FINA 470 Chapter 1 True/False

If a company has no liabilities, its return on equity will equal its return on assets.

TRUE Yes. Pure math. With no liabilities, equity = total assets Assets = Liabilities + Equity Assets = zero + Equity ......if there are no liabilities Assets = Equity .....if there are no liabilities Therefore Return/Assets = Return/Equity

Financial statement analysis is an exact science.

FALSE Any analysis is replete with estimates

The current ratio is used to evaluate a company's operating performance.

FALSE Liquidity, not operations

When comparing two companies, the company with the highest net income should normally have the highest stock price.

FALSE Many other factors to consider, Book Value, Fair Value of assets, growth rates, industry trends....

The explanatory notes (footnotes) accompanying the financial statements are generally of little value in aiding a financial analyst when interpreting the financial statements.

FALSE No, they add significant insight into the financials.

A capital-intensive company requires high cash turnover.

FALSE Not necessarily. Receivables and inventory could turn slowly. A capital-intensive industry may make it hard for competitors to enter the business and inventory could turn very slowly/. Cash turnover is not necessarily affected.

The statement of cash flows is separated into four parts: operating, investing, financing, and planning.

FALSE Only the first three: operating cash flow, investing cash flow, and financing cash flow. There is no section for planning.

In a common-size balance sheet, total assets are expressed as 100 percent.

FALSE SALES are expressed as 100%

A bank with a loan to a company is generally exposed to a greater risk than the shareholders of the company.

FALSE Shareholder can lose all equity, bank can lose its entire loan but only that. Banks also tend to have collateral to protect themselves. Shareholders have no collateral.

Debt-to-equity ratio is a commonly used measure of liquidity.

FALSE Solvency, not liquidity. Solvency is ability to meet long-term obligations such as debt. Liquidity refers to ability to meet short term obligations such as accounts payable and other current liabilities.

The income statement is the only one of the four basic financial statements that does not contain balances at a specific point in time.

FALSE The Balance Sheet shows balances of assets, liabilities and equity at a specific point in time. The statement of cash flows, the statement of owers' equity and the income statement all show how balances changed over a period of time. The cash flow statement certainly shows a cash balance at a point I time. The statement of equity shows beginning and ending balances at a point in time.

Dividend yield is defined as dividends divided by shareholders' equity.

FALSE The dividend yield is the ratio of a company's annual dividend compared to its share price. The dividend yield is represented as a percentage and is calculated as follows: Annual dividend/share price.

The value of a bond is equal to the sum of the present value of future expected interest and principal payments, discounted at the coupon rate.

FALSE The value changes as the market rate changes, not the coupon rate. A $1,000 bond with a coupon rate of 5% will pay a dividend of $50 (5% x $1,000). If the market rate is 6%, the price of the bond (its value, will be less than $1,000. If the market rate is 4%, the price of the bond will be more than $1,000.

A creditor's risk is said to be asymmetric because the downside is limited to the required interest payments.

TRUE A creditor is the borrower. He can't lose what he has borrowed, he already had the dollars and only needs to pay it back. His only real risk is the interest payments he must make. The lender is risking the money he lent plus the interest payments that may or may not be paid.

A security can be under- or overvalued, depending on the extent of an incorrect interpretation or faulty evaluation of available information by the aggregate market.

TRUE Bad information, bad results. A market inefficiency.

The current ratio will always be greater than or equal to the acid test ratio.

TRUE Has to be true. Denominator for both ratios is current liabilities. But numerator in current ratio includes inventory which makes it larger than acid ratio which excludes inventory

Inventory turnover is generally a more important ratio for a manufacturing firm than a service firm.

TRUE Inventory is significant for manufacturing companies but insignificant for service companies.

Earnings yield is the reciprocal of the price-to-earnings ratio.

TRUE Price earnings: Price of stock/earnings Earnings Yield: Earnings/price of stock

All other things being equal, the lower a company's cost of equity the higher will be its stock price.

TRUE Pure math Anything (cash flow, dividends, residual value divided by a lower number will be greater 1,000/.05 > 1,000/.15 Lower K -=> value

When calculating the return on assets, you should use average total assets.

TRUE Yes see back of book or ratio sheet. Average always

Theoretically, the value of a stock should equal the sum of the present value of future expected dividends, discounted at the cost of equity.

TRUE Yes, One of the three methods of valuation explored in the text is the dividend discount model. Dividends/k is the formula used if dividends are the same forever. K is the cost of capital. Dividends*(1+k)/(k-g) id the formula used for a permanent dividend stream with constant growth. K is again the cost of capital while g is the steady growth rate.

Two popular techniques of comparative analysis are year-to-year change analysis and index-number trend analysis.

TRUE Yes, a third is common-size financial statements.

The SEC requires that Management Discussion and Analysis found in the annual report (10K) contains, among other things, a discussion about the company's liquidity, capital resources, and results of operations.

TRUE Yes, all must be included in MD&A

Prospective analysis is the forecasting of future payoffs—typically earnings, cash flows, or both.

TRUE Yes, full business analysis requires looking into the future. Ii is what "prospective" means - the opposite of retrospective.

Common-size statements are useful for intercompany comparisons.

TRUE Yes, it allows you to compare (with reservations) different companies, companies within the industry or different industries

Details of compensation paid to officers and directors can be found in proxy statements.

TRUE Yes, occasionally found in the 10K, compensation is most often found in the proxy which goes to the shareholders prior to the shareholder meeting. The proxy includes all items that will come for a vote of the shareholders including election of board members.