FIN 370 Exam 1 - Chapter 7

Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects. True or False

True

Companies Heidee and Leaudy have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both companies have positive net incomes. Company Heidee has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT? a) Heidee has more net income than Leaudy. b) Heidee pays less in taxes than Leaudy. c) Heidee has a lower equity multiplier than Leaudy. d) Heidee has a higher ROA than Leaudy. e) Heidee has a higher times interest earned (TIE) ratio than Leaudy.

b) Heidee pays less in taxes than Leaudy.

You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT? a) Its total assets turnover must equal the industry average. b) Its total assets turnover must be above the industry average. c) Its return on assets must equal the industry average. d) Its TIE ratio must be below the industry average. e) Its total assets turnover must be below the industry average.

b) Its total assets turnover must be above the industry average.

A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio? a) Issue new common stock and use the proceeds to acquire additional fixed assets. b) Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable. c) Issue new common stock and use the proceeds to increase inventories. d) Speed up the collection of receivables and use the cash generated to increase inventories. e) Use some of its cash to purchase additional inventories.

b) Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.

The Cavendish Company 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 debt ratio increased. b) The company's current ratio increased. c) The company's times interest earned ratio decreased. d) The company's basic earning power ratio increased. e) The company's equity multiplier increased.

b) The company's current ratio increased.

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 DSO (days' sales outstanding) is 40, whereas the average for its competitors is 30. b) The division's basic earning power ratio is above the average of other firms in its industry. c) The division's total assets turnover ratio is below the average for other firms in its industry. d) The division's debt ratio is above the average for other firms in the industry. e) The division's inventory turnover is 6, whereas the average for its competitors is 8.

b) The division's basic earning power ratio is above the average of other firms in its industry.

A decline in a firm's inventory turnover ratio suggests that it is managing its inventory more efficiently and also that its liquidity position is improving, i.e., it is becoming more liquid. True or False

False

High current and quick ratios always indicate that a firm is managing its liquidity position well. True or False

False

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. True or False

False

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. True or False

False

Since the ROA measures the firm's effective utilization of assets (without considering how these assets are financed), two firms with the same EBIT must have the same ROA. True or False

False

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. True or False

False

The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects. True or False

False

Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position. True or False

True

Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage. True or False

True

Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of measuring changes in a firm's performance over time. True or False

True

Profitability ratios show the combined effects of liquidity, asset management, and debt management on operating results. True or False

True

Ratio analysis involves analyzing financial statements in order to appraise a firm's financial position and strength. True or False

True

Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used similar accounting methods. True or False

True

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. True or False

True

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. True or False

True

The "apparent," but not the "true," financial position of a company whose sales are seasonal can differ dramatically, depending on the time of year when the financial statements are constructed. True or False

True

The current ratio and inventory turnover ratios both help us measure the firm's liquidity. The current ratio measures the relationship of a firm's current assets to its current liabilities, while the inventory turnover ratio gives us an indication of how long it takes the firm to convert its inventory into cash. True or False

True

The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged. True or False

True

The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its assets. True or False

True

The times-interest-earned ratio is one, but not the only, indication of a firm's ability to meet its long-term and short-term debt obligations. True or False

True

Which of the following statements is CORRECT? a) An increase in a firm's debt ratio, with no changes in its sales or operating costs, could be expected to lower the profit margin. b) The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio. c) If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE. d) An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio. e) An increase in the DSO, other things held constant, could be expected to increase the ROE.

a) An increase in a firm's debt ratio, with no changes in its sales or operating costs, could be expected to lower the profit margin.

Companies A and C each reported the same earnings per share (EPS), but Company A's stock trades at a higher price. Which of the following statements is CORRECT? a) Company A trades at a higher P/E ratio. b) Company A probably has fewer growth opportunities. c) Company A is probably judged by investors to be riskier. d) Company A must have a higher market-to-book ratio. e) Company A must pay a lower dividend.

a) Company A trades at a higher P/E ratio.

Companies Heidee and Leaudy have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Company Heidee has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT? a) Heidee has a lower times interest earned (TIE) ratio than Leaudy. b) Heidee has a lower equity multiplier than Leaudy. c) Heidee has more net income than Leaudy. d) Heidee pays more in taxes than Leaudy. e) Heidee has a lower ROE than Leaudy.

a) Heidee has a lower times interest earned (TIE) ratio than Leaudy.

Which of the following statements is CORRECT? a) If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline. b) If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average and was also increasing and trending still higher, this would be interpreted as a sign of strength. c) If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding (DSO) will increase. d) There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things. e) A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.

a) If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.

Companies Heidee and Leaudy have the same total assets, sales, operating costs, and tax rates, and they pay the same interest rate on their debt. However, company Heidee has a higher debt ratio. Which of the following statements is CORRECT? a) If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company Heidee will have the higher ROE. b) Given this information, Leaudy must have the higher ROE. c) Company Leaudy has a higher basic earning power ratio (BEP). d) Company Heidee has a higher basic earning power ratio (BEP). e) If the interest rate the companies pay on their debt is more than their basic earning power (BEP), then Company Heidee will have the higher ROE.

a) If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company Heidee will have the higher ROE.

Which of the following would indicate an improvement in a company's financial position, holding other things constant? a) The current and quick ratios both increase. b) The inventory and total assets turnover ratios both decline. c) The debt ratio increases. d) The profit margin declines. e) The EBITDA coverage ratio declines.

a) The current and quick ratios both increase.

Which of the following statements is CORRECT? a) "Window dressing" is any action that improves a firm's fundamental, long-run position and thus increases its intrinsic value. b) Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." 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 another example of "window dressing." c) 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." d) 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." e) Using some of the firm's cash to reduce long-term debt is an example of "window dressing."

c) 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."

Which of the following statements is CORRECT? a) If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same. b) If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be the same. c) If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same. d) If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price earnings ratio. e) If Firm X's P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and also to be expected to grow at a faster rate.

c) If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.

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 inventories while holding sales and cost of goods sold constant. b) Increase accounts receivable while holding sales constant. c) Increase EBIT while holding sales constant. d) Increase accounts payable while holding sales constant. e) Increase notes payable while holding sales constant.

c) Increase EBIT while holding sales constant.

Other things held constant, which of the following alternatives would increase a company's cash flow for the current year? a) Increase the number of years over which fixed assets are depreciated for tax purposes. b) Pay down the accounts payables. c) Reduce the days' sales outstanding (DSO) without affecting sales or operating costs. d) Pay workers more frequently to decrease the accrued wages balance. e) Reduce the inventory turnover ratio without affecting sales or operating costs.

c) Reduce the days' sales outstanding (DSO) without affecting sales or operating costs.

Which of the following statements is CORRECT? a) If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease. b) A reduction in inventories held would have no effect on the current ratio. c) An increase in inventories would have no effect on the current ratio. d) If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase. e) A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.

d) If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.

If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT? a) Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm. b) The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm. c) Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm. d) Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm. e) The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.

d) Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.

Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant? a) The total assets turnover decreases. b) The TIE declines. c) The DSO increases. d) The EBITDA coverage ratio increases. e) The current and quick ratios both decline.

d) The EBITDA coverage ratio increases.

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). e) If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average.

d) The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA).

Cordelion Communications is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Cordelion pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue? a) The times interest earned ratio will decrease. b) The ROA will decline. c) Taxable income will decrease. d) The tax bill will increase. e) Net income will decrease.

d) The tax bill will increase.

Considered alone, which of the following would increase a company's current ratio? a) An increase in accounts payable. b) An increase in net fixed assets. c) An increase in accrued liabilities. d) An increase in notes payable. e) An increase in accounts receivable.

e) An increase in accounts receivable.

Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company Heidee has the higher debt ratio. Which of the following statements is CORRECT? a) Heidee has lower operating income (EBIT) than Leaudy. b) Heidee has a lower total assets turnover ratio than Leaudy. c) Heidee has a lower equity multiplier than Leaudy. d) Heidee has a higher fixed assets turnover ratio than Leaudy. e) Heidee has a higher ROE than Leaudy.

e) Heidee has a higher ROE than Leaudy.

Heidee Corp. and Leaudy Corp. have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, Heidee uses more debt than Leaudy. Which of the following statements is CORRECT? a) Heidee would have higher net income as shown on the income statement than Leaudy. b) Without more information, we cannot tell if Heidee or Leaudy would have a higher or lower net income. c) Heidee would have a lower equity multiplier for use in the DuPont equation than Leaudy. d) Heidee would have to pay more in income taxes than Leaudy. e) Heidee would have lower net income as shown on the income statement than Leaudy.

e) Heidee would have lower net income as shown on the income statement than Leaudy.

A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio? a) Use cash to increase inventory holdings. b) Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment. c) Use cash to repurchase some of the company's own stock. d) Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year. e) Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

e) Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.