exam3 multiple choice questions

Which of the following is the best measure of operating efficiency? A. Return on net operating assets B. Return on equity C. Return on sales D. Return on inventory

A. Return on net operating assets

Which of the following statements concerning quality of earnings is correct? A. The more cyclical the industry within which a company operates the lower its quality of earnings, all other things equal B. The smoother the earnings stream of a company, the greater the quality of the earnings C. Quality of earnings is independent of business risk D. Quality of earnings is largely beyond management's control

A. The more cyclical the industry within which a company operates the lower its quality of earnings, all other things equal

Which of the following would explain an observed decrease in return on equity, all else equal? A. Decrease in tax rate B. Increase in interest rate on debt C. Stock split D. Stock dividend

B. Increase in interest rate on debt

Variability in earning numbers: A. Is desirable as it increases variance of earnings and hence value of stock options B. Increases if a company increases its operating leverage C. Increases if a company decreases its financial leverage D. Is independent of operating leverage

B. Increases if a company increases its operating leverage

A growing company with disappointing profitability would generally have A. High price/book and high price/earnings B. High price/book and low price/earnings C. Low price/book and high price/earnings D. Low price/book and low price/earnings

C. Low price/book and high price/earnings

Debt may contain sinking fund provisions. This means that bond is insured by government and that in the event of default on the debt the government will sink into its funds in order to honor the debt.

FALSE Sinking funds are cash accounts that a company must establish so that funds are available when the bonds mature.

An increase in the current ratio over time is always a good indication of increased liquidity of the firm.

FALSE The term always is the issue.

"Trading on the equity" means that a company is publicly traded as opposed to being closely held.

FALSE trading on equity means being able to leverage the company.

An analysis of a company's performance requires joint analysis of net income in relation to the invested capital.

T

It is possible to have increasing earnings growth while having decreasing return on net operating assets.

TRUE

A stock that has a high price/earnings ratio and a high price/book value ratio is an indicator of a stock that is definitely overvalued.

false

Two companies operate in the same industry but one has a much higher price/earnings (P/E) ratio than the other. One reason for the difference in P/E ratio could be the quality of earnings.

true

Interim financial reports A. Are not required by SEC B. Are as reliable as annual reports C. Require allocation of certain discretionary costs across interim periods D. Normally use FIFO inventory reporting, regardless of method used for annual reports

C. Require allocation of certain discretionary costs across interim periods

The value of common stockholders' equity can be estimated as the present value of future abnormal earnings discounted at the cost of equity.

true

When assessing earnings persistence is important to determine if there has been any earnings management.

true

When calculating earnings coverage ratios it is common to remove the effects of extraordinary gains and losses and other one-time gains and losses from the numerator.

true

When calculating the times interest earned adjustments should normally be made for existence of operating leases. A portion of rental payments should be reclassified as interest.

true

When examining a company's current ratio it is important to also assess the quality of the current assets and liabilities.

true

When examining the current ratio and trends in the current ratio it is important to evaluate the turnover rate of current assets and current liabilities and trends in these turnover ratios.

true

When examining the debt/equity ratio of a company, consideration should be given to pension liabilities. Specifically, it should be determined if the projected benefit obligation significantly exceeds the plan assets, and if it does compare this to any liability recorded on balance sheet.

true

Which of the following will increase the sustainable equity growth of a company, all other things equal? A. Increase dividend payout B. Pay suppliers more quickly C. Pay suppliers more slowly D. Decrease dividend payout

D. Decrease dividend payout

A retrenching company with poor prospects would generally have A. High price/book and high price/earnings B. High price/book and low price/earnings C. Low price/book and high price/earnings D. Low price/book and low price/earnings

D. Low price/book and low price/earnings

Which of the following statements is correct? A. Net operating profit margin divided by net operating asset turnover equals return on net operating assets B. Return on net operating assets can be disaggregated into net operating profit margin and leverage C. Return on equity equals return on net operating assets less interest, net of tax D. Return on equity can be disaggregated into net operating profit margin, net operating asset turnover and leverage

D. Return on equity can be disaggregated into net operating profit margin, net operating asset turnover and leverage

The current ratio is a superior tool to cash flow projections and pro forma financial statements in assessing short-term liquidity.

FALSE - Ratio is a point in time. Cashflow is prediction of the future.

Liquidity is viewed as the company's ability to meet its short term and long term obligations.

FALSE - That is the definition of Solvency.

Analysis of profitability of a company is more important when considering short-term liquidity than when considering long-term solvency of a company.

FALSE A company can survive for a short period of time even if it is not profitable. But lack of profitable over the long term will significantly effect solvency.

Capitalization of interest results in an understatement of the times interest earned.

FALSE Again not sure that I completely agree. I think it is important to understand that a portion of the interest has be capitalized and that fact taken into consideration when evaluating the ratio.

If a company has a current ratio greater than one then there is no chance it will go bankrupt in the next year.

FALSE Again the ratio is only a point in time.

The total debt to total capital ratio is more useful than the total debt to equity capital ratio.

FALSE Confusing. I assume that they mean common equity. Preferred stock would required a preferred dividend to be paid.

Debt is better than equity because the interest on the debt is tax deductible whereas dividends are not tax deductible.

FALSE Debt creates leverage. If operations decline, the debt may not be renewed.

If a company sells its receivables this is an indication that it has very high quality receivables.

FALSE Even poor quality can be sold at a low enough price.

The higher the company's inventory turnover the better is company.

FALSE Generally high turnover is good, but it is only effective if you have reasonable profit margins.

The higher the company's cash to current liabilities ratio, the better is the company.

FALSE Having excess cash which is non earning is can lower returns on operations and equity.

Deferred tax assets should be deducted from the assets and equity if they are not expected to reverse.

FALSE I believe that this is a true statement. If they do not reverse then they would have no value and should be written off or at least reserved for.

All current assets, by definition, will result in cash inflows within the next year or operating cycle whichever is longer.

FALSE Inventory may not turn over completely in one year.

If accounts payable turnover decreases this could be an indication that suppliers are cutting off credit to the company.

FALSE It is more likely that the company is paying vendors slowly.

Minority shareholders' interest on the balance sheet represents a liability to the company and should always be included in debt when calculating the debt/equity ratio.

FALSE Minority is not debt. It is the portion of the company that is not owned by the companies shareholders.

One would expect restaurants to have lower inventory turnovers than general merchandise stores.

FALSE Restaurants inventory is food. It must turn quickly of some or all will go bad.

An increase in the credit days offered to customers by a company will improve the company's financial situation because of the likely increase in sales.

FALSE Sale may increase, but collections may be negatively impacted.

Dividends on preferred stock with characteristics of debt such as mandatory redemption, fixed maturity or sinking fund must be tax-affected and treated as debt for calculation of common stock dividend coverage.

FALSE There is no reason to tax effect the dividend, because the dividend are not tax deductible.

Guaranteed debt of unconsolidated subsidiaries should generally be ignored when analyzing the long-term solvency of a parent company, as subsidiaries are separate legal entities.

FALSE True except that if guaranteed then the parent is responsible and it should be considered.

The use of LIFO will inflate the current ratio under normal economic conditions.

FALSE With Lifo the inventory is priced at the earlier period prices, which will be lower if we have inflation.

which ratio best measures the profitability of a company? A. return on equity b. gross margin c. current ratio d. net operating asset turnover

a. return on equity

Quality of earnings is said to be high if analysts' earnings forecasts have a small standard deviation.

false

The number of shares outstanding a company has will affect its earnings per share and price/earnings ratio.

false

There is only one way to measure invested capital.

false

When calculating return on total equity it is normal to add back preferred dividends to net income.

false

. If a company has a return on equity that is lower than its cost of equity capital it could be said to be destroying value.

true

. Management Discussion and Analysis provides information that is useful in helping assess company's liquidity.

true

A company that operates in a highly competitive industry with low barriers to entry is likely to have low net operating profit margins compared to companies that operate in less competitive industries.

true

A company's return on assets will equal its return on equity if the after-tax cost of debt equals the return on assets.

true

A decrease in provision for doubtful accounts relative to gross accounts receivable could indicate improved collection of accounts receivable or it could indicate that management has failed to make adequate provisions for non-collectible accounts.

true

A joint venture may result in significant liabilities that are not recorded on the balance sheet of the parent company.

true

A leveraged buyout is when a group of investors use equity to buy a highly leveraged company that is in distress, and pay down the debt using their equity.

true

Adjusting earnings includes assigning earnings components from the recast income statements to periods they likely belong.

true

Although growth is often touted as one of the key drivers of the value of a stock, no amount of growth will increase the value of a company if its return to providers of capital is less than the cost of that capital.

true

An increase in the current ratio due to increased inventory and receivables could be consistent with a recession in the economy.

true

Companies in certain industries do not make the distinction between current and non-current on their balance sheets.

true

Companies that have low net operating profit margins generally only earn a reasonable return on net operating assets if they can utilize their net operating assets very efficiently.

true

Determination of short-term liquidity is important to both investors and creditors.

true

Earnings management uses acceptable accounting reporting principles for purposes of reporting specific results.

true

Financial ratios are often used in models that predict financial distress.

true

For purposes of long-term solvency analysis the calculation of balance sheet ratios such as debt/equity or debt to total capital are of limited value and are used mostly as screening mechanisms to indicate whether further analysis is warranted.

true

If a company switches from FIFO to LIFO during a period of rising prices, inventory turnover will probably increase.

true

If a company's days receivables outstanding increases this could be an indication that there are problems with the quality of the company's products.

true

If a company's return on equity is lower than its cost of equity capital, then the higher the dividend payout ratio the higher the P/E of the stock.

true

In assessing the quality of receivables it is important to consider the revenue recognition methods used by a company.

true

Interim financial reports are generally prepared using the same accounting methods as used for the annual financial reports.

true

It is possible to assess the common equity growth rate by analyzing the retention of earnings.

true

Liquidity depends to a large extent on prospective cash flows and to a lesser extent on the level of cash and cash equivalents.

true

Liquidity is generally measured by the company's ability to pay its short term obligations using its short assets.

true

Sustainable equity growth rate is a function of return on common stockholders' equity and the dividend payout ratio.

true

The SEC requires disclosure if fixed charges exceed earnings.

true

The cash ratio is a measure of the degree of current asset liquidity.

true

The greater the variability of sales the higher the earnings coverage ratios should ideally be, all other things equal.

true

The higher the company's cash to current liabilities ratio, the more liquid is the company

true

The lower equity is as a proportion of total capital, all other things equal, the greater the risk borne by the other providers of capital.

true