Principles of Corporate Finance 2nd Canadian Edition by Gitman Test Bank

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Principles of Corporate Finance 2nd Canadian Edition by Gitman Test Bank

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Exam

Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Ratios provide a ________ measure of a companys performance and condition. 1)
A) qualitative B) gross C) definitive D) relative
Answer: D
Explanation: A)
B)
C)
D)
2) As the financial leverage multiplier increases this may result in 2)
A) an increase in the net profit margin and return on investment, due to the increase in interest expense as debt increases.
B) a decrease in the net profit margin and return on investment, due to the increase in interest expense as debt increases.

C) a decrease in the net profit margin and return on investment, due to the decrease in interest expense as debt decreases.

D) an increase in the net profit margin and return on investment, due to the decrease in interest expense as debt decreases.

Answer: B
Explanation: A)
B)
C)
D)

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

1

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900
Balance Sheet
Dana Dairy Products
December 31, 2002
ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000

2

3) Dana Dairy Products gross profit margin is inferior to the industry standard. This may have 3)
resulted from (See Figure 3.2)
A) excessive interest expense.
B) the high cost of goods sold.
C) excessive selling and administrative expenses.
D) a high sales price.
Answer: B
Explanation: A)
B)
C)
D)

4) Since 2001, the liquidity of Dana Dairy Products ________. (See Figure 3.2) 4)
A) remained the same B) has improved
C) has deteriorated D) cannot be determined
Answer: C
Explanation: A)
B)
C)
D)
5) In the DuPont system, the return on total assets (asset) is equal to 5)
A) (net profit margin) (fixed asset turnover).
B) (return on equity) (financial leverage multiplier).
C) (return on equity) (total asset turnover).
D) (net profit margin) (total asset turnover).
Answer: D
Explanation: A)
B)
C)
D)
6) The ________ of a business firm is measured by its ability to satisfy its short-term obligations as 6)
they come due.
A) activity B) debt C) liquidity D) profitability
Answer: C
Explanation: A)
B)
C)
D)
7) The ________ ratio is commonly used to assess the owners appraisal of the share value. 7)
A) price/earnings B) debt
C) return on equity D) return on total assets
Answer: A
Explanation: A)
B)
C)
D)

3

8) The ________ measures the overall effectiveness of management in generating profits with its 8)
available assets.
A) return on equity B) return on total assets
C) price/earnings ratio D) net profit margin
Answer: B
Explanation: A)
B)
C)
D)
9) The ________ ratios are primarily measures of return. 9)
A) liquidity B) profitability C) activity D) debt
Answer: B
Explanation: A)
B)
C)
D)
10) The analyst should be careful when evaluating a ratio analysis that 10)
A) the dates of the financial statements being compared are from the same time.
B) pre-audited statements are used.
C) the overall performance of the firm may be judged on a single ratio.
D) all of the above.

Answer: A
Explanation: A)
B)
C)
D)

11) The ________ measures the return on owners (both preferred and common stockholders) 11)
investment in the firm.
A) net profit margin B) return on equity
C) return on total assets D) price/earnings ratio
Answer: B
Explanation: A)
B)
C)
D)
12) The ________ is a measure of liquidity which excludes ________, generally the least liquid asset. 12)
A) current ratio; accounts receivable B) quick ratio; inventory
C) current ratio; inventory D) quick ratio; accounts receivable
Answer: B
Explanation: A)
B)
C)
D)

4

13) The ________ ratio may indicate that the firm will not be able to meet interest obligations due on 13)
outstanding debt.
A) return on total assets B) times interest earned
C) debt D) net profit margin

Answer: B
Explanation: A)
B)
C)
D)

14) As a firms cash flows become more predictable, A) current liabilities will decrease.
C) the return on equity will increase.

14)
B) the current ratio will expand.
D) current assets will decrease.

Answer: D
Explanation: A)
B)
C)
D)

15) To analyze the firms financial performance, the following types of ratio analyses EXCEPT ________ 15)
may be used.
A) marginal analysis B) time-series analysis
C) cross-section analysis D) combined analysis
Answer: A
Explanation: A)
B)
C)
D)
16) The two categories of ratios that should be utilized to assess a firms true liquidity are the 16)
A) liquidity and profitability ratios. B) liquidity and debt ratios.
C) current and quick ratios. D) liquidity and activity ratios.
Answer: D
Explanation: A)
B)
C)
D)
17) The ________ ratio may indicate the firm is experiencing stockouts and lost sales. 17)
A) quick B) inventory turnover
C) average collection period D) average payment period
Answer: B
Explanation: A)
B)
C)
D)

5

18) A firm has a current ratio of 1; in order to improve its liquidity ratios, this firm might 18)
A) improve its collection practices and pay accounts payable, thereby decreasing current liabilities and increasing the current and quick ratios.
B) increase inventory, thereby increasing current assets and the current and quick ratios.
C) decrease current liabilities by utilizing more long-term debt, thereby increasing the current and quick ratios.
D) improve its collection practices, thereby increasing cash and increasing its current and quick ratios.

Answer: C
Explanation: A)
B)
C)
D)

19) The ________ ratio may indicate poor collections procedures or a lax credit policy. 19)
A) quick B) average collection period
C) average payment period D) inventory turnover

Answer: B
Explanation: A)
B)
C)
D)

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

6

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900
Balance Sheet
Dana Dairy Products
December 31, 2002
ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000
20) The debt ratio for Dana Dairy Products in 2002 is (See Figure 3.2) 20)
A) 11 percent. B) 44 percent. C) 50 percent. D) 55 percent.
Answer: D
Explanation: A)
B)
C)
D)

7

FIGURE 3.1

Balance Sheet
Cole Eagan Enterprises
December 31, 2002

Cash $4,500 Accounts Payable $10,000
Accounts Receivable Notes Payable
Inventories Accruals 1,000
Total Current Assets Total Current Liab.
Net Fixed Assets Long-Term Debt
Total Assets Stockholders Equity
Total Liab. & S.E.
Information (2002 values)
1. Sales totaled $110,000
2. The gross profit margin was 25 percent.
3. Inventory turnover was 3.0.
4. There are 360 days in the year.
5. The average collection period was 65 days.
6. The current ratio was 2.40.
7. The total asset turnover was 1.13.
8. The debt ratio was 53.8 percent.
21) Net fixed assets for CEE in 2002 were ________. (See Figure 3.1) 21)
A) $45,484 B) $69,341 C) $48,975 D) $54,511
Answer: A
Explanation: A)
B)
C)
D)
22) Accounts receivable for CEE in 2002 was ________. (See Figure 3.1) 22)
A) $19,861 B) $14,056 C) $14,895 D) $18,333
Answer: A
Explanation: A)
B)
C)
D)
23) Over the last year, a firms average collection period increased from 30 days to 45 days. This 23)
increase could be the result of
A) a slowdown in the economy.
B) the deterioration of the product you sell.
C) a loss of the accounts receivable manager due to a heart attack.
D) all of the above.
Answer: D
Explanation: A)
B)
C)
D)

8

24) A firm with a substandard net profit margin can improve its return on total assets by 24)
A) increasing its debt ratio. B) increasing its total asset turnover.
C) decreasing its total asset turnover. D) decreasing its fixed asset turnover.
Answer: B
Explanation: A)
B)
C)
D)
25) ________ is a term used to describe the magnification of risk and return introduced through the use 25)
of fixed cost financing such as preferred stock and long-term debt.
A) Financial leverage B) The acid-test
C) Fixed-payment coverage D) Operating leverage
Answer: A
Explanation: A)
B)
C)
D)

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

9

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900
Balance Sheet
Dana Dairy Products
December 31, 2002
ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000
26) The return on equity for Dana Dairy Products for 2002 is (See Figure 3.2) 26)
A) 0.6 percent. B) 50 percent. C) 5.6 percent. D) 0.9 percent.
Answer: C
Explanation: A)
B)
C)
D)

10

27) The ________ ratios provide the information critical to the long-run operation of the firm. 27)
A) profitability B) activity C) liquidity D) debt
Answer: D
Explanation: A)
B)
C)
D)
28) ________ is used by financial managers as a structure for dissecting the firms financial statements 28)
to assess its financial condition.
A) A statement of cash flows B) A cross-sectional analysis
C) The DuPont system of analysis D) A common-size income statement
Answer: C
Explanation: A)
B)
C)
D)
29) ________ are especially interested in the average payment period, since it provides them with a 29)
sense of the bill-paying patterns of the firm.
A) Customers B) Borrowers and buyers
C) Stockholders D) Lenders and suppliers
Answer: D
Explanation: A)
B)
C)
D)
30) Two frequently cited ratios of profitability that can be read directly from the common-size income 30)
statement are:
A) the gross profit margin and the net profit margin.
B) the gross profit margin and the earnings per share.
C) the gross profit margin and the return on total assets.
D) the earnings per share and the return on total assets.
Answer: A
Explanation: A)
B)
C)
D)
31) Present and prospective shareholders are mainly concerned with a firms 31)
A) risk and return. B) leverage. C) profitability. D) liquidity.
Answer: A
Explanation: A)
B)
C)
D)

11

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900

Balance Sheet
Dana Dairy Products
December 31, 2002

12

ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000
32) The average collection period for Dana Dairy Products in 2002 is (See Figure 3.2) 32)
A) 11 days. B) 25 days. C) 35 days. D) 32 days.
Answer: D
Explanation: A)
B)
C)
D)
33) The higher the value of ________ ratio, the better able the firm is to fulfill its interest obligations. 33)
A) debt B) times interest earned
C) average payment period D) average collection period
Answer: B
Explanation: A)
B)
C)
D)

13

34) In ratio analysis, a comparison to a standard industry ratio is made to isolate ________ deviations 34)
from the norm.
A) standard B) negative C) positive D) any
Answer: D
Explanation: A)
B)
C)
D)
35) A firm with a total asset turnover lower than industry standard may have 35)
A) excessive cost of goods sold. B) insufficient fixed assets.
C) excessive debt. D) insufficient sales.
Answer: D
Explanation: A)
B)
C)
D)
36) A firm with a total asset turnover lower than industry standard and a current ratio which meets 36)
industry standard must have excessive
A) fixed assets. B) debt.
C) accounts receivable. D) inventory.
Answer: A
Explanation: A)
B)
C)
D)
37) In the DuPont system, the return on equity is equal to 37)
A) (stockholders equity) (financial leverage multiplier).
B) (net profit margin) (total asset turnover).
C) (return on total assets) (financial leverage multiplier).
D) (return on total assets) (total asset turnover).

Answer: C
Explanation: A)
B)
C)
D)

38) Without adjustment, inflation may tend to cause ________ firms to appear more efficient and 38)
profitable than ________ firms, all else being the same.
A) newer; older B) older; newer C) large; smaller D) smaller; larger

Answer: B
Explanation: A)
B)
C)
D)

14

39) The ________ ratio measures the firms ability to pay contractual interest payments. 39)
A) times interest earned B) average payment period
C) fixed-payment coverage D) debt

Answer: A
Explanation: A)
B)
C)
D)

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900

Balance Sheet
Dana Dairy Products
December 31, 2002

15

ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000
40) The net working capital for Dana Dairy Products in 2002 is ________. (See Figure 3.2) 40)
A) $1,425 B) -$1,425 C) $14,250 D) $10,325
Answer: B
Explanation: A)
B)
C)
D)
41) The current ratio for Dana Dairy Products in 2002 is ________. (See Figure 3.2) 41)
A) 0.91 B) 1.58 C) 1.10 D) 0.63
Answer: A
Explanation: A)
B)
C)
D)

16

42) A firm with a gross profit margin which meets industry standard and a net profit margin which is 42)
below industry standard must have excessive
A) dividend payments. B) principal payments.
C) cost of goods sold. D) general and administrative expenses.

Answer: D
Explanation: A)
B)
C)
D)

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900

Balance Sheet
Dana Dairy Products
December 31, 2002

17

ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000
43) The inventory management at Dana Dairy Products ________ since 2001. (See Figure 3.2) 43)
A) remained the same B) has improved slightly
C) has deteriorated D) cannot be determined
Answer: B
Explanation: A)
B)
C)
D)

44) The DuPont system merges the income statement and balance sheet into two summary measures of 44) profitability:
A) return on total assets and return on equity.
B) net profit margin and return on equity.
C) net profit margin and price/earning ratio.
D) net profit margin and return on total assets.

Answer: A
Explanation: A)
B)
C)
D)

18

45) Inflation can distort 45)
A) accumulated depreciation. B) interest write-offs.
C) salaries and wages. D) inventory costs.
Answer: D
Explanation: A)
B)
C)
D)
46) The ________ measures the percentage of each sales dollar remaining after ALL expenses, 46)
including taxes, have been deducted.
A) operating profit margin
B) gross profit margin
C) earnings available to common shareholders
D) net profit margin
Answer: D
Explanation: A)
B)
C)
D)
47) An increase in financial leverage will result in ________ in the return on equity. 47)
A) an increase B) no change
C) a decrease D) an undetermined change
Answer: A
Explanation: A)
B)
C)
D)

19

FIGURE 3.1

Balance Sheet
Cole Eagan Enterprises
December 31, 2002

Cash $4,500 Accounts Payable $10,000
Accounts Receivable Notes Payable
Inventories Accruals 1,000
Total Current Assets Total Current Liab.
Net Fixed Assets Long-Term Debt
Total Assets Stockholders Equity
Total Liab. & S.E.
Information (2002 values)
1. Sales totaled $110,000
2. The gross profit margin was 25 percent.
3. Inventory turnover was 3.0.
4. There are 360 days in the year.
5. The average collection period was 65 days.
6. The current ratio was 2.40.
7. The total asset turnover was 1.13.
8. The debt ratio was 53.8 percent.
48) Total assets for CEE in 2002 were ________. (See Figure 3.1) 48)
A) $58,603 B) $124,300 C) $45,895 D) $97,345
Answer: D
Explanation: A)
B)
C)
D)
49) Which of the following firms would have the slowest inventory turnover ratio? 49)
A) Macs convenience stores B) Canada Safeway
C) Prestons Jewellers D) Walmart
Answer: C
Explanation: A)
B)
C)
D)
50) The ________ ratio measures the proportion of total assets provided by the firms creditors. 50)
A) total asset turnover B) fixed asset turnover
C) debt D) current
Answer: C
Explanation: A)
B)
C)
D)

20

51) A firm with a total asset turnover lower than the industry standard may have 51)
A) excessive debt. B) insufficient sales.
C) excessive cost of goods sold. D) insufficient fixed assets.

Answer: B
Explanation: A)
B)
C)
D)

52) A firm with a substandard return on total assets can improve its return on equity, all else remaining 52)
the same, by
A) decreasing its debt ratio. B) increasing its total asset turnover.
C) increasing its debt ratio. D) decreasing its total asset turnover.

Answer: C
Explanation: A)
B)
C)
D)

53) A firm with sales of $1,000,000, net income after taxes of $30,000, total assets of $1,500,000, and total 53)
liabilities of $750,000 has a return on equity of
A) 4 percent. B) 15 percent. C) 20 percent. D) 3 percent.
Answer: A
Explanation: A)
B)
C)
D)
FIGURE 3.2
Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

21

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900
Balance Sheet
Dana Dairy Products
December 31, 2002
ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000
54) The return on total assets for Dana Dairy Products for 2002 is (See Figure 3.2) 54)
A) 5.5 percent. B) 25 percent. C) 2.5 percent. D) 0.9 percent.
Answer: C
Explanation: A)
B)
C)
D)

22

55) If a project was financed with 50% equity and 50% debt costing 8%, the return on equity would be 55)
________ assuming the project pays a ________ return.
A) 10%; 8% B) 24%; 16% C) 16%; 10% D) 28%; 21%
Answer: B
Explanation: A)
B)
C)
D)
56) The ________ indicates the percentage of each sales dollar remaining after the firm has paid for its 56)
goods.
A) operating profit margin
B) gross profit margin
C) earnings available to common shareholders
D) net profit margin
Answer: B
Explanation: A)
B)
C)
D)
57) Time-series analysis is often used to 57)
A) standardize results.
B) reflect performance relative to some norm.
C) assess developing trends.
D) correct errors of judgement.

Answer: C
Explanation: A)
B)
C)
D)

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

23

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900
Balance Sheet
Dana Dairy Products
December 31, 2002
ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000

24

58) The inventory turnover for Dana Dairy Products in 2002 is ________. (See Figure 3.2) 58)
A) 5 B) 25 C) 20 D) 43
Answer: C
Explanation: A)
B)
C)
D)
59) The ________ is useful in evaluating credit and collection policies. 59)
A) current ratio B) current asset turnover
C) average payment period D) average collection period
Answer: D
Explanation: A)
B)
C)
D)
60) ________ analysis involves comparison of current to past performance and the evaluation of 60)
developing trends.
A) Quantitative B) Marginal C) Time-series D) Cross-sectional
Answer: C
Explanation: A)
B)
C)
D)
61) The following groups of ratios provide the information critical to the short-run operation of the 61)
firm:
A) liquidity, activity, and common stock. B) liquidity, activity, and debt.
C) liquidity, activity, and profitability. D) activity, debt, and profitability.
Answer: C
Explanation: A)
B)
C)
D)
62) The ________ is useful in evaluating credit and collection policies. 62)
A) average collection period B) current asset turnover
C) current ratio D) average payment period
Answer: A
Explanation: A)
B)
C)
D)

25

63) ________ evidence of the existence of a problem or outstanding management performance is 63)
provided by ratio analysis.
A) Complete B) Definitive C) Conclusive D) Inconclusive
Answer: D
Explanation: A)
B)
C)
D)
64) The ________ is a popular approach for evaluating profitability in relation to sales by expressing 64)
each item on the income statement as a percent of sales.
A) retained earnings statement B) common-size income statement
C) profit and loss statement D) source and use statement
Answer: B
Explanation: A)
B)
C)
D)
65) The ________ measures the activity, or liquidity, of a firms inventory. 65)
A) current ratio B) quick ratio
C) inventory turnover D) average collection period
Answer: C
Explanation: A)
B)
C)
D)
66) A firm with a total asset turnover lower than the industry standard and a current ratio which meets 66)
the industry standard may have
A) excessive inventory. B) excessive accounts receivable.
C) excessive debt. D) excessive fixed assets.
Answer: D
Explanation: A)
B)
C)
D)
67) A decrease in total asset turnover will result in ________ in the return on equity. 67)
A) an increase B) an undetermined change
C) a decrease D) no change
Answer: C
Explanation: A)
B)
C)
D)

26

68) Which of the following ratios is difficult for creditors of a firm to analyze because the data is 68)
usually not available in published financial statements?
A) quick ratio B) average age of inventory
C) operating leverage D) average payment period
Answer: D
Explanation: A)
B)
C)
D)
69) When assessing the fixed-payment coverage ratio, 69)
A) the higher its value, the higher is the firms liquidity.
B) preferred stock dividend payments can be disregarded.
C) the lower its value the more risky is the firm.
D) the lower its value, the lower is the firms financial leverage.

Answer: C
Explanation: A)
B)
C)
D)

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

27

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900
Balance Sheet
Dana Dairy Products
December 31, 2002
ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000

28

70) If Dana Dairy Products has credit terms which specify that accounts receivable should be paid in 25 70) days, the average collection period ________ since 2001. (See Figure 3.2)
A) has improved
B) has deteriorated
C) remained the same D) cannot be determined
Answer: B
Explanation: A)
B)
C)
D)

71) An analysis in which the firms ratio values are compared to those of a key competitor or group of 71)
competitors, primarily to identify areas for improvement is called
A) combined analysis. B) time-series analysis.
C) benchmarking. D) none of the above.
Answer: C
Explanation: A)
B)
C)
D)
72) ________ ratios are a measure of the speed with which various accounts are converted into sales or 72)
cash.
A) Liquidity B) Debt C) Activity D) Profitability
Answer: C
Explanation: A)
B)
C)
D)

29

FIGURE 3.1

Balance Sheet
Cole Eagan Enterprises
December 31, 2002

Cash $4,500 Accounts Payable $10,000
Accounts Receivable Notes Payable
Inventories Accruals 1,000
Total Current Assets Total Current Liab.
Net Fixed Assets Long-Term Debt
Total Assets Stockholders Equity
Total Liab. & S.E.
Information (2002 values)
1. Sales totaled $110,000
2. The gross profit margin was 25 percent.
3. Inventory turnover was 3.0.
4. There are 360 days in the year.
5. The average collection period was 65 days.
6. The current ratio was 2.40.
7. The total asset turnover was 1.13.
8. The debt ratio was 53.8 percent.
73) Notes payable for CEE in 2002 were ________. (See Figure 3.1) 73)
A) $10,608 B) $52,372 C) $41,372 D) $113,466
Answer: A
Explanation: A)
B)
C)
D)
74) The primary concern of creditors when assessing the strength of a firm is the firms 74)
A) profitability. B) share price.
C) leverage. D) short-term liquidity.
Answer: D
Explanation: A)
B)
C)
D)
75) ABC Corp. extends credit terms of 45 days to its customers. Its credit collection would be 75)
considered poor if its average collection period was
A) 47 days. B) 57 days. C) 36 days. D) 30 days.
Answer: B
Explanation: A)
B)
C)
D)

30

76) ________ analysis involves the comparison of different firms financial ratios at the same point in 76)
time.
A) Cross-sectional B) Quantitative C) Time-series D) Marginal
Answer: A
Explanation: A)
B)
C)
D)
77) One means to negate the effect of inflation on ratio analysis is to value the fixed assets at 77)
A) replacement value. B) liquidation value.
C) book value. D) depreciation.
Answer: A
Explanation: A)
B)
C)
D)
78) The three summary ratios basic to the DuPont system of analysis are 78)
A) net profit margin, total asset turnover, and return on equity.
B) net profit margin, total asset turnover, and equity multiplier.
C) net profit margin, financial leverage multiplier, and return on equity.
D) net profit margin, total asset turnover, and return on investment.

Answer: B
Explanation: A)
B)
C)
D)

79) The financial leverage multiplier is an indicator of a corporation utilizing 79)
A) total debt. B) operating leverage.
C) long-term debt. D) total assets.
Answer: A
Explanation: A)
B)
C)
D)
80) The two basic measures of liquidity are 80)
A) inventory turnover and current ratio. B) current ratio and total asset turnover.
C) current ratio and quick ratio. D) gross profit margin and ROE.
Answer: C
Explanation: A)
B)
C)
D)

31

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900

Balance Sheet
Dana Dairy Products
December 31, 2002

32

ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000
81) The gross profit margin and net profit margin for Dana Dairy Products in 2002 are (See Figure 3.2) 81)
A) 2 percent and 1.5 percent, respectively. B) 2 percent and 0.9 percent, respectively.
C) 13 percent and 1.5 percent, respectively. D) 13 percent and 0.9 percent, respectively.
Answer: D
Explanation: A)
B)
C)
D)
82) The analyst should be careful when evaluating ratios that 82)
A) audited statements are used.
B) the dates of the financial statements being compared are the same.
C) the overall performance of the firm is not judged on a single ratio.
D) all of the above.

Answer: D
Explanation: A)
B)
C)
D)

33

83) Cross-sectional ratio analysis is used to 83)
A) isolate the causes of problems.
B) correct expected problems in operations.
C) provide conclusive evidence of the existence of a problem.
D) reflect the symptoms of a possible problem.

Answer: D
Explanation: A)
B)
C)
D)

84) 84) The ________ measures the percentage of profit earned on each sales dollar before interest and

taxes.
A) gross profit margin
B) operating profit margin
C) net profit margin
D) earnings available to common shareholders

Answer: B
Explanation: A)
B)
C)
D)

85) The following groups of ratios primarily measure risk:

A) activity, debt, and profitability.
C) liquidity, activity, and profitability.

85)
B) liquidity, activity, and debt.
D) liquidity, activity, and common stock.

Answer: B
Explanation: A)
B)
C)
D)

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products

34

For the Year Ended December 31, 2002

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900
Balance Sheet
Dana Dairy Products
December 31, 2002
ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000

35

86) Dana Dairy Products has a ________ degree of financial leverage than the industry standard, 86)
resulting in ________. (See Figure 3.2)
A) higher; higher return on total assets B) higher; higher return on equity
C) lower; lower return on equity D) lower; lower return on total assets

Answer: C
Explanation: A)
B)
C)
D)

FIGURE 3.1

Balance Sheet
Cole Eagan Enterprises
December 31, 2002

Cash $4,500 Accounts Payable $10,000
Accounts Receivable Notes Payable
Inventories Accruals 1,000
Total Current Assets Total Current Liab.
Net Fixed Assets Long-Term Debt
Total Assets Stockholders Equity
Total Liab. & S.E.

Information (2002 values)
1. Sales totaled $110,000
2. The gross profit margin was 25 percent.
3. Inventory turnover was 3.0.
4. There are 360 days in the year.
5. The average collection period was 65 days.
6. The current ratio was 2.40.
7. The total asset turnover was 1.13.
8. The debt ratio was 53.8 percent.

87) Long-term debt for CEE in 2002 was ________. (See Figure 3.1) 87)
A) $41,372 B) $10,608 C) $30,737 D) $52,372
Answer: C
Explanation: A)
B)
C)
D)
88) The financial leverage multiplier is an indicator of a corporation utilizing 88)
A) current liabilities. B) financial leverage.
C) long-term debt. D) operating leverage.
Answer: B
Explanation: A)
B)
C)
D)

36

FIGURE 3.2

Dana Dairy Products Key Ratio

Industry Actual Actual
Average 2001 2002

Current Ratio 1.3 1.0
Quick Ratio 0.8 0.75
Average collection Period 23 days 30 days
Inventory Turnover 21.7 19
Debt Ratio 64.7% 50%
Times Interest Earned 4.8 5.5
Gross Profit Margin 13.6% 12.0%
Net Profit Margin 1.0% 0.5%
Return on total assets 2.9% 2.0%
Return on Equity 8.2% 4.0%

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2002

Sales Revenue $100,000
Less: Cost of Goods Sold 87,000
-
Gross Profits $ 13,000
Less: Operating Expenses 11,000
-
Operating Profits $ 2,000
Less: Interest Expense 500
-
Net Profits Before Taxes $ 1,500
Less: Taxes (40%) 600
-
Net Profits After Taxes $ 900

Balance Sheet
Dana Dairy Products
December 31, 2002

37

ASSETS
Cash $ 1,000
Accounts Receivable 8,900
Inventories 4,350
-
Total Current Assets $14,250
Gross Fixed Assets $35,000
Less: Accumulated Depreciation 13,250
Net Fixed Assets 21,750
-
Total Assets $36,000
Liabilities & Stockholders Equity
Accounts Payable $ 9,000
Accruals 6,675
-
Total Current Liabilities $15,675
Long-term Debts 4,125
-
Total Liabilities $19,800
Common Stock 1,000
Retained Earnings 15,200
-
Total Stockholders Equity $16,200
-
Total Liab. & S.E. $36,000
89) Using the modified DuPont formula allows the analyst to break Dana Dairy Products return on 89)
equity into 3 components: the net profit margin, the total asset turnover, and a measure of leverage
(the financial leverage multiplier). Which of the following mathematical expressions represents the modified DuPont formula relative to Dana Dairy Products 2002 performance? (See Figure 3.2)
A) 5.6(ROE) = 2.5(ROA) 2.24(Financial leverage multiplier)
B) 5.6(ROE) = 3.3(ROA) 1.70(Financial leverage multiplier)
C) 2.5(ROE) = 5.6(ROA) 0.44(Financial leverage multiplier)
D) 4.0(ROE) = 2.0(ROA) 2.00(Financial leverage multiplier)

Answer: A
Explanation: A)
B)
C)
D)

90) The modified DuPont formula relates the firms return on total assets (ROA) to the 90)
A) return on equity (ROE). B) net profit margin.
C) total asset turnover. D) financial leverage multiplier.

Answer: A
Explanation: A)
B)
C)
D)

38

FIGURE 3.1

Balance Sheet
Cole Eagan Enterprises
December 31, 2002

Cash $4,500 Accounts Payable $10,000
Accounts Receivable Notes Payable
Inventories Accruals 1,000
Total Current Assets Total Current Liab.
Net Fixed Assets Long-Term Debt
Total Assets Stockholders Equity
Total Liab. & S.E.
Information (2002 values)
1. Sales totaled $110,000
2. The gross profit margin was 25 percent.
3. Inventory turnover was 3.0.
4. There are 360 days in the year.
5. The average collection period was 65 days.
6. The current ratio was 2.40.
7. The total asset turnover was 1.13.
8. The debt ratio was 53.8 percent.
91) Inventories for CEE in 2002 were ________. (See Figure 3.1) 91)
A) $27,500 B) $36,667 C) $32,448 D) $ 9,167
Answer: A
Explanation: A)
B)
C)
D)
92) If the inventory turnover is divided into 360, it becomes a measure of 92)
A) the average collection period. B) sales turnover.
C) sales efficiency. D) the average age of the inventory.
Answer: D
Explanation: A)
B)
C)
D)
93) In the near term, the important ratios that provide the information critical to the short-run 93)
operation of the firm are
A) liquidity, activity, and debt. B) activity, debt, and profitability.
C) liquidity, activity, and common stock. D) liquidity, activity, and profitability.
Answer: D
Explanation: A)
B)
C)
D)

39

TRUE/FALSE. Write T if the statement is true and F if the statement is false.

94) The firms creditors are primarily interested in the short-term liquidity of the company and its 94)
ability to make interest and principal payments.
Answer: True False
Explanation:
95) The net profit margin measures the percentage of each sales dollar remaining after all costs and 95)
expenses, including interest and taxes, have been deducted.
Answer: True False
Explanation:
96) If a firm has annual sales of $2,000,000, gross profit of $800,000 and an average investment in 96)
accounts payable of $100,000, the firms payables period is 15 days (one-half month).
Answer: True False
Explanation:
97) If a firm has annual sales of $1,000,000, a gross profit margin of 20% and an average investment in 97)
accounts receivable of $100,000, the firms receivables turnover is eight times per year.
Answer: True False
Explanation:
98) Benchmarking is a type of cross-sectional analysis in which the firms ratio values are compared to 98)
those of firms in other industries, primarily to identify areas for improvement.
Answer: True False
Explanation:
99) The price/earnings (P/E) ratio represents the degree of confidence that investors have in the firms 99)
future performance.
Answer: True False
Explanation:
100) Earnings per share represents the dollar amount earned and distributed to shareholders. 100)
Answer: True False
Explanation:
101) The gross margin measures the percentage of each sales dollar left after the firm has paid for its cost 101)
of goods sold and operating expenses.
Answer: True False
Explanation:
102) Present and prospective shareholders and lenders pay close attention to the firms degree of 102)
indebtedness and ability to repay debt. Shareholders are concerned since the claims of creditors
must be satisfied prior to the distribution of earnings to them. Lenders are concerned since the
more indebted the firm, the higher the probability that the firm will be unable to satisfy the claims
of all its creditors.
Answer: True False
Explanation:

40

103) The time-series analysis evaluates performance of firms at the same point in time using financial 103)
ratios.
Answer: True False
Explanation:
104) Total asset turnover commonly measures the liquidity of a firms total assets. 104)
Answer: True False
Explanation:
105) Ratio analysis merely directs the analyst to potential areas of concern; it does not provide 105)
conclusive evidence as to the existence of a problem.
Answer: True False
Explanation:
106) The cross-section ratio analysis involves comparing the firms ratios to those of firms in other 106)
industries at the same point in time.
Answer: True False
Explanation:
107) Since the differences in the composition of a firms current assets and liabilities can significantly 107)
affect the firms true liquidity, it is important to look beyond measures of overall liquidity to
assess the activity (liquidity) of specific current accounts.
Answer: True False
Explanation:
108) The liquidity of a business firm refers to the solvency of the firms overall financial position. 108)
Answer: True False
Explanation:
109) The use of differing accounting treatments especially relative to inventory and depreciation can 109)
distort the results of ratio analysis, regardless of whether cross-sectional or time-series analysis is
used.
Answer: True False
Explanation:
110) The liquidity of a business firm is measured by its ability to satisfy its long-term obligations as they 110)
come due.
Answer: True False
Explanation:
111) In general, the more debt (other peoples money) a firm uses in relation to its assets, the smaller its 111)
financial leverage.
Answer: True False
Explanation:
112) In cross-sectional comparison of firms operating in several lines of business, the industry average 112)
ratios of any of the firms product lines may be used to analyze the multiproduct firms financial
performance.
Answer: True False
Explanation:

41

113) Typically, higher coverage ratios are preferred, but too high a ratio may indicate under utilization 113)
of fixed-payment obligations, which may result in unnecessarily low risk and return.
Answer: True False
Explanation:
114) The inflationary effects typically have greater impact, the larger the differences in the age of the 114)
assets of the firms being compared. Without adjustment, inflation tends to cause older firms (older
assets) to appear more efficient and profitable than newer firms (newer assets).
Answer: True False
Explanation:
115) If an analysis is concerned only with certain specific aspects of a firms financial position, one or 115)
two ratios may provide sufficient information from which to make a reasonable judgement.
Answer: True False
Explanation:
116) The DuPont formula allows the firm to break down its return into the net profit margin, which 116)
measures the firms profitability on sales, and its total asset turnover, which indicates how
efficiently the firm has used its assets to generate sales.
Answer: True False
Explanation:
117) The return on total assets (ROA) measures the overall effectiveness of management in generating 117)
profits with the owners investment in the firm.
Answer: True False
Explanation:
118) The higher the value of the times interest earned ratio, the higher the proportion of the firms 118)
interest earnings compared to its contractual interest payments.
Answer: True False
Explanation:
119) The use of the audited financial statements for ratio analysis may not be preferable because there 119)
may be no reason to believe that the data contained in them reflect the firms true financial
condition.
Answer: True False
Explanation:
120) Time-series analysis is the evaluation of the firms financial performance in comparison to other 120)
firms at the same point in time.
Answer: True False
Explanation:
121) The less fixed-cost debt, or financial leverage, a firm uses, the greater will be its risk and return. 121)
Answer: True False
Explanation:

42

122) The current ratio provides a better measure of overall liquidity only when a firms inventory cannot 122)
easily be converted into cash. If inventory is liquid, the quick ratio is a preferred measure of overall
liquidity.
Answer: True False
Explanation:
123) If a firm has annual sales of $600,000, a gross profit margin of 40% and an average inventory 123)
balance of $60,000, the firms inventory period is 60 days (two months).
Answer: True False
Explanation:
124) As a rule, the necessary inputs to an effective financial analysis include, at minimum, the income 124)
statement and the statement of cash flow.
Answer: True False
Explanation:
125) The lower the fixed-payment coverage ratio, the lower is the firms financial leverage. 125)
Answer: True False
Explanation:
126) The average age of inventory is viewed as the average length of time inventory is held by the firm 126)
or as the average number of days sales in inventory.
Answer: True False
Explanation:
127) Due to inflationary effects, inventory costs and depreciation write-offs can differ from their true 127)
values, thereby distorting profits.
Answer: True False
Explanation:
128) The higher the debt ratio, the more financial leverage a firm has and, thus, the greater will be its 128)
risk and return.
Answer: True False
Explanation:
129) Benchmarking is a type of time-series analysis in which the firms ratio values are compared to 129)
those of a key competitor or group of competitors, primarily to isolate areas of opportunity for
improvement.
Answer: True False
Explanation:
130) The comparison of a particular ratio to the standard (industry average) is made in order to isolate 130)
any deviations from the norm. In the case of ratios for which higher values are preferred, as long as
the firm being analyzed has a value in excess of the industry average it can be viewed favorably.
Answer: True False
Explanation:

43

131) The magnification of risk and return introduced through the use of fixed-cost financing such as 131)
debt and preferred stock is called financial leverage.
Answer: True False
Explanation:
132) In ratio analysis, the financial statements being used for comparison should be dated at the same 132)
point in time during the year. If not, the effect of seasonality may produce erroneous conclusions
and decisions.
Answer: True False
Explanation:
133) The DuPont system allows the firm to break its return on equity into a profit-on-sales component, 133)
an efficiency-of-asset-use component, and a use-of-leverage component.
Answer: True False
Explanation:

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

134) What do liquidity ratios measure?
Define the three liquidity ratios using their formulas.
Explain what units the result of the calculations are in and explain what the answers mean.

Answer: Liquidity ratios measure how well the firm can meet its current (short-term) obligations when they come due.

Net working capital is measured in currency. This liquidity measure is useful for internal controls to ensure the firm maintains adequate operating liquidity.

Net working capital = current assets current liabilities

The current ratio indicates the dollar amount of current assets the firm has for every dollar of current liabilities. The rule of thumb is 2, but the most appropriate comparison would be a firms current ratio relative to similar firms in the industry.

Current ratio = current assets current liabilities

The quick (acid-test) ratio is similar to the current ratio except that it includes only the most liquid current assets. The quick ratio acknowledges that the cash required to repay current liabilities will come from the most liquid assets.

Quick ratio = cash + marketable securities + accounts receivables current liabilities

135) Given the Income Statement, Statement of Changes in Retained Earnings and Balance Sheet, calculate the following:

a. Current ratio

b. Quick ratio
c. Total debt ratio
d. Long-term debt ratio

e. Times interest earned ratio
f. Cash coverage ratio
g. Inventory turnover ratio
h. Receivables turnover ratio

44

i. Payables turnover ratio

j. Profit margin
k. Return on assets
l. Return on equity

m. Price/earnings ratio
n. Market-to-book ratio

Note: The company had a 100,000 shares outstanding and a market value of $5.00 per share at the end of 2003.

ABC Confectionary Limited

Income Statement
For the year ended December 31, 2003

Sales Revenue $1,000,000
less: Cost of Goods Sold 575,000

Gross Profit $425,000
Expenses:
Operating Expenses $225,000
Marketing Expenses 25,000
Administrative Expenses 25,000

Total Expenses 275,000
EBIT $150,000
Interest Expense 15,000

EBT $135,000
Taxes 27,000

Net Income $108,000
Note: Amortization Expense = $10,400

ABC Confectionary Limited

Statement of Changes in Retained Earnings
For the year ended December 31, 2003

Retained Earnings, January 1, 2003 $20,000
Add: Net Income 108,000

Total $128,000
less: Dividends Declared and Paid 120,000

Retained Earnings, December 31, 2003 $8,000
ABC Confectionary Limited
Balance Sheet
December 31, 2003
Assets 2003 2002
Current Assets:
Cash $ 36,900 $ 16,000

45

Accounts Receivable 6,000 4,000
Inventory 44,000 50,000
Prepaid Expenses 2,000 2,000
- -
Total Current Assets $ 88,900 $ 72,000
Fixed Assets:
Fixtures and Equipment $ 90,000 $ 80,000
less: Accumulated Amortization (68,000) (60,000)
Building 120,000 120,000
less: Accumulated Amortization (62,400) (60,000)
Net Building 57,600 60,000
- -
Total Fixed Assets $ 79,600 $ 80,000
- -
Total Assets $168,500 $152,000
Liabilities
Current Liabilities:
Accounts Payable $ 22,500 15,000
Interest Payable 3,000 4,000
Taxes Payable 40,000 8,000
- -
Total Current Liabilities $ 65,500 $ 27,000
Long-term Liabilities:
Business Loan $ 25,000 $ 35,000
Mortgage on Building 57,500 60,000
-
Total Long-term Liabilities $ 82,500 $ 95,000
-
Total Liabilities $148,000 $122,000
Shareholders Equity:
Common Shares $ 12,500 $ 10,000
Retained Earnings 8,000 20,000
- -
Total Shareholders Equity $ 20,500 $ 30,000
- -
Total Liab. and Shareholders Equity $168,500 $152,000

Answer: a. Current Ratio = 88,900/65,500 = 1.36 times
b. Quick Ratio = (88,900 44,000)/65,500 = 0.69 times
c. Total Debt Ratio = (168,500 20,500)/168,500 = 0.878 or 87.8%
d. Long-term Debt Ratio = 82,500/(82,500 + 20,500) = 0.801 or 80.1%

e. Times interest earned ratio = 150,000/15,000 = 10 times
f. Cash coverage ratio = (150,000 + 10,400)/15,000 = 10.69 times
g. Inventory turnover ratio = 575,000/47,000 = 12.23 times
(or: 575,000/44,000 = 13.07 times)
h. Receivables turnover ratio = 1,000,000/5,000 = 200 times (or: 1,000,000/6,000 = 166.67 times)
i. Payables turnover ratio = 575,000/18,750 = 30.67 times (or: 575,000/22,500 = 25.56 times)

46

Answer: j. Profit Margin = 108,000/1,000,000 = 0.108 or 10.8%
k. Return on assets = 108,000/168,500 = 0.641 or 64.1%
l. Return on equity = 108,000/20,500 = 5.268 or 526.8%
m. Price/earnings ratio = 5.00/1.08 = 4.63 times
n. Market-to-book ratio = 5.00/0.205 = 24.39 times

136) Key Financial Data

Dreamscape, Inc. Industry Average
Ratio For the Year Ended For the Year Ended
(% of Sales) December 31, 2001 December 31, 2002

cost of goods sold 74.5% 70.0%
gross profits 25.5 30.0
selling expense 8.0 7.0
gen. & admin. expense 5.1 4.9
depreciation expense 2.4 2.0
total operating expense 15.5 13.9
operating profits 10.0 16.1
interest expense 1.4 1.0
net profits before taxes 8.6 15.1
taxes 2.4 6.0
net profits after taxes 5.2 9.1

Income Statement
Dreamscape, Inc.
For the Year Ended December 31, 2002

Sales revenue $1,000,000
Less: Cost of goods sold 750,000

Gross profits $ 250,000
Less: Operating expenses
Selling expense $70,000
Gen. & admin. expense 48,000
Depreciation expense 20,000
Total operating expense $ 138,000

Operating profits $ 112,000
Less: Interest expense $ 20,000

Net profits before taxes $ 92,000
Less: Taxes $ 36,800

Net profits after taxes $ 55,200

Prepare a common-size income statement for Dreamscape, Inc. for the year ended December 31, 2002. Evaluate the companys performance against industry average ratios and against last years results.

47

Answer: Common-Size Income Statement
Dreamscape, Inc.
For the Year Ended December 31, 200

Sales revenue 100%
Less: Cost of goods sold 75%

Gross profits 25%
Less: Operating expenses
Selling expense 7.0%
Gen. & admin. expense 4.8%
Depreciation expense 2.0%
Total

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