Finance Chapter 4

__________and _______accounting differences are both part of scrubbing the data.

Aligning year-end data identifying/correcting

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

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

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

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?

Answer: 1.25 150 / 120 = 1.25

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

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

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?

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?

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

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

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.

The flexibility aspect of ratios and ratio analysis refers to which of the following?

Answer: Analysts can create new ratios if needed.

The OIROI (operating income return on investment) uses what elements on the income statement?

Answer: EBIT, total assets

Consider the following table comparing Firm A and Firm B to the industry average (both firms operate in the same industry): Firm A Firm B Current Ratio 0.5 higher than the industry 0.5 higher than the industry ROE Industry average Industry average Fixed Asset Turnover Lower than the industry by 0.3 Industry average Quick Ratio Higher than the industry Industry average Gross Margin Industry average Industry average Sales/Current Assets Industry average Lower than the industry Net Margin Higher than the industry Industry average Current Liabilities Industry average Industry average 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.

Which of the following best describes the problem associated with GAAP accounting standards when performing ratio analysis?

Answer: GAAP accounting standards allow for significant managerial discretion in reported financial statements.

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:

Answer: Hoogle's OIROI is higher than Mapple's but Hoogle is NOT more efficient.

Why would a company be interested in the TAT (total asset turnover) ratio?

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

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:

Answer: Lower than Big-Tokyo's.

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?

Answer: Macrosoft's higher current ratio and quick ratio could be due to the build up illiquid current assets.

Suppose an analyst is reviewing the profitability ratios for a firm. Which of the following statements represents the most valid insight for the analyst?

Answer: Since the profitability ratios of the firm declined, the analyst devotes additional effort to understanding revenues and costs.

Suppose the inventory turnover of a company is higher than the industry. Based on this observation, which of the following is most likely?

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

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?

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

company

Answer: You cannot tell without looking at other liquidity ratios.

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.

higher _____ results in higher OIROI

EBIT

________help identify the areas of a firm that need investigation.

Ratios

The process of making a target firm's data _________to a peer group is known as scrubbing the data.

comparable

If a company wishes to obtain a bank loan, will it want to have a higher current ratio or a lower current ratio?

higher

uncertainty in the times interest earned ratio will cause lenders to view Macrosoft as a _______risk borrowing candidate.

higher

4 Ratio categories

liquidity, asset use efficency, fiancing, profitability

_________depreciation expense leads to higher EBIT.

lower

The DuPont decomposes ROE into three factors:

profitability assets usage efficiency leverage

Choosing the comparison set is important, but is not part of s_______

scrubbing the data

While GAAP rules must be understood, ratio analysis is not _________by GAAP.

standardized