Question 1

Leverage measures:

Accepted Answer

Leverage measures the proportion of borrowed funds compared to equity, which indicates the extent to which a company is relying on borrowed money to finance its operations. It is a measure of the company's financial risk, as high leverage increases the company's vulnerability to changes in interest rates or economic downturns. This measure is commonly used in financial analysis to evaluate a company's financial health and its ability to manage its debt obligations.

Question 2

Kaplan has a current ratio of 2.5 to 1 and current liabilities of $12 000. If Kaplan has $9000 of inventory what is the quick ratio?

Accepted Answer

Quick ratio excludes inventory from current assets, so we need to subtract the inventory from the numerator. 
Quick ratio = (Current assets - Inventory) / Current liabilities
Quick ratio = ($9000) / $12 000
Quick ratio = 0.75
Quick ratio = 1.75 to 1 (rounded to the nearest hundredth)

Question 3

An increase in the inventory turnover ratio is normally considered to be favourable but could be unfavourable if it means:

Accepted Answer

An increase in inventory turnover ratio means that inventory is being sold and restocked more frequently, which could be indicative of a higher demand for the products. However, if the firm is not carrying enough inventory to meet its customer's needs, this could result in lost sales and dissatisfied customers. Therefore, an increase in the inventory turnover ratio could be unfavourable if it means the firm is not carrying enough inventory to meet demand.

Question 4

All of these are limitations of financial ratio analysis except:

Accepted Answer

Excessive information disclosed in company annual reports is not a limitation of financial ratio analysis, but rather an advantage as it provides the necessary data to perform the analysis. The other three options are valid limitations of financial ratio analysis.

Question 5

Which statement concerning the current (working capital) ratio is incorrect?

Accepted Answer

The statement "A current ratio of $1.50 of current assets for each $1 of current liabilities should always be maintained" is incorrect. While it is generally desirable to have a current ratio above 1, there is no specific number that must always be maintained. The appropriate current ratio will vary depending on the industry, the specific company, and the economic environment.

Question 6

Which statement relating to the debt ratio of a company is not true?

Accepted Answer

A higher level of debt is not normally preferable from a creditor's point of view as it increases the risk of default on the debt. A lower debt ratio is generally considered better as it indicates that the company has a lower level of financial leverage and is less risky.

Question 7

Which P/E ratios and earnings yields do not match?

Accepted Answer

Earnings yield is calculated as the inverse of the P/E ratio, expressed as a percentage. For choice C, with a P/E ratio of 9, the earnings yield should be 1/9 = 11.11%, not 12%.

Question 8

A company has a current ratio of 3:1. Which action will decrease this ratio?

Accepted Answer

Declaration of a dividend will decrease the current assets (cash) and therefore decrease the current ratio.

Question 9

The quick ratio (acid test ratio) reflects:

Accepted Answer

The quick ratio (acid test ratio) reflects the belief that not all current assets can be liquidated immediately. It measures the ability of a company to meet its short-term obligations with its most liquid assets (cash, marketable securities, and accounts receivable) while excluding inventory, which may not be easily convertible to cash. This ratio is used to evaluate a company's short-term liquidity and its ability to pay its current liabilities without relying on inventory sales.

Question 10

Accepted Answer

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Question 11

Accepted Answer

Without any further information, the best choice is to pick the option with the highest percentage, which is 60% (choice C).

Question 12

Financial stability refers to the ability of an entity to:

Accepted Answer

Financial stability involves the ability to meet long-term obligations, ensuring that an entity can sustain its operations and obligations over time.

Question 13

If the average market price of Silver Bling Ltd's shares is $3.50 and earnings per ordinary share are 70c the P/E ratio is:

Accepted Answer

P/E ratio is calculated by dividing the market price per share by earnings per share. So, P/E ratio = 3.5/0.7 = 5.0. Therefore, the answer is C.

Question 14

Which statement concerning the cash flow adequacy ratio is not correct?

Accepted Answer

A ratio of 100% or more over several years indicates an excess of operating cash flow. Therefore, it would indicate an adequate ability to generate operating cash to cover requirements, not an inadequate ability as stated in option C.

Question 15

When calculating the quick (acid test) ratio, which of these is normally deducted from current assets?

Accepted Answer

The quick (acid test) ratio is a measure of a company's ability to meet its short-term financial obligations. To calculate the quick ratio, inventory and prepaid expenses are normally deducted from current assets as they are not easily convertible to cash. The remaining amount is then divided by current liabilities to arrive at the ratio.

Question 16

Of the following firms, would be expected to have the fastest inventory turnover?

Accepted Answer

A fruit and vegetable shop sells perishable goods and has a high demand for fresh produce, so it is expected to have a high inventory turnover. Sports car showrooms and jewellery stores sell expensive goods that are not frequently purchased, leading to low inventory turnover. Clothing stores may have a moderate inventory turnover rate, depending on the frequency of new clothing releases and trends.

Question 17

Dividend yield on ordinary shares is calculated as:

Accepted Answer

Dividend yield is calculated by dividing the dividend per share by the market price per share. This ratio expresses the amount of income earned per share relative to the price per share.

Question 18

Cash flows from operating activities divided by (repayments of long-term borrowings + assets acquired + dividends paid) is the formula for:

Accepted Answer

The formula given is for cash flow adequacy ratio, which is a measure of a company's ability to generate enough cash flow to cover its debt servicing obligations and other investing or financing activities.

Question 19

The ratio which would be most helpful to an investor who is investing in ordinary shares primarily for dividends rather than for appreciation in market price, is:

Accepted Answer

The dividend yield represents the amount of dividends paid per share relative to the market price of the share. This ratio is particularly helpful for investors who prioritize dividend income over capital appreciation.

Question 20

Buyer Co has ordered goods on credit from Seller Co. Before Seller ships the goods it would like to be sure that Buyer will be able to pay for them within the normal credit period. Assuming Seller has access to Buyer's financial statements, in which of the following ratios will Seller be most interested?

Accepted Answer

Seller will be most interested in the current ratio, as it measures Buyer's ability to meet its short-term obligations (including payment for the goods being ordered) with its current assets. The higher the current ratio, the better the indication of Buyer's ability to pay its debts on time. Dividend yield ratio and price earnings ratio are more relevant for equity investors and are not relevant for assessing creditworthiness. The debt ratio measures the extent to which a company is financed with debt instead of equity and does not necessarily indicate its ability to pay its debts in a timely manner.

Quiz 25: Analysis and Interpretation of Financial Statements