Chapter 03 review questions PDF

Preview

Summary

Download Chapter 03 review questions PDF

Description

Foundations of Financial Management Chapter 3 Financial Analysis TRUE or FALSE 1) Ratios are used to compare different firms in the same industry. 2) Ratios are not considered as important to non-accounting functional areas of a business such as marketing, head of production and human resources. 3) Asset utilization ratios include receivable turnover, average collection period, inventory turnover, fixed asset turnover and total asset turnover. 4) Financial ratios are used to weigh and evaluate the operational performance of the firm. 5) Liquidity ratios indicate how fast a firm can generate cash to pay bills. 6) Asset utilization ratios describe how capital is being utilized to buy assets. 7) Profitability ratios allow one to measure the ability of the firm to earn an adequate profit compared to sales, total assets, and invested capital. 8) Asset utilization ratios measure the net returns on various assets such as return on total assets. 9) A trade creditor is most concerned about a firm's profitability ratios. 10) Ratios are only useful for those areas of business that involve investment decisions. 11) Debt utilization ratios are used to evaluate the firm's debt position with regard to its asset base and earning power. 12) The DuPont system of analysis emphasizes that profit generated by assets can be derived by a combination of profit levels and how fast an asset can turnover. 13) Satisfactory return on assets may be achieved through high profit margins or rapid turnover of assets, but not a combination of both. 14) Heavy use of long-term debt can be of benefit to a firm to help expand, although it adds to the firm's overall level of risk. 15) Return on equity will be higher than return on assets if there is higher amounts of debt in the capital structure. 16) Higher debt utilization ratios will always increase a firm's return on equity given a positive return on assets. 17) Return on equity will not change if the firm increases its use of debt.

18) The age of the firm's assets is not necessary for analyzing ratios. 19) Asset utilization ratios relate balance sheet assets to income statement net income. 20) A current ratio of 2 to 1 is always acceptable for a company in any industry. 21) To compute the quick ratio, accounts receivable are not included in current assets. 22) Asset utilization ratios can be used to measure the effectiveness of a firm's managers. 23) Ratios are not misleading by inflation. 24) Profitability ratios are distorted by inflation because profits are stated in current dollars, while assets and equity are stated in historical dollars. 25) As long as prices of products continue to rise faster than costs in an inflationary environment, reported profits will generally continue to rise. 26) Industries with cyclical products such as lumber and copper are more sensitive to inflation-induced profits because many sales prices and/or expenses are set by the market. 27) Although Apple Computers has a profit margin significantly greater than that of a long-time industry giant such as IBM, IBM continues to have a higher return on equity than Apple. The primary reason for this unusual condition is that IBM has a much greater equity than Apple. 28) The stock market tends to move up when inflation goes up. 29) Economists believe that prices of goods may rise before 2020 since the prices of most goods fell during the 2008-2009 recession. 30) Under generally acceptable accounting principles, two companies with identical operating results may not report identical net incomes. 31) Inflation causes phantom sources of profit that may mislead even the most alert analyst. 32) One of the major problems during inflationary times is that revenue is almost always stated in current dollars, whereas plant and equipment or inventory may have been purchased at lower levels. 33) During disinflation, stock prices tend to go up because the investor's required rate of return goes down. 34) LIFO and FIFO are two ways that companies following the generally accepted accounting principles value their inventory. One method may be preferred over the other during inflationary time periods, which results in different profits, even though both methods are legal to use.

35) Analysts agree that extraordinary gains/losses should be excluded from ratio analysis because they are one-time events, and can distort annual results from normal operations. 36) LIFO inventory pricing does a better job than FIFO in equating current costs with current revenue. 37) Trend analysis is used to project the future performance of an industry. 38) If two companies have the same return on equity (ROE), they will also have the same return on assets (ROA). 39) A company can improve its return on equity (ROE) by changing its capital structure. 40) Because ratios are historic, they have minimal value to an investor. 41) Times interest earned is an example of a profitability ratio. 42) Investors are most concerned with the liquidity ratios of a company. 43) Ratio analysis can be useful for A) historical trend analysis within a firm. B) comparison of ratios within a single industry. C) measuring the effects of debt or equity financing. D) All of the options are true. 44) In examining the liquidity ratios, the primary emphasis is the firm's A) ability to effectively employ its resources. B) overall debt position. C) ability to pay short-term obligations on time. D) ability to earn an adequate return or profits. 45) Which of the following is not an asset utilization ratio? A) Inventory turnover B) Return on assets C) Fixed asset turnover D) Average collection period 46) Which of the following is not a debt utilization ratio? A) Debt to total assets B) Times interest earned C) Fixed asset turnover D) Fixed charge coverage 47) A short-term creditor would be most interested in A) profitability ratios. B) asset utilization ratios. C) liquidity ratios. D) debt utilization ratios.

48) Which of the following is not considered to be a profitability ratio? A) Profit margin B) Times interest earned C) Return on equity D) Return on assets (investment) 49) Which two ratios are used in the DuPont system to create return on assets? A) Return on assets and asset turnover B) Profit margin and asset turnover C) Return on total capital and profit margin D) Inventory turnover and return on fixed assets 50) The Bubba Corp. had earnings before taxes of $400,000 and sales of $2,000,000. If it is in the 40% tax bracket, its after-tax profit margin is A) 40%. B) 12%. C) 20%. D) 25%. 51) A firm has a debt-to-equity ratio of 40%, a debt of $250,000, and a net income of $100,000. The return on equity is A) 60%. B) 16%. C) 30%. D) There's not enough information to determine the return on equity. 52) A firm has a debt-to-total assets ratio of 60%, $300,000 in debt, and a net income of $50,000. Calculate return on equity. A) 40% B) 20% C) 25% D) There is not enough information to calculate return on equity. 53) For a given level of profitability as measured by profit margin, the firm's return on equity will A) increase as its debt-to-assets ratio decreases. B) decrease as its current ratio increases. C) increase as its debt-to-assets ratio increases. D) decrease as its times-interest-earned ratio decreases. 54) ABC Co. has an average collection period of 90 days for its accounts receivable. If total credit sales for the year were $6,000,000, what is the balance in accounts receivable at year-end? Assume a 360-day calendar year. A) $150,000 B) $2,250,000 C) $1,500,000

D) $40,000 55) Asset utilization ratios A) relate balance sheet assets to income statement sales. B) measure how much cash is available for reinvestment into current assets. C) are most important to stockholders. D) measure the firm's ability to generate a profit on sales. 56) XYZ's receivables turnover is 4x. The accounts receivable at year-end are $600,000. The average collection period is 90 days. What was the sales figure for the year assuming all sales are on credit? A) $60,000 B) $6,000,000 C) $2,400,000 D) $54,000,000 57) If ABC's sales are $1,000,000, while accounts receivable is $100,000, inventory is $45,000, and fixed assets are $132,000, what is ABC's fixed asset turnover? A) 7.58 B) 10.00 C) 0.13 D) 22.22 58) If XYZ's receivables turnover is 4x, what does that mean? A) XYZ's total sales are rotated four times a year. B) XYZ has a really good receivables turnover rate. C) XYZ is able to collect its receivables every 90 days, or 4 times a year. D) XYZ generates four times as much sales through receivables than sales through cash. 59) A decreasing average receivables collection period could be associated with A) increasing account receivable. B) decreasing sales. C) increasing sales and decreasing accounts receivable. D) none of the answers are correct. 60) If accounts receivable stays the same, and credit sales go up A) the average collection period will go up. B) the average collection period will go down. C) accounts receivable turnover will decrease. D) the average collection period will go down and accounts receivable turnover will decrease. 61) Total asset turnover indicates the firm's A) liquidity. B) debt position. C) ability to use its assets to generate sales. D) profitability.

62) A firm only has current assets and fixed assets. Its current assets are $100,000 and total assets are $300,000. The firm's sales are $900,000. The firm's fixed asset turnover is A) 4.5x. B) 12.0x. C) 2.4x. D) 5.0x. 63) A quick ratio that is much smaller than the current ratio reflects A) a small portion of current assets is in inventory. B) a large portion of current assets is in inventory. C) that the firm will have a high inventory turnover. D) that the firm will have a high return on assets. 64) A firm's long-term assets = $100,000, total assets = $400,000, inventory = $50,000 and current liabilities = $200,000. What are the firm's current ratio and quick ratio? A) Current ratio = 0.5; quick ratio = 1.25 B) Current ratio = 1.0; quick ratio = 2.0 C) Current ratio = 1.5; quick ratio = 1.25 D) Current ratio = 2.5; quick ratio = 2.0 65) Investors and financial analysts wanting to evaluate the operating efficiency of a firm's managers would primarily look at the firm's A) debt utilization ratios. B) liquidity ratios. C) asset utilization ratios. D) profitability ratios. 66) An increasing average receivables collection period indicates A) the firm is generating more income. B) accounts receivable are going down. C) the company is becoming more efficient in its collection policy. D) the company is becoming less efficient in its collection policy. 67) In addition to comparison with industry ratios, it is also helpful to analyze ratios using A) future projections B) historical data C) only industry ratios provide valid comparisons. D) trend analysis and historical comparisons. 68) If a firm has both a fixed interest expense and fixed lease payments, A) times interest earned ratio will be smaller than fixed charge coverage ratio. B) times interest earned ratio will be greater than fixed charge coverage ratio. C) times interest earned ratio will be the same as fixed charge coverage ratio. D) fixed charge coverage ratio cannot be computed.

69) A firm has operating profit of $210,000 after deducting fixed lease payments of $30,000. The fixed interest expense is $50,000. What is the firm's fixed charge coverage ratio? A) 6.00x B) 2.33x C) 2.00x D) 3.00x 70) A firm has total assets of $3,000,000 and stockholders equity is $1,000,000. What is the debt-to-total asset ratio? A) 45% B) 75% C) 55% D) 67% 71) The higher a firm's debt utilization ratios, excluding debt-to-total assets, the A) less risky the firm's financial position. B) more risky the firm's financial position. C) more easily the firm will be able to pay dividends. D) None of the options 72) If fixed lease payments are reduced and everything else remains constant, A) times interest earned goes up. B) fixed charge coverage goes up. C) fixed charge coverage stays the same. D) debt to total assets goes down. 73) Industries most sensitive to inflation-induced profits are those with A) seasonal products. B) cyclical products. C) consumer products. D) high-profit products. 74) Replacement cost accounting (current cost method) during a period of inflation will usually A) increase assets, decrease net income before taxes, and lower the return on equity. B) increase assets, increase net income before taxes, and increase the return on equity. C) decrease assets, increase net income before taxes, and increase the return on equity. D) None of the options apply. 75) During inflation, replacement cost accounting will A) increase the value of assets. B) lower the debt-to-asset ratio. C) reduce incomes. D) All of the options

76) Income can be distorted by factors other than inflation. The most important causes of distortion for inter-industry comparisons are A) timing of revenue receipts and nonrecurring gains or losses. B) tax write-off policy and use of different inventory methods. C) Both of these. D) None of the options 77) Disinflation may cause A) an increase in the value of gold, silver, and gems. B) a reduced required return demanded by investors on financial assets. C) additional profits through falling inventory costs. D) None of the options are true 78) Disinflation, as compared to inflation, would normally be good for investments in A) bonds. B) gold. C) collectible antiques. D) textbooks. 79) Industries most sensitive to inflation-induced profits are: A) cyclical products like lumber, copper, and rubber B) food products C) industries which inventory is a significant percentage of sales and profits. D) all of the above. 80) A conservative company experiencing rapid price increases for its products would use LIFO to try to: A) Allow the inventory that was just purchased at a higher price to be moved to cost of goods sold, showing a lower net income. B) Allow the inventory that was just purchased at a higher price to remain in ending inventory values and move older inventory to cost of goods sold, showing a higher net income. C) Allow the inventory that was just purchased at a lower price to remain in ending inventory values and move older inventory to cost of goods sold, showing a lower net income. D) Allow the inventory that was just purchased at a lower price to be moved to cost of goods sold, showing a higher net income. 81) The ________ method of inventory costing is least likely to lead to inflation-induced profits. A) FIFO B) LIFO C) Weighted average D) Lower of cost or market 82) Assuming proper accounting disclosure is used, a large extraordinary loss has what effect on the normal operating profits in the future?

A) It raises it. B) It lowers it. C) It has no effect. D) More information is needed to determine the effect. 83) Which of the following is a potential problem of utilizing ratio analysis? A) Trends and industry averages are historical in nature. B) Financial data may be distorted due to price-level changes. C) Firms within an industry may not use similar accounting methods. D) All of the options 84) If government bonds pay 7.0% interest and insured savings accounts pay 5.0% interest, stockholders in a moderately risky firm would expect return-on-equity values of A) 5.0%. B) 7.0%. C) 9.0%. D) above 7.0%. 85) The most rigorous test of a firm's ability to pay its short-term obligations is its A) current ratio. B) quick ratio. C) debt-to-assets ratio. D) times-interest-earned ratio. 86) If the company's accounts receivable turnover is increasing, the average collection period A) is going up slightly. B) is going down. C) could be moving in either direction. D) is going up by a significant amount. 87 )

MEGAFRAME COMPUTER COMPANY Balance Sheet As of December 31 ASSETS Cash $ 50,000 Accounts receivable 70,000 Inventory 110,000 Net plant and equipment 220,000 Total assets

$ 450,000

LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 70,000 Accrued expenses 50,000 Long-term debt 130,000

Common stock Paid-in capital Retained earnings Total liabilities and stockholders' equity

70,000 40,000 90,000 $ 450,000

MEGAFRAME COMPUTER COMPANY Income Statement For the year ended December 31 Sales (all on credit) $ 875,000 Cost of goods sold 600,000 Gross profit $ 275,000 Sales and administrative expenses 30,000 Depreciation 55,000 Operating profit Interest expense Profit before taxes Taxes (30%) Net income

$ 190,000 25,000 $ 165,000 49,500 $ 115,500

Refer to the tables above. Using the DuPont method, return on assets (investment) for Megaframe Computer is approximately A) 13%. B) 22%. C) 26%. D) 35%. 88 )

MEGAFRAME COMPUTER COMPANY Balance Sheet As of December 31 ASSETS Cash $ 50,000 Accounts receivable 70,000 Inventory 110,000 Net plant and equipment 220,000 Total assets $ 450,000 LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 70,000 Accrued expenses 50,000 Long-term debt 130,000 Common stock 70,000

Paid-in capital Retained earnings Total liabilities and stockholders' equity

40,000 90,000 $ 450,000

MEGAFRAME COMPUTER COMPANY Income Statement For the year ended December 31 Sales (all on credit) $ 875,000 Cost of goods sold 600,000 Gross profit $ 275,000 Sales and administrative expenses 30,000 Depreciation 55,000 Operating profit $ 190,000 Interest expense 25,000 Profit before taxes $ 165,000 Taxes (30%) 49,500 Net income

$ 115,500

Refer to the tables above. Compute Megaframe's after-tax profit margin. A) 5.7% B) 13.2% C) 15.4% D) 18.9% 89 )

MEGAFRAME COMPUTER COMPANY Balance Sheet As of December 31 ASSETS Cash $ 50,000 Accounts receivable 70,000 Inventory 110,000 Net plant and equipment 220,000 Total assets $ 450,000 LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 70,000 Accrued expenses 50,000 Long-term debt 130,000 Common stock 70,000 Paid-in capital 40,000 Retained earnings 90,000

Total liabilities and stockholders' equity

$ 450,000

MEGAFRAME COMPUTER COMPANY Income Statement For the year ended December 31 Sales (all on credit) $ 875,000 Cost of goods sold 600,000 Gross profit $ 275,000 Sales and administrative expenses 30,000 Depreciation 55,000 Operating profit $ 190,000 Interest expense 25,000 Profit before taxes Taxes (30%) Net income

$ 165,000 49,500 $ 115,500

Refer to the tables above. The firm's return on equity is A) 23%. B) 56%. C) 58%. D) 100%. 90 )

MEGAFRAME COMPUTER COMPANY Balance Sheet As of December 31 ASSETS Cash $ 50,000 Accounts receivable 70,000 Inventory 110,000 Net plant and equipment 220,000 Total assets $ 450,000 LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 70,000 Accrued expenses 50,000 Long-term debt 130,000 Common stock 70,000 Paid-in capital 40,000 Retained earnings 90,000 Total liabilities and stockholders' equity $ 450,000

MEGAFRAME COMPUTER COMPANY Income Statement For the year ended December 31 Sales (all on credit) $ 875,000 Cost of goods sold 600,000 Gross profit $ 275,000 Sales and administrative expenses 30,000 Depreciation 55,000 Operating profit Interest expense Profit before taxes Taxes (30%) Net income

$ 190,000 25,000 $ 165,000 49,500 $ 115,500

Refer to the tables above. What is the firm's average collection period? Assume a 360day calendar year. A) 29 days B) 25 days C) 13 days D) 20 days 91 )

MEGAFRAME COMPUTER COMPANY Balance Sheet As of December 31 ASSETS Cash $ 50,000 Accounts receivable 70,000 Inventory 110,000 Net plant and equipment 220,000 Total assets

$ 450,000

LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 70,000 Accrued expenses 50,000 Long-term debt 130,000 Common stock 70,000 Paid-in capital 40,000 Retained earnings 90,000 Total liabilities and stockholders' equity $ 450,000 MEGAFRAME COMPUTER COMPANY

Income Statement For the year ended December 31 Sales (all on credit) Cost of goods sold Gross profit Sales and administrative expenses Depreciation Operating profit Interest expense Profit before taxes Taxes (30%) Net income

$ 875,000 600,000 $ 275,000 30,000 55,000 $ 190,000 25,000 ...