Question 1

Liquidity ratios address the question of whether a company can meet its obligations over the long term,and financial leverage ratios address the question of whether a company can meet its obligations over the short term.

Accepted Answer

This statement is incorrect. Liquidity ratios address the question of whether a company can meet its short-term obligations, while financial leverage ratios address the question of whether a company can meet its long-term obligations.

Question 2

________ break(s)down the return-on-equity into three components.

Accepted Answer

The DuPont identity breaks down the return-on-equity into three components: net profit margin, asset turnover, and financial leverage. This helps to analyze the sources of a company's return-on-equity and identify areas for improvement. Market value ratios, profitability ratios, and asset management ratios do not provide such a breakdown of return-on-equity.

Question 3

The net income is $100,sales are $200,total assets are $500,and total equity is $300.According to the DuPont method of financial ratio analysis,ROE is about 33.33%.

Accepted Answer

The DuPont method of financial ratio analysis states that ROE (Return on Equity) is equal to Net Income/Sales multiplied by Sales/Total Assets multiplied by Total Assets/Total Equity. 
ROE = (Net Income/Sales) * (Sales/Total Assets) * (Total Assets/Total Equity) 
Plugging in the given values, ROE = ($100/$200) * ($200/$500) * ($500/$300) = 0.1667*0.4*1.6667 = 0.1111 = 11.11%
Therefore, the statement in the question is False. However, if we assume that the net income is $200 instead of $100, then ROE would indeed be approximately 33.33%.

Question 4

Great Plains Inc.has a profitability ratio of 0.23,an asset turnover ratio of 1.45,a gross margin of 32%,and a total asset to equity ratio of 1.60.What is the firm's ROE?

Accepted Answer

ROE (Return on Equity) can be calculated by multiplying the profitability ratio (Net Income/Sales) with the asset turnover ratio (Sales/Total Assets), and then multiplying the result with the total asset to equity ratio.

ROE = Profitability ratio * Asset turnover ratio * Total asset to equity ratio
ROE = 0.23 * 1.45 * 1.60
ROE = 0.6676 or 66.76%

Therefore, the closest answer is D) 53.36%, which might be due to rounding errors. The correct answer is approximately 66.76%.

Question 5

Earnings per share is the ________.

Accepted Answer

Earnings per share is calculated by dividing net income by the number of outstanding shares. Therefore, choice B, net income divided by the number of outstanding shares, is the correct answer.

Question 6

Return on equity can increase as a result of an increase in which of the following ratios?

Accepted Answer

Return on Equity (ROE) is influenced by three main components: net profit margin (Net income/Sales), asset turnover (Sales/Total Assets), and financial leverage (Total Assets/Equity). An increase in any of these ratios indicates a more efficient use of equity, thereby increasing the ROE.

Question 7

A standard interpretation of the P/E ratio is that firms with high P/E ratios need to have high growth rates to justify the current price.

Accepted Answer

A high P/E ratio means that investors are willing to pay more per dollar of earnings, indicating high expectations for growth and future earnings. Therefore, firms with high P/E ratios need to have high growth rates to justify the current price.

Question 8

If the stock price is $20,earnings per share is $1,and the earnings growth rate is 5%,then the PEG ratio is four.

Accepted Answer

PEG ratio is calculated by dividing the P/E ratio by the earnings growth rate. In this case, the P/E ratio is 20/1 = 20 and the earnings growth rate is 5%. So the PEG ratio is 20/5= 4. Therefore, the statement is true.

Question 9

For potential investors,what question can be answered by market value ratios? Do financial statements contain all of the necessary information to answer this question? Explain in terms of the P/E (price earnings)ratio.

Accepted Answer

The answer of For potential investors,what question can be answered...

Question 10

The DuPont identity measures ROE by multiplying ________.

Accepted Answer

The DuPont identity formula is ROE = Net Profit Margin × Total Asset Turnover × Equity Multiplier. This means that the formula for calculating ROE involves multiplying the profitability ratio (net profit margin), the total asset turnover, and the equity multiplier. Therefore, option C, which includes the profitability ratio, total asset turnover, and equity multiplier, is the correct choice.

Question 11

Describe the three components of the DuPont ratio.

Accepted Answer

The answer of Describe the three components of the DuPont...

Question 12

________ is the percentage of sales dollars that reaches net income on the common-size statements.

Accepted Answer

The profit margin, also known as the net income margin, is the percentage of sales dollars that reaches net income on the common-size statements. It is a measure of a company's profitability. The formula for calculating the profit margin is net income divided by sales, multiplied by 100.

Question 13

Ace Engineering Inc.has a profitability ratio of 0.16,an asset turnover ratio of 1.5,a debt to equity ratio of 0.40,and a total asset to equity ratio of 1.40.What is the firm's ROE?

Accepted Answer

The firm's Return on Equity (ROE) can be calculated using the Dupont formula, which is ROE = Profitability Ratio * Asset Turnover Ratio * Equity Multiplier. The Equity Multiplier is calculated as 1 + Debt to Equity Ratio. Given the profitability ratio of 0.16, asset turnover ratio of 1.5, and debt to equity ratio of 0.40, the Equity Multiplier is 1 + 0.40 = 1.40. Therefore, ROE = 0.16 * 1.5 * 1.40 = 0.336 or 33.60%.

Question 14

Which of the statements below is TRUE?

Accepted Answer

DuPont analysis breaks down Return on Equity (ROE) into three components: Profit Margin ($\frac{\text{Net Income}}{\text{Sales}}$), Asset Turnover ($\frac{\text{Sales}}{\text{Total Assets}}$), and Financial Leverage ($\frac{\text{Total Assets}}{\text{Total Equity}}$). This formula shows how efficiently a company is using its assets to generate profit and how effectively it is leveraging its debt.

Question 15

To determine market value for a company,we cannot rely exclusively on its financial statements for our information.

Accepted Answer

Market value for a company is dependent on factors beyond just its financial statements, such as industry trends, competition, brand perception, management expertise, etc. Therefore, relying exclusively on financial statements would not provide a complete picture of the company's market value.

Question 16

The current ratio,the quick ratio,and the cash ratio are asset management ratios.

Accepted Answer

The current ratio, the quick ratio, and the cash ratio are liquidity ratios, not asset management ratios. They measure a company's ability to meet its short-term obligations.

Question 17

The higher the current ratio,the better.

Accepted Answer

A very high current ratio may indicate that a company is not efficiently using its current assets or its short-term financing facilities. It could also suggest that the company is holding too much inventory or has too much cash that could be better invested elsewhere.

Question 18

ACME Inc.has a profitability ratio of 0.11,an asset turnover ratio of 1.7,a price to earnings ratio of 17.4,and a total asset to equity ratio of 1.50.What is the firm's ROE?

Accepted Answer

ROE can be calculated by multiplying profitability ratio with asset turnover ratio and then multiplying the product with the total asset to equity ratio.

ROE = Profitability ratio x Asset Turnover ratio x Total Asset to Equity ratio

ROE = 0.11 x 1.7 x 1.5

ROE = 0.28 or 28.05%

Therefore, the correct answer is Choice C.

Question 19

Only firms with P/E ratios below 50 have great growth and earnings potential not yet demonstrated in current earnings.

Accepted Answer

The statement is not necessarily true as a low P/E ratio does not always indicate great growth and earnings potential. It could also be a result of poor market performance or lack of investor confidence in the company.

Question 20

A PEG ratio of 0.5 indicates that a firm is overvalued.

Accepted Answer

A PEG ratio of 0.5 is generally considered a good investment opportunity as it suggests that the stock is undervalued relative to its expected earnings growth. Therefore, the statement is false as a PEG ratio of 0.5 would indicate that a firm is undervalued, not overvalued.

Quiz 14: Financial Ratios and Firm Performance