BEC - Ratio Analysis
If a CPA's client expected a high inflation rate in the future, the CPA would suggest to the client which of the following types of investments? A. Precious metals. B. Treasury bonds. C. Corporate bonds. D. Common stock.
A, correct Of the alternative answer choices listed, during a period of high inflation, the best investment is precious metals. Because of their scarcity, precious metals tend to increase in market value during periods of inflation. Treasury bonds and corporate bonds, both of which typically pay fixed rates of return, face market interest rate risk and will lose market value as inflation drives up the general rate of interest. While common stock may provide some protection during a period of high inflation, that inflation causes the costs of productive inputs to increase, therefore, increasing pressure on company profits and returns to common stock shareholders.
What is the maximum additional amount Barr will be able to borrow if the stock is issued? A. $225,000 B. $330,000 C. $525,000 D. $750,000
B, correct In summary, if Barr issues $300,000 in new common stock, it would have $1,000,000 in common stock outstanding. With a maximum debt to equity ratio of .75, the maximum debt is .75 x $1,000,000 = $750,000. Since it now has total debt of $420,000, a maximum additional $330,000 in debt could be incurred.
Information that relates to a firm's solvency is used primarily to assess a firm's ability to A. Convert assets to cash. B. Pay it debts. C. Generate profits. D. Collect its receivables in a timely manner.
B, correct
Return on assets is computed as Net Income (as appropriately adjusted)/Average Total Assets. DuPont Company developed a method of separating the return on assets computation into two component ratios. Which one of the following sets identifies the two component ratios that make up the DuPont return on assets approach? A. Gross profit margin (ratio) and average total asset turnover ratio. B. Net profit margin (ratio) and average total asset turnover ratio. C. Gross profit margin (ratio) and average fixed asset turnover ratio. D. Net profit margin (ratio) and average fixed asset turnover ratio.
B, correct
Ral Co.'s target gross margin is 60% of the selling price of a product that costs $5.00 per unit. The product's selling price per unit should be A. $17.50 B. $12.50 C. $8.33 D. $7.50
B, correct $5.00/.40 = $12.50.
Bobcat Company has a current ratio of 2:1. Which one of the following transactions could Bobcat use to increase its current ratio? A. Borrowing cash by giving a short-term note. B. Paying off accounts payable. C. Paying off long-term debt. D. Factoring accounts receivable.
B, correct A 2:1 current ratio means that Bobcat has twice the book value of current assets as its book value of current liabilities. For example, current assets (CA) of $200,000, with current liabilities (CL) of $100,000, would give a current ratio of CA/CL = $200,000/$100,000 = 2:1. Because Bobcat's current ratio is greater than 1:1, an equal dollar decrease in current assets and current liabilities will be a greater percentage decrease in current liabilities than in current assets, resulting in an increase in the ratio of remaining current assets and liabilities. Assuming the above values, paying off $10,000 of accounts payable would result in a reduction in the current asset cash ($200,000 - $10,000 = $190,000), and an equal dollar reduction in the current liability accounts payable ($100,000 - $10,000 = $90,000). The resulting new current ratio would be $190,000/$90,000 = 2.11:1, an increase over the previous 2.00:1.
Which of the following factors is inherent in a firm's operations if it utilizes only equity financing? A. Financial risk. B. Business risk. C. Interest rate risk. D. Marginal risk.
B, correct A firm that utilizes only equity financing would face business risk. Business risk derives from the broad, macro-risk a firm faces largely as a result of the relationship between the firm and the environment in which it operates. The extent of that risk would depend on the susceptible of the firm to changes in the overall economic climate.
The controller of Peabody, Inc. has been asked to present an analysis of accounts receivable collections at the upcoming staff meeting. The following information is used: 12/31, year 2 12/31, year 1 Accounts receivable $100,000 $130,000 Allowance, doubtful accounts (20,000) (40,000) Sales 400,000 200,000 Cost of goods sold 350,000 70,000 What is the receivables turnover ratio as of December 31, year 2? A. 5.0 B. 4.7 C. 3.5 D. 0.6
B, correct Accounts receivable turnover is calculated as: (Net Credit) Sales/Average Net Accounts Receivable. In this question, it is first necessary to compute average net accounts receivable. Average Net Accounts Receivable = [Beginning Net Accounts Receivable ($130,000 - $40,000 = $90,000) + Ending Net Accounts Receivable ($100,000 - $20,000 = $80,000)]/2 = ($90,000 + $80,000 = $170,000)/2 = $85,000 Accounts Receivable Turnover = $400,000/$85,000 = 4.705
The following information was taken from the income statement of Hadley Co.: Beginning inventory 17,000 Purchases 56,000 Ending inventory 13,000 What is Hadley Co.'s inventory turnover? A. 3. B. 4. C. 5. D. 6.
B, correct Inventory turnover is computed as: Cost of Goods Sold/Average Inventory. Cost of goods sold (COGS) is the sum of beginning inventory (BI) plus purchases (P), which equals cost of goods available for sale (COGAS), less ending inventory (EI); that difference is cost of goods sold. It would be computed as: BI $17,000 + P $56,000 = COGAS $73,000 - (EI) $13,000 = (COGS) $60,000. Average inventory (AI) is computed as (BI) $17,000 + (EI) $13,000/2, or (AI) $30,000/2 = $15,000. Thus, inventory turnover is (COGS) $60,000/(AI) $15,000 = 4.
Residual income of an investment center is the center's A. Income plus the imputed interest on its invested capital. B. Income less the imputed interest on its invested capital. C. Contribution margin plus the imputed interest on its invested capital. D. Contribution margin less the imputed interest on its invested capital.
B, correct Residual income is the achieved income of the division less a measure of the minimum required income that should be earned by a division with that amount of capital invested. Residual income = division income - [(imputed interest rate)(division capital)]. Thus, residual income is the amount of income over and above the minimum required of the division with its amount of invested capital. A larger number indicates a more successful division.
A company's return on investment is the A. Profit margin percentage divided by the capital turnover. B. Profit margin percentage multiplied by the capital turnover. C. Capital turnover divided by invested capital. D. Capital turnover multiplied by invested capital.
B, correct Return on investment = Income/Investment Profit margin percentage = Income/Sales Capital turnover = Sales/Investment Therefore: Return on investment = (Income/Sales) x (Sales/Investment) = Profit margin percentage x capital turnover. This answer correctly states: Profit margin percentage MULTIPLIED by the capital turnover.
What is the primary disadvantage of using return on investment (ROI) rather than residual income (RI) to evaluate the performance of investment center managers? A. ROI is a percentage, while RI is a dollar amount. B. ROI may lead to rejecting projects that yield positive cash flows. C. ROI does not necessarily reflect the company's cost of capital. D. ROI does not reflect all economic gains.
B, correct When managers are currently producing high ROI rates, they may be reluctant to accept a project that has a lower ROI than their current rate of return. A project may meet the company's return requirements, but if it causes a manager's overall ROI to decrease, they may be reluctant to accept the project.
Company specific risk is also known as which one of the following? A. Market-related risk. B. Business risk. C. Unsystematic risk. D. Non-diversifiable risk.
C, correct Company specific risk (also called firm-specific risk and diversifiable risk) are unsystematic risk. This risk includes those elements of business risk that can be eliminated through diversification. Specifically, this risk can be mitigated by diversification of projects, investments, etc.
Green, Inc., a financial investment-consulting firm, was engaged by Maple Corp. to provide technical support for making investment decisions. Maple, a manufacturer of ceramic tiles, was in the process of buying Bay, Inc., its prime competitor. Green's financial analyst made an independent detailed analysis of Bay's average collection period to determine which of the following? A. Financing. B. Return on equity. C. Liquidity. D. Operating profitability.
C, correct A detailed analysis of average collection period most likely would be used to assess or determine liquidity. An analysis of average collection period would measure how long, on average, it takes an entity to collects its receivables -- how long it takes to convert accounts receivable to cash.
Which of the following types of risk can be reduced by diversification? A. High interest rates. B. Inflation. C. Labor strikes. D. Recession.
C, correct Risks that can be reduced by diversification (also called diversifiable risk or unsystematic risk) are risks that relate to a particular undertaking, firm or industry, and typically are not associated with macroeconomic conditions. Diversifiable risk are mitigated by engaging in multiple different investments or undertakings so that an unexpected unfavorable outcome of one investment or undertaking will represent only a small portion of all investments or undertakings and so that unfavorable outcomes on some investments or undertakings will be offset by favorable outcomes on other investments or undertakings. Labor strikes typically are peculiar to a particular undertaking, plant, firm or industry and are, therefore, diversifiable by having labor forces in other undertakings, plants, or industries.
A company has several long-term floating-rate bonds outstanding. The company's cash flows have stabilized, and the company is considering hedging interest rate risk. Which of the following derivative instruments is recommended for this purpose? A. Structured short-term note. B. Forward contract on a commodity. C. Futures contract on a stock. D. Swap agreement.
D, correct A swap agreement would be recommended to hedge interest rate risk on long-term floating-rate bonds. In an interest rate swap agreement one stream of future interest payments (e.g., floating-rate payments) is exchanged for another stream of future interest payments (e.g., fixed-rate payments) for a specified principal amount. In this case, an interest rate swap would hedge (mitigate) exposure to fluctuations in interest rates of the floating-rate bonds by exchanging those payments for a fixed-rate payment.
Which of the following statements concerning ratio analysis is/are correct? I. Ratio analysis uses only monetary measures for analysis purposes. II. Ratio analysis uses only measures from financial statements for analysis purposes. A. I. only. B. II only. C. Both I and II. D. Neither I nor II.
D, correct Ratio analysis uses monetary measures as well as other quantitative measures. For example, in the earnings per share calculation, the number of shares of common stock, a non-monetary measure, is used. Ratio analysis also uses financial statement measures in addition to measures that are not a part of financial statements. For example, the price-earnings ratio uses the market price of the stock, a measure not found in the financial statements.
Kim Co.'s profit center Zee had 2004 operating income of $200,000 before a $50,000 imputed interest charge for using Kim's assets. Kim's aggregate net income from all of its profit centers was $2,000,000. During 2004, Kim declared and paid dividends of $30,000 and $70,000 on its preferred and common stock, respectively. Zee's 2004 residual income was A. $140,000 B. $143,000 C. $147,000 D. $150,000
D, correct Residual income = operating income - imputed charge
Farrow Co. is applying for a loan in which the bank requires a quick ratio of at least 1. Farrow's quick ratio is 0.8. Which of the following actions would increase Farrow's quick ratio? A. Purchasing inventory through the issuance of a long-term note. B. Implementing stronger procedures to collect accounts receivable at a faster rate. C. Paying an existing account payable. D. Selling obsolete inventory at a loss.
D, correct Selling obsolete inventory at a loss (or at a gain) would increase Farrow's quick ratio. The quick ratio (also known as the acid test ratio) measures the number of times that cash and assets that can be converted quickly to cash cover current liabilities. It is calculated as: (Cash + Current Receivables + Marketable Securities)/Current Liabilities. Selling obsolete inventory would increase cash, in the numerator, without changing current liabilities, the denominator, which would increase the quick ratio.
A company has income after tax of $5.4 million, interest expense of $1 million for the year, depreciation expense of $1 million, and a 40% tax rate. What is the company's times-interest-earned ratio? A. 5.4 B. 6.4 C. 7.4 D. 10.0
D, correct The company's times-interest-earned ratio is 10.0. The times-interest-earned ratio measures the ability of current earnings to cover interest payments for a period. It is measured as: Times-Interest-Earned Ratio = (Net Income + Interest Expense + Income Tax Expense) / Interest Expense Therefore: Times-Interest-Earned Ratio = ($5.4M + $1M + $3.6M*)/$1M = $10M/$1M = 10.0 times Income before taxes is computed as: .6X = $5.4M (i.e., 60% of taxable income equals $5.4M). Therefore: X (income before taxes) = $5.4M/.6 = $9.0M. Income before taxes = $9.0M - income after taxes = $5.4M = income taxes = $3.6M.) The $10M also can be determined as $9.0 income before taxes + $1M interest expense= $10M.
he following selected data pertain to the Darwin Division of Beagle Co. for 2005: Sales $400,000 Operating income 40,000 Capital turnover 4 Imputed interest rate 10% What was Darwin's 2005 residual income? A. $0 B. $4,000 C. $10,000 D. $30,000
D,correct Residual income is the excess of the division's income over the income that would be required based on the 10% imputed interest rate and the amount invested in divisional assets. This question requires a determination of divisional assets. The division's assets turned over four times, meaning, with sales of $400,000, the division has $100,000 of assets. The expected income for this division is then 10% of that amount, or $10,000. Thus, residual income is: Operating income ($40,000) - expected income ($10,000) = $30,000. This amount represents the excess of actual operating income of the division over the minimum amount that is required for a division with $100,000 worth of assets invested.
A company has two divisions. Division A has operating income of $500 and total assets of $1,000. Division B has operating income of $400 and total assets of $1,600. The required rate of return for the company is 10%. The company's residual income would be which of the following amounts? A. $0 B. $260 C. $640 D. $900
Residual income is the difference between the actual income and the required return on investment. For the facts given actual income is $900 ($500 + $400) and the required return is of $260 [($1,000 + $1,600) * 10%], resulting in residual income of $640 ($900 - $260).
A company has cash of $100 million, accounts receivable of $600 million, current assets of $1.2 billion, accounts payable of $400 million, and current liabilities of $900 million. What is its acid-test (quick) ratio? A. 0.11 B. 0.78 C. 1.75 D. 2.11
The acid-test ratio (also known as the quick ratio) is computed as the relationship between highly liquid assets and current liabilities. Highly liquid assets include cash, accounts receivable, and marketable securities. In this case, the company has only cash and accounts receivable. Therefore, the correct calculation is $100m (cash) + $600m (accounts receivable) = $700m/$900 (current liabilities) = 0.777 (or 0.78).
Super Sets, Inc. manufactures and sells television sets. All sales are finalized on credit with terms of 2/10, n/30. Seventy percent of Super Set customers take discounts and pay on day 10, while the remaining 30% pay on day 30. What is the average collection period in days? A. 10. B. 16. C. 24. D. 40.
The average collection period is 16 days, computed as: Customers paying on day 10 = .70 x 10 days = 7 days average. Customers paying on day 30 = .30 x 30 days = 9 days average. Average collection period = 16 days On average, 70% are outstanding for 10 days and 30% are outstanding for 30 days. By getting the weighted average of each group and summing them, the average collection period is determined.
Cyco, Inc. determined the following concerning its operating activities: Accounts receivable conversion cycle 18 days Accounts payable conversion cycle 21 days Inventory conversion cycle 24 days Which one of the following is the length of Cyco's cash cycle? A. 42 days. B. 39 days. C. 21 days. D. 15 days.
The cash cycle can be determined as the operating cycle (i.e., inventory conversion cycle [24 days] + accounts receivable conversion cycle [18 days]) less the accounts payable conversion cycle [21 days]. Thus, Cyco's cash cycle would be computed as 24 + 18 = 42 - 21 = 21 days, the correct answer.
Which one of the following measures would be least appropriate in evaluating working capital management? A. Inventory turnover ratio. B. Quick ratio. C. Days' sales in average receivables. D. Return on assets.
The management of working capital is concerned with the effective and efficient use of current assets and current liabilities, not with all assets. The return on assets measures the rate of return earned on total assets or total equity and, therefore, is not useful in evaluating just current assets (or current liabilities).
The following calculations were made from Clay Co.'s 2003 books: Number of days' sales in inventory 61 Days Number of days' sales in trade accounts receivable 33 Days Which one of the following was the number of days in Clay's 2003 operating cycle? A. 33 days B. 47 days C. 61 days D. 94 days
The operating cycle measures the average length of time to invest cash in inventory, convert the inventory to accounts receivable, and collect the receivables. Thus, for Clay, its operating cycle is the sum of its number of days' sales in inventory plus the number of days' sales in trade accounts receivable, or 61 days + 33 days = 94 days. Basically, this measures the number of days to go from cash through inventory and accounts receivable, back to cash.
Para Co. is reviewing the following data relating to an energy saving investment proposal: Cost $50,000 Residual value at the end of 5 years 10,000 Present value of an annuity of 1 at 12% for 5 years 3.60 Present value of 1 due in 5 years at 12% 0.57 What would be the annual savings needed to make the investment realize a 12% yield? A. $8,189 B. $11,111 C. $12,306 D. $13,889
To solve this problem, let "A" equal the unknown annual savings needed to realize a 12% annual yield. Recall that the net present value (NPV) is the difference between the present value of cash inflows from the investment and the cost of the investment, and that NPV would be zero (0) when the project earns 12%. Since the unknown "A" is an annual cash savings, it must be "measured" by applying an annuity factor. In addition, the $10,000 residual value is a single cash inflow, that must be converted to present value. The cost of the investment, $50,000, is a present value. Thus, the formula for solving for a NPV of zero (0) is: "A" (3.60) + $10,000 (.57) - $50,000 = 0 Rearranged: "A" (3.60) = $50,000 - $5,700, or "A" = $44,300/3.60; "A" = $12,306. Thus, an annual savings of $12,306 would yield a 12% return on the project investment.
