Question 1

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

Accepted Answer

The answer of One benefit of ratio analysis is that...

Question 2

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

Accepted Answer

If selling expenses increase as a percentage of sales, it means that the cost of selling the product or service has increased, which can lead to lower profit margins or even losses for the company. Therefore, it is considered bad news for the company.

Question 3

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.

Accepted Answer

Academic research has actually shown the opposite, indicating that stock markets do pay attention to news about company earnings despite the differences in accounting and economic measurements of income.

Question 4

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

Accepted Answer

The profit margin used in analyzing return on common equity is calculated as net income divided by common equity while the profit margin used in analyzing return on assets is calculated as net income divided by total assets. Therefore, the two profit margins are not the same.

Question 5

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

Accepted Answer

The answer of The asset turnover used in analyzing return...

Question 6

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

Accepted Answer

The operating leverage effect is the extent to which fixed costs are present in a company's cost structure. When fixed operating costs become a larger percentage of a company's operating costs, the operating leverage effect increases. This means that a small change in revenue can result in a larger change in profits. This effect can work in a company's favor when sales are increasing, but can also be a risk if sales decrease.

Question 7

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?

Accepted Answer

Buying inventory just before year-end, without selling it, increases the inventory on hand, which lowers the inventory turnover ratio. This ratio measures how many times a company sells and replaces its inventory over a period. An increase in inventory without a corresponding increase in sales reduces this ratio.

Question 8

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

Accepted Answer

A company with high operating leverage has fixed operating costs that do not change with changes in sales volume. This means that when sales increase, the company's operating profits increase at a faster rate than the sales increase. However, when sales decrease, the company's operating profits decrease at a faster rate than the sales decrease. Therefore, a company with high operating leverage will have higher operating profits in periods of high sales.

Question 9

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?

Accepted Answer

A decreasing inventory turnover ratio suggests that the company is selling fewer products relative to the amount of inventory held, which could be an indication that there are more obsolete products in inventory that are not selling. The number of days of inventory on hand and the inventory turnover ratio are not necessarily indicative of the age or obsolescence of the products in inventory.

Question 10

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

Accepted Answer

Accounts receivable turnover is calculated as net credit sales divided by average accounts receivable. By allowing customers to wait 60 days before paying, the average accounts receivable will increase as customers take longer to pay. This will decrease the accounts receivable turnover from its current level of around 12 to around 6.

Question 11

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

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The answer of "Liquidity" and "solvency" mean the same thing....

Question 12

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

Accepted Answer

The answer of The total leverage effect for a company...

Question 13

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

Accepted Answer

The current ratio is a liquidity ratio that measures a company's ability to meet its short-term financial obligations. It compares a company's current assets to its current liabilities. Therefore, the answer is B - Liquidity.

Question 14

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?

Accepted Answer

Buying land using borrowed money increases the company's debt, which in turn increases its leverage. Therefore, capital structure leverage will increase. The interest coverage ratio will decrease as a result of the interest expenses associated with the borrowing. The current ratio will be unaffected since the acquisition of land is not considered current assets or liabilities. Finally, buying the land will not generate any income, so the return on assets will not increase.

Question 15

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

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The answer of Financial statements prepared under GAAP are designed...

Question 16

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

Accepted Answer

The answer of In general, a high current ratio would...

Question 17

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

Accepted Answer

This formula is correct. ROA can be calculated as profit margin * asset turnover.

Question 18

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

Accepted Answer

Return on common equity (ROCE) considers the return earned for the common equity shareholders while return on assets (ROA) only considers the return earned from all assets. Capital structure leverage can increase or decrease the return on common equity by using debt financing, which amplifies the ROCE.

Question 19

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

Accepted Answer

Financial leverage refers to the impact of fixed operating costs on the relationship between changes in revenues and changes in net income.

Question 20

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

Accepted Answer

The answer of "Operating leverage" arises due to the presence...

Quiz 4: Managing Your Accounts