module 4

If a company's current liabilities are increasing faster than its current assets, the company's liquidity position is weakening.

true

Pellegrini Southern Corporation has less liquidity but also a greater reliance on outside cash flow to finance its short-term obligations than Jing Foodstuffs Corporation.

true

Can a company's shares exhibit a negative P/E ratio?

yes

Operating Margin

EBIT / Sales= 21.97%9.85%

Ratios that help assess a company's ability to service the interest and repayment obligations on its long-term debt and the degree to which it uses borrowed versus invested financial capital are called

debt or financial leverage management

Ratios that help determine whether a company can access its cash and pay its short-term obligations are called

liquity

Ratio analysis is an important component of evaluating company performance. It can provide great insights into how a company matches up against itself over time and against other players within the industry. However, like many tools and techniques, ratio analysis has a few limitations and weaknesses. Which of the following statements represent a weakness or limitation of ratio analysis? Check all that apply.

-Different firms may use different accounting -practices.Window dressing might be in effect. -Seasonal factors can distort data. -A firm may operate in multiple industries.

Which of the following statements is true about market value ratios?

Companies with high research and development (R&D) expenses tend to have high P/E ratios

The US tax structure influences a firm's willingness to finance with debt. The tax structure ______ more debt.

encourages

ratios help measure a company's ability to generate income and profits based on its invested capital.

profitability

One possible explanation for an increase in a firm's profitability ratios over a certain time span is that the company's income has increased.

true

Basic Earning Power

=EBIT / Total Assets=7.42%4.19%

Return on Common Equity

=Net Income / Common Equity=15.04%5.12%

Return on Total Assets

=Net Income / Total Assets=5.00%2.72%

If Green Caterpillar's forecast turns out to be correct and its price/earnings (P/E) ratio does not change, what does the company's management expect its stock price to be one year from now? (Round any P/E ratio calculation to four decimal places.)

EPSEPS = = Net Income/Shares OutstandingNet Income/Shares Outstanding = = $9,250,000/5,500,000shares$9,250,000/5,500,000shares = $1.68 P/E RatioP/E Ratio = = $12.00/$1.68$12.00/$1.68 = = 7.1429× Expected EPSExpected EPS = = Expected Net Income/Outstanding Shares Next YearExpected Net Income/Outstanding Shares Next Year = = $11,562,500/8,500,000$11,562,500/8,500,000 = $1.36 Expected Stock PriceExpected Stock Price = = Expected EPS × P/E RatioExpected EPS × P/E Ratio = = $1.36 × 7.1429$1.36 × 7.1429 = = $9.71 per share 9.71 per share

How would you expect this situation to affect the assessment of Northern's financial condition and performance?

Its low barriers to entry expose Northern to increased risk of competition, which could negatively affect the predictability of its expected future sales revenues.

How would you expect this situation to affect the assessment of Western's financial condition and performance?

The purchasing manager's behavior should be expected to increase Western's riskiness by increasing its exposure to potential supply shortages or mistimed deliveries.

Purple Panda Products Inc. has a total asset turnover ratio of 6.00x, net annual sales of $40 million, and operating expenses of $18 million (including depreciation and amortization). On its balance sheet and income statement, respectively, it reported total debt of $2.50 million on which it pays a 7% interest rate. To analyze a company's financial leverage situation, you need to measure the firm's debt management ratios. Based on the preceding information, what are the values for Purple Panda's debt management ratios?

Total Asset Turnover RatioTotal Asset Turnover Ratio = = Sales / Total AssetsSales / Total Assets6.00 times6.00 times = = $40 million / Total Assets$40 million / Total AssetsTotal AssetsTotal Assets = = $40 million / 6.00 times$40 million / 6.00 times = = $6.67million Debt Ratio=$2.50 million / $6.67 million=37.48% EBIT = = Total Sales - Total Operating CostsTotal Sales - Total Operating Costs = = $40 million - $18 million$40 million - $18 million = = $22.00million$22.00millionInterest ChargesInterest Charges = = Interest Rate × Debt OutstandingInterest Rate × Debt Outstanding = = 7% × $2.50million7% × $2.50million = = $0.1750million$0.1750million TIE Ratio=$22.00 million / $0.1750 million=125.71 x

Which of the following is true about the leveraging effect?

Under economic growth conditions, firms with relatively more leverage will have higher expected returns.

You decide also to conduct a qualitative analysis based on the factors summarized by the American Association of Individual Investors (AAII). According to your understanding, a company with one key product is considered to be ____ risky than companies with a wide range of products.

more

A company exhibiting a high liquidity ratio is likely to have enough resources to pay off its short-term obligations.

true

Asset management or activity ratios provide insights into management's efficiency in using a firm's working capital and long-term assets.

true

If a company has a quick ratio of less than 1 but a current ratio of more than 1 and if the difference between the two ratios is large, then the company depends heavily on the sale of its inventory to meet its short-term obligations.

true

Decision makers and analysts look deeply into profitability ratios to identify trends in a company's profitability. Profitability ratios give insights into both the survivability of a company and the benefits that shareholders receive. Identify which of the following statements are true about profitability ratios. Check all that apply.

-If a company has a profit margin of 10%, it means that the company earned a net income of $0.10 for each dollar of sales. -If a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes.

Along with calculating the ratios, what else is needed for your report?

-Making observations and identifying trends that are suggested by the ratio analysis -Identifying the factors that drive the trends in the ratios

Which of the following statements about your analysis report is true?

The analysis likely includes incorrect and misleading conclusions.

Profit Margin

net income/net sales =14.80%6.40%

Analysts and investors often use return on equity (ROE) to compare profitability of a company with other firms in the industry. ROE is considered a very important measure, and managers strive to make the company's ROE numbers look good. If a firm takes steps that increase its expected future ROE, its stock price will______ increase.

not necessarily

.Market value or market based ratios help analysts figure out what investors and the markets think about the firm's growth prospects or current and future operational performance.

true

Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company's performance. If you wanted to conduct a trend analysis, you would:

Analyze the firm's financial ratios over time

Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company's performance. If you wanted to conduct a comparative analysis for the current year, you would:

Compare the firm's financial ratios with other firms in the industry for the current year

Based on your understanding of the uses and limitations of ROE, which of the following projects will a manager likely choose if his or her bonus is solely based on the ROE of the next project?

Project Y, with 40% ROE and a small investment, generating low expected cash flows

Ratios that help determine the efficiency with which a company manages its day-to-day tasks and assets are called

asset management or activity

Company A uses long-term debt to finance its assets, and company B uses capital generated from shareholders to finance its assets. Which company would be considered a financially leveraged firm?

company A

Debt or financial leverage ratios help analysts determine whether a company has sufficient cash to repay its short-term debt obligations.

false

ratios examine the market value of a company's share price, its profits and cash dividends, and the book value of the firm's assets and relate them to other data items to determine how the firm is perceived in the stock market.

market value or market based

Which of the following asset classes is generally considered to be the least liquid?

real estate