Chapter 3 Smartbook

If Union Aerospace Corporation's Current ratio is 2.5 and it's Quick Ratio is 2, what is the size of its inventory if it's current assets total $1,000,000

$200,000 Reason: CR = CA / CL ; QR = (CA - Inventories) / CL 2.5 = 1,000,000 / CL ; 2 = (1,000,000 - Inventories) / CL CL = 400,000 ; 2 = (1,000,000 - Inventories) / 400,000 Inventories = 200,000

Which of the following are considered Asset Management ratios?

- Average Collection Period - Capital Intensity

Debt management ratios are used to do which of the following? Select all that apply.

- Debt management ratios determine whether or not a firm can meet its debt obligations. - Debt management ratios measure the capital structure of a firm. - Debt management ratios determine the amount of financial leverage used by a firm.

A levered firm's sustainable growth rate increased this year. Which one of these might have caused that increase, all else equal? Select all that apply.

- Increase in financial leverage - Increase in operating efficiency

Which of these are correct versions of the return on equity? Select all that apply.

- ROE = ROA × (1+Debt−to−equity) - ROE = Profit margin × (1 / Capitalintensityratio) × (1+Debt−to−equity) - ROE = Profit margin × Total asset turnover × Equity multiplier

Which of these is (are) a factor which requires caution when using ratios to evaluate firm performance? Select all that apply.

- Ratios may be calculated differently by different firms. - The future may differ from the past. - Firms may use different accounting methods to value inventory.

How is inventory turnover related to days' sales in inventory? Select all that apply.

- The shorter the inventory period, the higher the turnover rate - The lower the turnover rate, the more days' sales that are held in inventory.

Union Aerospace Corporation has an ROE of 15% based on a profit margin of 10%, a total asset turnover of 1.5, and an equity multiplier of 1. The industry values are 13.1%, 7.2%, 1.3, and 1.4, respectively. Which one of these statements is accurate?

- Union Aerospace Corporation provides a greater return on its common stock than does the average firm in its industry. - Union Aerospace Corporation uses its assets more efficiently to produce sales than does the average firm in the industry. - Union Aerospace Corporation produces more earnings for its common shareholders for each dollar of sales than does the average firm in its industry.

Which of these is (are) a factor which requires caution when using ratios to evaluate firm performance? Select all that apply.

- Window dressing of annual financial statements by some firms - Comparing firms with varying fiscal years

Market Value ratios relate a firm's market value to

- its earnings. - its book value.

What must the capital intensity ratio be if the total asset turnover rate is 2?

0.5 Reason: The total asset turnover is the inverse of the capital intensity ratio. Capital intensity = 1/2 = 0.5

Assume cash = $500, notes payable in six months = $600, accounts receivable = $900, inventory = $1,500, and accounts payable = $1,100. What is the quick ratio?

0.82 Reason: Quick ratio = ($500 + $900)/($1,100 + $600) = 0.82

Which one of these is equivalent in value to the equity multiplier?

1 + Debt-to-equity ratio

Jen's has current assets of $2,200, cash of $400, and inventory of $1,300. The firm has accounts payable of $300, long-term debt of $3,100, and accrued wages and taxes of $400. What is the quick ratio?

1.29 Reason: Quick ratio = ($2,200 - $1,300)/($300 + $400) = 1.29

Martin's has current assets of $600 and total assets of $2,900. The firm has total debt of $1,500 and long-term debt of $1,100. What is the current ratio?

1.5 Reason: Current liabilities = $1,500 - $1,100 = $400 Current ratio = $600/$400 = 1.5

The Shoe Store has cash of $300, accounts receivable of $700, accounts payable of $800, inventory of $1,300, long-term debt of $1,900, and notes payable in three months of $500. What is the current ratio?

1.77 Reason: Current assets = $300 + $700 + $1,300 = $2,300 Current liabilities = $800 + $500 = $1,300 Current ratio = $2,300/$1,300 = 1.77

Valley Markets has an inventory turnover of 3.2 and a capital intensity ratio of 1.9. What are the days in inventory for Valley Markets?

114

A firm has taxes of $2,000, interest expense of $1,000, EBIT of $7,500, common stock dividends of $1,500, and preferred dividends of $1,200. What is the profit margin if sales are $22,000?

15.00 percent Reason: Net income available to common stockholders = $7,500 - $1,000 - $2,000 - $1,200 = $3,300 Profit margin = $3,300/$22,000 = 15 percent

A firm has net income of $38,000, preferred stock dividends of $10,000, and common stock dividends of $8,000. The firm has 10,000 shares of common stock outstanding that sells for $46 a share. What is the price-earnings (PE) ratio?

16.43 Reason: Earnings per share = ($38,000 - $10,000)/10,000 = $2.80 PE = $46/$2.80 = 16.43

NY News has net earnings per share of $3.24, a book value per share of $22, and a market-to-book ratio of 2.5. What is the price-earnings (PE)ratio?

16.98 Reason: Market price = 2.5 × $22 = $55 PE = $55/$3.24 = 16.98

What does a dividend payout of 45 percent indicate?

A 45 percent dividend payout indicates a firm pays 45 percent of its net income available to common stockholders out in common dividends.

Which one of these is a correct interpretation of a cash coverage ratio of 1.4?

A cash coverage ratio of 1.4 indicates a firm generates $1.40 of operating cash for every dollar of interest and fixed charges that the firm owes.

How is a debt ratio of 0.45 interpreted?

A debt ratio of 0.45 means that for every dollar of assets, a firm has $0.45 of debt.

Buster's has a debt ratio of 1.2. What does this imply?

A debt ratio of 1.2 means a firm uses 20 percent more debt financing than equity financing.

What does a debt-to-equity ratio of 0.8 mean?

A debt-to-equity ratio of 0.8 means the firm has $0.80 of debt for every $1 of equity.

What does a dividend payout of 30 percent indicate if a firm has no preferred stock outstanding?

A dividend payout of 30 percent for a firm with no preferred stock indicates that common stock dividends equal 30 percent of net income.

Which one of these statements correctly interprets a sustainable growth rate of 4 percent?

A firm can grow by 4 percent annually without increasing its probability of incurring financial distress.

Which one of these best illustrates time series analysis?

A firm's profit margin has been 4.6 percent, 4.9 percent, and 4.7 percent over the past three years.

How can a low dividend payout increase future returns on equity (ROE)?

A low dividend payout means more of a firm's earnings are retained for future growth, which is expected to increase earnings and ROE.

The Eatery has a market-to-book ratio of 3.2. What does this ratio indicate?

A market-to-book ratio of 3.2 means shareholders are willing to pay $3.20 per dollar of book equity to buy the firm's stock.

Al's Services has a current ratio of exactly 1.2 and a quick ratio of exactly 1.2. What can you infer from these ratios?

Al's has no inventory.

The common-size values of both net income and costs of goods sold increased this year over last year. What does this mean?

As a percentage of sales, the cost of goods sold increased while the sum of total expenses, interest, and taxes decreased for the year.

If you want to compare the operations of similar firms without the firm's capital structure or tax status affecting that comparison, which ratio should you use?

Basic earnings power

Buster's quick ratio decreased from 0.81 to 0.76 during the year while its current ratio increased from 1.43 to 1.57. What do these changes in the ratio values imply?

Buster's is increasingly reliant on selling its inventory to meet its current obligations.

Which of these best defines cross-sectional analysis?

Cross-sectional analysis analyzes the performance of a firm against one or more companies in the same industry.

The common-size balance sheet value of current assets was 0.21 last year and 0.23 this year. How do you interpret this?

Current assets as a percentage of total assets increased.

Dee's had a return on assets (ROA) of 14.4 percent last year as compared to 14.7 percent this year. What do these ratio values imply?

Dee's earned more income for its common shareholders per dollar of assets than it did last year.

The suppliers of Denver Press offer the firm 30 days credit on all its purchases. Denver Press has an average payment period of 84 days as compared to its industry average of 43 days. Which of these statements applies to Denver Press?

Denver Press is most likely abusing its credit terms.

True or false: A firm can always increase its share price by lowering its dividend payout ratio.

False Reason: Only if the firm's ROE is high enough.

True or false: To reduce the number of days' sales held in inventory, a firm needs to decrease the inventory turnover rate.

False Reason: To reduce the number of days' sales held in inventory, the turnover rate must be increased.

Two firms have the same amount of assets and equity. Firm A has a market-to-book value of 3.6 compared to 2.9 for Firm B. Which one of these statements is generally correct given this information?

Firm A is expected to outperform Firm B in the future.

DJ's has an equity multiplier of 1.5. Which one of these statements is correct given this information?

For every $1 of equity, DJ's has $0.50 of debt and total assets of $1.50.

Generally speaking, a high price-earnings (PE) ratio indicates which one of the following as compared to a low PE ratio?

Greater risk

Abel's has a total asset turnover rate of 2.2 as compared to its industry average of 1.8. Which one of these might be the cause of Abel's higher rate?

Inventory stockouts

JJ's has a cash ratio of 0.25. How do you interpret this value?

JJ's has sufficient cash and marketable securities to pay 25 percent of its current liabilities.

For publicly traded firms, market value ratios may be more important than other ratios for which reason?

Market value ratios reflect investors' opinion of a firm's future performance and risk.

McDowell's has an ROE of 12.6 percent based on a profit margin of 6 percent, a total asset turnover of 1.4, and an equity multiplier of 1.5. The industry values are 13.1 percent, 7.2 percent, 1.3, and 1.4, respectively. Which one of these statements is accurate?

McDowell's uses its assets more efficiently to produce sales than does the average firm in the industry.

The return on assets reflects which value as a percentage of total assets?

Net income available to common stockholders

Northern Goods and Southern Goods have similar levels of EBIT and depreciation. However, Northern Goods has a much higher cash coverage ratio. Given this, which of these statements is correct?

Northern Goods is diluting its return to stockholders more than its competitors are.

Kelso's has an average collection period of 49 days. How do you interpret this?

On average, Kelso's receives cash for a sale 49 days after a credit sale occurs.

Orr's Hardware had a cash ratio of 0.12 last year as compared to 0.22 this year. How do you interpret this change?

Orr's is less dependent now on its receivables and inventory to pay its current debt than it was one year ago.

Treeline Resorts has a basic earnings power ratio of 1.6 compared to 1.8 for Outer Limits Resorts. Which one of these statements is correct based on this information?

Outer Limits is generating more operating profit per dollar of assets than Treeline.

Oyster Fields has an average payment period of 21 days as compared to its industry average of 33 days. Suppliers in the industry have a 30-day credit policy. Which one of these statements most applies to Oyster Fields?

Oyster Fields is not maximizing its use of free financing.

Petty's has a fixed asset turnover of 2 and a sales to working capital ratio of 4. The industry averages are 1.5 and 3, respectively. Assume all firms in the industry use the same depreciation method and have equipment of similar age. Which one of these statements is correct?

Petty's has twice the amount of net fixed assets as it does net working capital.

Assume you are given the values for sales, taxable income, preferred and common stock dividends, interest, and the tax rate. How would you calculate the profit margin?

Profit margin = {(Taxableincome×(1−Taxrate))−Preferreddividends}Taxableincome×1-Taxrate-Preferreddividends/Sales

Which one of these is the correct fully deconstructed version of the return on assets?

ROA = Net income available to common stockholders / Sales × Sales / Total assets

Which one of these formulas correctly defines the retention ratio (RR) for a levered firm with both preferred and common stock?

RR = 1 - Dividend payout ratio

Which one of these best states a requirement found in the definition of cross-sectional analysis?

Ratio comparisons must be made between firms in the same industry.

Russell's has a fixed asset turnover of 3.1. How do you interpret this information?

Russell's generates $3.10 in sales for every dollar of fixed assets.

The Bakery has a quick ratio of 1. This means the firm can pay it short-term debts without doing which one of the following?

Selling any inventory

Assume a firm has an equity multiplier of 1.2. Given this, what is the relationship between the internal growth rate and the sustainable growth rate?

Sustainable growth rate > Internal growth rate

Which one of these is the best definition of the DuPont system of analysis?

The DuPont system is an analytical method of breaking the ROA and ROE down into their component pieces.

Walker's has a price-earnings (PE) ratio of 16 compared to its industry average of 17. Generally speaking, which one of these statements applies to this situation?

The average firm in the industry outperforms Walker's.

Last year, Delta's times interest earned ratio was 1.8. This year the ratio is 0.8. How should this change in value be interpreted?

The decrease in the ratio to a value less than 1 indicates the firm's debt load may have become too large for the firm.

ABE Co. has a times interest earned ratio of 3.2. How is this value interpreted?

The earnings before interest and taxes is 3.2 times greater than the firm's interest expense for the period.

How do you interpret an internal growth rate of 3 percent?

The firm can grow by a maximum of 3 percent if it only uses internally-generated financing.

Lester's has a current ratio of 0.86. What does this indicate?

The firm has $0.86 in current assets for every $1 it must pay in obligations within the next year.

Last year, a firm had a current ratio of 1.14. This year, the ratio is 0.98. Assuming everything else equal, what do these values imply?

The firm is less liquid this year than it was last year.

Over the past three years, Art's Bakery has increased its debt and lowered its equity. Which one of these statements is most apt to apply to this firm?

The firm's safety cushion that helps absorb earnings fluctuations is diminishing.

PJ's has an average collection period of 42 days as compared to the industry average of 40 days. Which of these statements is supported by this information?

The industry, on average, turns over its accounts receivables more times a year than PJ's does.

What is the retention ratio?

The retention ratio is the percentage of net income available to common stockholders that is added to retained earnings.

Which statement is correct?

The sustainable growth rate is the maximum rate achievable using internal equity and debt financing and maintaining a constant debt-to-equity ratio.

True or false: The Corner Store graphs its return on equity by quarter for a running 5-year period. This is time series analysis.

True Reason: Analyzing a firm's performance by monitoring ratio trends over time is time series analysis.

True or false: The greater the debt the greater the financial leverage

True Reason: debt acts as leverage to move equity.

True or false: The DuPont system of analysis shows how the return on equity is dependent upon the return on assets.

True Reason: The statement is true. ROE = ROA × Equity multiplier

Valley Markets has an inventory turnover of 3.2 versus an industry average of 3.5 and a capital intensity ratio of 1.9 versus an industry average of 1.8. What can you determine about the efficiency of Valley Markets?

Valley Markets uses its assets less efficiently than the average firm in its industry.