(Corporate Finance) Ch. 4 Financial Analysis

When it comes to financial ratios and assessing company performance, management usually look at which of the following?

How the company's financial ratios have changed over time Comparing ratios with companies in the same line of business

Which of the following ratios shows the percent of long-term capital that is financed by debt?

Long-term debt ratio

A healthy current ratio and an unhealthy quick ratio may be caused by excess inventory. (T or F)

True

When determining if a ratio is good or bad, managers look at industry norms in order to

compare their measures with the measures of companies in the same line of business.

Which of the following ratios are used to determine the liquidity of the firm? 1. Quick ratio 2. Interest coverage ratio 3. Current ratio 4. Inventory turnover ratio

1. Quick ratio 3. Current ratio

Which of the following are helpful for measuring the firm's profits per dollar of assets? 1. Return on capital 2. Return on assets 3. Return of debt 4. Return on equity

1. Return on capital 2. Return on assets 4. Return on equity

Which of the following ratios shows the number of days in which a company has sufficient inventories to maintain operations?

Average days in inventory

The higher the times interest earned ratio, the higher the interest expense. (T or F)

False

Which of the following refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity?

Financial leverage

Which of the following ratios are used to determine if the financial leverage of the firm is prudent?

Interest coverage ratio Debt ratios

Which of the following ratios compares the level of inventories with the cost of goods sold?

Inventory turnover

ABC Corporation has long-term debt of $100,000 and equity of $160,000. ABC's long-term debt ratio is

Long-term debt ratio = long-term debt/(long-term debt + equity) = $100,000/($100,000 + $160,000) = 0.385 or 38.5%.

XYZ Corporation's shares are selling for $50 a share and the number of shares currently outstanding is 1,000. XYZ's market capitalization is:

Market capitalization = share price x number of outstanding shares = $50 x 1,000 = $50,000

Which of the following figures shows the company's potential net reservoir of cash?

Net working capital

ABC Corporation has current assets of $50,000, total assets of $150,000, current liabilities of $35,000, total liabilities of $90,000, and shareholders' equity of $25,000. What is ABC Corporation's net working capital worth?

Net working capital = Current assets − current liabilities = $50,000 − $35,000 = $15,000.

Which of the following ratios measures the proportion of sales that finds its way into profits?

Profit margin

Which of the following ratios shows the amount of quick assets for every dollar of current liabilities?

Quick ratio

ABC Corporation had $3,000,000 in cost of goods sold and $370,000 in inventory. ABC's inventory turnover is _____.

Rationale: Inventory turnover = cost of goods sold/inventory = $3,000,000/$370,000= 8.11

Which of the following ratios shows the number of times outstanding credit accounts are collected during the year?

Receivables turnover

Why do analysts look at a firm's cash ratio?

The cash ratio is a measure of the firm's liquidity.

Which of the following ratios shows the extent to which interest obligations are covered by earnings?

Times interest earned ratio

Market value added is the difference between the market value of the firm's equity and its book value. (T or F)

True

Operating profit margin differs from profit margin in that it considers the company's

after-tax debt interest

Liquid assets are those that can be quickly converted to

cash

Inventory turnover is __________________________ divided by inventory at the start of the year

cost of goods sold

The inventory turnover ratio is equal to

cost of goods sold divided by inventory at the start of the year

Net working capital of $4,000 states that the company's

current assets exceed current liabilities by $4,000

Net working capital is equal to

current assets minus current liabilities

An asset turnover ratio of 2.10 states that

each dollar of assets produced $2.10 in sales

Return on capital and return on assets are used instead of _____ to compare managers whose assets differ in size.

economic value added

The goal of _________ is to earn at least the cost of capital on assets employed.

economic value added

Asset turnover, inventory turnover, and receivables turnover are all ratios used to measure a firm's __________.

efficiency

A quick ratio of .50 states that

for every dollar in current liabilities the company has $0.50 cents in quick assets

A current ratio of 2 states that

for every dollar in current liabilities the company has $2 in current assets

An operating profit margin of 6.5% states that

for every dollar in sales $0.065 cents is generated in after-tax operating income

A profit margin of 7% states that

for every dollar in sales the company generates $0.07 cents in profit

A highly leveraged company will have a long-term debt-equity ratio that is _________ a less leveraged company.

higher than

A times interest earned ratio of 5 states that

income before interest and taxes covers the interest obligation 5 times.

In good times, financial leverage _____ returns to shareholders.

increases

The long-term debt-equity ratio is a measure of

leverage

When loaning money, creditors are interested in the borrower's financial leverage as well as their

liquidity

The long-term debt-equity ratio is equal to

long-term debt divided by equity

The long-term debt ratio is equal to

long-term debt divided by long-term debt plus equity

Market value added is equal to

market capitalization minus book value of equity.

The market-to-book ratio is equal to

market value of equity divided by book value of equity.

Market value added is defined as

market value of the firm's shares minus shareholder investment

The profit margin is equal to

net income divided by sales

Economic value added is equal to

net income minus the cost of capital.

Economic value added is defined as the

profit after deducting all costs, including the cost of capital.

Managers can improve economic value added by

reducing assets that are not contributing adequately to profit

Economic value added is also referred to as

residual income.

Which part of the return on equity equation depends on the firm's production and marketing skills, not the firm's financing mix?

return on assets

The asset turnover ratio is equal to

sales divided by total assets

An average collection period of 32 states that

the company collected payment on average in 32 days

An average days in inventory ratio of 30 states that

the company has inventory to maintain operations for 30 days

A long-term debt ratio of 40% states that

$0.40 cents of every dollar of long-term capital is in the form of debt.

Which of the following ratios shows the amount of cash and marketable securities for every dollar of current liabilities?

Cash ratio

Which of the following are considered drawbacks associated with performance measures? 1. The market value of a company's shares reflects investors' expectations 2. Market values fluctuate 3. Market values of privately owned companies are not available for observation 4. Make the cost of capital visible to managers

1. The market value of a company's shares reflects investors' expectations 2. Market values fluctuate 3. Market values of privately owned companies are not available for observation

Most firms would prefer both high profit margin and high turnover; however, this strategy typically leads to lower sales per dollar of assets. The Du Pont formula can help companies 1. determine if they should pursue a high profit margin/low turnover strategy 2. determine if they should pursue different management hiring practices 3. determine if they should pursue a high turnover/low profit margin strategy 4. Identify the constraints firms face

1. determine if they should pursue a high profit margin/low turnover strategy 3. determine if they should pursue a high turnover/low profit margin strategy 4. Identify the constraints firms face

Which of the following statements are possible explanations for a high receivables turnover number? 1. unpaid bills are a small proportion of sales 2. unpaid bills are a large proportion of sales 3. the firm has an efficient credit department that is quick to follow up on late payers 4. the firm has a restrictive credit policy

1. unpaid bills are a small proportion of sales 3. the firm has an efficient credit department that is quick to follow up on late payers 4. the firm has a restrictive credit policy

XYZ's market value of equity is $50,000 and its book value of equity is $45,000. XYZ's market-to-book ratio is _____.

1.11 Rationale: Market-to-book ratio = market value of equity/book value of equity= $50,000/$45,000=1.11

Which of the following ratios measure the firm's efficiency with which it uses its assets? 1. Return on equity 2. Inventory turnover 3. Return on assets 4. Asset turnover

2. Inventory turnover 4. Asset turnover

Which of the following are considered advantages of using EVA and Accounting rates of return over market-value based measures? 1. Current market values of assets are considered 2. Show current performance 3. Not affected by economic factors that move stock market prices 4. Can be calculated for a particular division

2. Show current performance 3. Not affected by economic factors that move stock market prices 4. Can be calculated for a particular division

ABC Corporation had sales of $125,000. Total assets at the beginning of the year were 53,000 and at the end of the year were $55,000. ABC's asset turnover for the entire year was. . (Use the average total assets to solve)

2.31 Sales/average total assets = $125,000/(($53,000+$55,000)/2).

Which of the following are considered disadvantages of using EVA and Accounting rates of return over market-value based measures? 1. Not affected by economic factors that move stock market prices 2. Show current performance 3. Assets could be grossly undervalued 4. Current market values of assets are not considered

3. Assets could be grossly undervalued 4. Current market values of assets are not considered

8)Last year's asset turnover ratio was 2.0. Sales have increased by 25% and total assets have increased by 10% since that time. What is the current asset turnover ratio? A) 2.27 B) 2.50 C) 1.82 D) 2.15

A) 2.27

What is the debt ratio for a firm with a debt-equity ratio of 0.5? A) 33.3% B) 35% C) 66.7% D) 54%

A) 33.3%

Assume BDS acquired its main supplier, ABC. As a result of the acquisition, BDS finds that its profit margin increased but its ROA remained constant. A decrease in which one of these ratios is most apt to be the reason why the ROA did not increase with the increase in the profit margin? [Application of DuPont Identify] A) Asset turnover B) Leverage ratio C) Debt burden D) Market-to-book ratio

A) Asset turnover

How would you interpret an inventory turnover ratio of 10.7? A) The firm has sufficient inventories to maintain sales for 34.1 days. B) It takes 50 days on average to collect receivables. C) Assets are converted into sales every 50 days. D) Inventory is converted into sales every 50 days.

A) The firm has sufficient inventories to maintain sales for 34.1 days.

A total debt ratio of 0.35: A) would exist if a firm had liabilities of $700 and assets of $2,000. B) indicates that 35 cents of every dollar of capital is in the form of long-term debt. C) indicates that the firm is financed with 35% long-term debt. D) indicates that 35 cents of every dollar of capital is in the form of short-term debt.

A) would exist if a firm had liabilities of $700 and assets of $2,000.

According to the Du Pont System, return on assets is dependent upon which of the following two factors?

Asset turnover Operating profit margin

Which of the following ratios shows how much sales are generated by each dollar of total assets?

Asset turnover ratio

Which of the following ratios are used to answer whether assets are used efficiently?

Asset turnover ratios Inventory turnover ratio Receivables turnover ratio

Which of the following ratios shows the number of days it takes customers to pay their bills?

Average collection period

The DuPont identity can be used to help a financial manager determine the: I. degree of financial leverage used by a firm. II. operating efficiency of a firm. III. utilization rate of a firm's assets. IV. rate of return on a firm's assets. A) I and III only B) I, II, III, and IV C) II, III, and IV only D) I, II, and III only

B) I, II, III, and IV all

Leon is the owner of a corner store. Which ratio should he compute if he wants to know how long the store can pay its bills given its current level of cash and accounts receivable? Assume all receivables are collectible when due. A) Cash ratio B) Quick ratio C) Current ratio D) Cash coverage ratio

B) Quick ratio

If ROC is less than a firm's cost of capital, which of the following must be true? A) The firm's ROE is negative. B) The firm's EVA is negative. C) The firm's EVA is positive. D) The firm's ROE is equal to zero.

B) The firm's EVA is negative.

A retail store with zero net working capital has: A) no current debt. B) a quick ratio that is less than 1. C) insufficient inventory. D) no cash or marketable securities.

B) a quick ratio that is less than 1.

Efficiency ratios: A) include the quick ratio, asset turnover ratio, and return on equity. B) are used to measure how well the company uses its assets. C) measure the profits generated by a firm's equity and assets. D) are used to measure how liquid the company is

B) are used to measure how well the company uses its assets.

12) An asset turnover ratio of 1.75 can be interpreted as: A) $1.75 in assets are used to generate $1 of sales. B) $1 in sales are used to generate $1.75 in assets. C) $1.75 in sales are generated by every $1 of assets. D) $1.75 in additional assets are generated by every $1 of sales.

C) $1.75 in sales are generated by every $1 of assets.

What is the ROE for a firm with a times interest earned ratio of 2, a tax liability (amount of tax paid) of $1 million, and interest expense of $1.5 million if equity equals $1.5 million? A) 30.00% B) 50.00% C) 33.33% D) 26.67%

C) 33.33%

What is the inventory turnover ratio for ABC Corp. if cost of goods sold equals $5,000, current ratio equals 3, quick ratio equals 1.5, and the firm has $1,800 in current assets? A) 8.33 times B) 2.78 times C) 5.56 times D) 4.17 times

C) 5.56 times

Calculate the average collection period for Dots Inc. if its accounts receivables were $550 at the beginning of a year in which the firm generated $3,000 of sales? A) 73 days B) 60 days C) 67 days D) 61 days

C) 67 days how: 365 days divided by (3000 sales/550 beg rec)

A times interest earned ratio of 5 indicates the firm: A) pays 5 times its earnings in interest expense. B) has interest expense equal to 5% of EBIT. C) earns significantly more than its interest obligations. D) has a low tax liability.

C) earns significantly more than its interest obligations.

If a company has a healthy current ratio but a significantly lower quick ratio, then you can assume that: A) current liabilities exceed current assets. B) the firm sells only on a cash basis. C) inventory represents a large portion of the firm's current assets. D) the cost of goods sold represents more than half of sales.

C) inventory represents a large portion of the firm's current assets.

In order to drill down to compare the performance of a firm's individual divisions, you need to use accounting measures of profitability such as ________.

Correct Answer economic value added market value added (market value performance measure, not accounting) market-to-book ratio (market value performance measure, not an accounting)

Which of the following ratios shows the dollar value of current assets for every dollar in current liabilities?

Current ratio

You would like to borrow money three years from now to build a new building. In preparation for applying for that loan, you are in the process of developing target ratios for your firm. Which set of ratios represents the best target mix considering that you want to obtain outside financing in the relatively near future? A) Cash coverage ratio = .5; total debt ratio = .2 B) Times interest earned = 1.7; debt-equity ratio = 1.6 C) Cash coverage ratio = .8; debt-equity ratio = .8 D) Cash coverage ratio = 2.6; debt-equity ratio = .3

D) Cash coverage ratio = 2.6; debt-equity ratio = .3

When a firm's long-term debt-equity ratio is .98, the firm: A) has too much long-term debt in relation to leases. B) is nearing insolvency. C) has as much in long-term liabilities as in equity. D) has less long-term debt than equity.

D) has less long-term debt than equity.

Which parts of the return on equity equation depend on the firm's financing mix (its debt-equity mix)?

Debt burden Leverage ratio

Market capitalization is equal to

total market value of the firm's equity.