Chapter 04: Analyzing Financial Statements

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managers, shareholders, and creditors.

The three different perspectives on financial statement analysis are those of the:

determine the total cash dividend distribution they are likely to receive.

Shareholders analyze financial statements in order to:

determine the likelihood that the firm will have sufficient cash to pay their interest and principal at maturity.

Bondholders primarily analyze financial statements to:

ability to meet its short-term obligations.

The creditors of a firm analyze financial statements so that they can better understand the firm's:

get feedback on their investing, financing, and working capital decisions by identifying trends in the various accounts that are reported in the financial statements, and focus on profitability, dividend, capital appreciation, and return on investment.

A firm's management analyzes financial statements so that they can:

use audited financial statements.

Anyone analyzing a firm's financial statements should:

use unaudited financial statements.

An individual analyzing a firm's financial statements should do all of the following except:

The relative ratios of the major competitors

Which of the following would be unrelated to analyzing a firm's trend over time?

Why a firm's cash flows are increasing or decreasing

Which of the following can financial statement analysis help to determine?

Analyzing financial data for changes in a firm's performance over time

Which of the following best describes trend analysis?

Share value and expected cash from dividends

Stockholders' primary concern includes the firm's

Creditor's perspective

Which perspective is most concerned with ensuring the company has enough liquidity to pay off its short-term and long-term obligations?

Financing, investment, and working capital

Financial statements reflect managers' decisions in which of the following areas?

Changes in financial statement figures over several periods

When performing trend analysis, what is typically analyzed?

Each asset and liability item on the balance sheet is standardized by dividing it by sales.

Which of the following is NOT true of common-size balance sheets?

Each income statement item is standardized by dividing it by total assets.

Which of the following is NOT true of common-size income statements?

are prepared by having each financial statement item expressed as a percentage of some base number, such as total assets or total revenues.

Common-size financial statements:

It can tell the analyst a great deal about a firm's efficiency and profitability.

Which of the following is the best advantage of a common-size income statement?

It is very useful to assess how effectively a firm collected its accounts receivable.

Which of the following is the best advantage of a common-size balance sheet?

Net sales

In a common-size income statement, cost of goods sold is typically expressed as a percentage of:

Total assets

In a common-size balance sheet, long-term debt is expressed as a percentage of:

Total assets

A balance sheet can be standardized by expressing each asset and liability as a percentage of:

Property, Plant, and Equipment makes up 52% of the firm's total assets

If "Property, Plant, and Equipment" is listed as 52% on a common-size balance sheet, what does this percentage represent?

A firm's creditors' primary concern is the ability of the firm to repay their loans with interest on a timely manner. They analyze the firm's financial statements to gauge the ability of the firm to generate sufficient cash flows to meet not only the legal financial obligations, but also the creditors' debt obligations. Shareholders, on the other hand, want to know how much cash they can expect to receive for their stocks, what their return on investment will be, and/or how much their stock is worth in the market.

Compare how a firm's creditor would analyze a firm's financial statements with a firm's shareholders' analysis.

A ratio is computed by dividing one balance sheet item or income statement item by another.

Which of the following is true of ratio analysis?

Offer price reductions that would enable the firm to sell some of its inventory.

Which of the following actions would increase a firm's quick ratio?

Borrow using short-term notes payable and use part of the proceeds to reduce long-term debt.

A company's current ratio is 2.0. Which of the following actions would lower the company's current ratio, assuming everything else remains the same?

For manufacturing firms, quick ratios will tend to be much higher than current ratios.

Which of the following is NOT true of liquidity ratios?

Inventory, not being very liquid, is subtracted from total current assets to determine the most liquid assets for a quick ratio calculation.

Which of the following is TRUE about the quick ratio?

The firm collects its accounts receivables.

Which of the following does NOT change a firm's current ratio?

An increase in accounts payable

All else being equal, which of the following will decrease a firm's current ratio?

It is calculated by dividing inventory by cost of goods sold.

Which of the following is NOT true about the inventory turnover ratio?

The more days that it takes a firm to collect its receivables, the more efficient the firm is.

Which one of the following statements is NOT true?

The fixed assets turnover ratio is less significant for equipment-intensive manufacturing industry firms than the total assets turnover ratio.

Which of the following statements is NOT true of the asset turnover ratio?

The lower the level of a firm's debt, the lower the firm's equity multiplier.

Which of the following statements is correct?

firm B has a lower equity multiplier than firm A.

If firm A has a higher debt-to-equity ratio than firm B, then:

Current ratio

Which of the following is an example of a liquidity ratio?

Inventory turnover ratio

Which of the following is an example of an efficiency ratio?

How much debt the firm has and its ability to cover its long-term obligations

Leverage ratios are used to assess:

The firm is better able to meet its short-term obligations

An increase in the firm's current ratio from 1.4 to 1.6 indicates that:

Increasing cash reserves while decreasing accounts payable

Which of the following strategies would improve a company's liquidity?

Increasing the debt-to-equity ratio

Which of the following is most likely to increase a firm's equity multiplier?

The quick ratio would decrease

How would a firm's quick ratio be affected if it finances additional inventory through accounts payable?

The efficiency of converting assets into revenue

Asset turnover ratios help managers assess:

The firm is taking longer to collect cash from credit sales

If a firm's days' sales outstanding (DSO) increases from 35 days to 43 days, this suggests:

Manufacturing firm with significant investments in equipment

For which type of firm is the fixed asset turnover ratio more significant?

The use of debt to magnify returns to equity holders

Which of the following best describes financial leverage?

The company is using more debt in its capital structure

If a company's equity multiplier increases, it typically indicates:

The firm has a greater ability to meet its interest payment obligations

What does a higher times interest earned (TIE) ratio indicate for a firm?

The P/E ratio increases

What happens to a firm's price-to-earnings (P/E) ratio if its earnings per share (EPS) decreases but its stock price does not change?

creditors to assess how well the firm will meet its interest obligations.

Coverage ratios, like times interest earned and cash coverage ratio, allow a firm's:

1.01

Lionel, Inc., has total current assets of $623,122, including inventory of $241,990, and total current liabilities of $378,454. What is the quick ratio? Round your final answer to two decimal places.

1.83

Bathez Corp. has receivables of $334,227, inventory of $451,000, cash of $73,913, and accounts payables of $469,553. What is the firm's current ratio? Round your final answer to two decimal places.

1.20

Zidane Enterprises has a current ratio of 1.92, current liabilities of $272,934, and inventory of $197,333. What is the firm's quick ratio? Round your final answer to two decimal places.

$777,777

The firm's current ratio now is 2.1. The firm plans to acquire additional inventory to meet a surge in the demand for its products and will pay for the inventory with short-term debt. How much inventory can the firm purchase without violating its debt agreement, to maintain current ratio of 1.75 if their total current assets equal $3.5 million? Round your final answer to the nearest dollar.

Borrow long-term debts to reduce accounts payable

A company's current ratio is 0.5. Everything else held constant, which of the following actions would increase the company's current ratio?

$288,000

Pedro & Co. has $720,000 of assets and is all-equity financed. The new CFO wants to use enough debt to raise the total debt to total capital ratio to 40 percent, using the proceeds from borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?

2.95 times

If Randolph Corp. has accounts receivables of $654,803 and net sales of $1,932,349, what is its accounts receivable turnover? Round your final answer to two decimal places.

$881,234

If Viera, Inc., has an accounts receivable turnover of 3.9 times and net sales of $3,436,812, what is its level of accounts receivables? Round your final answer to the nearest dollar.

65 days

Gateway Corp. has an inventory turnover ratio of 5.6. What are its days' sales in inventory? Round your final answer to nearest day.

$298.08

Viera Industries has net sales of $200,000, accounts receivable of $18,500, and gives its customers 25 days to pay. The industry average DSO is 27 days based on a 365-day year. If the company changes its credit and collection policy sufficiently to cause its DSO to change to the industry average, and if it earns 8.0 percent on any cash freed-up by this change, how would that affect its net income assuming other things are held constant?

51.49%

An all-equity new firm is developing its business plan. It has $615,000 of common equity and it projects $450,000 of sales and $355,000 of operating costs for the first year. Management is reasonably sure of these numbers because of contracts with its customers and suppliers. It can borrow at a rate of 7.5 percent, but the bank requires it to have a TIE of at least 4.0. The firm will use debt and common equity for financing. What is the maximum debt to capital ratio (measured as debt/total common equity) the firm can use? (Hint: Find the maximum dollars of interest, then the debt that produces that interest, and then the related debt to capital ratio.)

$223,750

Water Inc.'s net sales last year were $315,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio of 2.4. The firm's new CFO believes the firm has excess assets that can be sold so as to bring the total assets turnover ratio down to the industry average without affecting sales. By how much will the assets need to be reduced to bring the total assets turnover ratio to the industry average, holding sales constant?

9.45%

Chang Corp. has $375,000 of assets, and it uses only common equity capital (zero debt). Its sales for the last year were $595,000, and its net income was $25,000. Stockholders recently voted in a new management team that has promised to lower costs and raise the return on equity to 15.0 percent. What profit margin would the firm need in order to achieve the 15 percent ROE, holding everything else constant?

4.26 times; 86 days

Jet, Inc., has net sales of $712,478 and accounts receivable of $167,435. What are the firm's accounts receivable turnover and days' sales outstanding? Round your accounts receivable turnover to two decimal places and days' sales outstanding to nearest day.

$2,074,557

Ellicott City Manufacturers, Inc., has sales of $6,344,210, and a gross profit margin of 67.3 percent. What is the firm's cost of goods sold? Round your final answer to the nearest dollar.

-$373,816.23

Deutsche Bearings has total sales of $9,745,923, inventories of $2,237,435, cash and equivalents of $755,071, and days' sales outstanding of 49 days. If the firm's management wanted its days' sales outstanding (DSO) to be 35 days, by how much will the accounts receivable have to change? Round your final answer to two decimal places.

12 times

Trident Corp., has debt of $3,350,000 with an interest rate of 6.875 percent. The company has an EBIT of $2,766,009. What is its times interest earned ratio? Round your final answer to nearest number.

14.15 times

Sectors, Inc., has EBIT of $7,221,643 and interest expense of $611,800. Its depreciation for the year is $1,434,500. What is its cash coverage ratio? Round your final answer to two decimal places.

13.8 times; 19.4 times

Fahr Company has depreciation expenses of $630,715, interest expenses of $112,078, and an EBIT of $1,542,833. What are the times interest earned and cash coverage ratios for this company? Round your final answers to one decimal place.

1.47

Your firm has an equity multiplier of 2.47. What is its debt-to-equity ratio? Round your final answer to two decimal places.

1.82

What will be a firm's equity multiplier given a debt ratio of 0.45? Round your final answer to two decimal places.

2.31; 1.31, respectively

Dreisen Traders has total debt of $1,233,837 and total assets of $2,178,990. What are the firm's equity multiplier and debt-to-equity ratio? Round your final answers to two decimal places.

5.17 times

RTR Corp. has reported a net income of $812,425 for the year. The company's share price is $13.45, and the company has 312,490 shares outstanding. Compute the firm's price-earnings ratio. Round your final answer to two decimal places.

$34.05

Perez Electronics Corp. has reported that its net income for the year is $1,276,351. The firm has 420,000 shares outstanding and a PE ratio of 11.2 times. What is the firm's share price? Round your intermediate and final answer to two decimal places.

27.4%

Juventus Corp. has total assets of $4,744,288, total debt of $2,912,000, and net sales of $7,212,465. Their net profit margin for the year is 18 percent. What is Juventus's return on assets (ROA)? Round intermediate calculations to nearest dollar and percentage answer to one decimal place.

3.72%; 1.90

GenTech Pharma has reported the following information: Sales/Total assets = 2.89; ROA = 10.74% ROE = 20.36% What are the firm's profit margin and equity multiplier? Round your profit margin answer to one decimal place, and equity multiplier answer to two decimal places.

34.7%; 32.6%, respectively

Tigger Corp. has reported the financial results for the year. Based on the information given, calculate the firm's gross profit margin and operating profit margin. Round your final answers to one decimal place. Net sales = $4,156,700 Cost of goods sold = $2,715,334 Net income = $778,321 EBIT $1,356,098

34.7%

Andrade Corp. has debt of $2,834,950, total assets of $5,178,235, sales of $8,234,121, and net income of $812,355. What is the firm's return on equity? Round your final answer to one decimal place.

It leaves out the least liquid current asset from the numerator of the ratio.

Why is the quick ratio considered by some to be a better measure of liquidity than the current ratio?

13.1%

In the latest year, Photon, Inc. reported $276,000 in net income. The firm maintains a debt ratio of 30 percent and has total assets of $3,000,000. What is Photon's return on equity? (Round your percentage answer to one decimal place.)

ROA and ROE will be equal

For a company without any debt, what is true about its return on assets (ROA) and return on equity (ROE)?

A leveraged firm is less risky than a firm that has no leverage.

Which one of the following statements is NOT correct?

The profit generated from the shareholders' equity

Return on Equity (ROE) measures:

ROE will increase

If a firm's equity decreases while maintaining the same level of after-tax income, how will this affect ROE?

It increases the firm's ROE but adds more risk

According to the DuPont system, what does an increase in financial leverage typically do to a firm's ROE?

It increases the firm's ROE but adds more risk

What effect does an increase in financial leverage have on a firm's ROE, according to the DuPont system?

Net profit margin, total asset turnover, and equity multiplier

The DuPont equation reveals the relationship between ROE and which of the following elements?

Higher leverage from using more debt

Which factor would most likely cause a firm's ROE to be higher than its ROA?

17.28%

Pedro & Son's total common equity at the end of last year was $405,000 and its net income was $70,000. What was its ROE?

Its return on equity (ROE) will be equal to its return on asset (ROA).

Which of the following is true of a firm that has no debt in its capital structure?

Its return on equity (ROE) will be greater than its return on asset (ROA).

Which of the following is true of a firm that has both debt and equity?

The DuPont system includes the current ratio.

Which one of the following statements is NOT correct?

net profit margin, total asset turnover, and the equity multiplier.

The DuPont equation shows that a firm's return on equity (ROE) is determined by three factors:

ROE ignores the size of the initial investment as well as future cash flows.

Which of the following is a criticism of a policy of maximizing the firm's return on equity (ROE)?

ROE does not consider risk.

Which one of the following is NOT an advantage of using return on equity (ROE) as a goal?

13.42%

Last year Viera Corp had $155,000 of assets, $305,000 of sales, $20,000 of net income, and a debt to total capital ratio of 37.5 percent. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $33,000. Assets, total invested capital, sales, and the debt to capital ratio would not be affected. By how much would the cost reduction improve the ROE?

13.8%

Last year Gray Corp. had net sales of $325,000 and a net income of $19,000, and its year-end assets were $250,000. The firm's total debt to total-capital ratio was 45.0 percent. The firm uses only debt and common equity as financing. Based on the DuPont equation, what was the ROE?

2.59%

Covent Gardens Inc. is considering two financial plans for the coming year. Management expects sales to be $300,000, operating costs to be $265,000, assets to be $200,000, and its tax rate to be 35 percent. Under Plan A it would use 25 percent debt and 75 percent common equity. The interest rate on the debt would be 8.8 percent, but under a contract with existing bondholders the times interest earned (TIE) ratio would have to be maintained at or above 4.5. Under Plan B, the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure?

$75,281.25

Saunders, Inc., has a ROE of 18.7 percent, an equity multiplier of 2.53 times, sales of $2.75 million, and a total assets turnover of 2.7 times. What is the firm's net income? Round your final answer to two decimal places.