109.59
Additional Net Income = Return on cash Added cash flow = $488.77
Alternative Calculation:
A/R at industry DSO $12,390.41
Change in A/R $6,109.59
Additional Net Income $488.77

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.
49. Faldo Corp sells on terms that allow customers 45 days to pay for merchandise. Its sales last year
were $435,000, and its year-end receivables were $60,000. If its DSO is less than the 45-day credit
period, then customers are paying on time. Otherwise, they are paying late. By how much are
customers paying early or late? Base your answer on this equation: DSO - Credit Period = Days
early or late, and use a 365-day year when calculating the DSO. A positive answer indicates late
payments, while a negative answer indicates early payments.
a. 5.18
b. 4.86
c. 5.29
d. 5.34
e. 5.40
ANS: D
Credit period 45
Sales $435,000
Sales/day = Sales / 365 = $1,191.78
Receivables $60,000
Company DSO = Receivables / Sales per day = 50.34
Company DSO - Credit Period = Days early (-) or late (+) = 5.34

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

50. Han Corp's sales last year were $395,000, and its year-end receivables were $52,500. The firm sells
on terms that call for customers to pay 30 days after the purchase, but some delay payment beyond
Day 30. On average, how many days late do customers pay? Base your answer on this equation:
DSO - Allowed credit period = Average days late, and use a 365-day year when calculating the DSO.
a. 15.92
b. 15.18
c. 13.88
d. 18.51
e. 14.07
ANS: D
Sales $395,000
Sales/day = Sales / 365 = $1,082.19
Receivables $52,500
Company DSO = Receivables / Sales per day = 48.51
Credit period 30
DSO - Credit period = Days late 18.51

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

51. Wie Corp's sales last year were $365,000, and its year-end total assets were $355,000. The average
firm in the industry has a total assets turnover ratio (TATO) of 2.4. The firm's new CFO believes the
firm has excess assets that can be sold so as to bring the TATO down to the industry average without
affecting sales. By how much must the assets be reduced to bring the TATO to the industry average,
holding sales constant?
a. $202,917
b. $221,179
c. $213,063
d. $160,304
e. $184,654
ANS: A
Sales $365,000
Actual total assets $355,000
Target TATO = Sales / Total assets = 2.40
Target assets = Sales / Target TATO = $152,083
Asset reduction = Actual assets - Target assets = $202,917

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

52. A new firm is developing its business plan. It will require $635,000 of assets, and it projects $450,000
of sales and $355,000 of operating costs for the first year. Management is reasonably sure of these
numbers because of contracts with its customers and suppliers. It can borrow at a rate of 7.5%, but the
bank requires it to have a TIE of at least 4.0, and if the TIE falls below this level the bank will call in
the loan and the firm will go bankrupt. What is the maximum debt ratio the firm can use? (Hint: Find
the maximum dollars of interest, then the debt that produces that interest, and then the related debt
ratio.)
a. 50.87%
b. 59.34%
c. 49.87%
d. 62.34%
e. 42.89%
ANS: C
Assets $635,000
Sales $450,000
Operating costs $355,000
Operating income (EBIT) $95,000
Target TIE 4.00
Maximum interest expense = EBIT / Target TIE $23,750
Interest rate 7.50%
Max. debt = Max interest expense/Interest rate $316,667
Maximum debt ratio = Debt/Assets 49.87%

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

53. Chang Corp. has $375,000 of assets, and it uses only common equity capital (zero debt). Its sales for
the last year were $520,000, and its net income was $25,000. Stockholders recently voted in a new
management team that has promised to lower costs and get the return on equity up to 15.0%. What
profit margin would the firm need in order to achieve the 15% ROE, holding everything else constant?
a. 10.71%
b. 9.41%
c. 10.82%
d. 8.11%
e. 12.66%
ANS: C
Total assets = Equity because zero debt $375,000
Sales $520,000
Net income $25,000
Target ROE 15.00%
Net income req'd to achieve target ROE = Target ROE Equity = $56,250
Profit margin needed to achieve target ROE = NI / Sales = 10.82%

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

54. Last year Ann Arbor Corp had $300,000 of assets, $305,000 of sales, $20,000 of net income, and a
debt-to-total-assets ratio of 37.5%. The new CFO believes a new computer program will enable it to
reduce costs and thus raise net income to $33,000. Assets, sales, and the debt ratio would not be
affected. By how much would the cost reduction improve the ROE?
a. 5.34%
b. 5.82%
c. 6.59%
d. 8.67%
e. 6.93%
ANS: E
Assets $300,000
Debt ratio 37.5%
Debt = Assets Debt% = $112,500
Equity = Assets - Debt = $187,500
Sales $305,000
Old net income $20,000
New net income $33,000
New ROE = New NI / Equity = 17.600%
Old ROE = Old NI / Equity = 10.667%
Increase in ROE = New ROE - Old ROE = 6.93%

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

55. Brookman Inc's latest EPS was $2.75, its book value per share was $22.75, it had 280,000 shares
outstanding, and its debt ratio was 44%. How much debt was outstanding?
a. $4,704,700
b. $5,355,350
c. $5,205,200
d. $4,054,050
e. $5,005,000
ANS: E
EPS $2.75
BVPS $22.75
Shares outstanding 280,000
Debt ratio 44.0%
Total equity = Shares outstanding BVPS = $6,370,000
Total assets = Total equity / (1 - Debt ratio) = $11,375,000
Total debt = Total assets - Equity = $5,005,000

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.
56. Last year Harrington Inc. had sales of $325,000 and a net income of $19,000, and its year-end assets
were $250,000. The firm's total-debt-to-total-assets ratio was 67.5%. Based on the DuPont equation,
what was the ROE?
a. 21.98%
b. 18.94%
c. 23.38%
d. 22.68%
e. 22.22%
ANS: C
Sales $325,000
Assets $250,000
Net income $19,000
Debt ratio 67.5%
Debt = Debt% Assets = $168,750
Equity = Assets - Debt = $81,250
Profit margin = NI / Sales = 5.85%
TATO 1.30
Equity multiplier = Assets / Equity = 3.08
ROE 23.38%

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

57. Last year Rennie Industries had sales of $240,000, assets of $175,000, a profit margin of 5.3%, and an
equity multiplier of 1.2. The CFO believes that the company could reduce its assets by $51,000
without affecting either sales or costs. Had it reduced its assets by this amount, and had the debt ratio,
sales, and costs remained constant, how much would the ROE have changed?
a. 3.55%
b. 3.19%
c. 3.66%
d. 3.01%
e. 3.59%
ANS: E
Old New
Sales $240,000 $240,000
Original assets $175,000
Reduction in assets $51,000
New assets = Old assets - Reduction = $124,000
TATO = Sales / Assets = 1.37 1.94
Profit margin 5.30% 5.30%
Equity multiplier 1.20 1.20
ROE = PM TATO Eq Multiplier = 8.72% 12.31%
Change in ROE 3.59%

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.
58. Last year Blease Inc had a total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were
$320,000 and its net income was $10,600. The CFO believes that the company could have operated
more efficiently, lowered its costs, and increased its net income by $10,250 without changing its sales,
assets, or capital structure. Had it cut costs and increased its net income by this amount, how much
would the ROE have changed?
a. 5.82%
b. 9.10%
c. 7.31%
d. 8.87%
e. 7.46%
ANS: E
Old New
Sales $320,000 $320,000
Original net income $10,600 $10,600
Increase in net income $0 $10,250
New net income $10,600 $20,850
Profit margin = NI / Sales = 3.31% 6.52%
TATO 1.33 1.33
Equity multiplier 1.75 1.75
ROE = PM TATO Eq Multiplier = 7.71% 15.17%
Change in ROE 7.46%

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

59. Last year Jandik Corp. had $325,000 of assets, $18,750 of net income, and a debt-to-total-assets ratio
of 37%. Now suppose the new CFO convinces the president to increase the debt ratio to 48%. Sales
and total assets will not be affected, but interest expenses would increase. However, the CFO believes
that better cost controls would be sufficient to offset the higher interest expense and thus keep net
income unchanged. By how much would the change in the capital structure improve the ROE?
a. 2.19%
b. 1.67%
c. 1.57%
d. 1.94%
e. 2.17%
ANS: D
Assets $325,000
Old debt ratio 37%
Old debt = Assets Old debt% = $120,250
Old equity $204,750
New debt ratio 48%
New debt = Assets New debt% = $156,000
New Equity = Assets - New debt = $169,000
Net income $18,750
New ROE = New income / New Equity 11.09%
Old ROE = Old income / Old Equity 9.16%
Increase in ROE 1.94%

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.
60. Last year Kruse Corp had $355,000 of assets, $403,000 of sales, $28,250 of net income, and a debt-to-
total-assets ratio of 39%. The new CFO believes the firm has excessive fixed assets and inventory that
could be sold, enabling it to reduce its total assets to $252,500. Sales, costs, and net income would not
be affected, and the firm would maintain the same debt ratio (but with less total debt). By how much
would the reduction in assets improve the ROE?
a. 5.67%
b. 5.30%
c. 4.40%
d. 4.18%
e. 5.98%
ANS: B
Original New
Assets $355,000 $252,500
Sales $403,000 $403,000
Net income $28,250 $28,250
Debt ratio 39.00% 39.00%
Debt = Assets debt% = $138,450 $98,475
Equity = Assets - Debt = $216,550 $154,025
ROE = NI / Equity = 13.045% 18.341%
Increase in ROE 5.30%

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

61. Jordan Inc has the following balance sheet and income statement data:

Cash $14,000 Accounts payable $42,000


Receivables 70,000 Other current liabilities 28,000
Inventories 280,000 Total CL $70,000
Total CA $364,000 Long-term debt 140,000
Net fixed assets 126,000 Common equity 280,000
Total assets $490,000 Total liab. and equity $490,000
Sales $280,000
Net income 21,000

The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the
current ratio to equal the industry average, 2.10, without affecting either sales or net income.
Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and
that the funds generated are used to buy back common stock at book value, by how much would the
ROE change?
a. 28.16%
b. 20.93%
c. 24.28%
d. 32.29%
e. 25.83%
ANS: E
Original balance sheet and income statement data:
Cash $14,000 Accounts payable $42,000
Receivables 70,000 Other current liabilities 28,000
Inventories 280,000 Total CL $70,000
Total CA $364,000 Long-term debt 140,000
Net fixed assets 126,000 Common equity 280,000
Total assets $490,000 Total liab. and equity $490,000
Sales $280,000
Net income 21,000

Actual current ratio 5.20


Target current ratio 2.10

Old current assets = $364,000


Current assets to have CR = Target: Target current ratio Cur. Liab = $147,000
Reduction in current assets = Old CA - New CA = Inventory reduction = $217,000
Reduction in common equity = Reduction in inventory = $217,000
New common equity = Old equity - Reduction = $63,000

Orig ROE = NI/Old Equity: 7.50%


New ROE = NI/New Equity: 33.33%
D ROE = 25.83%

PTS: 1 DIF: HARD NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

62. Last year Hamdi Corp. had sales of $500,000, operating costs of $450,000, and year-end assets of
$355,000. The debt-to-total-assets ratio was 17%, the interest rate on the debt was 7.5%, and the
firm's tax rate was 35%. The new CFO wants to see how the ROE would have been affected if the
firm had used a 50% debt ratio. Assume that sales, operating costs, total assets, and the tax rate would
not be affected, but the interest rate would rise to 8.0%. By how much would the ROE change in
response to the change in the capital structure?
a. 3.17%
b. 3.42%
c. 3.48%
d. 3.08%
e. 2.99%
ANS: D
O N
ld ew
Interest rate 7.5% 8.0%
Tax rate 35% 35%
Assets $355,000 $355,000
Debt ratio 17% 50%
Debt = Assets Debt ratio = $60,350 $177,500
Equity = Assets - Debt = $294,650 $177,500

Sales $500,000 $500,000


Operating costs 450,000 450,000
EBIT = Sales - Operating costs = $50,000 $50,000
Interest paid = Interest rate Debt = 4,526 14,200
Taxable income $45,474 $35,800
Taxes 15,916 12,530
Net income $29,558 $23,270
ROE 10.03% 13.11%
Change in ROE 3.08%

PTS: 1 DIF: HARD NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.
63. Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be
$300,000, operating costs to be $265,000, assets to be $200,000, and its tax rate to be 35%. Under
Plan A it would use 25% debt and 75% common equity. The interest rate on the debt would be 8.8%,
but under a contract with existing bondholders the TIE ratio would have to be maintained at or above
3.2. Under Plan B, the maximum debt that met the TIE constraint would be employed. Assuming that
sales, operating costs, assets, the interest rate, and the tax rate would all remain constant, by how much
would the ROE change in response to the change in the capital structure?
a. 7.10%
b. 7.40%
c. 8.21%
d. 8.73%
e. 7.25%
ANS: B
Work down the Plan A column, find the Max Debt, then use it to complete Plan B and the ROEs.
Plan A Plan B
Interest rate 8.80% 8.80%
Tax rate 35% 35%
Assets $200,000 $200,000
Debt ratio: Plan A given, Plan B calculated 25% 62.1 49.7%
Debt $50,000 $124,290
Equity $150,000 $75,710

Sales $300,000 $300,000


Operating costs 265,000 265,000 Constant
EBIT $35,000 $35,000
Interest 4,400 10,938
Taxable income $30,600 $24,063
Taxes 10,710 8,422
Net income $19,890 $15,641
ROE = NI / Equity = 13.26% 20.66%
TIE = EBIT/Interest = 7.95
Minimum TIE 3.20
$ of Interest consistent with
minimum TIE = EBIT/Min TIE = $10,938
Max debt = Interest/interest rate = $124,290
Change in ROE 7.40%

PTS: 1 DIF: HARD NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

64. What is the firm's current ratio?


a. 1.17
b. 1.04
c. 1.28
d. 1.32
e. 1.11
ANS: D
Current ratio = Current assets/Current liabilities = 1.32

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

65. What is the firm's quick ratio?


a. 0.46
b. 0.59
c. 0.57
d. 0.73
e. 0.60
ANS: B
Quick ratio = (CA - Inventory)/CL = 0.59

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

66. What is the firm's days sales outstanding? Assume a 365-day year for this calculation.
a. 55.27
b. 66.46
c. 80.45
d. 57.37
e. 69.96
ANS: E
DSO = Accounts receivable/(Sales/365) = 69.96

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

67. What is the firm's total assets turnover?


a. 1.26
b. 1.43
c. 1.20
d. 1.48
e. 1.38
ANS: C
Total assets turnover ratio = TATO = Sales/Total assets = 1.20

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

68. What is the firm's inventory turnover ratio?


a. 3.75
b. 3.98
c. 3.19
d. 3.23
e. 3.79
ANS: A
Inventory turnover ratio = Sales/Inventory = 3.75

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.
69. What is the firm's TIE?
a. 2.56
b. 2.62
c. 2.80
d. 2.64
e. 2.70
ANS: D
TIE = EBIT/Interest charges = 2.64

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

70. What is the firm's debt ratio?


a. 65.15%
b. 76.11%
c. 49.67%
d. 78.05%
e. 64.50%
ANS: E
Debt ratio = Total debt/Total assets = 64.5%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

71. What is the firm's ROA?


a. 2.30%
b. 1.96%
c. 2.44%
d. 2.51%
e. 1.87%
ANS: A
ROA = Net income/Total assets = 2.30%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

72. What is the firm's ROE?


a. 7.92%
b. 6.49%
c. 6.16%
d. 6.94%
e. 5.77%
ANS: B
ROE = Net income/Common equity = 6.49%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

73. What is the firm's BEP?


a. 5.81%
b. 5.59%
c. 5.70%
d. 6.44%
e. 4.85%
ANS: C
BEP = EBIT/Total assets = 5.70%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

74. What is the firm's profit margin?


a. 1.79%
b. 1.90%
c. 1.88%
d. 1.92%
e. 1.96%
ANS: D
Profit margin = Net income/Sales = 1.92%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

75. What is the firm's operating margin?


a. 3.75%
b. 4.51%
c. 5.27%
d. 5.42%
e. 4.75%
ANS: E
Operating margin = EBIT/Sales = 4.75%

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

76. What is the firm's dividends per share?


a. $0.85
b. $0.69
c. $0.79
d. $0.73
e. $0.65
ANS: B
DPS = Common dividends paid/Shares outstanding = $0.69

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

77. What is the firm's EPS?


a. $2.36
b. $1.68
c. $1.98
d. $1.94
e. $1.62
ANS: C
EPS = Net income/Common shares outstanding = $1.98

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

78. What is the firm's P/E ratio?


a. 12.0
b. 12.6
c. 13.2
d. 13.9
e. 14.6
ANS: A
P/E ratio = Price per share/Earnings per share = 12.0
We actually fixed the P/E ratio at 12 in order to get a stock price. Either the price or the P/E ratio must
be fixed or the model becomes very complicated and a stock pricing equation is required.

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

79. What is the firm's book value per share?


a. $28.09
b. $30.84
c. $28.39
d. $30.53
e. $38.16
ANS: D
BVPS = Common equity/Shares outstanding = $30.53

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

80. What is the firm's market-to-book ratio?


a. 0.65
b. 0.85
c. 0.74
d. 0.95
e. 0.78
ANS: E
Market/book ratio (M/B) = Price per share/BVPS = 0.78

PTS: 1 DIF: EASY NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

81. What is the firm's equity multiplier?


a. 2.82
b. 3.49
c. 2.31
d. 2.14
e. 2.2
ANS: A
Equity multiplier = Total assets/Common equity = 2.82

PTS: 1 DIF: MEDIUM NAT: Analytic skills


LOC: Students will acquire knowledge of financial analysis and cash flows.

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