Deck 4: Managing Your Accounts

Question 1

In general, when a company has greater operating leverage, and its sales increase, profits

A) Increase proportionally with sales
B) Increase proportionately faster than sales
C) Increase proportionately slower than sales

Answer 1

B

Question 2

It would be easiest to see the percentage growth in a company's 2015 accounts receivable by looking at a

A) Common size balance sheet
B) Common size income statement
C) Percentage change balance sheet
D) Percentage change income statement

Answer 2

C

Question 3

In a typical cash flow statement, prepared using the indirect method, which of the following statements about depreciation is correct?

A) Depreciation expense usually appears in the investing section, as a reduction to investing cash flows.
B) Depreciation expense usually appears in the investing section, as an addition to investing cash flows.
C) Depreciation expense usually appears in the operating section, as a reduction to operating cash flows.
D) Depreciation expense usually appears in the operating section, as an addition to operating cash flows.

Answer 3

D

Question 4

Assume that during the year, the Cui Company had net income of $100,000. One of the expenses that was included in the computation of net income was depreciation expense of $3,000. The company also had a gain on the sale of investment property of $4,000. Based on this information, net operating cash flows for the year equal

A) 93000
B) 99000
C) 101000
D) 107000

Question 5

Assume that during the year, the Foley Company had net income of $200,000. Its accounts receivable increased by $6,000, and its accrued expenses payable increased by $7,000. Based on this information, net operating cash flows for the year equal

A) 187000
B) 199000
C) 201000
D) 213000

Question 6

Assume that during the year, the Grey Company had net income of $300,000. Its inventory increased by $6,000 and its accounts payable decreased by $7,000. Based on this information, net operating cash flows for the year equal

A) 287000
B) 299000
C) 301000
D) 313000

Question 7

Under the Du Pont framework of analysis, which of the following relationships is true?

A) Return on assets = return on common equity + capital structure leverage
B) Return on common equity = asset turnover ÷ capital structure leverage
C) Return on common equity = asset turnover × profit margin × capital structure leverage
D) Return on assets = asset turnover + return on equity

Question 8

A commonly used ratio to judge company profitability is

A) The current ratio
B) The debt to equity ratio
C) Times interest earned
D) Return on assets

Question 9

A commonly used ratio to judge the amount a company is earning, not just for its owners, but related to all the resources that managers have to use in the business, is

A) Net income
B) Return on assets
C) Return on common equity
D) Earnings per share

Question 10

It would be easiest to see the company's 2014 interest expense, as a percentage of revenues for the year, by looking at a

A) Common size balance sheet
B) Common size income statement
C) Percentage change balance sheet
D) Percentage change income statement

Question 11

Research indicates that all of the following statements are correct, except:

A) Stock price movements are more closely related to income statement information than cash flow information.
B) Useful (but not perfect) models exist that use financial statement data to predict company bankruptcy.
C) Useful (but not perfect) models exist that use financial statement data to detect improper reporting of financial information.
D) Stock price movements are greater when a change in income is due to one-time items than when the change in income is due to persistent items.

Question 12

According to research, movements in stock prices are most closely related to movements in which financial statement?

A) Balance sheet
B) Income statement
C) Statement of owners' equity
D) Cash flow statement

Question 13

Which of the following is most likely a sign that a company has solvency or liquidity problems?

A) A current ratio is low compared to other companies in the industry.
B) An interest coverage ratio is high compared to other companies in the industry.
C) A ratio of debt to equity that low compared to other companies in the industry.
D) A capital structure leverage ratio is low compared to other companies in the industry.

Question 14

Assume a company acquires inventory, using cash. Which of the following statements is correct regarding the effect of this purchase on its ratios?

A) The current ratio will fall.
B) The quick ratio will fall.
C) The inventory turnover ratio increases.
D) The capital structure leverage increases.

Question 15

In general, when fixed operating costs become a smaller percentage of a company's operating costs, the operating leverage effect

A) Decreases
B) Stays the same
C) Increases

Question 16

Reasons that a private company might decide to prepare financial statements include all of the following, except:

A) The company's lenders require the company to send them financial statements.
B) The company has several owners, who wish to monitor their ownership interests.
C) All U.S. companies must file annual audited financial statements with the U.S. government each year.
D) The company has profit-sharing plans that require it to base payments on financial statement information.

Question 17

Historical financial statements are meant to help users assess all of the following, except:

A) Likely success of new products
B) Performance of management in earning income
C) Profitability of the business
D) Solvency of the business

Question 18

When a financial statement analyst compares figures for a company's revenues over a five-year period, this can best be describes as an example of

A) Vertical analysis
B) Horizontal analysis
C) Credit analysis
D) Solvency analysis

Question 19

When a financial statement analyst compares various figures on a company's income statement for a single year, and notes that a particular expense is 23% of sales, the analyst is performing

A) Vertical analysis
B) Horizontal analysis
C) Credit analysis
D) Solvency analysis

Question 20

Benefits of using ratio analysis include all of the following except:

A) Ratios are usually easy to compute.
B) It is always clear what the optimal ratio is for a company.
C) Ratios allow analysts to look at one figure in the financial statements in relation to a second one.
D) Ratios can be used to compare companies that report results in different currencies.

Question 21

The proper numerator to use in computing return on assets is

A) Net income after noncontrolling interests - interest expense + noncontrolling interest in income
B) Net income after noncontrolling interests + (1- tax rate) × interest expense + noncontrolling interest in income
C) Net income after noncontrolling interests + (tax rate) × interest expense + noncontrolling interest in income
D) Net income after noncontrolling interests - (1- tax rate) × interest expense + noncontrolling interest in income

Question 22

The proper denominator to use in computing return on common equity is

A) Beginning total shareholders' equity, including both common and preferred shares
B) Beginning total shareholders' equity, including common but not preferred shares
C) Average total shareholders' equity, including both common and preferred shares
D) Average total shareholders' equity, including common but not preferred shares

Question 23

The text discusses various factors that relate to the risk of a company facing financial distress or bankruptcy. Which of the following might be in indicator of higher risk, based on the discussion in the text?

A) The company has a low rate of asset turnover.
B) The company's assets are mostly liquid assets.
C) Most of the company's debts are long-term, not short-term.
D) The company's sales levels do not vary much from year to year.

Question 24

The text discusses various factors that relate to the risk of a company facing financial distress or bankruptcy. Which of the following might be in indicator of risk, based on the discussion in the text?

A) The company has a high inventory turnover.
B) Most of the company's assets are fixed assets and intangible assets that would take considerable time to sell.
C) The company's sales are relatively stable over time.
D) The company is large, with a variety of different product lines.

Question 25

The type of audit report that means that auditors have done enough work to reach an opinion, and that the auditors believe the financial statements are fairly stated, is called

A) An unqualified report
B) A qualified report
C) A facts and circumstances report
D) A quality compliance certification

Question 26

Limitations of the usefulness of financial statements prepared under GAAP include:

A) The statements are often not the most timely source of information.
B) Statements from different companies may follow different accounting methods.
C) The statements are not designed to show the current market value of the company.
D) All of the above

Question 27

Which of the following is one of the useful features of financial statements?

A) GAAP statements always clearly separately disclose fixed and variable costs.
B) GAAP statements include adjustments for the effects of inflation.
C) GAAP statements are prepared and issued weekly, so they are the most timely sources of information to investors.
D) GAAP financial statements are produced periodically, and contain information that can be used to analyze company profitability and solvency.

Question 28

_____ A company now has a profit margin for ROCE of 8%. Its asset turnover is 2. It has capital structure leverage of 1.5. Compute the Return on common equity.

Question 29

____ A company now has a profit margin for ROA of 10%. Its asset turnover is 3. Compute the Return on assets.

Question 30

_____ A company now has a profit margin for ROA of 4%. Its asset turnover is 5. Compute the Return on assets.

Question 31

Analysts use various different ratios to assess a company's long-term solvency. Which of these ratios is typically measured using average data for the year, rather than year-end data?

A) Current liabilities to assets ratio
B) Long term debt to equity ratio
C) Liabilities to equity ratio
D) Capital structure leverage ratio

Question 32

The Freire Corp. has sales of $1,000, operating expenses of $840, interest expense of $20, and tax expense of $40. Its net income was $100. The interest coverage ratio equals

A) 5
B) 6
C) 7
D) 8

Question 33

When a company borrows money at a fixed interest cost each year

A) Neither operating nor financial leverage increase.
B) Operating leverage is not affected, and financial leverage increases.
C) Operating leverage increases, but financial leverage is not affected.
D) Both operating and financial leverage increase.

Question 34

The correct formula for asset turnover is

A) Total revenues ÷ Average total assets
B) Total revenues ÷ Beginning of year total assets
C) Total revenues ÷ End of year total assets
D) Total revenues ÷ Maximum level of total assets during the year

Question 35

ROCE can be decomposed into three ratios. Which of the following is the correct set of ratios?

A) Gross margin percentage, return on assets, current ratio
B) Asset turnover, effective tax rate, capital structure leverage
C) Capital structure leverage, asset turnover, profit margin for ROCE
D) Asset turnover, Debt to equity ratio, profit margin for ROCE

Question 36

The Allen Corp. in 2016 had total revenues = $10 million, variable costs = $3 million, operating income of $5 million, and net income = $2 million. The operating leverage effect is

A) 1.4
B) 2.6
C) 3.5
D) 6.5

Question 37

The Alpert Corp. in 2016 had total revenues = $20 million, variable costs = $8 million, operating income = $9 million, and net income = 6 million. The financial leverage effect is

A) 0.67
B) 1.5
C) 2
D) 3.33

Question 38

The Chen Corp. in 2016 had revenues of $1,200, variable costs of $600, fixed operating costs of $200, interest expenses of $100, no taxes, and net income = $300. The total leverage effect for this company is

A) 1
B) 1.33
C) 3
D) 4

Question 39

The Chi Corp. in 2016 had revenues of $12,000, variable costs of $6,000, fixed operating costs of $2,000, interest expenses of $1,000, no taxes, and net income = $3,000. The operating leverage effect for this company is

A) 1.333
B) 1.5
C) 3
D) 4

Question 40

The Fan Corp. in 2016 had revenues of $24,000, variable costs of $12,000, fixed operating costs of $4,000, interest expenses of $2,000, no taxes, and net income = $6,000. The financial leverage effect for this company is

A) 1.333
B) 2
C) 3
D) 4

Question 41

The Coda Corp. in 2016 had an operating leverage effect = 3, and a financial leverage effect = 1.333. The total leverage effect is

A) 1.667
B) 4
C) 4.333
D) Cannot be determined

Question 42

_____ A company now has a profit margin for ROCE of 6%. Its asset turnover is 1.5. Its capital structure leverage ratio is 2. Compute the Return on common equity.

Question 43

Assume a company now has a current ratio of 3. Just before year end, it decides to pay back some of its current liabilities, using its cash. Which of the following statements is correct regarding the effect of this decision?

A) The current ratio will decrease.
B) Its interest coverage ratio will increase.
C) Its capital structure leverage ratio will decrease.
D) Its return on assets will decrease.

Question 44

The FASB says that financial statements should provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to business enterprises.

Question 45

On a statement of cash flows prepared using the indirect method, an increase in accounts payable will be shown as something that increases operating cash flows.

Question 46

On a statement of cash flows prepared using the indirect method, an increase in prepaid expenses will be shown as something that increases operating cash flows.

Question 47

On a statement of cash flows prepared using the indirect method, an decrease in income taxes payable will be shown as something that increases operating cash flows.

Question 48

On a statement of cash flows prepared using the indirect method, decreases in current assets are typically shown as additions to operating cash flows.

Question 49

The appropriate section of a cash flow statement to show the money spent by a company to buy back its own stock is the financing section.

Question 50

The appropriate section of a cash flow statement to show the money spent by a company to buy a new factory is the financing section.

Question 51

One ratio used to assess company profitability is "return on assets."

Question 52

The "return on common equity" ratio is primarily used to judge company solvency.

Question 53

Common size balance sheets present all of a company's asset, liabilities, and equity accounts expressed as a percentage of total net income for the year.

Question 54

Goodwill is an intangible asset that is generally recorded when one company buys another.

Question 55

Academic research shows that the major reason for movements in stock prices are the release of financial statements by companies.

Question 56

Most American businesses are publicly traded.

Question 57

An important role of financial reports is to confirm that prior reports were correct.

Question 58

The FASB's Conceptual Framework says that, to be relevant, information must have predictive value, and that information that only has confirmatory value is never relevant.

Question 59

The method of comparing financial statement information that involves comparing the same accounts, across two or more time periods, is called "horizontal analysis."

Question 60

The method of comparing financial statement information that involves comparing figures for different accounts, in a single time period, is called "horizontal analysis."

Question 61

One benefit of ratio analysis is that it allows analysts to compare companies of different sizes.

Question 62

It is always bad news for a company when its selling expenses increase as a percentage of sales.

Question 63

Academic research has shown that, because accounting statements measure income differently than the way economists say it should be measured, stock markets generally ignore news about company earnings.

Question 64

The profit margin used in analyzing return on common equity is the same as the profit margin used in analyzing return on assets.

Question 65

The asset turnover used in analyzing return on common equity is the same as the asset turnover used in analyzing return on assets.

Question 66

In general, when fixed operating costs become a larger percentage of a company's operating costs, the operating leverage effect

A) Decreases
B) Stays the same
C) Increases

Question 67

Assume a company buys inventory with cash, just before year end. Assume the inventory has not been sold before the end of the year. Which of the following statements is correct regarding the effect of buying the inventory?

A) Its current ratio will increase.
B) Its inventory turnover ratio will decrease.
C) Capital structure leverage will decrease.
D) Its return on assets will decrease.

Question 68

In general, compared to a company with no leverage, a company with high operating leverage will have

A) Lower operating profits in periods of high sales
B) No difference in operating profits, regardless of the level of sales
C) Higher operating profits in periods of high sales

Question 69

Which of the following might be an indication that a company has more obsolete ("out of date") products than it did in the previous year?

A) The number of days of inventory on hand is decreasing.
B) The inventory turnover ratio is increasing.
C) The inventory turnover ratio is decreasing.
D) None of the above

Question 70

A company currently allows its customers to take 30 days to pay their accounts receivable. Almost all of its customers pay in around 30 days. If a company changes its policy, and allows customers to wait 60 days before paying, it is likely that in future years

A) Accounts receivable turnover will increase from about 12 to about 24.
B) Accounts receivable turnover will decrease from about 12 to about 6.
C) Accounts receivable turnover will increase from around 6 to about 12.
D) Accounts receivable turnover will decrease from around 6 to around 3.

Question 71

"Liquidity" and "solvency" mean the same thing. They are two different words for the same concept.

Question 72

The total leverage effect for a company equals the operating leverage effect multiplied by the financial leverage effect.

Question 73

The current ratio is used to get information about a company's

A) Profitability
B) Liquidity
C) Interest rates
D) Total assets

Question 74

Assume a company acquires land, using borrowed money. Assume the land earns no income during the year. Which of the following statements is correct regarding the effect of buying the land and borrowing the money?

A) Capital structure leverage will increase.
B) Its interest coverage ratio will increase.
C) Its current ratio will increase.
D) Its return on assets will increase.

Question 75

Financial statements prepared under GAAP are designed to measure the company's current market value as of the balance sheet date.

Question 76

In general, a high current ratio would be a signal of low liquidity risk.

Question 77

Return on assets equals "profit margin for ROA" multiplied by "asset turnover."

Question 78

A major reason why a company's return on common equity is often different than its return on assets is capital structure leverage.

Question 79

"Financial leverage" is the term for the effect of fixed operating costs on the relation between changes in revenues and changes in net income.

Question 80

"Operating leverage" arises due to the presence of fixed operating costs at a company.