Quiz Chapter 7 FIN 4040

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

True

8. 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. a. True b. False

True

3. 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. a. True b. False

True

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.

Company A trades at a higher P/E ratio

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

False

6. 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. a. True b. False

False

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

The EBITDA coverage ratio increases

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.

The current and quick ratios both increase

Which of the following statements is CORRECT? a. All else equal, increasing the debt ratio will increase the ROA. b. The use of debt financing will tend to lower the basic earning power ratio, other things held constant. c. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. d. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE. e. Holding bonds is better than holding stock for investors because income from bonds is taxed on a more favorable basis than income from stock.

A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.

Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio? a. Use cash to reduce accounts payable. b. Borrow using short-term notes payable and use the proceeds to reduce accruals. c. Borrow using short-term notes payable and use the proceeds to reduce long-term debt. d. Use cash to reduce accruals. e. Use cash to reduce short-term notes payable.

Borrow using short-term notes payable and use the proceeds to reduce long-term debt

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."

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"

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. Company Heidee has a lower operating income (EBIT) than Company LD. b. Company Heidee has a lower total assets turnover than Company Leaudy. c. Company Heidee has a lower equity multiplier than Company Leaudy. d. Company Heidee has a higher fixed assets turnover than Company Leaudy. e. Company Heidee has a higher ROE than Company Leaudy.

Company Heidee has a higher ROE than company Leaudy

It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets. a. True b. 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. a. True b. 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. a. True b. 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. a. True b. False

False

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

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

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. ANSWER: a

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

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.

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

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.

The tax bill will increase

Which of the following statements is CORRECT? a. If two firms differ only in their use of debt⎯i.e., they have identical assets, sales, operating costs, and tax rates⎯but one firm has a higher debt ratio, the firm that uses more debt will have a higher profit margin on sales. b. If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses. c. A firm's use of debt will have no effect on its profit margin on sales. d. If two firms differ only in their use of debt⎯i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates⎯but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales. e. The debt ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable.

If two firms differ only in their use of debt⎯i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates⎯but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.

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.

Increase EBIT while holding sales constant

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.

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

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.

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

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

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.

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

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.

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

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

True

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

True

11. 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. a. True b. False

True

12. 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. a. True b. False

True

2. 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. a. True b. False

True

21. 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. a. True b. False

True

5. 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. a. True b. False

True

7. 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. a. True b. False

True

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

True

26. 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.

an increase in accounts receivable

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.

issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash