Deck 8: Profitability

Question 1

Net profit margin measures return on:

A)sales.
B)owners' equity.
C)productive assets.
D)total assets.
E)inventory.

Answer 1

A

Question 2

Operating income is:

A)net sales less cost of goods sold.
B)earnings before interest and tax.
C)earnings before tax and nonrecurring items.
D)gross profit less operating expenses.
E)net income plus interest.

Answer 2

D

Question 3

Total asset turnover measures the ability of a firm to:

A)generate profits on sales.
B)generate sales through the use of assets.
C)buy new assets.
D)move inventory.
E)cover long-term debt.

Answer 3

B

Question 4

Which of the following circumstances will cause sales to fixed assets to be abnormally high?

A)A recent purchase of land.
B)A labor-intensive industry.
C)A highly mechanized facility.
D)High direct labor costs from a new union contract.
E)The use of units-of-production depreciation.

Question 5

Gross profit margin is an important ratio of merchandising firms because:

A)their investments in real property are high.
B)cost of goods sold is usually the largest expense.
C)selling expenses, like advertising, are usually quite high.
D)it measures their ability to collect receivables.
E)it measures their ability to use total assets.

Question 6

Which of the following could cause return on assets to decline when net profit margin is increasing?

A)Sale of investments at year-end
B)Increased turnover of operating assets
C)Decline in book value
D)A stock split
E)Purchase of a new building at year-end

Question 7

Which of the following ratios will usually have the lowest percent?

A)Return on investment
B)Return on total equity
C)Return on common equity
D)Return on total assets
E)There is not enough information to tell

Question 8

Which of the following is not a type of operating asset?

A)Inventory
B)Cash
C)Land
D)Long-term investments
E)Equipment

Question 9

Which of the following is not a base against which profits are measured?

A)Owners' equity
B)Owners' and creditors' funds provided
C)Intangibles
D)Revenues
E)Productive assets

Question 10

Which of the following is not a reporting requirement on interim reports?

A)Seasonal information
B)Major changes in income tax provision
C)Full balance sheet
D)Earnings per share
E)Significant changes in financial position

Question 11

Net earnings before deducting noncontrolling share of earnings is utilized in the following ratios, since noncontrolling interests are included in the base.Which ratio is an exception to this statement?

A)Net profit margin
B)Return on assets
C)Return on equity
D)Return on investment
E)None of the answers are correct.

Question 12

A reason that equity earnings create a problem in analyzing profitability is that equity earnings are:

A)usually greater than the related cash flow.
B)less than dividends declared.
C)more than dividends declared.
D)extraordinary.
E)nonrecurring.

Question 13

Noncontrolling interest share of earnings is:

A)the total earnings of unconsolidated subsidiaries.
B)earnings based on the percent of holdings by parent company of unconsolidated subsidiaries.
C)the total earnings of consolidated subsidiaries.
D)earnings based on the percent of holdings by outside owners of consolidated subsidiaries.
E)none of the answers are correct.

Question 14

Income tax expense in interim reporting should:

A)be based on the quarterly income only.
B)contain a judgment estimation of the annual effective tax rate.
C)be based on the income year-to-date.
D)exclude extraordinary items in earlier quarters of the year.
E)disregard year-end adjustments.

Question 15

In the analysis of profitability, if equity earnings are substantial, it is advisable to:

A)consider them as extraordinary.
B)consider them as nonrecurring.
C)investigate the earning power of the parent outside of the related investing activities.
D)recompute the debt ratio and times interest earned to remove the impact of equity earnings.
E)use the DuPont method to lessen the impact of equity earnings.

Question 16

The DuPont method return on assets uses two component ratios.What are they?

A)Inventory turnover * gross profit margin
B)Times interest earned * debt ratio
C)Return on equity * dividend payout
D)Net profit margin * total asset turnover
E)Return on investment * total investment turnover

Question 17

Which suppliers of funds bear the greatest risk and should therefore earn the greatest return?

A)Bondholders
B)Suppliers
C)General creditors such as banks
D)Preferred shareholders
E)Common shareholders

Question 18

Which of the following expresses DuPont analysis?

A)Net profit margin = total asset turnover times return on assets
B)Total asset turnover = operating asset turnover times financial leverage
C)Return on assets = net profit margin times total asset turnover
D)Return on investment = return on equity (1 - tax rate)
E)Dividend yield = dividend payout times earnings per share

Question 19

Which of the following would most likely cause a rise in net profit margin?

A)Increased sales
B)Decreased preferred dividends
C)Increased cost of sales
D)Decreased operating expenses
E)Decreased earnings per share

Question 20

Return on assets cannot fall under which of the following circumstances? $$\begin{array} { l l l } & \text { Net Profit Margin } & \text { Total Asset Turnover } \\\text { I. } & \text { decline } & \text { rise } \\\text { II. } & \text { rise } & \text { decline } \\\text { III. } & \text { rise } & \text { rise } \\\text { IV. } & \text { decline } & \text { decline }\end{array}$$

A)I
B)II
C)III
D)IV
E)The ratio could fall under all of the answers.

Question 21

Redeemable preferred stock is best considered as equity for ratio analysis.

Question 22

Changes in the cost of goods sold can have a substantial impact on gross profit margin.

Question 23

High fixed costs in a period of low activity can cause a low net profit margin.

Question 24

In profitability analysis, absolute numbers are more meaningful than relative numbers because the analyst needs to know if one firm earned more dollars than the other.

Question 25

The use of debt with high interest charges may cause the net profit margin to be low.

Question 26

Operating assets equals:

A)cash, accounts receivable, and equipment.
B)current assets plus tangible assets.
C)total assets minus intangible assets.
D)only long-term assets.
E)only current assets.

Question 27

Net profit margin is net profit before noncontrolling share of earnings and nonrecurring items to total assets.

Question 28

Equity earnings are usually lower than the cash generated from the investment as dividends.

Question 29

Sales to fixed assets will have the least meaning if assets are relatively new.

Question 30

Return on investment will typically be lower than return on equity.

Question 31

In the formula for return on investment, interest expense is multiplied by (1 - tax rate).Why is this adjustment made?

A)Interest is not tax deductible
B)Debt is excluded from the denominator
C)Net income in the formula is after tax
D)Dividends are not deductible for tax purposes
E)None of the answers are correct.

Question 32

Operating assets exclude investments, land, and intangibles from the asset base.

Question 33

DuPont analysis can be done with net income or operating income figures as long as the related asset base is consistent.

Question 34

In order to compute gross profit margin, the income statement must be in single-step format.

Question 35

Either a drop in net profit margin or a drop in total asset turnover, or both, can cause return on assets to fall.

Question 36

DuPont analysis breaks return on assets into net profit margin and borrowing capacity.

Question 37

Return on investment measures the return on long-term suppliers of funds.

Question 38

Profitability is the ability of the firm to generate earnings.

Question 39

The operating ratios may give significantly different results from net earnings ratios if a firm has large amounts of nonoperating assets generating income.

Question 40

Return on investment measures:

A)return to all suppliers of funds.
B)return to all long-term creditors.
C)return to all long-term suppliers of funds.
D)return to stockholders.
E)return to all short-term suppliers of funds.

Question 41

Interim reports are useful in analyzing the impact of seasonality.

Question 42

Interim reports are usually audited.

Question 43

Interim reporting recognizes that timeliness of data offsets lack of detail and requires only minimum data.

Question 44

Ratios of profits to sales and to identifiable assets can help to analyze profitability by segment.

Question 45

An interim period is a fiscal period less than one year.

Question 46

Segment data contain information about geographic markets, including foreign countries.

Question 47

Interim reports cover fiscal periods of less than one year.

Question 48

The SEC requires interim financial data on Form 10-Q.