Question 1

Which statement about inventories is correct?
A)A reduction in inventories held would have no effect on the current ratio.
B)An increase in inventories would have no effect on the current ratio.
C)If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
D)A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.

Accepted Answer

This statement is correct because inventory turnover ratio measures how efficiently a company is managing its inventory by relating cost of goods sold to the average inventory for a period. As sales increase and inventories are kept constant, the cost of goods sold will increase and the average inventory will remain the same, resulting in a higher inventory turnover ratio.

The other statements are incorrect:
A) A reduction in inventories held would decrease the current ratio because current assets (including inventories) are in the numerator, while current liabilities (the denominator) remain constant.
B) An increase in inventories would increase the current ratio because current assets would increase while current liabilities remain constant.
D) A reduction in inventory turnover ratio (i.e., a decrease in the efficiency of managing inventory) would generally lead to a decrease in ROE because lower sales or higher cost of goods sold would decrease the net income used in the ROE calculation.

Question 2

Suppose Firms A and B have the same amount of assets,pay the same interest rate on their debt,have the same basic earning power (BEP),and have the same tax rate.However,Firm A has a higher debt ratio.If BEP is greater than the interest rate on debt,Firm A will have a higher ROE as a result of its higher debt ratio.

Accepted Answer

This is because a higher debt ratio means that a larger portion of Firm A's assets are financed by debt, which has a lower cost than equity. As long as the BEP is greater than the interest rate on the debt, the use of debt will amplify Firm A's profits, resulting in a higher ROE compared to Firm B with a lower debt ratio. However, it should be noted that a higher debt ratio also increases the financial risk of the firm.

Question 3

Considered alone,which of the following would increase a company's current ratio?
A)an increase in net fixed assets
B)an increase in accrued liabilities
C)an increase in notes payable
D)an increase in accounts receivable

Accepted Answer

The current ratio is calculated by dividing current assets by current liabilities. An increase in accounts receivable (current asset) would increase the numerator of the ratio, while the denominator (current liabilities) remains the same, causing the current ratio to increase. An increase in net fixed assets (non-current asset) would not affect the current ratio. An increase in accrued liabilities or notes payable (current liabilities) would decrease the current ratio.

Question 4

Suppose a firm wants to maintain a specific TIE ratio.It knows the amount of its debt,the interest rate on that debt,the applicable tax rate,and its operating costs.With this information,the firm can calculate the amount of sales required to achieve its target TIE ratio.

Accepted Answer

This statement is true. The TIE ratio (interest coverage ratio) is calculated by dividing the earnings before interest and taxes (EBIT) by the interest expense. By knowing the amount of debt, interest rate, tax rate, and operating costs, the firm can calculate the EBIT required to achieve its desired TIE ratio and then calculate the sales required to generate that EBIT.

Question 5

A firm's new president wants to strengthen the company's financial position.Which action would make it financially stronger?
A)increase accounts receivable while holding sales constant
B)increase EBIT while holding sales constant
C)increase accounts payable while holding sales constant
D)increase notes payable while holding sales constant

Accepted Answer

Increasing EBIT (Earnings Before Interest and Taxes) while holding sales constant improves profitability without increasing sales volume, directly strengthening the company's financial position by enhancing its ability to generate income from its current operations.

Question 6

Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable.This action had no effect on the company's total assets or operating income.What would occur as a result of this action?
A)The company's current ratio would increase.
B)The company's times-interest-earned ratio would decrease.
C)The company's basic earning power ratio would increase.
D)The company's equity multiplier would increase.

Accepted Answer

By using the proceeds from the new common stock issuance to pay off some of its short-term notes payable, Casey Communications would decrease its current liabilities without affecting its assets or operating income. This would increase the company's current ratio, a measure of its ability to pay off short-term obligations.

Question 7

If the CEO of a large,diversified firm were filling out a fitness report on a division manager (i.e.,"grading" the manager),which of the following situations would likely result in the manager receiving a better grade? In all cases,assume that other things are held constant.
A)The division's basic earning power ratio is above the average of other firms in its industry.
B)The division's total assets turnover ratio is below the average for other firms in its industry.
C)The division's debt ratio is above the average for other firms in the industry.
D)The division's inventory turnover is 6, whereas the average for its competitors is 8.

Accepted Answer

The CEO would likely give a better grade to the division manager if the basic earning power ratio is above the average for other firms in the industry, as it suggests that the division is generating more profit per dollar of assets. This is a key indicator of the division's efficiency and profitability.

Question 8

Which of the following is an example of window dressing?
A)borrowing on a long-term basis and using the proceeds to retire short-term debt to improve the current ratio
B)offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories
C)using some of the firm's cash to reduce long-term debt
D)any action that improves a firm's fundamental, long-run position and thus increases its intrinsic value.

Accepted Answer

Window dressing refers to actions taken by a company to improve its financial statements or ratios in the short term, often to make the financial health of the company appear better than it actually is, especially before reporting periods. Borrowing on a long-term basis to retire short-term debt is an example of window dressing because it can temporarily improve the current ratio (an indicator of liquidity), making the company appear more financially stable without actually improving its long-term financial health.

Question 9

Suppose firms follow similar financing policies,face similar risks,have equal access to capital,and operate in competitive product and capital markets.Under these conditions,then firms that have high profit margins will tend to have high asset turnover ratios,and firms with low profit margins will tend to have low turnover ratios.

Accepted Answer

Asset turnover ratio is a measure of how efficiently a company uses its assets to generate sales, and it is not directly correlated with profit margins. A company can have a high profit margin with a low asset turnover if it sells high-margin products less frequently, or a low profit margin with a high asset turnover if it sells low-margin products more frequently.

Question 10

If a firm finances with only debt and common equity,and if its equity multiplier is 3.0,then its debt ratio must be 0.667.

Accepted Answer

The equity multiplier can be calculated as follows: Equity Multiplier = Total Assets/Total Equity. If the equity multiplier is 3.0, then total assets are three times the total equity. Therefore, Total Debt = Total Assets - Total Equity. Let's assume the total equity is 1. Then, total assets are 3 and total debt is 2. So, the debt ratio can be calculated as Total Debt/Total Assets = 2/3, which is equal to 0.667. Hence, the statement is true.

Question 11

Firms A and B have the same current ratio,0.75; the same amount of sales,and the same amount of current liabilities.However,Firm A has a higher inventory than B.Therefore,we can conclude that A's quick ratio must be smaller than B's.

Accepted Answer

The quick ratio only takes into account liquid assets, which are those that can be easily converted into cash. Since the current ratio includes inventory, which is not a highly liquid asset, Firm A's current ratio is inflated compared to its quick ratio. Therefore, it is possible that Firm B has a lower quick ratio than Firm A even though Firm A has a higher inventory.

Question 12

Even though Firm A's current ratio exceeds that of Firm B,Firm B's quick ratio might exceed that of A.However,if A's quick ratio exceeds B's,then we can be certain that A's current ratio is also larger than that of B.

Accepted Answer

The quick ratio excludes inventory from current assets, focusing on more liquid assets, while the current ratio includes all current assets. It's possible for Firm A to have a higher quick ratio due to more liquid assets but still have a lower current ratio if Firm B has significantly more inventory or other less liquid current assets.

Question 13

Which of the following would,generally,indicate an improvement in a company's financial position,other things held constant?
A)The TIE declines.
B)The DSO increases.
C)The EBITDA coverage ratio increases.
D)The current and quick ratios both decline.

Accepted Answer

An increase in the EBITDA coverage ratio, which measures a company's ability to cover its interest expenses and repay its debts, would generally indicate an improvement in its financial position. A decline in the TIE (Times Interest Earned) ratio, which measures a company's ability to meet its interest payments, or an increase in the DSO (Days Sales Outstanding), which measures the average time it takes to collect receivables, would indicate a deterioration in the company's financial position. Also, a decline in both the current and quick ratios would indicate a weakening of the company's liquidity position, which is not necessarily a sign of improvement in overall financial position.

Question 14

A firm wants to strengthen its financial position.Which action would increase its current ratio?
A)Use cash to repurchase some of the company's own stock.
B)Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than 1 year.
C)Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.
D)Use cash to increase inventory holdings.

Accepted Answer

The current ratio is calculated as current assets divided by current liabilities. Issuing new stock increases cash (a current asset) without immediately increasing current liabilities, thus improving the current ratio. Using some of the proceeds to purchase additional inventory also increases current assets, further improving the ratio. Holding the remainder as cash maintains the improved ratio.

Question 15

One problem with ratio analysis is that relationships can be manipulated.For example,we know that if our current ratio is less than 1.0,then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.

Accepted Answer

The answer of One problem with ratio analysis is that...

Question 16

One problem with ratio analysis is that relationships can be manipulated.For example,if our current ratio is greater than 1.5,then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to increase.

Accepted Answer

The answer of One problem with ratio analysis is that...

Question 17

Other things held constant,a decline in sales and a simultaneous increase in financial leverage must result in a lower profit margin.

Accepted Answer

A decline in sales would typically lead to lower profits, but an increase in financial leverage does not directly affect profit margins. Financial leverage amplifies the returns (or losses) on equity but does not inherently change the profit margin, which is calculated before the effects of financing are considered.

Question 18

Which of the following statements is correct?
A)If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.
B)If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.
C)Other things held constant, the higher a firm's expected future growth rate, the lower its P/E ratio is likely to be.
D)The higher the market/book ratio, then, other things held constant, the higher one would expect to find the market value added (MVA).

Accepted Answer

A high market/book ratio indicates that the market values the company more highly than its book value, which often reflects the market's expectations of the firm's future growth potential. Therefore, a higher market/book ratio is generally associated with a higher Market Value Added (MVA), as it suggests that investors believe the company will generate more value in the future.

Question 19

Which of the following would indicate an improvement in a company's financial position,other things held constant?
A)The debt ratio increases.
B)The profit margin declines.
C)The EBITDA coverage ratio declines.
D)The current and quick ratios both increase.

Accepted Answer

An increase in current and quick ratios indicates an improvement in a company's liquidity position, which is generally considered positive for its financial health. The other options - increasing debt ratio, declining profit margin, and declining EBITDA coverage ratio - would all indicate a deteriorating financial position.

Question 20

Companies E and P each reported the same earnings per share (EPS),but Company E's stock trades at a higher price.Which of the following statements is correct?
A)Company E probably has fewer growth opportunities than company P.
B)Company E is probably judged by investors to be riskier than company P.
C)Company E must pay a lower dividend than company P.
D)Company E trades at a higher P/E ratio than company P.

Accepted Answer

Since both E and P have the same EPS, the higher stock price for Company E indicates that investors are willing to pay more for each dollar of earnings. This means that Company E likely has a higher P/E ratio than Company P, which could be due to factors such as a stronger brand or better growth prospects. Thus, choice D is the correct answer. Note that we cannot infer anything about growth opportunities, riskiness, or dividends solely based on the information given.

Quiz 3: Analysis of Financial Statements

Which statement about inventories is correct?

Considered alone,which of the following would increase a company's current ratio?

Suppose a firm wants to maintain a specific TIE ratio.It knows the amount of its debt,the interest rate on that debt,the applicable tax rate,and its operating costs.With this information,the firm can calculate the amount of sales required to achieve its target TIE ratio.

A firm's new president wants to strengthen the company's financial position.Which action would make it financially stronger?

Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable.This action had no effect on the company's total assets or operating income.What would occur as a result of this action?

If the CEO of a large,diversified firm were filling out a fitness report on a division manager (i.e.,"grading" the manager) ,which of the following situations would likely result in the manager receiving a better grade? In all cases,assume that other things are held constant.

Which of the following is an example of window dressing?

If a firm finances with only debt and common equity,and if its equity multiplier is 3.0,then its debt ratio must be 0.667.

Firms A and B have the same current ratio,0.75; the same amount of sales,and the same amount of current liabilities.However,Firm A has a higher inventory than B.Therefore,we can conclude that A's quick ratio must be smaller than B's.

Even though Firm A's current ratio exceeds that of Firm B,Firm B's quick ratio might exceed that of A.However,if A's quick ratio exceeds B's,then we can be certain that A's current ratio is also larger than that of B.

Which of the following would,generally,indicate an improvement in a company's financial position,other things held constant?

A firm wants to strengthen its financial position.Which action would increase its current ratio?

One problem with ratio analysis is that relationships can be manipulated.For example,we know that if our current ratio is less than 1.0,then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.

One problem with ratio analysis is that relationships can be manipulated.For example,if our current ratio is greater than 1.5,then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to increase.

Other things held constant,a decline in sales and a simultaneous increase in financial leverage must result in a lower profit margin.

Which of the following statements is correct?

Which of the following would indicate an improvement in a company's financial position,other things held constant?

Companies E and P each reported the same earnings per share (EPS) ,but Company E's stock trades at a higher price.Which of the following statements is correct?