Chapter 04 Analysis of Financial Statements

CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS
To keep this chapter from involving too much memorization, we provide our students with a formula sheet for use on
exams. That makes a few of the questions trivially easy, but most require some thought, and some are downright
challenging. Even the very easy ones make students think about the ratios. The challenging questions are labeled
CHALLENGING, and most students will agree with that designation.
Some of these questions are just definitions, but others require real thought about the make-up of the ratios and
relationships among the ratios. We tell our students that to answer some of these questions it is useful (1) to write out the
relevant ratio or ratios, (2) then to think about how the ratios would change if the accounting data changed, and (3)
occasionally to make up illustrative data to test their conclusions.
Note that there is some overlap between the True/False and the multiple choice questions, as some T/F statements are
used in the MC questions.
1. Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 4-1 Ratio Analysis
TOPICS: Ratio analysis
KEYWORDS: Bloom’s: Knowledge
2. The current and quick ratios both help us measure a firm's liquidity. The current ratio measures the relationship of the
firm's current assets to its current liabilities, while the quick ratio measures the firm's ability to pay off short-term
obligations without relying on the sale of inventories.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 4-2 Liquidity Ratios
TOPICS: Liquidity ratios
3. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-
to-use estimates of a firm's liquidity position.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
4. High current and quick ratios always indicate that the firm is managing its liquidity position well.
a. True
Cengage Learning Testing, Powered by Cognero Page 1
b. False
ANSWER: False
RATIONALE: It might have too much liquidity. Liquid assets generally provide low
returns.
POINTS: 1
DIFFICULTY: EASY
TOPICS: Current ratio
KEYWORDS: Bloom's: Comprehension
5. If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change
much, but its quick ratio would decline.
a. True
b. False
ANSWER: False
POINTS: 1
DIFFICULTY: EASY
TOPICS: Current and quick ratios
6. If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio would
increase.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
7. If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick
ratio would change.
a. True
b. False
ANSWER: False
RATIONALE: The quick ratio would increase as receivables replaced inventory.
POINTS: 1
DIFFICULTY: EASY
8. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a
firm is managing its current assets.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 4-3 Asset Management Ratios
TOPICS: Asset management ratios
9. A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its
liquidity position, i.e., that it is becoming more liquid.
a. True
b. False
ANSWER: False
POINTS: 1
DIFFICULTY: EASY
TOPICS: Inventory turnover ratio
10. In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio indicates that the firm has
an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock.
a. True
b. False
ANSWER: False
POINTS: 1
DIFFICULTY: EASY
11. The days sales outstanding tells us how long it takes, on average, to collect after a sale is made. The DSO can be
compared with the firm's credit terms to get an idea of whether customers are paying on time.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
TOPICS: Days sales outstanding
12. If a firm's fixed assets turnover ratio is significantly higher than its industry average, this could indicate that it uses its
fixed assets very efficiently or is operating at over capacity and should probably add fixed assets.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
TOPICS: Fixed assets turnover ratio
13. Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners'
capital through the use of financial leverage.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 4-4 Debt Management Ratios
TOPICS: Debt management ratios
14. The more conservative a firm's management is, the higher its total debt to total capital ratio [measured as (Short-term
debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is likely to be.
a. True
b. False
ANSWER: False
POINTS: 1
DIFFICULTY: EASY
15. Other things held constant, the higher a firm's total debt to total capital ratio [measured as (Short-term debt + Long-
term debt)/(Debt + Preferred stock + common equity)], the higher its TIE ratio will be.
a. True
b. False
ANSWER: False
POINTS: 1
DIFFICULTY: EASY
16. The times-interest-earned ratio measures the extent to which operating income can decline before the firm is unable to
meet its annual interest costs.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
TOPICS: TIE ratio
17. Profitability ratios show the combined effects of liquidity, asset management, and debt management on a firm's
operating results.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 4-5 Profitability
Ratios
TOPICS: Profitability ratios
18. The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial
leverage and tax effects.
a. True
b. False
ANSWER: False
RATIONALE: BEP = EBIT/Assets. EBIT reflects earnings before the effects of leverage (interest) and taxes, so the
statement is false.
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 4-5 Profitability Ratios
TOPICS: BEP ratio
19. The operating margin measures operating income per dollar of assets.
a. True
b. False
ANSWER: False
POINTS: 1
DIFFICULTY: EASY
Ratios
TOPICS: Operating margin
20. The profit margin measures net income per dollar of sales.

a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
Ratios
TOPICS: Profit margin
21. The return on invested capital measures the total return that a company has provided for its investors.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
Ratios
TOPICS: ROIC ratio
22. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change
dramatically during a given year, depending on the time of year when the financial statements are constructed.
a. True
b. False
ANSWER: True
RATIONALE: Many of the ratios show sales over some past period such as the last 12 months divided by an asset
such as inventories as of a specific date. Assets like inventories vary at different times of the year for a
seasonal business, thus leading to big changes in the ratio.
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 4-10 Uses and Limitations of Ratios
TOPICS: Balance sheet changes
23. Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more
difficult than if all firms used the same or similar accounting methods.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 4-10 Uses and Limitations of
Ratios
TOPICS: Ratio limitations

24. The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory
turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of
the inventory is obsolete or damaged.
a. True
b. False
ANSWER: True
RATIONALE: A high current ratio is consistent with a lot of inventory. A low inventory turnover is also consistent with a
lot of inventory. If the CR exceeds industry norms and the turnover is below the norms, then the firm has
more inventory than most other firms, given its sales. It could just be carrying a lot of good inventory, but
it might also have a normal amount of "good" inventory plus some "bad" inventory that has not been
written off. So the statement is true.
POINTS: 1
DIFFICULTY: MODERATE
25. It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if
and only if all the firms being compared have the same proportion of fixed assets to total assets.
a. True
b. False
ANSWER: False
RATIONALE: The FA turnover is Sales/FA, and it gives an indication of how effectively the firm utilizes its FA. The
proportion of FA to TA is not relevant to this usage.
POINTS: 1
TOPICS: Fixed assets turnover
26. Other things held constant, the more debt a firm uses, the lower its profit margin will be.
a. True
b. False
ANSWER: True
POINTS: 1
27. Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a profit margin
of 8% for Firm B. Firm A's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt +
Preferred stock + Common equity)] is 70% versus one of 20% for Firm B. Based only on these two facts, you cannot
reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the
cause of Firm A's higher profit margin.
a. True
b. False
ANSWER: False
RATIONALE: A's higher total debt to total capital ratio would tend to lower its profit margin. Since its margin is already
higher, this indicates that A is the better managed company.
POINTS: 1
KEYWORDS: Bloom's: Analysis
28. Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower
profit margin.
a. True
b. False
ANSWER: False
RATIONALE: PM = NI/Sales. A decline in sales would, other things held constant, increase the PM. An increase in
financial leverage would lead to higher interest charges, which would decrease net income, which would
decrease the PM. So, the net effect could be an increase or a decrease in the PM, or no change.
POINTS: 1
29. Other things held constant, the more debt a firm uses, the lower its operating margin will be.
a. True
b. False
ANSWER: False
POINTS: 1
30. The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating
efficiency is that the BEP does not reflect the effects of debt and taxes.
a. True
b. False
ANSWER: True
POINTS: 1
TOPICS: BEP ratio

31. Other things held constant, the more debt a firm uses, the lower its return on total assets will be.
a. True
b. False
ANSWER: True
POINTS: 1
TOPICS: ROA
32. Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed,
two firms with the same EBIT must have the same ROA.
a. True
b. False
ANSWER: False
RATIONALE: Two firms could have identical EBITs but different amounts of interest, tax rates, and different amounts
of assets, and thus different ROAs.
Example: A B
EBIT = Sales revenues − Operating costs = EBIT $100.0 $100.0
Interest differs. B has more debt: Interest 10.0 20.0
EBT $ 90.0 $ 80.0
Both have 35% rate: Taxes 31.5 28.0
$
AT Inc.
$ 58.5 52.0
Assets differ: Assets $200.0 $500.0
ROA 29.3% 10.4%
POINTS: 1
TOPICS: ROA
33. The return on common equity (ROE) is generally regarded as being less significant, from a stockholder's viewpoint,
than the return on total assets (ROA).
a. True
b. False
ANSWER: False
RATIONALE: Stockholders should, and generally do, consider the ROE as being probably the single most important
ratio based strictly on the financial statements.
POINTS: 1
TOPICS: ROE
34. The return on invested capital (ROIC) differs from the return on assets (ROA). First, ROIC is based on total invested
capital rather than total assets. Second, the numerator of the ROIC is after-tax operating income rather than net income.
a. True
b. False
ANSWER: True
POINTS: 1
Ratios
TOPICS: ROIC and ROA
35. Market value ratios provide management with an indication of how investors view the firm's past performance and
especially its future prospects.
a. True
b. False
ANSWER: True
POINTS: 1
REFERENCES: 4-6 Market Value Ratios
TOPICS: Market value ratios
36. In general, if investors regard a company as being relatively risky and/or having relatively poor growth prospects, then
it will have relatively high P/E and M/B ratios.
a. True
b. False
ANSWER: False
POINTS: 1
37. The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In
general, investors regard companies with higher P/E ratios as being less risky and/or more likely to enjoy higher growth in
the future.
a. True
b. False
ANSWER: True
POINTS: 1
TOPICS: P/E ratio
38. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In
general, investors regard companies with higher M/B ratios as being less risky and/or more likely to enjoy higher growth
in the future.
a. True
b. False
ANSWER: True
POINTS: 1
TOPICS: M/B ratio
39. Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in
competitive product and capital markets. However, firms face different operating conditions because, for example, the
grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will
tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.
a. True
b. False
ANSWER: False
RATIONALE: Think about the DuPont equation: ROE = PM × TATO × Equity multiplier. Similar financing policies will
lead to similar Equity multipliers. Moreover, competition in the capital markets will cause ROEs to be
similar, because otherwise capital would flow to industries with high ROEs and drive returns down
toward the average, given similar risks. To have similar ROEs, firms with relatively high PMs must have
relatively low TATOs, and vice versa. Therefore, the statement is false.
POINTS: 1
REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation
TOPICS: DuPont equation
40. Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, no debt and therefore an equity
multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow funds using long-term debt, use the
funds to buy back stock, and raise the equity multiplier to 2.0. The size of the firm (assets) would not change. She thinks
that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would
probably be a good move, as it would increase the ROE from 7.5% to 13.5%.
a. True
b. False
ANSWER: True
RATIONALE: DuPont equation: ROE = PM × TATO × Equity multiplier. Given the data, the statement is true.
PM × TATO × Eq. Mult. = ROE
5.0% 1.5 1.0 7.5%
4.5% 1.5 2.0 13.5%
POINTS: 1
KEYWORDS: Bloom's: Application
41. Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios
for a given year. Trend analysis is one method of examining changes in a firm's performance over time.

a. True
b. False
ANSWER: True
POINTS: 1
REFERENCES: 4-9 Using Financial Ratios to Assess Performance
TOPICS: Trend analysis
42. Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if
A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's.
a. True
b. False
ANSWER: False
RATIONALE: This question can be answered by thinking carefully about the ratios: Demonstration that the first
sentence is true: QR(B) > QR(A)
CR: A > B B>A
A: = 1.67 = 0.67
B: = 1.50 = 1.00
Demonstration that the second sentence is false: QR(B) < QR(A)
CR: A < B B<A
A: = 1.00 = 0.67
B: = 1.50 = 0.50
The key is inventory, which is in the CR but not in the QR. The firm with more inventory can have the
higher CR but the lower QR.
POINTS: 1
DIFFICULTY: CHALLENGING
43. Firms A and B have the same current ratio, 0.75, the same amount of sales, and the same amount of current liabilities.
However, Firm A has a higher inventory turnover ratio than B. Therefore, we can conclude that A's quick ratio must be
smaller than B's.
a. True
b. False
ANSWER: False
RATIONALE: Firm A has the higher inventory turnover, S/I. So, given the same sales, A must have less inventory.
Since the two firms have the same CR, A must have the higher QR, not the lower one. Therefore, the
statement is false.
POINTS: 1
44. Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt,
the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required
to achieve its target TIE ratio.
a. True
b. False
ANSWER: True
RATIONALE: TIE = EBIT/Interest = (Sales − Op Cost)/(Debt × Interest Rate). If we know the op. costs, the amount of
debt, and the interest rate, then we can solve for the sales level required to achieve the target TIE.
POINTS: 1
TOPICS: TIE ratio
45. Suppose Firms A and B have the same amount of assets, total assets are equal to total invested capital, pay the same
interest rate on their debt, have the same basic earning power (BEP), finance with only debt and common equity, and have
the same tax rate. However, Firm A has a higher debt to capital ratio. If BEP is greater than the interest rate on debt, Firm
A will have a higher ROE as a result of its higher debt ratio.
a. True
b. False
ANSWER: True
RATIONALE: The easiest way to think about this problem is to realize that if you can borrow at a cost of 10% and
invest the proceeds to earn 11%, you'll earn a surplus. If you were previously earning an ROE of 10%,
then after raising and investing additional funds at 11%, your income will be higher, your equity will be
the same, and thus your ROE will increase. Similarly, if a firm earns more on assets than the interest
rate, there will be a surplus after paying interest on the debt that will go to the equity, thus increasing the
ROE. So, if BEP > rd, then the firm can increase its expected ROE by using more debt leverage. The
answer can also be seen by working out an example. The one below shows that leverage increases
ROE if BEP > rd, but it could be varied to show no difference in ROE if interest rates and BEP are the
same, and a reduction in ROE if the interest rate exceeds the BEP.
Firm A: Uses Debt Firm B: No Debt
Assets = Invested capital $100 Assets = Invested capital $100
Debt 60% Debt 0%
Equity 40% Equity 100%
BEP 15% BEP 15%
Interest rate, rd 10% Interest rate, rd 10%
Tax rate 40% Tax rate 40%
EBIT = BEP × Assets $15.0 EBIT = BEP × Assets $15.0
Interest 6.0 Interest 0
Taxable income 9.0 Taxable income 15.0
Taxes 3.6 Taxes 6.0
NI 5.4 NI 9.0
ROE 13.50% ROE 9.00%
POINTS: 1
TOPICS: BEP and ROE
46. If a firm's ROE is equal to 9% and its ROA is equal to 6%, its equity multiplier must be 1.5.
a. True
b. False
ANSWER: True
RATIONALE: Equity multiplier = ROE/ROA = 9%/6% = 1.5. Thus, the statement is true.
POINTS: 1
TOPICS: Equity multiplier
47. A firm's ROE is equal to 9% and its ROA is equal to 6%. The firm finances only with short-term debt, long-term debt,
and common equity, so assets equal total invested capital. The firm's total debt to total capital ratio must be 50%.
a. True
b. False
ANSWER: False
RATIONALE: Equity multiplier = ROE/ROA = 9%/6% = 1.5
E/A = 1/1.5 = 0.6667
D/A = 1 – 0.6667 = 0.3333
Since assets = Total invested capital, Debt/Total invested capital = 33.33%. Therefore, the statement is
false.
POINTS: 1
TOPICS: Equity multiplier and leverage
48. One problem with ratio analysis is that relationships can sometimes be manipulated. For example, if our current ratio
is greater than 1.5, then borrowing on a short-term basis and using the funds to build up our cash account would cause the
current ratio to INCREASE.
a. True
b. False
ANSWER: False
RATIONALE: The key here is to recognize that if the CR is greater than 1.0, then a given increase in both current
assets and current liabilities would lead to a decrease in the CR. The reverse would hold if the initial CR
were less than 1.0. Here the initial CR is greater than 1.0, so borrowing on a short-term basis to build the
cash account would lower the CR. For example:
Original Plus New Old New
CA/CL $1 CA/CL CR CR

1
1.50 1.33 CR falls if initial CR is greater than 1.0
1
1
0.67 0.75 CR rises if initial CR is less than 1.0
1
POINTS: 1
49. One problem with ratio analysis is that relationships can be manipulated. For example, we know that if our current
ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to
increase and thus make the firm look stronger.
a. True
b. False
ANSWER: False
RATIONALE: The key here is to recognize that if the CR is less than 1.0, then a given reduction in both current assets
and current liabilities would lead to a decrease in the CR. The reverse would hold if the initial CR were
greater than 1.0. In the question, the initial CR is less than 1.0, so using cash to reduce current liabilities
would lower the CR. If the CR were greater than 1.0, the statement would have been true. Here's an
illustration:
Original Less New Old New
–1
0.67 0.50 CR falls if initial CR is less than 1.0
–1
–1
1.50 2.00 CR rises if initial CR is greater than 1.0
–1
POINTS: 1
Multiple Choice: Conceptual
50. Considered alone, which of the following would increase a company's current ratio?
a. An increase in net fixed assets.
b. An increase in accrued liabilities.
c. An increase in notes payable.
d. An increase in accounts receivable.
e. An increase in accounts payable.
ANSWER: d
POINTS: 1
DIFFICULTY: EASY

OTHER: Multiple Choice: Conceptual
51. Which of the following would, generally, indicate an improvement in a company's financial position, holding other
things constant?
a. The TIE declines.
b. The DSO increases.
c. The quick ratio increases.
d. The current ratio declines.
e. The total assets turnover decreases.
ANSWER: c
POINTS: 1
DIFFICULTY: EASY
52. A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?
a. Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to
purchase plant and equipment.
b. Use cash to repurchase some of the company's own stock.
c. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
d. Issue new stock, then use some of the proceeds to purchase additional inventory and hold the remainder as
cash.
e. Use cash to increase inventory holdings.
ANSWER: d
POINTS: 1
DIFFICULTY: EASY
53. Which of the following statements is CORRECT?

a. A reduction in inventories would have no effect on the current ratio.
b. An increase in inventories would have no effect on the current ratio.
c. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory
turnover ratio will increase.
d. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
e. If a firm increases its sales while holding its inventories constant, then, other things held constant, its fixed
assets turnover ratio will decline.
ANSWER: c
POINTS: 1
DIFFICULTY: EASY
TOPICS: Inventories
54. Companies E and P each reported the same earnings per share (EPS), but Company E's stock trades at a higher price.
Which of the following statements is CORRECT?
a. Company E probably has fewer growth opportunities.
b. Company E is probably judged by investors to be riskier.
c. Company E must have a higher market-to-book ratio.
d. Company E must pay a lower dividend.
e. Company E trades at a higher P/E ratio.
ANSWER: e
POINTS: 1
DIFFICULTY: EASY
TOPICS: Financial statement analysis

a. Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an
example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit
and then using the funds that come in quicker to purchase additional inventories is another example of
"window dressing."
b. Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current
ratio and thus could be considered to be an example of "window dressing."
c. Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that
come in quicker to purchase fixed assets is an example of "window dressing."
d. Using some of the firm's cash to reduce long-term debt is an example of "window dressing."
e. "Window dressing" is any action that does not improve a firm's fundamental long-run position and thus
increases its intrinsic value.
ANSWER: b
POINTS: 1
DIFFICULTY: EASY
REFERENCES: 4-10 Uses and Limitations of
Ratios
TOPICS: Window dressing
56. Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term
notes payable. This action had no effect on the company's total assets or operating income. Which of the following effects
would occur as a result of this action?
a. The company's current ratio increased.
b. The company's times interest earned ratio decreased.
c. The company's basic earning power ratio increased.
d. The company's equity multiplier increased.
e. The company's total debt to total capital ratio
increased.
ANSWER: a
POINTS: 1
DIFFICULTY: EASY
REFERENCES: Comprehensive
TOPICS: Miscellaneous ratios
57. A firm's new president wants to strengthen the company's financial position. Which of the following actions would
make it financially stronger?
a. Increase accounts receivable while holding sales
constant.
b. Increase EBIT while holding sales and assets constant.
c. Increase accounts payable while holding sales constant.
d. Increase notes payable while holding sales constant.
e. Increase inventories while holding sales constant.
ANSWER: b
POINTS: 1
DIFFICULTY: EASY
58. If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., "grading" the
manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases,
assume that other things are held constant.
a. The division's basic earning power ratio is above the average of other firms in its industry.
b. The division's total assets turnover ratio is below the average for other firms in its industry.
c. The division's total debt to total capital ratio is above the average for other firms in the industry.
d. The division's inventory turnover is 6×, whereas the average for its competitors is 8×.
e. The division's DSO (days' sales outstanding) is 40 days, whereas the average for its competitors is 30
days.
ANSWER: a
POINTS: 1
DIFFICULTY: EASY
59. Which of the following would indicate an improvement in a company's financial position, holding other things
constant?
a. The inventory and total assets turnover ratios both
decline.
b. The total debt to total capital ratio increases.
c. The profit margin declines.
d. The times-interest-earned ratio declines.
e. The current and quick ratios both increase.
ANSWER: e
POINTS: 1
DIFFICULTY: EASY
60. If a bank loan officer were considering a company's loan request, which of the following statements would you
consider to be CORRECT?
a. The lower the company's inventory turnover ratio, other things held constant, the lower the interest rate the
bank would charge the firm.
b. Other things held constant, the higher the days sales outstanding ratio, the lower the interest rate the bank
would charge.
c. Other things held constant, the lower the total debt to total capital ratio, the lower the interest rate the bank
would charge.
d. The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would
charge.
e. Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the
firm.
ANSWER: c
POINTS: 1
DIFFICULTY: EASY

a. The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
b. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm
that has no debt in its capital structure.
c. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are
financed, the firm with less debt will generally have the higher expected ROE.
d. The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because interest is paid with
post-tax dollars, so the firm's ability to pay current interest is affected by taxes.
e. All else equal, increasing the total debt to total capital ratio will increase the ROA.
ANSWER: b
POINTS: 1
DIFFICULTY: EASY
TOPICS: Leverage effects
62. A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?
a. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its
excess inventory and (2) lead to an increase in accounts receivable.
b. Issue new common stock and use the proceeds to increase inventories.
c. Speed up the collection of receivables and use the cash generated to increase inventories.
d. Use some of its cash to purchase additional inventories.
e. Issue new common stock and use the proceeds to acquire additional fixed assets.
ANSWER: a
POINTS: 1
TOPICS: Quick ratio
63. Amram Company's current ratio is 2.0. Considered alone, which of the following actions would lower the current
ratio?
a. Borrow using short-term notes payable and use the proceeds to reduce accruals.
b. Borrow using short-term notes payable and use the proceeds to reduce long-term
debt.
c. Use cash to reduce accruals.
d. Use cash to reduce short-term notes payable.
e. Use cash to reduce accounts payable.
ANSWER: b
RATIONALE: A quick scan of the alternatives would indicate that b is obviously correct—it would lower the CR. Since
there is only one correct answer, b must be the right answer. The following equation can also be used. If
you add equal amounts to the numerator and denominator, then if Orig CR = or > 1.0, CR will decline,
but if Orig CR < 1.0, CR will increase. Obviously, if you add to one but not the other, CR will increase or
decrease in a predictable manner. This is the situation with choice b. CR = (Orig CA +/− Δ)/(Orig CL +/−
Δ). a is false; it would leave the QR unchanged. b would obviously reduce the CR—CA remain constant
and CL would increase. c is false, given that the initial CR > 1.0. d is false, given that the initial CR > 1.0.
e is false, given that the initial CR > 1.0.
POINTS: 1

a. If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average, and
was increasing and trending still higher, this would be interpreted as a sign of strength.
b. A high average DSO indicates that none of its customers are paying on time. In addition, it makes no sense to
evaluate the firm's DSO with the firm's credit terms.
c. There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP).
These ratios measure entirely different things.
d. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase
in the quick ratio.
e. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its
days' sales outstanding will decline.
ANSWER: e
POINTS: 1
TOPICS: Accounts receivable

a. If one firm has a higher total debt to total capital ratio than another, we can be certain that the firm with the
higher total debt to total capital ratio will have the lower TIE ratio, as that ratio depends entirely on the amount
of debt a firm uses.
b. A firm's use of debt will have no effect on its profit margin.
c. If two firms differ only in their use of debt—i.e., they have identical assets, identical total invested capital,
sales, operating costs, interest rates on their debt, and tax rates—but one firm has a higher total debt to total
capital ratio, the firm that uses more debt will have a lower profit margin on sales and a lower return on assets.
d. The total debt to total capital ratio as it is generally calculated makes an adjustment for the use of assets leased
under operating leases, so the debt ratios of firms that lease different percentages of their assets are still
comparable.
e. If two firms differ only in their use of debt—i.e., they have identical assets, identical total invested capital,
operating costs, and tax rates—but one firm has a higher total debt to total capital ratio, the firm that uses more
debt will have a higher operating margin and return on assets.
ANSWER: c
RATIONALE: a is false, because the TIE also depends on the interest rate and EBIT. b is false, because interest
affects the profit margin. c is correct, because the more interest the lower the profits, hence the lower the
profit margin and ROE. d is simply incorrect. e is incorrect. Operating margin would be identical because
EBIT is in the numerator and return on assets would be lower.
POINTS: 1
TOPICS: Debt management

a. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be equal.
b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E
ratios must also be the same.
c. If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same
price/earnings ratio.
d. If Firm X's P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and/or be expected to grow at a
faster rate.
e. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their
market-to-book ratios must also be the same.
ANSWER: b
RATIONALE: No reason for a to be true. b must be true, as EPS and P will be equal. No reason for c to be true.
Wrong, because high risk and low growth lead to low P/Es. No reason for e to be true.
POINTS: 1

a. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises
from 9% to 10%, and its debt increases from 40% of total assets to 60%. The firm finances using only debt
and common equity and total assets equal total invested capital. Under these conditions, the ROE will
increase.
b. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises
from 9% to 10% and its debt increases from 40% of total assets to 60%. The firm finances using only debt and
common equity and total assets equal total invested capital. Without additional information, we cannot tell
what will happen to the ROE.
c. The DuPont equation provides information about how operations affect the ROE, but the equation does not
include the effects of debt on the ROE.
d. Other things held constant, an increase in the total debt to total capital ratio will result in an increase in the
profit margin.
e. Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises
from 9% to 10%, and its debt increases from 40% of total assets to 60%. The firm finances using only debt
and common equity and total assets equal total invested capital. Under these conditions, the ROE will
decrease.
ANSWER: a
RATIONALE: PM × TATO × Eq. Mult. = ROE
Old 9% 1.0 1.66666667 15.0%
New 10% 0.9 2.5 22.5%
The changes in the PM and TATO offset one another, but the increase in the equity multiplier increases
ROE. Since a is true, b and e must be false. We can also see that c and d are false.
POINTS: 1
TOPICS: DuPont analysis

68. You observe that a firm's ROE is above the industry average, but both its profit margin and equity multiplier are
below the industry average. Which of the following statements is CORRECT?
a. Its total assets turnover must be above the industry average.
b. Its return on assets must equal the industry average.
c. Its TIE ratio must be below the industry average.
d. Its total assets turnover must be below the industry average.
e. Its total assets turnover must equal the industry average.
ANSWER: a
RATIONALE: Thinking through the DuPont equation, we can see that if the firm's PM and equity multiplier are below
the industry average, the only way its ROE can exceed the industry average is if its total assets turnover
exceeds the industry average. The following data illustrate this point:
ROE = PM × TATO × Eq. Mult. ROA

Firm 30% 9% 2.0 1.67 18%
Industry 25% 10% 1 2.50 10%
The above demonstrates that a is correct, and that makes d and e incorrect. Now consider the following:
NI/Assets = NI/Sales × Sales/Assets
ROA = PM × TATO
If its ROA were equal to the industry average, then with its low equity multiplier (hence lower financial
leverage and use of less debt) its ROE would also be below the industry average. So b is incorrect. With
lower debt (since equity multiplier is less than industry average), its interest charges should also be low,
which would increase its TIE ratio, making c incorrect.
POINTS: 1
69. Companies HD and LD are both profitable, and they have the same total assets (TA), total invested capital, sales (S),
return on assets (ROA), and profit margin (PM). Both firms finance using only debt and common equity. However,
Company HD has the higher total debt to total capital ratio. Which of the following statements is CORRECT?
a. Company HD has a lower total assets turnover than Company LD.
b. Company HD has a lower equity multiplier than Company LD.
c. Company HD has a higher fixed assets turnover than Company LD.
d. Company HD has a higher ROE than Company LD.
e. Company HD has a lower operating income (EBIT) than Company LD.
ANSWER: d
RATIONALE: Rule out all answers except d because they are false. Alternative answer using the DuPont equation:
ROE = PM × TATO × Eq. multiplier
ROE = NI/S × S/TA × TA/Equity
The first two terms are the same, but HD has a higher equity multiplier due to its higher debt, hence
higher ROE.
POINTS: 1

70. Taggart Technologies is considering issuing new common stock and using the proceeds to reduce its outstanding debt.
The stock issue would have no effect on total assets, the interest rate Taggart pays, EBIT, or the tax rate. Which of the
following is likely to occur if the company goes ahead with the stock issue?
a. The ROA will decline.
b. Taxable income will decline.
c. The tax bill will increase.
d. Net income will decrease.
e. The times-interest-earned ratio will
decrease.
ANSWER: c
RATIONALE: a is false because reducing debt will lower interest, raise net income, and thus raise ROA. b is false for
the above reason. c is true for the above reason. d is false The TIE will increase because interest
charges will be smaller due to less debt.
POINTS: 1

a. The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the
DSO or the inventory turnover ratio.
b. If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE.
c. An increase in the DSO, other things held constant, could be expected to increase the total assets turnover
ratio.
d. An increase in the DSO, other things held constant, could be expected to increase the ROE.
e. An increase in a firm's total debt to total capital ratio, with no changes in its sales or operating costs, could be
expected to lower its profit margin.
ANSWER: e
RATIONALE: a. Sales fluctuations would have more effects on the DSO and S/Inventory ratios.
b. ROE = ROA × Equity multiplier, so the more debt, the higher ROE for a given ROA.
DSO = Receivables/Sales per day. With sales constant, an increase in DSO would mean an
c.
increase in receivables, hence a decline, not a rise, in the TATO (S/TA).
An increase in the DSO might increase or decrease ROE, depending on how it affected
d.
sales and costs.
More debt would mean more interest, hence a lower NI, given a constant EBIT. This would
e.
lower the profit margin = NI/Sales.
POINTS: 1

72. HD Corp and LD Corp have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. Both firms
finance using only debt and common equity and total assets equal total invested capital. However, HD uses more debt
than LD. Which of the following statements is CORRECT?
a. Without more information, we cannot tell if HD or LD would have a higher or lower net
income.
b. HD would have the lower equity multiplier for use in the DuPont equation.
c. HD would have to pay more in income taxes.
d. HD would have the lower net income as shown on the income statement.
e. HD would have the higher operating margin.
ANSWER: d
RATIONALE: More debt would mean more interest, hence a lower NI, given a constant EBIT, so d is correct. Also, we
can rule out a and e, and HD would also have the higher multiplier, which rules out b. And with more
interest, HD would have to pay less taxes, not more.
POINTS: 1
73. Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power.
Both firms finance using only debt and common equity and total assets equal total invested capital. Both companies have
positive net incomes. Company HD has a higher total debt to total capital ratio and, therefore, a higher interest expense.
Which of the following statements is CORRECT?
a. Company HD pays less in taxes.
b. Company HD has a lower equity multiplier.
c. Company HD has a higher ROA.
d. Company HD has a higher times-interest-earned (TIE)
ratio.
e. Company HD has more net income.
ANSWER: a
RATIONALE: Under the stated conditions, HD would have more interest charges, thus lower taxable income and
taxes. Thus, a is correct. All of the other statements are incorrect.
POINTS: 1
TOPICS: Leverage, taxes, ratios
74. Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both companies have
positive net incomes. Both firms finance using only debt and common equity and total assets equal total invested capital.
Company HD has a higher total debt to total invested capital ratio and, therefore, a higher interest expense. Which of the
following statements is CORRECT?
a. Company HD has a lower equity multiplier.
b. Company HD has more net income.
c. Company HD pays more in taxes.
d. Company HD has a lower ROE.
e. Company HD has a lower times-interest-earned (TIE) ratio.
ANSWER: e
RATIONALE: HD has higher interest charges. Basic earning power equals EBIT/Assets, and since assets and BEP are
equal, EBIT must also be equal. TIE = EBIT/Interest. Therefore, HD's higher interest charges means that
its TIE must be lower. Thus, e is correct. All of the other statements are incorrect.
POINTS: 1
TOPICS: Leverage, taxes, ratios

a. If a firm has high current and quick ratios, this always indicate that the firm is managing its liquidity position
well.
b. If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably
not change much, but its quick ratio would decline.
c. If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio
would decline.
d. If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or
quick ratio would change.
e. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how
effectively a firm is managing its current assets.
ANSWER: e
POINTS: 1
TOPICS: Various ratios

a. A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and
its liquidity position, i.e., that it is becoming more liquid.
b. In general, it's better to have a low inventory turnover ratio than a high one, as a low one indicates that the firm
has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of
stock.
c. If a firm's fixed assets turnover ratio is significantly lower than its industry average, this could indicate that it
uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets.
d. The more conservative a firm's management is, the higher its total debt to total capital ratio is likely to be.
e. The days sales outstanding ratio tells us how long it takes, on average, to collect after a sale is made. The DSO
can be compared with the firm's credit terms to get an idea of whether customers are paying on time.
ANSWER: e
POINTS: 1

a. Other things held constant, the more debt a firm uses, the higher its operating margin will be.
b. Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on
owners' capital through the use of financial leverage.
c. Other things held constant, the more debt a firm uses, the higher its profit margin will be.
d. Other things held constant, the higher a firm's total debt to total capital ratio, the higher its TIE ratio will be.
e. Debt management ratios show the extent to which a firm's managers are attempting to reduce risk through the
use of financial leverage. The higher the total debt to total capital ratio, the lower the risk.
ANSWER: b
POINTS: 1

a. Other things held constant, the less debt a firm uses, the lower its return on total assets will be.
b. The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's
operating efficiency is that the BEP does not reflect the effects of debt and taxes.
c. The return on common equity (ROE) is generally regarded as being less significant, from a stockholder's
viewpoint, than the return on total assets (ROA).
d. The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In
general, investors regard companies with higher P/E ratios as being more risky and/or less likely to enjoy
higher future growth.
e. Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a margin
of 8% for Firm B. Firm A's total debt to total capital ratio is 70% versus 20% for Firm B. Based only on
these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in
debt, not better management, could be the cause of Firm A's higher profit margin.
ANSWER: b
POINTS: 1

a. In general, if investors regard a company as being relatively risky and/or having relatively poor growth
prospects, then it will have relatively high P/E and M/B ratios.
b. The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to
financial leverage and tax effects.
c. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can
change dramatically during a given year, depending on the time of year when the financial statements are
constructed.
d. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book
value. In general, investors regard companies with higher M/B ratios as being more risky and/or less likely to
enjoy higher future growth.
e. It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed
assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.
ANSWER: c
POINTS: 1
80. Walter Industries' current ratio is 0.5. Considered alone, which of the following actions would increase the company's
current ratio?
a. Borrow using short-term notes payable and use the cash to increase
inventories.
b. Use cash to reduce accruals.
c. Use cash to reduce accounts payable.
d. Use cash to reduce short-term notes payable.
e. Use cash to reduce long-term bonds outstanding.
ANSWER: a
RATIONALE: The following equation can be used. If you add equal amounts to the numerator and denominator, then if
Orig CR = or > 1.0, CR will decline, but if Orig CR < 1.0, CR will increase. Obviously, if you add to one
but not the other, CR will increase or decrease in a predictable manner. We see that a is correct.
Example:
1
0.50 0.67 CR rises if initial CR is less than 1.0
1
POINTS: 1

81. Safeco's current assets total to $20 million versus $10 million of current liabilities, while Risco's current assets are $10
million versus $20 million of current liabilities. Both firms would like to "window dress" their end-of-year financial
statements, and to do so they tentatively plan to borrow $10 million on a short-term basis and to then hold the borrowed
funds in their cash accounts. Which of the statements below best describes the results of these transactions?
a. The transactions would improve Safeco's financial strength as measured by its current ratio but lower Risco's
current ratio.
b. The transactions would lower Safeco's financial strength as measured by its current ratio but raise Risco's
current ratio.
c. The transactions would have no effect on the firm' financial strength as measured by their current ratios.
d. The transactions would lower both firm' financial strength as measured by their current ratios.
e. The transactions would improve both firms' financial strength as measured by their current ratios.
ANSWER: b
RATIONALE: The key here is to recognize that if the CR is less than 1.0, then a given increase to both current assets
and current liabilities will increase the CR, while the reverse will hold if the initial CR is greater than 1.0.
Thus, the transactions would make Risco look stronger but Safeco look weaker. Here's an illustration:
Safeco:
2.00 1.50 CR falls because initial CR is greater than 1.0
Risco:
0.50 0.67 CR rises because initial CR is less than 1.0
All of the statements except b are incorrect.

POINTS: 1
82. Companies HD and LD have the same total assets, sales, operating costs, and tax rates, and they pay the same interest
rate on their debt. Both firms finance using only debt and common equity and total assets equal total invested capital.
However, company HD has a higher total debt to total capital ratio. Which of the following statements is CORRECT?
a. Given this information, LD must have the higher ROE.
b. Company LD has a higher basic earning power ratio (BEP).
c. Company HD has a higher basic earning power ratio (BEP).
d. If the interest rate the companies pay on their debt is more than their basic earning power (BEP), then
Company HD will have the higher ROE.
e. If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company
HD will have the higher ROE.
ANSWER: e
RATIONALE: The companies have the same EBIT and assets, hence the same BEP ratio. If the interest rate is less
than the BEP, then using more debt will raise the ROE. Therefore, statement e is correct. The others are
all incorrect.
POINTS: 1
TOPICS: Leverage effects

a. Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A.
However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's.
b. Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that
debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount
of sales required to achieve its target TIE ratio.
c. Since the ROA measures the firm's effective utilization of assets without considering how these assets are
financed, two firms with the same EBIT must have the same ROA.
d. Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate
in competitive product and capital markets. However, firms face different operating conditions because, for
example, the grocery store industry is different from the airline industry. Under these conditions, firms with
high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to
have low turnover ratios.
e. Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, no debt and therefore an
equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow funds using long-
term debt, use the funds to buy back stock, and raise the equity multiplier to 2.0. The size of the firm (assets)
would not change. She thinks that operations would not be affected, but interest on the new debt would lower
the profit margin to 4.5%. This would probably not be a good move, as it would decrease the ROE from 7.5%
to 6.5%.
ANSWER: b
POINTS: 1
Multiple Choice: Problems

A good bit of relatively simple algebra is involved in these problems, and although the calculations are simple, it will take
students some time to set up the problems and do the arithmetic. We allow for this when assigning problems for a timed
test. Also, note that students must know the definitions of a number of ratios to answer the questions. We provide our
students with a formula sheet on exams, using the relevant sections of Appendix C at the then of the text. Otherwise, they
spend too much time trying to memorize thing rather than trying to understand the issues.
The difficulty of the problems depends on (1) whether or not students are provided with a formula sheet and (2) the
amount of time they have to work the problems. Out difficulty assessments assume that they have a formula sheet and a
"reasonable" amount of time for the test. Note that a few of the problems are trivially easy if students have formula sheets.
To work some of the problems, students must transpose equations and solve for items that are normally inputs. For
example, the equation for the profit margin is given as Profit margin = Net income/Sales. We might have a problem where
sales and the profit margin are given and then require students to find the firm's net income. We explain to our students in
class before the exam that they will have to transpose terms in the formulas to work some problems.
Problems 84 through 114 are all stand-alone problems with individualized data. Problems 115 through 133 are all
based on a common set of financial statements, and they require students to calculate ratios and find items like EPS, TIE,
and the like using this data set. The financial statements can be changed algorithmically, and this changes the calculated

ratios and other items.
84. Ryngard Corp's sales last year were $38,000, and its total assets were $16,000. What was its total assets turnover ratio
(TATO)?
a. 2.04
b. 2.14
c. 2.26
d. 2.38
e. 2.49
ANSWER: d
RATIONALE: Sales $38,000
Total assets $16,000
TATO = Sales/Total assets = 2.38
POINTS: 1
DIFFICULTY: EASY
TOPICS: Total assets turnover
OTHER: Multiple Choice: Problem
85. Beranek Corp has $720,000 of assets (which equal total invested capital), and it uses no debt—it is financed only with
common equity. The new CFO wants to employ enough debt to raise the total debt to total capital ratio to 40%, 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?
a. $273,600
b. $288,000
c. $302,400
d. $317,520
e. $333,396
ANSWER: b
RATIONALE: Total assets = Total invested capital $720,000
Target debt to total capital ratio 40%
Debt to achieve target ratio = Amount borrowed = Target % × Invested capital = $288,000
POINTS: 1
DIFFICULTY: EASY
TOPICS: Debt to capital ratio
86. Ajax Corp's sales last year were $435,000, its operating costs were $362,500, and its interest charges were $12,500.
What was the firm's times-interest-earned (TIE) ratio?
a. 4.72
b. 4.97
c. 5.23

d. 5.51
e. 5.80
ANSWER: e
Operating costs $362,500
Operating income (EBIT) $ 72,500
Interest charges $ 12,500
TIE ratio = EBIT/Interest = 5.80
POINTS: 1
DIFFICULTY: EASY
TOPICS: Times interest earned
87. Royce Corp's sales last year were $280,000, and its net income was $23,000. What was its profit margin?
a. 7.41%
b. 7.80%
c. 8.21%
d. 8.63%
e. 9.06%
ANSWER: c
Net income $23,000
Profit margin = NI/Sales 8.21%
POINTS: 1
DIFFICULTY: EASY
88. River Corp's total assets at the end of last year were $415,000 and its net income was $32,750. What was its return on
total assets?
a. 7.89%
b. 8.29%
c. 8.70%
d. 9.14%
e. 9.59%
ANSWER: a
RATIONALE: Total assets $415,000
Net income $32,750
ROA = NI/Assets = 7.89%
POINTS: 1
DIFFICULTY: EASY
TOPICS: Return on total assets
89. X-1 Corp's total assets at the end of last year were $405,000 and its EBIT was 52,500. What was its basic earning
power (BEP) ratio?
a. 11.70%
b. 12.31%
c. 12.96%
d. 13.61%
e. 14.29%
ANSWER: c
RATIONALE: Total assets $405,000
EBIT $52,500
BEP = EBIT/Assets = 12.96%
POINTS: 1
DIFFICULTY: EASY
TOPICS: Basic earning power
90. Zero Corp's total common equity at the end of last year was $405,000 and its net income was $70,000. What was its
ROE?
a. 14.82%
b. 15.60%
c. 16.42%
d. 17.28%
e. 18.15%
ANSWER: d
RATIONALE: Common equity $405,000
Net income $70,000
ROE = NI/Equity = 17.28%
POINTS: 1
DIFFICULTY: EASY
TOPICS: Return on equity
91. Your sister is thinking about starting a new business. The company would require $375,000 of assets, and it would be
financed entirely with common stock. She will go forward only if she thinks the firm can provide a 13.5% return on the
invested capital, which means that the firm must have an ROE of 13.5%. How much net income must be expected to
warrant starting the business?
a. $41,234
b. $43,405
c. $45,689
d. $48,094
e. $50,625
ANSWER: e
RATIONALE: Assets = Equity $375,000
Target ROE 13.5%
Required net income = Target ROE × Equity = $50,625
POINTS: 1
DIFFICULTY: EASY
92. Herring Corporation has operating income of $225,000 and a 40% tax rate. The firm has short-term debt of $120,000,
long-term debt of $330,000, and common equity of $450,000. What is its return on invested capital?
a. 13.75%
b. 14.33%
c. 15.00%
d. 16.25%
e. 17.10%
ANSWER: c
RATIONALE: EBIT $225,000
Tax rate 40%
Short-term debt $120,000
Long-term debt $330,000
Common equity $450,000
ROIC = [EBIT(1 – T)]/(STD + LTD + E) 15%
POINTS: 1
DIFFICULTY: EASY
TOPICS: Return on invested capital
93. Song Corp's stock price at the end of last year was $23.50 and its earnings per share for the year were $1.30. What was
its P/E ratio?
a. 17.17
b. 18.08
c. 18.98
d. 19.93
e. 20.93
ANSWER: b
RATIONALE: Stock price $23.50
EPS $1.30
P/E = Stock price/EPS 18.08
POINTS: 1
DIFFICULTY: EASY
TOPICS: Price/Earnings ratio
94. Hoagland Corp's stock price at the end of last year was $33.50, and its book value per share was $25.00. What was its
market/book ratio?
a. 1.34
b. 1.41
c. 1.48
d. 1.55
e. 1.63
ANSWER: a
RATIONALE: Stock price $33.50
Book value per share $25.00
M/B ratio = Stock price/Book value per share = 1.34
POINTS: 1
DIFFICULTY: EASY
TOPICS: Market/Book ratio
95. Precision Aviation had a profit margin of 6.25%, a total assets turnover of 1.5, and an equity multiplier of 1.8. What
was the firm's ROE?
a. 15.23%
b. 16.03%
c. 16.88%
d. 17.72%
e. 18.60%
ANSWER: c
RATIONALE: Profit margin 6.25%
TATO 1.50
Equity multiplier 1.80
ROE = PM × TATO × Eq. multiplier = 16.88%
POINTS: 1
DIFFICULTY: EASY
96. Meyer Inc's total invested capital is $625,000, and its total debt outstanding is $185,000. The new CFO wants to
establish a total debt to total capital ratio of 55%. The size of the firm will not change. How much debt must the
company add or subtract to achieve the target debt to capital ratio?
a. $158,750
b. $166,688
c. $175,022
d. $183,773
e. $192,962
ANSWER: a
RATIONALE: Total invested capital $625,000
Old debt $185,000
Target debt to capital ratio 55%
Target amount of debt = Target debt % × Total invested capital = $343,750
Change in amount of debt outstanding = Target debt − Old debt = $158,750
POINTS: 1
DIFFICULTY: EASY/MODERATE
97. Helmuth Inc's latest net income was $1,250,000, and it had 225,000 shares outstanding. The company wants to pay
out 45% of its income. What dividend per share should it declare?
a. $2.14
b. $2.26
c. $2.38
d. $2.50
e. $2.63
ANSWER: d
RATIONALE: Net income $1,250,000
Shares outstanding 225,000
Payout ratio 45%
EPS = NI/shares outstanding = $5.56
DPS = EPS × Payout % = $2.50
POINTS: 1
DIFFICULTY: EASY/MODERATE
TOPICS: EPS, DPS, and payout
98. Garcia Industries has sales of $200,000 and accounts receivable of $18,500, and it 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 fall to the industry average, and if it earns 8.0% on any cash freed-up by this change, how
would that affect its net income, assuming other things are held constant?
a. $241.45
b. $254.16
c. $267.54
d. $281.62
e. $296.44
ANSWER: e
RATIONALE: Rate of return on cash generated 8.0%
Sales $200,000
A/R $18,500
Days in Year 365
Sales/day = Sales/365 = $547.95
Company DSO = Receivables/Sales per day = 33.8
Industry DSO 27.0
Difference = Company DSO − Industry DSO = 6.8
Cash flow from reducing the DSO = Difference × Sales/day = $3,705.48
Additional Net Income = Return on cash × Added cash flow = $296.44
Alternative Calculation:
A/R at industry DSO $14,794.52
Change in A/R $3,705.48
Additional Net Income $296.44
POINTS: 1
TOPICS: DSO effect on net income
99. Faldo Corp sells on terms that allow customers 45 days to pay for merchandise. Its sales last year were $325,000, and
its year-end receivables were $60,000. If its DSO is less than the 45-day credit period, then customers are paying on time.
Otherwise, they are paying late. By how much are customers paying early or late? Base your answer on this equation:
DSO − Credit Period = Days early or late, and use a 365-day year when calculating the DSO. A positive answer indicates
late payments, while a negative answer indicates early payments.
a. 21.27
b. 22.38
c. 23.50
d. 24.68
e. 25.91
ANSWER: b
RATIONALE: Credit period 45
Sales $325,000
Sales/day = Sales/365 = $890.41
Receivables $60,000
Company DSO = Receivables/Sales per day = 67.38
Company DSO − Credit Period = Days early (−) or late (+) = 22.38
POINTS: 1
100. Han Corp's sales last year were $425,000, and its year-end receivables were $52,500. The firm sells on terms that call
for customers to pay 30 days after the purchase, but some delay payment beyond Day 30. On average, how many days late
do customers pay? Base your answer on this equation: DSO − Allowed credit period = Average days late, and use a 365-
day year when calculating the DSO.
a. 12.94
b. 13.62
c. 14.33
d. 15.09
e. 15.84
ANSWER: d
Sales/day = Sales/365 = $1,164.38
Receivables $52,500
Company DSO = Receivables/Sales per
45.09
day =
Credit period 30
DSO − Credit period = Days late 15.09
POINTS: 1
101. Wie Corp's 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 (TATO) of 2.4. The firm's new CFO believes the firm has excess assets that can
be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be
reduced to bring the TATO to the industry average, holding sales constant?
a. $201,934
b. $212,563
c. $223,750
d. $234,938
e. $246,684
ANSWER: c
Actual total assets $355,000
Target TATO = Sales/Total assets = 2.40
Target assets = Sales/Target TATO = $131,250
Asset reduction = Actual assets − Target assets = $223,750
POINTS: 1
102. A new firm is developing its business plan. It will require $615,000 of assets (which equals total invested capital),
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%, but the bank requires
it to have a TIE of at least 4.0, and if the TIE falls below this level the bank will call in the loan and the firm will go
bankrupt. The firm will use only debt and common equity for financing. What is the maximum debt to capital ratio
(measured as debt/total invested capital) 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.)
a. 41.94%
b. 44.15%
c. 46.47%
d. 48.92%
e. 51.49%
ANSWER: e
RATIONALE: Assets = Total invested capital $615,000
Sales $450,000
Operating costs $355,000
Operating income (EBIT) $ 95,000
Target TIE 4.00
Maximum interest expense = EBIT/Target TIE $23,750
Interest rate 7.50%
Max. debt = Max interest expense/Interest rate $316,667
Maximum debt to capital ratio = Debt/Total invested capital 51.49%
POINTS: 1
103. Duffert Industries has total assets of $1,000,000 and total current liabilities (consisting only of accounts payable and
accruals) of $125,000. Duffert finances using only long-term debt and common equity. The interest rate on its debt is 8%
and its tax rate is 40%. The firm's basic earning power ratio is 15% and its debt-to capital rate is 40%. What are Duffert's
ROE and ROIC?
a. 12.00%; 10.29%
b. 12.57%; 10.29%
c. 13.94%; 9.86%
d. 13.94%; 10.29%
e. 13.94%; 11.50%
ANSWER: d
RATIONALE: Total assets $1,000,000
Balance sheet:
Current liabilities $125,000
Debt 350,000
Common equity 525,000
Total liabilities $1,000,000
D/(D + E) = 0.4
D/($1,000,000 – $125,000,000) = 0.4
D = $350,000
Now calculate EBIT:

BEP = 0.15 = EBIT/TA = EBIT/$1,000,000
EBIT = $150,000
Calculate ROIC: ROIC = [EBIT(1 – T)]/(D + E) = [$150,000(0.6)]/$875,000 = 10.29%
Now determine net income from income statement:

EBIT $150,000
Interest 28,000 (0.08 × $350,000)
EBT $122,000
Taxes (40%) 48,800
NI $ 73,200
ROE = NI/E = $73,200/$525,000 = 13.94%

POINTS: 1
TOPICS: Return on invested capital and ROE
104. 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 get the return on equity up to 15.0%. What profit margin would the firm need in order to
achieve the 15% ROE, holding everything else constant?
a. 9.45%
b. 9.93%
c. 10.42%
d. 10.94%
e. 11.49%
ANSWER: a
RATIONALE: Total assets = Equity because zero debt $375,000
Sales $595,000
Net income $25,000
Target ROE 15.00%
Net income req'd to achieve target ROE = Target ROE × Equity = $56,250
Profit margin needed to achieve target ROE = NI/Sales = 9.45%
POINTS: 1
TOPICS: Profit margin and ROE
105. Last year Ann Arbor Corp had $155,000 of assets (which equals total invested capital), $305,000 of sales, $20,000 of
net income, and a debt-to-total-capital ratio of 37.5%. The new CFO believes a new computer program will enable it to
reduce costs and thus raise net income to $33,000. The firm finances using only debt and common equity. 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?
a. 11.51%

b. 12.11%
c. 12.75%
d. 13.42%
e. 14.09%
ANSWER: d
Debt to total capital ratio 37.5%
Debt = Capital × Debt % = $58,125
Equity = Assets − Debt = $96,875
Sales $305,000
Old net income $20,000
New net income $33,000
New ROE = New NI/Equity = 34.065%
Old ROE = Old NI/Equity = 20.645%
Increase in ROE = New ROE − Old ROE = 13.42%
POINTS: 1
TOPICS: Cost reduction and ROE
106. Brookman Inc's latest EPS was $2.75, its book value per share was $22.75, it had 315,000 shares outstanding, and its
debt/total invested capital ratio was 44%. The firm finances using only debt and common equity and its total assets equal
total invested capital. How much debt was outstanding?
a. $4,586,179
b. $4,827,557
c. $5,081,639
d. $5,349,094
e. $5,630,625
ANSWER: e
RATIONALE: EPS $2.75
BVPS $22.75
Shares outstanding 315,000
Total equity = Shares outstanding × BVPS = $7,166,250
Total assets = Total equity/(1 − Debt to total capital ratio) = $12,796,875
Total debt = Total assets − Equity = $5,630,625
POINTS: 1
TOPICS: EPS, book value, and debt
107. Last year Harrington Inc. had 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%. The firm finances using only debt and common equity and its total
assets equal total invested capital. Based on the DuPont equation, what was the ROE?

a. 13.82%
b. 14.51%
c. 15.23%
d. 16.00%
e. 16.80%
ANSWER: a
Assets = Total invested capital $250,000
Net income $19,000
Debt = Debt % × Capital = $112,500
Equity = Assets − Debt = $137,500
Profit margin = NI/Sales = 5.85%
TATO = Sales/Assets = 1.30
Equity multiplier = Assets/Equity = 1.82
ROE 13.82%
POINTS: 1
108. Last year Rennie Industries had sales of $305,000, assets of $175,000 (which equals total invested capital), a profit
margin of 5.3%, and an equity multiplier of 1.2. The CFO believes that the company could reduce its assets by $51,000
without affecting either sales or costs. The firm finances using only debt and common equity. Had it reduced its
assets by this amount, and had the debt/total invested capital ratio, sales, and costs remained constant, how much would
the ROE have changed?
a. 4.10%
b. 4.56%
c. 5.01%
d. 5.52%
e. 6.07%
ANSWER: b
RATIONALE: Old New
Sales $305,000 $305,000
Original assets = Original capital $175,000
Reduction in assets = Reduction in capital $ 51,000
New assets = Old assets − Reduction = $124,000
TATO = Sales/Assets = 1.74 2.46
Profit margin 5.30% 5.30%
Equity multiplier 1.20 1.20
ROE = PM × TATO × Eq. multiplier = 11.08% 15.64%
Change in ROE 4.56%
POINTS: 1
REFERENCES: 4-7
109. Last year Blease Inc had a total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were $295,000 and
its net income was $10,600. The firm finances using only debt and common equity and its total assets equal total
invested capital. The CFO believes that the company could have operated more efficiently, lowered its costs, and
increased its net income by $10,250 without changing its sales, assets, or capital structure. Had it cut costs and increased
its net income by this amount, how much would the ROE have changed?
a. 6.55%
b. 7.28%
c. 8.09%
d. 8.90%
e. 9.79%
ANSWER: c
RATIONALE: Old New
Sales $295,000 $295,000
Original net income $ 10,600 $ 10,600
Increase in net income $ 0 $ 10,250
New net income $ 10,600 $ 20,850
Profit margin = NI/Sales = 3.59% 7.07%
TATO 1.33 1.33
Equity multiplier 1.75 1.75
ROE = PM × TATO × Eq. multiplier = 8.36% 16.45%
Change in ROE 8.09%
POINTS: 1
110. Last year Jandik Corp. had $295,000 of assets (which is equal to its total invested capital), $18,750 of net income,
and a debt-to-total-capital ratio of 37%. Now suppose the new CFO convinces the president to increase the debt-to-total-
capital ratio to 48%. Sales, total assets, and total invested capital will not be affected, but interest expenses would
increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and
thus keep net income unchanged. By how much would the change in the capital structure improve the ROE?
a. 2.13%
b. 2.35%
c. 2.58%
d. 2.84%
e. 3.12%
ANSWER: a
Old debt to capital ratio 37%
Old debt = Capital × Old debt % = $109,150
Old equity = Assets – Debt $185,850
New debt to capital ratio 48%
New debt = Capital × New debt % = $141,600
New Equity = Assets − New debt = $153,400
Net income $18,750
New ROE = New income/New Equity 12.22%
Old ROE = Old income/Old Equity 10.09%
Increase in ROE 2.13%
POINTS: 1
111. Last year Kruse Corp had $305,000 of assets (which is equal to its total invested capital), $403,000 of sales, $28,250
of net income, and a debt-to-total-capital ratio of 39%. The new CFO believes the firm has excessive fixed assets and
inventory that could be sold, enabling it to reduce its total assets and total invested capital to $252,500. The firm
finances using only debt and common equity. Sales, costs, and net income would not be affected, and the firm would
maintain the same capital structure (but with less total debt). By how much would the reduction in assets improve the
ROE?
a. 2.85%
b. 3.00%
c. 3.16%
d. 3.31%
e. 3.48%
ANSWER: c
RATIONALE: Original New
Assets = Total invested capital $305,000 $252,500
Sales $403,000 $403,000
Net income $28,250 $28,250
Debt to capital ratio 39.00% 39.00%
Debt = Capital × debt % = $118,950 $98,475
Equity = Assets − Debt = $186,050 $154,025
ROE = NI/Equity = 15.184% 18.341%
Increase in ROE 3.16%
POINTS: 1
TOPICS: Reducing assets and ROE
112. Jordan Inc has the following balance sheet and income statement data:
Cash $ 14,000 Accounts payable $ 42,000
Receivables 70,000 Other current liab. 28,000
Inventories 280,000 Total CL $ 70,000
Total CA $364,000 Long-term debt 140,000
Net fixed assets 126,000 Common equity 280,000
Total assets $490,000 Total liab. and equity $490,000
Sales $280,000
Net income $ 21,000
The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the
industry average, 2.75, without affecting either sales or net income. Assuming that inventories are sold off and not
replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at
book value, by how much would the ROE change?
a. 11.26%
b. 11.85%
c. 12.45%
d. 13.07%
e. 13.72%
ANSWER: b
RATIONALE: Original balance sheet and income statement data:
Cash $ 14,000 Accounts payable $ 42,000
Receivables 70,000 Other current liabilities 28,000
Inventories 280,000 Total CL $ 70,000
Total CA $364,000 Long-term debt 140,000
Net fixed assets 126,000 Common equity 280,000
Total assets $490,000 Total liab. and equity $490,000
Sales $280,000
Net income $ 21,000
Actual current ratio 5.20

Target current ratio 2.75
Old current assets = $364,000

Current assets to have CR = Target: Target current ratio × Cur. Liab. = $192,500
Reduction in current assets = Old CA − New CA = Inventory reduction = $171,500
Reduction in common equity = Reduction in inventory = $171,500
New common equity = Old equity − Reduction = $108,500
Orig ROE = NI/Old Equity: 7.50%

New ROE = NI/New Equity: 19.35%
ΔROE = 11.85%
POINTS: 1
TOPICS: DSO and net income
113. Last year Hamdi Corp. had sales of $500,000, operating costs of $450,000, and year-end assets (which is equal to
its total invested capital) of $395,000. The debt-to-total-capital ratio was 17%, the interest rate on the debt was 7.5%,
and the firm's tax rate was 35%. The new CFO wants to see how the ROE would have been affected if the firm had used a
50% debt-to-total-capital ratio. Assume that sales, operating costs, total assets, total invested capital, and the tax rate
would not be affected, but the interest rate would rise to 8.0%. By how much would the ROE change in response to the
change in the capital structure?
a. 1.71%
b. 1.90%
c. 2.11%
d. 2.34%
e. 2.58%
ANSWER: d
RATIONALE: Old New
Interest rate 7.5% 8.0%
Tax rate 35% 35%
Assets = Total capital $395,000 $395,000
Debt-to-capital ratio 17% 50%
Debt = Capital × Debt ratio = $ 67,150 $197,500
Equity = Assets − Debt = $327,850 $197,500
Sales $500,000 $500,000

Operating costs 450,000 450,000
EBIT = Sales − Operating costs = $ 50,000 $ 50,000
Interest paid = Interest rate × Debt = 5,036 15,800
Taxable income $ 44,964 $ 34,200
Taxes 15,737 11,970
Net income $ 29,226 $ 22,230
ROE 8.91% 11.26%
Change in ROE 2.34%
POINTS: 1
TOPICS: ROE and debt
114. Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be $300,000,
operating costs to be $265,000, assets (which is equal to its total invested capital) to be $200,000, and its tax rate to be
35%. Under Plan A it would finance the firm using 25% debt and 75% common equity. The interest rate on the debt
would be 8.8%, but under a contract with existing bondholders the TIE ratio would have to be maintained at or above 4.0.
Under Plan B, the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs,
assets, total invested capital, 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?
a. 3.71%
b. 4.08%
c. 4.48%
d. 4.93%
e. 5.18%
ANSWER: a
RATIONALE: Work down the Plan A column, find the Max Debt, then use it to complete Plan B and the ROEs.
Plan A Plan B
Interest rate 8.80% 8.80%
Tax rate 35% 35%
Assets = Total capital $200,000 $200,000
Debt ratio: Plan A given, Plan B calculated 25% 49.7%
Debt $ 50,000 $ 99,432
Equity $150,000 $100,568
Sales Constant $300,000 $300,000

Operating costs Constant 265,000 265,000
EBIT Constant $ 35,000 $ 35,000
Interest 4,400 8,750
Taxable income $ 30,600 $ 26,250
Taxes 10,710 9,188
Net income $ 19,890 $ 17,063
ROE = NI/Equity = 13.26% 16.97%
TIE = EBIT/Interest = 7.95
Minimum TIE 4.00
$ of Interest consistent with minimum TIE
= EBIT/Min. TIE = $8,750
Max debt = Interest/interest rate = $99,432
Change in ROE 3.71%
POINTS: 1
Exhibit 4.1
The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it
does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled
over.
Balance Sheet (Millions of $)

Assets 2015
Cash and securities $ 2,500
Accounts receivable 11,500
Inventories 16,000
Total current assets $30,000
Net plant and equipment $20,000
Total assets $50,000
Liabilities and Equity
Accounts payable $ 9,500
Accruals 5,500
Notes payable 7,000
Total current liabilities $22,000
Long-term bonds $15,000

Total liabilities $37,000
Common stock $ 2,000
Retained earnings 11,000
Total common equity $13,000
Total liabilities and equity $50,000
Income Statement (Millions of $) 2015

Net sales $87,500
Operating costs except depreciation 81,813
Depreciation 1,531
Earnings bef interest and taxes (EBIT) $ 4,156
Less interest 1,375
Earnings before taxes (EBT) $ 2,781
Taxes 973
Net income $ 1,808

Other data:
Shares outstanding (millions) 500.00
Common dividends $632.73
Int rate on notes payable & L-T bonds 6.25%
Federal plus state income tax rate 35%
Year-end stock price $43.39
115. Refer to Exhibit 4.1. What is the firm's current ratio?

a. 0.99
b. 1.10
c. 1.23
d. 1.36
e. 1.50
ANSWER: d
RATIONALE: Current ratio = Current assets/Current liabilities = 1.36
POINTS: 1
DIFFICULTY: EASY
OTHER: Multiple Choice: Multiple Parts
116. Refer to Exhibit 4.1. What is the firm's quick ratio?

a. 0.51
b. 0.64
c. 0.76
d. 0.92
e. 1.10
ANSWER: b
RATIONALE: Quick ratio = (CA − Inventory)/CL = 0.64
POINTS: 1
DIFFICULTY: EASY
TOPICS: Quick ratio
117. Refer to Exhibit 4.1. What is the firm's days sales outstanding? Assume a 365-day year for this calculation.
a. 39.07
b. 41.13
c. 43.29
d. 45.57
e. 47.97
ANSWER: e

RATIONALE: DSO = Accounts receivable/(Sales/365) = 47.97
POINTS: 1
TOPICS: DSO
118. Refer to Exhibit 4.1. What is the firm's total assets turnover?
a. 1.12
b. 1.40
c. 1.75
d. 2.10
e. 2.52
ANSWER: c
RATIONALE: Total assets turnover ratio = TATO = Sales/Total assets = 1.75
POINTS: 1
DIFFICULTY: EASY
119. Refer to Exhibit 4.1. What is the firm's inventory turnover ratio?
a. 5.47
b. 5.74
c. 6.03
d. 6.33
e. 6.65
ANSWER: a
RATIONALE: Inventory turnover ratio = Sales/Inventory = 5.47
POINTS: 1
DIFFICULTY: EASY
TOPICS: Inventory turnover
120. Refer to Exhibit 4.1. What is the firm's TIE?

a. 2.20
b. 2.45
c. 2.72
d. 3.02
e. 3.33
ANSWER: d
RATIONALE: TIE = EBIT/Interest charges = 3.02
POINTS: 1
DIFFICULTY: EASY
TOPICS: Times interest earned
121. Refer to Exhibit 4.1. What is the firm's total debt to total capital ratio?
a. 48.55%
b. 53.95%
c. 59.94%
d. 62.80%
e. 68.11%
ANSWER: d
RATIONALE: Debt to capital ratio = Total debt/Total invested capital = 62.86%
POINTS: 1
DIFFICULTY: EASY
122. Refer to Exhibit 4.1. What is the firm's ROA?

a. 3.62%
b. 3.98%
c. 4.37%
d. 4.81%
e. 5.29%
ANSWER: a
RATIONALE: ROA = Net income/Total assets = 3.62%
POINTS: 1
DIFFICULTY: EASY
TOPICS: Return on assets
123. Refer to Exhibit 4.1. What is the firm's ROE?

a. 13.21%
b. 13.91%
c. 14.60%
d. 15.33%
e. 16.10%
ANSWER: b
RATIONALE: ROE = Net income/Common equity = 13.91%
POINTS: 1
DIFFICULTY: EASY
124. Refer to Exhibit 4.1. What is the firm's BEP?

a. 7.50%
b. 7.90%
c. 8.31%
d. 8.73%
e. 9.16%
ANSWER: c
RATIONALE: BEP = EBIT/Total assets = 8.31%
POINTS: 1
DIFFICULTY: EASY
TOPICS: Basic earning power
125. Refer to Exhibit 4.1. What is the firm's profit margin?

a. 1.51%
b. 1.67%
c. 1.86%
d. 2.07%
e. 2.27%
ANSWER: d
RATIONALE: Profit margin = Net income/Sales = 2.07%
POINTS: 1
DIFFICULTY: EASY
126. Refer to Exhibit 4.1. What is the firm's return on invested capital?
a. 4.25%
b. 5.67%
c. 7.72%
d. 9.33%
e. 11.87%
ANSWER: c
RATIONALE: Return on invested capital = [EBIT(1 – T)]/Total invested capital = 7.72%
POINTS: 1
TOPICS: Return on invested capital
127. Refer to Exhibit 4.1. What is the firm's operating margin?

a. 3.12%
b. 3.46%
c. 3.85%
d. 4.28%
e. 4.75%
ANSWER: e
RATIONALE: Operating margin = EBIT/Sales = 4.75%
POINTS: 1
DIFFICULTY: EASY
128. Refer to Exhibit 4.1. What is the firm's dividends per share?
a. $1.14
b. $1.27
c. $1.39
d. $1.53
e. $1.68
ANSWER: b
RATIONALE: DPS = Common dividends paid/Shares outstanding = $1.27
POINTS: 1
DIFFICULTY: EASY
TOPICS: DPS
129. Refer to Exhibit 4.1. What is the firm's EPS?

a. $3.26
b. $3.43
c. $3.62
d. $3.80
e. $3.99
ANSWER: c
RATIONALE: EPS = Net income/Common shares outstanding = $3.62
POINTS: 1
DIFFICULTY: EASY
TOPICS: EPS
130. Refer to Exhibit 4.1. What is the firm's P/E ratio?

a. 12.0
b. 12.6
c. 13.2
d. 13.9
e. 14.6
ANSWER: a
RATIONALE: P/E ratio = Price per share/Earnings per share = 12.0 We actually fixed the P/E ratio at 12 in order to get
a stock price. Either the price or the P/E ratio must be fixed or the model becomes very complicated and
a stock pricing equation is required.
POINTS: 1
DIFFICULTY: EASY
TOPICS: P/E ratio
131. Refer to Exhibit 4.1. What is the firm's book value per share?
a. $22.29
b. $23.47
c. $24.70
d. $26.00
e. $27.30
ANSWER: d
RATIONALE: BVPS = Common equity/Shares outstanding = $26.00
POINTS: 1
TOPICS: Book value per share

132. Refer to Exhibit 4.1. What is the firm's market-to-book ratio?
a. 0.87
b. 1.02
c. 1.21
d. 1.42
e. 1.67
ANSWER: e
RATIONALE: Market/book ratio (M/B) = Price per share/BVPS = 1.67
POINTS: 1
DIFFICULTY: EASY
TOPICS: Market/Book ratio
133. Refer to Exhibit 4.1. What is the firm's equity multiplier?

a. 3.85
b. 4.04
c. 4.24
d. 4.45
e. 4.68
ANSWER: a
RATIONALE: Equity multiplier = Total assets/Common equity = 3.85
POINTS: 1
TOPICS: Equity multiplier

Chapter 04 Analysis of Financial Statements

Uploaded by

Copyright:

Available Formats

You might also like

Chapter 04 Analysis of Financial Statements

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 04 Analysis of Financial Statements

Uploaded by

Copyright:

Available Formats

CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS

Cengage Learning Testing, Powered by Cognero Page 5

Cengage Learning Testing, Powered by Cognero Page 6

Cengage Learning Testing, Powered by Cognero Page 8

Cengage Learning Testing, Powered by Cognero Page 11

CR: A > B B>A

Demonstration that the second sentence is false: QR(B) < QR(A)

CR: A < B B<A

Cengage Learning Testing, Powered by Cognero Page 14

Multiple Choice: Conceptual

Cengage Learning Testing, Powered by Cognero Page 15

53. Which of the following statements is CORRECT?

55. Which of the following statements is CORRECT?

61. Which of the following statements is CORRECT?

64. Which of the following statements is CORRECT?

65. Which of the following statements is CORRECT?

66. Which of the following statements is CORRECT?

67. Which of the following statements is CORRECT?

Cengage Learning Testing, Powered by Cognero Page 22

ROE = PM × TATO × Eq. Mult. ROA

Cengage Learning Testing, Powered by Cognero Page 23

71. Which of the following statements is CORRECT?

Cengage Learning Testing, Powered by Cognero Page 24

75. Which of the following statements is CORRECT?

76. Which of the following statements is CORRECT?

77. Which of the following statements is CORRECT?

78. Which of the following statements is CORRECT?

79. Which of the following statements is CORRECT?

Cengage Learning Testing, Powered by Cognero Page 28

2.00 1.50 CR falls because initial CR is greater than 1.0

0.50 0.67 CR rises because initial CR is less than 1.0

All of the statements except b are incorrect.

83. Which of the following statements is CORRECT?

Multiple Choice: Problems

Cengage Learning Testing, Powered by Cognero Page 30

Cengage Learning Testing, Powered by Cognero Page 31

ROIC = [EBIT(1 – T)]/(STD + LTD + E) 15%

Now calculate EBIT:

Calculate ROIC: ROIC = [EBIT(1 – T)]/(D + E) = [$150,000(0.6)]/$875,000 = 10.29%

Now determine net income from income statement:

ROE = NI/E = $73,200/$525,000 = 13.94%

Cengage Learning Testing, Powered by Cognero Page 40

Cengage Learning Testing, Powered by Cognero Page 41

Actual current ratio 5.20

Old current assets = $364,000

Orig ROE = NI/Old Equity: 7.50%

Sales $500,000 $500,000

Sales Constant $300,000 $300,000

Balance Sheet (Millions of $)

Long-term bonds $15,000

Income Statement (Millions of $) 2015

Cengage Learning Testing, Powered by Cognero Page 47

115. Refer to Exhibit 4.1. What is the firm's current ratio?

116. Refer to Exhibit 4.1. What is the firm's quick ratio?

Cengage Learning Testing, Powered by Cognero Page 48

120. Refer to Exhibit 4.1. What is the firm's TIE?

122. Refer to Exhibit 4.1. What is the firm's ROA?

123. Refer to Exhibit 4.1. What is the firm's ROE?

124. Refer to Exhibit 4.1. What is the firm's BEP?