FAR 3

PLEASE ANSWER THE FOLLOWING: THEORIES 1PT. PROBLEMS 2PTS.

1. When a balance sheet amount is related to an income statement amount in computing a

ratio,
a. The income statement amount should be converted to an average for the year.
b. Comparisons with industry ratios are not meaningful.
c. The balance sheet amount should be converted to an average for the year.
d. The ratio loses its historical perspective because a beginning-of-the-year amount is
combined with an end-of-the-year amount.

2. How are financial ratios used in decision making?

a. They can help identify the reasons for success and failure in business, but decision
making requires information beyond the ratios.
b. They remove the uncertainty of the business environment.
c. They aren’t useful because decision making is too complex.
d. They give clear signals about the appropriate action to take.

3. A useful tool in financial statement analysis is the common-size financial statement.

What does this tool enable the financial analyst to do?
a. Evaluate financial statements of companies within a given industry of approximately the
same value.
b. Determine which companies in the same industry are at approximately the same stage of
development.
c. Compare the mix of assets, liabilities, capital, revenue, and expenses within a
company over time or between companies within a given industry without respect
to relative size.
d. Ascertain the relative potential of companies of similar size in different industries.
4. Which of the following is not revealed on a common size balance sheet?
a. The debt structure of a firm.
b. The capital structure of a firm.
c. The peso amount of assets and liabilities.
d. The distribution of assets in which funds are invested.

5. If a transaction causes total liabilities to decrease but does not affect the owners’ equity,
what change if any, will occur in total assets?
a. Assets will be increased. c. No change in total assets.
b. Assets will be decreased. d. None of the above.

6. Last year, a business had no long-term investments; this year long term investments
amount to P100,000. In a horizontal analysis the change in long-term investments
should be expressed as
a. An absolute value of P100,000, and an increase of 100%
b. An absolute value of P100,000 and an increase of 1,000%
c. An absolute value of P100,000 and no value for a percentage change
 d. No change in any terms because there was no investment in the previous year.

7. In a set of comparative financial statements, you observed a gradual decline in the net of
gross ratio, i.e., between net sales and gross sales. This indicates that:
a. There is a stiffening in the grant of discounts to the customers.
b. The discount period is being lengthened.
c. There is adherence to the collection policies of the company.
d. Sales volume is decreasing.

8. Which of these ratios are measures of a company’s profitability?

1. Earnings per share 5. Return on assets
2. Current ratio 6. Inventory turnover
3. Return on sales 7. Receivables turnover
4. Debt-equity ratio 8. Price-earnings ratio
a. All eight ratios. c. 1, 3, 5, 6, 7, and 8 only.
b. 1, 3, 5, and 8 only. d. 1, 3, and 5 only

9. Which ratio is most helpful in appraising the liquidity of current assets?

a. Current ratio. c. Debt ratio.
b. Acid-test ratio. d. Accounts receivable turnover.

10. Which one of the following ratios would provide a best measure of liquidity?
A. Sales minus returns to total debt.
B. Total assets minus goodwill to total equity.
C. Current assets minus inventories to current liabilities.
D. Net profit minus dividends to interest expense.

11. North Bank is analyzing Belle Corp.’s financial statements for a possible extension of
credit. Belle’s quick ratio is significantly better than the industry average. Which of the
following factors should North consider as possible limitation of using this ratio when
evaluating Belle’s creditworthiness?
a. Fluctuating market prices of short-term investments may adversely affect the ratio.
b. Increasing market prices for Belle’s inventory may adversely affect the ratio.
c. Belle may need to sell its available-for-sale investments to meet its current obligations.
d. Belle may need to liquidate its inventory to meet its long-term obligations.

12. The ratio of analytical measurements which measures the productivity of assets
regardless of capital structure is
a. Current ratio. c. Quick (acid test) ratio.
b. Debt ratio. d. Return on total assets.

13. How are the following used in the calculation of the dividend-pay-out ratio for a
company with only common stock outstanding?
a. b. c. d.
Dividends per share Denominator Denominator Numerator Numerator
 Earnings per share Numerator Not used Denominator Not used
Book value per share Not used Numerator Not used Denominator

14. An investor has been given several financial ratios for an enterprise but none of the
financial reports. Which combination of ratios can be used to derive return on equity?
A. Market-to-book-value ratio and total-debt-to-total-assets ratio.
B. Price-to-earnings ratio, earnings per share, and net profit margin.
C. Price-to-earnings ratio and return-on-assets ratio.
D. Net profit margin, total assets turnover, and equity multiplier.

15. Which of the following actions will increase a company’s quick ratio?
a. Reduce inventories and use the proceeds to reduce long-term debt.
b. Reduce inventories and use the proceeds to reduce current liabilities.
c. Issue short-term debt and use the proceeds to purchase inventory.
d. Issue long-term debt and use the proceeds to purchase fixed assets.
e. Issue equity and use the proceeds to purchase inventory.

16. On December 31, 1991, Northpark Co. collected a receivable due from a major
customer. Which of the following ratios would be increased by this transaction?
a. Inventory turnover ratio. c. Current ratio.
b. Receivable turnover ratio. d. Quick ratio.

17. Jack & Sons, Inc. has a 2 to 1 acid test (quick) ratio. This ratio would decrease to less
than 2 to 1 if the company
a. Purchased inventory on open account.
b. Sold merchandise on open account that earned a normal gross margin.
c. Collected an account receivable.
d. Paid an account payable.

18. The ratio that measures a firm's ability to generate earnings from its resources is
A. Days' sales in inventory. C. Days' sales in receivables.
B. Sales to working capital. D. Asset turnover.

19. In comparing the current ratios of two companies, why is it invalid to assume that the
company with the higher current ratio is the better company? a. The current ratio
includes assets other than cash.
b. A high current ratio may indicate inadequate inventory on hand.
c. A high current ratio may indicate inefficient use of various assets and liabilities.
d. The two companies may define working capital in different terms.

20. Mabuhay Corp. has current assets of P180,000 and current liabilities of P360,000.
Which of the following transactions would improve Mabuhay’s current ratio?
a. Refinancing a P60,000 long-term mortgage with a short-term note.
 b. Collecting P20,000 of short-term accounts receivable.
c. Purchasing P100,000 of merchandise inventory with a short-term accounts payable.
d. Paying P40,000 of short-term accounts payable.

PROBLEMS.

1. The net sales of Grand Manufacturing Co. in 1990 is total, P580,600. The cost of goods
manufactured is P480,000. The beginning inventories of goods in process and finished
goods are P82,000 and P65,000, respectively. The ending inventories are, goods in process,
P75,000, finished goods, P55,000. The selling expenses is 5%, general and administrative
expenses 2.5% of cost of sales, respectively. The net profit in the year 1990 is
a. P90,000 b. P45,725 c. P53,850 d. P83,000

2. In 19x5, MPX Corporation’s net income was P800,000 and in 19x6 it was P200,000. What
percentage increase in net income must MPX achieve in 19x7 to offset the 19x6 decline in
net income?
a. 60% b. 600% c. 400% d. 300%

3. Barr Co. has total debt of $420,000 and shareholders’ equity of $700,000. Barr is seeking
capital to fund an expansion. Barr is planning to issue an additional $300,000
in common stock, and is negotiating with a bank to borrow additional funds. The bank is
requiring a debt-to-equity rate of 0.75. What is the maximum additional amount Barr will be
able to borrow?
A. $225,000 B. $330,000 C. $525,000 D. $750,000

4. Perry Technologies Inc. had the following financial information for the past year:
Sales $860,000 Inventory turnover 8x
Quick ratio 1.5 Current ratio 1.75
What were Perry’s current liabilities?

a. $430,000 b. $500,000 c. $107,500 d. $ 61,429

5. A service company's working capital at the beginning of January of the current year was
$70,000. The following transactions occurred during January:
Performed services on account $30,000
Purchased supplies on account 5,000
Consumed supplies 4,000
Purchased office equipment for cash 2,000
Paid short-term bank loan 6,500
Paid salaries 10,000
Accrued salaries 3,500
What is the amount of working capital at the end of January?
A. $90,000 B. $80,500 C. $50,500 D. $47,500
6. The working capital of Regalado Co. is P600,000 and its current ratio is 3 to 1. The amount
of current assets is
a. P900,000 b. P1,200,000 c. P600,000 d. P1,800,000

7. Blasso Co.’s net accounts receivable were $500,000 at December 31, 2000 and $600,000 at
December 31, 2001. Net cash sales for 2001 were $200,000. The accounts receivable
turnover for 2001 was 5.0. What were Blasso’s total net sales for 2001?

a. $2,950,000 b. $3,000,000 c. $3,200,000 d. $5,500,000

8. During 1989, Rand Co. purchased $960,000 of inventory. The cost of goods sold for 1989
was $900,000, and the ending inventory at December 31, 1989 was $180,000.
What was the inventory turnover for 1989?

a. 6.4 b. 6.0 c. 5.3 d. 5.0

9. Last year's asset turnover ratio for Wuerffel Airlines was 2.5. This year, sales increased by
20% and average total assets increased by 10%. What is the new asset turnover ratio?
A. 2.50 B. 2.59 C. 2.73 D. 3.00

10. The following information pertains to AL Corporation as of and for the year-ended
December 31, 19x7.
Liabilities P 60,000
Stockholders’ equity P 500,000
Shares of common stock issued and outstanding 10,000
Net income P 30,000
During 1997, AL officers exercised stock options for 1,000 shares of stock at an option price
of P8 per share. What was the effect of exercising the stock option?

a. No ratios were affected. c. Debt to equity ratio decreased to 12%.

b. Asset turnover increased to 50.4% d. Earnings per share increased by P0.33

11. Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10
percent annually on its bank loan. Alumbat’s annual sales are $3,200,000, its average tax rate
is 40 percent, and its net profit margin on sales is 6 percent. If the company does not
maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy
will result. What is Alumbat’s current TIE ratio?
a. 2.4 b. 3.4 c. 3.6 d. 5.0

12. OTW Corporation has current assets totaling P15 million and a current ratio of 2.5 to 1.
What is OTW’s current ratio immediately after it has paid P2million of its accounts payable?
a. 3.75 to 1 b. 2.75 to 1 c. 3.25 to 1 d. 4.75 to 1
13. What would be a company’s “times interest earned ratio” if interest paid on loans amount to
P9,000 and its net income after income tax is P99,000. (Assume a 25% income tax rate on
first P100,000 of income and 35% income tax rate on income in excess of
P100,000.)

a. 10 times b. 12 times c. 13 times d. 16.21 times

14. The average stockholders equity for ABC Company for 2000 was P2,000,000. Included in
this figure is P200,000 par value of 8% preferred stock, which remained unchanged during
the year. The return on common shareholders’ equity was 12.5% during the 2000. How
much was the net income of the company in 2000?
a. P234,000 b. P241,000 c. P250,000 d. P225,000

15. Planners have determined that sales will increase by 25% next year, and that the profit
margin will remain at 15% of sales. Which of the following statements is correct?
A. Profit will grow by 25%.
B. The profit margin will grow by 15%.
C. Profit will grow proportionately faster than sales.
D. Ten percent of the increase in sales will become net income.

16. Given the following information, calculate the market price per share of WAM Inc.
Net income = $200,000 Earnings per share = $2.00
Stockholders’ equity = $2,000,000 Market/Book ratio = 0.20

a. $20.00 b. $ 8.00 c. $ 4.00 d. $ 2.00

17. Associated Co. paid out one-half of its 1994 earnings by dividends. Its earnings increased by
20% and the amounts of its dividends increased by 15% in 1995.
Associated’s dividend payout ratio for 1995 was

a. 51.5% b. 52.3% c. 75.0% d. 47.9%

18. Earnings per share amount to P10 and the price earnings ratio is 5. If the dividend yield is
8%,
a. Market price of the stock must be P40.
b. Market value of the stock cannot be determined.
c. The amount of dividend cannot be determined.
d. The dividend is P4 per share.

19. Victoria Enterprises has $1.6 million of accounts receivable on its balance sheet. The company’s DSO is 40 (based on a 360-day year), its
current assets are $2.5 million, and its current ratio is 1.5. The company plans to reduce its DSO from 40 to the industry average
of 30 without causing a decline in sales. The resulting decrease in accounts receivable will free up cash that will be used to
reduce current liabilities. If the company succeeds in its plan, what will Victoria’s new current ratio be?

a. 1.50 b. 1.97 c. 0.72 d. 1.66

20. Ehrenburg Co. had net income of $5.3 million and earnings per share of common stock of
$2.50. Included in the net income was $500,000 of bond interest expense related to its long-
term debt. The income tax rate was 50%. Dividends on preferred stock were $300,000. The
 dividend payout ratio on common stock was 40%. What were the dividends on common
stock?
a. $1,800,000 b. $1,900,000 c. $2,000,000 d. $2,120,000

21. Taft Technologies has the following relationships:

Annual sales $1,200,000 Inventory turnover ratio 4.8
Current liabilities $ 375,000 Current ratio 1.2
Days sales outstanding 40 (360-day year)
(DSO)
The company’s current assets consist of cash, inventories, and accounts receivable.
How much cash does Taft have on its balance sheet?

a. -$ 8,333 b. $ 66,667 c. $125,000 d. $200,000

22. JC Goods, Inc. has a total assets turnover of 0.30 and a profit margin of 10%. The president
is unhappy with the current return on assets, and he thinks it could be doubled. This could
be accomplished (1) by increasing the profit margin to 15% and (2) by increasing total assets
turnover. What new asset turnover ratio, along with the 15% profit margin, is required to
double the return on assets?
a. 35% b. 45% c. 40% d. 50%

23. Rainier Inc. has $2 million in current assets, its current ratio is 1.6, and its quick ratio is 1.2.
The company plans to raise funds as additional notes payable and to use these funds to
increase inventory. By how much can Rainier’s short-term debt (notes payable) increase
without pushing its quick ratio below 0.8?
a. $625,000 b. $556,000 c. $333,000 d. $278,000

24. Shepherd Enterprises has an ROE of 15 percent, a debt ratio of 40 percent, and a profit
margin of 5 percent. The company’s total assets equal $800 million. What are the company’s
sales? (Assume that the company has no preferred stock.)
a. $1,440,000,000 b. $2,400,000,000 c. $ 360,000,000 d. $ 960,000,000

25. A fire has destroyed many of the financial records of R. Son & Co. You are assigned to put
together a financial report. You have found the return on equity to be 12% and the debt ratio
was 0.40. What was the return on assets?
a. 5.35% b. 8.40% c. 6.60% d. 7.20%

26. The following were reflected from the records of War Freak Company:
Earnings before interest and taxes P1,250,000

Interest expense 250,000

Preferred dividends 200,000
 Payout ratio 40%
Shares outstanding throughout 2003

Preferred 20,000
Common 35,000
Income tax ratio 40%
Price earnings ratio The 5 times
dividend yield ratio is:

A. 0.50 B. 0.40 C. 0.12 D. 0.08

27. Selzer Inc. sells all its merchandise on credit. It has a profit margin of 4 percent, days sales
outstanding equal to 60 days, receivables of $150,000, total assets of $3 million, and a debt
ratio of 0.64. What is the firm’s return on equity (ROE)? Assume a 360day year.
a. 7.1% b. 33.3% c. 8.1% d. 3.3%

28. Deb & Co. has a debt ratio of 0.50, a total assets turnover of 0.25, and a profit margin of
10%. The president is unhappy with the current return on equity, and he thinks it could be
doubled. This could be accomplished (1) by increasing the profit margin to 14% and (2)
increasing debt utilization. Total assets turnover will not change. What new debt ratio,
along with the 14% profit margin, is required to double the return on equity?
a. 0.75 b. 0.70 c. 0.65 d. 0.55

29. Last year, Quayle Energy had sales of $200 million and its inventory turnover ratio was 5.0.
The company’s current assets totaled $100 million and its current ratio was 1.2.
What was the company’s quick ratio?

a. 1.20 b. 1.39 c. 0.72 d. 0.55

30. Oliver Incorporated has a current ratio equal to 1.6 and a quick ratio equal to 1.2. The
company has $2 million in sales and its current liabilities are $1 million. What is the
company’s inventory turnover ratio?
a. 5.0 b. 5.2 c. 5.5 d. 6.0

31. Vance Motors has current assets of $1.2 million. The company’s current ratio is 1.2, its
quick ratio is 0.7, and its inventory turnover ratio is 4. The company would like to increase
its inventory turnover ratio to the industry average, which is 5, without reducing its sales.
Any reductions in inventory will be used to reduce the company’s current liabilities. What
will be the company’s current ratio, assuming that it is successful in improving its inventory
turnover ratio to 5?
a. 1.33 b. 1.67 c. 1.22 d. 0.75

32. The following ratios and data were computed from the 1997 financial statements of Star Co.:
Current ratio 1.5
 Working capital P20,000
Debt/equity ratio .8
Return on equity .2
If net income for 1997 is P40,000, the balance sheet at the end of 1997 total assets of

a. P340,000 b. P360,000 c. P300,000 d. P400,000

33. An enterprise has total asset turnover of 3.5 times and a total debt to total assets ratio of
70%. If the enterprise has total debt of $1,000,000, it has a sales level of
A. $5,000,000.00 B. $2,450,000.00 C. $408,163.26 D. $200,000.00

34. Selected information from the accounting records of the Blackwood Co. is as follows:
Net A/R at December 31, 2000 $ 900,000
Net A/R at December 31, 2001 $1,000,000
Accounts receivable turnover 5 to 1
Inventories at December 31, 2000 $1,100,000

Inventories at December 31, $1,200,000

2001
Inventory turnover 4 to 1
What was the gross margin for 2001?
a. $150,000 b. $200,000 c. $300,000 d. $400,000

35. The Meryl Corporation’s common stock is currently selling at $100 per share, which
represents a P/E ratio of 10. If the firm has 100 shares of common stock outstanding, a return
on equity of 20 percent, and a debt ratio of 60 percent, what is its return on total assets
(ROA)?
a. 8.0% b. 10.0% c. 12.0% d. 16.7%

36. A firm has total assets of $1,000,000 and a debt ratio of 30 percent. Currently, it has sales of
$2,500,000, total fixed costs of $1,000,000, and EBIT of $50,000. If the firm’s before-tax
cost of debt is 10 percent and the firm’s tax rate is 40 percent, what is the firm’s ROE?
a. 1.7% b. 2.5% c. 6.0% d. 8.3%

37. Dean Brothers Inc. recently reported net income of $1,500,000. The company has 300,000
shares of common stock, and it currently trades at $60 a share. The company continues to
expand and anticipates that one year from now its net income will be $2,500,000. Over the
next year the company also anticipates issuing an additional 100,000 shares of stock, so that
one year from now the company will have 400,000 shares of common stock. Assuming the
company’s price/earnings ratio remains at its current level, what will be the company’s stock
price one year from now?
a. $55 b. $60 c. $70 d. $75

38. Southeast Packaging’s ROE last year was only 5 percent, but its management has developed
a new operating plan designed to improve things. The new plan calls for a total debt ratio of
60 percent, which will result in interest charges of $8,000 per year. Management projects an
 EBIT of $26,000 on sales of $240,000, and it expects to have a total assets turnover ratio of
2.0. Under these conditions, the average tax rate will be 40 percent. If the changes are
made, what return on equity will Southeast earn?
a. 9.00% b. 11.25% c. 17.50% d. 22.5%

39. Lone Star Plastics has the following data:

Assets: $100,000 Interest rate: 8.0%
Debt ratio: 40.0% Total assets turnover: 3.0
Profit margin: 6.0% Tax rate: 40%
What is Lone Star’s EBIT?
b. $12,000 c. $18,000 d. $30,000 d. $33,200

40. A firm has a debt/equity ratio of 50 percent. Currently, it has interest expense of $500,000
on $5,000,000 of total debt outstanding. Its tax rate is 40 percent. If the firm’s ROA is 6
percent, by how many percentage points is the firm’s ROE greater than its ROA?
a. 0.0% b. 3.0% c. 5.2% d. 7.4%