Deck 2: Introduction to Financial Statement Analysis

Question 1

Which of the following amounts would be included on the right side of a balance sheet?

A) the value of government bonds held by the company
B) the cash held by the company
C) the amount of deferred tax liability held by the company
D) the amount of money owed to the company by customers who have not yet paid for goods and services they have received

Answer 1

the amount of deferred tax liability held by the company

Question 2

Which of the following best describes why a firm produces financial statements?

A) to use as a tool when planning future investments within a firm
B) to increase the intrinsic value of a firm
C) to provide a means for interested outside parties such as creditors to obtain information about a firm, with an overview of the short- and long-term financial condition of a business
D) to show the daily activities a firm has undertaken in the previous financial year, and what activities are planned for the near future

Answer 2

to provide a means for interested outside parties such as creditors to obtain information about a firm, with an overview of the short- and long-term financial condition of a business

Question 3

What is the main problem in using a balance sheet to provide an accurate assessment of the value of a company's equity?

A) Valuable assets such as the company's reputation, the quality of its work force, and the strength of its management are not captured on the balance sheet.
B) The balance sheet does not accurately represent the book value of assets held by the company.
C) The equity shown on the balance sheet does not reflect the market capitalization of the company.
D) Knowing at a single point in time what assets a firm possesses and the liabilities a firm owes does not give any indication of what those assets can produce in the future.

Answer 3

Valuable assets such as the company's reputation, the quality of its work force, and the strength of its management are not captured on the balance sheet.

Question 4

What is the role of an auditor in financial statement analysis?

Question 5

The exchanges in which of the following countries or regions do NOT accept the International Financial Reporting Standards set out by the International Accounting Standards Board?

A) Germany
B) France
C) United States
D) United Kingdom

Question 6

A small company has current assets of $112,000 and current liabilities of $117,000. Which of the following statements about that company is most likely to be true?

A) Since net working capital is negative, the company will not have enough funds to meet its obligations.
B) Since net working capital is high, the company will likely have little difficulty meeting its obligations.
C) Since net working capital is very high, the company will have ample money to invest after it meets its obligations.
D) Since net working capital is nearly zero, the company is well run and will have little difficulty attracting investors.

Question 7

What is the main reason that it is necessary for public companies to follow the rules and format set out in the Generally Accepted Accounting Principles (GAAP) when creating financial statements?

A) It ensures that the market value of assets and debt are reported accurately.
B) It ensures that information on the performance of public companies is reported on cash-basis accounting.
C) It ensures that important budgetary information is not omitted.
D) It makes it easier to compare the financial results of different firms.

Question 8

U.S. public companies are required to file their annual financial statements with the U.S. Securities and Exchange Commission on which form?

A) 10-A
B) 10-K
C) 10-Q
D) 10-SEC

Question 9

The third party who checks annual financial statements to ensure that they are prepared according to Generally Accepted Accounting Principles (GAAP) and verifies that the information reported is reliable is the ________.

A) NYSE Enforcement Board
B) Accounting Standards Board
C) Securities and Exchange Commission (SEC)
D) auditor

Question 10

The balance sheet shows the assets, liabilities, and stockholders' equity of a firm over a given length of time.

Question 11

In the United States, publicly traded companies can choose whether or not they wish to release periodic financial statements.

Question 12

Which of the following is NOT one of the financial statements that must be produced by a public company?

A) the balance sheet
B) the income statement
C) the statement of cash flows
D) the statement of activities

Question 13

Stockholders' equity is the difference between a firm's assets and liabilities, as shown on the balance sheet.

Question 14

A delivery company is creating a balance sheet. Which of the following would most likely be considered a short-term liability on this balance sheet?

A) the depreciation over the last year in the value of the vehicles owned by the company
B) revenue received for the delivery of items that have not yet been delivered
C) a loan which must paid back in two years
D) prepaid rent on the offices occupied by the company

Question 15

Financial statements are optional accounting reports issued periodically by a firm which present information on the past performance of the firm, a summary of the firm's assets and the financing of those assets, and a prediction of the firm's future performance.

Question 16

Which of the following is NOT a financial statement that every public company is required to produce?

A) income statement
B) statement of sources and uses of cash
C) balance sheet
D) statement of stockholders' equity

Question 17

Which of the following best describes why the left and right sides of a balance sheet are equal?

A) In a properly run business, the value of liabilities will not exceed the assets held by the company.
B) By definition, the assets plus the liabilities will be the same as the stockholders' equity.
C) The assets must equal liabilities plus stockholders' equity because stockholders' equity is the difference between the assets and the liabilities.
D) By accounting convention, the assets of a company must be equal to the liabilities of that company.

Question 18

International Financial Reporting Standards are taking root throughout the world. However, it is unlikely that the U.S. will report according to IFRS before the second half of the twenty-first century.

Question 19

What are the four financial statements that all public companies must produce?

Question 20

A company that produces drugs is preparing a balance sheet. Which of the following would be most likely to be considered a long-term asset on this balance sheet?

A) commercial paper held by the company
B) the inventory of chemicals used to produce the drugs made by the company
C) a patent for a drug held by the company
D) the cash reserves of the company

Question 21

Which of the following is NOT an operating expense?

A) interest expense
B) depreciation and amortization
C) selling, general, and administrative expenses
D) research and development

Question 22

The above diagram shows a balance sheet for a certain company. All quantities shown are in millions of dollars. How would the balance sheet change if the company's long-term assets were judged to depreciate at an extra $5 million per year?

A) Net property, plant, and equipment would rise to $126 million, and total assets and stockholders' equity would be adjusted accordingly.
B) Net property, plant, and equipment would fall to $116 million, and total assets and stockholders' equity would be adjusted accordingly.
C) Long-term liabilities would rise to $131 million, and total liabilities and stockholders' equity would be adjusted accordingly.
D) Long-term liabilities would fall to $111 million, and total liabilities and stockholders' equity would be adjusted accordingly.

Question 23

The income statement reports the firm's revenues and expenses, and it computes the firm's bottom line of net income, or earnings.

Question 24

The above diagram shows a balance sheet for a certain company. All quantities shown are in millions of dollars. What is the company's net working capital?

A) $133 million
B) $2 million
C) $89 million
D) $45 million

Question 25

The major components of stockholders' equity are ________.

A) cash, common stock, and paid-in surplus
B) common stock, paid-in surplus, and net income
C) common stock, paid-in surplus, and retained earnings
D) common stock, liabilities, and retained earnings

Question 26

What is a firm's net income?

A) the difference between the sales and other income generated by a firm, and all costs, taxes, and expenses incurred by the firm in a given period
B) the last or "bottom" line of the income statement
C) a measure of the firm's profitability over a given period
D) all of the above

Question 27

Luther Corporation
Consolidated Income Statement
Year ended December 31 (in $millions)

Refer to the income statement above. For the year ending December 31, 2006 Luther's earnings per share is closest to ________.

A) $0.51
B) $1.03
C) $0.82
D) $1.23

Question 28

The above diagram shows a balance sheet for a certain company. If the company pays back all of its accounts payable today using cash, what will its net working capital be?

A) $131 million
B) $6 million
C) $88 million
D) $45 million

Question 29

Luther Corporation
Consolidated Balance Sheet
December 31, 2006 and 2005 (in $ millions)

Refer to the balance sheet above. What is Luther's net working capital in 2006?

A) $16.8 million
B) $296.0 million
C) $33.6 million
D) $8.4 million

Question 30

Cash is a ________.

A) long-term asset
B) current asset
C) current liability
D) long-term liability

Question 31

What is a firm's gross profit?

A) the difference between the sales and other income generated by the firm, and all costs, taxes, and expenses incurred by a firm in a given period
B) the difference between sales revenues and the costs
C) the difference between sales revenues and cash expenditures associated with those sales
D) all of the above

Question 32

Which of the following statements regarding the income statement is INCORRECT?

A) The income statement shows the cash flows and expenses at a given point in time.
B) The income statement shows the flow of revenues and expenses generated by a firm between two dates.
C) The last or "bottom" line of the income statement shows a firm's net income.
D) The first line of an income statement lists the revenues from the sales of products or services.

Question 33

Accounts payable is a ________.

A) long-term liability
B) current asset
C) long-term asset
D) current liability

Question 34

The above diagram shows a balance sheet for a certain company. All quantities shown are in millions of dollars. If the company has 5 million shares outstanding, and these shares are trading at a price of $6.39 per share, what does this tell you about how investors view this firm's book value?

A) Investors consider that the firm's market value is worth very much less than its book value.
B) Investors consider that the firm's market value is worth less than its book value.
C) Investors consider that the firm's market value and its book value are roughly equivalent.
D) Investors consider that the firm's market value is worth more than its book value.

Question 35

Which of the following balance sheet equations is INCORRECT?

A) Assets - Liabilities = Shareholders' equity
B) Assets = Liabilities + Shareholders' equity
C) Assets - Current liabilities = Long-term liabilities
D) Assets - Current liabilities = Long-term liabilities + Shareholders' equity

Question 36

The above diagram shows a balance sheet for a certain company. If the company buys new property, plant and equipment today using its entire cash balance, what will its net working capital be?

A) -$12 million
B) $12 million
C) -$24 million
D) $24 million

Question 37

A 30-year mortgage loan is a ________.

A) long-term liability
B) current liability
C) current asset
D) long-term asset

Question 38

Which of the following statements regarding the balance sheet is INCORRECT?

A) The balance sheet provides a snapshot of a firm's financial position at a given point in time.
B) The balance sheet lists a firm's assets and liabilities.
C) The balance sheet reports stockholders' equity on the right-hand side.
D) The balance sheet reports liabilities on the left-hand side.

Question 39

Gross profit is calculated as ________.

A) total sales - cost of sales - selling, general, and administrative expenses - depreciation and amortization
B) total sales - cost of sales - selling, general, and administrative expenses
C) total sales - cost of sales
D) none of the above

Question 40

Which of the following is NOT considered to be an operating expense on the income statement?

A) administrative expenses and overhead
B) corporate taxes
C) salaries
D) depreciation and amortization

Question 41

A printing company prints a brochure for a client and then bills them for this service. At the time the printing company's financial disclosure statements are prepared, the client has not yet paid the bill for this service. How will this transaction be recorded?

A) The sale will be added to Net Income on the income statement and retained in Net Income on the statement of cash flows.
B) The sale will be added to Net Income on the income statement but deducted from Net Income on the statement of cash flows.
C) The sale will not be added to Net Income on the income statement but added to Net Income on the statement of cash flows.
D) The sale will neither be added to Net Income on the income statement nor used to adjust Net Income on the statement of cash flows.

Question 42

A manufacturer of plastic bottles for the medical trade purchases a new compression blow molder for its bottle production plant. How will the cost to the company of this piece of equipment be recorded?

A) It will be depreciated over time on the income statement and subtracted as a capital expenditure on the statement of cash flows.
B) It will be depreciated over time on the income statement and subtracted as Inventory on the statement of cash flows.
C) It will be depreciated over time on the income statement and therefore not be recorded separately on the statement of cash flows.
D) It will be subtracted from Gross Profit on the income statement and therefore, not be recorded separately on the statement of cash flows.

Question 43

The notes to the financial statements would LEAST likely be used for which of the following purposes?

A) to provide information regarding the context in which these financial numbers were generated
B) to disclose the financial implications of any off-balance sheet transactions
C) to show how the value of assets listed in the financial statements were arrived at
D) to explain the method of accounting that was used in the preparation of the financial statements

Question 44

Which of the following is NOT a reason that the income statement does not accurately indicate how much cash a firm has earned?

A) It includes entries for the depreciation of assets.
B) It does not include entries for expenditures on inventory.
C) It does not include entries for collection of money from account receivables.
D) It includes cash inflows from services rendered.

Question 45

Which of the following is a way that the operating activity section of the statement of cash flows adjusts Net Income from the balance sheet?

A) It subtracts all expenses and costs related to a firm's operating activities.
B) It adds all non-cash entries related to a firm's operating activities.
C) It adds the cash that flows from investors to a firm.
D) It removes the cash used for investment purposes.

Question 46

A firm whose primary business is in a line of regional grocery stores would be most likely to have to include which of the following facts, if true, in the firm's management discussion and analysis (MD&A)?

A) that a large number of funds were allocated to advertising to increase awareness of the firm's brand in new areas it had expanded into this year
B) that some senior members of the management team have retired in this financial year
C) that the company has lost a class action suit brought against the firm by its employees and is expected to have to pay a large amount of damages
D) that the firm has plans to expand into the organic food business in the next financial year by purchasing several small organic food retailers

Question 47

Luther Corporation
Consolidated Income Statement
Year ended December 31 (in $millions)

Refer to the income statement above. Assuming that Luther has no convertible bonds outstanding, then for the year ending December 31, 2006 Luther's diluted earnings per share are closest to ________.

A) $1.03
B) $0.51
C) $0.82
D) $1.23

Question 48

What will be the effect on the income statement if a firm buys a new processing plant through a new loan?

Question 49

How can we cross check the statement of cash flows?

Question 50

How does a firm select the dates for preparation of its income statement?

Question 51

AOS Industries Statement of Cash Flows for 2008

Consider the above statement of cash flows. In 2008, AOS Industries had contemplated buying a new warehouse for $3 million, the cost of which would be depreciated over 10 years. If AOS Industries has a tax rate of 25%, what would be the impact for the amount of cash held by AOS at the end of the 2008?

A) It would have $3,000,000 less cash at the end of 2008.
B) It would have $2,925,000 less cash at the end of 2008.
C) It would have $1,500,000 less cash at the end of 2008.
D) It would have an additional $7,500,000 in cash at the end of 2008.

Question 52

Allen Company bought a new copy machine to be depreciated straight line for three years for use by sales personnel. Where would this purchase be reflected on the Statement of Cash Flows?

A) It would be an expense on the income statement so it would be reflected in operating cash flows.
B) It would be an addition to property, plant and equipment so it would be an investing activity.
C) It would be an addition to cash so it would be reflected in the change in cash.
D) None of the above answers is correct.

Question 53

A firm's statement of cash flows uses the balance sheet and the income statement to determine the amount of cash a firm has generated and how it has used that cash during a given period.

Question 54

What will be the effect on the statement of cash flows if a firm buys a new processing plant through a new loan?

Question 55

AOS Industries Statement of Cash Flows for 2008

Consider the above statement of cash flows. If all amounts shown above are in millions of dollars, what were AOS Industries' retained earnings for 2008?

A) $5.2 million
B) $2.2 million
C) $4.4 million
D) $3.1 million

Question 56

The management of public companies is not legally required to disclose any off-balance sheet transactions.

Question 57

Use the table for the question(s) below.
AOS Industries Statement of Cash Flows for 2008

Consider the above statement of cash flows. Which of the following is true of AOS Industries' operating cash flows?

A) It collected more cash from its customers than it charged.
B) It sold more inventory than it bought.
C) It charged more on its accounts payable back than it paid back.
D) All of the above are true.

Question 58

A software company acquires a smaller company in order to acquire the patents that it holds. Where will the cost of this acquisition be recorded on the statement of cash flows?

A) as an outflow under operating activities
B) as an outflow under investment activities
C) as an outflow under financial activities
D) not recorded on the statement of cash flows

Question 59

Use the table for the question(s) below.
AOS Industries Statement of Cash Flows for 2008

Consider the above statement of cash flows. What were AOS Industries' major means of raising money in 2008?

A) from investment activities
B) by sale of stock
C) from its operations
D) by issuing debt

Question 60

What is the need for the notes to the financial statements when a firm's operations are already documented in the financial statements?

Question 61

Luther Corporation
Consolidated Balance Sheet
December 31, 2006 and 2005 (in $ millions)

Refer to the balance sheet above. If in 2006 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share, then using the market value of equity, the debt-equity ratio for Luther in 2006 is closest to ________.

A) 3.45
B) 1.72
C) 0.86
D) 2.41

Question 62

A public company has a book value of $128 million. They have 20 million shares outstanding, with a market price of $4 per share. Which of the following statements is true regarding this company?

A) Investors may consider this firm to be a growth company.
B) Investors believe the company's assets are not likely to be profitable since its market value is worth less than its book value.
C) The firm's market value is more than its book value.
D) The value of the firm's assets is greater than their liquidation value.

Question 63

Luther Corporation
Consolidated Balance Sheet
December 31, 2006 and 2005 (in $ millions)

Refer to the balance sheet above. The change in Luther's quick ratio from 2005 to 2006 is closest to ________.

A) a decrease of 0.01
B) an increase of 0.01
C) a decrease of 0.02
D) an increase of 0.02

Question 64

Luther Corporation
Consolidated Balance Sheet
December 31, 2006 and 2005 (in $ millions)

Refer to the balance sheet above. If in 2006 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share, then what is Luther's enterprise value?

A) -$540.0 million
B) $771.4 million
C) $385.7 million
D) $521.4 million

Question 65

Luther Corporation
Consolidated Balance Sheet
December 31, 2006 and 2005 (in $ millions)

Refer to the balance sheet above. When using the book value of equity, the debt-equity ratio for Luther in 2006 is closest to ________.

A) 4.51
B) 2.25
C) 1.13
D) 3.16

Question 66

In general, a successful firm will have a market-to-book ratio that is substantially greater than 1.

Question 67

GenCorp. has a total debt of $140 million and stockholders' equity of $50 million. It also has 26 million shares outstanding, with a market price of $4.00 per share. What is GenCorp's market debt-equity ratio?

A) 0.67
B) 1.08
C) 2.80
D) 1.35

Question 68

Luther Corporation
Consolidated Balance Sheet
December 31, 2006 and 2005 (in $ millions)

Refer to the balance sheet above. If in 2006 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share, then Luther's market-to-book ratio would be closest to ________.

A) 2.58
B) 0.64
C) 1.29
D) 1.80

Question 69

Use the table for the question(s) below.

If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in the balance sheet between 2007 and 2008?

A) The company is having difficulties selling its product.
B) The company has reduced its debt.
C) The company has added a major new asset in terms of plant and equipment.
D) The company has experienced a significant rise in its market value.

Question 70

A company has a share price of $22.15 and 118 million shares outstanding. Its market-to-book ratio is 4.2, its book debt-equity ratio is 3.2, and it has cash of $800 million. How much would it cost to take over this business assuming you pay its enterprise value?

A) $1.9 billion
B) $3.044 billion
C) $4.566 billion
D) $3.8 billion

Question 71

Luther Corporation
Consolidated Balance Sheet
December 31, 2006 and 2005 (in $ millions)

Refer to the balance sheet above. Luther's quick ratio for 2006 is closest to ________.

A) 0.87
B) 1.75
C) 0.88
D) 1.31

Question 72

Use the table for the question(s) below.

If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in quick ratio between 2007 and 2008?

A) The company has eliminated the risk that it will experience a cash shortfall in the near future.
B) The company has reduced the risk that it will experience a cash shortfall in the near future.
C) The risk that the company will experience a cash shortfall in the near future is unchanged.
D) The company has increased the risk that it will experience a cash shortfall in the near future.

Question 73

Luther Corporation
Consolidated Balance Sheet
December 31, 2006 and 2005 (in $ millions)

Refer to the balance sheet above. Luther's current ratio for 2006 is closest to ________.

A) 1.67
B) 2.22
C) 0.56
D) 1.11

Question 74

Use the table for the question(s) below.

If the above balance sheet is for a retail company, how has the company's leverage changed between 2007 and 2008?

A) The company has experienced a very significant decrease in its leverage.
B) The company has experienced a significant decrease in its leverage.
C) The company has experienced no significant change in its leverage.
D) The company has experienced a significant increase in its leverage.

Question 75

Which ratio would you use to measure the financial health of a firm by assessing that firm's leverage?

A) debt-equity or equity multiplier ratio
B) market-to-book ratio
C) market debt-equity ratio
D) current or quick ratio

Question 76

Use the table for the question(s) below.

If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in stockholders' equity between 2007 and 2008?

A) The company is very profitable because it is obviously collecting receivables faster.
B) The company is selling its property, plant and equipment, which may result in a long-term deficiency in production capacity.
C) The company's net income in 2008 was negative.
D) No conclusions can be drawn regarding stockholders' equity without additional information.

Question 77

Company A has current assets of $42 billion and current liabilities of $41 billion. Company B has current assets of $2.7 billion and current liabilities of $1.8 billion. Which of the following statements is correct, based on this information?

A) Company A is less likely than Company B to have sufficient working capital to meet its short-term needs.
B) Company A has greater leverage than Company B.
C) Company A has less leverage than Company B.
D) Company A and Company B have roughly equivalent enterprise values.

Question 78

Use the table for the question(s) below.

Refer to the balance sheet above. If on December 31, 2005 Luther has 8 million shares outstanding trading at $15 per share, then what is Luther's enterprise value?

Question 79

Convex Industries has inventories of $218 million, current assets of $1.4 billion, and current liabilities of $504 million. What is its quick ratio?

A) 1.17
B) 0.94
C) 2.81
D) 2.35

Question 80

Use the table for the question(s) below.

Refer to the partial balance sheet above. If on December 31, 2005 Luther has 8 million shares outstanding trading at $15 per share, then what is Luther's market-to-book ratio?