Chapter 3 Questions

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

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

What does NOT affect ROE according to the DuPont identity?

investor sentiment

What is true about the sustainable growth rate?

it is the maximum rate of growth a firm can maintain without increasing 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

Time-trend analysis is an example of

management by exception

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

market

What is the correct equation for computing return on assets (ROA)?

net income/total assets

What is the correct equation for return on equity?

net income/total equity

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?

non-cash expenses

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

peer

If a company has had negative earnings for several periods they might choose to use a _____-_____ _____.

price-sales ratio

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

solvency

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

standardized

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

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

T/F: It is important to investigate trends in financial ratios to identify the reason for the trend.

true

T/F: The cash ratio is found by dividing cash by current liabilities.

true

T/F: The debt-equity ratio equals the total assets minus total equity all over total assets.

true

What will decrease a firm's sustainable rate of growth?

an increase in the dividend payout ratio

A firm with a profit margin of 10% 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 which ratio?

365/Receivables turnover

Short-term solvency ratios are also called _________ ratios.

liquidity

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

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)

What is the correct representation of the total debt ratio?

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

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

market price per share/earnings per share

The price-earnings (PE) ratio is a ______ _____ ratio.

market value

The profit margin is equal to net income divided by ______.

sales

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

total assets

T/F: A way to establish a benchmark for ratio analysis is to identify a peer group.

true

T/F: In a common-size income statement, each item is expressed as a percentage of total sales.

true

T/F: The current ratio will decrease if current assets increase, while everything else remains unchanged.

false

T/F: The price-earnings ratio is price per share * earnings per share.

false

T/F: The times interest earned ratio is EBIT minus interest.

false

T/F: There is a solid and prescriptive method to select which ratios to use in financial statement analysis.

false

Given an internal growth rate of 3 percent, a firm can ____ __ _ _______ __ ____ _______ ___ __________ ________ _________.

grow by 3 percent or less without any additional external financing

What can create problems with financial statement analysis?

- the firm or its competitors are conglomerates - the firm or its competitors are global companies - the firm and its competitors operate under different regulatory environments

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

it will increase

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

its financial leverage

How is the market-to-book ratio measured?

market value per share/book value per share

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 of the following represents the receivables turnover ratio?

sales/accounts receivable

What equation defines the total asset turnover ratio?

sales/total assets

Cal's Market has 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.

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

DuPont

Long-term solvency ratios are also known as:

financial leverage ratios

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

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

financial statements

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 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

the ________ payout ratio equals cash dividends divided by net income.

dividend

Financial statement analysis is primarily "management by _________ ."

exception

T/F: 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

T/F: Financial ratios are computed using balance sheet information.

false

T/F: If a company has inventory, the quick ratio will always be greater than the current ratio.

false

T/F: If there is a conflict between market and accounting data, accounting data should be given precedence.

false

T/F: Inventory turnover is sales divided by inventory.

false

T/F: Market-to-book ratio equals book value per share divided by market value per share.

false

T/F: Receivables turnover is cost of goods sold divided by accounts receivable.

false

T/F: The DuPont identity is a popular expression breaking ROA into three parts.

false

T/F: The retention ratio equals one minus the ROA

false

What are the items used to compute the current ratio?

- cash - accounts payable

What would help a company take action to improve its ratios?

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

Common-size statements are best used for comparing

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

Based on the DuPont Identity, an increase in sales, all else held equal, ___ _______ __ _______ / ___ ___ _____ ROE.

- may increase or decrease - may not change

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

- net - profit - margin

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

- price - earnings

Based on the sustainable growth rate, what are some of the factors that affect a firm's ability to sustain growth?

- profit margin - dividend policy - financial policy

What are the traditional financial ratio categories?

- profitability ratios - financial leverage ratios - turnover ratios

Which of the following is (are) true of financial ratios?

- they are used for comparison purposes - they are developed from a firm's financial information