Part 2 Liquidity and Profitability Ratios - Sol 13 Jan 2024

12/27/23, 9:31 AM CMA Exam Review - Part 2 - Assessment Review
Question 1
2.A.2.a
tb.liquid.ratios.012_1711
LOS: 2.A.2.a
Lesson Reference: Liquidity Ratios
Difficulty: medium
Bloom Code: 4
To calculate a firm's current ratio, you only need access to the firm's
Correct
balance sheet.
income statement.
Your Answer
statement of cash flows.
statement of retained earnings.
Rationale
 balance sheet.
The current ratio is defined as Current Assets ÷ Current Liabilities. Both of these items are from the balance sheet. Therefore, this is the correct
answer.
Rationale
 income statement.
The current ratio is defined as Current Assets ÷ Current Liabilities. Neither of these items are from the income statement. Therefore, this is an
incorrect answer.
Rationale
 statement of cash flows.
The current ratio is defined as Current Assets ÷ Current Liabilities. Neither of these items are from the statement of cash flows. Therefore, this is an
incorrect answer.
Rationale
 statement of retained earnings.
The current ratio is defined as Current Assets ÷ Current Liabilities. Neither of these items are from the statement of retained earnings. Therefore,
this is an incorrect answer.
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Question 2
2.A.2.c
2A2-LS54
LOS: 2.A.2.c
Difficulty: medium
Bloom Code: 3
When reviewing a credit application, the credit manager should be most concerned with the applicant's:
*Source: Retired ICMA CMA Exam Questions.

price-earnings ratio and current ratio.
Your Answer
working capital and return on equity.

Correct
working capital and current ratio.
profit margin and return on assets.
Rationale
 price-earnings ratio and current ratio.
This answer is incorrect. When reviewing a credit application, the credit manager should not be most concerned with the applicant's price-earnings
ratio and current ratio.
Rationale
 working capital and return on equity.
This answer is incorrect. When reviewing a credit application, the credit manager should not be most concerned with the applicant's working
capital and return on equity.
Rationale
 working capital and current ratio.
Liquidity measures, such as net working capital and the current ratio, help determine ability to pay expenses on a timely basis. Therefore, the credit
manager should be most concerned with these measures in comparison to the others listed in the problem. Profit margin, price-earnings ratio, and
return on equity are profitability measures.
Rationale
 profit margin and return on assets.
This answer is incorrect. When reviewing a credit application, the credit manager should not be most concerned with the applicant's profit margin
and return on assets.
Question 3
2.A.2.o
tb.profit.use.004_1711
LOS: 2.A.2.o
Lesson Reference: Profitability – Use of Assets
Difficulty: hard
Bloom Code: 3
Last year, Beecher Manufacturing had a 12.5% ROA, net income of $800,000, and net sales of $1,600,000. Given these values, what was the firm's asset
turnover ratio?
Correct
0.25 times
Your Answer
4 times
0.50 times
2 times
Rationale
 0.25 times
Asset turnover measures how much sales revenue a company generates per dollar in average total assets. Return on assets (ROA) measures how
much income a company generates per dollar in average total assets. One way to measure ROA is Net Income ÷ Average Total Assets. Another way,
known as DuPont Analysis, is Asset Turnover × Return on Sales. Return on sales (ROS) is defined as Net Income ÷ Net Sales. It measures how much
of every dollar in sales a company keeps as net income. Rearranging the DuPont Analysis formula results in asset turnover being equal to ROA ÷
ROS. Beecher's return on sales is 50% ($800,000 ÷ $1,600,000). Its asset turnover is 0.25 (12.5% ÷ 50%). Therefore, this is the correct answer.
Rationale
 4 times
Asset turnover measures how much sales revenue a company generates per dollar in average total assets. Return on assets (ROA) measures how
much income a company generates per dollar in average total assets. One way to measure ROA is Net Income ÷ Average Total Assets. Another way,
known as DuPont Analysis, is Asset Turnover × Return on Sales. Return on sales (ROS) is defined as Net Income ÷ Net Sales. It measures how much
of every dollar in sales a company keeps as net income. Rearranging the DuPont Analysis formula results in asset turnover being equal to ROA ÷
ROS. Beecher's return on sales is 50% ($800,000 ÷ $1,600,000). Its asset turnover would be 4 if the figures are reversed (50% ÷ 12.5%). Therefore,
Rationale
 0.50 times
Asset turnover measures how much sales revenue a company generates per dollar in average total assets. Return on sales (ROS) is defined as Net
Income ÷ Net Sales. It measures how much of every dollar in sales a company keeps as net income. Beecher's return on sales is 50% ($800,000 ÷
$1,600,000). However, the question asks for asset turnover, not return on sales. Therefore, this is an incorrect answer.
Rationale
 2 times
Asset turnover measures how much sales revenue a company generates per dollar in average total assets. Higher values are generally preferred as
it shows the company is using its assets more efficiently to generate sales. It is defined as Net Sales ÷ Average Total Assets. Beecher's asset turnover
would be 2 if it was calculated as Net Sales ÷ Net Income ($1,600,000 ÷ $800,000). Therefore, this is an incorrect answer.
Question 4
2.A.2.p
cma11.p2.t1.me.0008_0820
LOS: 2.A.2.p
Lesson Reference: Profitability – Vertical Analysis Revisited and Return Ratios
Difficulty: medium
Bloom Code: 4
A company had $5 million in sales, $3 million in cost of goods sold, and $1 million in selling and administrative expenses during the last fiscal year. If the
company's income tax rate was 25%, what was the company's gross profit margin percentage?
20%
Your Answer
15%
Correct
40%
60%
Rationale
 20%
This answer is incorrect. The pretax margin percentage is 20%.
Rationale
 15%
This answer is incorrect. The net income margin percentage is 15%.
Rationale
 40%
“Gross margin” is defined as Sales – Cost of goods sold. The gross margin percentage is Gross margin ÷ Sales. In this example, the gross margin is
$2 million ($5 – $3). This makes the gross margin percentage 40 ($2 ÷ $5).
Rationale
 60%
This answer is incorrect. Cost of goods sold is 60% of sales revenue.
Question 5
2.A.2.f
2A2-AT09
LOS: 2.A.2.f
Lesson Reference: Operating Leverage and Financial Leverage
Difficulty: medium
Bloom Code: 3
Nelson Industries increased earnings before interest and taxes by 17%. During the same period, net income after tax increased by 42%. The degree of
financial leverage (DFL) that existed during the year is:
Correct
2.47.
0.40.
Your Answer
0.07.
0.25.
Rationale
 2.47.
The DFL is defined as the percent change in net income after tax given a percent change in operating income (earnings before interest and taxes, or
EBIT).
Nelson's degree of financial leverage is calculated as:
DFL = (% change in net income after tax) ÷ (% change in operating income, or EBIT)
Nelson's DFL = (42%) ÷ (17%) = 2.47.
Rationale
 0.40.
This answer is incorrect. This answer was calculated by dividing % change in operating income by % change in net income after tax. Instead, %
change in net income after tax should be divided by % change in operating income.
Rationale
 0.07.
This answer is incorrect. This answer was calculated by multiplying % change in net income after tax by % change in operating income. Instead, %
change in net income after tax should be divided by % change in operating income.
Rationale
 0.25.
This answer is incorrect. This answer was calculated by subtracting % change in operating income from % change in net income after tax. Instead,
% change in net income after tax should be divided by % change in operating income.
Question 6
2.A.3.e
tb.rev.current.007_1809
LOS: 2.A.3.e
Lesson Reference: Revenues and Its Relationship to Current Assets
Difficulty: hard
Bloom Code: 5
Bear Co. began operations on 1/1/20X0. The information shown here is available for 20X1.
Sales $1,400,000
Accounts Receivable Collections to Date $240,000
Gross Profit Margin for All Sales 40%
Beginning of Year Accounts Receivable $150,000
1/1/20X1 Allowance for Doubtful Accounts $30,000
Bad Debt Expense $70,000
12/31/20X1 Allowance for Doubtful Accounts $25,000
For the year ended 12/31/20X1, what amount should Bear report as ending Accounts Receivable?
$840,000
Your Answer
$1,310,000
$1,160,000
Correct
$1,235,000
Rationale
 $840,000
This answer is incorrect. This is the Year X1 Sales times the Gross Profit Margin. This is not the ending Accounts Receivable balance.
Rationale
 $1,310,000
This answer is incorrect. This answer correctly calculates ending Accounts Receivable with the exception of neglecting to include accounts written
off.
Rationale
 $1,160,000
This answer is incorrect. This is the Sales less Accounts Receivable collections to date. It does not account for the Accounts Receivable written off.
Rationale
 $1,235,000
This answer is correct. First, Accounts Receivable written off should be determined as follows:
Beginning allowance for doubtful accounts + Bad debt expense – Ending allowance for doubtful accounts = Accounts Receivable written off
$30,000 + $70,000 − $25,000 = $75,000
Then, solve for ending Accounts Receivable as follows:
Beginning Accounts Receivable + Sales – Accounts Receivable written off – Accounts Receivable collections to date = ending Accounts Receivable
$150,000 + $1,400,000 – $75,000 – $240,000 = $1,235,000.
Question 7
2.A.3.h
tb.cost.sales.004_1711
LOS: 2.A.3.h
Lesson Reference: Cost of Sales and the Different Profit Margins
Difficulty: medium
Bloom Code: 4
Green Tree Organics is comparing itself to Good Earth Produce. Their gross margin percentages are presented below.
20×1 20×2 20×3 20×4 20×5 20×6 20×7 20×8 20×9

GreenTree 44.63 45.82 43.23 43.15 42.92 42.03 41.84 41.96 41.80
Good Earth 52.56 52.86 53.90 53.45 53.98 54.20 54.22 54.56 54.50
For the nine year period from 20x1 to 20x9, which of the following statements is correct?
Cost of goods sold for Green Tree has decreased and that for Good Earth has increased as a percentage of sales.
Your Answer
Good Earth had a higher average cost of goods sold over this period.
Green Tree had a lower average cost of goods sold over this period.
Correct
Cost of goods sold for Green Tree has increased and that for Good Earth has decreased as a percentage of sales.
Rationale
 Cost of goods sold for Green Tree has decreased and that for Good Earth has increased as a percentage of sales.
Gross profit is defined as Net Sales – Cost of Goods Sold. Gross margin rate is defined as Gross Profit ÷ Net Sales. It measures the percentage of
sales revenue left after the cost of goods sold is deducted. When the gross margin rate decreases, it means gross profit has decreased as a
percentage of sales. Another way of saying this is that cost of goods sold increased as a percentage of sales. The opposite is true if the gross margin
rate increases. Since the gross margin rate for Green Tree decreased, its cost of goods sold increased as a percentage of sales, not decreased. Since
Good Earth's gross margin rate increased, its cost of goods sold decreased as a percentage of sales, not increased. Therefore, this is an incorrect
answer.
Rationale
 Good Earth had a higher average cost of goods sold over this period.
sales revenue left after the cost of goods sold is deducted. Higher gross margin rates indicate that cost of goods sold is a lower percentage of sales.
Since Good Earth's gross margin rate is consistently above Green Tree's, it means Good Earth has a lower average cost of goods sold, not higher.
Therefore, this is an incorrect answer.
Rationale
 Green Tree had a lower average cost of goods sold over this period.
sales revenue left after the cost of goods sold is deducted. Higher gross margin rates indicate that cost of goods sold is a lower percentage of sales.
Since Green Tree's gross margin rate is consistently below Good Earth's, it means Green Tree has a higher average cost of goods sold, not lower.
Rationale
 Cost of goods sold for Green Tree has increased and that for Good Earth has decreased as a percentage of sales.
sales revenue left after the cost of goods sold is deducted. When the gross margin rate decreases, it means gross profit has decreased as a
percentage of sales. Another way of saying this is that cost of goods sold increased as a percentage of sales. The opposite is true if the gross margin
rate increases. Since the gross margin rate for Green Tree decreased, its cost of goods sold increased as a percentage of sales. Since Good Earth's
gross margin rate increased, its cost of goods sold decreased as a percentage of sales. Therefore, this is the correct answer.
Question 8
2.A.2.u
2A2-AT15
LOS: 2.A.2.u
Lesson Reference: Profitability – EPS, Yields, and Shareholder Returns
Difficulty: hard
Bloom Code: 4
At the beginning of the fiscal year, June 1, Year 1, Boyd Corporation had 80,000 shares of common stock outstanding. Also outstanding was $200,000 of
8% convertible bonds that had been issued at $1,000 par. The bonds were convertible into 20,000 shares of common stock; however, no bonds were
converted during the year. The company's tax rate is 34%, and the Aa bond interest rate has been 10%. Boyd's net income for the year was $107,000. The
fully diluted earnings per share (EPS) (rounded to the nearest cent) of Boyd common stock for the fiscal year ended May 31, Year 2, was:
Correct
$1.18.
Your Answer
$1.47.
$1.34.
$1.07.
Rationale
 $1.18.
EPS = (net income − the preferred stock dividend) ÷ (weighted average number of common stock shares outstanding).
Calculating fully diluted EPS requires the adjusting of the numerator and denominator for the effects of conversions of convertible securities
and/or the exercise of options or warrants.
Boyd's basic EPS = (net income) ÷ (80,000 shares) = ($107,000) ÷ (80,000 shares)
Fully diluted EPS requires adjusting the numerator for the after-tax effect of the interest expense eliminated by the conversion, and adjusting the
denominator for the additional 20,000 shares from the conversion. The conversion is assumed to occur at the earliest possible date; in this case,
June 1 of Year 1.
The after-tax effect of the interest expense = (1 − tax rate)(interest expense)
= (1 − 0.34)(0.08)($200,000) = (0.66)($16,000) = $10,560
Boyd's fully diluted EPS = ($107,000 + $10,560) ÷ (80,000 shares + 20,000 shares) = ($117,560)÷(100,000 shares) = $1.18 per share.
Rationale
 $1.47.
This answer is incorrect. This answer did not consider the additional shares from the conversion.
Rationale
 $1.34.
This answer is incorrect. This answer did not consider the after-tax effect of interest. Additionally, this answer did not consider the additional
shares from the conversion.
Rationale
 $1.07.
This answer is incorrect. This answer did not consider the after-tax effect of interest.
Question 9
2.A.2.w
aq.limit.ratio.0005_1710
LOS: 2.A.2.w
Lesson Reference: Limitations of Ratio Analysis
Difficulty: hard
Sampson Corp. had 500,000 shares of common stock outstanding at the beginning of the year. The average market price was $20.
On April 1, Sampson issued 100,000 shares of $1,000 par value 10% preferred stock.
On July 1, Sampson issued 200,000 warrants to purchase 10 shares of common stock each at $22 per share.
On October 1, Sampson repurchased 60,000 of common stock as Treasury stock for $15 per share.
What is the weighted average common shares outstanding Sampson should use to compute basic earnings per share (EPS) and what would the
weighted average common shares outstanding have been if the Treasury stock hadn't been repurchased, respectively?
515,000; 500,000
Your Answer
560,000; 575,000
635,000; 650,000
Correct
485,000; 500,000
Rationale
 515,000; 500,000
Only the October 1 transaction affects the weighted average common shares outstanding because the April 1 transaction would not affect the
number of shares outstanding and the July 1 transaction involves warrants, which would not be included in the basic EPS calculation. The weighted
average common shares outstanding is reduced by the weighted average of the reacquired shares. Thus, the weighted average common shares
outstanding is 485,000 [500,000 − (60,000 × 3/12)]. If the Treasury stock hadn't been repurchased, then the weighted average common shares
outstanding would have been 500,000.
Rationale
 560,000; 575,000
Rationale
 635,000; 650,000
Rationale
 485,000; 500,000
Question 10
2.A.3.b
tb.roa.roe.004_1711
LOS: 2.A.3.b
Lesson Reference: ROA and ROE – A Closer Look
Difficulty: hard
Bloom Code: 3
Financial statements from Broker Inc. indicate the company has the following balances:
What were Broker's net sales if its asset turnover is 2.25 times?
$1,719,000
Correct
$1,659,375
$1,599,750
$675,000
Rationale
 $1,719,000
it shows the company is using its assets more efficiently to generate sales. It is defined as Net Sales ÷ Average Total Assets. Rearranging the formula
results in net sales being equal to Asset Turnover × Average Total Assets. Broker's average total assets is $737,500 [($764,000 + $711,000) ÷ 2].
Broker's net sales would be $1,719,000 if beginning total assets is used instead of average total assets (2.25 × $764,000). Therefore, this is an
incorrect answer.
Rationale
 $1,659,375
results in net sales being equal to Asset Turnover × Average Total Assets. Broker's average total assets is $737,500 [($764,000 + $711,000) ÷ 2]. This
results in Broker having net sales of $1,659,375 (2.25 × $737,500). Therefore, this is the correct answer.
Rationale
 $1,599,750
Broker's net sales would be $1,599,750 if ending total assets is used instead of average total assets (2.25 × $711,000). Therefore, this is an incorrect
answer.
Rationale
 $675,000
Broker's net sales would be $675,000 if common stock is used instead of average total assets (2.25 × $300,000). Therefore, this is an incorrect
answer.
Question 11
2.A.2.j
tb.solvency.rat.025_1711
LOS: 2.A.2.j
Lesson Reference: Solvency Ratios
Difficulty: medium
Bloom Code: 3
The Treehouse Company's income statement for December 31, 20x4 reported the following data:
Sales $750,000
Cost of goods sold 400,000
Gross margin 350,000
General expenses 190,000
Interest expense 40,000
Income tax expense 20,000
Net income $100,000
The company had 50,000 shares of common stock outstanding during 20x4 with a market price of $18 per share at the end of the year. Cash dividends of
$45,000 were paid, including $8,000 paid to preferred stockholders. Calculate the company's times interest earned ratio for 20x4, rounding to two
decimal places.
Correct
4.00 times
8.00 times
3.00 times
2.50 times
Rationale
 4.00 times
One way to assess a company's solvency is with the times interest earned ratio. Sometimes called the interest coverage ratio, it measures how many
times a company could pay its interest expense with earnings before interest and taxes (EBIT). It is defined as EBIT ÷ Interest Expense. Higher figures
indicate higher solvency as the company has more EBIT to cover its interest expense. Treehouse's times interest earned is 4.00 [$160,000 ($100,000
+ $40,000 + $20,000) ÷ $40,000]. Therefore, this is the correct answer.
Rationale
 8.00 times
indicate higher solvency as the company has more EBIT to cover its interest expense. Treehouse's times interest earned would be 8.00 if income tax
expense is used as the denominator [$160,000 ($100,000 + $40,000 + $20,000) ÷ $20,000]. This is not the correct formula. Therefore, this is an
incorrect answer.
Rationale
 3.00 times
indicate higher solvency as the company has more EBIT to cover its interest expense. Treehouse's times interest earned would be 3.00 if only
income tax expense is added back to get the numerator [$120,000 ($100,000 + $20,000) ÷ $40,000]. This is not the correct formula. Therefore, this is
an incorrect answer.
Rationale
 2.50 times
indicate higher solvency as the company has more EBIT to cover its interest expense. Treehouse's times interest earned would be 2.50 if net income
is used as the numerator ($100,000 ÷ $40,000). This is not the correct formula. Therefore, this is an incorrect answer.
Question 12
2.A.2.b
2A2-LS02
LOS: 2.A.2.b
Difficulty: medium
Bloom Code: 3
Consider the following transactions:
I. A firm receives cash on account.
II. A firm sells goods on account (cost of goods sold [COGS] is less than sales price).
III. A firm makes a payment on account.
IV. A firm purchases inventory on account.
If a firm has a quick ratio greater than one, which of the transactions above would cause its quick ratio to decrease?
I, II, and III.
Your Answer
I and IV.
None of these choices.

Correct
IV only.
Rationale
 I, II, and III.
This answer is incorrect. If a firm has a quick ratio greater than one, the firm receiving cash on account, the firm selling goods on account, and the
firm making a payment on account would not cause its quick ratio to decrease.
Rationale
 I and IV.
This answer is incorrect. If a firm has a quick ratio greater than one, the firm receiving cash on account would not cause its quick ratio to decrease.
However, the firm purchasing inventory on account would cause its quick ratio to decrease.
Rationale
 None of these choices.
This answer is incorrect. If a firm has a quick ratio greater than one, at least one of the transactions above would cause its quick ratio to decrease.
Rationale
 IV only.
The quick ratio is defined as current assets less inventory divided by current liabilities. Examine each transaction for its effect on either current
assets or current liabilities:
I. Debit to cash, credit to accounts receivable; the net result is no change in either current assets or current liabilities. Therefore, there is
no change to the quick ratio.
II. Debit to accounts receivable, credit to sales for an amount greater than a debit to COGS and a credit to inventory. The result will be an
increase in current assets less inventory. Therefore, there is an increase in the quick ratio.
III. Debit to accounts payable, credit to cash. The result of this transaction is an equal decrease in current assets and current liabilities.
Given that the quick ratio is greater than 1, this transaction will result in an increase in the quick ratio.
IV. Debit to inventory and credit to accounts payable. The result of this transaction is no change in current assets less inventory and an
increase in current liabilities. This transaction will decrease the quick ratio.
Question 13
2.A.2.p
profit.vertical.tb.044_0220
LOS: 2.A.2.p
Difficulty: hard
Bloom Code: 6
Company ABC’s profit margin declined between 2014 and 2015 as shown here.
2015 2014
Sales price $20 100% $20 100%
Cost of goods sold 5 25% 4 20%
Gross profit $15 75% $16 80%
Which one of the following is the best explanation for the decline?
There was a write-down of inventory in 2015.
There was an increase in advertising expenses.

Correct
There was an increase in depreciation of the manufacturing equipment.
There was a decrease in sales.
Rationale
 There was a write-down of inventory in 2015.
This answer is incorrect. An inventory write-down is a non-operating item and does not affect cost of goods sold.
Rationale
 There was an increase in advertising expenses.
This answer is incorrect. Advertising expenses are selling and administrative expenses, which are not a part of cost of goods sold.
Rationale
 There was an increase in depreciation of the manufacturing equipment.
The selling price remained the same from 2014 to 2015. However, the cost of goods sold increased. This means the cost incurred to manufacture
the goods increased. Depreciation of manufacturing equipment is a component of manufacturing overhead and is included in cost of goods sold.
Rationale
 There was a decrease in sales.
This answer is incorrect. There is no indication that sales decreased (although we do know the sales price remained the same).
Question 14
2.A.2.a
LOS: 2.A.2.a
Difficulty: medium
Bloom Code: 3
Potential creditors for Addison Enterprises want to determine Addison's liquidity. If Addison has current assets of $942 million and current liabilities of
$735 million, which of the following would provide an accurate measure of Addison's liquidity?
A debt to asset ratio of 128%
Your Answer
A debt to asset ratio of 78%

Correct
A current ratio of 1.28:1
A current ratio of 0.78:1
Rationale
 A debt to asset ratio of 128%
Liquidity measures a company's ability to pay its short-term liabilities. The debt to asset ratio is used to measure solvency, or a company's ability to
pay its long-term liabilities. The debt to asset ratio is defined as Long-Term Liabilities ÷ Total Assets. Neither of these figures is provided, so the
debt to asset ratio cannot be determined. Even if it is determined, it is not an accurate measure of Addison's liquidity. Therefore, this is an incorrect
answer.
Rationale
 A debt to asset ratio of 78%
Liquidity measures a company's ability to pay its short-term liabilities. The debt to asset ratio is used to measure solvency, or a company's ability to
pay its long-term liabilities. The debt to asset ratio is defined as Long-Term Liabilities ÷ Total Assets. Neither of these figures is provided, so the
debt to asset ratio cannot be determined. Even if it is determined, it is not an accurate measure of Addison's liquidity. Therefore, this is an incorrect
answer.
Rationale
 A current ratio of 1.28:1
Liquidity measures a company's ability to pay its short-term liabilities. One of the most common ratios used to assess liquidity is the current ratio. It
is defined as Current Assets ÷ Current Liabilities. Higher current ratios indicate greater liquidity, as there are more current assets available to satisfy
current liabilities. This company's current ratio is 1.28 ($942 million ÷ $735 million). This will provide an accurate measure of Addison's liquidity.
Therefore, this is the correct answer.
Rationale
 A current ratio of 0.78:1
Liquidity measures a company's ability to pay its short-term liabilities. One of the most common ratios used to assess liquidity is the current ratio. It
is defined as Current Assets ÷ Current Liabilities. Higher current ratios indicate greater liquidity, as there are more current assets available to satisfy
current liabilities. This company's current ratio is 1.28 ($942 million ÷ $735 million). The answer is 0.78 if the figures are reversed ($735 million ÷
$942 million). Since this is an incorrect figure, it will not provide an accurate measure of Addison's liquidity. Therefore, this is an incorrect answer.
Question 15
2.A.2.q
tb.profit.vertical.027_0820
LOS: 2.A.2.q
Difficulty: medium
Bloom Code: 3
For fiscal year 20x7 Beach Entertainment had return on assets of 12.4%, beginning total assets of $4 million, and ending total assets of $3.58 million.
What was its net income?
Correct
$469,960
$496,000
$443,920
$939,920
Rationale
 $469,960
ROA (return on assets) measures the amount of net income earned per dollar of average total assets. Higher levels are preferred as it indicates the
firm is using its assets more efficiently to produce net income. It is defined as Net Income ÷ Average Total Assets. Rearranging the formula results in
net income being equal to ROA × Average Total Assets. Beach's net income is $469,960 [12.4% × $3.79 million (($4 million + $3.58 million) ÷ 2)].
Rationale
 $496,000
net income being equal to ROA × Average Total Assets. Beach's net income would be $496,000 if beginning total assets is used (12.4% × $4.00
million). Therefore, this is an incorrect answer.
Rationale
 $443,920
net income being equal to ROA × Average Total Assets. Beach's net income would be $443,920 if ending total assets is used (12.4% × $3.58 million).
Rationale
 $939,920
net income being equal to ROA × Average Total Assets. Beach's net income would be $939,920 if average total assets is incorrectly calculated as
$7.58 million [12.4% × $7.58 million ($4 million + $3.58 million)]. Therefore, this is an incorrect answer.
Question 16
2.A.3.g
aq.cost.sales.0003_1710
LOS: 2.A.3.g
Difficulty: medium
Bloom Code: 3
Given the following income statement and balance sheet for a company, what is the gross profit margin for Year 2?
0.333
0.450
Correct
0.666
1.500
Rationale
 0.333
Gross Profit Margin = Gross Profit ÷ Net Sales, not Cost of Goods Sold ÷ Net Sales.
Rationale
 0.450
Gross Profit Margin = Gross Profit ÷ Net Sales, not EBT ÷ Net Sales.
Rationale
 0.666
Gross Profit Margin = Gross Profit ÷ Net Sales = $2,000 ÷ $3,000 = 0.666
Rationale
 1.500
Gross Profit Margin = Gross Profit ÷ Net Sales, not Net Sales ÷ Gross Profit.
Question 17
2.A.2.p
2A3-LS01
LOS: 2.A.2.p
Difficulty: medium
Bloom Code: 3
BDU Company has net income of $500,000 and average assets of $2,000,000 for the current year. If its asset turnover is 1.25 times, then what is its profit
margin?
0.80.
Your Answer
0.25.
5.00.
Correct
0.20.
Rationale
 0.80.
This answer is incorrect. This answer was calculated by dividing average assets by sales.
Rationale
 0.25.
This answer is incorrect. This answer was calculated by dividing net income by average assets.
Rationale
 5.00.
This answer is incorrect. This answer was calculated by dividing sales by net income.
Rationale
 0.20.
Profit Margin = Net Income ÷ Sales
Calculate Sales by rearranging the following formula:
Asset Turnover = Sales ÷ Assets
Sales = (Asset Turnover) (Assets)
Sales = (1.25) ($2,000,000) = $2,500,000
Profit Margin = $500,000 ÷ $2,500,000 = 0.2.
Question 18
2.A.2.w
cma11.p2.t1.me.0024_0820
LOS: 2.A.2.w
Lesson Reference: Limitations of Ratio Analysis
Difficulty: easy
Bloom Code: 2
There are people who believe that the analysis of financial statements has limitations. Which of the statements below would qualify as a limitation of
financial statement analysis?
Ratio analysis requires the analyst to evaluate a firm's performance over a period of time to be of any value.
Proper ratio analysis requires the analyst to rely on audited financial statements, which can be easily manipulated.
Your Answer
Thorough ratio analysis requires the analyst to refer to benchmarking, which is very easy to misinterpret.
Correct
Ratio analysis requires the analyst to utilize accounting data that is based on historical costs instead of current market values.
Rationale
 Ratio analysis requires the analyst to evaluate a firm's performance over a period of time to be of any value.
This answer is incorrect. Ratios can be informative without evaluating a firm's performance over time.
Rationale
 Proper ratio analysis requires the analyst to rely on audited financial statements, which can be easily manipulated.
This answer is incorrect. It is not accurate to say that audited financial statements “can be easily manipulated.”
Rationale
 Thorough ratio analysis requires the analyst to refer to benchmarking, which is very easy to misinterpret.
This answer is incorrect. Ratio analysis can be informative without referring to benchmarking. For example, ratio trends over time can provide
valuable information, and some ratios are informative by themselves.
Rationale
 Ratio analysis requires the analyst to utilize accounting data that is based on historical costs instead of current market values.
The use of historical cost for the computation of ratios is a limitation, since historical costs may be dramatically different from current market
values.
Question 19
2.A.2.l
aq.eff.ratios.0004_1710
LOS: 2.A.2.l
Lesson Reference: Efficiency Ratios
Difficulty: hard
Bloom Code: 6
The company that is most likely to have lost sales due to an inventory shortage is:
Company B, which has an average days in inventory of 23.8 days.
Your Answer
Company C, which has an inventory turnover of 14.6.

Correct
Company A, which has an inventory turnover of 28.9.
Company D, which has an average days in inventory of 19.4 days.
Rationale
 Company B, which has an average days in inventory of 23.8 days.
Companies with high inventory turnover or low days in inventory are more likely to lose sales due to a lack of inventory because they carry relatively
little inventory. Company B has a days in inventory of 23.8 days, which is not the lowest value. Therefore, this is an incorrect answer.
Rationale
 Company C, which has an inventory turnover of 14.6.
little inventory. Company C has a days in inventory of 25.0 days (calculated as 365 ÷ 14.6), which is not the lowest value. Therefore, this is an
incorrect answer.
Rationale
 Company A, which has an inventory turnover of 28.9.
little inventory. Of the four companies, Company A has the lowest days in inventory (12.6 days, calculated as 365 ÷ 28.9). Therefore, this is the
correct answer.
Rationale
 Company D, which has an average days in inventory of 19.4 days.
little inventory. Company D has a days in inventory of 19.4 days, which is not the lowest value. Therefore, this is an incorrect answer.
Question 20
2.A.2.l
tb.eff.ratios.006_1711
LOS: 2.A.2.l
Difficulty: medium
Bloom Code: 4
Increasing the amount of average inventory can cause
an increase in inventory turnover.
a decrease in cost of goods sold.

Correct
a decrease in inventory turnover.
an increase in cost of goods sold.
Rationale
 an increase in inventory turnover.
Inventory turnover is measured as Cost of Goods Sold ÷ Average Inventory. Increasing average inventory increases the denominator of the formula.
This results in a decrease, not an increase, in inventory turnover. Therefore, this is an incorrect answer.
Rationale
 a decrease in cost of goods sold.
Cost of goods sold is not directly related to the amount of average inventory on hand. Therefore, this is an incorrect answer.
Rationale
 a decrease in inventory turnover.
Inventory turnover is measured as Cost of Goods Sold ÷ Average Inventory. Increasing average inventory increases the denominator of the formula.
This results in a decrease in inventory turnover. Therefore, this is the correct answer.
Rationale
 an increase in cost of goods sold.
Cost of goods sold is not directly related to the amount of average inventory on hand. Therefore, this is an incorrect answer.
Question 21
2.A.3.b
tb.roa.roe.002_1711
LOS: 2.A.3.b
Difficulty: medium
Bloom Code: 3
Gemini Group sold some of its major assets in 20x7 while having higher sales than in 20x6. What would be the effect on its asset turnover?
Correct
Gemini Group would see a higher asset turnover in 20x7 than in 20x6.
Gemini Group would see a lower asset turnover in 20x7 than in 20x6.
Your Answer
Gemini Group would see no change in its asset turnover between 20x6 and 20x7.
Gemini Group would see either an increase or a decrease in asset turnover but comparing the two years would require knowing how much sales
increased in 20x7 compared to 20x6.
Rationale
 Gemini Group would see a higher asset turnover in 20x7 than in 20x6.
it shows the company is using its assets more efficiently to generate sales. It is defined as Net Sales ÷ Average Total Assets. Increasing sales and
decreasing total assets will result in an increase in asset turnover. This is because increasing the numerator and decreasing the denominator of a
fraction increases the fraction. Therefore, this is the correct answer.
Rationale
 Gemini Group would see a lower asset turnover in 20x7 than in 20x6.
fraction increases the fraction. Therefore, this is an incorrect answer.
Rationale
 Gemini Group would see no change in its asset turnover between 20x6 and 20x7.
fraction increases the fraction. For there to be no change in asset turnover when sales increase, total assets would have to increase by the exact
same percentage. Similarly, for there to be no change in asset turnover when total assets decrease, sales would have to decrease by the exact same
percentage. Therefore, this is an incorrect answer.
Rationale
 Gemini Group would see either an increase or a decrease in asset turnover but comparing the two years would require knowing how much
sales increased in 20x7 compared to 20x6.
fraction increases the fraction. It would be necessary to know how much sales increased if assets increased. Therefore, this is an incorrect answer.
Question 22
2.A.2.a
LOS: 2.A.2.a
Difficulty: medium
Bloom Code: 3
The Downtown Company has current assets of $2,400,000. Of these, $750,000 is cash, $1,000,000 is accounts receivable, and the remainder is inventory.
Current liabilities are $1,250,000.
Determine the company's acid-test ratio, rounding to two decimal places.
Correct
1.40
1.92
Your Answer
2.69
1.32
Rationale
 1.40
One of the most common ratios used to assess liquidity is the acid-test ratio. Sometimes called the quick ratio, it is defined as Quick Assets ÷
Current Liabilities. Quick assets are the most liquid current assets. They include cash, short-term investments, and accounts receivable. Inventory is
not a quick asset as it takes a relatively long period of time to convert inventory into cash. A higher quick ratio indicates greater liquidity, as there
are more quick assets available to satisfy current liabilities. Downtown's acid-test ratio is 1.40 [$1,750,000 ($1,000,000 + $750,000) ÷ $1,250,000].
Rationale
 1.92
are more quick assets available to satisfy current liabilities. Downtown's current ratio is 1.92 ($2,400,000 ÷ $1,250,000). However, inventory should
not be included as the question asks for the acid-test ratio. Therefore, this is an incorrect answer.
Rationale
 2.69
are more quick assets available to satisfy current liabilities. Downtown's quick ratio would be 2.69 if inventory is used as the denominator instead
of current liabilities ($1,750,000 ÷ $650,000). Therefore, this is an incorrect answer.
Rationale
 1.32
are more quick assets available to satisfy current liabilities. Downtown's acid-test ratio would be 1.32 if accounts receivable and inventory are
considered to be quick assets ($1,650,000 ÷ $1,250,000). However, inventory should not be included and cash needs to be included. Therefore, this
is an incorrect answer.
Question 23
2.A.2.a
2A2-AT07
LOS: 2.A.2.a
Difficulty: medium
Bloom Code: 3
The Statement of Financial Position for King Products Corporation for the fiscal years ended June 30, Year 2, and June 30, Year 1, is presented below.
Net sales and cost of goods sold for the year ended June 30, Year 2, were $600,000 and $440,000, respectively.
King Products Corporation's quick (acid test) ratio at June 30, Year 2, was:
Correct
1.12 to 1.
Your Answer
2.00 to 1.
1.82 to 1.
0.59 to 1.
Rationale
 1.12 to 1.
The acid-test ratio (also known as the quick ratio) is the ratio of quick assets to current liabilities. Quick assets are those easily converted to cash
without significant loss. The quick assets are cash, short-term investments (marketable securities), and net receivables.
King's acid-test ratio for Year 2 is calculated as:
Acid-test ratio = (cash + marketable securities + net receivables) ÷ current liabilities
Acid-test ratio = ($60 cash + $40 marketable securities + $90 net accounts receivable) ÷ ($170 current liabilities)
Acid-test ratio = $190 ÷ $170 = ratio of 1.12 to 1.
Rationale
 2.00 to 1.
This answer is incorrect. This answer included inventory and prepaids in the calculation of the quick (acid test) ratio.
Rationale
 1.82 to 1.
This answer is incorrect. This answer included inventory in the calculation of the quick (acid test) ratio.
Rationale
 0.59 to 1.
This answer is incorrect. This answer did not include accounts receivable (net) in the calculation of the quick (acid test) ratio.
Question 24
2.A.2.h
oplev.tb.009_2104
LOS: 2.A.2.h
Difficulty: medium
Bloom Code: 3
Ingram Industries has the following financial results. What is its financial leverage for 20X2?
20X2 20X1
Net Sales $13,047 $12,135
Gross Profit 6,123 5,747
Income from Operations 1,944 1,856
EBIT 1,933 1,859
Net Income 1,197 1,122
Total Assets 20,349 19,074
Total Liabilities 16,076 15,450
Total Equity 4,273 3,624
0.53
Your Answer
1.68
Correct
4.76
5.26
Rationale
 0.53
This answer is incorrect. This incorrect solution is Ingram Industries’ degree of operating leverage.
Rationale
 1.68
This answer is incorrect. This incorrect solution is Ingram Industries’ degree of financial leverage.
Rationale
 4.76
This answer is correct. The calculation for financial leverage is Total Assets ÷ Equity.
$20,349 ÷ $4,273 = 4.76
Rationale
 5.26
This answer is incorrect. This incorrect solution is financial leverage for 20X1.
Question 25
2.A.2.m
LOS: 2.A.2.m
Difficulty: medium
Bloom Code: 4
If days in inventory increases, then
Your Answer
inventory turnover increases.

Correct
inventory turnover decreases.
average inventory decreases.
operating expenses increase.
Rationale
 inventory turnover increases.
Days in inventory is defined as 365 ÷ Inventory Turnover. It moves in the opposite direction as inventory turnover. That is, as days in inventory
increases (it takes longer to sell inventory), inventory turnover decreases (inventory is turned over fewer times in a period). Therefore, this is an
incorrect answer.
Rationale
 inventory turnover decreases.
Days in inventory is defined as 365 ÷ Inventory Turnover. It moves in the opposite direction as inventory turnover. That is, as days in inventory
increases (it takes longer to sell inventory), inventory turnover decreases (inventory is turned over fewer times in a period). Therefore, this is the
correct answer.
Rationale
 average inventory decreases.
Days in inventory is defined as 365 ÷ Inventory Turnover. Inventory turnover is defined as Cost of Goods Sold ÷ Average Inventory. As average
inventory decreases, inventory turnover increases. As inventory turnover increases, days in inventory decreases, not increases. Therefore, this is an
incorrect answer.
Rationale
 operating expenses increase.
Days in inventory is defined as 365 ÷ Inventory Turnover. There is no unambiguous relationship between days in inventory and operating expenses.
Question 26
2.A.2.o
LOS: 2.A.2.o
Difficulty: medium
Bloom Code: 3
Hyperion Enterprises had asset turnover of .40 in 20x7. If total assets were $678,000 at the beginning of the year and $895,000 at the end of the year, what
were net sales for 20x7?
$358,000
$271,200
Correct
$314,600
$1,966,250
Rationale
 $358,000
yields net sales is Asset Turnover × Average Total Assets. Hyperion's 20x7 net sales would be $358,000 if ending total assets is used (0.40 ×
$895,000). Therefore, this is an incorrect answer.
Rationale
 $271,200
yields net sales is Asset Turnover × Average Total Assets. Hyperion's 20x7 net sales would be $271,200 if beginning total assets is used (0.40 ×
$678,000). Therefore, this is an incorrect answer.
Rationale
 $314,600
yields net sales is Asset Turnover × Average Total Assets. Hyperion's 20x7 net sales is $314,600 [0.40 × $786,500 (($678,000 + $895,000) ÷ 2)].
Rationale
 $1,966,250
yields net sales is Asset Turnover × Average Total Assets. Hyperion's 20x7 net sales would be $1,966,250 if average total assets is divided by asset
turnover [$786,500 (($678,000 + $895,000) ÷ 2) ÷ 0.40]. This is not the correct formula. Therefore, this is an incorrect answer.
Question 27
2.A.3.j
2A3-CQ04
LOS: 2.A.3.j
Difficulty: medium
Bloom Code: 3
Consider the following factors relating to Tech Manufacturing:
Sales $15,000,000
Cost of Goods Sold $ 6,000,000
Operating Expenses $ 4,500,000
Total Assets $ 6,500,000
Total Equity $ 2,000,000
Corporate Tax Rate 40%
Dividend Payout Ratio 30%
What is Tech Manufacturing's Sustainable Growth Rate if Tech has no interest-bearing debt?
0.700.
Your Answer
1.350.
0.405.
Correct
0.945.
Rationale
 0.700.
This answer is incorrect. This answer subtracted the dividend payout ratio from 1, but did not multiply the amount by ROE.
Rationale
 1.350.
This answer is incorrect. This answer represents ROE, not the Sustainable Growth Rate.
Rationale
 0.405.
This answer is incorrect. This answer did not subtract the dividend payout ratio from 1 before multiplying it by ROE.
Rationale
 0.945.
The formula for Sustainable Growth Rate is (1 − Dividend Payout Ratio) × ROE
The formula for Return on Equity is ROE = (Net Profit ÷ Sales) × (Sales ÷ Assets) × (Assets ÷ Equity). First, net profit must be computed. To compute
net profit, we take the Sales of $15,000,000 less the COGS of $6,000,000 to give us a gross profit of $9,000,000. Next we remove the operating
expenses of $4,500,000, giving us Earnings Before Taxes of $4,500,000. We remove 40%, or $1,800,000 of the Earnings Before Taxes, and we get a
Net Profit of $2,700,000.
Next, we place the numbers into the ROE formula as follows: ROE = ($2,700,000 ÷ $15,000,000) × ($15,000,000 ÷ $6,500,000) × ($6,500,000 ÷
$2,000,000), which equals 1.35.
Next we place the numbers into the Sustainable Growth Rate formula as follows: SGR = (1 − 30%) × 1.35, which equals 0.945.
Question 28
2.A.2.q
LOS: 2.A.2.q
Difficulty: medium
Bloom Code: 3
In 20x7, Kaplan Commodities had a profit margin of 5.7% and an asset turnover of 1.29. What was Kaplan's return on assets for 20x7?
22.63
4.42%
Your Answer
9.49%
Correct
7.35%
Rationale
 22.63
Return on assets (ROA) measures how much income a company generates per dollar in average total assets. One way to measure ROA is Net Income
÷ Average Total Assets. Another way, known as DuPont Analysis, is Asset Turnover × Return on Sales. Asset turnover measures how much sales
revenue a company generates per dollar in average total assets. It is defined as Net Sales ÷ Average Total Assets. Return on sales (ROS) is defined as
Net Income ÷ Net Sales. It measures how much of every dollar in sales a company keeps as net income. Kaplan's ROA would be 22.63 if the figures
are reversed (1.29 ÷ 5.7%). However, this is not the correct formula. Therefore, this is an incorrect answer.
Rationale
 4.42%
Net Income ÷ Net Sales. It measures how much of every dollar in sales a company keeps as net income. Kaplan's ROA would be 4.42% if asset
turnover is divided by return on sales (5.7% ÷ 1.29). However, this is not the correct formula. Therefore, this is an incorrect answer.
Rationale
 9.49%
Net Income ÷ Net Sales. It measures how much of every dollar in sales a company keeps as net income. Kaplan's ROA would be 9.49% if ROS is
multiplied by the square of asset turnover (5.7% × 1.29 × 1.29). However, this is not the correct formula. Therefore, this is an incorrect answer.
Rationale
 7.35%
Net Income ÷ Net Sales. It measures how much of every dollar in sales a company keeps as net income. Kaplan's ROA is 7.35% (1.29 × 5.7%).
Question 29
2.A.2.r
2A2-AT20
LOS: 2.A.2.r
Lesson Reference: Profitability – Market Value Ratios
Difficulty: medium
Bloom Code: 3
Information concerning Hamilton's common stock is presented below for the fiscal year that ended May 31.
The basic price/earnings (P/E) ratio for Hamilton's common stock is:
Correct
4 times.
Your Answer
5 times.
6 times.
10 times.
Rationale
 4 times.
The P/E ratio for a common stock is the ratio of the common stock price to the latest primary earnings per share (EPS).
P/E ratio = (market price per share) ÷ (primary EPS)
Hamilton's P/E ratio = ($45.00) ÷ ($11.25) = 4 times.
Rationale
 5 times.
This answer is incorrect. This answer used fully diluted EPS instead of primary EPS.
Rationale
 6 times.
This answer is incorrect. This answer used Year 2 dividends paid per share instead of primary EPS.
Rationale
 10 times.
This answer is incorrect. This answer used Year 1 dividends paid per share instead of primary EPS.
Question 30
2.A.2.f
2A3-LS12
LOS: 2.A.2.f
Difficulty: easy
Bloom Code: 1
Earnings power is:
Correct
the best possible estimate of the average business earnings over a number of years.
Your Answer
a forecasting tool that anticipates probable future conditions instead of making the assumption of a continued trend.
a mathematical calculation based on past earnings that can absolutely predict future earnings.
the company's ability to turn liabilities into income-generating activities.
Rationale
 the best possible estimate of the average business earnings over a number of years.
Earnings power is defined as the best possible estimate of the average business earnings that can be expected to be sustained in the future for a
number of years, preferably over an entire business cycle. Earnings power is used as a forecasting tool but does not try to anticipate probable
future conditions other than a continued trend.
Rationale
 a forecasting tool that anticipates probable future conditions instead of making the assumption of a continued trend.
This answer is incorrect. Earnings power is not a forecasting tool that anticipates probable future conditions instead of making the assumptions of
a continued trend.
Rationale
 a mathematical calculation based on past earnings that can absolutely predict future earnings.
This answer is incorrect. Earnings power is not a mathematical calculation based on past earnings that can absolutely predict future earnings.
Rationale
 the company's ability to turn liabilities into income-generating activities.
This answer is incorrect. Earnings power is not the company's ability to turn liabilities into income-generating activities.
Question 31
2.A.2.u
aq.profit.eps.0001_1710
LOS: 2.A.2.u
Difficulty: easy
Bloom Code: 2
The weighted average of common shares outstanding should be used when calculating earnings per share because:
it calculates the average value of common and preferred shares.
Your Answer
it weights preferred shares more than common shares.

Correct
the number of shares outstanding can change during a single period.
the number of shares outstanding grows each period.
Rationale
 it calculates the average value of common and preferred shares.
The weighted average of common shares outstanding concerns the number of common shares outstanding during a time period. It does not
concern the value of those shares. It also is not related to preferred shares at all. Therefore, this is an incorrect answer.
Rationale
 it weights preferred shares more than common shares.
The weighted average of common shares outstanding does not weight preferred shares outstanding at all. Therefore, this is an incorrect answer.
Rationale
 the number of shares outstanding can change during a single period.
The numerator for earnings per share is “net income available to common shareholders.” This figure is based on activity for the entire time period,
not for any individual day. To be consistent, the denominator should also reflect the entire time period. Since the number of shares outstanding
changes during a time period due to new stock issuances and stock repurchases, the weighted average number of shares best reflects activity for
the entire time period. Therefore, this is the correct answer.
Rationale
 the number of shares outstanding grows each period.
The number of common shares outstanding does not necessarily grow each period. For example, the number of shares outstanding could
decrease if the firm buys back stock on the open market (Treasury stock). Therefore, this is an incorrect answer.
Question 32
2.A.2.v
tb.profit.eps.030_1711
LOS: 2.A.2.v
Difficulty: medium
Bloom Code: 3
M&M has provided the following comparative income statements and supplemental information:
20×2 20×3 20×4

Net sales $120,000 $132,000 $136,000
Cost of goods sold 62,000 68,000 72,000
Gross margin 58,000 64,000 64,000
Selling and administrative expenses 24,000 26,000 36,000
Depreciation 4,000 6,000 8,000
Operating profit 30,000 32,000 20,000
Income taxes 10,000 8,000 5,000
Net income $ 20,000 $ 24,000 $ 15,000
Common shares outstanding 10,000 9,000 8,400
Dividends paid on common shares $14,000 $12,780 $12,180
Dividends per preferred share $0.75 $0.75 $0.75
Number of preferred shares 1,200 1,200 1,200
Market price per share $12 $16 $10
Calculate the payout ratio for 20x4, rounding to two decimal places.
Correct
86.38%
81.20%
92.77%
31.91%
Rationale
 86.38%
The payout ratio measures the percentage of net income available to common stockholders paid out as dividends. Lower ratios are consistent with
higher expected future growth as more income is being reinvested in the company. It is defined as Common Stock Dividends ÷ Net Income Available
to Common Stockholders. The amount of income available to common shareholders is Net Income – Preferred Dividends. Preferred dividends are
$900 (1,200 shares × $0.75). M&M's payout ratio in 20x4 is 86.38% [$12,180 ÷ ($15,000 − $900)]. Therefore, this is the correct answer.
Rationale
 81.20%
to Common Stockholders. The amount of income available to common shareholders is Net Income – Preferred Dividends. M&M's payout ratio in
20x4 would be 81.20% if preferred stock dividends are not subtracted when calculating the denominator ($12,180 ÷ $15,000). Therefore, this is an
incorrect answer.
Rationale
 92.77%
20x4 would be 92.77% if preferred dividends are included in the numerator [$13,080 ÷ ($15,000 − $900)]. The payout ratio only pertains to dividends
paid to common stockholders. Therefore, this is an incorrect answer.
Rationale
 31.91%
20x4 would be 31.91% if preferred dividends are used as the numerator and common dividends are subtracted when calculating the denominator
[$900 ÷ ($15,000 − $12,180)]. Therefore, this is an incorrect answer.
Question 33
2.A.2.p
cma11.p2.t1.me.0016_0820
LOS: 2.A.2.p
Difficulty: medium
Bloom Code: 4
A company reported the following financial data.
Sales $2,000,000
Operating expenses 400,000
Interest expense 200,000
Income tax 300,000
The company's operating profit margin percentage is
15%.
30%.
Correct
40%.
80%.
Rationale
 15%.
This answer is incorrect. The net income of $300,000 is 15% of sales.
Rationale
 30%.
This answer is incorrect. The earnings before taxes of $600,000 is 30% of sales.
Rationale
 40%.
“Operating profit” is defined as Sales – Cost of goods sold – Operating expenses. In this example, it is $800,000. This represents 40% of the sales of
$2,000,000.
Rationale
 80%.
This answer is incorrect. If cost of goods sold is not subtracted when determining operating profit, then operating profit would be $1,600,000 in this
example. This is 80% of sales. However, cost of goods sold should be subtracted when determining operating profit.
Question 34
2.A.2.r
tb.profit.market.001_1711
LOS: 2.A.2.r
Difficulty: medium
Bloom Code: 3
The Treehouse Company's income statement for December 31, 20x4 reported the following:
The company had 50,000 shares of common stock outstanding during 20x4 with a market price of $18 per share at the end of the year. Cash dividends of
$45,000 were paid, including $8,000 paid to preferred stockholders. Compute the company's price-earnings ratio for 20x4, rounding to two decimal
places.
Correct
9.78
Your Answer
9.00
14.29
16.36
Rationale
 9.78
Price-earnings ratio (P/E) is a measure of expected growth in a company's earnings and stock price. Higher P/E ratios indicate higher expected
growth. It is defined as Market Price ÷ Earnings per Share. Earnings per share is defined as Net Income Available to Common Shareholders ÷
Average Number of Common Shares Outstanding. Treehouse's EPS is $1.84 [($100,000 − $8,000) ÷ 50,000]. From this, Treehouse's P/E ratio is 9.78
($18 ÷ $1.84). Therefore, this is the correct answer.
Rationale
 9.00
Average Number of Common Shares Outstanding. Treehouse's EPS would be $2.00 if preferred dividends is not subtracted ($100,000 ÷ 50,000].
From this, Treehouse's P/E ratio would be 9.00 ($18 ÷ $2.00). Therefore, this is an incorrect answer.
Rationale
 14.29
Average Number of Common Shares Outstanding. Treehouse's EPS would be $1.26 if common dividends is subtracted instead of preferred
dividends [($100,000 − $37,000) ÷ 50,000]. From this, Treehouse's P/E ratio would be 14.29 ($18 ÷ $1.26). Therefore, this is an incorrect answer.
Rationale
 16.36
Average Number of Common Shares Outstanding. Treehouse's EPS would be $1.10 if total dividends is subtracted to get the numerator [($100,000
− $45,000) ÷ 50,000]. From this, Treehouse's P/E ratio would be 16.36 ($18 ÷ $1.10). Therefore, this is an incorrect answer.
Question 35
2.A.2.q
cma11.p2.t1.me.0001_0820
LOS: 2.A.2.q
Difficulty: medium
Bloom Code: 4
A company's year-end selected financial data is shown below.
Year 2 Year 1
Current assets $250,000 $175,000
Total assets 600,000 500,000
Total liabilities 300,000 225,000
Net sales 200,000 150,000
Net income 75,000 60,000
The company's rate of return on assets and rate of return on equity for Year 2 are
12% and 22%, respectively.

Your Answer

Correct
Rationale
 12% and 22%, respectively.
This answer is incorrect. These are the figures using Year 1 values for net income, total assets, and total equity.
Rationale
This answer is incorrect. You need to use average total assets to calculate ROA and average total equity to calculate ROE.
Rationale
 14% and 26%, respectively.
“ROA” is defined as Net income ÷ Average total assets. “ROE” is defined as (Net income – Preferred stock dividends) ÷ Average total equity. Year 2
average total assets is $550,000 (the average of $600,000 and $500,000), and Year 2 average total equity is $287,500 (the average of $300,000 and
$275,000). ROA for Year 2 = $75,000 ÷ $550,000 = 14% (rounded). ROE for Year 2 = $75,000 ÷ $287,500 = 26% (rounded).
Rationale
This answer is incorrect. ROA is based on net income, not net sales. In addition, ROE for Year 2 uses the average total equity for Year 2, not just Year
2 total equity.
Question 36
2.A.2.i
tb.solvency.rat.003_1711
LOS: 2.A.2.i
Difficulty: medium
Bloom Code: 4
The Treehouse Company's financial position for December 31 in consecutive years is as follows:
The company had 85,000 shares of common stock outstanding during 20x4 and 87,500 shares in 20x5 with a market price of $18 per share at the end of
20x4 and $18.54 at the end of 20x5. Cost of goods sold was $97,000 in 20x5 and $85,000 in 20x4. What is the debt-to-asset ratio for 20x5? Is it higher or
lower than 20x4?
51.6%; the ratio is lower than in 20x4.
40.0%; the ratio is higher than in 20x4.

Correct
51.6%; the ratio is higher than in 20x4.
40.0%; the ratio is lower than in 20x4.
Rationale
 51.6%; the ratio is lower than in 20x4.
The debt-to-asset ratio is a solvency ratio. It is defined as Total Liabilities ÷ Total Assets. Higher values indicate greater risk to solvency as it means
there is more debt per dollar of assets. In 20x5 the value is 51.6% ($400,000 ÷ $775,000). In 20x4 the value is 40.0% ($300,000 ÷ $750,000). It is higher
in 20x5, not lower. Therefore, this is an incorrect answer.
Rationale
 40.0%; the ratio is higher than in 20x4.
there is more debt per dollar of assets. In 20x5 the value is 51.6% ($400,000 ÷ $775,000). In 20x4 the value is 40.0% ($300,000 ÷ $750,000). The ratio is
higher in 20x5, but it is 40.0% in 20x4. Therefore, this is an incorrect answer.
Rationale
 51.6%; the ratio is higher than in 20x4.
there is more debt per dollar of assets. In 20x5 the value is 51.6% ($400,000 ÷ $775,000) while in 20x4 the value is 40.0% ($300,000 ÷ $750,000). It is
higher in 20x5 than in 20x4. Therefore, this is the correct answer.
Rationale
 40.0%; the ratio is lower than in 20x4.
there is more debt per dollar of assets. In 20x5 the value is 51.6% ($400,000 ÷ $775,000). In 20x4 the value is 40.0% ($300,000 ÷ $750,000). The ratio is
not lower than in 20x4. In addition, it is 40.0% in 20x4, not 20x5. Therefore, this is an incorrect answer.
Question 37
2.A.2.a
LOS: 2.A.2.a
Difficulty: medium
Bloom Code: 3
Butler Resources currently has $700 million in assets. Of these assets, $450 million are in cash or can be readily converted to cash. Other companies in
Butler Resources' industry have cash as a percentage of total assets of around 25%. This is an example of:
Correct
high liquidity.
low liquidity.
Your Answer
high solvency.
low solvency.
Rationale
 high liquidity.
Liquidity addresses a company's ability to pay its short-term liabilities. High liquidity means a company has a relatively large percentage of its assets
in cash or in items that can be readily converted into cash. Since $450 million of $700 million in assets are in cash or can be readily converted into
cash, which is 64% compared to the industry of 25%, this company has high liquidity. Therefore, this is the correct answer.
Rationale
 low liquidity.
Liquidity addresses a company's ability to pay its short-term liabilities. High liquidity means a company has a relatively large percentage of its assets
in cash or in items that can be readily converted into cash. Since $450 million of $700 million in assets are in cash or can be readily converted into
cash, this company has high liquidity, not low liquidity. Therefore, this is an incorrect answer.
Rationale
 high solvency.
Liquidity addresses a company's ability to pay its short-term liabilities. Solvency addresses a company's ability to pay interest and long-term
liabilities. The amount of assets in cash or in items that can be readily converted into cash measures liquidity, not solvency. Therefore, this is an
incorrect answer.
Rationale
 low solvency.
Liquidity addresses a company's ability to pay its short-term liabilities. Solvency addresses a company's ability to pay interest and long-term
liabilities. The amount of assets in cash or in items that can be readily converted into cash measures liquidity, not solvency. Therefore, this is an
incorrect answer.
Question 38
2.A.2.y
aq.sources.fin.0007_1710
LOS: 2.A.2.y
Lesson Reference: Sources of Financial Information and Their Use in Evaluating a Company’s Financial Strength
Difficulty: medium
Bloom Code: 3
A financial analyst is evaluating the efficiency of a company using multiple ratios. She has gathered the following information about the company.
What is the inventory turnover ratio, receivables turnover ratio, and receivables collection period, respectively?
0.57, 0.68, and 537

Your Answer
1.76, 1.47, and 248

Correct
1.29, 2.0, and 183
0.77, 0.5, and 730
Rationale
 0.57, 0.68, and 537
Inventory turnover = 1,100(COGS) ÷ 850(inventory) = 1.29; however, in this answer inventory turnover was calculated as inventory ÷ sales, which is
incorrect.
Receivables turnover = 1,500(sales) ÷ 750(receivables) = 2.0; however, in this answer receivables turnover was calculated as receivables ÷ COGS,
which is incorrect.
Average receivables collection period = 365 ÷ 2 (receivables turnover) = 182.5 or 183; however, in this answer average receivables collection period
was calculated as 365 ÷ 0.68 (receivables turnover), which is incorrect.
Rationale
 1.76, 1.47, and 248
Inventory turnover = 1,100(COGS) ÷ 850(inventory) = 1.29; however, in this answer inventory turnover was calculated as sales ÷ inventory, which is
incorrect.
Receivables turnover = 1,500(sales) ÷ 750(receivables) = 2.0; however, in this answer receivables turnover was calculated as COGS ÷ receivables,
which is incorrect.
Average receivables collection period = 365 ÷ 2(receivables turnover) = 182.5 or 183; however, in this answer average receivables collection period
Rationale
 1.29, 2.0, and 183
Inventory turnover = 1,100(COGS) ÷ 850(inventory) = 1.29
Receivables turnover = 1,500(sales) ÷ 750(receivables) = 2.0
Average receivables collection period = 365 ÷ 2 (receivables turnover) = 182.5 or 183
Rationale
 0.77, 0.5, and 730
Inventory turnover = 1,100(COGS) ÷ 850(inventory) = 1.29; however, in this answer inventory turnover was calculated as inventory ÷ COGS, which is
incorrect.
Receivables turnover = 1,500(sales) ÷ 750(receivables) = 2.0; however, in this answer receivables turnover was calculated as receivables ÷ sales,
which is incorrect.
Average receivables collection period = 365 ÷ 2(receivables turnover) = 182.5 or 183; however, in this answer average receivables collection period
Question 39
2.A.2.h
2A2-CQ24
LOS: 2.A.2.h
Difficulty: medium
Bloom Code: 4
Easton Bank has received loan applications from three companies in the computer service business and will grant a loan to the company with the best
prospect of fulfilling the loan obligations. Specific data, shown below, has been selected from these applications for review and comparison with
industry averages.
Based on the information above, select the strategy that would fulfill Easton's objective.
Your Answer
Grant the loan to SysGen as the company has the highest net profit margin and degree of financial leverage.
Easton should not grant any loans as none of these companies represents a good credit risk.
Grant the loan to CompGo as all the company's data approximate the industry average.
Correct
Grant the loan to Astor as both the debt/equity (D/E) ratio and degree of financial leverage (DFL) are below the industry average.
Rationale
 Grant the loan to SysGen as the company has the highest net profit margin and degree of financial leverage.
This answer is incorrect. Based on the data selected from the applications and industry averages, “granting the loan to SysGen as the company has
the highest net profit margin and degree of financial leverage” is not the strategy that would be the most beneficial to Easton Savings.
Rationale
 Easton should not grant any loans as none of these companies represents a good credit risk.
This answer is incorrect. Based on the data selected from the applications and industry averages, “not granting any loans as none of these
companies represent a good credit risk” is not the strategy that would be the most beneficial to Easton Savings.
Rationale
 Grant the loan to CompGo as all the company's data approximate the industry average.
This answer is incorrect. Based on the data selected from the applications and industry averages, “granting the loan to CompGo as all the
company's data approximate the industry average” is not the strategy that would be the most beneficial to Easton Savings.
Rationale
 Grant the loan to Astor as both the debt/equity (D/E) ratio and degree of financial leverage (DFL) are below the industry average.
The D/E ratio and the DFL both measure an organization's risk. The lower the D/E ratio, the lower the risk. Similarly, the lower the DFL, the lower
the risk. In the case of Astor, both the D/E ratio and DFL measures are below the industry averages. Therefore, it is the least risky of the three
choices.
Question 40
2.A.2.l
2A2-CQ39
LOS: 2.A.2.l
Difficulty: easy
Bloom Code: 3
Zubin Corporation experiences a decrease in sales and the cost of goods sold, an increase in accounts receivable, and no change in inventory. If all else
is held constant, what is the total effect of these changes on the receivables turnover and inventory ratios?

Inventory Turnover: Increased; Receivables Turnover: Increased.
Inventory Turnover: Decreased; Receivables Turnover: Increased.

Your Answer
Inventory Turnover: Increased; Receivables Turnover: Decreased.

Correct
Inventory Turnover: Decreased; Receivables Turnover: Decreased.
Rationale
 Inventory Turnover: Increased; Receivables Turnover: Increased.
This answer is incorrect. If Zubin Corporation experiences a decrease in sales and cost of goods sold, an increase in accounts receivable, and no
change in inventory, inventory turnover will not increase. Additionally, receivables turnover will not increase.
Rationale
 Inventory Turnover: Decreased; Receivables Turnover: Increased.
change in inventory, inventory turnover will decrease. However, receivables turnover will not increase.
Rationale
 Inventory Turnover: Increased; Receivables Turnover: Decreased.
change in inventory, inventory turnover will not increase. However, receivables turnover will decrease.
Rationale
 Inventory Turnover: Decreased; Receivables Turnover: Decreased.
The inventory turnover ratio is cost of goods sold (COGS) divided by average inventory. The accounts receivables turnover is net sales on credit
divided by average receivables. Since sales and COGS decreased, accounts receivable increased, and inventory remained constant, both ratios
would decrease.
Question 41
2.A.2.q
LOS: 2.A.2.q
Difficulty: medium
Bloom Code: 4
A financial analyst is comparing Fremont Computers to its industry. Fremont's return on common equity ratios are presented here.
Over the 5-year period from 20x1 to 20x5,
Correct
Fremont has performed better than the industry average.

Your Answer
Fremont has performed worse than the industry average.
Fremont has improved its profitability over time.
industry profitability deteriorated more than that for Fremont.
Rationale
 Fremont has performed better than the industry average.
The rate of return on common equity (ROCE) expresses the amount of net income available to common shareholders per dollar of average
common equity. Higher values are preferred as it indicates that the company has generated more income for common shareholders per dollar of
average common equity. Since Fremont's ROCE is higher than the industry average every year from 20x1 to 20x5, it is fair to conclude that Fremont
performed better than the industry average. Therefore, this is the correct answer.
Rationale
 Fremont has performed worse than the industry average.
average common equity. Since Fremont's ROCE is higher than the industry average every year from 20x1 to 20x5, it is fair to conclude that Fremont
performed better than the industry average, not worse. Therefore, this is an incorrect answer.
Rationale
 Fremont has improved its profitability over time.
average common equity. Since Fremont's ROCE decreased between 20x1 and 20x5, it appears that Fremont has not improved its profitability over
time. Therefore, this is an incorrect answer.
Rationale
 industry profitability deteriorated more than that for Fremont.
average common equity. Since Fremont's ROCE decreased more between 20x1 and 20x5 than did the industry average ROCE, it appears that
Fremont's profitability deteriorated more than industry profitability. Therefore, this is an incorrect answer.
Question 42
2.A.2.o
aq.profit.use.0002_1710
LOS: 2.A.2.o
Difficulty: medium
Bloom Code: 4
XYZ, Inc.’s latest Income Statement, Balance Sheet, and Statement of Cash Flows are shown here. Use this information to answer the following question.
What was the Fixed Asset Turnover for Year 2?
3.81
Your Answer
1.51
1.31
Correct
2.62
Rationale
 3.81
Remember to use average fixed assets over the two years when calculating Average Fixed Asset Turnover for Year 2, not just Year 2 Fixed Assets.
Fixed asset turnover = Net sales ÷ Average fixed assets
Rationale
 1.51
Remember to use net fixed assets (Land + PPE − Accumulated Depreciation) when calculating Average Fixed Asset Turnover for Year 2.
Rationale
 1.31
Remember to use average fixed assets over the two years when calculating Average Fixed Asset Turnover for Year 2.
Remember to divide the net amount of fixed assets by 2 once added together when calculating Average Fixed Asset Turnover for Year 2.
Average net FA = (5, 138 + 9, 800) ÷ 2 = 7, 469
Rationale
 2.62
Fixed asset turnover = Net sales ÷ Average fixed assets = 19,580 ÷ [(ending 20x2 net Fixed Assets + ending 20x1 net Fixed Assets) ÷ 2]
From the balance sheet:
Ending net FA20 × 2 = Land + PPE − Accumulated Depreciation = 0 + 11, 000 − 5, 862 = 5, 138
Ending net FA20 × 1 = Land + PPE − Accumulated Depreciation = 4, 000 + 11, 000 − 5, 200 = 9, 800
Average net FA = (5, 138 + 9, 800) ÷ 2 = 7, 469
Fixed asset turnover = 19, 580 ÷ 7, 469 = 2. 62 times
Question 43
2.A.2.u
2A2-AT01
LOS: 2.A.2.u
Difficulty: medium
Bloom Code: 4
The Dwyer Company balance sheet indicates that the company has $2,000,000 of 7.5% convertible bonds, $1,000,000 of 9% cumulative preferred stock,
par value $100, and $1,000,000 common stock, par value $10. The company reported net income of $317,000. The bonds can be converted into 50,000
common shares. The income tax rate is 36%. Which one of the following would Dwyer report as diluted earnings per share (EPS)?
Correct
$2.15.
$3.23.
Your Answer
$2.75.
$1.51.
Rationale
 $2.15.
EPS is calculated as:
EPS = (Net Income − Preferred Stock Dividend) ÷ Weighted average # of common stock shares
Basic EPS ignores common stock equivalents (convertible securities, and stock options and warrants). Fully-diluted EPS considers the dilution
effect of the common stock equivalents.
To calculate fully-diluted EPS, adjust net income to reflect the conversion of the bonds and adjust the weighted-average number of shares for the
additional shares from the conversion. The conversion of the bonds would add back to the net income the after-tax effect of the interest.
The after-tax effect of the interest is one minus the tax rate, or 0.64, times the interest on the bonds, or 7.5% of $2,000,000, which is $96,000.
After-tax effect of the interest = (1 − tax rate) × Bond interest = (1 − 36%) × ($2,000,000 × 7.5%) = 0.64 × $150,000 = $96,000.
The conversion of the bonds results in 50,000 additional shares.
Remember that only preferred dividends that are declared, or if not declared, dividends on cumulative preferred stock can be deducted. In this
case, because the preferred stock is cumulative, the preferred dividends are computed as $1,000,000 value × 9% or $90,000.
Fully-diluted EPS = (Net income − Preferred Stock Dividend + After-tax effect of interest) ÷ Weighted average # of common stock shares + the
additional shares from conversion
Fully-diluted EPS = ($317,000 − $90,000 + $96,000) ÷ (100,000 + 50,000)
= ($323,000) ÷ (150,000) = $2.15
Fully-diluted EPS = $2.15.
Rationale
 $3.23.
This answer is incorrect. This answer did not consider the additional shares from conversion.
Rationale
 $2.75.
This answer is incorrect. This answer did not consider the preferred stock dividend.
Rationale
 $1.51.
This answer is incorrect. This answer did not consider the after-tax effect of interest.
Question 44
2.A.2.b
2A4-LS22
LOS: 2.A.2.b
Difficulty: medium
Bloom Code: 3
Consider the statements below comparing financial ratios based on historical cost to those based on fair value. Which statements are correct?
I. Fair Value disclosures can supplement historical cost ratio analysis.
II. If market prices decline, then ratios using fair value prices will show better results than those using historical cost.
III. If market prices decline, then ratios using fair value prices will show worse results than those using historical cost.
IV. If market prices increase, ratios using fair value prices will show higher ratios than those using historical cost.
Correct
I, III, and IV, only.

Your Answer
I and III, only.
II, III and IV, only.
I, II and IV, only.
Rationale
 I, III, and IV, only.
Fair Value disclosures can supplement historical cost ratio analysis. If market prices decline, then ratios using fair value prices will show worse
results than those using historical cost. If market prices increase, ratios using fair value prices will show higher ratios than those using historical
cost.
Rationale
 I and III, only.
This answer is incorrect. The statement “if market prices increase, ratios using fair value prices will show higher ratios than those using historical
cost” is correct.
Rationale
 II, III and IV, only.
This answer is incorrect. The statement “Fair Value disclosures can supplement historical cost ratio analysis” is correct. Additionally, the statement
“if market prices decline, then ratios using fair value prices will show better results than those using historical cost” is incorrect.
Rationale
 I, II and IV, only.
This answer is incorrect. The statement “if market prices decline, then ratios using fair value prices will show worse results than those using
historical cost” is correct. Additionally, the statement “if market prices decline, then ratios using fair value prices will show better results than those
using historical cost” is incorrect.
Question 45
2.A.2.b
aq.liquid.ratios.0009_1710
LOS: 2.A.2.b
Difficulty: easy
Which of the following is not a ratio or measure used to evaluate a firm's liquidity?
Current ratio
Correct
Return on assets
Your Answer
Net working capital (NWC)
Quick ratio
Rationale
 Current ratio
Current ratio is a ratio used to evaluate a firm's liquidity.
Rationale
 Return on assets
Liquidity is the ability of a firm to pay its bills in the short term and normally utilizes all or some portion of current assets and current liabilities.
Return on assets (net income divided by total assets) is a measure of profitability not liquidity.
Rationale
 Net working capital (NWC)
Net working capital (NWC) is a ratio used to evaluate a firm's liquidity.
Rationale
 Quick ratio
Quick ratio is a ratio used to evaluate a firm's liquidity.
Question 46
2.A.3.h
2A2-LS18
LOS: 2.A.3.h
Difficulty: hard
Bloom Code: 5
During the current year, Beverly Industries reports an inventory turnover of 10 times, a gross profit margin of 30%, a net profit margin of 4%, and average
inventory of $21,000. What are net sales for the year?
$525,000.
Your Answer
$70,000.
$210,000.
Correct
$300,000.
Rationale
 $525,000.
This answer is incorrect. This answer was calculated by dividing average inventory by the net profit margin. However, this does not represent net
sales.
Rationale
 $70,000.
This answer is incorrect. This answer was calculated by dividing average inventory by the gross profit margin. However, this does not represent net
sales.
Rationale
 $210,000.
This answer is incorrect. This answer represents cost of goods sold, not sales.
Rationale
 $300,000.
Since we know that average inventory is $21,000 and the inventory turnover rate is 10X, we can find that cost of goods sold (COGS) is $210,000.
Since the gross profit margin is 30%, the firm's COGS must be 70% of net sales. Therefore, net sales must be $300,000.
Question 47
2.A.2.o
LOS: 2.A.2.o
Difficulty: hard
Bloom Code: 3
For the fiscal year that just ended, Oliver Industries had a 15% ROA, net income of $2.1 million, and an asset turnover ratio of 0.4. Given these values,
what were the firm's net sales?
Your Answer
$14 million
Correct
$5.6 million
$3.5 million
$5.25 million
Rationale
 $14 million
÷ Average Total Assets. Return on sales (ROS) is defined as Net Income ÷ Net Sales. It measures how much of every dollar in sales a company keeps
as net income. Beecher's net sales would be $14 million if ROS is 15% ($2.1 million ÷ 15%). However, the question says ROA is 15%, not ROS.
Rationale
 $5.6 million
Net Income ÷ Net Sales. It measures how much of every dollar in sales a company keeps as net income. Rearranging the DuPont Analysis formula
results in return on sales being equal to ROA ÷ Asset Turnover. Beecher's return on sales is 37.5% (15% ÷ 40%). Its net sales are $5.6 million ($2.1
million ÷ 37.5%). Therefore, this is the correct answer.
Rationale
 $3.5 million
as net income. Beecher's net sales would be $3.5 million if net sales is divided by “100% − asset turnover” ($2.1 million ÷ 60%). However, this is not
the correct formula. Therefore, this is an incorrect answer.
Rationale
 $5.25 million
as net income. Beecher's net sales would be $5.25 million if net sales is divided by asset turnover of 40% ($2.1 million ÷ 40%). However, this is not
the correct formula. Therefore, this is an incorrect answer.
Question 48
2.A.2.i
aq.solvency.rat.0008_1710
LOS: 2.A.2.i
Difficulty: medium
Bloom Code: 4
Selected information from the comparative financial statements of Faure Company for the year ended December 31, appears below:
Compare the debt-to-assets ratio for the two years, rounding to two decimal places. What is the debt-to-assets ratio for 20x4? Is it higher or lower than
20x3?
45%, the ratio is higher than in 20x3.

Your Answer
51%, the ratio is higher than in 20x3.
51%, the ratio is lower than in 20x3.

Correct
45%, the ratio is lower than in 20x3.
Rationale
 45%, the ratio is higher than in 20x3.
The debt-to-assets ratio is a solvency ratio. It is defined as Total Liabilities ÷ Total Assets. Higher values indicate greater risk to solvency as it means
there is more debt per dollar of assets. In 20x4 the value is 45% [($140,000 + 400,000) ÷ $1,200,000] while in 20x3 the value is 51% [($110,000 +
$300,000) ÷ $800,000]. The ratio is lower in 20x4 than in 20x3, not higher. Therefore, this is an incorrect answer.
Rationale
 51%, the ratio is higher than in 20x3.
$300,000) ÷ $800,000]. The ratio is lower in 20x4 than in 20x3, not higher. In addition, the ratio is 51% in 20x3, not in 20x4. Therefore, this is an
incorrect answer.
Rationale
 51%, the ratio is lower than in 20x3.
$300,000) ÷ $800,000]. The ratio is lower in 20x4 than in 20x3. However, the ratio is 51% in 20x3, not in 20x4. Therefore, this is an incorrect answer.
Rationale
 45%, the ratio is lower than in 20x3.
$300,000) ÷ $800,000]. The ratio is lower in 20x4 than in 20x3. Therefore, this is the correct answer.
Question 49
2.A.2.t
profit.market.tb.009_2104
LOS: 2.A.2.t
Difficulty: easy
Bloom Code: 2
Which of the following statements about book value is a true statement?
Book value is what you will pay for a share of stock on the open market.
Correct
Book value represents the amount of net assets owned by the common stockholders.
Your Answer
Book value is calculated using all shares of stock outstanding, both common and preferred.
Book value is most relevant for service companies.
Rationale
 Book value is what you will pay for a share of stock on the open market.
This answer is incorrect. The stock or market price is what you will pay for stock on the open market.
Rationale
 Book value represents the amount of net assets owned by the common stockholders.
This answer is correct. Book value measures the value of a share of stock based upon historical cost as recorded on the company’s balance sheet.
This means the value per share may be low compared to market value.
Rationale
 Book value is calculated using all shares of stock outstanding, both common and preferred.
This answer is incorrect. Book value is calculated as Common stockholders’ equity ÷ Common shares outstanding. Preferred stock shares are not
included in this calculation.
Rationale
 Book value is most relevant for service companies.
This answer is incorrect. Because book value is based upon net asset value as reported on the balance sheet, it represents historical value of assets
and includes management’s estimates and assumptions. Therefore, it is most relevant for financial companies with high cash or other investment
assets and manufacturing companies with high fixed assets.
Question 50
2.A.2.l
LOS: 2.A.2.l
Difficulty: medium
Bloom Code: 3
Determine inventory turnover for 20x7 for Morgan Sellers given the following information:
Your Answer
2.35 times
3.55 times
1.37 times
Correct
3.41 times
Rationale
 2.35 times
Inventory turnover measures the number of times in a period that inventory is sold. Higher turnover is generally preferred as it means inventory is
sold more quickly. It is defined as Cost of Goods Sold ÷ Average Inventory. Cost of Goods Sold (COGS) = Net Sales – Gross Profit. In this example,
COGS is $740,725 ($1,250,725 − $510,000). Morgan's inventory turnover would be 2.35 if gross profit is used in the numerator instead of cost of
goods sold [$510,000 ÷ $217,000 (($208,500 + $225,500) ÷ 2)]. Therefore, this is an incorrect answer.
Rationale
 3.55 times
sold more quickly. It is defined as Cost of Goods Sold ÷ Average Inventory. Cost of Goods Sold = Net Sales – Gross Profit. In this example, it is
$740,725 ($1,250,725 − $510,000). Morgan's inventory turnover would be 3.55 times in 20x7 if beginning inventory is used as the denominator
($740,725 ÷ $208,500). Therefore, this is an incorrect answer.
Rationale
 1.37 times
$740,725 ($1,250,725 − $510,000). Morgan's inventory turnover would be 1.37 if net sales is the numerator and ending total assets is the
denominator ($1,250,725 ÷ $910,000). Therefore, this is an incorrect answer.
Rationale
 3.41 times
$740,725 ($1,250,725 − $510,000). Morgan's inventory turned over 3.41 times in 20x7 [$740,725 ÷ $217,000 (($208,500 + $225,500) ÷ 2)]. Therefore,
this is the correct answer.
Question 51
2.A.2.v
aq.profit.eps.0006_1710
LOS: 2.A.2.v
Difficulty: medium
All else being equal, which of the following will help decrease a company's total debt-to-equity ratio?
Buying Treasury stock
Paying cash dividends to stockholders

Your Answer
Converting long-term debt to short-term debt

Correct
Lowering the dividend payout ratio
Rationale
 Buying Treasury stock
Buying Treasury stock will decrease stockholders’ equity, and thus increase the debt-to-equity ratio.
Rationale
 Paying cash dividends to stockholders
Paying cash dividends will decrease stockholders’ equity, and thus increase the debt-to-equity ratio.
Rationale
 Converting long-term debt to short-term debt
Converting long-term debt to short-term debt will have no effect on total debt or stockholders’ equity.
Rationale
 Lowering the dividend payout ratio
Lowering the dividend payout ratio will increase retained earnings, thus increasing stockholders’ equity and decreasing the debt-to-equity ratio.
Question 52
2.A.2.l
LOS: 2.A.2.l
Difficulty: medium
Bloom Code: 3
Selected information from the comparative financial statements of Faure Company for the year ended December 31, appears here:
Compute the company's accounts receivable turnover for 20x4.
7.39 times
Your Answer
6.65 times
6.00 times
Correct
7.00 times
Rationale
 7.39 times
Accounts receivable turnover measures the number of times in a period that accounts receivable are collected. Higher turnover is generally
preferred as it means receivables are collected more quickly. It is defined as Net Credit Sales ÷ Average Accounts Receivable. Faure's accounts
receivable turnover would be 7.39 times if ending accounts receivable is used as the denominator ($1,330,000 ÷ $180,000). Therefore, this is an
incorrect answer.
Rationale
 6.65 times
receivable turnover would be 6.65 times if beginning accounts receivable is used as the denominator ($1,330,000 ÷ $200,000). Therefore, this is an
incorrect answer.
Rationale
 6.00 times
preferred as it means receivables are collected more quickly. It is defined as Net Credit Sales ÷ Average Accounts Receivable. Faure's inventory
turnover is 6.00 times [$900,000 ÷ $150,000 (($140,000 + $160,000) ÷ 2)]. However, the question asks for accounts receivable turnover. Therefore,
Rationale
 7.00 times
receivable turned over 7.00 times [$1,330,000 ÷ $190,000 (($180,000 + $200,000) ÷ 2)]. Therefore, this is the correct answer.
Question 53
2.A.2.a
LOS: 2.A.2.a
Difficulty: medium
Bloom Code: 4
A small business is looking to acquire a short-term loan. A possible lender is most concerned with which type of ratio?
Solvency
Correct
Liquidity
Profitability
Comparative
Rationale
 Solvency
A lender considering a short-term loan would be most concerned with the borrower's liquidity. Liquidity measures a company's ability to pay short-
term liabilities. Solvency measures a company's ability to pay its long-term liabilities. Therefore, this is an incorrect answer.
Rationale
 Liquidity
term liabilities. Therefore, this is the correct answer.
Rationale
 Profitability
term liabilities. Profitability measures a company's ability to generate sales and convert sales into income. Therefore, this is an incorrect answer.
Rationale
 Comparative
term liabilities. Comparative ratios are ratios that compare one firm to another. Therefore, this is an incorrect answer.
Question 54
2.A.3.e
aq.rev.current.011_1809
LOS: 2.A.3.e
Lesson Reference: Revenues and Its Relationship to Current Assets
Difficulty: medium
Bloom Code: 3
Mountain Company is set to sell 5,000 of its widgets to Larry Company. However, due to the financial condition of Larry Co., Larry will only pay when and
if it has the resources. Will Mountain recognize revenue when it sells the widgets?
Correct
No, because there is no contract.

Your Answer
Yes, because Larry might be able to pay.
No, because small inventory items such as widgets are only recognized in revenue at year-end.
Yes, because delivery of the widgets fulfills the performance obligations.
Rationale
 No, because there is no contract.
This answer is correct. There is no enforceable contract because Larry is not obligated to pay.
Rationale
 Yes, because Larry might be able to pay.
This answer is incorrect. Present conditions indicate that Larry is not likely able to pay. This is evidence that revenue should not be recognized.
Rationale
 No, because small inventory items such as widgets are only recognized in revenue at year-end.
This answer is incorrect. Revenue is recognized as performance obligations are fulfilled, not at year-end.
Rationale
 Yes, because delivery of the widgets fulfills the performance obligations.
This answer is incorrect. Even though delivery of the widgets fulfills the performance obligations, the collection of the transaction price is doubtful.
This indicates that there may not be a contract.
Question 55
2.A.2.l
LOS: 2.A.2.l
Difficulty: medium
Bloom Code: 3
Ottoman Manufacturing Company reported net sales (all credit) of $120,000 and $140,000 for 20x3 and 20x4, respectively, and net income of $24,000 and
$32,000 for 20x3 and 20x4, respectively. Ottoman's 20x3 and 20x4 balance sheets appear below:
Calculate the accounts receivable turnover ratio for 20x4, rounding to two decimal places.
Correct
7.18 times
Your Answer
6.92 times
7.00 times
7.37 times
Rationale
 7.18 times
preferred as it means receivables are collected more quickly. It is defined as Net Credit Sales ÷ Average Accounts Receivable. The company's
accounts receivable turned over 7.18 times in 20x4 [$140,000 ÷ $19,500 (($20,000 + $19,000) ÷ 2)]. Therefore, this is the correct answer.
Rationale
 6.92 times
accounts receivable turnover would be 6.92 times in 20x4 if average sales for 20x3 and 20x4 is used as the numerator [$135,000 (($140,000 +
$130,000) ÷ 2) ÷ $19,500 (($20,000 + $19,000) ÷ 2)]. Therefore, this is an incorrect answer.
Rationale
 7.00 times
accounts receivable turnover would be 7.00 times in 20x4 if beginning accounts receivable is used in the denominator ($140,000 ÷ $20,000).
Rationale
 7.37 times
accounts receivable turnover would be 7.37 times in 20x4 if ending accounts receivable is used in the denominator ($140,000 ÷ $19,000). Therefore,
Question 56
2.A.2.q
LOS: 2.A.2.q
Difficulty: medium
Bloom Code: 4
GreenTree Organics is comparing itself to GoodEarth Produce. GreenTree's return on assets ratios are presented here.
Over the 9-year period from 20x1 to 20x9,
GreenTree has improved its profits relative to its assets.
GoodEarth's total assets have increased at a pace faster than its profits.
Your Answer
GreenTree has increased its assets faster than GoodEarth.

Correct
GoodEarth has improved its performance.
Rationale
 GreenTree has improved its profits relative to its assets.
Return on assets (ROA) measures how much income a company generates per dollar in average total assets. Higher values are generally preferred
as it indicates that the firm is using its assets more efficiently to generate income. Since GreenTree's ROA has decreased over the 9-year period, it
has not improved its profits relative to its assets. Therefore, this is an incorrect answer.
Rationale
 GoodEarth's total assets have increased at a pace faster than its profits.
as it indicates that the firm is using its assets more efficiently to generate income. Since GoodEarth's ROA has increased over the 9-year period, its
total assets have not increased faster than its profits. For that to be the case, ROA would decrease. Therefore, this is an incorrect answer.
Rationale
 GreenTree has increased its assets faster than GoodEarth.
as it indicates that the firm is using its assets more efficiently to generate income. Comparing ROAs does not provide information on how assets
have grown between the companies. It does provide information on how assets have grown relative to profits. Therefore, this is an incorrect
answer.
Rationale
 GoodEarth has improved its performance.
as it indicates that the firm is using its assets more efficiently to generate income. Since GoodEarth's ROA has increased over the 9-year period, it is
fair to conclude that it has improved its profitability over that time. Therefore, this is the correct answer.
Question 57
2.A.2.s
aq.profit.market.0005_1710
LOS: 2.A.2.s
Difficulty: hard
Bloom Code: 5
Georgia, Inc. has authorized capital of 1,000 shares of $100 par, 8% cumulative preferred stock and 100,000 shares of $10 par common stock. The equity
account balances at December 31, Year 5, are shown in the accompanying table.
Dividends on preferred stock are in arrears for Year 5. The book value of a share of common stock, at December 31, Year 5, should be:
$11.78.
Your Answer
$12.22.
$12.36.
Correct
$11.91.
Rationale
 $11.78.
Remember to subtract Treasury stock shares from common shares outstanding as Treasury stock are not outstanding shares.
Rationale
 $12.22.
Rationale
 $12.36.
Rationale
 $11.91.
Question 58
2.A.2.a
2A2-LS32
LOS: 2.A.2.a
Difficulty: hard
Bloom Code: 5
Selected data from KJ, Inc., financial statements for the end of the current year are:
What is ending inventory for the current year?
Correct
$210,000.
$600,000.
Your Answer
$90,000.
$390,000.
Rationale
 $210,000.
If current liabilities are $300,000 and the current ratio is 2.0, then total current assets must be $600,000. If current liabilities are $300,000 and the
quick ratio is 1.3, then total current assets less inventory must be 390,000. The difference between $600,000 and $390,000 represents inventory,
which is $210,000.
Rationale
 $600,000.
This answer is incorrect. This answer was calculated by multiplying the current liabilities by the current ratio. However, this amount represents the
current assets, not inventory.
Rationale
 $90,000.
This answer is incorrect. This answer was calculated by subtracting $300,000 from $390,000 (1.3 × $300,000). Current assets must be calculated and
current liabilities should be subtracted from current assets.
Rationale
 $390,000.
This answer is incorrect. This answer was calculated by multiplying the current liabilities by the quick ratio. However, this amount represents the
current assets less inventory, not inventory.
Question 59
2.A.2.p
LOS: 2.A.2.p
Difficulty: medium
Bloom Code: 3
Information from Gatsby Industries’ 20x7 income statement is shown in the accompanying chart. Based on this information, what was Gatsby's gross
profit rate for 20x7? Round to the nearest hundredth.
76.31%
Your Answer
23.69%
Correct
62.31%
33.69%
Rationale
 76.31%
Gross profit is defined as Net Sales – Cost of Goods Sold. Gross profit rate is defined as Gross Profit ÷ Net Sales. It measures the percentage of sales
revenue left after the cost of the inventory is deducted. Gatsby's total expenses as a percentage of net sales is 56.08% [$49,600 ($24,500 + $18,600 +
$6,500) ÷ $65,000]. The question asks about Gatsby's gross profit rate, not its total expenses as a percentage of net sales. Therefore, this is an
incorrect answer.
Rationale
 23.69%
revenue left after the cost of the inventory is deducted. Gatsby's return on sales (Net Income ÷ Net Sales) is 23.69% ($15,400 ÷ $65,000). The
question asks about Gatsby's gross profit rate, not its return on sales. Therefore, this is an incorrect answer.
Rationale
 62.31%
revenue left after the cost of the inventory is deducted. Gatsby's gross profit rate is 62.31% [$40,500 ($65,000 − $24,500) ÷ $65,000]. Therefore, this
is the correct answer.
Rationale
 33.69%
revenue left after the cost of the inventory is deducted. Gatsby's operating income as a percentage of net sales (Net Sales – Cost of Goods Sold –
Operating Expenses) is 33.69% [$21,900 ($65,000 − $24,500 − $18,600) ÷ $65,000]. The question asks about Gatsby's gross profit rate, not its
operating income as a percentage of net sales. Therefore, this is an incorrect answer.
Question 60
2.A.2.y
tb.sources.fin.003_1711
LOS: 2.A.2.y
Lesson Reference: Sources of Financial Information and Their Use in Evaluating a Company’s Financial Strength
Difficulty: medium
Bloom Code: 4
A financial analyst is evaluating the efficiency of a company using multiple ratios. She has gathered the following information about the company:
Balance Sheet
Assets
Cash $ 100
Accounts receivable 750
Marketable securities 300
Inventory 850
Property, plant, and equipment 900
Accumulated depreciation (150)
Total assets $2,750
Liabilities and Stockholders’ Equity
Accounts payable $300
Short-term debt 130
Long-term debt 700
Common stock 1,000
Retained earnings 620
Total liabilities and stockholders’ equity $2,750
Income Statement
Sales $1,500
Gross profit 400
General and administration expense 150
Operating profit 250
Interest expense 25
Taxes 75
Net income $150
What is the current ratio, debt-to-asset ratio, and the times interest earned ratio, respectively?
Correct
4.65, 0.41, 10
Your Answer
3.95, 0.39, 10
2.67, 0.41, 6
4.65, 0.30, 6
Rationale
 4.65, 0.41, 10
Current ratio = $2,000 (Current Assets) ÷ $430 (Current Liabilities) = 4.65.
$2,000 (Current Assets) = $100 (Cash) + $750 (Accounts Receivable) + $300 (Marketable Securities) + $850 (Inventory).
$430 (Current Liabilities) = $300 (Accounts Payable) + $130 (Short-term Debt).
Debt-to-asset ratio = $1,130 (Total Debt) ÷ $2,750 (Total Assets) = 0.41.
$1,130 (Total Debt) = $300 (Accounts Payable) + $130 (Short-term Debt) + $700 (Long-term Debt).
$2,750 (Total Assets) = $100 (Cash) + $750 (Accounts Receivable) + $300 (Marketable Securities) + $850 (Inventory) + $900 (Property, Plant, and
Equipment) – $150 (Accumulated Depreciation).
Times interest earned ratio = $250 (EBIT) ÷ $25 (Interest Expense) = 10.
$250 (EBIT) = $1,500 (Sales) – $1,100 (Cost of Goods Sold) – $150 (General and Administration Expense).
Rationale
 3.95, 0.39, 10
Current ratio = Current Assets ÷ Current Liabilities. Current Assets = Cash + Accounts Receivable + Marketable Securities + Inventory. Current
Liabilities = Accounts Payable + Short-term Debt. However, in this answer, marketable securities was not included in current assets.
Debt-to-asset ratio = Total Debt ÷ Total Assets. Total Debt = Accounts Payable + Short-term Debt + Long-term Debt. Total Assets = Cash + Accounts
Receivable + Marketable Securities + Inventory + Property, Plant, and Equipment – Accumulated Depreciation. However, in this answer,
accumulated depreciation was not included in total assets.
Times interest earned ratio = $250 (EBIT) ÷ $25 (Interest Expense) = 10.
$250 (EBIT) = $1,500 (Sales) – $1,100 (Cost of Goods Sold) – $150 (General and Administration Expense).
Rationale
 2.67, 0.41, 6
Current ratio = Current Assets ÷ Current Liabilities. Current Assets = Cash + Accounts Receivable + Marketable Securities + Inventory. Current
Liabilities = Accounts Payable + Short-term Debt. However, in this answer, inventory was not included in current assets.
Debt-to-asset ratio = $1,130 (Total Debt) ÷ $2,750 (Total Assets) = 0.41.
$1,130 (Total Debt) = $300 (Accounts Payable) + $130 (Short-term Debt) + $700 (Long-term Debt).
$2,750 (Total Assets) = $100 (Cash) + $750 (Accounts Receivable) + $300 (Marketable Securities) + $850 (Inventory) + $900 (Property, Plant, and
Equipment) – $150 (Accumulated Depreciation).
Times interest earned ratio = EBIT ÷ Interest Expense. EBIT = Sales – Cost of Goods Sold – General and Administration Expense. However, in this
answer, net income was used instead of EBIT.
Rationale
 4.65, 0.30, 6
Current Ratio = $2,000 (Current Assets) ÷ $430 (Current Liabilities) = 4.65.
$2,000 (Current Assets) = $100 (Cash) + $750 (Accounts Receivable) + $300 (Marketable Securities) + $850 (Inventory).
$430 (Current Liabilities) = $300 (Accounts Payable) + $130 (Short-term Debt).
Debt-to-asset ratio = Total Debt ÷ Total Assets. Total Debt = Accounts Payable + Short-term Debt + Long-term Debt. Total Assets = Cash + Accounts
Receivable + Marketable Securities + Inventory + Property, Plant, and Equipment – Accumulated Depreciation. However, in this answer, accounts
payable was not included in total debt.
Times interest earned ratio = EBIT ÷ Interest Expense. EBIT = Sales – Cost of Goods Sold – General and Administration Expense. However, in this
answer, net income was used instead of EBIT.

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12/27/23, 9:31 AM CMA Exam Review - Part 2 - Assessment Review

statement of cash flows.

statement of retained earnings.

*Source: Retired ICMA CMA Exam Questions.

working capital and return on equity.

working capital and current ratio.

profit margin and return on assets.

*Source: Retired ICMA CMA Exam Questions.

Nelson's degree of financial leverage is calculated as:

Nelson's DFL = (42%) ÷ (17%) = 2.47.

$30,000 + $70,000 − $25,000 = $75,000

Then, solve for ending Accounts Receivable as follows:

$150,000 + $1,400,000 – $75,000 – $240,000 = $1,235,000.

20×1 20×2 20×3 20×4 20×5 20×6 20×7 20×8 20×9

The after-tax effect of the interest expense = (1 − tax rate)(interest expense)

= (1 − 0.34)(0.08)($200,000) = (0.66)($16,000) = $10,560

I. A firm receives cash on account.

III. A firm makes a payment on account.

IV. A firm purchases inventory on account.

None of these choices.

*Source: Retired ICMA CMA Exam Questions.

There was a write-down of inventory in 2015.

There was an increase in advertising expenses.

There was an increase in depreciation of the manufacturing equipment.

There was a decrease in sales.

A debt to asset ratio of 78%

A current ratio of 1.28:1

A current ratio of 0.78:1

Profit Margin = Net Income ÷ Sales

Calculate Sales by rearranging the following formula:

Asset Turnover = Sales ÷ Assets

Sales = (Asset Turnover) (Assets)

Sales = (1.25) ($2,000,000) = $2,500,000

Profit Margin = $500,000 ÷ $2,500,000 = 0.2.

Company C, which has an inventory turnover of 14.6.

Company A, which has an inventory turnover of 28.9.

Company D, which has an average days in inventory of 19.4 days.

a decrease in cost of goods sold.

a decrease in inventory turnover.

an increase in cost of goods sold.

Determine the company's acid-test ratio, rounding to two decimal places.

King's acid-test ratio for Year 2 is calculated as:

Acid-test ratio = (cash + marketable securities + net receivables) ÷ current liabilities

Acid-test ratio = $190 ÷ $170 = ratio of 1.12 to 1.

$20,349 ÷ $4,273 = 4.76

inventory turnover increases.

inventory turnover decreases.

average inventory decreases.

operating expenses increase.

Consider the following factors relating to Tech Manufacturing:

P/E ratio = (market price per share) ÷ (primary EPS)

Hamilton's P/E ratio = ($45.00) ÷ ($11.25) = 4 times.

the company's ability to turn liabilities into income-generating activities.

it weights preferred shares more than common shares.

the number of shares outstanding can change during a single period.

the number of shares outstanding grows each period.

20×2 20×3 20×4

A company reported the following financial data.

The company's operating profit margin percentage is