Question 1

A firm wants to strengthen its financial position. Which of the following actions 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

Issuing new stock increases cash, which increases current assets, thus increasing the current ratio. Purchasing inventory also increases current assets, further improving the current ratio.

Question 2

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

The answer of Which of the following statements is correct?
A)...

Question 3

If a bank loan officer were considering a company's request for a loan, which of the following statements is correct?
A) The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.
B) Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.
C) Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.
D) The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.

Accepted Answer

A lower debt ratio (i.e. less debt relative to assets) indicates lower financial risk for the company, which is attractive to the bank. Therefore, other things held constant, the bank would charge a lower interest rate. The other statements are incorrect - a higher EBITDA coverage ratio and TIE ratio indicate higher ability to cover interest expenses, which would also be attractive to the bank and result in a lower interest rate. A higher debt ratio indicates higher financial risk for the company and would result in a higher interest rate.

Question 4

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 improvement in a company's financial position would be indicated by an increase in the current and quick ratios, as this indicates that the company has a stronger ability to meet short-term obligations. An increase in the debt ratio would indicate an increase in leverage and potential financial risk. A decline in profit margin and EBITDA coverage ratio indicate a decrease in profitability and ability to cover debt obligations, respectively, which would indicate a decline in the company's financial position.

Question 5

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 the most liquid current assets, which are cash and accounts receivable. Inventory is not considered in the quick ratio calculation. Therefore, even if Firm A has a higher inventory than B, it does not necessarily mean that its quick ratio is smaller. It depends on the amount of cash and accounts receivable that each firm has.

Question 6

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

Equity multiplier = Total Asset / Total Equity

3 = Total Asset / Common Equity

Total Asset = 3 * Common Equity

As the firm finances with only debt and common equity,

Total Asset = Total Debt + Common Equity

Substituting Total Asset:

3 * Common Equity = Total Debt + Common Equity

2 * Common Equity = Total Debt

Debt ratio = Total Debt / Total Asset

Debt ratio = (2 * Common Equity) / (3 * Common Equity)

Debt ratio = 0.667

Question 7

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 8

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 Firm A has a higher leverage ratio, which means it is financing more of its assets with debt. As long as its BEP is greater than the interest rate on its debt, the additional debt will amplify its return on equity (ROE). However, if BEP is less than the interest rate on debt, the additional debt will depress its ROE.

Question 9

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 current ratio and quick ratio measure different aspects of a company's liquidity. It's possible for Firm A to have a higher quick ratio than Firm B while still having a lower current ratio, as these ratios consider different sets of assets in their calculations. The quick ratio excludes inventory and other less liquid current assets, focusing on those assets that can be quickly converted to cash.

Question 10

A firm's new president wants to strengthen the company's financial position. Which of the following actions 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 would increase the company's profitability and financial position. Increasing accounts receivable, accounts payable, or notes payable would increase the company's liabilities and potentially lead to cash flow problems.

Question 11

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. Which of the following effects would occur as a result of this action?
A) The company's current ratio increased.
B) The company's times-interest-earned ratio decreased.
C) The company's basic earning power ratio increased.
D) The company's equity multiplier increased.

Accepted Answer

Paying off short-term notes payable with the proceeds from issuing new common stock would reduce the company's liabilities and increase its equity, which would increase the current ratio (current assets/current liabilities). However, it would have no effect on the company's times-interest-earned ratio (which measures the company's ability to meet its interest payments), basic earning power ratio (which measures the company's ability to generate earnings from its total assets), or equity multiplier (which measures the company's financial leverage or how much debt is used to finance assets).

Question 12

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 13

Which of the following statements best describes window dressing?
A) Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of window dressing.
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 is an example of window dressing.
C) Using some of the firm's cash to reduce long-term debt is an example of window dressing.
D) Window dressing is 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 to make financial statements appear more attractive, often temporarily. Borrowing long-term to retire short-term debt can improve the current ratio, making the company's liquidity appear better, which is a form of window dressing.

Question 14

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

The firm can use the following formula to calculate the sales required to achieve its target TIE ratio:
Sales = (Interest Expense / (1 - Tax Rate)) / TIE Ratio + Operating Costs

Question 15

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 ratios and profit margins are not directly correlated in this manner. A firm 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. The conditions described do not inherently lead to a correlation between profit margins and asset turnover ratios.

Question 16

Which of the following statements best describes inventories?
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

Inventories are the goods that a company produces or purchases to sell to customers. The inventory turnover ratio measures how efficiently a company is selling its inventory by comparing its sales to the amount of inventory it holds. Therefore, if a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.

Question 17

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. Increasing accounts receivable (a current asset) would increase the numerator of the ratio, while keeping the denominator constant, resulting in an increase in the current ratio. Increases in net fixed assets, accrued liabilities, and notes payable would not directly impact the current ratio.

Question 18

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 19

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.
B) Company E is probably judged by investors to be riskier.
C) Company E must pay a lower dividend.
D) Company E trades at a higher P/E ratio.

Accepted Answer

If two companies have the same EPS but one trades at a higher price, it means that investors are willing to pay more for each dollar of earnings from that company. This implies that Company E has a higher P/E ratio than Company P, indicating that investors are willing to pay more for its growth prospects. Therefore, option D is the correct answer. Options A, B, and C are not necessarily true based on the given information.

Question 20

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 be likely to cause the manager to receive 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

A higher basic earning power ratio indicates that the division is generating higher profits relative to its assets, which is a good indicator of successful management.

Quiz 3: Analysis of Financial Statements

A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?

Which of the following statements is correct?

If a bank loan officer were considering a company's request for a loan, 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?

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.

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.

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.

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.

A firm's new president wants to strengthen the company's financial position. Which of the following actions 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. Which of the following effects would occur as a result of this action?

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

Which of the following statements best describes window dressing?

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.

Which of the following statements best describes inventories?

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

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.

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?

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 be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant.