-
Chapter 19 Financial Statement Analysis
Multiple Choice
Questions
1.
A firm has a higher quick
(or acid test) ratio than the industry average,
which implies.
A)
the firm has a higher P/E
ratio than other firms in the industry.
B)
the firm is more likely to avoid
insolvency in short run than other firms in the
industry.
C)
the firm may be less
profitable than other firms in the industry.
D)
A
and B.
E)
B and C.
Answer: E Difficulty: Easy
Rationale: Current assets earn less
than fixed assets; thus, a firm with a relatively
high
level of current assets may be
less profitable than other firms. However, its
high level of
current assets makes it
more liquid.
2.
An example of a liquidity
ratio is _______.
A)
fixed asset turnover
B)
current ratio
C)
acid test or quick ratio
D)
A
and C
E)
B and C
Answer: E Difficulty: Easy
Rationale: Both B and C are measures of
liquidity; A relates to fixed assets.
3.
__________ a snapshot of the financial
condition of the firm at a particular time.
A)
The balance sheet provides
B)
The income
statement provides
C)
The statement of cash
flows provides
D)
All of the above provide
E)
None of the above provides
Answer: A Difficulty:
Easy
Rationale: The balance sheet is
statement of assets, liabilities, and equity at
one point in
time.
462
Chapter 19 Financial
Statement Analysis
4.
__________ of the cash flow generated
by the firm's operations, investments and
financial activities.
A)
The balance sheet is a
report
B)
The
income statement is a report
C)
The statement of cash
flows is a report
D)
the auditor's statement of financial
condition
E)
None of the above is a report
Answer: C Difficulty:
Easy
Rationale: Only statement C is correct;
the balance sheet reports assets, liabilities, and
equity at a point in time; the income
statement is a summary of earnings over a period
of
time.
5.
A firm has a higher asset turnover
ratio than the industry average, which implies
A)
the firm has
a higher P/E ratio than other firms in the
industry.
B)
the
firm is more likely to avoid insolvency in the
short run than other firms in the
industry.
C)
the firm is more profitable than other
firms in the industry.
D)
the firm is utilizing assets more
efficiently than other firms in the industry.
E)
the firm has
higher spending on new fixed assets than other
firms in the industry.
Answer: D Difficulty: Easy
Rationale: The
higher the asset turnover ratio the more
efficiently the firm is using
assets.
6.
If you wish to compute economic
earnings and are trying to decide how to account
for
inventory, _______.
A)
FIFO is better than LIFO
B)
LIFO is
better than FIFO
C)
FIFO and LIFO are equally good
D)
FIFO and LIFO
are equally bad
E)
none of the above
Answer: B Difficulty: Easy
Rationale: LIFO
reflects the current cost of goods sold, and thus
is a better determinant
of economic
earnings.
463
Chapter 19 Financial Statement
Analysis
7.
__________ of the profitability of the
firm over a period of time such as a year.
A)
The balance
sheet is a summary
B)
The income statement is a summary
C)
That
statement of cash flows is a summary
D)
The audit report is a
summary
E)
None
of the above is a summary
Answer: B Difficulty: Easy
Rationale: The
income statement summarizes revenues and expenses
over a period of
time.
8.
Given the results of the
study by Clayman, you would __________the stocks
of firms
with high ROEs and __________
the stocks of firms with low ROEs.
A)
want to buy, want to buy
B)
want to buy,
not want to buy
C)
not want to buy, want to buy
D)
not want to
buy, not want to buy
E)
be unable to buy, want to buy
Answer: C Difficulty:
Moderate
Rationale: Clayman found that investing
in firms with high ROEs produced results
inferior to those obtained by investing
in stocks with lower ROEs.
9.
Over a period of thirty-
odd years in managing investment funds, Benjamin
Graham
used the approach of investing
in the stocks of companies where the stocks were
trading
at less than their working
capital value. The average return from using this
strategy was
approximately ______.
A)
5%
B)
10%
C)
15%
D)
20%
E)
none of the
above
Answer: D
Difficulty: Moderate
Rationale: Although Graham said in 1976
that markets were so efficient that one could
not expect to identify undervalued
securities consistently as he had done throughout
his
career, he continued to find this
one variable useful.
464
Chapter 19 Financial Statement
Analysis
10.
A study by Speidell and
Bavishi (1992) found that when accounting
statements of
foreign firms were
restated on a common accounting basis,
A)
the original
and restated P/E ratios were quite similar.
B)
the original and restated P/E ratios
varied considerably.
C)
most variation was
explained by tax differences.
D)
most firms
were consistent in their treatment of goodwill.
E)
none of the above.
Answer: B Difficulty:
Moderate
Rationale: This study found that
restated P/E ratios varied considerably from those
originally reported.
11.
If the interest rate on debt is higher
than ROA, then a firm will __________ by
increasing the use of debt in the
capital structure.
A)
increase the ROE
B)
not change the ROE
C)
decrease the
ROE
D)
change the ROE in an indeterminable
manner
E)
none of the above
Answer: C Difficulty:
Moderate
Rationale: If ROA is less than the
interest rate, then ROE will decline by an amount
that
depends on the debt to equity
ratio.
12.
A firm has a market to
book value ratio that is equivalent to the
industry average and an
ROE that is
less than the industry average, which
implies_______.
A)
the firm has a higher P/E
ratio than other firms in the industry
B)
the firm is
more likely to avoid insolvency in the short run
than other firms in the
industry
C)
the firm is more profitable than other
firms in the industry
D)
the firm is utilizing its
assets more efficiently than other firms in the
industry
E)
none of the above
Answer: A Difficulty:
Moderate
Rationale: The relationship P/E = (P/B)
/ ROE indicates that A is possible.
465
Chapter 19 Financial
Statement Analysis
13.
In periods
of inflation, accounting depreciation is
__________ relative to replacement
cost
and real economic income is________.
A)
overstated,
overstated
B)
overstated, understated
C)
understated,
overstated
D)
understated, understated
E)
correctly,
correctly
Answer: C Difficulty: Moderate
Rationale: Fixed assets are depreciated
based on historical costs and, as a result, are
understated relative to replacement
costs during periods of inflation; as a result,
real
economic income is
overstated.
14.
If a firm has a positive
tax rate, a positive ROA, and the interest rate on
debt is the same
as ROA, then ROA will
be ________.
A)
greater than the ROE
B)
equal to the
ROE
C)
less than the ROE
D)
greater than
zero but it is impossible to determine how ROA
will compare to ROE
E)
negative in all cases
Answer: A
Difficulty: Moderate
Rationale: If interest rate
= ROA; ROE = (1 - tax rate)ROA; ROA >
ROE.
15.
A firm has a P/E ratio
of 12 and a ROE of 13% and a market to book value
of
__________.
A)
0.64
B)
0.92
C)
1.08
D)
1.56
E)
none of the
above
Answer: D
Difficulty: Moderate
Rationale: E/P = ROE /
(P/B); 1/12 = 0.13) P/B; 0.0833 = 0.13/(P/B);
0.0833(P/B) =
0.13; P/B =
1.56.
466
Chapter
19 Financial Statement Analysis
Use the following to answer
questions 16-26:
The financial statements of Fine Furs
Company are given below.
Fine Furs Company
Income
Statement (2005)
Sales
Cost of goods sold
Gross
profit
Selling and administrative
expenses
Operating profit
Interest expense
Income
before tax
Tax expense
Net
income
$$4,000,000
3,040,000
960,000
430,000
530,000
160,000
370,000
148,000
$$222,000
Balance Sheet
2005
2004
Cash
$$60,000
$$50,000
Accounts receivable
550,000
500,000
Inventory
690,000
620,000
Total current assets
1,300,000
1,170,000
Fixed assets
1,300,000
1,230,000
Total assets
2,600,000
2,400,000
Accounts payable
270,000
250,000
Bank loan
580,000
500,000
Total current liabilities
850,000
750,000
Bonds payable
900,000
1,000,000
Total liabilities
1,750,000
1,750,000
Common stock (25,000 shares)
250,000
250,000
Retained earnings
600,000
400,000
Total liabilities &
equity
$$2,600,000
$$2,400,000
Note: The common shares are trading in
the stock market for $$100 each.
467
Chapter 19 Financial
Statement Analysis
16.
Refer to the
financial statements for Fine Furs Company. The
firm's current ratio for
2005 is
___________.
A)
1.98
B)
2.47
C)
0.65
D)
1.53
E)
none of the above
Answer: D
Difficulty: Easy
Rationale:
$$1,300,000/$$850,000 = 1.53.
17.
Refer to the
financial statements of Fine Furs Company. The
firm's quick ratio for 2005
is _______.
A)
1.68
B)
1.12
C)
0.72
D)
1.92
E)
none of the above
Answer: C
Difficulty: Moderate
Rationale: ($$1,300,000 -
$$690,000)/$$850,000 = 0.72.
18.
Refer to the
financial statements of Fine Furs Company. The
firm's leverage ratio for
2005 is
_________.
A)
2.25
B)
3.53
C)
2.61
D)
3.06
E)
none of the above
Answer: D
Difficulty: Moderate
Rationale:
$$2,600,000/$$850,000 = 3.06.
19.
Refer to the
financial statements of Fine Furs Company. The
firm's times interest
earned ratio for
2005 is __________.
A)
2.26
B)
3.16
C)
3.84
D)
3.31
E)
none of the
above
Answer: D
Difficulty: Moderate
Rationale:
$$530,000/$$160,000 = 3.31.
468
Chapter 19 Financial
Statement Analysis
20.
Refer to the
financial statements of Fine Furs Company. The
firm's average collection
period for
2005 is _______days.
A)
47.90
B)
48.53
C)
46.06
D)
47.65
E)
none of the
above
Answer: A
Difficulty: Moderate
Rationale: (525,000 /
4,000,000) (365) = 47.90.
21.
Refer to the
financial statements of Fine Furs Company. The
firm's inventory turnover
ratio for
2005 is ________.
A)
4.64
B)
4.16
C)
4.41
D)
4.87
E)
none of the
above
Answer: A
Difficulty: Moderate
Rationale:
$$3,040,000/[($$620,000 + $$690,000) / 2] =
4.64.
22.
Refer to the financial
statements of Fine Furs Company. The firm's fixed
asset turnover
ratio for 2005 is _____.
A)
4.60
B)
3.61
C)
3.16
D)
5.46
E)
none of the above
Answer: C
Difficulty: Moderate
Rationale:
$$4,000,000/[($$1,300,000 + $$1,230,000) / 2] =
3.16.
23.
Refer to the financial
statements of Fine Furs Company. The firm's asset
turnover ratio
for 2005 is _____.
A)
1.60
B)
3.16
C)
3.31
D)
4.64
E)
none of the above
Answer: A
Rationale: $$4,000,000/[($$2,600,000 +
$$2,400,000) / 2] = 1.60.
469
Chapter 19 Financial Statement
Analysis
24.
Refer to the financial
statements of Fine Furs Company. The firm's
return on sales ratio
for 2005 is
________.
A)
0.0133
B)
0.1325
C)
1.325
D)
1.260
E)
none of the above
Answer: B
Difficulty: Moderate
Rationale:
$$530,000/$$4,000,000 = 0.1325.
25.
Refer to the financial statements of
Fine Furs Company. The firm's return on equity
ratio for 2005 is ________.
A)
0.1235
B)
0.0296
C)
0.2960
D)
2.2960
E)
none of the above
Answer: C Difficulty:
Moderate
Rationale: $$222,000/[($$850,000 +
$$650,000) / 2] = 0.2960.
26.
Refer to the
financial statements of Fine Furs Company. The
firm's market to book
value for 2005 is
_____.
A)
0.7256
B)
1.5294
C)
2.9400
D)
3.6142
E)
none of the above
Answer: C
Difficulty: Moderate
Rationale: $$100/[($$850,000
/ 25,000)] = 2.9400.
470
Chapter 19 Financial Statement
Analysis
Use
the following to answer questions
27-38:
The
financial statements of Frederick Fence Company
are given below
Frederick Fence Company
Income Statement (2005)
Sales
Cost of goods sold
Gross profit
Selling and
administrative expenses
Operating
profit
Interest expenses
Income before tax
Tax
expense
Net income
$$8,000,000
5,260,000
2,740,000
1,500,000
1,240,000
140,000
1,100,000
440,000
$$660,000
Balance
Sheet
2005
2004
Cash
$$200,000
$$50,000
Accounts receivable
1,200,000
950,000
Inventory
1,840,000
1,500,000
Total current
assets
3,240,000
2,500,000
Fixed assets
3,200,000
3,000,000
Total assets
$$6,440,000
$$5,500,000
Accounts payable
800,000
720,000
Bank loan
600,000
100,000
Total current liabilities
1,400,000
820,000
Bonds payable
900,000
1,000,000
Total liabilities
2,300,000
1,820,000
Common stock(130,000 shares)
300,000
300,000
Retained earnings
3,840,000
3,380,000
Total liabilities
& equity
$$6,440,000
$$5,500,000
Note: The common shares are
trading in the stock market for $$40 each.
471
Chapter 19
Financial Statement Analysis
27.
Refer to the financial statements of
Frederick Fence Company. The firm's current ratio
for 2005 is _____.
A)
2.31
B)
1.87
C)
2.22
D)
2.46
E)
none of the above
Answer: A Difficulty:
Moderate
Rationale: $$3,240,000/$$1,400,000 =
2.31.
28.
Refer to the financial
statements of Frederick Fence r Company. The
firm's quick ratio
for 2005 is _____.
A)
1.69
B)
1.52
C)
1.23
D)
1.07
E)
1.00
Answer: E Difficulty:
Moderate
Rationale: ($$3,240,000 -
$$1,840,000)/$$1,400,000 = 1.00.
29.
Refer to the financial statements of
Frederick Fence Company. The firm's leverage
ratio for 2005 is _____.
A)
1.65
B)
1.89
C)
2.64
D)
1.31
E)
1.56
Answer: E Difficulty: Moderate
Rationale: $$6,440,000/$$4,140,000 =
1.56.
30.
Refer to the financial
statements of Frederick Fence Company. The firm's
times interest
earned ratio for 2005 is
_____.
A)
8.86
B)
7.17
C)
9.66
D)
6.86
E)
none of the above
Answer: A
Difficulty: Moderate
Rationale:
$$1,240,000/$$140,000 = 8.86.
472
Chapter 19 Financial
Statement Analysis
31.
Refer to the
financial statements of Frederick Fence Company.
The firm's average
collection period
for 2005 is _____.
A)
59.31
B)
55.05
C)
61.31
D)
49.05
E)
none of the
above
Answer: D
Difficulty: Moderate
Rationale: AR Turnover =
$$8,000,000 / [($$1,200,000 + $$950,000) / 2] = 7.44;
ACP =
365 / 7.44 = 49.05
days
32.
Refer to the financial
statements of Frederick Fence Company. The firm's
inventory
turnover ratio for 2005 is
_____.
A)
3.15
B)
3.63
C)
3.69
D)
2.58
E)
4.20
Answer: A Difficulty:
Moderate
Rationale: $$5,260,000/[($$1,840,000 +
$$1,500,000) / 2] = 3.15.
33.
Refer to the
financial statements of Frederick Fence Company.
The firm's fixed asset
turnover ratio
for 2005 is _____.
A)
2.04
B)
2.58
C)
2.97
D)
1.58
E)
none of the
above
Answer: B
Difficulty: Moderate
Rationale:
$$8,000,000/[($$3,200,000 + $$3,000,000) / 2] =
2.58.
473
Chapter
19 Financial Statement Analysis
34.
Refer to the financial statements of
Frederick Fence Company. The firm's asset
turnover ratio for 2005 is _____.
A)
1.79
B)
1.63
C)
1.34
D)
2.58
E)
none of the above
Answer: C
Difficulty: Moderate
Rationale:
$$8,000,000/[($$6,440,000 + $$5,500,000) / 2] =
1.34.
35.
Refer to the financial
statements of Frederick Fence Company. The firm's
return on
sales ratio for 2005 is _____
percent.
A)
15.5
B)
14.6
C)
14.0
D)
15.0
E)
16.5
Answer: A Difficulty:
Moderate
Rationale: $$1,240,000/$$8,000,000 =
0.155 or 15.5%.
36.
Refer to the financial
statements of Frederick Fence Company. The firm's
return on
equity ratio for 2005 is
_____.
A)
16.90%
B)
15.63%
C)
14.00%
D)
15.00%
E)
16.24%
Answer: A Difficulty:
Moderate
Rationale: $$660,000/[($$4,140,000 +
$$3,680,000) / 2] = .169.
37.
Refer to the
financial statements of Frederick Fence Company.
The firm's P/E ratio for
2005 is _____.
A)
8.88
B)
7.63
C)
7.88
D)
7.32
E)
none of the above
Answer: C
Difficulty: Moderate
Rationale: EPS =
$$660,000/130,000 = $$5.08; $$40/$$5.08 =
7.88.
474
Chapter
19 Financial Statement Analysis
38.
Refer to the financial statements of
Frederick Fence Company. The firm's market to
book value for 2003 is _____.
A)
1.13
B)
1.62
C)
1.00
D)
1.26
E)
none of the above
Answer: D
Difficulty: Moderate
Rationale: $$40/$$31.85 =
1.26.
39.
A firm has a (net profit
/ pretax profit ratio) of 0.625, a leverage ratio
of 1.2, a (pretax
profit / EBIT) of
0.9, an ROE of 17.82%, a current ratio of 8, and a
return on sales ratio
of 8%. The
firm's asset turnover is _________.
A)
0.3
B)
1.3
C)
2.3
D)
3.3
E)
none of the above
Answer: D Difficulty:
Difficult
Rationale: 17.82% = 0.625 X 0.9 X 8% X
asset turnover X 1.2; asset turnover =
3.3.
40.
A firm has an ROA of
14%, a debt/equity ratio of 0.8, a tax rate of
35%, and the interest
rate on the debt
is 10%. The firm's ROE is _________.
A)
11.18%
B)
8.97%
C)
11.54%
D)
12.62%
E)
none of the above
Answer: A Difficulty:
Difficult
Rationale: ROE = (1 - 0.35)[14% + (14%
- 10%)0.8] = 11.18%.
475
Chapter 19 Financial Statement
Analysis
41.
A firm has an ROE of
-2%, a debt/equity ratio of 1.0, a tax rate of 0%,
and an interest
rate on debt of 10%.
The firm's ROA is ________.
A)
2%
B)
4%
C)
6%
D)
8%
E)
none of the above
Answer: B Difficulty:
Difficult
Rationale: -2% = (1)[ROA + (ROA -
10%)1] = 4%.
42.
A firm has a (net
profit/pretax profit) ratio of 0.6, a leverage
ratio of 2, a (pretax
profit/EBIT) of
0.6, an asset turnover ratio of 2.5, a current
ratio of 1.5, and a return on
sales
ratio of 4%. The firm's ROE is _________.
A)
4.2%
B)
5.2%
C)
6.2%
D)
7.2%
E)
none of the above
Answer: D
Difficulty: Difficult
Rationale: ROE = 0.6 X 0.6
X 4% X 2.5 X 2 = 7.2%.
43.
A measure of
asset utilization is ________.
A)
sales divided
by working capital
B)
return on total assets
C)
return on equity capital
D)
operating
profit divided by sales
E)
none of the above
Answer: B
Difficulty: Easy
Rationale: B measures how
efficiently the firm is utilizing assets to
generate returns.
476
Chapter 19 Financial Statement
Analysis
44.
During periods of
inflation, the use of FIFO (rather than LIFO) as
the method of
accounting for
inventories causes ________.
A)
higher
inventory turnover
B)
higher incomes taxes
C)
lower ending inventory
D)
higher
reported sales
E)
none of the above
Answer: B
Difficulty: Moderate
Rationale: In inflationary
periods, the use of FIFO causes overstated
earnings, which
result in higher
taxes.
45.
Return on total assets
is a function of _______.
A)
interest rates and pre-
tax profits
B)
the debt-equity ratio
C)
the after-tax
profit margin and the asset turnover ratio
D)
sales and fixed assets
E)
none of the
above
Answer: C
Difficulty: Moderate
Rationale: ROA = Net profit
margin X Total asset turnover.
46.
DUK Company has a ratio of (total
debt/total assets) that is above the industry
average,
and a ratio of (long term
debt/equity) that is below the industry average.
These ratios
suggest that the firm
_________.
A)
utilizes assets effectively
B)
has too much
equity in the capital structure
C)
has
relatively high current liabilities
D)
has a
relatively low dividend payout ratio
E)
none of the
above
Answer: C
Difficulty: Moderate
Rationale: Total debt
includes both current and long term debt; the
above relationships
could occur only if
DUK Company has a higher than average level of
current liabilities.
477
Chapter 19 Financial Statement
Analysis
47.
A firm's current ratio
is above the industry average; however, the firm's
quick ratio is
below the industry
average. These ratios suggest that the firm
_________.
A)
has relatively more total current
assets and even more inventory than other firms in
the industry
B)
is very efficient at
managing inventories
C)
has liquidity that is
superior to the average firm in the industry
D)
is near technical insolvency
E)
none of the above
Answer: A Difficulty:
Moderate
Rationale: A is the only possible
answer; total current assets are high, and
inventory is a
very large portion of
total current assets, relative to other firms in
the industry.
48.
Which of the following
ratios gives information on the amount of profits
reinvested in
the firm over the
years?
A)
Sales/total assets
B)
Debt/total
assets
C)
Debt/equity
D)
Retained earnings/total
assets
E)
None of the above
Answer: D Difficulty:
Moderate
Rationale: Only retained earnings
reflect profits reinvested over the
years.
49.
Jarvis Corp. wants to
increase its current ratio from the present level
of 1.5 when it
closes the books next
week. The action of __________ will have the
desired effect.
A)
payment of current
payables from cash
B)
sales of current
marketable securities for cash
C)
write down of
impaired assets
D)
delay of next payroll
E)
none of the above
Answer: A Difficulty:
Moderate
Rationale: Example: CA = $$150; CL =
$$100; current ratio = 1.5; Pay $$50 of CL with
cash; CA = $$100; CL = $$50; current
ratio = 2. B has no effect on ratio (CA remain
same); C does not affect current
account; D would decrease ratio.
478
Chapter 19 Financial
Statement Analysis
50.
Assuming
continued inflation, a firm that uses LIFO will
tend to have a(n) ________
current
ratio than a firm using FIFO, and the difference
will tend to __________ as time
passes.
A)
higher, increase
B)
higher,
decrease
C)
lower, decrease
D)
lower, increase
E)
identical, remain the same
Answer: D Difficulty:
Moderate
Rationale: A firm using LIFO will have
lower priced inventory, thus resulting in a lower
current ratio. If inflation continues,
these differences will increase over
time.
51.
Fundamental analysis
uses __________.
A)
earnings and dividends
prospects
B)
relative strength
C)
price
momentum
D)
A and B
E)
A and C
Answer: A Difficulty:
Easy
Rationale: Relative strength and price
momentum are technical, not fundamental,
tools.
52.
__________ is a
true
statement.
A)
During
periods of inflation, LIFO makes the balance sheet
less representative of the
actual
inventory values than if FIFO were used
B)
During periods of inflation, FIFO makes
the balance sheet less representative of
actual inventory values than if LIFO
were used
C)
After inflation ends, distortion due to
LIFO will disappear as inventory is sold
D)
During periods of inflation, LIFO
overstates earnings relative to FIFO
E)
None of the
above
Answer: A
Difficulty: Moderate
Rationale: During periods
of inflation, the use of LIFO results in lower
priced inventory
remaining in stock;
thus the balance sheet understates the actual
inventory values.
479