Deck 4: Analyzing Financial Statements

Question 1

The most frequent method used for creating a common-size balance sheet is to divide each of the accounts by fixed assets, expressing each account as a percentage of fixed assets.

Answer 1

False

Question 2

Efficiency ratios (such as inventory and asset turnover ratios) measure how efficiently a firm uses its assets to generate sales.

Answer 2

True

Question 3

A firm's current ratio changed from 1.4 times in the previous year to 1.6 times in the current year. Based on this information, we can conclude that the firm's liquidity has improved.

Answer 3

True

Question 4

Stockholders are primarily concerned about the value of their shares but not about how much cash they can expect to receive from dividends and/or capital appreciation over time.

Question 5

A balance sheet can be standardized by expressing each asset and liability as a percentage of total assets.

Question 6

Liquidity ratios illustrate the firm's ability to pay its current bills without putting the firm in financial difficulty.

Question 7

Common-size balance sheets are those that are prepared with numbers that reflect the common measures of a firm's revenues.

Question 8

A firm increased its day's sales outstanding from 35 days to 43 days. This implies the firm is more efficient in collecting the debts.

Question 9

Financial statement analysis can help us determine why a firm's cash flows are increasing or decreasing.

Question 10

A company can improve its equity multiplier by increasing its debt ratio, holding everything else constant in the balance sheet.

Question 11

The purchase of additional inventory by a firm should decrease a firm's quick ratio.

Question 12

A company can improve its liquidity by increasing its accounts payable, while maintaining the other accounts constant.

Question 13

The shareholders of a firm are most interested in knowing if the firm is generating enough cash flows to meet all of its required obligations

Question 14

Total asset turnover is more relevant for service-industry firms, while the fixed asset turnover ratio is more relevant for manufacturing industry firms.

Question 15

A financial statement analysis conducted over a period of time is called trend analysis.

Question 16

A typical way in which a common-size income statement is constructed is by dividing all expense items in an income statement by net income.

Question 17

Trend analysis is a method of examining changes in a firm's performance over time.

Question 18

Turnover ratios are useful for managers in identifying inefficient use of current and long-term assets.

Question 19

Financial statements reflect managers' decisions regarding financing, investment, and working capital.

Question 20

Leverage ratios measure the extent to which a firm uses equity rather than debt financing and show the firm's ability to pay its current bills without putting the firm in financial difficulty.

Question 21

A firm's management analyzes financial statements so that:

A) they can get feedback on their investing, financing, and working capital decisions by identifying trends in the various accounts that are reported in the financial statements.
B) they can focus on profitability, dividend, capital appreciation, and return on investment.
C) they can get more stock options.
D) Both a and b

Question 22

The DuPont equation shows the combined impact of a firm's control on its expenses along with its efficient use of assets and debt on its return on equity.

Question 23

For a given share price of a firm's stock, the lower the EPS the lower the price-earnings ratio.

Question 24

For a given level of after-tax income, the lower the level of equity a firm has, then the higher the return on equity its shareholders will earn.

Question 25

In a peer group analysis, the benchmark for financial statement analysis is the performance of a competitor that is roughly the same size and that offer a similar range of products.

Question 26

Bondholders primarily analyze financial statements to:

A) assess the cash flows that the firm will generate from its operations.
B) determine the firm's profitability, the return on equity for that period, and the dividend they are likely to distribute.
C) focus on the value of the company stock.
D) determine the likelihood of the return of their principal at maturity.

Question 27

The three different perspectives on financial statement analysis are those of the:

A) manager, regulator, and bondholder.
B) manager, shareholder, and creditor.
C) regulator, shareholder, and creditor.
D) shareholder, creditor, and regulator.

Question 28

Financial leverage refers to the use of preferred stock in a firm's capital structure.

Question 29

The DuPont equation relates a firm's net profit margin, total asset turnover ratio, and equity multiplier with its return on equity.

Question 30

Shareholders analyze financial statements in order to:

A) assess the cash flows that the firm will generate from its operations.
B) determine the firm's profitability, their return for that period, and the dividend they are likely to receive.
C) focus on the value of the stock they hold.
D) All of the above

Question 31

For a given level of after-tax income, the higher the level of equity a firm has, then the higher the return on equity its shareholders will earn.

Question 32

While doing an industry group analysis, you form the comparison group by choosing firms that are larger than the firm being compared.

Question 33

To compute the equity multiplier, divide the total equity by its total assets.

Question 34

One of the three major shortcomings of return on equity is that it ignores risk.

Question 35

Anyone analyzing a firm's financial statements should:

A) use audited financial statements.
B) do a trend analysis.
C) perform a benchmark analysis.
D) All of the above.

Question 36

The creditors of a firm analyze financial statements so that they can better understand:

A) the firm's amount of debt.
B) the firm's ability to generate sufficient cash flows to meet its legal obligations first and still have sufficient cash flows to meet debt repayment and interest payments.
C) the firm's ability to meet its short-term obligations.
D) All of the above.

Question 37

The higher the times-interest-earned ratio, the greater the ability the firm has is in meeting its interest obligations.

Question 38

Firms with a lower return on assets (ROA) and higher leverage will have a lower return on equity (ROE) than firms with a higher return on assets (ROA) and lower leverage.

Question 39

A firm that has no debt will have its return on assets (ROA) equal to its return on equity (ROE).

Question 40

The Standard Industrial Classification (SIC) codes are four-digit numbers in which the last two digits describe the type of business or industry the firm is engaged in.

Question 41

Common-size financial statements:

A) are a specialized application of ratio analysis.
B) allow us to make meaningful comparisons between the financial statements of two firms that are different in size.
C) are prepared by having each financial statement item expressed as a percentage of some base number, such as total assets or total revenues.
D) All of the above are true.

Question 42

Which of the following statements is correct?

A) The lower the level of a firm's debt, the higher the firm's leverage.
B) The lower the level of a firm's debt, the lower the firm's equity multiplier.
C) The lower the level of a firm's debt, the higher the firm's equity multiplier.
D) The tax benefit from using debt financing reduces a firm's risk.

Question 43

All else being equal, which of the following will decrease a firm's current ratio?

A) A decrease in the net fixed assets
B) A decrease in depreciation expense
C) An increase in accounts payable
D) None of the above

Question 44

Which one of the following statements is NOT true?

A) The accounts receivables turnover ratio measures how quickly the firm collects its credit sales.
B) One ratio that measures the efficiency of a firm's collection policy is day's sales outstanding.
C) The more days that it takes a firm to collect on its receivables, the more efficient the firm is.
D) Day's sales outstanding measures in days, the time a firm takes to convert its receivables into cash.

Question 45

Which of the following is an advantage of a common-size income statement?

A) It is very useful to assess how effectively a firm collected its accounts receivable.
B) It reveals a great deal of information about the adequacy of a firm's net working capital.
C) It can tell the analyst a great deal about a firm's efficiency and profitability.
D) It reveals how effectively a firm has increased its assets.

Question 46

Which of the following is an advantage of a common-size balance sheet?

A) It is very useful to assess how effectively a firm collected its accounts receivable.
B) It reveals a great deal of information about how the firm is controlling its expenses.
C) It can tell the shareholders how dividends have changed over time.
D) It reveals how the firm has managed its tax payments.

Question 47

Which of the following is NOT true of common-size income statements?

A) Each income statement item is standardized by dividing it by total assets.
B) Income statement accounts are represented as percentages of net sales.
C) Each income statement item is standardized by dividing it by net sales.
D) Common-size income statements analysis is a specialized application of ratio analysis.

Question 48

Which of the following is true about the quick ratio?

A) The quick ratio is calculated by dividing the least liquid of current assets by current liabilities.
B) Service firms that tend not to carry too much inventory will see significantly higher quick ratios than current ratios.
C) Inventory, being not very liquid, is subtracted from total current assets to determine the most liquid assets.
D) Quick ratios will tend to be much larger than current ratio for manufacturing firms or other industries that have a lot of inventory.

Question 49

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

A) Offer price reductions that would enable the firm to sell some of its inventory.
B) Issue new common stock and use the proceeds to increase inventories.
C) Speed up the collection of receivables and use the cash generated to increase inventories.
D) Use some of its cash to purchase additional inventories.

Question 50

Which of the following is true of ratio analysis?

A) A ratio is computed by dividing one balance sheet item or income statement item by another.
B) The choice of the scale determines the story that can be garnered from the ratio.
C) Ratios can be calculated based on the type of firm being analyzed or the kind of analysis being performed.
D) All of the above are true.

Question 51

Which of the following is NOT true of common-size balance sheets?

A) Each asset and liability item on the balance sheet is standardized by dividing it by total assets.
B) Balance sheet accounts are represented as percentages of total assets.
C) Each asset and liability item on the balance sheet is standardized by dividing it by sales.
D) Common-size balance sheets allow us to make meaningful comparisons between the balance sheets of two firms that are different in size.

Question 52

If firm A has a higher debt-to-equity ratio than firm B, then:

A) firm A has a lower equity multiplier than firm B.
B) firm B has a lower equity multiplier than firm A.
C) firm B has higher financial leverage than firm A.
D) None of the above.

Question 53

You observe that a firm's ROE has increased from the previous year, but both its profit margin and equity multiplier are below the previous year's levels. Which of the following statements is CORRECT?

A) Its total assets turnover must be higher than the previous year.
B) Its return on assets must be lower than the previous year.
C) Its TIE ratio must be higher than the previous year.
D) Its total assets turnover must be lower than the previous year.

Question 54

Which of the following is NOT true about the inventory turnover ratio?

A) It is calculated by dividing inventory by cost of goods sold.
B) It measures how many times the inventory is turned over into saleable products.
C) The more times a firm can turn over its inventory, the better.
D) Too high a turnover or too low a turnover could be a warning sign.

Question 55

Which of the following statements is NOT true of the asset turnover ratio?

A) Asset turnover ratio measures the dollar amount of sales per dollar of assets that the firm has.
B) The fixed assets turnover ratio is less significant for equipment-intensive manufacturing industry firms than the total assets turnover ratio.
C) The higher the total asset turnover, the more efficiently management is using total assets.
D) The ratio is quite useful in identifying the inefficient use of current and long-term assets.

Question 56

A company's current ratio is 2.0. Which of the following actions would lower the current ratio, assuming everything else remains the same?

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

Question 57

Which of the following would be unrelated to analyzing a firm's trend over time?

A) the relative ratios of the major competitors.
B) the sales growth.
C) the control of the firm's expenses.
D) the efficient use of the firm's assets.

Question 58

Which of the following is NOT true of liquidity ratios?

A) They measure the ability of a firm to meet short-term obligations with short-term assets without putting the firm in financial trouble.
B) There are two commonly used ratios to measure liquidity-current ratio and quick ratio.
C) For manufacturing firms, quick ratios will tend to be much larger than current ratios.
D) The higher the liquidity ratios, the more liquid the firm and the better its ability to pay its short-term bills.

Question 59

An individual analyzing a firm's financial statements should do all but which one of the following?

A) Use unaudited financial statements
B) Perform a trend analysis
C) Perform a benchmark analysis
D) Compare the firm's performance to that of its direct competitors

Question 60

Which of the following does NOT change a firm's current ratio?

A) The firm collects its accounts receivables.
B) The firm purchases inventory by taking a short-term loan.
C) The firm pays down its accounts payables.
D) None of the above.

Question 61

A company's current ratio is 0.5. Everything else held constant, which of the following actions would increase the company's current ratio?

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

Question 62

Pedro & Son's total common equity at the end of last year was $405,000 and its net income was $70,000. What was its ROE?

A) 14.82%
B) 15.60%
C) 16.42%
D) 17.28%

Question 63

An all-equity new firm is developing its business plan. It will require $615,000 of assets (which equals common equity), and it projects $450,000 of sales and $355,000 of operating costs for the first year. Management is reasonably sure of these numbers because of contracts with its customers and suppliers. It can borrow at a rate of 7.5%, but the bank requires it to have a TIE of at least 4.0The firm will use debt and common equity for financing. What is the maximum debt to capital ratio (measured as debt/total common equity) the firm can use? (Hint: Find the maximum dollars of interest, then the debt that produces that interest, and then the related debt to capital ratio.)

A) 44.15%
B) 46.47%
C) 48.92%
D) 51.49%

Question 64

Lionel, Inc., has current assets of $623,122, including inventory of $241,990, and current liabilities of $378,454. What is the quick ratio? Round your final answer to two decimal places.

A) 1.65
B) 0.64
C) 1.01
D) None of the above

Question 65

Bathez Corp. has receivables of $334,227, inventory of $451,000, cash of $73,913, and accounts payables of $469,553. What is the firm's current ratio? Round your final answer to two decimal places.

A) 1.83
B) 0.73
C) 1.67
D) None of the above

Question 66

Viera Industries has net sales of $200,000, accounts receivable of $18,500, and gives its customers 25 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) $241.45
B) $254.16
C) $267.54
D) $296.44

Question 67

Water Inc.'s net sales last year were $315,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio of 2.4. The firm's new CFO believes the firm has excess assets that can be sold so as to bring the total assets turnover ratio down to the industry average without affecting sales. By how much will the need assets be reduced to bring the total assets turnover ratio to the industry average, holding sales constant?

A) $201,934
B) $212,563
C) $223,750
D) $234,938

Question 68

If Randolph Corp. has accounts receivables of $654,803 and net sales of $1,932,349, what is its accounts receivable turnover? Round your final answer to two decimal places.

A) 0.34 times
B) 1.78 times
C) 2.95 times
D) None of the above

Question 69

Gateway Corp. has an inventory turnover ratio of 5.6. What is its day's sales in inventory? Round your final answer to nearest day.

A) 65 days
B) 64 days
C) 61 days
D) 57 days

Question 70

Jet, Inc., has net sales of $712,478 and accounts receivable of $167,435. What are the firm's accounts receivable turnover and day's sales outstanding? Round your accounts receivable turnover to two decimal places and day's sales outstanding to nearest day.

A) 0.24 times; 79 days
B) 4.26 times; 86 days
C) 5.2 times; 61 days
D) None of the above.

Question 71

Pedro & Co. has $720,000 of assets and is all-equity financed. The new CFO wants to use enough debt to raise the total debt to total capital ratio to 40%, using the proceeds from borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?

A) $273,600
B) $288,000
C) $302,400
D) $317,520

Question 72

Ellicott City Manufacturers, Inc., has sales of $6,344,210, and a gross profit margin of 67.3 percent. What is the firm's cost of goods sold? Round your final answer to the nearest dollar.

A) $2,074,557
B) $2,745,640
C) $274,560
D) None of the above.

Question 73

Coverage ratios, like times interest earned and cash coverage ratio, allow:

A) a firm's management to assess how well they meet short-term liabilities.
B) a firm's shareholders to assess how well the firm will meet its short-term liabilities.
C) a firm's creditors to assess how well the firm will meet its interest obligations.
D) a firm's creditors to assess how well the firm will meet its short-term liabilities other than interest expense.

Question 74

Which one of the following statements is NOT correct?

A) A leveraged firm is riskier than a firm that has no leverage.
B) A leveraged firm is less risky than a firm that has no leverage.
C) A firm that uses debt magnifies the return to its shareholders.
D) A firm that does not use debt incurs opportunity cost of increasing value of shares.

Question 75

Ronaldinho Trading Co. is required by its bank to maintain a current ratio of at least 1.75, and its current ratio now is 2.1. The firm plans to acquire additional inventory to meet an unexpected surge in the demand for its products and will pay for the inventory with short-term debt. How much inventory can the firm purchase without violating its debt agreement, if their total current assets equal $3.5 million? Round your final answer to the nearest dollar.

A) $0
B) $777,777
C) $1 million
D) None of the above

Question 76

Trident Corp., has debt of $3.35 million with an interest rate of 6.875 percent. The company has an EBIT of $2,766,009. What is its times-interest-earned ratio? Round your final answer to nearest number.

A) 13 times
B) 12 times
C) 11 times
D) None of the above

Question 77

If Viera, Inc., has an accounts receivable turnover of 3.9 times and net sales of $3,436,812, what is its level of receivables? Round your final answer to the nearest dollar.

A) $881,234
B) $13,403,567
C) $1,340,357
D) $81,234

Question 78

Chang Corp. has $375,000 of assets, and it uses only common equity capital (zero debt). Its sales for the last year were $595,000, and its net income was $25,000. Stockholders recently voted in a new management team that has promised to lower costs and raise the return on equity to 15.0%. What profit margin would the firm need in order to achieve the 15% ROE, holding everything else constant?

A) 9.45%
B) 9.93%
C) 10.42%
D) 10.94%

Question 79

Zidane Enterprises has a current ratio of 1.92, current liabilities of $272,934, and inventory of $197,333. What is the firm's quick ratio? Round your final answer to two decimal places.

A) 0.72
B) 1.20
C) 1.92
D) None of the above

Question 80

Deutsche Bearings has total sales of $9,745,923, inventories of $2,237,435, cash and equivalents of $755,071, and day's sales outstanding of 49 days. If the firm's management wanted its day's sales outstanding (DSO) to be 35 days, by how much will the accounts receivable have to change? Round your final answer to two decimal places.

A) $373,816.23
B) −$373,816.23
C) −$379,008.12
D) $379,008.12