Finance Exam 2 Ch. 3
As the financial leverage multiplier increases, this may result in ________.
A decrease in the net profit margin and return on investment, due to the increase in interest expense as debt increases
The net value of fixed assets is also called its ________.
Book Value
P/E ratio measures the ________.
Market value of the stock to earnings per share
An analyst should be careful when conducting ratio analysis to ensure that ________.
The overall performance of a firm is not judged on a single ratio
________ ratio measures a firm's ability to pay contractual interest payments.
Times Interest Earned
A firm with sales of $1,000,000, net profits after taxes of $30,000, total assets of $1,500,000, and common stockholders' investment of $750,000 has a return on equity of ________.
4 Percent
ABC Corp. extends credit terms of 45 days to its customers. Its credit collection would likely be considered poor if its average collection period was ________.
57 days
Nico Corporation has annual purchases of $300,000 and accounts payable of $30,000, then average purchases per day are ________ and the average payment period is ________.
821.9; 36.5
Other things being equal, a decrease in total asset turnover will result in ________ in the return on total assets.
A decrease
The stockholder's report includes ________.
A statement of retained earnings
________ ratios are a measure of the speed with which various accounts are converted into sales or cash.
Activity
The less fixed-cost debt (financial leverage) a firm uses, the greater will be its risk and return.
False
The liquidity of a business firm is measured by its ability to satisfy its long-term obligations as they come due.
False
The lower the fixed-payment coverage ratio, the lower is the firm's financial leverage.
False
The president's letter, the first component of the stockholders' report, is the primary communication from management to a firm's employees.
False
The statement of cash flows reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and end of that year.
False
Total asset turnover commonly measures the liquidity of a firm's total assets.
False
A firm with a total asset turnover that is lower than industry standard but with a current ratio that meets industry standard must have excessive ________.
Fixed Assets
A firm with a gross profit margin which meets industry standard and a net profit margin which is below industry standard must have excessive ________.
General Administrative Expenses
________ indicates the percentage of each sales dollar remaining after the firm has paid for its goods.
Gross Profit Margin
________ are especially interested in the average payment period, since it provides them with a sense of the bill-paying patterns of the firm.
Lenders and suppliers
Average age of inventory is viewed as the average length of time inventory is held by a firm or as the average number of days' sales in inventory.
True
Average payment period can be calculated as accounts payable divided by average purchases per day.
True
Both current and prospective shareholders are interested in the firm's current and future level of risk and return, which directly affect share price.
True
Earnings per share represents amount earned during the period on each outstanding share of common stock.
True
Higher the debt ratio, more the financial leverage a firm has and thus, the greater will be its risk and return.
True
Return on total assets (ROA) measures the overall effectiveness of management in generating profits with its available assets.
True
The DuPont formula allows a firm to break down its return into the net profit margin, which measures the firm's profitability on sales, and its total asset turnover, which indicates how efficiently the firm has used its assets to generate sales.
True
Typically, higher coverage ratios are preferred, but a very high ratio may indicate under-utilization of fixed-payment obligations, which may result in unnecessarily low risk and return.
True
Which of the following ratios is difficult for the creditors of a firm to analyze from the published financial statements?
Average Payment Period
The ________ of a business firm is measured by its ability to satisfy its short-term obligations as they come due.
Liquidity
A firm's annual stockholders' report ________.
Summarizes and documents the firm's financial activities during the past year
The common stock entry in balance sheet is the par value of common stock.
True
In general, the more debt a firm uses, the smaller its financial leverage.
False
On the balance sheet, net fixed assets represent ________.
Gross fixed assets at cost minus accumulated depreciation
Operating profit is ________.
Gross profit minus operating expenses
Paid-in capital in excess of par represents the amount of proceeds ________.
In excess of the par value from the original sale of common stock
The ________ measures the activity, or liquidity, of a firm's stock of goods.
Inventory Turnover Ratio
________ measures the percentage of profit earned on each sales dollar before interest and taxes but after all costs and expenses.
Operating Profit Margin
Gross profit is ________.
Sales revenue minus cost of goods sold
Two frequently cited ratios of profitability that can be read directly from the common-size income statement are ________.
The gross profit margin and the net profit margin
The ________ ratio indicates the efficiency with which a firm uses its assets to generate sales.
Total Asset Turnover
The use of the unaudited financial statements for ratio analysis is preferable because it reflects the firm's true financial condition.
False
Time-series analysis evaluates the performance of various firms at the same point in time using financial ratios.
False
The stockholders' annual report must include ________.
An income statement
A(n) ________ is useful in evaluating credit policies.
Average Collection Period
Book value per share is the ratio of ________.
Common stock equity to number of outstanding common shares
The two basic measures of liquidity are ________.
Current ratio and quick ratio
Which of the following is excluded when calculating quick ratio? A) accounts receivable B) accounts payable C) cash D) inventory
D) Inventory
________ ratio measures the proportion of total assets financed by the firm's creditors.
Debt
The ________ is used by financial managers as a structure for dissecting a firm's financial statements to assess its financial condition.
Dupont System of Analysis
________ may indicate a firm is experiencing stockouts and lost sales.
Inventory turnover ratio
The primary concern of creditors when assessing the strength of a firm is its ________.
Short-term Liquidity
Average age of inventory can be calculated as 365 divided by inventory turnover.
True
A firm's year-end retained earnings balances are $320,000 and $400,000, for 2014 and 2015 respectively. The firm reported net profits after taxes of $100,000 in 2015. The firm's dividend payment for 2015 is ________.
$20,000
A firm's year-end retained earnings balance are $670,000 and $560,000 for 2014 and 2015, respectively. The firm reported net profits after taxes of $100,000 in 2015. The firm paid dividends of ________ in 2015.
$210,000
A firm has a year-end retained earnings balance of $220,000 for 2014. The firm reported net profits after taxes of $50,000 and paid dividends of $30,000 in 2015. The firm's retained earnings balance at 2015 year end is ________.
$240,000
In the DuPont system of analysis, the return on total assets (asset) is equal to ________.
(net profit margin) × (total asset turnover)
Nico Corporation has cost of goods sold of $300,000 and inventory of $30,000, then the inventory turnover is ________ and the average age of inventory is ________.
10; 36.5
Which of the following is true of current ratio? A) The more predictable a firm's cash flows, the higher the acceptable current ratio. B) A higher current ratio indicates a higher return on equity. C) The more predictable a firm's current ratio, the higher the current liabilities. D) A higher current ratio indicates a greater degree of liquidity.
D) A higher current ratio indicates a greater degree of liquidity.
Average payment period can be calculated as accounts payable divided by average sales per day.
False
Earnings per share represents the dollar amount earned and distributed to shareholders.
False
Gross profit margin measures the percentage of each sales dollar left after a firm has paid for its goods and operating expenses.
False
The DuPont system allows a firm to break its return on equity into a profit-on-sales component, an efficiency-of-asset-use component, and a use-of-operating leverage component.
False
Which of the following is a limitation of ratio analysis? A) Financial ratios cannot reveal certain specific aspects of a firm's financial position. B) Ratios that reveal large deviations from the norm merely indicate the possibility of a problem. C) It is difficult to access audited financial statements for ratio analysis. D) Ratio analysis assumes that inflation has no effect on a firm's business.
Ratios that reveal large deviations from the norm merely indicate the possibility of a problem.
Ratios provide a ________ measure of a company's performance and condition.
Relative
________ measures the return earned on the common stockholders' investment in the firm.
Return on Equity
The modified DuPont formula relates the firm's return on total assets (ROA) to its ________.
Return on Equity (ROE)
________ measures the overall effectiveness of management in generating profits with its available assets.
Return on Total Assets
If an inventory turnover is divided into 365, it becomes a measure of ________.
The average age of the inventory
________ ratio indicates that a firm will be able to meet interest obligations due on outstanding debt.
Times Interest Earned
The financial leverage multiplier is an indicator of how much ________ a corporation is utilizing.
Total Debt
Financial leverage multiplier is the ratio of ________.
Total assets to common stockholders' equity
A firm's year-end retained earnings balances are $670,000 and $560,000, for 2014 and 2015 respectively. The firm paid $10,000 in dividends in 2015. The firm's net profit after taxes in 2015 was ________.
-$100,000
The ________ represents a summary statement of a firm's financial position at a given point in time.
Balance sheet
Which of the following groups of ratios primarily measure risk? A) liquidity, activity, and profitability B) liquidity, profitability, and market C) liquidity, activity, and debt D) activity, debt, and profitability
C) liquidity, activity, and debt
A U.S. parent company's foreign retained earnings are not adjusted for currency movements to reflect each year's operating profits or losses.
False
A single key ratio of a firm provides all the information required to judge the overall performance of the firm.
False
Firm ABC had operating profits of $100,000, taxes of $17,000, interest expense of $34,000, and preferred dividends of $5,000. What was the firm's net profit after taxes?
$49,000
Candy Corporation had pretax profits of $1.2 million, an average tax rate of 34 percent, and it paid preferred stock dividends of $50,000. There were 100,000 shares outstanding and no interest expense. What was Candy Corporation's earnings per share?
$7.42
In the DuPont system of analysis, the return on equity is equal to ________.
(return on total assets) × (financial leverage multiplier)
Earnings available for common stockholders is calculated as net profits ________.
After taxes minus preferred dividends
Using the DuPont system of analysis, holding other factors constant, an increase in financial leverage will result in ________.
An increase in the return on equity
Time-series analysis is often used to ________.
Assess developing trends
The ________ ratio may indicate poor collections procedures or a relaxed credit policy.
Average Collection Period
The ________ is a popular approach for evaluating profitability in relation to sales by expressing each item on the income statement as a percent of sales.
Common-size Income Statement
________ analysis involves the comparison of different firms' financial ratios at the same point in time.
Cross-Sectional
Retained earnings on the balance sheet represents the ________.
Cumulative total of all earnings reinvested in the firm
Total assets less net fixed assets equals ________.
Current Assets
A firm has a current ratio of 1; in order to improve its liquidity ratios, this firm might ________.
Decrease current liabilities by utilizing more long-term debt, thereby increasing the current and quick ratios
When preparing the retained earnings statement, ________ is(are) subtracted in order to derive at the ending balance of retained earnings.
Dividends
Net profit after taxes is ________.
EBIT minus interest and taxes
Operating profit is known as ________.
Earnings before interest and taxes
The 2002 Sarbanes-Oxley Act was designed to ________.
Eliminate the many disclosure and conflict-of-interest problems of corporations
A U.S. parent company's foreign equity accounts are translated into dollars using the historical rate or average rate based on the company's discretion.
False
Average age of inventory can be calculated as inventory divided by 365.
False
Average age of inventory can be calculated as inventory turnover divided by 365.
False
Benchmarking is a type of time-series analysis in which the firm's ratio values are compared to those of a key competitor or group of competitors, primarily to isolate areas of opportunity for improvement.
False
Common stock dividends paid to stockholders is equal to the earnings available for common stockholders divided by the number of shares of common stock outstanding.
False
Current ratio provides a firm's ability to meet its long-term obligations.
False
Earnings per share results from dividing earnings available for common stockholders by the number of shares of common stock authorized.
False
GAAP is the accounting profession's rule-setting body.
False
Higher the value of the times interest earned ratio, higher is the proportion of the firm's interest income compared to its contractual interest payments.
False
Market ratios only measure the risk
False
Paid-in capital in excess of par represents a firm's book value received from the original sale of common stock.
False
Profitability ratios capture both risk and return
False
Publicly owned corporations are those which are financed by the proceeds from the treasury securities.
False
The McCain-Feingold Act of 2002 was passed to eliminate many of the disclosure and conflict-of-interest problems of corporations.
False
Time-series analysis is the evaluation of a firm's financial performance in comparison to other firm(s) at the same point in time.
False
________ is a term used to describe the magnification of risk and return introduced through the use of fixed-cost financing, such as preferred stock and debt.
Financial Leverage
Accounting practices and procedures used to prepare financial statements are called ________.
GAAP
A(n) ________ provides a financial summary of a firm's operating results during a specified period.
Income Statement
A firm with a low net profit margin can improve its return on total assets by ________.
Increasing its Total Asset Turnover
A firm with a low return on total assets can improve its return on equity, all else remaining the same, by ________.
Increasing its debt ratio
A firm with a total asset turnover lower than industry standard may have ________.
Insufficient Sales
If the only information you are given about Ryan Corporation, a large public company in business for many years, is that it has a current ratio of 2.9, what could you infer from this?
It can meet the short-term obligations without any difficulty.
A firm's total asset turnover increased from 0.75 to 0.90. Which of the following is true about the given data?
Its assets have been efficiently used to derive the optimum level of sales.
Which of the following is a fixed asset? A) land B) accounts payable C) accruals D) notes payable
Land
The two categories of ratios that should be utilized to assess a firm's true liquidity are the ________.
Liquidity and activity ratios
Which of the following represents a current asset? A) automobiles B) buildings C) marketable securities D) equipment
Marketable Securities
Cross-sectional ratio analysis is used to ________.
Measure relative performance of a firm with its peers
In ratio analysis, a comparison to a standard industry ratio is made to isolate ________ deviations from the norm.
Negative
________ measures the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends, have been deducted.
Net Profit Margin
The three basic ratios used in the DuPont system of analysis are ________.
Net profit margin, total asset turnover, and equity multiplier
Which of the following is a current liability? A) accounts receivable B) cash C) notes payable D) inventory
Notes Payable
A ________ ratio is commonly used to assess owners' appraisal of the share value.
Price/Earnings
The ________ ratios are primarily used as measures of return.
Profitability
The statement of cash flows ________.
Provides insight into a firm's operating, investment, and financing cash flows
The DuPont system merges the income statement and balance sheet into two summary measures of profitability, ________.
Return on total assets, and return on common equity
The analyst should be careful when analyzing ratios that ________.
Right interpretation of the ratio value is made
Present and prospective shareholders are mainly concerned with a firm's ________.
Risk and Return
The federal regulatory body governing the sale and listing of securities is called the ________.
SEC
The 2002 law that established the Public Company Accounting Oversight Board (PCAOB) was called ________.
The Sarbanes-Oxley Act
When assessing the fixed-payment coverage ratio, ________.
The lower its value the more risky is the firm
Information on the accounting policies, procedures, calculations, and transactions underlying entries in the financial statements can be found on ________.
The notes to the financial statements
________ analysis involves comparison of current to past performance and the evaluation of developing trends.
Time-Series
Which of the following is used to analyze a firm's financial performance over different years?
Time-series Analysis
The higher, the value of ________ ratio, the better able a firm is to fulfill its interest obligations.
Times Interest Earned
Creditors are primarily interested in short-term liquidity of the company and its ability to make interest and principal payments.
True
Cross-sectional analysis involves the comparison of different firms' financial ratios at the same point in time.
True
In ratio analysis, the financial statements being used for comparison should be dated at the same point in time during the year. If not, the effect of seasonality may produce erroneous conclusions and decisions.
True
Net fixed assets represent the difference between gross fixed assets and accumulated depreciation of fixed assets.
True
Net profit margin measures the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and common stock dividends, have been deducted.
True
Publicly owned corporations with more than $5 million assets are required by the Securities and Exchange Commission (SEC) and individual state securities commissions to provide their stockholders with an annual stockholders' report.
True
The amount paid in by the original purchasers of common stock is shown by two entries in the firm's balance sheet—common stock and paid-in capital in excess of par on common stock.
True
The basic inputs to an effective financial analysis are a firm's income statement and the balance sheet.
True
The financial leverage multiplier is the ratio of a firm's total assets to common stock equity.
True
The income statement is a financial summary of a firm's operating results during a specified period while the balance sheet is a summary statement of a firm's financial position at a given point in time.
True
The magnification of risk and return introduced through the use of fixed-cost financing, such as debt and preferred stock is called financial leverage.
True
The original price per share received by the firm on a single issue of common stock is equal to the sum of the common stock and paid-in capital in excess of par accounts divided by the number of shares outstanding.
True
The price/earnings (P/E) ratio represents the degree of confidence that investors have in a firm's future performance.
True
The statement of cash flows provides insight into a firm's operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period of concern.
True
The use of differing accounting treatments—especially relative to inventory and depreciation—can distort the results of ratio analysis, regardless of whether cross-sectional or time-series analysis is used.
True
The liquidity of a business firm refers to the solvency of the firm's overall financial position.
True
The two basic measures of liquidity are the debt-to-equity ratio and the asset turnover ratio.
True
Which of the following is true of benchmarking? A) It is an analysis in which a firm's ratio values are analyzed to project the fundamental values of the assets for upcoming years or business cycle. B) It is an analysis in which a firm's ratio values are compared with those of a key competitor or with a group of competitors that it wishes to emulate. C) It is an analysis in which a firm's financial performance over time is evaluated using financial ratio analysis. D) It is a financial statement analysis technique which combines cross-sectional and time-series analyses.
B) It is an analysis in which a firm's ratio values are compared with those of a key competitor or with a group of competitors that it wishes to emulate.
The Public Company Accounting Oversight Board (PCAOB) ________.
Is a not-for-profit corporation that oversees auditors of public corporations
The liquidity of a firm is measured by its ability to satisfy its short term obligations as the are due
False
Inflation can distort ____________.
Book value of inventory costs
FASB Standard No. 52 mandates that U.S.-based companies must translate their foreign-currency-denominated assets and liabilities into dollars using the ________.
Current Rate
The rule-setting body, which authorizes generally accepted accounting principles is the ________.
FASB
The Sarbanes-Oxley Act of 2002 established the Private Company Accounting Oversight Board (PCAOB) which is a for-profit corporation that oversees CEOs of public corporations.
False
Without adjustment, inflation may tend to cause ________ firms to appear more efficient and profitable than ________ firms.
Older;Newer
Ratios merely direct an analyst to potential areas of concern and it does not provide conclusive evidence as to the existence of a problem.
True
Retained earnings represent the cumulative total of all earnings, net of dividends, that have been retained and reinvested in the firm since its inception.
True
The Financial Accounting Standards Board (FASB) Standard No. 52 mandates that U.S.-based companies translate their foreign-currency-denominated assets and liabilities into dollars using the current rate (translation) method.
True
The Sarbanes-Oxley Act of 2002 established the Public Company Accounting Oversight Board (PCAOB) which is a not-for-profit corporation that oversees auditors of public corporations.
True
The Sarbanes-Oxley Act of 2002 was passed to eliminate many of the disclosure and conflict-of-interest problems of corporations.
True
The balance sheet is a statement which balances a firm's assets (what it owns) against its debt (what it owes) or its equity (what is provided by owners).
True
Benchmarking is a type of cross-sectional analysis in which a firm's ratios are compared to a key competitor firm within the same industry, primarily to identify areas for improvement.
True
Due to inflationary effects, inventory costs and depreciation write-offs can differ from their true values, thereby distorting profits.
True
Generally accepted accounting principles are authorized by the Financial Accounting Standards Board (FASB).
True