Ch03 Test Bank 3-31-10 - financial management test bank PDF

Preview

Summary

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 3: Financial Analysis True/False Page 1CHAPTER 3ANALYSIS OF FINANCIAL STATEMENTSPlease see the preface for information on the AACSB letter i...

Description

CHAPTER 3 ANALYSIS OF FINANCIAL STATEMENTS Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject lines.

True/False Easy: We tell our students (1) that to answer some of these questions it is useful to write out the relevant ratio or ratios, then think about how the ratios would change if the accounting data changed, and (2) that sometimes it is useful to make up illustrative data to help see what would happen. (3.1) Ratio analysis 1.

F K

Answer: a

EASY

The current ratio and inventory turnover ratios both help us measure the firm's liquidity. The current ratio measures the relationship of a firm's current assets to its current liabilities, while the inventory turnover ratio gives us an indication of how long it takes the firm to convert its inventory into cash. a. b.

True False

(3.2) Liquidity ratios

a. b.

EASY

True False

(3.2) Liquidity ratios

3.

Answer: a

Ratio analysis involves analyzing financial statements in order to appraise a firm's financial position and strength. a. b.

2.

F K

F K

Answer: a

EASY

Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position. True False

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 3: Financial Analysis

True/False

Page 1

(3.2) Current ratio 4.

F K

True False

(3.3) Asset management ratios

F K

Answer: b

EASY

True False

(3.4) Debt management ratios

F K

Answer: a

EASY

Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage. a. b.

True False

(3.4) TIE ratio

F K

Answer: a

EASY

The times-interest-earned ratio is one, but not the only, indication of a firm's ability to meet its long-term and short-term debt obligations. a. b.

True False

(3.5) Profitability ratios 9.

F K

A decline in a firm's inventory turnover ratio suggests that it is managing its inventory more efficiently and also that its liquidity position is improving, i.e., it is becoming more liquid. a. b.

8.

EASY

True False

(3.3) Inventory turnover ratio

7.

Answer: a

The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its assets. a. b.

6.

EASY

High current and quick ratios always indicate that a firm is managing its liquidity position well. a. b.

5.

Answer: b

F K

Answer: a

EASY

Profitability ratios show the combined effects of liquidity, asset management, and debt management on operating results. a. b.

True False

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Page 2

True/False

Chapter 3: Financial Analysis

(3.6) Market value ratios 10.

F K

True False

(3.7) Trend analysis

F K

EASY

True False

(3.10) Balance sheet changes

F K

Answer: a

EASY

The "apparent," but not the "true," financial position of a company whose sales are seasonal can differ dramatically, depending on the time of year when the financial statements are constructed. a. b.

True False

(3.10) Limitations of ratio analysis 13.

Answer: a

Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of measuring changes in a firm's performance over time. a. b.

12.

EASY

Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects. a. b.

11.

Answer: a

F K

Answer: a

EASY

Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used similar accounting methods. a. b.

True False

Easy/Medium: (3.5) Basic earning power ratio 14.

F K

Answer: b

EASY/MEDIUM

The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects. a. b.

True False

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 3: Financial Analysis

True/False

Page 3

Medium: (3.3) Inventory turnover ratio 15.

F K

Answer: b

MEDIUM

It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets. a. b.

True False

(3.5) ROA

F K

Answer: b

MEDIUM

Since the ROA measures the firm's effective utilization of assets (without considering how these assets are financed), two firms with the same EBIT must have the same ROA. a. b.

True False

(3.8) Du Pont equation 18.

MEDIUM

True False

(3.3) Fixed assets turnover

17.

Answer: a

The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged. a. b.

16.

F K

F K

Answer: b

MEDIUM

Suppose firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. Under these conditions, then firms that have high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios. a. b.

True False

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Page 4

True/False

Chapter 3: Financial Analysis

Hard: (3.2) Liquidity ratios 19.

F K

Answer: b

HARD

Firms A and B have the same current ratio, 0.75, the same amount of sales, and the same amount of current liabilities. However, Firm A has a higher inventory turnover ratio than B. Therefore, we can conclude that A's quick ratio must be smaller than B's. a. b.

True False

(3.4) TIE ratio Suppose a amount of rate, and calculate a. b.

firm wants to its debt, the its operating the amount of

F K

Answer: a

HARD

maintain a specific TIE ratio. It knows the interest rate on that debt, the applicable tax costs. With this information, the firm can sales required to achieve its target TIE ratio.

True False

(3.5) BEP and ROE 22.

HARD

True False

(3.2) Liquidity ratios

21.

Answer: b

Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than that of B. a. b.

20.

F K

F K

Answer: a

HARD

Suppose Firms A and B have the same amount of assets, pay the same interest rate on their debt, have the same basic earning power (BEP), and have the same tax rate. However, Firm A has a higher debt ratio. If BEP is greater than the interest rate on debt, Firm A will have a higher ROE as a result of its higher debt ratio. a. b.

True False

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 3: Financial Analysis

True/False

Page 5

(3.8) Equity multiplier 23.

F K

True False

(3.10) Limitations of ratio analysis

F K

Answer: b

HARD

One problem with ratio analysis is that relationships can be manipulated. For example, if our current ratio is greater than 1.5, then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to increase. a. b.

True False

(3.10) Limitations of ratio analysis 25.

HARD

If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667. a. b.

24.

Answer: a

F K

Answer: b

HARD

One problem with ratio analysis is that relationships can be manipulated. For example, we know that if our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger. a. b.

True False

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Page 6

True/False

Chapter 3: Financial Analysis

Multiple Choice: Conceptual Easy: We tell our students (1) that to answer some of these questions it is useful to write out the relevant ratio or ratios, then think about how the ratios would change if the accounting data changed, and (2) that sometimes it is useful to make up illustrative data to help see what would happen. (3.2) Current ratio 26.

An An An An An

increase increase increase increase increase

in in in in in

(3.2) Current ratio

EASY

net fixed assets. accrued liabilities. notes payable. accounts receivable. accounts payable. C K

Answer: c

EASY

Which of the following would, generally, indicate an improvement in a company’s financial position, holding other things constant? a. b. c. d. e.

The The The The The

TIE declines. DSO increases. EBITDA coverage ratio increases. current and quick ratios both decline. total assets turnover decreases.

(3.2) Current ratio 28.

Answer: d

Considered alone, which of the following would increase a company’s current ratio? a. b. c. d. e.

27.

C K

C K

Answer: d

EASY

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

b. c. d. e.

Reduce the company’s days’ sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment. Use cash to repurchase some of the company’s own stock. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year. Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash. Use cash to increase inventory holdings.

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 3: Financial Analysis

Conceptual Questions

Page 7

(3.3) Inventories 29.

C K

b. c.

d. e.

A reduction in inventories held would have no effect on the current ratio. An increase in inventories would have no effect on the current ratio. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.

(3.6) Financial statement analysis

C K

Answer: e

EASY

Companies E and P each reported the same earnings per share (EPS), but Company E’s stock trades at a higher price. Which of the following statements is CORRECT? a. b. c. d. e.

Company Company Company Company Company

E E E E E

probably has fewer growth opportunities. is probably judged by investors to be riskier. must have a higher market-to-book ratio. must pay a lower dividend. trades at a higher P/E ratio.

(3.6) Market value ratios 31.

EASY

Which of the following statements is CORRECT? a.

30.

Answer: c

C K

Answer: d

EASY

Which of the following statements is CORRECT? a.

b.

c. d. e.

If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president. If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president. Other things held constant, the higher a firm’s expected future growth rate, the lower its P/E ratio is likely to be. The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA). If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average.

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Page 8

Conceptual Questions

Chapter 3: Financial Analysis

(3.10) Window dressing 32.

C K

b.

c.

d. e.

Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of “window dressing.” Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of “window dressing.” Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of “window dressing.” Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of “window dressing.” Using some of the firm’s cash to reduce long-term debt is an example of “window dressing.” “Window dressing” is any action that improves a firm’s fundamental, long-run position and thus increases its intrinsic value.

(Comp: 3.2,3.4-3.6) Miscellaneous ratios

C K

Answer: a

EASY

Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company’s total assets or operating income. Which of the following effects would occur as a result of this action? a. b. c. d. e.

The The The The The

company’s company’s company’s company’s company’s

current ratio increased. times interest earned ratio decreased. basic earning power ratio increased. equity multiplier increased. debt ratio increased.

(Comp: 3.2,3.3,3.5) Miscellaneous ratios 34.

EASY

Which of the following statements is CORRECT? a.

33.

Answer: b

C K

Answer: b

EASY

A firm’s new president wants to strengthen the company’s financial position. Which of the following actions would make it financially stronger? a. b. c. d. e.

Increase Increase Increase Increase Increase

accounts receivable while holding sales constant. EBIT while holding sales constant. accounts payable while holding sales constant. notes payable while holding sales constant. inventories while holding sales constant.

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 3: Financial Analysis

Conceptual Questions

Page 9

(Comp: 3.3-3.5) Miscellaneous ratios 35.

a. b. c. d. e.

EASY

C K

Answer: e

EASY

Which of the following would indicate an improvement in a company’s financial position, holding other things constant? a. b. c. d. e.

The The The The The

inventory and total assets turnover ratios both decline. debt ratio increases. profit margin declines. EBITDA coverage ratio declines. current and quick ratios both increase.

(Comp: 3.2,3.4) Miscellaneous ratios 37.

Answer: a

The division’s basic earning power ratio is above the average of other firms in its industry. The division’s total assets turnover ratio is below the average for other firms in its industry. The division’s debt ratio is above the average for other firms in the industry. The division’s inventory turnover is 6, whereas the average for its competitors is 8. The division’s DSO (days’ sales outstanding) is 40, whereas the average for its competitors is 30.

(Comp: 3.2-3.5) Miscellaneous ratios 36.

C K

If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., “grading” the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant.

C K

Answer: c

EASY

If a bank loan officer were considering a company’s request for a loan, which of the following statements would you consider to be CORRECT? a.

b. c. d. e.

The lower the company’s EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm. Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm. Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm. The lower the company’s TIE ratio, other things held constant, the lower the...