Question 1

Which of the following actions will increase a company's quick ratio?

Accepted Answer

The quick ratio is a measure of a company's ability to meet its short-term obligations with its most liquid assets. It is calculated by dividing the sum of cash, accounts receivable, and short-term investments by current liabilities. By reducing inventories, a company can increase its quick assets (cash, accounts receivable, and short-term investments), which will increase the quick ratio. Using the proceeds to reduce current liabilities will further increase the ratio because current liabilities are in the denominator of the quick ratio equation. None of the other actions listed will increase the quick ratio.

Question 2

Pepsi Corporation's current ratio is 0.5, while Coke Company's current ratio is 1.5. Both firms want to "window dress" their coming end-of-year financial statements. As part of their window dressing strategy, each firm will double its current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the statements below best describes the actual results of these transactions?

Accepted Answer

Doubling current liabilities will increase the current assets of both firms, but since Pepsi Corporation's current ratio was lower to begin with, the increase in current assets will have a greater impact on its current ratio compared to Coke Company. As a result, only Pepsi Corporation's current ratio will be increased.

Question 3

Devon Inc. has a higher ROE than Berwyn Inc. (17 percent compared to 14 percent), but it has a lower EVA than Berwyn. Which of the following factors could explain the relative performance of these two companies?

Accepted Answer

A higher ROE simply means that Devon is generating more profit relative to its shareholders' equity compared to Berwyn. However, EVA takes into account the cost of capital and measures the value that a company creates for its investors. A lower EVA indicates that Devon is not creating as much value for its investors as Berwyn. A possible explanation for this could be that Devon is riskier, has a higher WACC (weighted average cost of capital), and a higher cost of equity, which reduces its profitability despite generating a higher ROE. Option A is incorrect as the size of the company does not explain the difference in performance. Option C is also incorrect as a higher EBIT does not necessarily translate to a higher EVA. Option D is incorrect as only option B provides a likely explanation. Option E is incorrect as option A and C are incorrect.

Question 4

If the equity multiplier is 2.0, the debt ratio must be 0.5.

Accepted Answer

Equity multiplier = Total assets / Total equity 
We know equity multiplier = 2.0 
Therefore, Total assets / Total equity = 2.0

Let's assume total assets as X and total equity as Y 
So, X / Y = 2.0 
Multiplying both sides by Y, we get: 
X = 2Y

Debt Ratio = Total Debt / Total Assets 
We need to find the debt ratio.

Firstly, Total Debt + Total Equity = Total Assets 
From this equation, we can find Total Debt as: 
Total Debt = Total Assets - Total Equity

Total Assets = X (from the above equation) 
Total Equity = Y

Substituting the above values, we get:

Total Debt = X - Y

Debt Ratio = Total Debt / Total Assets 
= (X - Y) / X

To simplify the equation further, let's substitute X = 2Y (from the equation X / Y = 2.0)

Debt Ratio = (2Y - Y) / 2Y 
= Y / 2Y 
= 0.5

Therefore, we get a debt ratio of 0.5, which is equal to Total Debt / Total Assets when the equity multiplier is 2.0. Hence, the answer is A) True.

Question 5

Other things held constant, which of the following will not affect the current ratio, assuming an initial current ratio greater than 1.0?

Accepted Answer

The answer of Other things held constant, which of the...

Question 6

Which of the following alternatives could potentially result in a net increase in a company's free cash flow for the current year?

Accepted Answer

The answer of Which of the following alternatives could potentially...

Question 7

Which of the following statements is most correct?

Accepted Answer

The quick ratio excludes inventories from current assets, so increasing inventories while increasing current liabilities will decrease the quick ratio. The quick ratio can never exceed the current ratio because the current ratio includes all current assets, while the quick ratio excludes inventories.

Question 8

Company J and Company K each recently reported the same earnings per share (EPS). Company J's stock, however, trades at a higher price. Which of the following statements is most correct?

Accepted Answer

The most likely reason for Company J's stock trading at a higher price despite both companies having the same EPS is that investors perceive Company J to have higher growth prospects or less risk than Company K. This would result in a higher P/E ratio for Company J. The market to book ratio and risk level cannot be determined from the given information, and it is unlikely that Company J would have fewer growth opportunities if both companies have the same EPS. Therefore, only choice A is the most correct statement.

Question 9

Generally, firms with high profit margins have high asset turnover rates, and firms with low profit margins have low turnover rates; this result is exactly as predicted by the extended Du Pont equation.

Accepted Answer

The statement is incorrect. Firms with high profit margins can have both high and low asset turnover rates, and the same goes for firms with low profit margins. The relationship between profit margin and asset turnover rate is not so straightforward and can vary depending on the industry and other factors. The extended Du Pont equation, while useful for analyzing a firm's return on equity, does not necessarily predict this relationship.

Question 10

Other things held constant, which of the following will not affect the quick ratio? (Assume that current assets equal current liabilities.)

Accepted Answer

The quick ratio only includes assets that can be quickly converted to cash, such as cash and accounts receivable, and liabilities that are due in the short-term, such as accounts payable. Collecting accounts receivable will increase cash and therefore increase the quick ratio. Selling fixed assets for cash will also increase the quick ratio if the cash received is used to pay off short-term liabilities. Using cash to purchase inventories or paying off accounts payable will decrease the quick ratio as it reduces the amount of cash available for immediate use. Issuing long-term debt to pay off a short-term bank loan will not affect the quick ratio as it does not involve the current assets and liabilities included in the quick ratio calculation.

Question 11

Which of the following statements is most correct?

Accepted Answer

The answer of Which of the following statements is most...

Question 12

Which of the following statements is most correct about Economic Value Added (EVA)?

Accepted Answer

None of the statements are correct because EVA is calculated as NOPAT minus the capital charge (cost of capital times the capital invested), and it does not directly equate to net income, ROE, or cost of equity alone.

Question 13

One of the problems of ratio analysis is that account relationships can be manipulated. For example, we know that if we use some of our cash to pay off some of our current liabilities, the current ratio will always increase, especially if the current ratio is low initially, for example, below 1.0.

Accepted Answer

The answer of One of the problems of ratio analysis...

Question 14

Variations in accounting methods among firms can invalidate financial comparisons between firms.

Accepted Answer

Accounting methods can vary among firms, which can result in differences in reported financial numbers. These variations can include differences in inventory valuation methods, depreciation methods, and revenue recognition methods, among others. As a result, it can be difficult to make accurate financial comparisons between firms if their accounting methods differ significantly.

Question 15

Company R and Company S each have the same operating income (EBIT) and basic earning power (BEP) ratio. Company S, however, has a lower times-interest-earned (TIE) ratio. Which of the following statements is most correct?

Accepted Answer

Company S has a lower TIE ratio, which indicates that it has a higher interest expense relative to its EBIT, as TIE is calculated as EBIT divided by interest expense.

Question 16

Which of the following statements is most correct?

Accepted Answer

All of the statements above are correct.

A) It is true that it can be difficult to develop industry benchmarks for firms operating in multiple industries.
B) It is true that financial ratios should be interpreted with caution due to seasonal and accounting differences that can affect comparability.
C) It is true that financial ratios should be interpreted with caution because there is no one "good" value for each ratio, and it may vary depending on the industry and company in question.
D) It is true that ratio analysis standardizes numbers and allows for easier comparisons between companies.

Question 17

Which of the following statements is most correct?

Accepted Answer

Using cash to purchase inventories will decrease the quick ratio (as inventories are not included in quick assets) and will not affect the current ratio (as both cash and inventories are current assets). If a company's total assets turnover is high but fixed assets turnover is low, it suggests efficient use of current assets, not excessive current assets.

Question 18

The financial position of companies whose business is seasonal can be dramatically different depending upon the time of year chosen to construct financial statements. This time sensitivity is especially true with respect to the firm's balance sheet.

Accepted Answer

The statement is true. Since the financial position of seasonal companies can vary greatly depending on the time of year, their balance sheet can be affected by factors such as inventory levels, accounts receivable and payables, and cash flow at different times in the year. Therefore, the balance sheet can be significantly impacted by the seasonality of the company's operations.

Question 19

The basic earning power ratio (BEP) reflects the earning power of the firm's assets inclusive of the effects of leverage and taxes. Therefore, this ratio measures the net earning power of the firm reflecting the magnitude of the leverage employed.

Accepted Answer

The basic earning power ratio (BEP) measures the earning power of a firm's assets before the effects of leverage and taxes, focusing on operating income relative to total assets.

Question 20

Stennett Corp.'s CFO has proposed that the company issue new debt and use the proceeds to buy back common stock. Which of the following are likely to occur if this proposal is adopted? (Assume that the proposal would have no effect on the company's operating earnings.)

Accepted Answer

The proposal will reduce the number of shares outstanding, which will increase EPS and ROA. The proposal will also increase the amount of debt, which will increase interest expense and reduce taxes paid.

Quiz 8: Analysis of Financial Statements

Which of the following actions will increase a company's quick ratio?

Devon Inc. has a higher ROE than Berwyn Inc. (17 percent compared to 14 percent) , but it has a lower EVA than Berwyn. Which of the following factors could explain the relative performance of these two companies?

If the equity multiplier is 2.0, the debt ratio must be 0.5.

Other things held constant, which of the following will not affect the current ratio, assuming an initial current ratio greater than 1.0?

Which of the following alternatives could potentially result in a net increase in a company's free cash flow for the current year?

Which of the following statements is most correct?

Company J and Company K each recently reported the same earnings per share (EPS) . Company J's stock, however, trades at a higher price. Which of the following statements is most correct?

Generally, firms with high profit margins have high asset turnover rates, and firms with low profit margins have low turnover rates; this result is exactly as predicted by the extended Du Pont equation.

Other things held constant, which of the following will not affect the quick ratio? (Assume that current assets equal current liabilities.)

Which of the following statements is most correct?

Which of the following statements is most correct about Economic Value Added (EVA) ?

One of the problems of ratio analysis is that account relationships can be manipulated. For example, we know that if we use some of our cash to pay off some of our current liabilities, the current ratio will always increase, especially if the current ratio is low initially, for example, below 1.0.

Variations in accounting methods among firms can invalidate financial comparisons between firms.

Company R and Company S each have the same operating income (EBIT) and basic earning power (BEP) ratio. Company S, however, has a lower times-interest-earned (TIE) ratio. Which of the following statements is most correct?

Which of the following statements is most correct?

Which of the following statements is most correct?

The financial position of companies whose business is seasonal can be dramatically different depending upon the time of year chosen to construct financial statements. This time sensitivity is especially true with respect to the firm's balance sheet.

The basic earning power ratio (BEP) reflects the earning power of the firm's assets inclusive of the effects of leverage and taxes. Therefore, this ratio measures the net earning power of the firm reflecting the magnitude of the leverage employed.

Stennett Corp.'s CFO has proposed that the company issue new debt and use the proceeds to buy back common stock. Which of the following are likely to occur if this proposal is adopted? (Assume that the proposal would have no effect on the company's operating earnings.)