Deck 4: Profitability Analysis

Question 1

Which of the following might an analyst not want to eliminate from past earnings when using past earnings to forecast future earnings.

A) nonrecurring gains from the sale of assets.
B) unusual asset impairment charges.
C) nonrecurring restructuring charges.
D) revenue from the sale of inventory.

Answer 1

D

Question 2

Which of the following industries would you expect to have, on average, high asset turnover and low profit margin?

A) Hotels
B) Grocery stores
C) Utilities
D) Oil and Gas extraction

Answer 2

B

Question 3

Net Devices Inc. The following balance sheets and income statements are for Net Devices Inc., a manufacturer of small electronic devices, including calculators, personal digital assistants and mp3 players. For purposes of these questions assume that the company has an effective tax rate of 35%.
What is the accounts receivable turnover ratio for Net Devices for 2007?

A) 24.65
B) 14.85
C) 14.81
D) 10.50

Answer 3

C

Question 4

Orca Industries Below are the two most recent balance sheets and most recent income statement for Orca Industries. The company has an effective tax rate of 35%.
Income Statement
For the year ended December 31, 2007
Orca Industries' asset turnover is

A) 1.31
B) 1
C) 1.58
D) 1.44

Question 5

Net Devices Inc. The following balance sheets and income statements are for Net Devices Inc., a manufacturer of small electronic devices, including calculators, personal digital assistants and mp3 players. For purposes of these questions assume that the company has an effective tax rate of 35%.
What is the inventory turnover for Net Devices for 2007?

A) 10.32
B) 8.90
C) 2.51
D) 6.23

Question 6

Net Devices Inc. The following balance sheets and income statements are for Net Devices Inc., a manufacturer of small electronic devices, including calculators, personal digital assistants and mp3 players. For purposes of these questions assume that the company has an effective tax rate of 35%.
What is Net Devices' Return on Common Shareholders' Equity for 2007?

A) 26.54%
B) 30.89%
C) 35.81%
D) 42.16%

Question 7

Asset turnover represents

A) The ability of the firm to generate income from operations for a particular level of sales.
B) The ability to generate sales from a particular investment in assets.
C) The ability to manage the level of investment in assets for a particular level of assets.
D) The number of days, on average, it takes management to turnover assets.

Question 8

Net Devices Inc. The following balance sheets and income statements are for Net Devices Inc., a manufacturer of small electronic devices, including calculators, personal digital assistants and mp3 players. For purposes of these questions assume that the company has an effective tax rate of 35%.
What is the profit margin for ROA for Net Devices for 2006?

A) 7.26%
B) 4.22%
C) 5.00%
D) 3.97%

Question 9

Orca Industries Below are the two most recent balance sheets and most recent income statement for Orca Industries. The company has an effective tax rate of 35%.
Income Statement
For the year ended December 31, 2007
Orca Industries' inventory turnover is

A) 2.67
B) 3.0
C) 2.4
D) 1.0

Question 10

Orca Industries Below are the two most recent balance sheets and most recent income statement for Orca Industries. The company has an effective tax rate of 35%.
Income Statement
For the year ended December 31, 2007
Orca Industries' accounts receivable turnover is (assume that Orca makes all sales on account)

A) 7.0
B) .53
C) 11.2
D) 10

Question 11

One important difference between return on assets (ROA) and return on common shareholder's equity (ROCE) is

A) ROA does not differentiate based on how a company finances its assets, ROCE does.
B) ROA does not distinguish between the different types of income items, such as income from continuing operations, discontinued operations, extraordinary items and changes in accounting principles, ROCE does.
C) ROCE does not distinguish between the different types of income items, such as income from continuing operations, discontinued operations, extraordinary items and changes in accounting principles, ROA does.
D) ROCE does not differentiate based on how a company finances its assets, ROA does.

Question 12

Orca Industries Below are the two most recent balance sheets and most recent income statement for Orca Industries. The company has an effective tax rate of 35%.
Income Statement
For the year ended December 31, 2007
The profit margin for computing ROA for Orca Industries is

A) 9.4%
B) 13.5%
C) 4.8%
D) 12.3%

Question 13

Net Devices Inc. The following balance sheets and income statements are for Net Devices Inc., a manufacturer of small electronic devices, including calculators, personal digital assistants and mp3 players. For purposes of these questions assume that the company has an effective tax rate of 35%.
What is Net Devices' Capital Structure Leverage ratio for 2007?

A) 3.89
B) 1.68
C) 3.71
D) 10.32

Question 14

Net Devices Inc. The following balance sheets and income statements are for Net Devices Inc., a manufacturer of small electronic devices, including calculators, personal digital assistants and mp3 players. For purposes of these questions assume that the company has an effective tax rate of 35%.
What is Net Devices' Earnings per Share for 2007?

A) $1.00
B) $1.70
C) $1.96
D) $0

Question 15

Return on common equity can be disaggregated into three components, which of the three is not one of the components?

A) Assets Turnover ratio
B) Profit Margin ratio
C) Debt to Equity ratio
D) Capital Structure Leverage ratio

Question 16

Firms with high levels of operating leverage experience which of the following in comparison to firms with low levels of operating leverage

A) Higher levels of risk in operations.
B) Lower expected rates of return.
C) Lower variability in returns on assets.
D) Higher sales.

Question 17

Orca Industries Below are the two most recent balance sheets and most recent income statement for Orca Industries. The company has an effective tax rate of 35%.
Income Statement
For the year ended December 31, 2007
The return on assets for Orca Industries is

A) 6.8%
B) 13.5%
C) 10%
D) 12.3%

Question 18

Net Devices Inc. The following balance sheets and income statements are for Net Devices Inc., a manufacturer of small electronic devices, including calculators, personal digital assistants and mp3 players. For purposes of these questions assume that the company has an effective tax rate of 35%.
What is the rate of return on assets for Net Devices for 2007?

A) 11.64%
B) 14.50%
C) 12.60%
D) 13.88%

Question 19

Orca Industries Below are the two most recent balance sheets and most recent income statement for Orca Industries. The company has an effective tax rate of 35%.
Income Statement
For the year ended December 31, 2007
The return on common shareholders' equity for Orca Industries is

A) 15.2%
B) 13.5%
C) 10%
D) 11.9%

Question 20

Which of the following factors does not explain differences or changes in ROA?

A) Operating leverage
B) Cyclicality of sales
C) Product life cycle
D) Financial leverage

Question 21

Which of the following is not a way a company can achieve a low-cost position

A) economies of scale
B) production efficiency
C) customer service
D) outsourcing

Question 22

The profit margin for ROA indicates the ability of a firm to generate earnings for a particular level of

A) sales
B) assets
C) working capital
D) stockholders' equity

Question 23

Return on assets will likely differ across firms and across time, three elements of risk that will help explain these differences are ________________________________________, cyclicality of sales and stage and length of product life cycle.

Question 24

The numerator of the return on assets ratio is net income from operations excluding the effects of any ______________________________.

Question 25

Return on assets will likely differ across firms and across time, three elements of risk that will help explain these differences are operating leverage, ___________________________________, and stage and length of product life cycle.

Question 26

The statutory tax rate differs from a firm's average tax rate due to which of the following reasons

A) the statutory tax rate is a marginal tax rate.
B) some expenses are included in book income but do not enter into taxable income.
C) the average tax rate is for a period of three years.
D) the statutory tax rate does not effect GAAP measures of revenues and expenses.

Question 27

Return on assets can be disaggregated into profit margin for return on assets and ______________________________.

Question 28

Below is financial information for two sporting goods retailers. Extreme Sports Company operates a retail business and franchising business. At the end 2007, Extreme Sports had 263 Company-owned and 120 franchise-operated retail stores. Extreme's stores are located in suburban, strip mall and regional mall locations, the company operates in 32 states. All Sports Corporation sells sporting goods and related products at over 2,500 Company-operated retail stores. Selected Data for All Sports and Extreme Sports
(amounts in millions)
What is the return on assets for All Sports?

A) 11.9%
B) 10.8%
C) 9.2%
D) 8.6%

Question 29

Hall and Porter argue that firms have two generic alternative strategies for any particular product, these strategies are

A) low risk focus, low risk focus
B) retail customer focus, wholesale customer focus
C) product differentiation, low-cost leadership
D) low operating leverage, high operating leverage

Question 30

Firms with ____________________ levels of operating leverage experience greater variability in their return on assets.

Question 31

The ability of a firm to generate income from operations given a particular level of sales is measured by the ______________________________.

Question 32

Return on assets can be disaggregated into asset turnover and ____________________________________________________________.

Question 33

Sustainable earnings represent

A) the level of earnings expected to persist in the future.
B) the level of earnings and the growth in the levels of earnings expected to persist in the future.
C) the growth rate of future earnings.
D) retained earnings.

Question 34

The ____________________ effect of interest expense on net income equals one minus the marginal tax rate times the interest expense.

Question 35

In order to measure how profitable a firm is in generating a return for its common shareholders a financial analyst would examine the return on _____________________________________________.

Question 36

Below is financial information for two sporting goods retailers. Extreme Sports Company operates a retail business and franchising business. At the end 2007, Extreme Sports had 263 Company-owned and 120 franchise-operated retail stores. Extreme's stores are located in suburban, strip mall and regional mall locations, the company operates in 32 states. All Sports Corporation sells sporting goods and related products at over 2,500 Company-operated retail stores. Selected Data for All Sports and Extreme Sports
(amounts in millions)
Calculate All Sports' inventory turnover ratio

A) 5.3
B) 1.2
C) 3.9
D) .256

Question 37

Firms with high operating leverage have a higher proportion of _________________________ in their cost structure.

Question 38

Below is financial information for two sporting goods retailers. Extreme Sports Company operates a retail business and franchising business. At the end 2007, Extreme Sports had 263 Company-owned and 120 franchise-operated retail stores. Extreme's stores are located in suburban, strip mall and regional mall locations, the company operates in 32 states. All Sports Corporation sells sporting goods and related products at over 2,500 Company-operated retail stores. Selected Data for All Sports and Extreme Sports
(amounts in millions)
Compute the return on assets for Extreme Sports

A) 3.2%
B) 5.0%
C) 8.9%
D) 1.1%

Question 39

Which of the following would not be considered a committed fixed cost ( a cost that is incurred regardless of the level of activity during the period)

A) depreciation expense
B) amortization expense
C) advertising expense
D) rent expense

Question 40

Which of the following scenarios is consistent with a increasing cost of goods sold to sales percentage and increasing inventory turnover

A) Firm raises prices to increase its gross margin but inventory sells more slowly.
B) Weak economic conditions lead to reduced demand for a firm's products, necessitating price reductions to move goods.
C) Strong economic conditions lead to increased demand for a firm's products, allowing price increases.
D) Firm shifts its product mix toward lower margin, faster moving products.

Question 41

Operating income is negative in an amount equal to _________________________ when revenues are zero.

Question 42

Return on assets can be a misleading ratio when analyzing technology firms because two important assets, ______________________________ and ______________________________ do not appear on their balance sheets

Question 43

Snap-On Tools and Black and Decker manufacture and market power tools and accessories. Snap-on Tools target customers in the professional contractor market, while Black and Decker focuses on home users and professionals. Selected financial data for the companies appears below.
Required:

Question 44

EPS is an ambiguous measure of profitability because it reflects operating performance in the numerator and ________________________________________ in the denominator.

Question 45

Firms and industries characterized by heavy fixed capacity costs and lengthy periods required to add new capacity operate under a ___________________________________.

Question 46

The ___________________________________ of interest expense on net income equals one minus the marginal tax rate times interest expense.

Question 47

One problem with using EPS as a measure of profitability is that it does not consider the amount of ____________________ or ____________________ required to generate a particular level of earnings.

Question 48

________________________________________ is the level of earnings and the growth in the levels of earnings expected to persist in the future.

Question 49

When calculating return on common stockholders' equity the financial analyst subtracts ________________________________________ from net income.

Question 50

The rationale for adding back the _______________________________________________________ relates to attaining consistency in the numerator and denominator of ROA.

Question 51

Firms that have either convertible securities or stock options or warrants outstanding have __________________________________________________.

Question 52

Economic theory suggests that higher levels of ____________________ in any activity should lead to higher levels of ___________________________________.

Question 53

Snap-On Tools and Black and Decker manufacture and market power tools and accessories. Snap-On Tools target customer is the professional contractor, while Black and Decker focuses on home users and professionals. Both firms use the same cost flow assumption for valuing inventories and cost of goods sold. Selected financial data for the companies appears below.
Required:

Question 54

The ability of a firm to manage the level of investment in assets for a particular of sales is measured by the ______________________________.

Question 55

Return on common stockholders' equity can be disaggregated into profit margin, asset turnover and __________________________________________________.

Question 56

Accounts receivable turnover is calculated by dividing ________________________________________ by average accounts receivable.

Question 57

When an analyst uses measures of past profitability to forecast the firm's future profitability the emphasis is those revenues, gains, expenses and losses that will ____________________.

Question 58

Inventory turnover is calculated by dividing ________________________________________ by average inventories.

Question 59

All else being equal, firms with high levels of ________________________________________ incur more risk in their operations and should earn higher rates of return.

Question 60

To reduce the risk inherent in ______________________________ a company should strive for a high proportion of variable costs in its cost structure.

Question 61

Use the following information about Sanibel Corporation to calculate the following ratios (assume an effective tax rate of 35%):

Question 62

Discuss how the following three elements of risk help us understand return on assets differs across firms and changes over time:
1. Operating leverage
2. Cyclicality of sales
3. Product life cycle

Question 63

The return on assets measures operating performance independent of financing while the return on common shareholders' equity considers the cost of debt and preferred stock financing. Describe the relationship between ROA and ROCE in terms of where each dollar of return generated by assets is allocated.

Question 64

The following balance sheets and income statements are for Net Devices Inc., a manufacturer of small electronic devices, including calculators, personal digital assistants and mp3 players. Use the information to calculate the following information:
ADDITIONAL INFORMATION

Question 65

Discuss the economic characteristics of firms that have the following mix of profit margin and asset turnover. In addition provide an example of an industry that would have the relevant profit margin asset turnover mix:
A. High profit margin and low asset turnover.
B. Low profit margin and high asset turnover

Question 66

Below is financial information for two sporting goods retailers. Extreme Sports Company operates a retail business and franchising business. At the end 2007, Extreme Sports had 263 Company-owned and 120 franchise-operated retail stores. Extreme's stores are located in suburban, strip mall and regional mall locations, the company operates in 32 states. All Sports Corporation sells sporting goods and related products at over 2,500 Company-operated retail stores.
Selected Data for All Sports and Extreme Sports
(amounts in millions)
Calculate the following ratios for All Sports and Extreme Sports:
a. Return on Assets
b. Profit Margin for ROA
c. Assets turnover
d. Accounts Receivable turnover
e. Inventory turnover
f. Fixed Asset turnover

Question 67

Examine the four following conditions involving inventory turnover. Discuss what economic factors might be leading to the condition and whether it suggests positive or negative future economic conditions.

Question 68

Cali Inc. provides semiconductor manufacturing services. Below are the company's two most recent balance sheets and its most recent income statement. Use this information to answer the following questions:

Question 69

Linda's Clothing is a retailer of contemporary women's clothing. Selected financial information for Linda's appears below:
Required: