ACC 240 Chapter 11

Why is operating income frequently substituted for net income in the calculation of ROI and ROE?

Operating income excludes the effects of discontinued operations and thus provides a more forward looking measure of the firm's profitability. Operating income excludes income tax expense, which varies from firm to firm based on country-specific tax rates.

Which statements are true regarding the price/earning (P/E) ratio?

The P/E ratio should not be the sole, or even principal, consideration in an investment decision. An above-average P/E ratio often indicates that investors anticipate relatively favorable future developments, such as increased earnings per share or higher dividends per share. Low P/E ratios usually indicate poor earnings expectations.

The difference between the inventory valuation as reported under LIFO and the amount that would have been reported under FIFO is called the LIFO

reserve

Firm E had 30,000 shares of $100 par value and 8 percent cumulative preferred stock authorized, issued, and outstanding during Year 1 and Year 2 but did not pay any preferred or common stock dividends in either year. Net income was $1,000,000 in Year 1 and $1,200,000 in Year 2. What is Firm E's preferred dividend coverage ratio for Year 2 (rounded to one decimal)?

$1,200,000 / (30,000 x $100 x 8%) = 5.0 times

Sales for Year 1 and Year 2 amounted to $1,200,000 and $1,500,000, respectively. Plant and equipment was $700,000 at the end of Year 1 and $500,000 at the end of Year 2. The plant and equipment turnover for Year 2 (rounded to one decimal) was:

$1,500,000 / (($700,000 + $500,000) / 2) = 2.5 times

Sales for Year 2 were $2,400,000. Accounts receivable was $200,000 at the end of Year 1 and $300,000 at the end of Year 2. The accounts receivable turnover for Year 2 (rounded to one decimal) was:

$2,400,000 / (($200,000 + $300,000) / 2) = 9.6 times

For Year 2, sales were $300,000 and cost of goods sold was $180,000. Inventories amounted to $20,000 at the end of Year 1 and $30,000 at the end of Year 2. The days' sales in inventory for Year 2 (rounded to one decimal) was:

$30,000 / ($180,000 / 365) = 60.8 days

Cost of goods sold was $400,000 and $500,000 in Year 1 and Year 2, respectively. Sales for Year 2 were $1,000,000. Inventory was $60,000 at the end of Year 1 and $40,000 at the end of Year 2. The inventory turnover for Year 2 (rounded to one decimal) was:

$500,000 / (($60,000 + $40,000) / 2) = 10.0 times

Sales were $500,000 in Year 1 and $600,000 in Year 2. Accounts receivable was $50,000 at the end of Year 1 and $30,000 at the end of Year 2. The accounts receivable turnover for Year 2 (rounded to one decimal) was:

$600,000 / (($50,000 + $30,000) / 2) = 15.0 times

Cost of goods sold for Year 2 was $600,000. Sales for Year 2 were $800,000. Plant and equipment was $300,000 at the end of Year 1 and $500,000 at the end of Year 2. The plant and equipment turnover for Year 2 (rounded to one decimal) was:

$800,000 / (($300,000 + $500,000) / 2) = 2.0 times

Firm D had 20,000 shares of $50 par value and 6 percent cumulative preferred stock authorized, issued, and outstanding during Year 1 and Year 2 but did not pay any preferred or common stock dividends in either year. Net income was $800,000 in Year 1 and $900,000 in Year 2. What is Firm D's preferred dividend coverage ratio for Year 2 (rounded to one decimal)?

$900,000 / (20,000 x $50 x 6%) = 15.0 times

Suppliers or potential suppliers/creditors of a firm consider which of the following to be more important than the aggregate working capital or liquidity ratios of the firm?

Cash discounts availed by the firm for prompt payments made Current and recent payment experience of the firm

Which statements are true regarding the price/earning (P/E) ratio?

Firms with high P/E ratios generally have strong investor confidence. Low P/E ratios usually indicate poor earnings expectations. A high P/E ratio usually means that investors expect the firm to have strong future earnings and dividend growth.

What indicators help suppliers and creditors judge the liquidity of a company?

How promptly the company has been paying its current and recent bills How the company is portrayed in Dun & Bradstreet reports Whether the company is taking all available cash discounts for prompt payment

Credit-rating firms gather and report data about which of the following?

Industries Individual companies Segments of the economy

Which statements regarding financial leverage are true?

It can be arranged via debt and preferred stock, because of their fixed interest cost (or dividend rate). It can lead to bankruptcy if the firm cannot generate enough cash to make payments on the principal and interest of its loans. It adds risk to the operation of the firm.

Which of the following statements are true regarding the price/earning (P/E) ratio?

P/E ratios are shown in the stock listing tables of The Wall Street Journal. The P/E ratio is a measure of the relative expensiveness of a company's common stock. The P/E ratio is sometimes referred to as earnings multiple.

Which statements are true regarding the price/earning (P/E) ratio?

P/E ratios are significantly influenced by the company's reported earnings. An above-average P/E ratio indicates that the common stock price is high relative to the firm's current earnings. A low P/E ratio for a well-established company may be an indicator that the company's stock is undervalued.

Which of the following statements are true regarding the price/earning (P/E) ratio?

The P/E ratio is one of the most important measures used by investors to evaluate the market price of a firm's common stock. Analysts sometimes use expected future earnings per share and the current market price in the calculation to evaluate the prospects for changes in the stock's market price. Diluted earnings per share is usually the denominator of the P/E calculation.

How do debt and preferred stock provide financial leverage?

They have a fixed interest cost (or dividend rate). The interest on debt can be deducted as an expense, lowering income taxes.

The ratios used to facilitate the interpretation of an entity's financial position and results of operations can be grouped into four (4) categories:

liquidity, activity, profitability, and debt

Because firms within a given industry may vary considerably over time in terms of their Blank______, it is difficult to develop reliable rules of thumb for the evaluation of ratio results.

relative scale of operations cost and capital structures life cycle stage of development

To calculate the plant and equipment turnover, you would divide:

sales by the average plant and equipment.

Because firms within a given industry may vary considerably over time in terms of their Blank______, it is difficult to develop reliable rules of thumb for the evaluation of ratio results.

selected accounting methods market segmentation strategies relative scale of operations

The debt ratio is usually calculated by dividing the

total liabilities by total liabilities + stockholders' equity