Exam 4: Statement Analysis

Which of the following statements is CORRECT?

Brookman Inc's latest EPS was $2.75, its book value per share was $22.75, it had 315,000 shares outstanding, and its debt/assets ratio was 44%. How much debt was outstanding?

What is the firm's operating margin?

Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.

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

What is the firm's TIE?

The current and quick ratios both help us measure a firm's liquidity. The current ratio measures the relationship of the firm's current assets to its current liabilities, while the quick ratio measures the firm's ability to pay off short-term obligations without relying on the sale of inventories.

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

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

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

What is the firm's current ratio?

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

Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed, two firms with the same EBIT must have the same ROA.

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

If a bank loan officer were considering a company's loan request, which of the following statements would you consider to be CORRECT?

Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of examining changes in a firm's performance over time.

Last year Harrington Inc. had sales of $325,000 and a net income of $19,000, and its year-end assets were $250,000. The firm's total-debt-to-total-assets ratio was 45.0%. Based on the DuPont equation, what was the ROE?

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

Firms A and B have the same current ratio, 0.75, the same amount of sales, and the same amount of current liabilities. However, Firm A has a higher inventory turnover ratio than B. Therefore, we can conclude that A's quick ratio must be smaller than B's.

Considered alone, which of the following would increase a company's current ratio?