Deck 3: Analysis of Financial Statements

Question 1

A firm wants to strengthen its financial position.Which of the following actions would increase its quick ratio?

A) Issue new common stock and use the proceeds to acquire additional fixed assets.
B) Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.
C) Issue new common stock and use the proceeds to increase inventories.
D) Speed up the collection of receivables and use the cash generated to increase inventories.
E) Use some of its cash to purchase additional inventories.

Answer 1

Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.

Question 2

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

Answer 2

True

Question 3

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

Answer 3

False

Question 4

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

Question 5

A firm wants to strengthen its financial position.Which of the following actions would increase its current ratio?

A) Use cash to increase inventory holdings.
B) Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
C) Use cash to repurchase some of the company's own stock.
D) Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
E) Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

Question 6

Which of the following statements is CORRECT?

A) "Window dressing" is any action that improves a firm's fundamental, long-run position and thus increases its intrinsic value.
B) Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing."
C) Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."
D) Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of "window dressing."
E) Using some of the firm's cash to reduce long-term debt is an example of "window dressing."

Question 7

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.

Refer to the data for Pettijohn Inc.What is the firm's quick ratio?

A) 0.49
B) 0.61
C) 0.73
D) 0.87
E) 1.05

Question 8

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

A) An increase in accounts payable.
B) An increase in net fixed assets.
C) An increase in accrued liabilities.
D) An increase in notes payable.
E) An increase in accounts receivable.

Question 9

One problem with ratio analysis is that relationships can be manipulated.For example, we know that if our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.

Question 10

The current ratio and inventory turnover ratios both help us measure the firm's liquidity.The current ratio measures the relationship of a firm's current assets to its current liabilities, while the inventory turnover ratio gives us an indication of how long it takes the firm to convert its inventory into cash.

Question 11

Amram Company's current ratio is 1.9.Considered alone, which of the following actions would reduce the company's current ratio?

A) Use cash to reduce accounts payable.
B) Borrow using short-term notes payable and use the proceeds to reduce accruals.
C) Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
D) Use cash to reduce accruals.
E) Use cash to reduce short-term notes payable.

Question 12

Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant?

A) The total assets turnover decreases.
B) The TIE declines.
C) The DSO increases.
D) The EBITDA coverage ratio increases.
E) The current and quick ratios both decline.

Question 13

The "apparent," but not the "true," financial position of a company whose sales are seasonal can differ dramatically, depending on the time of year when the financial statements are constructed.

Question 14

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

Question 15

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

Question 16

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.

Refer to the data for Pettijohn Inc.What is the firm's current ratio?

A) 0.97
B) 1.08
C) 1.20
D) 1.33
E) 1.47

Question 17

One problem with ratio analysis is that relationships can be manipulated.For example, if our current ratio is greater than 1.5, then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to increase.

Question 18

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

Question 19

Lofland's has $20 million in current assets and $10 million in current liabilities, while Smaland's current assets are $10 million versus $20 million of current liabilities.Both firms would like to "window dress" their end-of-year financial statements, and to do so each plans to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts.Which of the statements below best describes the results of these transactions?

A) The transaction would improve both firms' financial strength as measured by their current ratios.
B) The transactions would raise Lofland's financial strength as measured by its current ratio but lower Smaland's current ratio.
C) The transactions would lower Lofland's financial strength as measured by its current ratio but raise Smaland's current ratio.
D) The transaction would have no effect on the firm' financial strength as measured by their current ratios.
E) The transaction would lower both firm' financial strength as measured by their current ratios.

Question 20

Lincoln Industries' current ratio is 0.5.Considered alone, which of the following actions would increase the company's current ratio?

A) Use cash to reduce long-term bonds outstanding.
B) Borrow using short-term notes payable and use the cash to increase inventories.
C) Use cash to reduce accruals.
D) Use cash to reduce accounts payable.
E) Use cash to reduce short-term notes payable.

Question 21

Which of the following statements is CORRECT?

A) If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.
B) A reduction in inventories held would have no effect on the current ratio.
C) An increase in inventories would have no effect on the current ratio.
D) If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
E) A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.

Question 22

The inventory turnover and current ratio are related.The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.

Question 23

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.

Refer to the data for Pettijohn Inc.What is the firm's EPS?

A) $5.84
B) $6.15
C) $6.47
D) $6.80
E) $7.14

Question 24

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.

Refer to the data for Pettijohn Inc.What is the firm's book value per share?

A) $61.73
B) $64.98
C) $68.40
D) $72.00
E) $75.60

Question 25

Heaton Corp.sells on terms that allow customers 45 days to pay for merchandise.Its sales last year were $425,000, and its year-end receivables were $60,000.If its DSO is less than the 45-day credit period, then customers are paying on time.Otherwise, they are paying late.By how much are customers paying early or late? Base your answer on this equation: DSO − Credit period = days early or late, and use a 365-day year when calculating the DSO.A positive answer indicates late payments, while a negative answer indicates early payments.

A) 6.20
B) 6.53
C) 6.86
D) 7.20
E) 7.56

Question 26

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

Question 27

Bonner Corp.'s sales last year were $415,000, and its year-end total assets were $355,000.The average firm in the industry has a total assets turnover ratio (TATO) of 2.4.Bonner's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales.By how much must the assets be reduced to bring the TATO to the industry average, holding sales constant?

A) $164,330
B) $172,979
C) $182,083
D) $191,188
E) $200,747

Question 28

Suppose firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets.Under these conditions, then firms that have high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.

Question 29

Aziz Industries has sales of $100,000 and accounts receivable of $11,500, and it gives its customers 30 days to pay.The industry average DSO is 27 days, based on a 365-day year.If the company changes its credit and collection policy sufficiently to cause its DSO to fall to the industry average, and if it earns 8.0% on any cash freed-up by this change, how would that affect its net income, assuming other things are held constant?

A) $267.34
B) $281.41
C) $296.22
D) $311.81
E) $328.22

Question 30

Emerson Inc.'s would like to undertake a policy of paying out 45% of its income.Its latest net income was $1,250,000, and it had 225,000 shares outstanding.What dividend per share should it declare?

A) $2.14
B) $2.26
C) $2.38
D) $2.50
E) $2.63

Question 31

It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

Question 32

Stewart Inc.'s latest EPS was $3.50, its book value per share was $22.75, it had 215,000 shares outstanding, and its debt-to-assets ratio was 46%.How much debt was outstanding?

A) $3,393,738
B) $3,572,356
C) $3,760,375
D) $3,958,289
E) $4,166,620

Question 33

Vang Corp.'s stock price at the end of last year was $33.50 and its earnings per share for the year were $2.30.What was its P/E ratio?

A) 13.84
B) 14.57
C) 15.29
D) 16.06
E) 16.86

Question 34

Other things held constant, which of the following alternatives would increase a company's cash flow for the current year?

A) Increase the number of years over which fixed assets are depreciated for tax purposes.
B) Pay down the accounts payables.
C) Reduce the days' sales outstanding (DSO) without affecting sales or operating costs.
D) Pay workers more frequently to decrease the accrued wages balance.
E) Reduce the inventory turnover ratio without affecting sales or operating costs.

Question 35

Harper Corp.'s sales last year were $395,000, and its year-end receivables were $42,500.Harper sells on terms that call for customers to pay 30 days after the purchase, but many delay payment beyond Day 30.On average, how many days late do customers pay? Base your answer on this equation: DSO − Allowed credit period = Average days late, and use a 365-day year when calculating the DSO.

A) 7.95
B) 8.37
C) 8.81
D) 9.27
E) 9.74

Question 36

Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000.What was its total assets turnover ratio (TATO)?

A) 2.03
B) 2.13
C) 2.25
D) 2.36
E) 2.48

Question 37

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.

Refer to the data for Pettijohn Inc.What is the firm's market-to-book ratio?

A) 0.56
B) 0.66
C) 0.78
D) 0.92
E) 1.08

Question 38

Lindley Corp.'s stock price at the end of last year was $33.50, and its book value per share was $25.00.What was its market/book ratio?

A) 1.34
B) 1.41
C) 1.48
D) 1.55
E) 1.63

Question 39

Which of the following statements is CORRECT?

A) If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.
B) If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average and was also increasing and trending still higher, this would be interpreted as a sign of strength.
C) If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding (DSO) will increase.
D) There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP).These ratios measure entirely different things.
E) A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.

Question 40

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.

Refer to the data for Pettijohn Inc.What is the firm's P/E ratio?

A) 12.0
B) 12.6
C) 13.2
D) 13.9
E) 14.6

Question 41

Last year Mason Inc.had a total assets turnover of 1.33 and an equity multiplier of 1.75.Its sales were $195,000 and its net income was $10,549.The CFO believes that the company could have operated more efficiently, lowered its costs, and increased its net income by $5,250 without changing its sales, assets, or capital structure.Had it cut costs and increased its net income in this amount, by how much would the ROE have changed?

A) 5.66%
B) 5.95%
C) 6.27%
D) 6.58%
E) 6.91%

Question 42

Last year Rosenberg Corp.had $195,000 of assets, $18,775 of net income, and a debt-to-total-assets ratio of 32%.Now suppose the new CFO convinces the president to increase the debt ratio to 48%.Sales and total assets will not be affected, but interest expenses would increase.However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged.By how much would the change in the capital structure improve the ROE?

A) 4.36%
B) 4.57%
C) 4.80%
D) 5.04%
E) 5.30%

Question 43

Last year Central Chemicals had sales of $205,000, assets of $127,500, a profit margin of 5.3%, and an equity multiplier of 1.2.The CFO believes that the company could reduce its assets by $21,000 without affecting either sales or costs.Had it reduced its assets in this amount, and had the debt-to-assets ratio, sales, and costs remained constant, by how much would the ROE have changed?

A) 1.81%
B) 2.02%
C) 2.22%
D) 2.44%
E) 2.68%

Question 44

Last year Vaughn Corp.had sales of $315,000 and a net income of $17,832, and its year-end assets were $210,000.The firm's total-debt-to-total-assets ratio was 42.5%.Based on the DuPont equation, what was Vaughn's ROE?

A) 14.77%
B) 15.51%
C) 16.28%
D) 17.10%
E) 17.95%

Question 45

Companies Heidee and Leaudy have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power.Both companies have positive net incomes.Company Heidee has a higher debt ratio and, therefore, a higher interest expense.Which of the following statements is CORRECT?

A) Heidee has more net income than Leaudy.
B) Heidee pays less in taxes than Leaudy.
C) Heidee has a lower equity multiplier than Leaudy.
D) Heidee has a higher ROA than Leaudy.
E) Heidee has a higher times interest earned (TIE) ratio than Leaudy.

Question 46

Companies Heidee and Leaudy have the same tax rate, sales, total assets, and basic earning power.Both companies have positive net incomes.Company Heidee has a higher debt ratio and, therefore, a higher interest expense.Which of the following statements is CORRECT?

A) Heidee has a lower times interest earned (TIE) ratio than Leaudy.
B) Heidee has a lower equity multiplier than Leaudy.
C) Heidee has more net income than Leaudy.
D) Heidee pays more in taxes than Leaudy.
E) Heidee has a lower ROE than Leaudy.

Question 47

Which of the following statements is CORRECT?

A) All else equal, increasing the debt ratio will increase the ROA.
B) The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
C) A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.
D) If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE.
E) Holding bonds is better than holding stock for investors because income from bonds is taxed on a more favorable basis than income from stock.

Question 48

If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.

Question 49

Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM).However, Company Heidee has the higher debt ratio.Which of the following statements is CORRECT?

A) Heidee has lower operating income (EBIT) than Leaudy.
B) Heidee has a lower total assets turnover ratio than Leaudy.
C) Heidee has a lower equity multiplier than Leaudy.
D) Heidee has a higher fixed assets turnover ratio than Leaudy.
E) Heidee has a higher ROE than Leaudy.

Question 50

Which of the following statements is CORRECT?

A) Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%.Under these conditions, the ROE will decrease.
B) Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%.Under these conditions, the ROE will increase.
C) Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%.Without additional information, we cannot tell what will happen to the ROE.
D) The modified DuPont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE.
E) Other things held constant, an increase in the debt ratio will result in an increase in the profit margin on sales.

Question 51

Heidee Corp.and Leaudy Corp.have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT.However, Heidee uses more debt than Leaudy.Which of the following statements is CORRECT?

A) Heidee would have higher net income as shown on the income statement than Leaudy.
B) Without more information, we cannot tell if Heidee or Leaudy would have a higher or lower net income.
C) Heidee would have a lower equity multiplier for use in the DuPont equation than Leaudy.
D) Heidee would have to pay more in income taxes than Leaudy.
E) Heidee would have lower net income as shown on the income statement than Leaudy.

Question 52

You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average.Which of the following statements is CORRECT?

A) Its total assets turnover must equal the industry average.
B) Its total assets turnover must be above the industry average.
C) Its return on assets must equal the industry average.
D) Its TIE ratio must be below the industry average.
E) Its total assets turnover must be below the industry average.

Question 53

Northwest Lumber had a profit margin of 5.25%, a total assets turnover of 1.5, and an equity multiplier of 1.8.What was the firm's ROE?

A) 12.79%
B) 13.47%
C) 14.18%
D) 14.88%
E) 15.63%