Question_testbank_12Dec

| August 14, 2017

1. Ratio analysis involves a comparison of the relationships betweenfinancial statement accounts so as to analyze the financial positionand strength of a firm.a. Trueb. False2. The current ratio and inventory turnover ratio measure the liquidity ofa firm. The current ratio measures the relationship of a firm’scurrent assets to its current liabilities and the inventory turnoverratio measures how rapidly a firm turns its inventory back intoa “quick” asset or cash.a. Trueb. False3. If a firm has high current and quick ratios, this is always a goodindication that a firm is managing its liquidity position well.a. Trueb. False4. The inventory turnover ratio and days sales outstanding (DSO) are tworatios that can be used to assess how effectively the firm is managingits assets in consideration of current and projected operating levels.a. Trueb. False5. A decline in the inventory turnover ratio suggests that the firm’sliquidity position is improving.a. Trueb. False6. The degree to which the managers of a firm attempt to magnify thereturns to owners’ capital through the use of financial leverage iscaptured in debt management ratios.a. Trueb. False7. The times-interest-earned ratio is one indication of a firm’s abilityto meet both long-term and short-term obligations.a. Trueb. False8. Profitability ratios show the combined effects of liquidity, assetmanagement, and debt management on operations.a. Trueb. False9. Since ROA measures the firm’s effective utilization of assets (withoutconsidering how these assets are financed), two firms with the sameEBIT must have the same ROA.a. Trueb. False10. Market value ratios provide management with a current assessment of howinvestors in the market view the firm’s past performance and futureprospects.a. Trueb. False11. Determining whether a firm’s financial position is improving ordeteriorating requires analysis of more than one set of financialstatements. Trend analysis is one method of measuring a firm’sperformance over time.a. Trueb. FalseMedium:12. If the current ratio of Firm A is greater than the current ratio ofFirm B, we cannot be sure that the quick ratio of Firm A is greaterthan that of Firm B. However, if the quick ratio of Firm A exceedsthat of Firm B, we can be assured that Firm A’s current ratio alsoexceeds B’s current ratio.a. Trueb. False13. The inventory turnover and current ratios are related. The combinationof a high current ratio and a low inventory turnover ratio relative tothe industry norm might indicate that the firm is maintaining too highan inventory level or that part of the inventory is obsolete or damaged.a. Trueb. False14. We can use the fixed assets turnover ratio to legitimately comparefirms in different industries as long as all the firms being comparedare using the same proportion of fixed assets to total assets.a. Trueb. False15. Suppose two firms have the same amount of assets, pay the same interestrate on their debt, have the same basic earning power (BEP), and havethe same tax rate. However, one firm has a higher debt ratio. If BEPis greater than the interest rate on debt, the firm with the higherdebt ratio will also have a higher rate of return on common equity.a. Trueb. False16. If the equity multiplier is 2.0, the debt ratio must be 0.5.a. Trueb. False17. Suppose a firm wants to maintain a specific TIE ratio. If the firmknows the level of its debt, the interest rate it will pay on thatdebt, and the applicable tax rate, the firm can then calculate theearnings level required to maintain its target TIE ratio.a. Trueb. False18. If sales decrease and financial leverage increases, we can say withcertainty that the profit margin on sales will decrease.a. Trueb. FalseMultiple Choice: Conceptual19. Other things held constant, which of the following will not affect thecurrent ratio, assuming an initial current ratio greater than 1.0?a. Fixed assets are sold for cash.b. Long-term debt is issued to pay off current liabilities.c. Accounts receivable are collected.d. Cash is used to pay off accounts payable.e. A bank loan is obtained, and the proceeds are credited to the firm’schecking account.20. Other things held constant, which of the following will not affect thequick ratio? (Assume that current assets equal current liabilities.)a. Fixed assets are sold for cash.b. Cash is used to purchase inventories.c. Cash is used to pay off accounts payable.d. Accounts receivable are collected.e. Long-term debt is issued to pay off a short-term bank loan.Answer: a21. Company J and Company K each recently reported the same earnings pershare (EPS). Company J’s stock, however, trades at a higher price.Which of the following statements is most correct?a. Company J must have a higher P/E ratio.b. Company J must have a higher market to book ratio.c. Company J must be riskier.d. Company J must have fewer growth opportunities.e. All of the statements above are correct.22. Stennett Corp.’s CFO has proposed that the company issue new debt anduse the proceeds to buy back common stock. Which of the following arelikely to occur if this proposal is adopted? (Assume that the proposalwould have no effect on the company’s operating earnings.)a. Return on assets (ROA) will decline.b. The times interest earned ratio (TIE) will increase.c. Taxes paid will decline.d. None of the statements above is correct.e. Statements a and c are correct.Medium:23. Which of the following statements is most correct?a. If a company increases its current liabilities by $1,000 andb. If a company increases its current liabilities by $1,000 andsimultaneously increases its inventories by $1,000, its currentratio must rise.simultaneously increases its inventories by $1,000, its quick ratiomust fall.c. A company’s quick ratio may never exceed its current ratio.d. Answers b and c are correct.e. None of the answers above is correct.24. Which of the following actions can a firm take to increase its currentratio?a. Issue short-term debt and use the proceeds to buy back long-termb. Reduce the company’s days sales outstanding to the industry averagec. Use cash to purchase additional inventory.d. Statements a and b are correct.e. None of the statements above is correct.debt with a maturity of more than one year.and use the resulting cash savings to purchase plant and equipment.25. Which of the following actions will cause an increase in the quickratio in the short run?a. $1,000 worth of inventory is sold, and an account receivable isb. A small subsidiary which was acquired for $100,000 two years ago andcreated. The receivable exceeds the inventory by the amount ofprofit on the sale, which is added to retained earnings.which was generating profits at the rate of 10 percent is sold for$100,000 cash. (Average company profits are 15 percent of assets.)c. Marketable securities are sold at cost.d. All of the answers above.e. Answers a and b above.26. As a short-term creditor concerned with a company’s ability to meet itsfinancial obligation to you, which one of the following combinations ofratios would you most likely prefer? Current Debt ratio TIE ratioa. 0.5 0.5 0.33b. 1.0 1.0 0.50c. 1.5 1.5 0.50d. 2.0 1.0 0.67e. 2.5 0.5 0.7127. Which of the following statements is most correct?a. If two firms pay the same interest rate on their debt and have theb. One of the problems of ratio analysis is that the relationships arec. Generally, firms with high profit margins have high asset turnoversame rate of return on assets, and if that ROA is positive, the firmwith the higher debt ratio will also have a higher rate of return oncommon equity.subject to manipulation. For example, we know that if we use someof our cash to pay off some of our current liabilities, the currentratio will always increase, especially if the current ratio is weakinitially.ratios, and firms with low profit margins have low turnover ratios;this result is exactly as predicted by the extended Du Pont equation.d. All of the statements above are correct.e. None of the statements above is correct.28. Which of the following statements is most correct?a. An increase in a firm’s debt ratio, with no changes in its sales andb. An increase in the DSO, other things held constant, would generallyoperating costs, could be expected to lower its profit margin onsales.lead to an increase in the total asset turnover ratio.c. An increase in the DSO, other things held constant, would generallyd. In a competitive economy, where all firms earn similar returns one. It is more important to adjust the Debt/Assets ratio than thelead to an increase in the ROE.equity, one would expect to find lower profit margins for airlines,which require a lot of fixed assets relative to sales, than forfresh fish markets.inventory turnover ratio to account for seasonal fluctuations.29. Company A is financed with 90 percent debt, whereas Company B, whichhas the same amount of total assets, is financed entirely with equity.Both companies have a marginal tax rate of 35 percent. Which of thefollowing statements is most correct?a. If the two companies have the same basic earning power (BEP),b. If the two companies have the same return on assets, Company B willc. If the two companies have the same level of sales and basic earningd. All of the answers above are correct.e. None of the answers above is correct.Company B will have a higher return on assets.have a higher return on equity.power (BEP), Company B will have a lower profit margin.30. A firm is considering actions which will raise its debt ratio. It isanticipated that these actions will have no effect on sales, operatingincome, or on the firm’s total assets. If the firm does increase itsdebt ratio, which of the following will occur?a. Return on assets will increase.b. Basic earning power will decrease.c. Times interest earned will increase.d. Profit margin will decrease.e. Total assets turnover will increase.31. Reeves Corporation forecasts that its operating income (EBIT) and totalassets will remain the same as last year, but that the company’s debtratio will increase this year. What can you conclude about thecompany’s financial ratios? (Assume that there will be no change inthe company’s tax rate.)a. The company’s basic earning power (BEP) will fall.b. The company’s return on assets (ROA) will fall.c. The company’s equity multiplier (EM) will increase.d. All of the answers above are correct.e. Answers b and c are correct.32. Which of the following statements is most correct?a. If two companies have the same return on equity, they should haveb. If Company A has a higher profit margin and higher total assetsthe same stock price.turnover relative to Company B, then Company A must have a higherreturn on assets.the same times interest earned (TIE) ratio.c. If Company A and Company B have the same debt ratio, they must haved. Answers b and c are correct.e. None of the answers above is correct.33. Which of the following statements is most correct?a. If a firm’s ROE and ROA are the same, this implies that the firm isfinanced entirely with common equity. (That is, common equity =total assets).b. If a firm has no lease payments or sinking fund payments, its times-interest-earned (TIE) ratio and fixed charge coverage ratios must bec. If Firm A has a higher market to book ratio than Firm B, then Firm Ad. All of the statements above are correct.e. Answers a and b are correct.the same.must also have a higher price earnings ratio (P/E).34. Which of the following statements is most correct?a. If Firms A and B have the same level of earnings per share, and theb. Firms A and B have the same level of net income, taxes paid, andc. Firms A and B have the same level of net income. If Firm A has asame market to book ratio, they must have the same price earningsratio.total assets. If Firm A has a higher interest expense, its basicearnings power ratio (BEP) must be greater than that of Firm B.higher interest expense, its return on equity (ROE) must be greaterthan that of Firm B.d. All of the answers above are correct.e. None of the answers above is correct.Tough:35. Which of the following statements is most correct?a. If Company A has a higher debt ratio than Company B, then we can beb. Suppose two companies have identical operations in terms of sales,c. The ROE of any company which is earning positive profits and whichsure that A will have a lower times-interest-earned ratio than B.cost of goods sold, interest rate on debt, and assets. However,Company A uses more debt than Company B; that is, Company A has ahigher debt ratio. Under these conditions, we would expect B’sprofit margin to be higher than A’s.has a positive net worth (or common equity) must exceed thecompany’s ROA.d. Statements a, b, and c are true.e. Statements a, b, and c are false.36. You are an analyst following two companies, Company X and Company Y.You have collected the following information:• The two companies have the same total assets.• Company X has a higher total assets turnover than Company Y.• Company X has a higher profit margin than Company Y.• Company Y has a higher inventory turnover ratio than Company X.• Company Y has a higher current ratio than Company X.Which of the following statements is most correct?a. Company X must have a higher net income.b. Company X must have a higher ROE.c. Company Y must have a higher quick ratio.d. Statements a and b are correct.e. Statements a and c are correct.37. You have collected the following information regarding Companies C andD:• The two companies have the same total assets.• The two companies have the same operating income (EBIT).• The two companies have the same tax rate.• Company C has a higher debt ratio and a higher interest expense than• Company C has a lower profit margin than Company D.Based on this information, which of the following statements is mostcorrect?a. Company C must have a higher level of sales.b. Company C must have a lower ROE.c. Company C must have a higher times-interest-earned (TIE) ratio.Company D.d. Company C must have a lower ROA.e. Company C must have a higher basic earning power (BEP) ratio.38. Blair Company has $5 million in total assets. The company’s assets arefinanced with $1 million of debt, and $4 million of common equity. Thecompany’s income statement is summarized below:The company wants to increase its assets by $1 million, and it plans tofinance this increase by issuing $1 million in new debt. This actionwill double the company’s interest expense, but its operating incomewill remain at 20 percent of its total assets, and its average tax ratewill remain at 40 percent. If the company takes this action, which ofthe following will occur:a. The company’s net income will increase.b. The company’s return on assets will fall.c. The company’s return on equity will remain the same.d. Statements a and b are correct.e. All of the answers above are correct.Multiple Choice: Problems39. Russell Securities has $100 million in total assets and its corporatetax rate is 40 percent. The company recently reported that its basicearning power (BEP) ratio was 15 percent and that its return on assets(ROA) was 9 percent. What was the company’s interest expense?a. $ 0b. $ 2,000,000c. $ 6,000,000d. $15,000,000e. $18,000,00040. A firm has a profit margin of 15 percent on sales of $20,000,000. Ifthe firm has debt of $7,500,000, total assets of $22,500,000, and anafter-tax interest cost on total debt of 5 percent, what is the firm’sROA?a. 8.4%b. 10.9%c. 12.0%d. 13.3%e. 15.1%

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