FIN 323 CHAPTER 3

Long-term solvency ratios are also known as:

financial leverage ratios

If sales increase while there is no change in accounts receivable, the receivables turnover ratio will ______.

increase Reason An increase in the numerator, all else equal, results in an increase in the ratio.

What will happen to the current ratio if current assets increase, while everything else remains unchanged?

it will increase Reason: An increase in the numerator, all else equal, results in an increase in the ratio.

Which of the following are sources of cash?

An increase in notes payable A decrease in accounts receivable

A times interest earned (TIE) ratio of 3.5 times means a firm has _____ that is(are) 3.5 times greater than the firm's interest expense.

Earnings before interest and taxes

True or false: A deteriorating time trend in a financial ratio is always a bad sign.

False Reason: It may not be a bad sign, but it does merit investigation. This could mean the business has changed its way of operating from last time to present

______ are the prime source of information about a firm's financial health.

Financial Statements Reason: Financial statements are the prime source of information about a firm's financial health. Historical returns are typically higher for financially healthy firms.

A(n) _____ is a measurable value that shows how effectively a company is achieving a business objective.

KPI

By evaluating the quick ratio, we can see that one sign of possible short-term trouble is the existence of relatively (small/large) inventories.

Large

The price-earnings (PE) ratio is a ______ ratio.

Market Value

Which ratios use some information that is not contained in financial statements?

Market Value Ratios

How is the price-earnings (PE) ratio computed?

Market price per share/Earnings per share Reason: If you multiply both the numerator and the denominator by shares outstanding, you'll have market capitalization/Total earnings.

What is the main difference between the cash coverage ratio and the times interest earned ratio?

Noncash expenses Reason: Cash ratio adds noncash expenses back to the EBIT to determine its ability to meet its interest obligations.

A common-size income statement helps compare financial results over time by controlling for changes in ______.

Sales

ROA and ROE are common and useful measures, but it is important to remember that they are ______rates of return.

accounting

Which of the following items are among the items used to compute the current ratio?

cash A/P

A firm with a market-to-book ratio that is greater than 1 is said to have ______ value for shareholders.

created Reason: A market-to-book ratio greater than one means the firm's market value is higher than its cost; the managers have created value.

One of the most important uses of financial statement information within the firm is:

performance evaluation

Some financial ratios are based on the market price per share of stock, which is information not contained in the financial statements. As a result, these measures can only be directly calculated for _____________traded companies.

publicly

The EBITDA ratio is similar in spirit to:

the PE ratio. Reason: The EBITDA ratio is a market value ratio. The DuPont identity is used to decompose ROE to identify strengths and weaknesses.

Financial ratios are ways of comparing and investigating Blank______.

the relationships between pieces of financial information

Total capitalization equals total equity plus total:

total equity plus total long-term debt.

A firm with a 26 percent return on equity earned ______ cents in profit for every one dollar in shareholders' equity.

26 Reason: ROE is Net Income/Equity. With ROE of 26%, if equity is $1, net income will be $0.26.

A firm with a profit margin of 6.8 percent generates ______ cents in net income for every one dollar in sales.

6.8 Reason: A firm with a profit margin of 6.8 percent generates 6.8 cents in net income for every one dollar in sales.

A useful way of standardizing financial statements is to choose a ____ and then express each item relative to the _____.

Base year; base amount

Long-term debt ratio is equal to long-term debt divided by the sum of long-term debt and total

EQUITY

True or false: Enterprise value equals total market value of the stock plus the book value of the liabilities plus cash.

False Reason: Enterprise value equals total market value of the stock plus the book value of the liabilities minus cash.

Financial managers use a common-size income statement to determine ___.

Financial managers use a common-size income statement to determine which costs are rising or falling as a percentage of sales. Sources and uses of cash are shown on the statement of cash flows.

One common way to identify potential peers is based on Standard_____________Classification codes.

Industrial

Which one of the following does not affect ROE according to the DuPont identity?

Investor Sentiment Reason Asset use efficiency is part of asset management. Operating efficiency is part of profitability The DuPont identity decomposes ROE into profitability, asset management, and financial leverage.

How is market-to-book ratio measured?

Market Value per share/ Book Value per share

Which of the following are traditional financial ratio categories?

Profitability ratios Market value ratios Asset management ratios Long-term solvency ( Financial Leverage) Short Term Solvency (Liquidity)

A firm has a total debt ratio of 0.30 times. This means the firm has ___ in total debt for every $1 in total assets.

Reason: Total debt/Assets =0.3. If assets = $1, then Total debt/1=0.3, so total debt is $0.30

A problem with the TIE ratio is that it is based on , which is not really a measure of cash available to pay interest.

Sales/A/R

Which two of the following groups are most interested in liquidity ratios?

Suppliers BAnkers

Because we are almost always unable to obtain all of the market information we want, we rely on _________________numbers for much of our financial information.

accounting

The ROE equals the net profit margin multiplied by the total__________ turnover multiplied by the equity multiplier.

asset

When combining common-size and common-base year analysis, the effect of overall growth in assets can be eliminated by first forming the:

common-size statements

The cash ratio is found by dividing cash by:

curerent liabilities

The quick ratio is computed just like the_________ ratio, except that inventory is omitted.

current

The current ratio shows the relationship between ____.

current assets and current liabilities

An important accounting goal is to report financial information to users in a way that is useful for _____.

decision making

EBITDA multiple is equal to the enterprise value__________ (divided/multiplied) by EBITDA.

divided

The debt-equity ratio expresses the total debt divided by total equity, while the ________________multiplier expresses the total assets divided by the total equity.

equity

When the typical stock in the S&P 500 Index has a PE ratio 12, a company with a PE ratio of 15 may have ______ than average growth prospects, given similar earnings per share.

higher

As long as all sales requests are being met, a ______ inventory turnover ratio is better.

higher Reason: A higher turnover implies more efficient operations provided there is sufficient inventory to meet demand.

A(n) Blank______ in net profit margin will increase ROE.

increase

Some financial ratios measure a firm's ______, which shows the ability to meet short-term obligations without undue stress, while others measure a firm's financial ______, which demonstrates the proportion of assets financed by long-term obligations.

liquidity; leverage Reason: Liquidity shows the ability to meet short-term obligations without undue stress, while leverage demonstrates the proportion of assets financed by long-term obligations.

True or false: The interval measure indicates how long a start-up company can operate until it needs more financing.

true

If a company's common-size income statement shows a lower percentage for cost of goods sold this period compared to last period, the company may be controlling its costs well or it has _____.

raised its prices relative to costs

The price-sales ratio is calculated as the price per____ divided by the sales per _______

share, share

Common-size statements are used for comparing firms with differing ____.

sizes

At the most fundamental level, firms generate cash and:

spend it

The cash coverage ratio adds ______ to operating earnings (EBIT) for a better of measure of how much cash is available to meet interest obligations.

depreciation

A common-base year financial statement presents items relative to a certain base, which is the _____.

dollar amount of each item during a common base year Reason: A common-base year balance sheet shows the percentage of each item relative to a common base year, which is set to one for each item.

Financial statements are used to:

assess a company's current financial position communicate financial information to outsiders communicate financial information within the firm

Long-term debt ratio is equal to long-term debt divided by the sum of long-term debt and total_______________

equity

If a company has inventory, the quick ratio will always be ______ the current ratio.

less than Reason: Since the quick ratio excludes inventory, it will always be less than the current ratio.

A common-size balance sheet expresses accounts as a percentage of:

total assets.

What does it mean when a firm has a days' sales in receivables of 45?

The firm collects its credit sales in 45 days on average.

What does a current ratio of 1.2 mean?

The firm has $1.20 in current assets for every $1 in current liabilities.

What is the impact on the total asset turnover ratio if sales increase significantly while there is no change in any of the other variables?

The total asset turnover ratio will increase. Reason: Because sales are in the numerator, the ratio would increase.

The statement of cash flows summarizes the sources and uses of cash, though which of the following is true of the statement?

There are different methods of preparing it.

Which one of the following equations defines the total asset turnover ratio?

Total asset turnover = sales/total assets

The _________ identity can help to explain why two firms with the same return on equity may not be operating in the same way.

DuPont

A problem with the TIE ratio is that it is based on ________ , which is not really a measure of cash available to pay interest.

EBIT