FINA 3320 Ch. 7

(True or False) A firm whose days sales outstanding is much higher than the industry's average is likely to either be too "tight" in its credit policy or too "loose" in its collection policy.

False

(True or False) An increase in an asset account is a source of cash, whereas an increase in a liability account is a use of cash.

False

(True or False) Depreciation, as shown on the income statement, is regarded as a use of cash because it is an expense.

False

(True or False) During a period of lowering prices, the FIFO accounting method will produce a higher balance sheet inventory but a lower cost of goods sold than the LIFO accounting method.

False

(True or False) If a firm has high current and quick ratios, this always is a good indication that a firm is managing its liquidity position well.

False

(True or False) In accounting, emphasis is placed on determining net income. In finance, the primary emphasis also is on net income because that is what investors use to value the firm. However, a secondary consideration is cash flow because that's what is used to run the business.

False

(True or False) On the balance sheet, total assets must always equal total liabilities. The amount remaining is what is used to finance the firm and includes equity and long-term debt.

False

(True or False) Since 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.

False

(True or False) The balance sheet is a financial statement measuring the flow of funds into and out of various accounts over time while the income statement measures the progress of the firm at a point in time.

False

(True or False) The balance sheet lists ant their fair market value as of midnight on the annual fiscal end date for the firm.

False

(True or False) The book value of an asset is the market value less any accumulated depreciation.

False

(True or False) The four basic financial statements included in the annual report are the balance sheet, the income statement, the statement of cash flows, and the statement of reported earnings.

False

(True or False) The inventory turnover ratio and days sales outstanding (DSO) are two ratios that can be used to assess how effectively the firm is managing its assets in consideration of current and projected operating levels.

False

(True or False) The time dimension is important in financial statement analysis. While the balance sheet and income statements represent the firm's financial position at a point in time, the statement of cash flows reports changes that were made to the firm's accounts over a period of time.

False

A firm has a profit margin of 15 percent on sales of $20,000,000. If the firm has debt of $7,500,000, total assets of $22,500,000, and an after-tax interest cost on total debt of 5 percent, what is the firm's ROA? a. 8.4% b. 10.9% c. 12.0% d. 13.3% e. 15.1%

d

A firm has total interest charges of $10,000 per year, sales of $1 million, a tax rate of 40 percent, and a net profit margin of 6 percent. What is the firm's times-interest-earned ratio? a. 16 times b. 10 times c. 7 times d. 11 times e. 20 times

d

Assume Meyer Corporation is 100 percent equity financed. Calculate the return on equity, given the following information: (1) Earnings before taxes = $1,500; (2) Sales = $5,000; (3) Dividend payout ratio = 60%; (4) Total assets turnover = 2.0; (5) Applicable tax rate = 30%. a. 25% b. 30% c. 35% d. 42% e. 50%

d

Other things held constant, which of the following will not affect the quick ratio? (Assume that current assets equal current liabilities.) a. Fixed assets are sold for cash. b. Cash is used to purchase inventories. c. Cash is used to pay off accounts payable. d. Accounts receivable are collected. e. Long-term debt is issued to pay off a short-term bank loan.

d

A stock dividend will, in and of itself, affect the amounts in which of the following accounts? (Assume the stock has a par value.) a. Common stock account. b. Paid-in capital account. c. Retained earnings account. d. Cash. e. Only answers a, b, and c above.

e

A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts? a. Cash. b. Common stock. c. Paid-in capital. d. Retained earnings. e. None of the above.

e

All of the following represent cash outflows to the firm except a. Taxes. b. Interest payments. c. Dividends. d. Purchase of plant and equipment. e. Depreciation.

e

Lone Star Plastics has the following data: Assets: $100,000 Profit margin: 6.0% Tax rate: 40% Debt ratio: 40.0% Interest rate: 8.0% Total asset turnover: 3.0 What is Lone Star's EBIT? a. $3,200 b. $12,000 c. $18,000 d. $30,000 e. $33,200

e

Other things held constant, if a firm holds cash balances in excess of their optimal level in a non-interest bearing account, this will tend to lower the firm's a. Operating profit margin. b. Total asset turnover. c. Return on equity. d. All of the above. e. Answers b and c above.

e

We can be sure that, in and of itself, a stock dividend will not affect which of the following financial aspects of the firm? (Assume the stock has a par value.) a. Market value per share. b. Book value per share. c. Common stock account. d. Paid-in capital account. e. Total assets.

e

quick (acid test) ratio

A ratio calculated by deducting inventories from current assets and dividing the remainder by current liabilities.

inventory turnover ratio

A ratio calculated by dividing cost of goods sold by inventories.

current ratio

A ratio calculated by dividing current assets by current liabilities. It indicates the extent to which current liabilities are covered by assets expected to be converted to cash in the near future.

times interest earned (TIE) ratio

A ratio calculated by dividing earnings before interest and taxes (EBIT) by interest charges; measures the ability of the firm to meet its annual interest payments.

return on equity (ROE)

A ratio calculated by dividing income available to stockholders by common equity; measures the rate of return on common stockholders' investments.

price/earnings (P/E) ratio

A ratio calculated by dividing market price per share by earning per share; measures how much investors are willing to pay per dollar of current profits.

net profit margin

A ratio calculated by dividing net income by sales; measures net income per dollar of sales.

return on assets (ROA)

A ratio calculated by dividing net income by total assets; provides an idea of the overall return on investment earned by the firm.

debt ratio

A ratio calculated by dividing total debt by total assets; indicates the percentage of total funds provided by creditors.

annual report

A report in the forms of 10-K issued by a corporation to its stockholders that contains basic financial statements as well as the opinions of management about the past year's operations and the firm's future prospects.

retained earnings

The portion of the firm's earnings that has been reinvested in the firm rather than paid out as dividends.

market/book (M/B) ratio

The ratio of a stock's market price to its book value.

statement of retained earnings

A statement reporting the change in the firm's retained earnings as a result of the income generated and retained during the year. The balance sheet figure for retained earnings is the sum of the earnings retained for each year that the firm has been in business.

income statement

A statement summarizing the firm's revenues and expenses over an accounting period, generally a quarter or a year.

statement of cash flows

A statement that reports the effects of a firm's operating, investing, and financing activities on cash flows over an accounting period.

balance sheet

A statement that shows the firm's financial position—assets, and liabilities and equity—at a specific point in time.

DuPont equation

A formula that gives the rate of return on assets by multiplying the profit margin by the total assets turnover.

free cash flow

A measure of the cash flow that the firm is free to pay to investors after considering cash investments that are needed to continue operations.

accounting profits

A firm's net income as reported on its income statement.

economic value added (EVA)

After-tax operating earnings adjusted for the costs associated with the firm's financing—shows how much a firm's economic value increased during a particular period.

"window dressing" techniques

Techniques employed by firms to make their financial statements look better than they actually are.

net working capital

The amount of current assets that is financed with long-term sources of funds —equals current assets minus current liabilities.

common stockholders' equity (net worth)

The funds provided by common stockholders— common stock, paid-in capital, and retained earnings. It equals total assets minus total liabilities.

operating cash flows

Those cash flows that arise from normal operations; the difference between cash collections and cash expenses associated with the manufacture and sale of inventory.

(True or False) A stock dividend and a stock split should, at least conceptually, have the same effect on shareholders' wealth.

True

(True or False) Market value ratios provide management with a current assessment of how investors in the market view the firm's past performance and future prospects.

True

(True or False) Net fixed assets reflect the historical costs for property, plant, and equipment less accumulated depreciation.

True

(True or False) The inventory turnover and current ratios are related. The combination of a high current ratio and a low inventory turnover ratio relative to the industry norm might indicate that the firm is maintaining too high an inventory level or that part of the inventory is obsolete or damaged.

True

(True or False) The times-interest-earned ratio is one indication of a firm's ability to meet both long-term and short-term obligations.

True

(True or False) When a firm pays off a loan using cash, the source of funds is the decrease in the asset account, cash, while the use of funds involves a decrease in a liability account, debt.

True

A fire has destroyed a large percentage of the financial records of the Carter Company. You have the task of piecing together information in order to release a financial report. You have found the return on equity to be 18 percent. If sales were $4 million, the debt ratio was 0.40, and total liabilities were $2 million, what was the return on assets (ROA)? a. 10.8% b. 0.8% c. 1.25% d. 12.6% e. Insufficient information.

a

A firm has total assets of $1,000,000 and a debt ratio of 30 percent. Currently, it has sales of $2,500,000, total fixed costs of $1,000,000, and EBIT of $50,000. If the firm's before-tax cost of debt is 10 percent and the firm's tax rate is 40 percent, what is the firm's ROE? a. 1.7% b. 2.5% c. 6.0% d. 8.3% e. 9.8%

a

Which of the following statements is correct? a. If two firms pay the same interest rate on their debt and have the same rate of return on assets, and if that ROA is positive, the firm with the higher debt ratio will also have a higher rate of return on common equity. b. One of the problems of ratio analysis is that the relationships are subject to manipulation. For example, we know that if we use some of our cash to pay off some of our current liabilities, the current ratio will always increase, especially if the current ratio is weak initially. c. Generally, firms with high profit margins have high asset turnover ratios, and firms with low profit margins have low turnover ratios; this result is exactly as predicted by the Du Pont equation. d. Firms A and B have identical earnings and identical dividend payout ratios. If Firm A's growth rate is higher than that of Firm B, Firm A's P/E ratio must be greater than Firm B's P/E ratio. e. None of the above statements is correct.

a

Which of the following statements is most correct? a. An increase in a firm's debt ratio, with no changes in its sales and operating costs, could be expected to lower its profit margin on sales. b. An increase in the DSO, other things held constant, would generally lead to an increase in the total asset turnover ratio. c. An increase in the DSO, other things held constant, would generally lead to an increase in the ROE. d. In a competitive economy, where all firms earn similar returns on equity, one would expect to find lower profit margins for airlines, which require a lot of fixed assets relative to sales, than for fresh fish markets. e. It is more important to adjust the Debt/Assets ratio than the inventory turnover ratio to account for seasonal fluctuations.

a

days sales outstanding (DSO)

also called the average collection period (ACP), A ratio calculated by dividing accounts receivable by average sales per day, which indicates the average length of time it takes the firm to collect for credit sales.

Culver Inc. has earnings after interest but before taxes of $300. The company's before-tax times-interest-earned ratio is 7.00. Calculate the company's interest charges. a. $42.86 b. $50.00 c. $40.00 d. $60.00 e. $57.93

b

Stock dividends a. Have the same effects on financial statements as cash dividends. b. Are similar to stock splits in that they do not change the fundamental position of current shareholders. c. Must be accompanied by cash dividends. d. Are viewed unfavorably by investors and thus should not be used. e. Have no effect on a firm's balance sheet.

b

The Charleston Company is a relatively small, privately owned firm. Last year the company had after-tax income of $15,000, and 10,000 shares were outstanding. The owners were trying to determine the market value for the stock, prior to taking the company public. A similar firm which is publicly traded had a price/earnings ratio of 5.0. Using only the information given, estimate the market value of one share of Charleston's stock. a. $10.00 b. $7.50 c. $5.00 d. $2.50 e. $1.50

b

Selzer Inc. sells all its merchandise on credit. It has a profit margin of 4 percent, days sales outstanding equal to 60 days, receivables of $150,000, total assets of $3 million, and a debt ratio of 0.64. What is the firm's return on equity (ROE)? a. 7.1% b. 33.3% c. 3.3% d. 71.0% e. 8.1%

c

The Amer Company has the following characteristics: Sales: $1,000 Total Assets: $1,000 Total Debt/Total Assets: 35% EBIT: $200 Tax rate: 40% Interest rate on total debt: 4.57% What is Amer's ROE? a. 11.04% b. 12.31% c. 16.99% d. 28.31% e. 30.77%

c

Which of the following statements is correct? a. The annual report contains four basic financial statements: the income statement; balance sheet; statement of cash flows; and statement of changes in long-term financing. b. Although the annual report is geared toward the average stockholder, it represents financial analysts' most complete source of financial information about the firm. c. The key importance of annual report information is that it is used by investors when they form their expectations about the firm's future earnings and dividends and the riskiness of those cash flows. d. The annual report provides no relevant information for use by financial analysts or by the investing public. e. None of the above statements is correct.

c

Pepsi Corporation's current ratio is 0.5, while Coke Company's current ratio is 1.5. Both firms want to "window dress" their coming end-of-year financial statements. As part of their window dressing strategy, each firm will double its current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the statements below best describes the actual results of these transactions? a. The transactions will have no effect on the current ratios. b. The current ratios of both firms will be increased. c. The current ratios of both firms will be decreased. d. Only Pepsi Corporation's current ratio will be increased. e. Only Coke Company's current ratio will be increased.

d