C214 Financial Management 4.1+

If a company has current assets of $90 and fixed assets of $140, if it has debt of $125, what is its debt ratio? 1.36 1.12 0.54 1.84

Answer: 0.54 (debt) 125 / 140 + 90 (total assets) = .5435

Macrosoft's total asset turnover is closest to which of the following? 0.38 2.11 0.72 1.39

Answer: 0.72 Solution: Total asset turnover = sales / total assets = 15k / 20.9k = 0.72

A company has cash of $100, accounts receivable of $250, inventory of $300, and accounts payable of $300. What is the quick ratio? 1.00 0.33 1.17 2.17

Answer: 1.17 100 + 250 / 300 = 1.17

If a company has current assets of $80 and fixed assets of $120, if sales are $150 and EBIT is $35, what is the fixed asset turnover? 2.29 5.71 0.80 1.25

Answer: 1.25 150 / 120 = 1.25

Kyoto Restaurant has total asset turnover of 1.50, ROE of 18.00%, and net profit margin of 6.00%. What is Kyoto's financial leverage ratio? 1.50 2.00 2.50 1.00

Answer: 2.00 ROE = Net Margin x TAT x FLR, so FLR = ROE / (Net Margin x TAT) = 0.18 / (0.06 x 1.50) = 2.00.

What is the ROA for Macrosoft? .0221% 3.92% 7.27% 2.21%

Answer: 2.21% ROA = 462/20900 = .0221 = 2.21%

What is the Times Interest Earned for Eastern Family? 7.34x 2.41x 0.41x 1.85x

Answer: 2.41x TIE = 1350 / 560 = 2.41x

Intel provides the following data for 2014: · A/R 600 · Inventory 800 · Fixed assets 1,000 · A/P 500 · Long term debt 900 · Common stock 400 What is the current ratio?

Answer: 2.8 600 + 800 / 500 = 2.8

What percentage of Macrosoft's sales is consumed by operating expense (including depreciation)? 59.53% 10.13% 40.47% 30.34%

Answer: 30.34% Operating Expense/Sales = Gross Margin - Operating Margin = 40.47% - 10.13% = 30.34%. Alternatively, Op Expense/Sales = (3250+1300)/15000 = 30.33%. (difference is due to rounding error)

A company has sales of $300, expenses of $200 and interest expense of $25, what is its times interest earned ratio? 1.75 4.00 3.00 2.00

Answer: 4.00 EBIT / Int Exp (300 - 200) / 25 = 4

Suppose a firm has a financial leverage ratio of 2.50. What percentage of the firm's assets are financed by equity? 40% 70% 50% 60%

Answer: 40% The correct answer is 40%. We know that Assets (100%) = Liabilities (X%) + Equity (Y%). So Financial leverage ratio = 2.5 = 100% / Y% = Assets/Equity; thus Y = 100 / 2.5 = 40%.

Suppose a firm has a financial leverage ratio of 2.50. What percentage of the firm's assets are financed by equity? 70% 40% 50% 60%

Answer: 40% The correct answer is 40%. We know that Assets (100%) = Liabilities (X%) + Equity (Y%). So Financial leverage ratio = 2.5 = 100% / Y% = Assets/Equity; thus Y = 100 / 2.5 = 40%.

Suppose a firm has a financial leverage ratio of 2.50. What percentage of the firm's assets is financed by equity? 40% 70% 60% 50%

Answer: 40% The ratio is 2.5 to 1. The amount financed by equity is a ratio of 1 to 2.5 or the inverse. 1 / 2.5 = .40

What is Macrosoft's interest-bearing debt to total capital ratio (IBDTC)? 51.24% 52.41% 43.73% 46.23%

Answer: 52.41% Solution: Interest bearing debt includes notes payable of $800 and long-term debt of $8340 (accounts payable and accrued expenses do not carry an explicit interest rate and are therefore excluded). Total capital includes interest bearing debt and equity of $8300. Hence, IBDTC = (800+8340)/(800+8340+8300) = 52.41%

For Eastern Family, what percentage of sales is consumed by Cost of Goods Sold? 58.90% 52.08% 47.92% 41.10%

Answer: 58.90% Since Gross Margin = Gross Profit / Sales = 4110 / 10000 = 41.10%, the COGS / Sales = 1 - Gross Margin = 58.90%.

If a firm's financial leverage ratio is 2.50, what percentage of assets are financed by debt? 40% 70% 50% 60%

Answer: 60% Solution: We know that Assets (100%) = Liabilities (X%) + Equity (Y%). So, Financial leverage ratio = 2.5 = 100%/Y% = Assets/Equity; thus Y = 40%, so X = 60% = percent financed by debt.

If a firm's financial leverage ratio is 2.50, what percentage of assets are financed by debt? 60% 40% 70% 50%

Answer: 60% Solution: We know that Assets (100%) = Liabilities (X%) + Equity (Y%). So, Financial leverage ratio = 2.5 = 100%/Y% = Assets/Equity; thus Y = 40%, so X = 60% = percent financed by debt.

What is the ROE for Eastern Family? 8.94% 23.70% 14.36% 2.93%

Answer: 8.94% ROE = 474 / 5300 = 8.94%

Macrosoft's average collection period is closest to which of the following? (Assume 365 days in a year.) 4.05 days 90 days 45 days 80 days

Answer: 90 days Solution: AR Turnover = credit sales/AR = 15000/3700 = 4.055. Average Collection Period = 365/AR Turnover = 90.0 days. (Note: in the absence of other information, all sales are assumed to be on credit).

The timing of a firm's fiscal year end would be most relevant to which of the following firms: A snowboard shop. A hospital. A restaurant. A supermarket.

Answer: A snowboard shop. When analyzing seasonal firms, an analyst must be careful to understand the relationship between fiscal year end and the sales cycle.

In order to make ratio analysis a more effective tool, you should carefully consider: Demographic trends. Bubbles and recessions. Technological changes. All the statements are correct.

Answer: All the statements are correct. All are examples of external risks that may affect a company's performance.

The flexibility aspect of ratios and ratio analysis refers to which of the following? Analysts can create new ratios if needed. Ratios determine the financial flexibility of a company. Ratios can be used to compare a firm to the industry's top performers. Firms of different size can be compared on the same scale.

Answer: Analysts can create new ratios if needed.

When performing ratio analysis, scrubbing the data includes all of the following except: Identifying accounting differences among competitors. Choosing a relevant comparison set. Alignment of ratios for companies with different fiscal year-ends. All are included in scrubbing the data.

Answer: Choosing a relevant comparison set. Choosing the comparison set is important, but is not part of scrubbing the data. Aligning year-end data and identifying/correcting accounting differences are both part of scrubbing the data.

The OIROI (operating income return on investment) uses what elements on the income statement? Operating income, EBIT, total liabilities Sales, total assets, equity EBIT, total assets Net margin, total current assets

Answer: EBIT, total assets

Assume that the industry average ROE is 12%. For Eastern Family, which of the following best describes their ROE: Eastern Family's ROE is 2.93%. Eastern Family is in a good position in the industry regarding to the return to its owner. Eastern Family is more profitable than the industry. Eastern Family is generating lower return to owners than the industry.

Answer: Eastern Family is generating lower return to owners than the industry. ROE for Eastern Family is 8.94% (474/5300 = 8.9%) which is less than the industry average.

If the industry average debt ratio is 60%, then: Eastern Family's debt is lower quality than the average in the industry. Eastern Family is more aggressively financed by debt than the industry. Eastern Family is more conservatively financed than the industry norm. Eastern Family has more owners' equity relative to its assets than the industry average.

Answer: Eastern Family is more aggressively financed by debt than the industry. Eastern Family's debt ratio is 67.28% (= total liabilities/total assets = 10,900 / 16200; remember, total liabilities equals current liabilities [$3,900] + long-term liabilities [$7,000]). Since the industry average is only 60%, Eastern Family finances a higher portion of its assets with debt than the industry norm. Thus, Eastern is more aggressively financed than the industry. Having a higher debt ratio does not necessarily mean that the company's debt is lower quality.

The industry has the following ratios: · Current ratio = 2.15 · Quick ratio = 1.5 · Inventory turnover = 1.95 · AR turnover = 4.5 Which one of the following statements is the most accurate about Eastern Family? Since Eastern Family has a higher current ratio than the industry average, it has a higher liquidity. Easter Family is a better inventory manager than the industry norm. Eastern Family takes longer to collect receivables than the industry. All the statements are correct.

Answer: Eastern Family takes longer to collect receivables than the industry. The accounts receivable turnover for Eastern Family is lower than the industry norm suggesting that it takes the company longer to collect receivables than the industry average. You cannot assess the company's liquidity based on ONLY current ratio. Also, since Eastern Family's inventory turnover ratio is lower than the industry this would imply it is NOT better at managing its inventory. Eastern Family's Current Ratio = 9700/3900 = 2.49; Quick Ratio = (9700-4000)/3900 = 1.46; Inventory turnover = 5890/4000 = 1.47; accounts receivable turnover = 10000/3000 = 3.33.

Which one of the following statements is most plausible? Firm B holds more inventory than Firm A. Firm B has a higher total asset turnover than Firm A. Firm B is more profitable than Firm A. None of the above is plausible.

Answer: Firm B holds more inventory than Firm A. Looking at the current ratios and the quick ratios of two companies, Firm B has lower quick ratio than Firm A while current ratios are the same for both firms suggesting that Firm B has more inventory than Firm A. Firm A's FAT is lower while Firm B's Sales/Current Assets ratio is lower. Thus, the volume of total assets relative to sales is ambiguous. Firm A also has a higher net margin (and both firms have the same gross margin) implying that Firm B is not more profitable.

Which one of the following statements is most likely correct? Firm B's inventory is more liquid than Firm A's. Firm B has higher total asset turnover than Firm A. Firm B should have higher debt ratio than Firm A. All the statements are correct.

Answer: Firm B should have higher debt ratio than Firm A. Recall the DuPont equation: ROE = net margin x TAT x FLR. Both firms have the same net profit margin, but Firm A has a higher TAT (total asset turnover) than Firm B. Thus, the equal ROEs for both firms imply that Firm B has a higher debt ratio (resulting in a higher FLR; FLR = Assets/Equity) than Firm A. Both firms have the same current ratio, but firm A has a higher quick ratio than firm B implying Firm B's inventory is NOT more liquid than Firm A's. Hence, firm A has relatively less inventory than firm B. The equal gross margin for both firms and the higher quick ratio (lower inventory) suggests that inventory turnover is higher for firm A than for firm B. Thus, if anything, firm A's inventory appears more liquid than firm B's inventory. Firm A's Sales/Current Assets is higher than Firm B's and both companies have the same fixed asset turnover. So, Firm A should have higher total asset turnover than Firm B.

Which one of the following is NOT included in the DuPont calculation? Net profit margin Fixed asset turnover Financial leverage ratio Return on asset

Answer: Fixed asset turnover ROE = Net Margin x TAT x FLR = ROA x FLR.

Which of the following best describes the problem associated with GAAP accounting standards when performing ratio analysis? GAAP accounting standards are too simplistic for most firms. Most firms use cash accounting rather than GAAP accounting. GAAP accounting standards allow for significant managerial discretion in reported financial statements. Most firms use cash accounting rather than accrual accounting.

Answer: GAAP accounting standards allow for significant managerial discretion in reported financial statements. Within the confines of GAAP, managers still have significant discretion over reported results.

If a company wishes to obtain a bank loan, will it want to have a higher current ratio or a lower current ratio? Lower It does not matter The same Higher

Answer: Higher

Consider Kyoto Restaurant. Kyoto's ROE is lower than the industry average. However, Kyoto's total asset turnover and financial leverage ratio are identical to the industry. The industry average net margin must be: Equal to Kyoto's net margin. Lower than Kyoto's net margin. Cannot be determined Higher than Kyoto's net margin.

Answer: Higher than Kyoto's net margin. Kyoto's TAT and FLR are the same as the industry. Since TAT x FLR x net margin = ROE, the industry average net margin must be higher than Kyoto's since the industry has a higher ROE.

Consider two companies, Hoogle and Mapple. They are economically identical. However, for reporting purposes Hoogle uses the managerial discretion that is required with accrual accounting to increase net income relative to Mapple (assume any balance sheet effects are inconsequential). Which of the following is correct: Mapple's OIROI is higher than Hoogle's but Mapple is NOT more efficient. Mapple's OIROI is higher than Hoogle's and Mapple is more efficient. Hoogle's OIROI is higher than Mapple's but Hoogle is NOT more efficient. Hoogle's OIROI is higher than Mapple's and Hoogle is more efficient.

Answer: Hoogle's OIROI is higher than Mapple's but Hoogle is NOT more efficient. Using the accrual accounting system to increase net income is known as earnings management. Since the firms are economically identical, Hoogle's use of accruals to increase net income and OIROI is just a ruse.

Why would a company be interested in the TAT (total asset turnover) ratio? It indicates what the turnover of sales is to liabilities. It indicates how efficient assets are to liabilities and equity. It indicates how efficient assets are at producing income. It indicates how efficient assets are at producing sales.

Answer: It indicates how efficient assets are at producing sales.

Macrosoft's biggest competitor, Mapple, has the gross margin of 41.84%, the operating margin of 11.50%, and the net margin of 3.13%. Both companies have a tax rate of 40%. Comparing these two companies, Macrosoft must have: Lower cost of goods sold relative to its sales than Mapple. Lower operating expense relative to its sales than Mapple. Lower interest expense relative to its sales than Mapple. Lower sales than Mapple.

Answer: Lower interest expense relative to its sales than Mapple. The difference between operating margin and net margin is the percent of sales consumed by interest and taxes; 8.37% for Mapple and 7.05% for Macrosoft. Since the tax rate is the same, it must be that Macrosoft has lower interest expense than Mapple. Macrosoft has lower gross margin than Mapple which suggests that Macrosoft has higher cost of goods sold than Mapple. Operating expense, as a percent of sales, is the same for both firms (note: operating expense as a percent of sales = Gross Margin - Operating Margin). And lastly, the level of sales cannot be addressed with ratios. For Macrosoft: 1) gross margin = Gross profit/Sales = 6070/15000 = 40.47%, 2) Operating margin = Operating Profit/Sales = 1520/15000 = 10.13%, and 3) net margin = NI/Sales = 462/15000 = 3.08%.

Eastern Family's main competitor has Gross Margin of 40.32%, operating margin of 15.53%, and net margin of 4.83%. Both Eastern Family and the competitor have the tax rate of 40%. Given this information, Eastern Family must have: Higher dollar amount sales than the competitor. Lower operating expense relative to its sales than the competitor. Lower interest expense than the competitor. Higher COGS relative to its sales than the competitor.

Answer: Lower interest expense than the competitor. Since Eastern Family has higher gross margin (41.10%), COGS is relatively low. Eastern Family has higher operating expenses since the drop in operating margin (drop from net margin to operating margin) is bigger than the competitor. You cannot tell dollar amount of sales with the given ratios. Given the other three answers can't be right, lower interest expense than competitor (as a percent of sales) must be correct. We can see this is the ratios. The difference between operating margin and net margin is driven by Interest and Taxes (recall operating margin is EBIT/Sales). As such, the change from operating to net margin indicates the percentage of revenues consumed by interest and taxes. For Eastern, the change is 8.76% (= operating margin - net margin = 13.5% - 4.47%). The equivalent change for the competitor is 10.7%. Given that both firms pay the same percentage in taxes (i.e., 40% of EBT), the smaller change for Eastern Family is likely due to small interest expense on a relative basis. Gross Margin = 4110/10000 = 41.1%; operating margin = 1350/10000 = 13.5%, net margin = 474/10000 = 4.74%

Big-Tokyo Inc. has a financial leverage ratio of 2.00, total asset turnover of 1.50 and ROE of 18.00%. For Big-Tokyo's industry, the average ROE is 16.00% and the industry average total asset turnover (TAT) and financial leverage ratio (FLR) are the same as Big-Tokyo. The industry average net margin must be: Cannot be determined with available data. Equal to Big-Tokyo's. Higher than Big-Tokyo's. Lower than Big-Tokyo's.

Answer: Lower than Big-Tokyo's. TAT and FLR are the same for the industry and Big-Tokyo. Hence, since Big-Tokyo has a higher ROE, Big-Tokyo must have a higher net margin than the industry.

Big-Tokyo Inc. has a financial leverage ratio of 2.00, total asset turnover of 1.50 and ROE of 18.00%. For Big-Tokyo's industry, the average ROE is 16.00% and the industry average total asset turnover (TAT) and financial leverage ratio (FLR) are the same as Big-Tokyo. The industry average net margin must be: Lower than Big-Tokyo's. Cannot be determined with available data. Higher than Big-Tokyo's. Equal to Big-Tokyo's.

Answer: Lower than Big-Tokyo's. TAT and FLR are the same for the industry and Big-Tokyo. Hence, since Big-Tokyo has a higher ROE, Big-Tokyo must have a higher net margin than the industry.

The industry average current ratio and quick ratio are 2.64 and 1.88 respectively. Which of the following would be the most plausible inference about Macrosoft's liquidity? Macrosoft has worse liquidity than the industry. Macrosoft has a larger amount of cash relative to its current assets than the industry average. Macrosoft has higher inventory relative to current liabilities than the industry average. Macrosoft has better liquidity than the industry.

Answer: Macrosoft has higher inventory relative to current liabilities than the industry average. · Current ratio = CA/CL = 12,550/4260 = 2.95 Macrosoft has a higher current ratio while the quick ratio is lower. This means that the company must be carrying a large amount of inventory (i.e., when we take inventory out of the numerator, the ratio falls significantly).

If the industry average ROE is 4.12% and ROA is 2.09%, the most plausible conclusion about Macrosoft's profitability is: The industry is outperforming Macrosoft Macrosoft is underperforming the industry. Macrosoft should use more equity financing. Macrosoft is more profitable than the industry.

Answer: Macrosoft is more profitable than the industry. For Macrosoft: ROE = NI/Equity = 462/8300 = 5.56%; ROA = 462/20900 = .0221 = 2.21%. Hence, Macrosoft is generating higher ROA and ROE than the industry.

If the industry average ROE is 4.12% and ROA is 2.09%, the most plausible conclusion about Macrosoft's profitability is: The industry is outperforming Macrosoft. Macrosoft is more profitable than the industry. Macrosoft is underperforming the industry. Macrosoft should use more equity financing.

Answer: Macrosoft is more profitable than the industry. For Macrosoft: ROE = NI/Equity = 462/8300 = 5.56%; ROA = 462/20900 = .0221 = 2.21%. Hence, Macrosoft is generating higher ROA and ROE than the industry.

For Macrosoft's industry, average fixed asset turnover is 2.31. Which of the following is the most plausible conclusion about Macrosoft? Macrosoft is using its fixed assets more efficiently than the industry norm. Macrosoft must relax credit standards to increase sales. Macrosoft likely needs to invest in fixed assets in the near future. Macrosoft it is using its fixed assets less efficiently than the industry norm.

Answer: Macrosoft it is using its fixed assets less efficiently than the industry norm. For Macrosoft, fixed asset turnover = Sales/ fixed assets = 15000/8350 = 1.80. Hence, Macrosoft generates $1.80 in sales for each dollar of fixed assets compared to $2.31 in sales for each dollar of fixed asset for the industry. While the fixed asset turnover doesn't tell the whole story, the most plausible conclusion is that Macrosoft is not using fixed assets as efficiently as the industry norm.

Suppose that Macrosoft decides to increase the estimated life over which fixed assets are depreciated. Which of the following is most likely? Macrosoft's OIROI will increase. Macrosoft's total asset turnover will increase. Macrosoft's inventory turnover will decrease. None of the above are likely.

Answer: Macrosoft's OIROI will increase. Solution: Microsoft's depreciation expense will be lower as a result of extended the estimated life of its assets. Lower depreciation expense leads to higher EBIT. Higher EBIT results in higher OIROI. (Note: the change in depreciation expense will increase EBIT and increase total assets; however, the change in EBIT will dominate).

Suppose that Macrosoft's times interest earned ratio has varied between 0.80 times and 5.23 over the past five years. Which of the following statements is most plausible? Macrosoft's borrowing cost may increase due to the fluctuations in interest coverage. Macrosoft should use more debt to finance assets. Banks will be eager to loan to Macrosoft because of the fluctuations in the times interest earned ratio. Macrosoft's borrowing cost may decrease due to the uncertainty of being able to cover interest payments.

Answer: Macrosoft's borrowing cost may increase due to the fluctuations in interest coverage. Solution: Uncertainty in the times interest earned ratio will cause lenders to view Macrosoft as a higher risk borrowing candidate. Therefore, if Macrosoft needs to borrow, they will likely pay a higher interest rate.

In Macrosoft's industry, the average current ratio is 2.76, the average quick ratio is 1.56, the average inventory turnover is 1.68 and the industry average collection period is 54.3 days. When comparing Macrosoft to the industry, which one of the following statements is the most accurate? Macrosoft is less liquid than the industry because of the firm's high current and quick ratios. Macrosoft inventories are less liquid than the industry average. Macrosoft's higher current ratio and quick ratio could be due to the build up illiquid current assets. None of the statements are correct.

Answer: Macrosoft's higher current ratio and quick ratio could be due to the build up illiquid current assets. The high level of both the current and quick ratios is likely due to the build up of low quality receivables. Notice that Macrosoft takes 90 days to collect compared to only 54.3 for the industry. Hence, the current and quick ratios, in isolation, are misleading. The build-up of uncollectable accounts receivable does nothing to provide liquidity for the firm. Firstly, the higher current and quick ratios point to greater liquidity. More importantly, liquidity requires a broader view of the firm that can be gained by looking at only the current ratios and quick ratios. Macrosoft has the same level of the inventory turnover as the industry so its inventories are not necessarily less liquid. For Macrosoft: 1) Current ratio = CA/CL = 12550/4260 = 2.94, 2) Quick ratio = (CA-Inv)/CL = (12550 - 5300)/4260 = 1.70, 3) Inventory turnover = Cost of goods sold/inventory = 8930/5300 = 1.68, and 4) AR Turnover = credit sales/AR = 15000/3700 = 4.055; Therefore, Average Collection Period = 365/AR Turnover = 90.0 days.

In Macrosoft's industry, the average current ratio is 2.76, the average quick ratio is 1.56, the average inventory turnover is 1.68 and the industry average collection period is 54.3 days. When comparing Macrosoft to the industry, which one of the following statements is the most accurate? Macrosoft is less liquid than the industry because of the firm's high current and quick ratios. Macrosoft inventories are less liquid than the industry average. Macrosoft's higher current ratio and quick ratio could be due to the build up of illiquid current assets. None of the statements are correct.

Answer: Macrosoft's higher current ratio and quick ratio could be due to the build up of illiquid current assets. For Macrosoft: 1) Current ratio = CA/CL = 12550/4260 = 2.94, 2) Quick ratio = (CA-Inv)/CL = (12550 - 5300)/4260 = 1.70, 3) Inventory turnover = Cost of goods sold/inventory = 8930/5300 = 1.68, and 4) AR Turnover = credit sales/AR = 15000/3700 = 4.055; Therefore, Average Collection Period = 365/AR Turnover = 90.0 days. A common mistake is to interpret Macrosoft's higher current and quick ratios as evidence the company is more liquid than the typical firm in the industry. Liquidity requires a broader view of the firm that can be gained by looking only at the current ratio and quick ratio. Macrosoft has the same level of the inventory turnover as the industry implying that inventories are NOT less liquid. What about the other current assets? Notice that Macrosoft takes 90 days to collect receivables compared to only 54.3 for the industry. The very long ACP relative to the industry indicates the Macrosoft's AR are low quality (i.e., the firm has slow paying customers or they are failing to write-off uncollectable receivables). Hence, the high level of both the current and quick ratio is likely due to the build up of low quality receivables. The build-up of uncollectable/low-quality accounts receivable does nothing to provide liquidity for the firm. Hence, the current and quick ratios, in isolation, are misleading for Macrosoft.

Which one of the following ratios is NOT part of the common ratio categories? Profitability Liquidity Financing Operating

Answer: Operating We discuss 4 ratios in the textbook: Liquidity, Asset Use Efficiency, Financing (Leverage), and Profitability.

Which one of the following is not an element of the DuPont decomposition? Portion of assets financed by equity. Earnings as a percentage of sales. Sales as a percentage of total assets. Percentage of net income paid out as dividends.

Answer: Percentage of net income paid out as dividends. The DuPont decomposes ROE into three factors: profitability (net margin; earnings as a percent of sales), assets usage efficiency (asset turnover; sales as a percent of assets), and leverage (financial leverage; portion of assets financed by equity). Dividend payout is not included in the DuPont decomposition of ROE.

Which one of the following is NOT an example of the use of meaningful comparison standards for ratio analysis? Using ratios to assess whether the firm is meeting established goals. Reporting ratios in annual financial statements. Comparing ratios over several years to understand changes in the company. Comparing a firm's ratios to the industry average to assess strengths and weaknesses.

Answer: Reporting ratios in annual financial statements. There are no required ratios for financial reporting. Simply including ratios for the year in an annual report does not provide a comparison or standard for the calculated ratios. The other answers are examples of internal goal monitoring, trend analysis, and cross-sectional analysis.

Suppose an analyst is reviewing the profitability ratios for a firm. Which of the following statements represents the most valid insight for the analyst? Since the profitability ratios of the firm declined, the analyst devotes additional effort to understanding revenues and costs. Since the profitability ratios of the firm declined, the firm is facing serious competitive pressures. Since the profitability ratios of the firm improved, the firm is not subject to competitive pressures. Since the profitability ratios of the firm improved, the firm is obviously headed in the right direction.

Answer: Since the profitability ratios of the firm declined, the analyst devotes additional effort to understanding revenues and costs. As the textbook states, ratios do not tell you about the company; rather, ratios helps you know what questions to ask.

Suppose the inventory turnover of a company is higher than the industry. Based on this observation, which of the following is most likely? The firm has too little inventory resulting in lost sales or stock-outs. The firm has lower liquidity than the industry average. The firm has too much inventory thus impairing overall liquidity. The firm has low sales volume.

Answer: The firm has too little inventory resulting in lost sales or stock-outs.

Suppose the inventory turnover of a company is higher than the industry. Based on this observation, which of the following is most likely? The firm has too little inventory resulting in lost sales or stock-outs. The firm has lower liquidity than the industry average. The firm has low sales volume. The firm has too much inventory thus impairing overall liquidity.

Answer: The firm has too little inventory resulting in lost sales or stock-outs. If a firm has a higher inventory turnover this implies that it is more liquid and does NOT necessarily have too much inventory on hand because it is able to sell its inventory. The only likely answer then is that it may have too little inventory on hand.

Ratios help identify the areas of a firm that need investigation. T/F

Answer: True Solution: True. Ratios tell you what questions to ask about the company.

True/False. The process of making a target firm's data comparable to a peer group is known as scrubbing the data.

Answer: True True. Scrubbing the data is a preliminary step in ratio analysis. The process entails recasting the target/peer financial statements to align significant accounting choices, fiscal year-ends, etc.

A company has cash sales of $200 and credit sales of $750. It's average accounts receivable is $90. What is the A/R turnover? What is the average collection period? Turnover 8.33 ACP: 43.8 Turnover: 10.56 ACP: 43.8 Turnover: 8.33 ACP: .694 Turnover 10.56 ACP: 24.9

Answer: Turnover 8.33 ACP: 43.8 750 / 90 = 8.33 ACP = 365 / 8.33 = 43.8

Which one of the following is NOT an example of meaningful ratio analysis? Analyzing the trend in ratios over time for a single firm. Using ratios to assess goal achievement. Using ratios to compare a firm with high performing competitors. Using GAAP rules to calculate standard ratios.

Answer: Using GAAP rules to calculate standard ratios. While GAAP rules must be understood, ratio analysis is not standardized by GAAP.

If the current ratio of a company is higher than the industry, then: The company has higher liquidity than the industry. You cannot tell without looking at other liquidity ratios. The company has lower liquidity than the industry. The company has about the same liquidity as the industry.

Answer: You cannot tell without looking at other liquidity ratios. You cannot tell a company's liquidity compared to the industry just by looking at one ratio.

DuPont equation

ROE = ROA x FLR (notice Net Margin x TAT = ROA)