Deck 8: Financial Statement Analysis

Question 1

The Beaver and Altman bankruptcy studies found that firms can survive at least two years once they declare bankruptcy.

Answer 1

False
Explanation: The Beaver and Altman studies were 72% accurate in predicting failure 2 years ahead of failure.

Question 2

A primary use of the source and use of funds statement is to determine how current assets and longer-term assets are financed.

Answer 2

True

Question 3

The Beaver and Altman bankruptcy studies indicated that ratios of failing firms signal failure as much as five years ahead of bankruptcy.

Answer 3

True
Explanation: The Beaver and Altman studies indicated that ratios of failing firms signal failure as much as five years ahead of bankruptcy.

Question 4

Cash flows from investing activities would involve the purchase or sale of plant and equipment.

Question 5

Cash flows from financing activities would include the repurchase of debt and equity.

Question 6

The liquidity ratios measure how quickly a firm can dispose of inventory.

Question 7

Listing all balance sheet items at historical cost helps to reduce the distortion in profits caused by inflation.

Question 8

Return on assets can be stated to equal (net income/sales) x (sales/total assets).

Question 9

An increase in assets is considered a source of funds.

Question 10

Cash flows from operating activities would include the payment of cash dividends.

Question 11

According to Z score analysis, the higher the Z score, the greater the firm's bankruptcy potential.

Question 12

Financial ratios are meaningless unless they are compared to a company standard or historical or industry data.

Question 13

Ratio analysis for large firms may be facilitated by dividing the company along industry, market, or geographic lines.

Question 14

Industry trend analysis provides a method of comparing industry performance throughout the economy, and of identifying the potential winning and losing companies within an industry.

Question 15

Firms with P/E ratios higher than the overall market ratio are expected to provide greater than normal returns with equal or less risk.

Question 16

Debt-utilization ratios do not consider current liabilities.

Question 17

Extraordinary gains and losses are usually included in ratio analysis, since they reflect on the annual operating performance of a firm.

Question 18

Balance sheet items are carried at original cost or market value, at the discretion of the individual firm.

Question 19

Ratio analysis is equally effective in identifying either winners or losers.

Question 20

The after-tax profit margin represents operating income divided by sales.

Question 21

The Statement of Financial Accounting Standards (SFAS) No. 95 requires that the statement of cash flows be divided into three sections: cash flows from operations, investments, and financing.

Question 22

For a firm with old, heavy fixed assets, replacement cost accounting will normally decrease the return-on-equity ratio.

Question 23

Debt-utilization ratios provide an indication of the way the firm is financed between debt (lenders) and equity (owners), and therefore helps the analyst determine the amount of financial risk present in the firm.

Question 24

Financial statements present a numerical picture of a company's financial and operating health.

Question 25

The current cost method of inflation accounting adjusts statements by using the Consumer Price Index.

Question 26

The primary emphasis of the profitability ratios is a determination of the firm's ability to pay off short-term obligations as they come due.

Question 27

Inflation-adjusted financial statements may be shown as supplements to the historical cost financial statements.

Question 28

A conservative investor or analyst might prefer examining the fixed-charge coverage ratio, rather than just the times interest earned ratio.

Question 29

For a firm with old, heavy fixed assets, replacement cost accounting will normally increase the debt-to-total-assets ratio.

Question 30

To examine the long-term performance over a number of years, one would use fundamental analysis.

Question 31

The DuPont method demonstrates the relationship between assets, sales, income, and debt for creating returns on assets and equity.

Question 32

DuPont analysis deals primarily with the current and quick ratios.

Question 33

Rapid asset-utilization tends to provide greater liquidity.

Question 34

The Financial Accounting Standards Board (FASB) 85 requires that the Statement of Cash Flows be divided into three sections: cash flows from operations, investments, and financing.

Question 35

Regardless of the method of presentation in the financial statements, the analyst should eliminate the effect of extraordinary gains and losses in projecting data into the future.

Question 36

The tax ratio for forest product companies may be low because of the tax treatment given timber cuttings.

Question 37

LIFO accounting tends to increase inventory profits.

Question 38

Industry comparisons allow an analyst to separate quality companies from losers.

Question 39

A firm with an average return on assets, but a high return on equity, was probably able to achieve this by keeping debt down to a very low level.

Question 40

Corporate diversification eases the task of the financial analyst.

Question 41

The ________ ratios help determine the degree of financial risk and earnings volatility present in a firm.

A)profitability
B)asset-utilization
C)liquidity
D)debt-utilization
E)price

Question 42

________________ ratios measure the ability of a firm to earn an adequate return on sales, total assets, and invested capital.

A)Asset-utilization
B)Liquidity
C)Profitability
D)Debt-utilization
E)Price

Question 43

The ________ does not represent continuing operations in any way but is simply a snapshot of the total worth of a firm at a given point in time.

A)income statement
B)balance sheet
C)source and use of funds statement
D)statement of cash flows
E)none of the above

Question 44

Ratio analysis, which compares a company to an industry, is complicated because:

A)reliable industry data is not readily accessible.
B)the accounting conventions between companies may be dissimilar.
C)large companies are diversified across several industries.
D)More than one of the above

Question 45

___________ ratios measure the impact of external market forces on the internal performance of a firm.

A)Price
B)Profitability
C)Liquidity
D)Asset-utilization
E)Debt-utilization

Question 46

The major device for measuring the profitability of a firm over a defined period of time is the

A)income statement.
B)balance sheet.
C)statement of cash flows.
D)None of the above

Question 47

Which of the following is NOT a key ratio in the prediction of bankruptcy, as developed by Edward Altman?

A)Debt-to-equity ratio
B)Current ratio
C)Retained earnings as a percent of total assets
D)Total assets
E)EBIT to total assets

Question 48

DuPont analysis illustrates that the return on equity can be increased by decreasing the amount of debt used in the capital structure.

Question 49

Asset-utilization ratios measure all of the following except:

A)productivity of fixed assets in terms of sales.
B)the relationship of sales on the income statement to various assets on the balance sheet.
C)how many times per year the inventory is sold and accounts receivable collected.
D)the firm's ability to pay off short-term obligations as they come due.

Question 50

Which of the following statements is(are) true?

A)Debt-to-equity and debt-to-asset ratios measure capital structure and vary widely among industries
B)Debt-utilization ratios alone do not measure a firm's ability to meet its cash obligations
C)DuPont analysis considers the impact of debt on the profitability of the firm
D)Two of the above are true

Question 51

The method of calculating return on assets which highlights the importance of sales, profit margin, and asset turnover is known as:

A)the sales method.
B)DuPont analysis.
C)the Altman model.
D)the Gordon model.
E)the Return on Assets model.

Question 52

__________ analysis is the process of studying a series of ratios for a company and/or industry over time.

A)DuPont
B)Trend
C)Common size
D)Critical
E)All of the above

Question 53

Since all companies must operate under generally accepted accounting principles, equal earnings per share for company A and B mean exactly the same thing to an investor.

Question 54

Cash inflows arise from _____ assets, ________ liabilities, and ___________ stockholders' equity.

A)increasing; increasing; decreasing
B)increasing; decreasing; decreasing
C)decreasing; increasing; increasing
D)decreasing; increasing; decreasing

Question 55

Which of the following statements about liquidity ratios is true?

A)The higher the current ratio, the more likely a firm is able to pay its short-term obligations
B)The lower the quick ratio relative to the current ratio, the safer a firm is in terms of liquidity
C)The ratio of net working capital to total assets always lies between 0 and 1
D)Relatively high current ratios are usually a sign of efficient working capital management
E)The lower the current ratio, the more likely a firm is able to pay its short-term obligations

Question 56

The statement of cash inflows and outflows shows all of the following, except:

A)how the firm's balance sheet changed from one period to another.
B)how funds from operations were used to finance the company's assets.
C)how the firm has matched short-term and long-term sources of funds with short-term and long-term uses of funds.
D)the firm's cost of new borrowing.

Question 57

DuPont analysis illustrates the interaction of financial leverage, profit margin, and asset turnover on generating return on equity.

Question 58

Treasury stock represents shares of common stock that have been authorized but not issued.

Question 59

A high payout ratio indicates that:

A)a firm is investing heavily in plant and equipment.
B)a firm has high current obligations.
C)the firm is probably in the mature phase of its life cycle and does not have many growth opportunities available.
D)the firm is probably in Stage II of its life cycle.
E)the firm probably has too many highly profitable investment opportunities.

Question 60

The primary purpose of the liquidity ratios is to determine:

A)how much working capital is tied up in inventory.
B)the relative level of short-term debt.
C)how well a firm is able to pay off short-term obligations.
D)More than one of the above

Question 61

The major device that indicates what the firm owns, and how these assets are financed, in the form of liabilities or ownership interest is:

A)the balance sheet.
B)the statement of cash flows.
C)the income statement.
D)the general ledger.

Question 62

Which of the following is not an Asset-utilization ratio:

A)Receivable turnover
B)Fixed-asset turnover
C)Quick ratio
D)Total assets turnover
E)All of the above are Asset-utilization ratios

Question 63

Price Printing Co. had sales of $10 million, operating income of $3 million, after-tax income of $1 million, assets of $8 million, stockholders' equity of $5 million, and a total debt of $4 million. What is Price Printing Company's return on assets?

A)37.5%
B)12.5%
C)30.0%
D)25.0%
E)20.0%

Question 64

The primary sections of a statement of cash flows are:

A)cash flows from investing, operating, and financing activities.
B)cash flows from investing and operating activities.
C)cash flows from investing, financing, and accounting activities.
D)cash flows from investing, operating, financing, and accounting activities.

Question 65

Price Printing Co. had sales of $10 million, operating income of $3 million, after-tax income of $1 million, assets of $8 million, stockholders' equity of $5 million, and a total debt of $3 million. If we measure Price's financial leverage, we would most likely use which of the following ratios from chapter 8?

A)Debt-to-equity (60%) and debt-to-sales (30%)
B)Debt-to-equity (60%) and equity-to-assets (62.5%)
C)Debt-to-equity (60%) and debt-to-assets (37.5%)
D)Equity-to-assets (62.5%) and after-tax income-to-debt (33.3%)

Question 66

Corporate pension funds pose a threat to future earnings of the company because

A)the company is liable for all payments.
B)unfunded pensions will be paid from future earnings.
C)the firm may be unable to reinvest in new assets.
D)All of the above

Question 67

An analyst can judge a company's level of debt by comparing these ratios:

A)return-on-equity to total debt-to-assets
B)return-on-equity to total asset turnover
C)return-on-equity to debt turnover
D)return-on-equity to return-on-assets
E)return-on-equity to current ratio

Question 68

You would find the payment of dividends in the statement of cash flow under:

A)cash flows from operating activities.
B)cash flows from investing activities.
C)cash flows from financing activities.
D)cash flows from purchasing activities.
E)cash flows from selling activities.

Question 69

A stock is a good buy when the value of which of these ratios is low, compared to a market index or company history?

A)Price-to-book-value
B)Price-to-earnings
C)Dividend yield
D)All of the above

Question 70

Replacement cost accounting __________ income but __________ assets and ____________ the debt-to-assets ratio.

A)reduces; increases; lowers
B)lowers; increases; increases
C)increases; decreases; lowers
D)none of the above

Question 71

Financial ratios are used to weigh and evaluate:

A)the operating performance and capital structure of the firm.
B)which stocks are the gold mine stocks when investing in the market.
C)which stocks are about to file for bankruptcy.
D)the net present value of the company.
E)which companies manage their inventories effectively.

Question 72

When a company repurchases shares of their own common stock,

A)the earnings per share will rise.
B)the dividends paid out in total will decline.
C)the earnings per share growth rate will rise.
D)All of the above will happen

Question 73

Which of the following is a good example of changes in accounting principles?

A)A change in earnings per share, due to an increase in the number of shares of common stock
B)A change in income, due to a change for post-retirement benefits
C)A change in earnings before taxes, because of a change in internal rates on debt
D)None of the above

Question 74

You would expect to find depreciation and amortized expenses in the statement of cash flows under:

A)cash flows from operating activities.
B)cash flows from investing activities.
C)cash flows from financing activities.
D)cash flows from purchasing activities.

Question 75

The statement of cash flows tells us

A)what the accounting profit or loss is.
B)how cash was created.
C)the actual profit or loss.
D)the actual value of assets and liabilities.
E)the source and use of net income.

Question 76

Price Printing Co. had sales of $10 million, operating income of $3 million, after-tax income of $1 million, assets of $8 million, stockholders' equity of $5 million, and a total debt of $3 million. What is Price Printing Company's profit margin?

A)10.0%
B)20.0%
C)30.0%
D)33.0%
E)90.0%

Question 77

The type of ratio that allows the analyst to measure the ability of the firm to earn an adequate return on sales, total assets, and invested capital is:

A)liquidity ratios.
B)profitability ratios.
C)asset-utilization ratios.
D)debt-utilization ratios.
E)price ratios.

Question 78

In an inflationary economy, many firms use the ________ method of inventory valuation to reduce distortion of profits.

A)Current cost
B)LIFO
C)FIFO
D)LILO
E)Average cost

Question 79

Price Printing Co. had sales of $10 million, operating income of $3 million, after-tax income of $1 million, assets of $8 million, stockholders' equity of $5 million, and a total debt of $3 million. What is Price Printing Company's asset turnover?

A).50x
B)1.25x
C)2.50x
D)3.33x
E).80x

Question 80

Price Printing Co. had sales of $10 million, operating income of $3 million, after-tax income of $1 million, assets of $8 million, stockholders' equity of $5 million, and a total debt of $3 million. What is Price Printing Company's return on equity?

A)37.5%
B)10.0%
C)20.0%
D)60.0%
E)12.5%