Chapter 3 Quiz, CH 3, Chaper 2, Finance Chapter 1, Chapter 2 Quiz

Cash Coverage Ratio

(EBIT + Depreciation) / Interest

total debt ratio

(Total Assets - Total Equity) / Total Assets takes into account all debts of all maturities to all creditors

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

False If a company has inventory, the quick ratio will always be less than the current ratio.

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

False The retention ratio equals one minus the dividend payout ratio.

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

False The times interest earned ratio is EBIT divided by interest.

Common-size statements

Financial statement in which data are expressed as percentages for comparing results from one accounting period to another.

financial ratios

Relationships between important financial data that is expressed as a fraction or a percentage. -are ways of comparing and investigating the relationships between different pieces of financial information

Receivables Turnover

Sales / Accounts Receivable

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

Standardized

dividend policy

a decrease in the percentage of net income paid out as dividends will increase the retention ratio. This increases internally generated equity and thus increases internal and sustainable growth

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

one problem with ratios is that

different people and different sources frequently don't compute them in exactly the same way and this leads to much confusion

financial statements are a prime source of information about a firm's

financial health

Long-term solvency ratios are also known as:

financial leverage ratios

EBIT plus depreciation is often abbreviated EBIDT (earnings before interest taxes and depreciation) it is a basic measure of the firm's ability to

generate cash from operations and it is frequently used as a measure of cash flow available to meet financial obligations

A common-size balance sheet helps financial managers determine:

if changes are occurring in a firm's mix of assets.

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

increase

considering the DuPont identity, it appears that a firm could leverage up it's a row by

increasing its amount of debt -this will happen only if the ratio of EBIT total assets is greater than the interest rate

weakness in either operating or asset use efficiency or both will show up in a diminished return on assets which will translate

into a lower ROE

low current ratio may not be a bad sign for a company with a

large reserve of untapped borrowing power

to the firm, a high current ratio indicates

liquidity but it also may indicate an inefficient use of cash and other short term assets

Market to Book Ratio

market value per share/book value per share

PE Ratio

measures how much investors are willing to pay per dollar of current earnings

A firm may use a price-sales ratio when it has had ___________ (negative/positive) earnings over the past year.

negative

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

performance evaluation.

2 important internal use of financial statement information involves

performance evaluations & planning for the future

Price-Sales Ratio

price per share/sales per share

Total Asset Turnover Ratio

sales / total assets measures the turnover of all of the firm's assets

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

sales or revenue

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

solvency

to a short term creditor such as a supplier, the higher the current ratio

the better

Long term solvency ratios are intended to address

the firm's long run ability to meet its obligations or more generally its financial leverage -sometimes called financial leverage ratios or leverage ratios

the basic problem with financial statement analysis is that

there is no underlying theory to help us identify which items or ratios to look at and to guide us in establishing benchmarks

Which one of the following best explains why financial managers use a common-size balance sheet? to monitor labor costs to track changes in a firm's capital structure to identify changes in operating costs to keep an eye on the firm's profit margin

to track changes in a firm's capital structure

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

total assets

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

total assets

book value per share is _______________ not just common stock divided by the number of shares outstanding because book value per share is an accounting number

total equity -it reflects historical costs

Internal Growth Rate

(ROA x b) / (1 - ROA x b) the maximum growth rate a firm can achieve without external financing of any kind

A firm has inventory of $46,500, accounts payable of $17,400, cash of $1,250, net fixed assets of $318,650, long-term debt of $109,500, and accounts receivable of $16,600. What is the common-size percentage of the equity?

66.87%

The Inside Door has total debt of $208,600, total equity of $343,560, and a return on equity of 13.27 percent. What is the return on assets?

8.26%

Rogers Radiators has net income of $48,200, sales of $947,100, a capital intensity ratio of .87, and an equity multiplier of 1.53. What is the return on equity?

8.95%

Inventory Turnover

COGS / avg inventory

How is the inventory turnover ratio computed?

COGS/Inventory

cash ratio

Cash / Current Liabilities

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

False Financial ratios can use information from all financial statements.

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

It will increase.

Return on Assets (ROA)

Measures how profitably a company uses its assets. Net income / Average total assets.

The sustainable growth rate is defined as the maximum rate at which a firm can grow given which of the following conditions?

No new external equity and a constant debt-equity ratio

Ratio analysis cannot be taken at face value for all of the following except which reason?

While GAAP is consistent across the globe, multiple currencies may be considered.

Retention Ratio (Plowback Ratio)

addition to retained earnings / net income

financial statement analysis is

an application of "management by exception"

the current ratio, like any ratio, is affected by various types of transactions. for example, suppose the firm borrows over the long term to raise money. the short run effect would be

an increase in cash from the issue proceeds and an increase in long term debt. current liabilities would not be affected so the current ratio would rise

Financial Policy

an increase in the debt equity ratio increases the firm's financial leverage. because this makes additional debt financing available it increases the sustainable growth rate

a very short term creditor might be interested in the

cash ratio

The cash ratio is found by dividing cash by:

current liabilities

A firm has an equity multiplier of 1.5. This means that the firm has a:

debt-equity ratio of .50.

The retention ratio equals one __________ the dividend payout ratio.

minus

how rapidly a firm can grow if

one, it wishes to maintain a particular total debt ratio end two, it is unwilling to sell new stock

The price-earnings ratio is _______ per share divided by ________ per share.

price, earnings

the market to book ratio compares

the market value of the firms investments to their costs -a value less than one could mean that the firm has not been successful overall in creating value for its stockholders

A firm has sales of $811,000 for the year. The profit margin is 5.1 percent and the retention ratio is 56 percent. What is the common-size percentage for the dividends paid?

2.24%

Peterboro Supply has a current accounts receivable balance of $391,648. Credit sales for the year just ended were $5,338,411. How long did it take on average for credit customers to pay off their accounts during the past year? Assume a 365-day year.

26.78 days

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

365/receivables turnover

Xinya Controls has a profit margin of 7.5 percent and net income of $112,545. What is the common-size percentage for the cost of goods sold if that expense amounted to $855,425 for the year?

56.99%

Amir's has a total asset turnover rate of 1.13, an equity multiplier of 1.46, a profit margin of 5.28 percent, a retention ratio of .74, and total assets of $138,000. What is the sustainable growth rate?

6.89%

Last year, a firm earned $67,800 in net income on sales of $934,600. Total assets increased by $62,000 and total equity increased by $43,500 for the year. No new equity was issued, and no shares were repurchased. What is the retention ratio?

64.16%

Western Hardwoods has total equity of $318,456, a profit margin of 3.79 percent, an equity multiplier of 1.68, and a total asset turnover of .97. What is the amount of the firm's sales?

$518,956

Napolitano Art Gallery sells its inventory in 68 days, on average. Costs of goods sold for the year are $313,256. What is the average value of the firm's inventory? Assume a 365-day year.

$58,360

the quick (or acid test) ratio

(Current Assets - Inventory) / Current Liabilities the current ratio except inventory is omitted quick ratio equals current assets inventory current liabilities -using cash to buy inventory does not affect the current ratio but it reduces the quick ratio

Sustainable Growth Rate (SGR)

(ROE x b) / (1 - ROE x b) The growth rate that allows a firm to maintain its present financial ratios without issuing new equity.

Average Collection Period

(another name for Days' Sales in Receivables) The average amount of time that a receivable is outstanding, calculated by dividing 365 days by the accounts receivable turnover.

Price to Earnings Ratio (P/E)

price per share/Earnings per share. It is the comparison of a company's share price to its earnings(net income). ideal around 15-20. If less than 10=undervalued; if more than 20=overvalued.

a firm's ability to sustain growth depends explicitly on the following four factors

profit margin, total asset turnover, Financial Policy, dividend policy

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

true

Quincy Real Estate pays out a fixed percentage of its net income to its shareholders in the form of annual dividends. Given this, the percentage shown on a common-size income statement for the dividend account will:

vary in direct relation to the net profit percentage.

it is important to emphasize that whenever we have market information

we will use it instead of accounting data -also if there is a conflict between accounting and market data market data should be given precedence

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

False

Return on Equity

Net Income/Total Equity measure on how stockholders fared during the year

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

True

Steamboat Bike Shoppe has total assets of $536,712 and an equity multiplier of 1.36. What is the debt-equity ratio?

.36

DuPont identity tells us that our ROE is affected by three things

1. operating efficiency (as measured by profit margin) 2. asset use efficiency (as measured by total asset turnover) 3. financial leverage (as measured by the equity multiplier)

Which one of the following statements is correct? Peer group analysis is simplified when firms use varying methods of depreciation. Peer group analysis is easier when a firm is a conglomerate versus when it has only a single line of business. Peer group analysis is easier when seasonal firms have different fiscal years. Adjustments have to be made when comparing the income statements of firms that use different methods of accounting for inventory. Comparing results across geographic locations is easier since all countries now use a common set of accounting standards.

Adjustments have to be made when comparing the income statements of firms that use different methods of accounting for inventory.

if you are ever using ratios as a tool for analysis you should

be careful to document how you calculate each one and if you are comparing your numbers to those of another source be sure you know how their numbers are computed

Darnell's Place has total assets of $152,080, a debt-equity ratio of .62, and net income of $14,342 What is the return on equity?

15.28%

Northside City Mart has a market-to-book ratio of 2.8, net income of $323,500, a book value per share of $31.25, and 7,500 shares of stock outstanding. What is the price-earnings ratio?

2.03

Days' Sales in Receivables

365/receivables turnover

Dividend payout ratio

Cash Dividends/Net Income

You would like to borrow money three years from now to build a new building. In preparation for applying for that loan, you are in the process of developing target ratios for your firm. Which set of ratios represents the best target mix considering that you want to obtain outside financing in the relatively near future?

Cash coverage ratio = 2.6; debt-equity ratio = .3

Times interest earned (TIE) ratio

EBIT/Interest Charges another common measure of long term solvency

DuPont Identity

Expression of the ROE in terms of the firm's profitability, asset efficiency, and leverage. ROE = profit marg x total asset turnover x equity multiplier

Which of the following best explains why financial managers use a common-size income statement? The common-size income statement can show sources of cash for the company. The common-size income statement can show which costs are rising or falling as a percentage of sales.

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

Which of the following are true of financial ratios? They are computed in the same manner by all firms. They use only balance sheet data. They always reflect market values. They are developed from a firm's financial information. They are used for comparison purposes.

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

total asset turnover

an increase in the firm's total asset turnover increases the sales generated for each dollar in assets. This decreases the firm's need for new assets as sales grow and thereby increases the sustainable growth rate. Notice that increasing total asset turnover is the same thing as decreasing capital intensity

profit margin

an increase profit margin will increase the firm's ability to generate funds internally and thereby increase its sustainable growth

absent some extraordinary circumstances, we would expect to see a current ratio of at least one because

because a current ratio of less than one would mean that net working capital (current assets less current liabilities) is negative -this would be unusual in a healthy firm at least for most types of businesses

Which of the following would help a company take action to improve its ratios? comparing to DOW 30 companies comparing to aspirant companies comparing to peer companies comparing to major competitors comparing to its own historical ratios

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

Peer Group Analysis

comparison to a select group of firms in the same industry.

Common-size statements are best used for comparing:

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

Current Ratio Formula

current assets - current liabilities

The current ratio computes the relationship between ______.

current assets and current liabilities