Fin 4-5

Since the 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. T or F

F

If a firm's fixed assets turnover ratio is significantly higher than its industry average, this could indicate that it uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets. T or F

T

Other things held constant, the more debt a firm uses, the higher its profit margin will be. T or F

F

Other things held constant, the more debt a firm uses, the higher its operating margin will be. T or F

F

A high average DSO indicates that none of its customers are paying on time. In addition, it makes no sense to evaluate the firm's DSO with the firm's credit terms. T or F

F

A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio. T or F

F

Debt management ratios show the extent to which a firm's managers are attempting to reduce risk through the use of financial leverage. The higher the total debt to total capital ratio, the lower the risk. T or F

F

Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's. T or F

F

If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average, and was increasing and trending still higher, this would be interpreted as a sign of strength. T or F

F

Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, no debt and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow funds using long-term debt, use the funds to buy back stock, and raise the equity multiplier to 2.0. The size of the firm (assets) would not change. She thinks that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would probably not be a good move, as it would decrease the ROE from 7.5% to 6.5%. T or F

F

Other things held constant, the higher a firm's total debt to total capital ratio, the higher its TIE ratio will be. T or F

F

Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios. T or F

F

There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things. T or F

F

If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline. T or F

T

Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage. T or F

T

Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required to achieve its target TIE ratio. T or F

T

The current and quick ratios help us measure a firm's liquidity. The current ratio measures the relationship of the firm's current assets to its current liabilities, while the quick ratio measures the firm's ability to pay off short-term obligations without relying on the sale of inventories. T or F

T

The return on invested capital measures the total return that a company has provided for its investors. T or F

T

The return on total assets (ROA) measures the return on all the firm's assets ________ interests and taxes

after

What would increase a company's current ratio?

an increase in accounts receivable

The basic earning power (BEP) ratio shows the earning power of the firm's assets __________ taxes and debt and is useful for comparing firms with different debt ratios and tax rates.

before

The Price/Earnings (P/E) ratio shows how much investors are willing to pay per dollar of current __________.

earnings

The return on common equity (ROE) measures the return on ____________ _______________ investment.

common stockholders

An alternative definition of the inventory turnover ratio replaces sales in the numerator with what?

cost of goods sold

If the DSO trend has been rising and _________ policy has not changed, this would indicate a need to speed up the collection of receivables

credit

A low ROA can result from a firm's decision to use more debt because high interest expenses will cause net income to ___________

decline

Profitability ratios reflect the net result of all the firm's ____________ policies and operating decisions.

financing

Companies with low risk and high growth have _______ M/B ratios.

high

P/E ratios are ______for firms with strong growth prospects and relatively little risk but _____for slowly growing and risky firms.

high, low

There can be problems interpreting the fixed asset turnover ratio due to ______________, particularly when an older firm is compared with a newer company.

inflation

Profit margin measures the firm's combined impact of operating efficiency and __________ on the firm's profitability

leverage

Excess inventory is unproductive and represents an investment with a _______ rate of return.

low

The profit margin indicates what percentage of sales _____ ____________ represents

net income

M/B ratios typically exceed _______, which means that investors are willing to pay more for stocks than their accounting book values.

one

The operating margin indicates what percentage of sales remain after ____________ ________ are accounted for.

operating costs

Market value ratios give management an indication of what investors think of the company's _______ and future prospects.

risk

The DSO can also be evaluated by comparison with the terms on which the firm _________ its goods.

sells

The inventory turnover ratio indicates how many times during the year inventory is ___________ and restocked

sold

Company A is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Company A pays, EBIT, or the tax rate. What is likely to occur if the company goes ahead with the stock issue?

the tax bill will increase