Deck 13: Analyzing Financial Statements

Question 1

A primary objective of financial statements is to provide information to current and potential investors and creditors.

Answer 1

True

Question 2

A company that has a high level of inventory and other assets above its investment in property, plant, and equipment should calculate the total asset turnover ratio in addition to the fixed asset turnover ratio.

Answer 2

True

Question 3

Some analysts do not use the cash ratio because they see it as too stringent a test of liquidity and it is very sensitive to small events.

Answer 3

True

Question 4

The quality of income ratio increases when net income increases.

Question 5

The financial leverage percentage is positive when return on assets is greater than return on equity.

Question 6

The return on assets ratio is influenced significantly by a company's relative debt and equity financing of its assets.

Question 7

A higher current ratio is preferable for companies that do not have predictable cash flows.

Question 8

Finding comparable companies in order to compare performance is important because ratios in isolation are difficult to evaluate.

Question 9

A company with a high amount of inventory will have a much lower fixed asset turnover ratio when compared to its total asset turnover ratio.

Question 10

Financial statement analysis is very precise and does not involve judgment.

Question 11

Earnings per share (EPS) is affected by treasury stock transactions.

Question 12

The fixed asset turnover ratio increases when net income increases.

Question 13

Return on equity (ROE) provides insight with respect to a company's use of its assets.

Question 14

Purchasing treasury stock increases the return on equity ratio.

Question 15

The profit margin ratio considers the asset base utilized to earn income.

Question 16

Finding comparable companies in order to compare performance is often difficult since no two companies have identical products, markets, and operating strategies.

Question 17

A negative financial leverage percentage occurs when a company has more debt than stockholders' equity.

Question 18

Time series analysis is a comparison of information for a specific company over a period of time to determine changes in operations.

Question 19

Component percentages are used to express items on financial statements as a percentage of a single base amount.

Question 20

Return on equity (ROE) is a function of three ratios: net profit margin, return on assets, and financial leverage.

Question 21

The debt-to-equity ratio is a risk measure used by both investors and lenders.

Question 22

The quick ratio decreases when the adjusting entry to record bad debt expense is recorded.

Question 23

Which of the following statements is not correct?

A) Purchasing fixed assets through debt financing decreases the financial leverage ratio.
B) Accruing an expense will affect the net profit margin ratio.
C)Return on equity may increase even when the financial leverage ratio decreases.
D)Purchasing treasury stock results in a decrease in asset turnover.

Question 24

A very high current ratio and low quick ratio may indicate the company is not collecting its accounts receivables in a timely manner.

Question 25

Which of the following statements is incorrect?

A) Purchasing fixed assets through equity financing decreases asset turnover.
B) Accruing an expense increases the financial leverage ratio.
C)The return on equity ratio increases when treasury stock is purchased.
D)The purchase of fixed assets will cause the asset turnover to decrease.

Question 26

Many companies use high levels of debt to finance their assets because of financial leverage benefits provided to investors when return on assets exceeds the after tax cost of interest.

Question 27

Which of the following statements is false?

A) When computing the component percentages for the income statement, net income is the base figure.
B) Time series analysis examines a company's performance over time.
C)It is often useful to compare a company's performance with that of a competitor.
D)The North American Industry Classification System assigns industry codes based on business operations.

Question 28

The base amount in preparing component percentages for an income statement is usually which of the following?

A) Income from operations.
B) Gross profit.
C)Net income.
D)Net sales.

Question 29

Dividend yield is calculated by dividing dividends per share by earnings per share and measures the current dividend return to investors.

Question 30

The inventory turnover ratio is significantly affected by the choice of inventory accounting method.

Question 31

Which of the following statements is correct?

A) A ratio calculation is most relevant in isolation.
B) One of the advantages of ratio analysis is that it allows companies of different sizes to be compared.
C)Finding benchmarks for comparison is a straightforward task.
D)It is always preferable to compare a company's performance to industry-wide ratios rather than to use a competitor's ratios.

Question 32

Home Depot's operating strategy is to offer a broad assortment of high-quality merchandise and services at competitive prices using highly knowledgeable service-oriented personnel and aggressive advertising. Which of the following is not as critical to achieving Home Depot's strategy?

A) Cost control
B) Product differentiation
C)High level of customer service
D)High sales volume

Question 33

The price/earnings ratio is affected by the amount of risk that investors are willing to take.

Question 34

The cash coverage ratio measures a firm's ability to pay its current liabilities with its cash flows from operating activities.

Question 35

Which of the following ratios is not part of the DuPont model?

A) Asset turnover.
B) Debt-to-equity.
C)Net profit margin.
D)Return on equity.

Question 36

A high price/earnings ratio usually indicates the market is optimistic about the company's future earnings potential.

Question 37

The dividend yield ratio decreases when earnings per share increases.

Question 38

Which of the following statements is correct?

A) Selling inventory at its cost does not affect the net profit margin ratio.
B) Accruing sales revenue does not affect the net profit margin ratio.
C)The asset turnover ratio increases when fixed assets are sold at a loss.
D)The net profit margin ratio decreases when common stock is issueD.Selling fixed assets at a loss reduces average total assets which is the denominator of the asset turnover ratio. The asset turnover ratio will therefore increase.

Question 39

When considering an investment, which of the following is not one of the three critical factors used to evaluate future earnings potential of that investment?

A) Global event factors.
B) Economy-wide factors.
C)Industry factors.
D)Individual company factors.

Question 40

Which of the following statements is incorrect about fundamental business strategies?

A) A company implementing a cost differentiation strategy is attempting to increase operating efficiency of assets and improve the asset turnover ratio.
B) A company implementing a product differentiation strategy is attempting to improve its profit margin through charging higher prices.
C)A company will be more profitable because it will attract a higher volume of customers and sales revenue when it follows a product differentiation strategy versus a cost differentiation strategy.
D)Financial leverage is how a company finances its assets and can affect total profitability return to stockholders.

Question 41

Negative financial leverage occurs when the:

A) Average net (after tax) interest rate on borrowed funds is less than the company's earnings rate on its assets.
B) Return on assets is more than return on equity.
C)Return on equity is more than return on assets.
D)Operating expenses exceed gross profit.

Question 42

Which of the following ratios is not considered to be a test of profitability?

A) Current ratio.
B) Profit margin.
C)Return on assets.
D)Earnings per share.

Question 43

Teague Company's working capital was $40,000 and total current liabilities were 1/4 of that amount. What was the current ratio?

A) 1.00
B) 1.25
C)3.00
D)5.00

Question 44

Which of the following transactions decreases earnings per share?

A) Declaring cash dividends payable to the common stockholders.
B) Purchasing treasury stock.
C)The accrual of revenue.
D)Declaring and distributing a 10% common stock dividenD.Issuing additional shares of common stock via a stock dividend increases the number of common shares outstanding and therefore decreases earnings per share.

Question 45

Which of the following transactions will increase the quality of income ratio?

A) Paying cash to suppliers.
B) Accruing sales revenue.
C)Selling treasury stock for more than its cost.
D)Collecting an account receivable.

Question 46

The records of Everyday Electronics Corporation for a particular period include the following: $\begin{array}{lr}\text { Average total assets } & \$ 760,000 \\\text { Average total liabilities } & 485,000 \\\text { Total revenue } & 200,500 \\\text { Total expenses (including income tax) } & 135,000\end{array}$ The return on equity ratio is closest to:

A) 13.2%
B) 23.8%
C)24.0%
D)8.4%

Question 47

Which of the following ratios is not an indicator of a company's short-term financial strength?

A) Price/earnings ratio.
B) Receivable turnover ratio.
C)Working capital.
D)Quick ratio.

Question 48

The records of Marshall Company include the following: $$\begin{array} { l r } \text { Average total assets } & \$ 3,500,000 \\\text { Average total liabilities } & 1,220,000 \\\text { Total revenue } & 4,580,000 \\\text { Total expense (including income tax) } & 4,100,000 \\\text { Interest expense (included in total expenses) } & 90,000 \\\text { Income tax rate } 40 \% &\end{array}$$ The return on equity is closest to:

A) 21.1%
B) 10.2%
C)16.4%
D)17.1%

Question 49

The records of Marshall Company include the following: $$\begin{array} { l r } \text { Average total assets } & \$ 3,500,000 \\\text { Average total liabilities } & 1,220,000 \\\text { Total revenue } & 4,580,000 \\\text { Total expense (including income tax) } & 4,100,000 \\\text { Interest expense (included in total expenses) } & 90,000 \\\text { Income tax rate } 40 \% &\end{array}$$ The financial leverage percentage is closest to:

A) 1.8%
B) 2.8%
C)5.8%
D)6.4%

Question 50

Which of the following transactions decreases earnings per share?

A) Collection of an account receivable.
B) Selling treasury stock for an amount less than its cost.
C)A decrease in the market value per share.
D)Paying cash in advance for rent.

Question 51

Cecilia Company reported net income of $1,200,000. The average total liabilities were $4,300,000 and average total stockholders' equity was $5,200,000. Interest expense was $100,000 and the tax rate was 40%. Cecilia's return on assets ratio is closest to:

A) 13.7%
B) 12.6%
C)11.6%
D)13.3%

Question 52

Which of the following transactions will increase a current ratio, which is currently 2.5?

A) Receiving cash from signing a 6-month note payable.
B) Accruing an expense.
C)Using cash to pay an account payable.
D)Collecting an account receivable.

Question 53

Trenton Company has provided the following information: • Net income, $240,000;
• Preferred shares issued, 6,000;
• Average number of common shares issued, 24,000;
• Cash dividends declared and paid on common stock, $30,000;
• Market price per share, $36;
• Average treasury shares of common stock, 4,000.
What is Trenton's price/earnings ratio?

A) 3.0
B) 5.1
C)3.4
D)4.5

Question 54

Which of the following statements is incorrect?

A) If selling and administrative expenses as a percentage of sales increases, then gross profit percentage will decrease.
B) If the cost of goods sold percentage decreases and other expenses do not change, then profit margin will increase as a percentage of sales.
C)If sales dollars decrease, a company might still report a higher gross profit percentage if cost of goods sold decreases at a faster rate than the decrease in sales.
D)It is possible that when selling and administrative expense in dollars decrease, selling and administrative expenses as a percentage of sales will increase.

Question 55

Trenton Company has provided the following information: • Net income, $240,000;
• Preferred shares issued, 6,000;
• Average number of common stock shares issued, 24,000;
• Cash dividends declared and paid on common stock, $30,000;
• Market price per share, $36;
• Average treasury shares of common stock, 4,000.
What is Trenton's earnings per share?

A) $8.00.
B) $7.00.
C)$10.50.
D)$12.00.

Question 56

During 2014, Home Style's cost of goods sold percentage was 68.2%, and selling and store operating costs was 19.3% of sales. During 2013, Home Style's cost of goods sold percentage was 68.9% while selling and store operating costs was 19.2% of sales. What effect would the change in these percentages have on 2014's gross profit percentage and profit margin percentage?

A) The decrease in the cost of goods sold percentage would increase both the gross profit and profit margin percentages, but the increase in the selling and store operating costs percentage would decrease both the gross profit and profit margin percentages.
B) The decrease in the cost of goods sold percentage would decrease both the gross profit and profit margin percentages, but the increase in the selling and store operating costs percentage would increase both the gross profit and profit margin percentages.
C)The decrease in the cost of goods sold percentage would increase both the gross profit and profit margin percentages, but the increase in the selling and store operating costs percentage would decrease only the profit margin percentage.
D)The decrease in the cost of goods sold percentage would decrease both the gross profit and profit margin percentages, but the increase in the selling and store operating costs percentage would increase only the profit margin percentage.

Question 57

The records of Marshall Company include the following: $$\begin{array} { l r } \text { Average total assets } & \$ 3,500,000 \\\text { Average total liabilities } & 1,220,000 \\\text { Total revenue } & 4,580,000 \\\text { Total expense (including income tax) } & 4,100,000 \\\text { Interest expense (included in total expenses) } & 90,000 \\\text { Income tax rate } 40 \% &\end{array}$$ The return on assets is closest to:

A) 14.9%.
B) 18.3%.
C)15.3%.
D)14.7%.

Question 58

Which of the following statements is correct?

A) When cost of goods sold as a percentage of sales increases, the gross profit percentage will increase.
B) It is possible that when cost of goods sold in dollars increases, cost of goods sold as a percentage of sales decreases.
C)If gross profit percentage is the same for the current and past year, then sales and cost of goods sold in dollars did not change.
D)If gross profit percentage increases from one year to the next, then the net income percentage will also increase from one year to the next.

Question 59

Agnes Company reported the following data: $$\begin{array} { l r } \text { Quick assets } & \$ 55,000 \\\text { Current assets } & 150,000 \\\text { Total liabilities } & 300,000 \\\text { Average net receivables } & 12,600 \\\text { Beginning inventory } & 38,000 \\\text { Long-term liabilities } & 200,000 \\\text { Net credit sales } & 126,000 \\\text { Cost of goods sold } & 84,000 \\\text { Ending inventory } & 46,000\end{array}$$ What was the current ratio?

A) 0.5
B) 1.5
C)2.5
D)0.75

Question 60

Which of the following transactions will not increase the cash ratio?

A) Receiving cash from a common stock issue.
B) Refinancing a current liability with long-term debt.
C)Using cash to purchase a two-month treasury bill.
D)Collecting an account receivable.

Question 61

Which ratio reflects the stock market's assessment of a company's future performance?

A) Price/earnings ratio.
B) Dividend yield ratio.
C)Fixed asset turnover ratio.
D)Cash coverage ratio.

Question 62

Potaw Company reported the following data at the end of 2014: $\begin{array}{lr}\text { Sales revenue ( } 75 \% \text { on credit) }&\$300,000\\\text { Expenses ( } 26 \% \text { on credit) }&60,000\\\text { Accounts receivable, net at December } 31,2014 \text { (a decrease }\\\text { of } \$ 4,000 \text { during 2014) } & 8,000 \\\text { Total assets } & 200,000 \\\text { Stockholders' equity } & 150,000\end{array}$ The average number of days to collect receivables during 2014 is closest to:

A) 16.2.
B) 14.3.
C)36.5.
D)21.9.

Question 63

The debt-to-equity ratio measures which of the following?

A) Liquidity.
B) Solvency.
C)Profitability.
D)Market strength.

Question 64

If the current ratio is 2, what will be the effect of the payment of a cash dividend, which was recorded as a liability on the date of declaration?

A) An increase in the current ratio.
B) A decrease in the current ratio.
C)No effect on the current ratio.
D)A decrease in the cash coverage ratio.

Question 65

Which of the accounting ratios considers the importance of cash flows relating to required interest payments?

A) Times interest earned.
B) Debt-to-equity.
C)Cash coverage.
D)Quick.

Question 66

Main Street Company paid out $2.30 in dividends per share of common stock and had earnings per share of $5.00 during 2014. The market price of the stock on December 31, 2014 was $21.00 per share. There were 15,000 shares of stock outstanding for the entire year. The dividend yield as of December 31, 2014 is closest to:

A) 16.43%
B) 10.95%
C)9.13%
D)46.00%

Question 67

Which of the following transactions would increase the current ratio of a company if the ratio is currently greater than 1?

A) Paid the principal on a long-term note payable.
B) Borrowed cash on a short-term note.
C)Sold inventory for more than cost.
D)Purchased supplies with cash.

Question 68

Wildlife Co. reported net income of $8.3 million, interest expense of $.5 million and is are in a 30% tax rate bracket. Wildlife's average total assets are $65.8 million and average stockholders' equity is $48.6 million. Wildlife's financial leverage percentage is closest to:

A) 3.7%
B) 4.5%
C)4.0%
D)4.7%

Question 69

The Apple Pie Company had net income of $47,500 and earnings per share of $3.17. Apple Pie declared dividends of $2 per share of common stock during 2014. On December 31, 2014, the stock had a market price of $18.50 per share. Apple Pie's price/earnings ratio is closest to:

A) 9.25
B) 8.11
C)5.84
D)0.17

Question 70

Which of the following is not a measure of solvency?

A) Debt-to-equity ratio.
B) Cash coverage ratio.
C)Times interest earned ratio.
D)Earnings per share.

Question 71

Agnes Company reported the following data: $$\begin{array} { l r } \text { Quick assets } & \$ 55,000 \\\text { Current assets } & 150,000 \\\text { Total liabilities } & 300,000 \\\text { Average net receivables } & 12,600 \\\text { Beginning inventory } & 38,000 \\\text { Long-term liabilities } & 200,000 \\\text { Net credit sales } & 126,000 \\\text { Cost of goods sold } & 84,000 \\\text { Ending inventory } & 46,000\end{array}$$ What was the average days' supply in inventory?

A) 165.9
B) 202.7
C)182.5
D)121.7

Question 72

Which of the following is correct?

A) The times interest earned ratio is considered a better test of the ability to cover interest charges than the cash coverage ratio.
B) The debt-to-equity ratio shows the relative proportion of total assets financed by debt.
C)The higher the debt-to-equity ratio, the higher the potential return to the stockholders if return on assets (ROA) exceeds the after tax cost of interest.
D)The cash coverage ratio compares the cash generated by a company to its cash obligations for the prior perioD.A high debt-to-equity ratio means that there is a lot of debt financing relative to equity financing. If the ROA exceeds the after-tax cost of financing, the excess represents a return to stockholders, which increases the return on their investment.

Question 73

Which of the following is false?

A) The cash ratio is the least stringent but most reliable test of liquidity.
B) A company with a high level of inventory will have a quick ratio significantly lower than its current ratio.
C)A current ratio that is too high could indicate funds tied up in inventory and other working capital assets.
D)Analysts consider a current ratio of 2 to be financially conservative.

Question 74

Cromwell Company began the year with a balance in inventory of $110,000 and ended the year with a balance of $102,000. The net sales for the year were $983,000 with a gross profit on sales of $295,000. The inventory turnover ratio is closest to:

A) 2.78
B) 9.27
C)6.49
D)2.89

Question 75

Which of the following is false?

A) The major difference between the quick and current ratios is inventory.
B) Current liabilities are the denominator in the cash, quick, and current ratios.
C)Companies that sell expensive merchandise tend to have high inventory turnover ratios.
D)Some analysts do not use the cash ratio because it is very sensitive to individual events.

Question 76

MusicPod's earnings per share ratios were $2.47 and $2.07 respectively for 2015 and 2014. MusicPod's stock was trading at $53.00 and $41.50 per share at the end of 2015 and 2014 respectively. The company paid cash dividends per share of $.85 in 2015 and $.63 in 2014. Total stockholders' equity was $13,572 million and $11,896 million in 2015 and 2014 respectively. The common shares outstanding were approximately 1,782,000 in both 2015 and 2014. MusicPod's price/earnings ratio for 2015 is closest to:

A) 21.5
B) 62.4
C)20.0
D)2.9

Question 77

Agnes Company reported the following data: $$\begin{array} { l r } \text { Quick assets } & \$ 55,000 \\\text { Current assets } & 150,000 \\\text { Total liabilities } & 300,000 \\\text { Average net receivables } & 12,600 \\\text { Beginning inventory } & 38,000 \\\text { Long-term liabilities } & 200,000 \\\text { Net credit sales } & 126,000 \\\text { Cost of goods sold } & 84,000 \\\text { Ending inventory } & 46,000\end{array}$$ What was the inventory turnover ratio?

A) 2.2
B) 1.8
C)2.0
D)3.0

Question 78

Bailey Corporation reported the following information for 2014: $\begin{array}{lr}\text { Net income } & \$ 10,000 \\\text { Total assets } & 16,000 \\\text { Total stockholders' equity } & 8,000\end{array}$ What is Bailey's debt-to-equity ratio?

A) 2
B) 1.25
C)1.0
D)3.0

Question 79

Thomas Company had income before interest and taxes of $120,000. Interest expense for the period was $17,000 and income taxes amounted to $28,500. The average stockholders' equity was $680,000. Thomas' return on equity (ROE) is closest to:

A) 17.65%
B) 15.15%
C)13.46%
D)10.96%

Question 80

Potaw Company reported the following data at the end of 2014: $\begin{array}{lr}\text { Sales revenue ( } 75 \% \text { on credit) }&\$300,000\\\text { Expenses ( } 26 \% \text { on credit) }&60,000\\\text { Accounts receivable, net at December } 31,2014 \text { (a decrease }\\\text { of } \$ 4,000 \text { during 2014) } & 8,000 \\\text { Total assets } & 200,000 \\\text { Stockholders' equity } & 150,000\end{array}$ What was the accounts receivable turnover ratio?

A) 30.0
B) 37.5
C)36.5
D)22.5