1) In words, an equity multiplier of 2 means that for every $1:


 William Webster
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1 Questions in [New Questions] 1) In words, an equity multiplier of 2 means that for every $1: [A] of debt, a firm has $2 in equity. [B] in equity, a firm has $2 in debt. [C] in assets, a firm has $2 in equity. [D] in equity, a firm has $2 in assets. [E] in equity, a firm has $2 in net income. [A] :What is the relationship between the debtequity ratio and the equity multiplier? Review section 3.3. [B] :What is the relationship between the debtequity ratio and the equity multiplier? Review section 3.3 [C] :You have this reversed. Review section 3.3 [E] :Net income is not related to the equity multiplier. Review section ) When the inventory turnover rate increases, the number of days it takes to sell inventory also increases. [A] :An increase in the inventory turnover rate decreases the number of days in inventory. Review section ) Which one of the following is a financing activity on a typical statement of cash flows? [A] change in longterm debt [B] change in accounts payable [C] change in accounts receivable [D] change in net fixed assets [E] net income [B] :This is an operating activity. Review section 3.1. [C] :This is an operating activity. Review section 3.1. [D] :This is an investment activity. Review section 3.1. [E] :This is an operating activity. Review section ) All else equal, return on equity will increase if the: [A] profit margin decreases. [B] return on assets increases. [C] debtequity ratio decreases. [D] accounts receivable turnover increases. [E] total asset turnover decreases. [A] :This will decrease, not increase the return on equity. Review section 3.4. [C] :This will decrease, not increase the return on equity. Review section 3.4. [D] :This is not a component of return on equity. Review section 3.4.
2 [E] :This will decrease, not increase, the return on equity. Review section ) Asset utilization ratios are intended to measure how efficiently or intensively a firm uses its assets to generate sales. [B] :This is the purpose of asset utilization ratios. Review section ) Which of the following are correct statements about the priceearnings ratio? I. A high P/E ratio is often assumed to mean the firm has significant prospects for future growth. II. A P/E ratio of 15 means investors are willing to pay $15 for each $1 of current earnings. III. Care must be taken in interpreting very high P/E ratios since they can result from a firm having very low earnings. IV. A firm with high earnings per share must also have a very high P/E ratio. [A] I and II only [B] II and III only [C] I, II, and III only [D] I, II, and IV only [E] I, II, III, and IV [A] :Correct, but there's also one more. Review section 3.3. [B] :Correct, but there's also one more. Review section 3.3. [D] :One of these is incorrect. Review section 3.3. [E] :One of these is incorrect. Review section ) Total asset turnover is one component of the Du Pont identity. [B] :What are the three components of the Du Pont identity? Review section ) Which one of the following is frequently used as a measure of the cash flow available to meet the financial obligations of a firm? [A] earnings before taxes [B] earnings before taxes and depreciation [C] earnings before interest, taxes, and depreciation [D] net income [E] taxable income [A] :You are missing some components. Review section 3.3. [B] :You are missing one more component. Review section 3.3. [D] :Does depreciation affect cash flow? Review section 3.3.
3 [E] :This is incorrect. Review section ) What does the fixed asset turnover ratio measure? [A] how well total assets are utilized during a year [B] the length of time it takes a firm to completely replace its fixed assets [C] the amount of net income a firm generates per dollar of fixed assets [D] the percent of total assets that are invested in fixed assets [E] the amount of sales each dollar of fixed assets generates [A] :Fixed assets are only a part of total assets. Review section 3.3. [B] :The length of time is not measured by the fixed asset turnover ratio. Review section 3.3. [C] :Net income is not a part of the fixed asset turnover. Review section 3.3. [D] :This is a part of a commonsize balance sheet, but not the fixed asset turnover ratio. Review section ) Which one of the following is a financing activity on a typical statement of cash flows? [A] depreciation [B] change in net fixed assets [C] change in inventory [D] change in accounts payable [E] dividends paid [A] :This is an operating activity. Review section 3.1. [B] :This is an investment activity. Review section 3.1. [C] :This is an operating activity. Review section 3.1. [D] :This is an operating activity. Review section ) The Du Pont identity decomposes return on equity into the profit margin, total asset turnover, and the current ratio. [A] :The current ratio is not a part of the Du Pont identity. Review section ) A firm has return on equity of 15 percent, earnings before taxes of $30,000, total asset turnover of.80, a profit margin of 4.5 percent, and a tax rate of 35 percent. What is the return on assets? [A] 3.6 percent [B] 3.9 percent [C] 5.7 percent [D] 6.4 percent [E] 9.3 percent [B] :How can you use the Du Pont identity to solve this problem? Review section 2.4.
4 [C] :How can you use the Du Pont identity to solve this problem? Review section 2.4. [D] :How can you use the Du Pont identity to solve this problem? Review section 2.4. [E] :How can you use the Du Pont identity to solve this problem? Review section ) Which of the following definitions are correct? I. The statement of cash flows summarizes the sources and uses of cash over a specified time period. II. A commonsize statement is a standardized financial statement presenting all items in percentage terms. III. A commonbase year statement expresses current values in terms of the base year values. IV. Financial ratios are relationships determined from a firm's financial information and used for comparison purposes. [A] I and II only [B] II and III only [C] I and IV only [D] I, II, and III only [E] I, II, III, and IV [A] :Correct, but there is at least one more correct option. Review sections 3.2 and 3.5. [B] :Correct, but there is at least one more correct option. Review sections 3.1 and 3.5. [C] :Correct, but there is at least one more correct option. Review section 3.2. [D] :Almost, but you need to add the last option also. Review section ) Which one of the following is a measure of financial leverage? [A] equity multiplier [B] profit margin [C] current ratio [D] total asset turnover [E] return on equity [B] :This is a measure of profitability. Review section 3.3. [C] :This is a measure of liquidity. Review section 3.3. [D] :This is a measure of asset utilization. Review section 3.3. [E] :This is a measure of profitability. Review section ) The current ratio is also known as the acidtest ratio. [A] :The quick ratio is known as the acidtest ratio. Review section 3.3 to find out why. 16) If a firm has only current assets and no fixed assets of any kind, its times interest earned ratio must exceed its cash coverage ratio.
5 [A] :With no fixed assets, depreciation will be zero and the ratios will be identical. Review section ) Tron, Inc. has a times interest earned ratio of 4.0. Based on this ratio, a creditor knows that Tron's EBIT must decline by more than before Tron will be unable to cover its interest expense. [A] 33 percent [B] 40 percent [C] 67 percent [D] 75 percent [E] 80 percent [A] :Suppose EBIT is $400 and interest expense is $100. By what percentage must EBIT decline to become $100? Review section 3.3. [B] :Suppose EBIT is $400 and interest expense is $100. By what percentage must EBIT decline to become $100? Review section 3.3. [C] :Suppose EBIT is $400 and interest expense is $100. By what percentage must EBIT decline to become $100? Review section 3.3. [E] :Suppose EBIT is $400 and interest expense is $100. By what percentage must EBIT decline to become $100? Review section ) An increase in which one of the following accounts is a source of cash? [A] cash [B] fixed assets [C] accounts payable [D] salary expense [E] inventory [A] :An increase in an asset account, including the cash account, is a use of cash. Review section 3.1. [B] :Do you spend or receive cash when you purchase new equipment? Review section 3.1. [D] :Don't you use cash when you pay employees their salary? Review section 3.1. [E] :Do you spend or receive cash when you purchase inventory? Review section ) While financial statements have many uses outside of the company, they are not useful internally. [A] :It can be used in evaluating the performance of a manager or a company division. Review section ) ratios are designed to determine a firm's longrun ability to meet its obligations.
6 [A] Liquidity [B] Assetutilization [C] Profitability [D] Financial leverage [E] Market value [A] :These are a measure of shortrun, not longrun solvency. Review section 3.3. [B] :These measure how a firm utilizes its assets. Review section 3.3. [C] :These measure how efficiently a firm uses its assets to generate profits. Review section 3.3. [E] :These measure investors' perceptions of company performance, not the firm's longrun ability to meet its obligations. Review section ) A commonbase year statement is a standardized financial statement presenting all items relative to their respective baseyear amounts. [B] :You need to review the construction of these statements in section ) Which one of the following actions will increase a firm's current ratio if the ratio is presently 1.5? [A] discarding and writing off spoiled inventory [B] receiving full payment on an account receivable [C] paying off a shortterm bank loan with the proceeds from new longterm debt [D] purchasing new fixed assets using the proceeds from a new issue of common stock [E] buying inventory on credit [A] :This would reduce both inventory and the current ratio. Review section 3.3. [B] :Will this change current assets? Review section 3.3. [D] :Will either current assets or current liabilities change? Review section 3.3. [E] :Because the current ratio is presently greater than one, this action would reduce the current ratio, not increase it. Review section ) The days' sales in receivables ratio measures the: [A] average percentage of total daily sales that are credit sales. [B] average number of days it takes to collect payment from a credit customer. [C] average number of days it takes for a firm to pay its' suppliers. [D] number of times during the year that a firm collects and reloans its receivables. [E] number of days it takes before a firm uses all of its' working capital. [A] :You are confused. Review section 3.3. [C] :You are confusing receivables and payables. Review section 3.3. [D] :What is the receivables turnover ratio? Review section 3.3. [E] :How is this related to collecting payment from a customer? Review section 3.3.
7 24) If the total assets of a firm decrease while all other components of ROE remain unchanged, you would expect the firm's: [A] ROE to increase. [B] ROA to decrease. [C] equity multiplier to increase. [D] ROE to remain unchanged. [E] profit margin to decrease. [A] :The total asset turnover will increase and the equity multiplier will decrease by exactly offsetting amounts. Review section 3.4. [B] :If a denominator declines won't the ratio increase? Review section 3.4. [C] :The equity multiplier will decrease. Review section 3.4. [E] :The profit margin is unaffected by a change in assets. Review section ) If a firm has a current ratio of 2 and a quick ratio of 1, then inventory must equal half of the total current assets. [B] :Assume current assets are $200, inventory is $100 and current liabilities are $100. What are the current and the quick ratios? What is the relationship between the inventory and the current assets? Review section ) Of the ratios below, the best overall measure of management's ability to judge the creditworthiness of the customers it chooses to extend trade credit to is the: [A] priceearnings ratio. [B] average collection period. [C] total capitalization ratio. [D] inventory turnover ratio. [E] equity multiplier. [A] :How does this relate to extending credit to customers? Review section 3.3. [C] :How does this relate to extending credit to customers? Review section 3.3. [D] :How does this relate to extending credit to customers? Review section 3.3. [E] :How does this relate to extending credit to customers? Review section ) Which one of the following is a use of cash? [A] decrease in fixed assets [B] decrease in accounts receivable [C] increase in accounts payable [D] decrease in inventory [E] decrease in longterm debt [A] :A decrease in an asset is a source of cash. Review section 3.1. [B] :A decrease in an asset is a source of cash. Review section 3.1.
8 [C] :An increase is a liability is a source of cash. Review section 3.1. [D] :A decrease in an asset is a source of cash. Review section ) Total debt plus total equity is the same thing as total capitalization. [A] :Total capitalization includes only longterm debt, not total debt. Review section ) Which of the following statements are correct? I. According to the Du Pont identity, ROE is affected by operating efficiency, asset use efficiency, and financial leverage. II. It is easy to evaluate a firm by comparing its financial ratios to those of a peer group identified strictly by using standard industrial classification codes. III. Asset utilization ratios measure the intensity and efficiency of asset use. IV. For commonsize statements, you express asset and liability accounts as a percentage of total assets. [A] III and IV only [B] I and III only [C] II, III, and IV only [D] I, III, and IV only [E] I, II, III, and IV [A] :There is another correct statement also. Review section 3.4. [B] :There is another correct statement also. Review section 3.2. [C] :One of these statements is false. Review section 3.5. [E] :One of these statements is false. Review section ) Which of the following are considered sources of cash? I. decrease in common stock II. increase in accounts payable III. decrease in accounts receivable IV. increase in inventory [A] I and II only [B] II and III only [C] III and IV only [D] I, II, and III only [E] I, II, III, and IV [A] :One of these is a use of cash. Review section 3.1. [C] :One of these is a use of cash. Review section 3.1. [D] :At least one of these is a use of cash. Review section 3.1. [E] :At least one of these is a use of cash. Review section 3.1.
9 31) Which of the following statements are true concerning accounting values versus market values? I. The primary reason for using accounting values is the lack of readily available market values. II. Accounting values more accurately reflect the current value of a firm than do market values. III. If market values and accounting values conflict, the accounting values should be given precedence. IV. If a firm has only current assets and current liabilities, accounting values and market values will tend to be very similar. [A] I and III only [B] I and IV only [C] I and II only [D] II, III, and IV only [E] I, III, and IV only [A] :Why should historical costs take precedence over current market values? Review section 3.5. [C] :Why do historical costs reflect current values? Review section 3.5. [D] :Why should historical costs take precedence over current market values? Review section 3.5. [E] :Why should historical costs take precedence over current market values? Review section ) CatchaTan Co. had net sales of $900,000 and average accounts receivables of $60,000 last year. How long on average does it take their credit customers to pay their bills? [A] 6.0 days [B] 15.0 days [C] 15.3 days [D] 24.0 days [E] 24.3 days [A] :This is incorrect. Review section 3.3. [B] :Is this the turnover rate or the number of days? Review section 3.3. [C] :You are confused. Review section 3.3. [D] :Do you use a 360 or a 365 day year in the computation? Review section ) Which one of the following types of ratios is most apt to reveal a firm's inability to control operating expenses? [A] liquidity [B] profitability [C] market value [D] asset utilization [E] longterm solvency [A] :How do liquidity ratios reflect operating expenses? Review section 3.3. [C] :How do market value ratios reflect operating expenses? Review section 3.3. [D] :How do asset utilization ratios reflect operating expenses? Review section 3.3. [E] :How do longterm solvency ratios reflect operating expenses? Review section 3.3.
10 34) A company has sales of $300, costs of goods sold of $150, other costs of $90, depreciation of $35, and taxes of $10. What is the profit margin? [A] 3 percent [B] 5 percent [C] 8 percent [D] 10 percent [E] 15 percent [A] :Did you get net income of $15? Review section 3.3. [C] :Did you get net income of $15? Review section 3.3. [D] :Did you get net income of $15? Review section 3.3. [E] :Did you get net income of $15? Review section ) Which of the following factors make it difficult to perform financial statement analysis? I. Many firms are conglomerates with diverse operations. II. The financial statements of firms outside the US do not necessarily conform to GAAP. III. Firms may use different accounting procedures for inventory and depreciation. IV. Firms with seasonal operations may have differing fiscal years. [A] II and III only [B] I and IV only [C] I, III, and IV only [D] I, II, and III only [E] I, II, III, and IV [A] :These are only some of the factors making financial statement analysis difficult. Review section 3.5. [B] :These are only some of the factors making financial statement analysis difficult. Review section 3.5. [C] :These are only some of the factors making financial statement analysis difficult. Review section 3.5. [D] :These are only some of the factors making financial statement analysis difficult. Review section ) The sales of Ace Sporting Goods have increased recently and inventory has declined slightly. All else equal, a financial analyst would expect to find that: [A] both the inventory turnover and the days' sales in inventory have increased. [B] both the inventory turnover and the days' sales in inventory have decreased. [C] the inventory turnover has increased while the days' sales in inventory have decreased. [D] the current ratio has increased. [E] the interval measure has increased. [A] :How can the number of days increase when you sell inventory faster? Review section 3.3. [B] :These are conflicting results. Review section 3.3. [D] :If all else is equal, then less inventory means less current assets. Review section 3.3. [E] :If all else is equal, then less inventory means less current assets. Review section 3.3.
11 37) Which of the following are uses of cash? I. increase in accounts receivable II. decrease in accounts payable III. increase in common stock IV. decrease in fixed assets in excess of the annual depreciation [A] I and IV only [B] II and III only [C] I and II only [D] I and III only [E] II, III, and IV only [A] :One of these is incorrect. Review section 3.1. [B] :One of these is incorrect. Review section 3.1. [D] :One of these is incorrect. Review section 3.1. [E] :At least one of these is incorrect. Review section ) The quick ratio: [A] considers all assets and liabilities with a life of one year or less. [B] incorporates all current assets except inventory. [C] excludes only the cash account from current assets in its computation. [D] will always be larger than the current ratio. [E] compares total assets minus inventory to total liabilities. [A] :This would include inventory, which is incorrect. Review section 3.3. [C] :The cash account is included in the quick ratio. Review section 3.3. [D] :No, it is generally smaller than the current ratio. Review section 3.3. [E] :Are longterm assets and liabilities included in the quick ratio? Review section ) A firm has net income of $390, interest expense of $40, and depreciation of $50. The corporate tax rate is 35 percent. What is the cash coverage ratio? [A] 9.75 [B] [C] [D] [E] [A] :The first step is to compute taxable income. Did you get $600 for this? Review section 3.3. [B] :The first step is to compute taxable income. Did you get $600 for this? Review section 3.3. [C] :Are you confusing net income with EBIT? Review section 3.3 [D] :The first step is to compute taxable income. Did you get $600 for this? Review section ) The profit margin appears on a commonsize income statement.
12 [B] :The profit margin is net income divided by sales. Review sections 3.2 and ) Vendors providing trade credit to a firm tend to be most interested in the firm's: [A] liquidity ratios. [B] profitability ratios. [C] market value. [D] asset utilization. [E] financial leverage. [B] :How do profitability ratios measure the ability of a firm to pay its shortterm debts? Review section 3.3. [C] :How does the market value of a firm measure the ability of the firm to pay its shortterm debts? Review section 3.3. [D] :Asset utilization ratios do not measure the ability of a firm to pay its shortterm debts. Review section 3.3. [E] :Is financial leverage related to the ability to pay shortterm debt? Review section ) Which of the following are directly incorporated into the calculation of the Du Pont identity? I. debtequity ratio II. equity multiplier III. total asset turnover IV. profit margin [A] I and III only [B] II and III only [C] I, II, and III only [D] I, III, and IV only [E] II, III, and IV only [A] :Only one of these is included in the Du Pont identity. Review section 3.4. [B] :Correct, but there is a third part also. Review section 3.4. [C] :One of these three is incorrect. Review section 3.4. [D] :One of these three is incorrect. Review section ) Market value ratios are measures of financial performance that can only be computed for publicly traded companies. [B] :Only publicly traded companies have an observable stock price. Review section ) Which of the following are measures of profitability? I. return on assets
13 II. return on equity III. priceearnings ratio IV. profit margin [A] I and II only [B] II and III only [C] I and IV only [D] I, II, and IV only [E] I, II, III, and IV [A] :Correct, but there's at least one more. Review section 3.3. [B] :One of these is incorrect. Review section 3.3. [C] :Why isn't the return on equity considered a measure of profitability as well? Review section 3.3. [E] :At least one of these is incorrect. Review section ) Longterm solvency ratios are intended to address a firm's ability to meet its financial obligations over the next twelve months. [A] :These ratios deal with the long run, not the short run. Review section ) In a commonsize income statement, all accounts are expressed as a percentage of: [A] net income. [B] sales. [C] operating cash flow. [D] net income less dividends paid. [E] cost of goods sold. [A] :You need to review commonsize statements in section 3.2. [C] :You need to review commonsize statements in section 3.2. [D] :You need to review commonsize statements in section 3.2. [E] :You need to review commonsize statements in section ) In a commonsize statement, income statement accounts are expressed as a percentage of: [A] sales. [B] EBIT. [C] EBIT plus depreciation. [D] net income less dividends paid. [E] cost of goods sold. [B] :Is this expressed as 100 percent on a commonsize income statement? Review section 3.2. [C] :Is this expressed as 100 percent on a commonsize income statement? Review section 3.2.
14 [D] :Is this expressed as 100 percent on a commonsize income statement? Review section 3.2. [E] :Is this expressed as 100 percent on a commonsize income statement? Review section ) Commonsize statements are created by: [A] expressing all accounts as a percentage of total assets. [B] dividing asset accounts by total assets, liability accounts by total liabilities, equity accounts by total equity, and income statement accounts by total sales. [C] expressing all accounts as a percentage of sales. [D] expressing each account as a percentage of the prior year's account value. [E] expressing each item on the balance sheet as a percentage of total assets. [A] :Income statement accounts are expressed as a percentage of sales Review section 3.2. [B] :All balance sheet accounts are expressed as a percentage of total assets. Review section 3.2. [C] :Balance sheet accounts are expressed as a percentage of total assets. Review section 3.2. [D] :What is the difference between a commonsize statement and a commonbase statement? Review section ) The return on equity equals the return on assets when the: [A] firm has no longterm debt. [B] firm's debt to equity ratio is equal to one. [C] firm's longterm debt ratio is equal to zero. [D] firm's return on equity is equal to 100 percent. [E] firm's total debt ratio is equal to zero. [A] :If the firm has current liabilities, the ROE will exceed the ROA. Review section 3.3. [B] :In this case, the ROE will exceed the ROA. Review section 3.3. [C] :If the firm has current liabilities the ROE will exceed the ROA. Review section 3.3. [D] :This does not preclude the ROA from being a different amount. Review section ) Jensen's, Inc. has a current ratio of 1.5. This implies that if the firm liquidates its current assets in order to pay off its current liabilities in full, it can sell the current assets for as little as of book value. [A] 15 percent [B] 25 percent [C] 33 percent [D] 67 percent [E] 150 percent [A] :Assume current assets are $150 and current liabilities are $100. $100 is what percentage of $150? Review section 3.3. [B] :Assume current assets are $150 and current liabilities are $100. $100 is what percentage of $150? Review section 3.3. [C] :Assume current assets are $150 and current liabilities are $100. $100 is what percentage of $150? Review section 3.3.
15 [E] :Assume current assets are $150 and current liabilities are $100. $100 is what percentage of $150? Review section ) One of the problems with financial statement analysis is that it s hard to define when a ratio is too high or too low. [B] :This is why benchmarking is an important concept. Review section ) A firm has current liabilities of $250, a current ratio of 1.2, and a quick ratio of How much inventory does this firm have? [A] $45 [B] $50 [C] $100 [D] $120 [E] $200 [A] :Did you get current assets of $300? Review section 3.3. [B] :Did you get current assets of $300? Review section 3.3. [D] :Did you get current assets of $300? Review section 3.3. [E] :Did you get current assets of $300? Review section ) The net change in cash over a period of time is equal to: [A] operating cash flow plus the change in net working capital. [B] the investment activity minus the operating activity. [C] net income plus depreciation, minus taxes and dividends. [D] ending cash minus changes in longterm debt minus additions to fixed assets. [E] cash flow from operating activities plus net cash from investment and financing activities. [A] :You need to review the statement of cash flows in section 3.1. [B] :You need to review the statement of cash flows in section 3.1. [C] :You need to review the statement of cash flows in section 3.1. [D] :You need to review the statement of cash flows in section ) The times interest earned ratio is considered a longterm solvency measure. [B] :This measures the ability of a firm to meet its interest obligations. Review section 3.3.
16 55) A firm. has cost of goods sold of $5,200, net working capital of $120, total current assets of $600, and a quick ratio of 0.8. What are the days' sales in inventory? [A] 12.7 days [B] 15.2 days [C] 17.1 days [D] 19.8 days [E] 22.7 days [A] :Did you use net working capital and the quick ratio to get inventory of $216? Review section 3.3. [C] :Did you use net working capital and the quick ratio to get inventory of $216? Review section 3.3. [D] :Did you use net working capital and the quick ratio to get inventory of $216? Review section 3.3. [E] :Did you use net working capital and the quick ratio to get inventory of $216? Review section ) If a firm uses cash to purchase inventory, its quick ratio will increase. [A] :Inventory is excluded from the quick ratio, so the numerator of the ratio is decreased. Review section ) Which one of the following can be computed with the use of only a balance sheet? [A] interval measure [B] equity multiplier [C] receivables turnover [D] times interest earned [E] return on equity [A] :You need operating costs to compute this. Review section 3.3. [C] :You need sales to compute this. Review section 3.3. [D] :You need EBIT and interest expense to compute this. Review section 3.3. [E] :You need net income to compute this. Review section ) The is a liquidity ratio. [A] return on assets [B] fixed asset turnover [C] cash ratio [D] times interest earned ratio [E] profit margin [A] :This is a profitability ratio. Review section 3.3. [B] :This is an asset utilization ratio. Review section 3.3. [D] :This is a longterm solvency ratio. Review section 3.3.
17 [E] :This is a profitability ratio. Review section ) A total asset turnover of 1.5 means that: [A] for each $1 of sales, a firm has total assets of $1.50. [B] for each $1 of total assets, a firm generates $1.50 in sales. [C] for each $1 of total assets, a firm generates $1.50 in net income. [D] for each $1 of net income, a firm has total assets of $1.50. [E] on average, a firm completely replaces its fixed assets 1.5 times each year. [A] :This statement would be correct if it were reversed. Review section 3.3. [C] :The total asset turnover does not relate assets to net income. Review section 3.3. [D] :The total asset turnover does not relate assets to net income. Review section 3.3. [E] :The total asset turnover does not address the replacement of fixed assets. Review section ) Another name for return on equity is return on total capitalization. [A] :Equity is only a part of total capitalization. Review section ) The interval measure is an example of a ratio. [A] shortterm solvency [B] financial leverage [C] asset utilization [D] profitability [E] market value [B] :The interval measure relates current assets to daily operating costs. Does this relate to financial leverage? Review section 3.3. [C] :The interval measure relates current assets to daily operating costs. Is this an asset utilization ratio? Review section 3.3. [D] :The interval measure relates current assets to daily operating costs. Does this relate to profitability? Review section 3.3. [E] :The interval measure relates current assets to daily operating costs. Does this relate to market value? Review section ) A very shortterm creditor, such as a supplier, is primarily interested in a firm's: [A] current ratio. [B] quick ratio. [C] NWC to total assets ratio. [D] cash ratio. [E] interval measure.
18 [A] :Are suppliers always willing to wait until inventory is sold and the cash is collected before receiving payment? Review section 3.3. [B] :Are your suppliers always willing to wait for you to collect from your customer before paying them? Review section 3.3. [C] :Is this the best indicator of your ability to pay your suppliers promptly? Review section 3.3. [E] :Is this the best indicator of your ability to pay your suppliers promptly? Review section ) It is difficult to compare the financial statements of two firms when the firms use different accounting procedures. [B] :This is one of the problems with financial statement analysis. Review section ) If you want to find out how long it will take before your firm runs out of cash, assuming no additional cash is received, you should look at the: [A] current ratio. [B] quick ratio. [C] cash ratio. [D] net working capital to total assets ratio. [E] interval measure. [A] :Does this consider the daily operating costs? Review section 3.3. [B] :Does this consider the daily operating costs? Review section 3.3. [C] :Does this consider the daily operating costs? Review section 3.3. [D] :Does this consider the daily operating costs? Review section ) In a commonsize statement, the balance sheet is expressed as a percentage of while the income statement is expressed as a percentage of [A] liabilities plus equity; net income. [B] assets; net income. [C] sales; assets. [D] liabilities plus equity; sales. [E] liabilities; sales. [A] :You are only half right. Review section 3.2. [B] :You are only half right. Review section 3.2. [C] :If you reverse the order of your answer, you will be right. Review section 3.2. [E] :You are only half right. Review section ) Which one of the following is a liquidity ratio? [A] return on assets
19 [B] fixed asset turnover [C] quick ratio [D] times interest earned [E] profit margin [A] :This is a profitability ratio. Review section 3.3. [B] :This is an asset utilization ratio. Review section 3.3. [D] :This is a financial leverage ratio. Review section 3.3. [E] :This is a profitability ratio. Review section ) Which one of the following statements is true? [A] The smaller the current ratio, the more liquid the firm. [B] Since inventory is less liquid than the other current assets, it is excluded from the quick ratio. [C] A current ratio greater than one indicates net working capital is negative. [D] In firms that carry an inventory, the quick ratio will always exceed the current ratio. [E] The current ratio is frequently less than zero. [A] :The reverse of this is generally considered true. Review section 3.3. [C] :Do current liabilities exceed current assets when the current ratio is greater than 1? Review section 3.3. [D] :The reverse of this is true. Review section 3.3. [E] :This would require either current assets or current liabilities to be negative. Review section ) Which one of the following correctly identifies the activity categories found on a statement of cash flows? [A] operating, income statement, financing [B] investment, purchasing, operating [C] financing, operating, income statement [D] operating, financing, investment [E] noncash, financing, investment [A] :The income statement is a separate accounting report. Review section 3.1. [B] :There is no purchasing category. Review section 3.1. [C] :The income statement is a separate accounting report. Review section 3.1. [E] :There is no category known as "noncash". Review section ) Which one of the following measures the amount that investors are willing to pay per dollar of earnings for one share of stock? [A] return on equity [B] market to book ratio [C] return on assets [D] price to earnings ratio [E] total asset turnover ratio [A] :Does this consider the market value of a share of stock? Review section 3.3. [B] :Does this include the earnings per share? Review section 3.3.
20 [C] :Does this consider the market value of a share of stock? Review section 3.3. [E] :Does this include either the price of stock or the earnings per share? Review section ) A firm has sales of $500, total assets of $300, and a debtequity ratio of If the return on equity is 15 percent, what is the net income? [A] $7.50 [B] $15.00 [C] $22.50 [D] $32.50 [E] $50.00 [A] :Did you get equity of $100 using the balance sheet identity and the debtequity ratio? Review section 3.3. [C] :Did you get equity of $100 using the balance sheet identity and the debtequity ratio? Review section 3.3. [D] :Did you get equity of $100 using the balance sheet identity and the debtequity ratio? Review section 3.3. [E] :Did you get equity of $100 using the balance sheet identity and the debtequity ratio? Review section ) When you buy inventory with cash, the: [A] quick ratio increases. [B] current ratio decreases. [C] current ratio increases. [D] quick ratio decreases. [E] cash ratio is unchanged. [A] :You have this backwards. Review section 3.3. [B] :Aren't both inventory and cash part of current assets? Review section 3.3. [C] :Aren't both inventory and cash part of current assets? Review section 3.3. [E] :How did you pay for the inventory? Review section ) A firm has sales of $15 million, net income of $1.2 million, retained earnings of $17 million, and total equity of $35 million. What is the return on equity? [A] 2.3 percent [B] 3.4 percent [C] 4.3 percent [D] 8.0 percent [E] 12.9 percent [A] :You need to review this computation in section 3.3. [C] :You need to review this computation in section 3.3. [D] :What is the profit margin ratio? Review section 3.3. [E] :You need to review this computation in section 3.3.
21 73) Which of the following formulas use sales as the numerator? I. accounts receivable turnover II. inventory turnover III. fixed asset turnover IV. accounts payable turnover [A] I and II only [B] I and III only [C] II, III, and IV only [D] I, II, and III only [E] I, III, and IV only [A] :Is inventory more related to sales or cost of goods sold? Review section 3.3. [C] :Are inventory and accounts payable more related to sales or costs of goods sold? Review section 3.3. [D] :Is inventory more related to sales or cost of goods sold? Review section 3.3. [E] :Is accounts payable more related to sales of cost of goods sold? Review section ) TopNotch Limo Corp. has an average collection period of 36.5 days. Sales are $300,000. What is the average accounts receivable balance? [A] $4,441 [B] $8,219 [C] $10,000 [D] $30,000 [E] $36,500 [A] :You need to review this computation in section 3.3. [B] :You need to review this computation in section 3.3. [C] :You need to review this computation in section 3.3. [E] :You need to review this computation in section ) Jorge Corp. has 100,000 shares of common stock outstanding. EBIT is $1 million and interest paid is $200,000. If the corporate tax rate is 34 percent, what are Jorge's earnings per share? [A] $2.72 [B] $3.40 [C] $5.28 [D] $6.60 [E] $10.00 [A] :Did you get net income of $528,000? Review section 3.3. [B] :Did you get net income of $528,000? Review section 3.3. [D] :You appear to be forgetting about interest expense. Review section 3.3. [E] :You are forgetting about interest and tax expenses. Review section ) A firm's accounts receivable declined by $25,000 while cash increased by $25,000. All else equal, the current ratio: [A] increased while the cash ratio decreased.
22 [B] and the cash ratio remained unchanged. [C] decreased while the cash ratio increased. [D] and the cash ratio both increased. [E] remained unchanged while the cash ratio increased. [A] :Did cash decrease? Review section 3.3. [B] :Is accounts receivable a part of the cash ratio? Review section 3.3. [C] :Aren't both accounts receivable and cash part of current assets? Review section 3.3. [D] :Aren't both accounts receivable and cash part of current assets? Review section ) Total capitalization is equal to: [A] total liabilities plus total equity. [B] net working capital. [C] longterm debt plus total equity. [D] total debt minus total equity. [E] total assets plus total equity. [A] :Are shortterm debts included? Review section 3.3. [B] :This is incorrect. Review section 3.3. [D] :Are shortterm debts included? Is your math correct? Review section 3.3. [E] :This is incorrect. Review section ) Hilton Publishing and Jordan Publishing have identical debttoequity ratios and profit margins. However, Hilton's ROA is higher than Jordan's. Therefore, it must be true that: [A] Hilton has a lower total asset turnover ratio. [B] Jordan's ROE is higher than Hilton's. [C] Hilton uses its assets more efficiently to generate sales. [D] Hilton's operating efficiency is higher than Jordan's. [E] Hilton has a lower investment in total assets than Jordan does. [A] :This conclusion is incorrect. Review the Du Pont identity in section 3.4. [B] :This conclusion is incorrect. Review the Du Pont identity in section 3.4. [D] :This conclusion is incorrect since they have the same profit margin. Review the Du Pont identity in section 3.4. [E] :Based on what is stated in the question, there is no basis for this conclusion. The most important consideration is total assets relative to sales. Review the Du Pont identity in section ) 59. Which of the following are financial leverage ratios? I. debtequity ratio II. cash coverage ratio III. times interest earned ratio IV. equity multiplier [A] I and II only [B] I, II, and III only [C] I, II, and IV only [D] II, III, and IV only
23 [E] I, II, III, and IV [A] :Correct, but at least one other choice is also a financial leverage ratio. Review section 3.3. [B] :How are the debtequity ratio and the equity multiplier related? Review section 3.3. [C] :Isn't interest related to debt? Review section 3.3. [D] :How are debt and equity related to financial leverage? Review section ) You can use financial statements to: I. determine the sources and uses of cash. II. compute commonsize financial statements for comparing two firms of differing size. III. compute financial ratios in order to evaluate the financial performance of a firm. [A] II only [B] II and III only [C] I and II only [D] I and III only [E] I, II, and III [A] :There is at least one other correct option. Review sections and 3.1 and 3.3. [B] :How do you determine the sources and uses of cash? Review section 3.1. [C] :Where do you get the information to compute financial ratios? Review section 3.3 [D] :Where do you get the information to compute commonsize statements? Review section ) Which of the following are components of the return on assets? I. profit margin II. total asset turnover III. net income IV. equity multiplier [A] I and III only [B] I and II only [C] I, II, and IV only [D] I, II, and III only [E] I, II, III, and IV [A] :True, but there is at least one more component listed. Review section 3.4. [B] :True, but there is at least one more component listed. Review section 3.4. [C] :One of these options is incorrect. Review section 3.4. [E] :Are you confusing return on equity with the return on assets? Review section ) Companies publish financial ratios in their annual reports. When using these ratios to compare two companies, you must consider the: I. accounting methods used by each firm. II. nature of the operations of each firm. III. fiscal year of each firm. [A] I only [B] II only [C] II and III only
24 [D] I and II only [E] I, II, and III [A] :Correct, but this is only part of the answer. Review section 3.5. [B] :Correct, but this is only part of the answer. Review section 3.5. [C] :Correct, but there is one more correct option also. Review section 3.5. [D] :Correct, but there is one more correct option also. Review section ) Martin's has a current ratio of 2, a quick ratio of 1.8, net income of $180,000, a profit margin of 10 percent, and an accounts receivable balance of $150,000. What is the firm's average collection period? [A] 50.0 days [B] 43.6 days [C] 30.4 days [D] 21.6 days [E] 10.8 days [A] :How can you use the profit margin to find sales? Review section 3.3. [B] :How can you use the profit margin to find sales? Review section 3.3. [D] :How can you use the profit margin to find sales? Review section 3.3. [E] :How can you use the profit margin to find sales? Review section ) To evaluate a firm, you often must choose a benchmark for comparison purposes. Peer group analysis is one means of establishing a benchmark. [B] :This is the purpose of peer group analysis. Review section ) A firm has total equity of $400, net income of $50, total liabilities of $200, and sales of $500. What is the return on assets? [A] 7.1 percent [B] 8.3 percent [C] 10.0 percent [D] 12.5 percent [E] 25.0 percent [A] :This is incorrect. Review section 3.3. [C] :What is the profit margin formula? Review section 3.3. [D] :What is the return on equity formula? Review section 3.3. [E] :This is incorrect. Review section 3.3.
25 86) The net cash from financing activities is $80. The net cash from operating activities is $500. The net cash from financing activities is $200 (negative). The cash balance at the beginning of the year was $60. What is the cash balance at the end of the year? [A] $320 [B] $160 [C] $380 [D] $440 [E] $840 [A] :Check your pluses and minuses. Review section 3.1. [B] :Check your pluses and minuses. Review section 3.1. [C] :Did you forget the beginning balance? Review section 3.1. [E] :Check your pluses and minuses. Review section ) Which one of the following statements concerning the current ratio is correct? [A] Using book values to compute the current ratio is unacceptable because the market values of the current assets tend to deviate from the book values. [B] The current ratio is computed by dividing current liabilities by current assets. [C] The current ratio will always be greater than the quick ratio in companies that carry inventory. [D] The current ratio measures the longrun liquidity position of a firm. [E] The higher the current ratio, the higher the level of cash in a firm. [A] :This is one of the few ratios where book and market values are typically fairly close to one another. Review section 3.3. [B] :You are reversing the numerator and denominator. Review section 3.3. [D] :How do shortterm assets and liabilities signal longrun performance? Review section 3.3. [E] :This does not have to be true. Review section ) In the most general sense, which one of the following would you expect to be true? [A] If current assets and current liabilities both increase by the same amount then there is a net use of funds. [B] If fixed assets decrease by the amount of depreciation for the year then there is a net use of funds. [C] Changes in income and expense accounts do NOT affect sources and uses of cash. [D] If a liability account increases and an asset account decreases by the same amount, there is a net source of funds. [E] An increase in the common stock account is a use of cash. [A] :In this case, the sources of cash equal the uses of cash. Review section 3.1. [B] :How can you use funds if there is no change other than that caused by a noncash expense? Review section 3.1. [C] :Yes, they do. Review section 3.1. [E] :Doesn't a firm receive cash when it sells stocks? Review section ) Comparison of the financial statements of two firms in the same general industry may be difficult if the:
26 I. size of the two firms varies. II. firms have identical product lines and operations. III. financial statements are prepared using different fiscal yearends. [A] I only [B] III only [C] I and II only [D] I and III only [E] I, II, and III [A] :Correct, but this is only half of the answer. Review section 3.5. [B] :Correct, but this is only half of the answer. Review section 3.5. [C] :At least one of these choices is incorrect. Review section 3.5. [E] :At least one of these choices is incorrect. Review section ) A firm has 2,500 shares of common stock outstanding, a return on equity of 10 percent, and a priceearnings ratio of 20. The net income for the year is $5,000. What is the market price per share of stock? [A] $5 [B] $20 [C] $40 [D] $100 [E] $200 [A] :What are the earnings per share? Review section 3.3. [B] :What are the earnings per share? Review section 3.3. [D] :What are the earnings per share? Review section 3.3. [E] :What are the earnings per share? Review section ) Which of the following will result in a lower profit margin, all else equal? I. decreasing cost of goods sold II. increasing the corporate tax rate III. doubling the amount of longterm debt while decreasing common equity by the same amount [A] I only [B] II only [C] III only [D] I and III only [E] II and III only [A] :This will increase the profit margin. Review section 3.3. [B] :Correct, but another choice is also correct. Review section 3.3. [C] :Correct, but another choice is also correct. Review section 3.3. [D] :At least one of these choices is incorrect. Review section ) If a firm has a total debt ratio of 0.5, what is its equity multiplier? [A] 0.50 [B] 0.67
27 [C] 1.00 [D] 1.50 [E] 2.00 [A] :If total assets are $2 and total debt is $1, what is total equity? Review section 3.3. [B] :If total assets are $2 and total debt is $1, what is total equity? Review section 3.3. [C] :If total assets are $2 and total debt is $1, what is total equity? Review section 3.3. [D] :If total assets are $2 and total debt is $1, what is total equity? Review section ) On a typical statement of cash flows, fixed asset acquisitions are classified under the heading of: [A] recognition activities. [B] operating activities. [C] investment activities. [D] financing activities. [E] income activities. [A] :There is no such category on a typical statement of cash flows. Review section 3.1. [B] :These activities include cash flows related to operations and current accounts, not fixed assets. Review section 3.1. [D] :These activities include cash flows related to longterm debt and equity, not fixed assets. Review section 3.1. [E] :There is no such category on a typical statement of cash flows. Review section ) All else equal, which of the following would explain a decrease in the fixed asset turnover ratio? I. an increase in sales II. the replacement of old, fullydepreciated equipment with new equipment III. selling more dollars worth of fixed assets than you purchase [A] I only [B] II only [C] III only [D] I and III only [E] II and III only [A] :This would increase the ratio, not decrease it. Review section 3.3. [C] :This would increase the ratio, not decrease it. Review section 3.3. [D] :These would increase the ratio, not decrease it. Review section 3.3. [E] :At least one of these choices is incorrect. Review section ) Your firm has a profit margin of 10 percent, return on equity of 20 percent, a debtequity ratio of 1.5, and assets of $200. How much are your sales? [A] $10 [B] $160 [C] $250 [D] $640 [E] $1,000
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