Question 1

Which is not one of the five ratio categories?

Accepted Answer

The five ratio categories are liquidity, asset management, debt management, profitability, and market value. Retained earnings management is not a recognized category of ratios.

Question 2

The statement, "you can't know where you're going 'till you know where you came from," means that the past, with consideration of current information, is usually one of the best indicators of the firm's future performance.

Accepted Answer

Knowing the history and past performance of a firm can help in making informed decisions about its future performance. Understanding the patterns, trends, and successes/failures of the past can provide valuable insights into how the firm may perform in the future. Therefore, the statement is true.

Question 3

If a firm has a large quantity of depreciation expense on its income statement, one would expect:

Accepted Answer

Depreciation expense is a non-cash expense that reduces net income but does not actually require a cash outflow. Therefore, if a firm has a large quantity of depreciation expense on its income statement, its TIE ratio (which measures the ability to cover interest expense with operating income) will be lower than its cash coverage ratio (which measures the ability to cover all fixed charges, including interest and principal payments, with operating cash flow).

Question 4

If a firm has no debt, then ROA is ____ ROE.

Accepted Answer

If a firm has no debt, then ROE will be equal to ROA since there is no interest expense to deduct from the profits before calculating ROE. Therefore, both return measures will have the same value.

Question 5

If a firm's current ratio less quick ratio is 1.0, then:

Accepted Answer

The current ratio minus the quick ratio equals the inventory divided by current liabilities. If this difference is 1.0, it implies that the inventory is equal to the current liabilities.

Question 6

Cash flow from operating activities is increased by:

Accepted Answer

An increase in accounts payable represents an increase in the amount of money owed to suppliers for goods or services received on credit. Since this represents an increase in the company's liabilities, it is a source of cash and increases cash flow from operating activities.

A) represents a use of cash as an increase in accounts receivable means that the company has not yet received payment for goods or services sold, and is waiting for payment from customers. 
B) represents a use of cash as an increase in inventory means the company has spent cash to purchase more inventory. 
C) does not directly impact cash flow from operating activities as depreciation is a non-cash expense that only impacts net income.

Question 7

If a firm increases its leverage, which extended Du Pont equation ratio is most directly affected?

Accepted Answer

The equity multiplier directly reflects the amount of leverage a firm is using to finance its operations. A higher equity multiplier indicates that the firm is relying more heavily on debt to fund its assets, which increases its financial risk. As a result, increasing leverage will impact the equity multiplier the most. The other ratios in the extended Du Pont equation (ROS, ROA, and total asset turnover) are not directly related to leverage.

Question 8

If a firm has an ROA of 5% and desires an ROE of 10%, what debt-to-equity ratio will accomplish this?

Accepted Answer

The formula for ROE is ROA * (1 + Debt/Equity). To achieve an ROE of 10% with an ROA of 5%, the equation is 10% = 5% * (1 + Debt/Equity). Solving for Debt/Equity gives 1.00.

Question 9

Average inventory is $25,000, sales is $250,000, gross margin is 40% of sales, and net income is $35,000. The most meaningful calculation of inventory turnover results in an inventory turns figure of:

Accepted Answer

The answer of Average inventory is $25,000, sales is $250,000,...

Question 10

If the current ratio is below one then:

Accepted Answer

The current ratio is calculated as current assets divided by current liabilities. A ratio below one indicates that current liabilities exceed current assets. This suggests that the entity may have difficulty meeting its current obligations and could potentially face financial distress. Since net working capital is calculated as current assets minus current liabilities, a current ratio below one suggests that net working capital is negative or less than zero. Therefore, the correct answer is D.

Question 11

Because the statement of cash flows derives its information from the balance sheets of the firm, it can be referred to more formally as the statement of changes in net working capital.

Accepted Answer

The statement of cash flows is a separate financial statement that reports a company's cash inflows and outflows during a specific period of time, as opposed to changes in net working capital. While the statement of cash flows may use information from the balance sheet, it is not the same as the statement of changes in net working capital.

Question 12

A firm has current liabilities of $200,000, long term debt of $500,000, and equity of $1,200,000. Its debt ratio is_____.

Accepted Answer

Debt ratio = (Current liabilities + Long term debt) / Total assets= (200,000 + 500,000) / (200,000 + 500,000 + 1,200,000)= 700,000 / 1,900,000= 0.37

Question 13

The quick ratio is the same as current ratio except it does not consider:

Accepted Answer

The quick ratio is a measure of a company's liquidity and ability to meet short-term obligations. It is calculated by subtracting inventory and prepaid expenses from current assets and then dividing by current liabilities. The purpose of subtracting inventory is to provide a more conservative measure of a company's ability to pay its debts quickly. Therefore, the correct answer is D - inventory.

Question 14

Which of the following is not affected by a change in interest expenses?

Accepted Answer

Gross margin and EBIT are not affected by a change in interest expenses. Gross margin is calculated as revenue minus cost of goods sold, regardless of interest expenses. EBIT (earnings before interest and taxes) is also calculated before interest expenses are deducted. A and B are affected by interest expenses because both gross margin and ROE (return on equity) include net income, which is reduced by interest expenses. C is affected by interest expenses because EBIT (earnings before interest and taxes) is reduced by interest expenses to calculate EBT (earnings before taxes).

Question 15

Henderson Inc. is forecasting sales of $24,000. What ACP must it achieve to keep its receivables at about $1,000?

Accepted Answer

The answer of Henderson Inc. is forecasting sales of $24,000....

Question 16

_____ ratios measure the ability to meet short-term financial obligations.

Accepted Answer

Liquidity ratios measure the ability of a company to meet short-term financial obligations and include ratios such as current ratio and quick ratio. Asset ratios measure how efficiently a company is utilizing its assets, profitability ratios measure a company's ability to generate profits, and market ratios measure a company's market value and investor sentiment.

Question 17

Both accounting and finance are concerned primarily with the creation of financial statements and their use as tools for evaluating the firm's future prospects.

Accepted Answer

Accounting focuses on the creation of financial statements, while finance uses these statements to evaluate and make decisions about the firm's future prospects.

Question 18

A major responsibility of the financial analyst is to gather information about a firm in order to predict its performance.

Accepted Answer

Gathering information and analyzing data is a crucial part of a financial analyst's job, as their assessments are used to predict and evaluate a company's performance.

Question 19

If a firm increases its leverage, which extended Du Pont equation ratio is directly affected?

Accepted Answer

The equity multiplier, which measures the amount of debt a company uses to finance its assets, is directly affected by changes in leverage. Increasing leverage by taking on more debt will increase the equity multiplier, allowing the firm to potentially earn greater returns on equity. Therefore, the correct answer is B) Equity Multiplier.

Question 20

An equity multiplier of 3 implies a debt ratio of:

Accepted Answer

Equity multiplier = Total assets / Total equity
Let the debt ratio be x, then the equity multiplier = (Total assets / Total equity) = (Total assets / Total assets - Total Debt) = 1 + (Total debt / Total equity) = 1 + Debt ratio
Hence, 3 = 1 + Debt ratio
Debt ratio = 3 - 1
Debt ratio = 2
Therefore, the debt ratio is 2/3 or 66.67%. Hence, the correct choice is B.

Quiz 3: Cash Flows and Financial Analysis