Chapter 3

Which of the following is the correct representation of the cash coverage ratio?

(EBIT + depreciation)/Interest expense

What is the formula for computing the internal growth rate (IGR)?

(ROA x b)/(1 - ROA x b)

What is the formula for computing a firm's sustainable growth rate?

(ROE x b)/(1 - ROE x b)

Which of the following is the correct representation of the total debt ratio?

(Total assets - Total equity)/(Total assets)

A firm with a profit margin of 10 percent generates ____ in net income for every dollar in sales.

10 cents

A firm with a 26 percent return on equity earned ____ cents in profit for every one dollar in shareholders' equity.

26

Days' sales in receivables is given by the following ratio:

365/receivables turnover

The ____ identity can help to explain why two firms with the same return on equity may not be operating in the same way.

DuPont

The quick ratio provides a more reliable measure of liquidity than the current ratio especially when the company's inventory takes ____ to sell,

a long time

Which one of these will decrease a firm's sustainable rate of growth?

an increase in the dividend payout ratio

Over the past year, the current assets account on the common-size balance sheet of a firm has decreased, while the current liabilities account on the common-size balance sheet of the same firm has increased. The firm has ____ its liquidity over the past year.

decreased

The cash coverage ratio adds ____ to operating earnings (EBIT) for a better of measure of how much cash is available to meet interest obligations.

depreciation

Return on assets equals net income ____ by total assets.

divided

The ____ payout ratio equals cash dividends divided by net income.

dividend

Financial statement analysis is primarily "management by

exception

Long-term solvency ratios are also known as:

financial leverage ratios.

Given an internal growth rate of 3 percent, a firm will

grow by 3 percent or less without any additional external financing

The information needed to compute the profit margin can be found on the

income statement

An increase in a firm's total asset turnover will ____ the sustainable growth rate.

increase

If sales increase while there is no change in accounts receivable, the receivables turnover ratio will

increase

Inventory turnover is cost of goods sold divided by

inventory

Which one of the following does not affect ROE according to the DuPont identity?

investor sentiment

Long-term solvency ratios measure what aspect of the firm's financial position?

its financial leverage

If a company has inventory, the quick ratio will always be ____ the current ratio.

less than

If the management of a company has been unsuccessful at creating value for their stockholders, the market-to-book ratio will be

less than 1

Current assets on the common-size balance sheet over the past three years have increased from 32 to 35 percent, while current liabilities have decreased from 29 to 25 percent. This indicates the firm has increased its

liquidity

Short-term solvency ratios are also called ____ ratios.

liquidity

Time-trend analysis is an example of:

management by exception.

Whenever ____ information is available, it should be used instead of accounting data.

market

The price-earnings (PE) ratio is a ____ ratio.

market value

The retention ratio equals one ____ the dividend payout ratio.

minus

A firm may use a price-sales ratio when it has had ____ earnings over the past year.

negative

Which one of the following is the correct equation for computing return on assets (ROA)?

net income/total assets

Which of the following items is added back to EBIT while calculating the cash coverage ratio, but not while calculating the times interest earned ratio?

noncash expenses

One of the most important uses of financial statement information within the firm is:

performance evaluation.

If a company has had negative earnings for several periods, they might choose to use a

price-sales ratio

The price-earnings ratio is ____ per share divided by ____ per share.

price; earnings

The DuPont identity shows that ____ ____ times total asset turnover times equity multiplier equals ROE.

profit margin

Return on assets (ROA) is a measure of

profitability

Return on equity (ROE) is a measure of

profitability

In a common-size income statement, each item is expressed as a percentage of total

sales

Receivables turnover is ____ divided by accounts receivable.

sales

The profit margin is equal to net income divided by

sales

Which one of the following equations defines the total asset turnover ratio?

sales/total assets

The times interest earned ratio is a measure of long-term ____

solvency

The DuPont identity breaks ROE into ____ parts.

three

Which one of the following best explains why financial managers use a common-size balance sheet?

to track changes in a firm's capital structure

A common-size balance sheet expresses accounts as a percentage of

total assets

Which of the following create problems with financial statement analysis?

•The firm and its competitors operate under different regulatory environments. •The firm or its competitors are global companies. •The firm or its competitors are conglomerates.

Which of the following are true of financial ratios?

•They are developed from a firm's financial information. •They are used for comparison purposes.

Which of the following items are used to compute the current ratio?

•cash •accounts payable

Which of the following would help a company take action to improve its ratios?

•comparing to aspirant companies •comparing to its own historical ratios •comparing to major competitors •comparing to peer companies

Based on the sustainable growth rate, which of the following factors affect a firm's ability to sustain growth?

•dividend policy •profit margin •financial policy

Based on the DuPont Identity, an increase in sales, all else held equal, ______ ROE.

•may increase or decrease •may not change

Which of the following are traditional financial ratio categories?

•turnover ratios •financial leverage ratios •profitability ratios

Common-size statements are best used for comparing:

•year-to-year for your firm. •firms of different sizes. •competitors.

What does it mean when a company reports ROA of 12 percent?

The company generates $12 in net income for every $100 invested in assets.

What does it mean when a firm has a days' sales in receivables of 45?

The firm collects its credit sales in 45 days on average.

What is the impact on the total asset turnover ratio if sales increase significantly while there is no change in any of the other variables?

The total asset turnover ratio will increase.

True or false: A way to establish a benchmark for ratio analysis is to identify a peer group.

True

True or false: In a common-size income statement, each item is expressed as a percentage of total sales.

True

True or false: It is important to investigate trends in financial ratios to identify the reason for the trend.

True

True or false: Profit margin equals net income divided by sales.

True

True or false: The cash ratio is found by dividing cash by current liabilities.

True

True or false: The total debt ratio equals the total assets minus total equity divided total assets.

True

Which of the following is true about the sustainable growth rate?

It is the maximum rate of growth a firm can maintain without increasing its financial leverage.

What will happen to the current ratio if current assets increase, while everything else remains unchanged?

It will increase.

How is the price-earnings (PE) ratio computed?

Market price per share/Earnings per share

How is the market-to-book ratio measured?

Market value per share/Book value per share

Which of the following is the correct equation for return on equity?

Net income/Total equity

____ group analysis is a way to establish a benchmark when using ratios.

Peer

Which of the following represents the receivables turnover ratio?

Sales/Accounts receivable

____ financial statements enable one to compare firms that differ in size.

Standardized

Which of the following best explains why financial managers use a common-size income statement?

The common-size income statement can show which costs are rising or falling as a percentage of sales.

Cal's Market has a return on equity (ROE) of 15 percent. What does this mean?

Cal's generated $.15 in profit for every $1 of book value of equity.

True or false: Financial ratios are computed using only balance sheet information.

False

True or false: If a company has inventory, the quick ratio will always be greater than the current ratio.

False

True or false: If there is a conflict between market and accounting data, accounting data should be given precedence.

False

True or false: Inventory turnover is sales divided by inventory.

False

True or false: Market-to-book ratio equals book value per share divided by market value per share.

False

True or false: Receivables turnover is cost of goods sold divided by accounts receivable.

False

True or false: The DuPont identity is a popular expression breaking ROA into three parts.

False

True or false: The current ratio will decrease if current assets Increase, while everything else remains unchanged.

False

True or false: The dividend payout ratio equals cash dividends divided by sales.

False

True or false: The price-earnings ratio is price per share times earnings per share.

False

True or false: The retention ratio equals one minus the ROA.

False

True or false: The times interest earned ratio is EBIT minus interest.

False

True or false: There is a solid and prescriptive method to select which ratios to use in financial statement analysis.

False

True or false: Blue Company and Red Company have equal levels of current assets and current liabilities. Blue Company has higher inventory levels than Red Company. Blue Company is more liquid than Red Company.

False Higher levels of inventory result in less liquidity, all else equal.

____ are the prime source of information about a firm's financial health.

Financial statements

A problem with the TIE ratio is that it is based on EBIT, which is not a measure of ____ available to pay interest.

cash

A firm with a market-to-book value that is greater than 1 is said to have ____ value for shareholders.

created

The current ratio computes the relationship between

current assets and current liabilities

The cash ratio is found by dividing cash by:

current liabilities.