Deck 18: Ratio Analysis, financial Analysis and Beyond

Question 1

Firm A and firm B are in the same risk class.Firm A has return on sales of 3% and an asset turnover of 4.Firm B generates 2 CU of profit per 100 CU of sales revenue and requires 25 CU of assets in order to support 100 CU of sales.In order for firm B to be seen as generating a better return on assets than firm A:

A) Firm A must increase its asset turnover to 6.67.
B) Firm A must increase its sales revenue to 110 CU.
C) Firm B must reduce the assets required to support its sales to 16.67 CU.
D) Firm B must increase its sales revenue to 110 CU.

Answer 1

C

Question 2

Profit margin is defined as the ratio of earnings to

A) Total assets
B) Total operating revenue
C) Total of interest-bearing and non interest-bearing liabilities
D) Total gross margin

Answer 2

B

Question 3

If a business entity sets the price of its services higher than competitors,it is likely that

A) Asset turnover will be higher than expected
B) Inventory turnover will be faster than expected
C) Gross margin will be higher than expected
D) Collection period will be longer than expected

Answer 3

C

Question 4

In order to calculate diluted earnings per share,the net profit attributable to ordinary shareholders and the weighted average number of shares outstanding should be adjusted for the effects of all dilutive potential ordinary shares.

Question 5

The so-called 'DuPont formula' defines capital employed as:

A) The sum of shareholders' equity plus long-term debt (including current portion).
B) The sum of fixed assets net of depreciation and current assets net of provision for bad debt.
C) Shareholder capital plus retained earnings,reserves (and provisions if applicable).
D) The sum of net fixed assets plus working capital.

Question 6

Which of the following situations represents an effective use of assets

A) Earning a larger amount of profit per currency unit of sales revenue.
B) Increasing sales revenue faster than gross asset growth.
C) Depreciating tangible assets using an accelerated depreciation method.
D) Divesting assets when sales revenue declines to keep the ratio of sales to assets constant.

Question 7

Euphoria Corp.operates in a world where there are no taxes of any kind.Euphoria Corporation's balance sheet on 31 December X1 shows shareholders' equity at 5,000 CU,long-term debt at 5,000 CU (interest on these loans is 5%)and accounts payable at 5,000 CU.The income statement for X1 shows that for sales of 15,000 CU the gross margin was 8,000 CU.The COGS includes 2,500 CU of depreciation expenses.Selling General and Administrative expenses amount to 5,500 CU which include,among other items,a 500 CU personnel training expenses for new technologies of production,500 CU spent on developing a new logo and its launch and total depreciation expenses of 1,500 CU.In addition Euphoria spent 1,000 CU on R&D in X1.The market expectation regarding return on long-term capital in the risk class where Euphoria operates is considered to be 15%.Intellectual investments are considered to benefit the firm for 4 years.What is the EVA of Euphoria for X1?

A) 1,275 CU
B) 1,500 CU
C) 1,725 CU
D) 1,000 CU

Question 8

If you multiply sales profit margin by asset turnover,you obtain:

A) A meaningless number
B) A metric that describes the profit generation efficiency of new assets
C) Return on assets
D) Return on shareholders equity

Question 9

The asset turnover ratio (ATR)for Jovial Inc.has evolved as follows over the past three years:
ATR(Y-3)= 200% ATR(Y-2)= 190% ATR(Y-1)= 180%

A) New assets are acquired for the same amount as the annual depreciation expense.
B) Sales revenue grew at a rate that is more rapid than the rate of growth of net assets.
C) Assets are being used more efficiently over time.
D) Assets are being used less efficiently over time.

Question 10

Two manufacturing business entities (A and B)were created at the same time this year and started operating on the very same day.They operate on two absolutely identical but separate worlds,but are not in competition with one another.They are absolutely identical in terms of their market success,their productive technology,equipment and infrastructure.They have the same headcount comprising the same categories of skills and competence.Both must pay cash for all their purchases.
The first year's income statements for each firm are as follows:
Which of the following statements is entirely true:

A) Firm A uses straight line depreciation and has a larger shareholders' equity than B which uses accelerated depreciation
B) Firm A could invest more in R&D than firm B and has more debt than B does
C) Firm A uses accelerated depreciation while firm B uses straight-line depreciation
D) Firm A has less debt than firm B and has more efficient productive equipment

Question 11

Economic Value Added (EVA)is defined as follows

A) Change,year on year,in the net present value of after-tax operating profit adjusted for the interest expense tax shield.
B) Residual Income adjusted for the after-tax effects of accounting adjustments and of the interest expense tax shield.
C) Net operating after-tax profit minus a cost of long-term financing adjusted for after-tax effects of accounting adjustments.
D) Net present value of future operating earnings adjusted for R&D,training and commercial expenses and after-tax effects of accounting adjustments.

Question 12

A scoring model is

A) A process used in ancient times to carve notches descriptive of quantities involved in accounting transactions.
B) A statistically developed process that when applied helps the user predict business failures.
C) A statistically developed process that when applied helps the user predict cash flows generated by new commercial contacts.
D) A statistically developed process that when applied helps the user predict sales volume generated by a marketing campaign.

Question 13

Segment reporting consists in:

A) Breaking down the earnings of the firm into the various functional components of its generation process.
B) Breaking down the earnings of a firm into the elements traceable to identifiable components of the business entity defined around markets,technologies or regions.
C) Reporting the three consolidated financial statements of a group plus,separately,those of each of its key subsidiaries.
D) Reporting the accrual-based earnings and the cash flows by structuring them by term.

Question 14

You have gathered data about three possible investments.The data are as follows
The earnings and operating cash flows can be estimated to be as follows:
Firm A Firm B Firm C
Earnings Cash flow Earnings Cash flow Earnings Cash flow

A) 4 14 2 14 20 14
B) 7 8 11 4 10 4
C) 10 -15 4 14 10 12
D) 4 8 4 11 4 10

Question 15

Residual income is:

A) Income remaining after taxes have been paid.
B) Income remaining after dividends have been paid.
C) Income minus a virtual expense representing the cost of capital employed.
D) Income after R&D and competitiveness maintenance expenditures.

Question 16

Firm A on 1 January X1 has 5,000 shares outstanding (valued at 14.5 CU per share on the market)and holds 600 shares in treasury stock.On 1 July,it issues 1,000 new shares that are fully subscribed and fully paid for in cash at 15 CU per share.On 1 October,managers exercise their stock options and the firm sells them the 600 shares it held in treasury at a price of 12 CU per share as agreed when the options were granted.The current market value of a share on 1 October is 16 CU per share.What is the time weighted average number of share for the year X1.On 31 December X1,the share is still valued by the market at 16 CU per share.

A) 5,650 shares
B) 6,300 shares
C) 6,600 shares
D) 6,000 shares

Question 17

If a business entity shows a high asset turnover ratio,it means that

A) It requires a high level of fixed assets to sustain is sales revenue year on year.
B) The profit generated year after year represents a high percentage of assets.
C) It always buys state of the art assets and discards older assets before they are fully obsolete.
D) It uses a small amount of assets to generate relatively large amounts of sales revenue.

Question 18

Firm A on 1 January X1 has 6,000 shares outstanding and holds 100 shares in treasury stock.On 1 January X1 shares trade at 13 CU per share.On 1 July,it acquires,at 13.5 CU per share,an additional 600 of its own shares in anticipation of service of managers' stock options.On October 1,managers exercise their stock options and the firm sells them the full 700 shares it held in treasury at a price of 14 CU per share as agreed when the options were granted.The market value of a share on October 1 is 16 CU per share.For X1,earnings after tax (attributable to ordinary equity holders)were 18,330 CU.The basic earnings per share for X1 amounts to:

A) 3.45 CU
B) 3.12 CU
C) 2.73 CU
D) 2.88 CU

Question 19

All things being otherwise equal,when a business entity is created,choosing a significantly higher financial leverage ratio (than the rule of the three thirds would command)will generally lead to (compared to a lower leverage ratio):

A) Larger earnings and larger earnings per share
B) Lower earnings and higher ROE
C) Higher earnings and lower ROE
D) Lower earnings and lower earnings per share

Question 20

Firms A and B have the same number of shares outstanding.Relative to firm A,firm B is less capital intensive,has a lower debt to asset ratio and pays a larger proportion of its earnings as dividends.On the basis of these facts,would you say that:

A) Firm A offers a higher level of risk to shareholders than firm B.
B) Firm A offers a lower level of profitability than firm B.
C) Firm A has more fixed assets as a proportion of its total assets than firm B.
D) Firm A book value per share is smaller than that of firm B.