CFA Chapter 7: Financial Analysis Techniques

What does the P/E ratio measure? The "multiple" that the stock market places on a company's EPS. The relationship between dividends and market prices. The earnings for one common share of stock.

A is correct. The P/E ratio measures the "multiple" that the stock market places on a company's EPS.

Which ratio would a company most likely use to measure its ability to meet short-term obligations? Current ratio. Payables turnover. Gross profit margin.

A is correct. The current ratio is a liquidity ratio. It compares the net amount of current assets expected to be converted into cash within the year with liabilities falling due in the same period. A current ratio of 1.0 would indicate that the company would have just enough current assets to pay current liabilities.

Which of the following would best explain an increase in receivables turnover? The company adopted new credit policies last year and began offering credit to customers with weak credit histories. Due to problems with an error in its old credit scoring system, the company had accumulated a substantial amount of uncollectible accounts and wrote off a large amount of its receivables. To match the terms offered by its closest competitor, the company adopted new payment terms now requiring net payment within 30 days rather than 15 days, which had been its previous requirement.

B is correct. A write off of receivables would decrease the average amount of accounts receivable (the denominator of the receivables turnover ratio), thus increasing this ratio. Customers with weaker credit are more likely to make payments more slowly or to pose collection difficulties, which would likely increase the average amount of accounts receivable and thus decrease receivables turnover. Longer payment terms would likely increase the average amount of accounts receivable and thus decrease receivables turnover.

A creditor most likely would consider a decrease in which of the following ratios to be positive news? Interest coverage (times interest earned). Debt-to-total assets. Return on assets.

B is correct. In general, a creditor would consider a decrease in debt to total assets as positive news. A higher level of debt in a company's capital structure increases the risk of default and will, in general, result in higher borrowing costs for the company to compensate lenders for assuming greater credit risk. A decrease in either interest coverage or return on assets is likely to be considered negative news.

When developing forecasts, analysts should most likely: develop possibilities relying exclusively on the results of financial analysis. use the results of financial analysis, analysis of other information, and judgment. aim to develop extremely precise forecasts using the results of financial analysis.

B is correct. The results of an analyst's financial analysis are integral to the process of developing forecasts, along with the analysis of other information and judgment of the analysts. Forecasts are not limited to a single point estimate but should involve a range of possibilities.

Assuming no changes in other variables, which of the following would decrease ROA? A decrease in the effective tax rate. A decrease in interest expense. An increase in average assets.

C is correct. Assuming no changes in other variables, an increase in average assets (an increase in the denominator) would decrease ROA. A decrease in either the effective tax rate or interest expense, assuming no changes in other variables, would increase ROA.

Comparison of a company's financial results to other peer companies for the same time period is called: technical analysis. time-series analysis. cross-sectional analysis.

C is correct. Cross-sectional analysis involves the comparison of companies with each other for the same time period. Technical analysis uses price and volume data as the basis for investment decisions. Time-series or trend analysis is the comparison of financial data across different time periods.

In order to assess a company's ability to fulfill its long-term obligations, an analyst would most likely examine: activity ratios. liquidity ratios. solvency ratios.

C is correct. Solvency ratios are used to evaluate the ability of a company to meet its long-term obligations. An analyst is more likely to use activity ratios to evaluate how efficiently a company uses its assets. An analyst is more likely to use liquidity ratios to evaluate the ability of a company to meet its short-term obligations.

An analyst observes a decrease in a company's inventory turnover. Which of the following would most likely explain this trend? The company installed a new inventory management system, allowing more efficient inventory management. Due to problems with obsolescent inventory last year, the company wrote off a large amount of its inventory at the beginning of the period. The company installed a new inventory management system but experienced some operational difficulties resulting in duplicate orders being placed with suppliers.

C is correct. The company's problems with its inventory management system causing duplicate orders would likely result in a higher amount of inventory and would, therefore, result in a decrease in inventory turnover. A more efficient inventory management system and a write off of inventory at the beginning of the period would both likely decrease the average inventory for the period (the denominator of the inventory turnover ratio), thus increasing the ratio rather than decreasing it.

Which of the following ratios would be most useful in determining a company's ability to cover its lease and interest payments? ROA. Total asset turnover. Fixed charge coverage.

C is correct. The fixed charge coverage ratio is a coverage ratio that relates known fixed charges or obligations to a measure of operating profit or cash flow generated by the company. Coverage ratios, a category of solvency ratios, measure the ability of a company to cover its payments related to debt and leases.