Chapter 13 - Learn Smart

The price-earnings ratio is calculated by dividing _______________ _______________per share by _______________ per share.

1. market price 2. earnigs Price-earnings ratio = market price per share divided by earnings per share

The dividend yield is calculated by dividing _______________ per share by _______________ _______________ per share.

1. dividends 2. market price Dividend yield = Dividends per share divided by market price per share.

Individuals and organizations use financial statements for

different purposes

Which of the following factors complicate the communication of financial information to decision makers?

1. Different individuals and companies use financial information for different purposes. 2. There is no one method of financial analysis that is appropriate for all decisions. 3. Various users of financial information have differing levels of sophistication related to financial analysis.

Which of the following ratios is used to assess the performance of a company's stock?

1. Earnings per share 2. Dividend yield 3. Book value per share 4. Price-earnings ratio

Which of the following statements are correct?

1. To correctly evaluate an absolute amount, the analyst must consider its relative importance. 2. Financial statement users with expertise in particular industries can look at absolute amounts and assess a company's performance in a certain area.

1. Debt to assets 2. Debt to equity 3. Number of times interest is earned 4. Plant assets to long-term liabilities

1. Total liabilities/Total assets 2. Total liabilities/Total stockholder's equity 3. Earnings before interest and taxes/Interest expense 4. Net plat assets/Long-term liabilities

If a company has current liabilities of $176,000, total liabilities of $1,065,000, current assets of $220,000, and total assets of $1,500,000, what is its current ratio?

1.25 to 1 current ratio = current assets divided by current liabilities $220,000/$176,000 = 1.25

Which of the following formulas yields the average days to collect receivables?

365 divided by accounts receivable turnover ratio average days to collect receivables = 365 days divided by Accounts receivable turnover.

Assume three companies in the same industry have the following return on investment ratios: Alice Co. = 8.7% Betsy Co. = 9.4% Carol Co. = 10.2% Based on this information alone, which company appears to have the worst return on investment ratio?

Alice

Assume three companies in the same industry have the following current ratios: Adams Co. = 1.33 to 1 Baker Co. = 1.15 to 1 Charles Co. = 1.27 to 1 Based on this information alone, which company appears to have the lowest liquidity?

Baker

If the debt to assets ratio for Dominion Resources, a large gas and electric utility company, is .71, and the debt to assets ratio for Home Depot, a large building supplies retailer, is .53, which of the following conclusions should a financial analysis reach?

Because the companies are in different industries, no good conclusion can be reached.

Assume three companies in the same industry have the following number of times interest is earned ratios: Fern Co. = 8.2 times Gardenia Co. = 6.4 times Hibiscus Co. = 3.9 times Based on this information alone, which company appears to have the highest financial risk?

Hibiscus

Liquidity ratios are used to assess

company's ability to pay short-term obligations.

Working capital is defined as

current assets minus current liabilities.

If a company has earnings before interest and taxes of $780,000, interest expense of $105,000, income tax expense of $230,000, and net income of $445,000, what is its number of times interest is earned?

7.43 times number of times interest is earned = earnings before interest and taxes expense divided by interest expense. $780,000/$105,000 = 7.43

If a company has sales of $2,700,000, cost of goods sold of $1,900,000, net income of $120,000, average current assets of $300,000, and average total assets of $1,600,000, what is its return on investment ratio?

7.5% ROI = net income divided by average total assets. $120,000/$1,600,000 = .075

Assume three companies in the same industry have the following quick ratios: Davis Co. = .83 to 1 Edwards Co. = .65 to 1 Fender Co. = .47 to 1 Based on this information alone, which company appears to have the highest liquidity?

Davis The quick ratio measures the assets that are liquid. It omits less liquid current assets such as inventories and prepaid expenses. Companies with higher quick ratios are more liquid.

Which of the following formulas yields the price-earnings ratio?

Market price per share divided by earnings per share Price-earnings ratio = market price per share divided by earnings per share

Which of the following formulas yields the return on investment ratio?

Net income divided by average total assets ROI = net income divided by average total assets.

Which of the following formulas yields the return on equity ratio?

Net income divided by average total stockholders' equity ROE = Net income divided by Average total stockholder's equity.

Which of the following formulas yields the net margin (return on sales) ratio?

Net income divided by net sales net margin = net income divided by net sales

If Delta Airlines assumes its airplanes will last 20 years, while United Airlines assumes its airplanes will last 30 years, which of the following statements is true?

The companies' return on assets ratios cannot be compared with confidence.

True or false: Users of financial statement information include managers, creditors, stockholders, potential investors and regulatory agencies.

True

If a company has net income of $150,000, gross profit of $1,100,000, net sales of $4,050,000, and total assets of $2,500,000, what is its net margin ratio?

3.70% net margin = net income divided by net sales. $150,000/$4,050,000 = .037

True or false: Financial statements can provide only highly summarized economic information.

True

Profitability ratios are used to assess management's ability to

generate earnings.

Other things being equal, the management of a company will prefer that the price-earnings ratio of its company's stock be

high

Other things being equal, a company would prefer that its asset turnover ratio be _______________, indicating good use of assets to generate sales.

higher

Other things being equal, the higher a company's current ratio, the (higher/lower) its liquidity.

higher

If an item would influence the decision of an informed user it is considered

material

Vertical analysis may be calculated using

only percentage amounts.

In order to perform vertical analysis on the balance sheet, it is necessary to divide the dollar amount of each account by

total assets.

Which of the following ratios is used to assess solvency?

1. Number of times interest is earned 2. Debt to equity ratio

The current ratio is calculated by dividing _______________ _______________ by _______________ _______________ .

1. current assets 2. current liabilities

If a company has an accounts receivable turnover ratio of 7.4, ending accounts receivable of $780,000, and average accounts receivable of $740,000, what is its average days to collect receivables?

49.3 days average days to collect receivables = 365 days divided by Accounts receivable turnover. 365/7.4 = 49.32

Which of the following formulas yields the asset turnover ratio?

Net sales÷ average total assets This ratio measures how many sales dollars were generated for each dollar of assets invested. Asset turnover will be high in industries that have low investments to operate and low in industries that require large investments in plant and machinery. asset turnover ratio = net sales divided by average total assets.

Studying various relationships between different items reported in a set of financial statements is called

ratio analysis.

Materiality refers to information's

relevant importance.

If a company has current assets of $500,000, average accounts receivable of $80,000, total assets of $900,000, credit sales of $1,000,000, and cost of goods sold of $700,000, what is its accounts receivable turnover ratio?

12.50 accounts receivable turnover = Net credit sales divided by Average accounts receivable $1,000,000/$80,000 = 12.5

If a company has average total assets of $2,500,000, average total common stock of $120,000, average total stockholders' equity of $1,600,000, sales of $4,500,000, and net income of $230,000, what is its return on equity ratio?

14.4% ROE = Net income divided by Average total stockholder's equity. $230,000/$1,600,000 = .1438

The following data are available for selected income statement accounts for two years for Bronze Company: Year 1 Year 2 Sales $750,000 $845,000 Cost of goods sold $457,000 $524,000 Income before taxes $88,500 $99,000 Net income $62,000 $70,000 If a percentage analysis approach for horizontal analysis is calculated, what is the percentage increase in cost of goods sold for Year 2?

14.66% ($524,000 - $457,000)/$524,000 = 14.66%

If a company has sales of $17,500,000, net income of $1,475,000, earnings before interest and taxes of $2,300,000, income tax expense of $695,000, and interest expense of $130,000, and what is its number of times interest is earned?

17.69 time number of times interest is earned = earnings before interest and taxes expense divided by interest expense. $2,300,000/$130,000 = 17.69

Assume a company has net income of $24,000, income before taxes of 33,000, income taxes $9,000, gross margin of $105,000, and sales of $350,000. If it is performing vertical analysis, what percentage would be assigned to income taxes?

2.6% $9,000/$350,000 = 2.6%

Assume three companies in the same industry have the following debt to equity ratios: Zebra Co. = 1.7 to 1 Albatross Co. = 1.2 to 1 Badger Co. = 0.8 to 1 Based on this information alone, which company appears to have the highest financial risk?

Zebra

If a company has net income of $8,500,000, average shares of common stock outstanding of 2,000,000, average total stockholders' equity of $154,400,000, and annual preferred stock dividends of $1,500,000, what is its EPS?

$3.50 EPS = Net earnings available for common stock divided by Average number of outstanding common shares. $7,000,000/$2,000,000 = 3.5 Net earnings available = net income - preferred dividend. $8,500,000 - $1,500,000 =

If a company has current assets of $178,000, total assets of $928,000, current liabilities of $132,000, and total liabilities of $643,000, how much working capital does it have?

$46,000 $178,000 - $132,000 = $46,000

Which of the following formulas yields the book value per share?

(Stockholders equity - preferred stock) ÷ average shares of common stock outstanding Book value per share = (stockholder's equity - preferred stock) divided by outstanding common shares.

If a company has current assets of $250,000, quick assets of $120,000, total assets of $1,000,000, current liabilities of $200,000, and total liabilities of $700,000, what is its quick ratio?

.60 to 1 Quick ratio = Quick assets divided by current liabilities. $120,000/$200,00. = .6

Which of the following statements about calculating the inventory turnover ratio are correct?

1. Average inventory should be used in the denominator. 2. Average inventory should be used in the denominator. inventory turnover = Cost of goods sold divided by Average inventory.

Which of the following statements about calculating the accounts receivable turnover ratio are correct?

1. Net credit sales should be used in the numerator. 2. Average net accounts receivable should be used in the denominator. accounts receivable turnover = Net credit sales divided by Average accounts receivable

Which of the following statements about the earnings per share (EPS) ratio are correct?

1. Preferred stock dividends should be subtracted from net income to calculate EPS. 2. The denominator of the EPS ratio includes only shares of common stock that are outstanding. EPS = Net earnings available for common stock divided by Average number of outstanding common shares. Net earnings available = net income - preferred dividend.

1. Current ratio 2. Quick ratio 3. Accounts receivable turnover 4. Average days to collect receivables 5. Inventory turnover 6. Average days to sell inventory

1. current assets/current liabilities 2. (current assets - inventory - prepaids) or quick assets/current liabilities 3. net credit sales/average receivables 4. 365/accounts receivable turnover 5. cost of goods sold/average inventory 6. 365/inventory turnover

Vertical analysis is performed by comparing items from:

1. the same financial statement. 2. the same accounting period.

If a company has current assets of $145,000, total assets of $1,200,000, current liabilities of $100,000, total liabilities of $660,000, and total stockholders' equity of $540,000, what is its debt to assets ratio?

55% debt to assets = total liabilities divided by total assets. $660,000/$1,200,000 = 55%

Assume a company has sales of $300,000, total assets of $500,000, cost of goods sold of $195,000, gross margin of $105,000, and net income of $21,000. If it is performing vertical analysis, what percentage would be assigned to cost of goods sold?

65% $195,000/$300,000 = 65%

(Horizontal/Vertical) analysis compares the same financial statement items over two or more accounting periods.

Horizontal

Assume three companies in the same industry have the following net margin ratios: Pamela Co. = 7.7% Rachel Co. = 5.4% Susan Co. = 6.3% Based on this information alone, which company appears to have the best net margin ratio?

Pamela

Which of the following ratios assess management's ability to generate earnings?

Profitability ratios

Which of the following formulas yields the quick ratio?

Quick assets divided by current liabilities

_______________ analysis involves studying various relationships between different items reported in a set of financial statements

Ratio

The type of financial analysis that uses percentages to compare individual items on a financial statement, such as Wages Expense, to a key figure on the same statement, such as Sales, is called

vertical analysis.

Horizontal analysis may be performed

with absolute dollar amounts or percentages.

Assume three companies in the same industry have the following number of times interest is earned ratios: Collins Co. = 7.2 times Dean Co. = 9.4 times Edgar Co. = 13.9 times Based on this information alone, which company appears to have the lowest financial risk?

Edgar Companies with higher times interest earned have lower financial risk.

Assume three companies in the same industry have the following return on investment ratios: Dogwood Co. = 11.4% Elm Co. = 19.4% Fir Co. = 13.7% Based on this information alone, which company appears to have the best return on investment ratio?

Elm

Assume three companies in the same industry have the following net margin ratios: Lemon Co. = 3.7% Mango Co. = 6.1% Nectarine Co. = 5.3% Based on this information alone, which company appears to have the worst net margin ratio?

Lemon

If a company has total assets of $13,100,000; net earnings of $1,400,000; 900,000 average shares of common stock outstanding; total stockholders' equity of $5,700,000; and preferred stock of $500,000, what is its book value per share?

$5.78 Book value per share = (stockholder's equity - preferred stock) divided by outstanding common shares. ($5,700,000 - $500,000)/900,000 = 5.78

When performing financial statement analysis,

1. it is easier to compare the financial ratios of companies in the same industry than to compare the ratios of companies in different industries. 2. comparison of financial ratios from year to year may be difficult if economic conditions are changing.

Assume a company has sales of $300,000, total assets of $500,000, total liabilities of $200,000, net income of $23,000, and accounts payable of $7,000. If it is performing vertical analysis, what percentage would be assigned to accounts payable?

1.40% $7,000/$500,000 = 1.4%

If a company has total assets of $2,200,000, current liabilities of $175,000, total liabilities of $1,300,000, common stock of $140,000 and total stockholders' equity of $900,000, what is its debt to equity ratio?

1.44 to 1 debt to equity = total liabilities divided by total stockholder's equity. $1,300,000/$900,000 = 1.44

If a company has earnings per share of $3.47, book value per share of $68.35, dividends per share of $1.20, and common stock with a current market price of $79.91 per share, what is its dividend yield percentage?

1.50% Dividend yield = Dividends per share divided by market price per share. $1.20/$79.91 = .015

Assume a company has sales of $2,700,000, total assets of $4,400,000, current assets of $160,000, net income of $350,000, and Inventory of $90,000. If it is performing vertical analysis, what percentage would be assigned to inventory?

2.05% $90,000/$4,400,000 = 2.05%

If a company has sales of $5,800,000, cost of goods sold of $4,300,000, net income of $470,000, average current assets of $1,300,000, and average total assets of $2,700,000, what is its assets turnover ratio?

2.15 asset turnover ratio = net sales divided by average total assets. $5,800,000/$2,700,000 = 2.15

If a company has total assets of $1,700,000, current liabilities of $300,000, total liabilities of $1,200,000, common stock of $150,000 and total stockholders' equity of $500,000, what is its debt to equity ratio?

2.40 to 1 debt to equity = total liabilities divided by total stockholder's equity. $1,200,000/$500,00 = 2.4

If a company has an inventory turnover ratio of 9.2, ending inventory of $780,000, and average accounts inventory of $740,000, what is its average days to sell inventory?

39.7 days average days to sell inventory = 365 days divided by Inventory turnover. 365/9.2 = 39.67

Assume a company has total assets of $750,000, sales of $470,000, gross margin of $350,000, income before taxes of 55,000, and net income of $40,000. If it is performing vertical analysis, what percentage would be assigned to net income?

8.5% $40,000/470,000 = 8.5%

Which of the following statements about the price-earnings ratio is correct?

A high P/E ratio often indicates the market is optimistic about the company's future.

Which of the following formulas yields the inventory turnover ratio?

Cost of good sold divided by average inventory inventory turnover = Cost of goods sold divided by Average inventory.

Which of the following formulas yields the debt to assets ratio?

Total liabilities divided by total assets debt to assets = total liabilities divided by total assets

Assume three companies in the same industry have the following asset turnover ratios: Texas Co. = 1.7% Utah Co. = 1.4% Virginia Co. = 2.1% Based on this information alone, which company appears to have the best asset turnover ratio?

Virginia

Assume three companies in the same industry have the following asset turnover ratios: Waters Co. = 3.7% Xenon Co. = 2.4% Zenith Co. = 2.6% Based on this information alone, which company appears to have the worst asset turnover ratio?

Xenon

When performing financial statement analysis of two companies,

even if the companies are in the same industry, if one company uses FIFO and the other uses LIFO, it will be unwise to compare their current ratios.

Financial statements are designed for

general purposes.

Other things being equal, a company would prefer that its accounts receivable turnover ratio be _______________, indicating that the company is faster at collecting its receivables.

high

An investor who places high importance on receiving dividends from his/her investments would prefer to invest in stock with a

higher dividend yield

If a company has current assets of $700,000, ending inventory of $500,000, average inventory of $450,000, sales of $2,500,000, and cost of goods sold of $1,750,000, what is its average days to sell inventory?

inventory turnover = Cost of goods sold divided by Average inventory $1,750,000/$450,000 = 3.89 average days to sell inventory = 365 days divided by Inventory turnover. 365/3.89 = 93.9

Which ratios indicate a company's ability to pay short-term debts?

liquidity ratios

Other things being equal, if a company's quick ratio is low, then its liquidity is

low.

Other things being equal, a company will appear to have less financial risk if its debt to equity ratio is _______________.

lower

The _______________ of information refers to its relative importance.

materiality

When making decisions, information _______________ is the problem of having so much data that important information becomes obstructed by trivial information.

overload

Other things being equal, a company would prefer that its average days to collect receivables be _______________, indicating that it takes the company fewer days to collect a receivable.

short