chapter 3 working with financial statements

What is the formula for computing the internal growth rate (IGR)?

(ROA × b)/(1 − ROA × b)

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

market price per share/earnings per share

Davis Company has provided the following financial data: Total Asset Turnover = .245 Net Income = $400,000 Equity Multiplier = 1.20 Net Sales = $1,300,000 What is the Return on Equity?

9.1% (400,000/1,300,000) * (.245) * (1.20)

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 Blank______.

current assets and current liabilities

The cash ratio is found by dividing cash by:

current liabilities

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

Return on assets equals net income _____________ by total assets.

divided

Return on assets equals net income___________ by total assets.

divided

The ____________ payout ratio equals cash dividends divided by net income.

dividend

The information needed to compute the profit margin can be found on the Blank______.

income statement

Time-trend analysis is an example of:

management by exception

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

market

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

market value

How is the market-to-book ratio measured?

market value per share/book value per share

What is true of financial ratios?

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

How to find IGR internal growth rate

=( ROA x B) (1- ROA x B)

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

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

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

Financial statements

Which of the following is true about the sustainable growth rate?

It is the maximum rate of growth a firm can maintain without increasing its financial leverage.

Which of the following is the correct equation for return on equity?

Net income/Total equity

______ 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.

A useful way of standardizing financial statements is to choose a _______ year and then express each item relative to that amount.

base

Financial statement analysis is primarily "management by______ ."

exception

Given an internal growth rate of 3 percent, a firm will Blank______.

grow by 3 percent or less without any additional external financing

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

increase

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

negative

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

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

sales

What equations defines the total asset turnover ratio?

sales/total assets

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

solvency

What best explains why financial managers use a common-size balance sheet?

to track changes in a firm's capital structure

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

total assets

What is the correct representation of the cash coverage ratio?

(EBIT + depreciation)/Interest expense

What is the formula for computing a firm's sustainable growth rate?

(ROE × b)/(1 − ROE × b)

Which of the following is the correct representation of the total debt ratio?

(Total assets − Total equity)/(Total assets)

Which of the following create problems with financial statement analysis?

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

Which of the following items are used to compute the current ratio?

-cash -accounts payable

Common-size statements are best used for comparing:

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

For the most recent fiscal year, the Hammock Company's total equity was $450 and net income was equal to $97. Of the $97 net income, $44 was retained. What is the sustainable growth rate for the Ladder Company?

10.83% (ROE x B)/ (1- (ROE x B)) ROE = 97/450 b= 44/97

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

365/receivables turnover

True or false: There is a solid and prescriptive method to select which ratios to use in financial statement analysis.

False

True or false: Inventory turnover is sales divided by inventory.

False Inventory turnover is cost of goods sold divided by inventory.

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

False The current ratio will increase if current assets increase, while everything else remains unchanged.

True or false: The price-earnings ratio is price per share times earnings per share.

False The price-earnings ratio is price per share divided by earnings per share.

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

It will increase.

The three parts of the Dupont equation are:

Profit margin, Total asset turnover, & Equity Multiplier.

For the most recent fiscal year, the Hammock Company's total assets were $850 and net income was equal to $97. Of the $97 net income, $44 was retained. What is the internal growth rate for the Hammock Company?

ROA= 97/850 = .1141 b= 44/97 = .4536 IGR = (.1141 x .4536) / (1-(.1141 x .4536)) = .0546= 5.46

Return on equity can be calculated as ROA × Equity multiplier. What is another way to express this equation?

ROE = ROA × (1 + Debt − Equity Ratio)

what is the sustainable growth rate

ROE*retention ratio / (1-ROE*retention ratio)

What represents the receivables turnover ratio?

Sales/Accounts receivable

Which of the following best explains why financial managers use a common-size income statement?

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

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

True or false: It is important to investigate trends in financial ratios to identify the reason for the trend.

True

True or false: Profit margin equals net income divided by sales.

True

True or false: The cash ratio is found by dividing cash by current liabilities.

True

Common size income statements show balance sheet items as a percentage of current assets.

false

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

false

True or false: If there is a conflict between market and accounting data, accounting data should be given precedence.

false

Long-term solvency ratios are also known as:

financial leverage ratios.

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

its financial leverage

If a company has inventory, the quick ratio will always be______ the current ratio.

less than: since the quick ratio excludes inventory

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

net income/total assets

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

price earnings

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

price-sales ratio

Return on assets (ROA) is a measure of Blank______.

profitability

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

true

True or false: The DuPont identity is a popular expression breaking ROE into three parts.

true

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

true The total debt ratio equals the total assets minus total equity all over total assets.

A firm with a profit margin of 10 percent generates______ in net income for every dollar in sales

10 cents

The DuPont identity breaks ROE into________ parts

3

American Corporation has the following financial information. Year 1 Year 2 Cash $202.95 $245.90 A/R 398.02 485.34 Inventory 785.12 648.54 If Year 1 is the base year, what is the percentage increase/decrease of each current asset amount?

Cash = 21% increase, A/R = 22% increase, Inventory = 17% decrease Cash: (245.90 -202.95) / 202.95 AR: (485.34-398.02) / 398.02 Inv: (648.54 - 785.12) / 785.12

How is the inventory turnover ratio computed?

Cost of goods sold/Inventory

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 dividend payout ratio equals cash dividends divided by sales

False