ch04tbfin300
Chapter 4 Test Bank
Format: True/False
Learning Objective: LO 1
Level of Difficulty: Easy
1. Financial statement analysis can help us determine why a firm's cash flows are
increasing or decreasing
A) True
B) False
Ans: A
Format: True/False
Learning Objective: LO 1
Level of Difficulty: Easy
2. Shareholders focus on the value of their stock but not on how much cash they can
expect to receive from dividends and/or capital appreciation.
A) True
B) False
Ans: B
Format: True/False
Learning Objective: LO 1
Level of Difficulty: Easy
3. Managers' decisions regarding financing, investment, and working capital are reflected
in the financial statements.
A) True
B) False
Ans: A
Format: True/False
Learning Objective: LO 1
Level of Difficulty: Easy
4. A financial statement analysis conducted over a three- to five-year period is called trend
analysis.
A) True
B) False
Ans: A
Learning Objective: LO 5
Level of Difficulty: Easy
5. A benchmark for a financial statement analysis is the performance of a multinational
firm in the same industry from another country.
A) True
B) False
Ans: B
Format: True/False
Learning Objective: LO 2
Level of Difficulty: Medium
6. A typical way common size income statement is constructed is by dividing all expense
items in an income statement by net income.
A) True
B) False
Ans: B
Format: True/False
Learning Objective: LO 2
Level of Difficulty: Medium
7. The most frequent method of adjusting balance sheets to a common-size basis is to
divide each of the accounts by total assets, expressing each account as a percentage of total assets.
A) True
B) False
Ans: A
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Easy
8. Liquidity ratios are concerned with the firm's ability to pay its current bills without
putting the firm in financial difficulty.
A) True
B) False
Ans: A
Learning Objective: LO 3
Level of Difficulty: Easy
9. A firm's current ratio changed from 1.4 times in the previous year to 1.6 times year.
Concluding that the firm's liquidity improved is ___________.
A) True
B) False
Ans: A
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Medium
10. A company can improve its liquidity by increasing its accounts payable, while holding
all else constant.
A) True
B) False
Ans: B
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Medium
11. The purchase of additional inventory by a firm should decrease a firm's quick ratio.
A) True
B) False
Ans: B
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Medium
12. Turnover ratios are used by managers to identify operational inefficiencies.
A) True
B) False
Ans: A
Learning Objective: LO 3
Level of Difficulty: Easy
13. A firm increased its days' sales outstanding from 35 days to 43 days. This implies the
firm is more efficient.
A) True
B) False
Ans: B
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Easy
14. Total asset turnover is more relevant for service industry firms, while the fixed asset
turnover ratio is more relevant for manufacturing industry firms.
A) True
B) False
Ans: A
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Medium
15. Financial leverage refers to the use of preferred stock in a firm's capital structure.
A) True
B) False
Ans: B
Format: True/False
Learning Objective: LO 3
Level of Difficulty: Easy
16. The equity multiplier is computed by dividing equity by total assets.
A) True
B) False
Ans: B
Learning Objective: LO 3
Level of Difficulty: Medium
17. The higher the times interest earned ratio, the more comfortable are a firm's creditors in
the ability of the firm to meet its interest obligations.
A) True
B) False
Ans: A
Format: True/False
Learning Objective: LO 4
Level of Difficulty: Medium
18. A firm that has no debt will have its ROA equal to its ROE.
A) True
B) False
Ans: A
Format: True/False
Learning Objective: LO 5
Level of Difficulty: Medium
19. For a given level of after-tax income, the lower the level of equity a firm has, the higher
the return on equity its shareholders will earn.
A) True
B) False
Ans: A
Format: True/False
Learning Objective: LO 5
Level of Difficulty: Hard
20. For a given share price of a firm's stock, the lower the EPS the lower the price-earnings
ratio.
A) True
B) False
Ans: B
Learning Objective: LO 4
Level of Difficulty: Medium
21. The DuPont equation relates a firm's net profit margin, total asset turnover ratio, and
equity multiplier to determine its return on equity.
A) True
B) False
Ans: A
Format: True/False
Learning Objective: LO 4
Level of Difficulty: Medium
22. Firms with a lower ROA and higher leverage will have a lower ROE than firms with a
higher ROA and lower leverage.
A) True
B) False
Ans: B
Format: True/False
Learning Objective: LO 5
Level of Difficulty: Medium
23. In doing an industry group analysis, you form the comparison group by choosing firms
that are larger than the firm being compared.
A) True
B) False
Ans: B
Format: True/False
Learning Objective: LO 6
Level of Difficulty: Medium
24. The Standard Industry Classification (SIC) system is a federal government established
system in which the last two digits indicate the business or industry in which the firm is engaged.
A) True
B) False
Ans: B
Learning Objective: LO 6
Level of Difficulty: Medium
25. The use of market value balance sheets serves to correct a weakness of ratio analysis.
A) True
B) False
Ans: A
Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Easy
26. Financial statements can be analyzed from the following three different perspectives:
A) management, regulator, and bondholder
B) management, shareholder, and creditor
C) regulator, shareholder, and creditor
D) shareholder, creditor, and regulator
Ans: B
Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Easy
27. Shareholders analyze financial statements in order to:
A) assess the cash flows that the firm will generate from operations/
B) determine the firm's profitability, their return for that period, and the dividend
they are likely to receive.
C) focus on the value of the stock they hold.
D) All of the above.
Ans: D
Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Easy
28. The creditors of a firm analyze financial statements so that they can focus on
A) the firm's amount of debt.
B) the firm's ability to generate sufficient cash flows to meet all legal obligations
first and still have sufficient cash flows to meet debt repayment and interest
payments.
C) the firm's ability to meet its short-term obligations.
D) All of the above.
Ans: D
Learning Objective: LO 1
Level of Difficulty: Easy
29. A firm's management analyzes financial statement's so that:
A) they can get feedback on their investing, financing, and working capital decisions
by identifying trends in the various accounts that are reported in the financial
statements.
B) similar to shareholders, they can focus on profitability, dividend, capital
appreciation, and return on investment.
C) they can get more stock options.
D) a and b.
Ans: D
Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Easy
30. Anyone analyzing a firm's financial statements should
A) use audited financial statements only.
B) do a trend analysis.
C) perform a benchmark analysis.
D) All of the above.
Ans: D
Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Easy
31. An individual analyzing a firm's financial statements should do all but one of the
following:
A) Use unaudited financial statements.
B) Do a trend analysis.
C) Perform a benchmark analysis.
D) Compare the firm's performance to that of its direct competitors.
Ans: A
Learning Objective: LO 2
Level of Difficulty: Easy
32. All but one of the following is true of common-size balance sheets.
A) Each asset and liability item on the balance sheet is standardized by dividing it by
total assets.
B) Balance sheet accounts are represented as percentages of total assets.
C) Each asset and liability item on the balance sheet is standardized by dividing it by
sales.
D) Common-size financial statements allow us to make meaningful comparisons
between the financial statements of two firms that are different in size.
Ans: C
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Easy
33. All but one of the following is true of common-size income statements.
A) Each income statement item is standardized by dividing it by total assets.
B) Income statement accounts are represented as percentages of sales.
C) Each income statement item is standardized by dividing it by sales.
D) Common-size financial statement analysis is a specialized application of ratio
analysis.
Ans: A
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Easy
34. Common-size financial statements:
A) are a specialized application of ratio analysis.
B) allow us to make meaningful comparisons between the financial statements of
two firms that are different in size.
C) are prepared by having each financial statement item expressed as a percentage of
some base number, such as total assets or total revenues.
D) All of the above are true.
Ans: D
Learning Objective: LO 3
Level of Difficulty: Medium
35. Which of the following is true of ratio analysis?
A) A ratio is computed by dividing one balance sheet or income statement by
another.
B) The choice of the scale determines the story that can be garnered from the ratio.
C) Ratios can be calculated based on the type of firm being analyzed or the kind of
analysis being performed.
D) All of the above are true.
Ans: D
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Medium
36. Which of the following is NOT true of liquidity ratios?
A) They measure the ability of the firm to meet short-term obligations with
short-term assets without putting the firm in financial trouble.
B) There are two commonly used ratios to measure liquidity—current ratio and
quick ratio.
C) For manufacturing firms, quick ratios will tend to be much larger than current
ratios.
D) The higher the number, the more liquid the firm and the better its ability to pay its
short-term bills.
Ans: C
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Easy
37. All but one of the following is true about quick ratios.
A) The quick ratio is calculated by dividing the most liquid of current assets by
current liabilities.
B) Service firms that tend not to carry too much inventory will see significantly
higher quick ratios than current ratios.
C) Inventory, being not very liquid, is subtracted from total current assets to
determine the most liquid assets.
D) Quick ratios will tend to be much smaller than current ratio for manufacturing
firms or other industries that have a lot of inventory.
Ans: B
Learning Objective: LO 3
Level of Difficulty: Easy
38. Which one of the following does NOT change a firm's current ratio?
A) The firm collects on its accounts receivables.
B) The firm purchases inventory by taking a short-term loan.
C) The firm pays down its accounts payables.
D) None of the above.
Ans: A
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Easy
39. All else being equal, which one of the following will decrease a firm's current ratio?
A) a decrease in the net fixed assets
B) a decrease in depreciation
C) an increase in accounts payable
D) None of the above
Ans: C
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Easy
40. All but one of the following is true about the inventory turnover ratio.
A) It is calculated by dividing inventory by cost of goods sold.
B) It measures how many times the inventory is turned over into saleable products.
C) The more times a firm can turnover the inventory, the better.
D) Too high a turnover or too low a turnover could be a warning sign.
Ans: A
Learning Objective: LO 3
Level of Difficulty: Medium
41. Which one of the following statements is NOT true?
A) The accounts receivables turnover ratio measures how quickly the firm collects
on its credit sales.
B) One ratio that measures the efficiency of a firm's collection policy is days' sales
outstanding.
C) The more days that it takes the firm to collect on its receivables, the more
efficient the firm is.
D) DSO measures in days, the time the firm takes to convert its receivables into
cash.
Ans: C
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Medium
42. One of the following statements is NOT true of asset turnover ratios.
A) Asset turnover ratios measure the level of sales per dollar of assets that the firm
has.
B) The fixed assets turnover ratio is less significant for equipment-intensive
manufacturing industry firms than the total assets turnover ratio.
C) The higher the total asset turnover, the more efficiently management is using total
assets.
D) All of the above are true.
Ans: B
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Easy
43. Which one of the following statements is correct?
A) The lower the level of a firm's debt, the higher the firm's leverage.
B) The lower the level of a firm's debt, the lower the firm's equity multiplier.
C) The lower the level of a firm's debt, the higher the firm's equity multiplier.
D) The tax benefit from using debt financing reduces a firm's risk.
Ans: B
Learning Objective: LO 3
Level of Difficulty: Medium
44. If firm A has a higher debt-to-equity ratio than firm B, then
A) firm A has a lower equity multiplier than firm B.
B) firm B has a lower equity multiplier than firm A.
C) firm B has lower financial leverage than firm A.
D) None of the above.
Ans: A
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Medium
45. Which one of the following statements is NOT correct?
A) A leveraged firm is more risky than a firm that is not leveraged.
B) A leveraged firm is less risky than a firm that is not leveraged.
C) A firm that uses debt magnifies the return to its shareholders.
D) All of the above statements are correct.
Ans: B
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Easy
46. Coverage ratios, like times interest earned and cash coverage ratio, allow
A) a firm's management to assess how well they meet short-term liabilities.
B) a firm's shareholders to assess how well the firm will meet its short-term
liabilities.
C) a firm's creditors to assess how well the firm will meet its interest obligations.
D) a firm's creditors to assess how well the firm will meet its short-term liabilities
other than interest expense.
Ans: C
Format: Multiple Choice
Learning Objective: LO 4
Level of Difficulty: Easy
47. For a firm that has no debt in its capital structure,
A) ROE > ROA.
B) ROE < ROA.
C) ROE = ROA.
D) None of the above.
Ans: C
Learning Objective: LO 4
Level of Difficulty: Easy
48. For a firm that has both debt and equity,
A) ROE > ROA.
B) ROE < ROA.
C) ROE = ROA
D) None of the above.
Ans: A
Format: Multiple Choice
Learning Objective: LO 4
Level of Difficulty: Medium
49. Which one of the following statements is NOT correct?
A) The DuPont system is based on two equations that relate a firm's ROA and ROE.
B) The DuPont system is a set of related ratios that links the balance sheet and the
income statement.
C) Both management and shareholders can use this tool to understand the factors
that drive a firm's ROE.
D) All of the above are correct.
Ans: D
Format: Multiple Choice
Learning Objective: LO 4
Level of Difficulty: Easy
50. The DuPont equation shows that a firm's ROE is determined by three factors:
A) net profit margin, total asset turnover, and the equity multiplier
B) operating profit margin, ROA, and the ROE
C) net profit margin, total asset turnover, the ROA
D) ROA, total assets turnover, and the equity multiplier
Ans: A
Format: Multiple Choice
Learning Objective: LO 4
Level of Difficulty: Medium
51. Which one of the following is a criticism of equating the goals of maximizing the ROE
of a firm and maximizing the firm's shareholder wealth?
A) ROE is based on after-tax earnings, not cash flows.
B) ROE does not consider risk.
C) ROE ignores the size of the initial investment as well as future cash flows.
D) All of the above are criticisms of ROE as a goal.
Ans: D
Format: Multiple Choice
Learning Objective: LO 4
Level of Difficulty: Easy
52. Which one of the following is NOT an advantage of using ROE as a goal?
A) ROE is highly correlated with shareholder wealth maximization.
B) ROE and the DuPont analysis allow management to break down the performance
and identify areas of strengths and weaknesses.
C) ROE does not consider risk.
D) All of the above are advantages of using ROE as a goal.
Ans: C
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
53. Which one of the following statements about trend analysis is NOT correct?
A) This benchmark is based on a firm's historical performance.
B) It allows management to examine each ratio over time and determine whether the
trend is good or bad for the firm.
C) The Standard Industrial Classification (SIC) System is used to identify
benchmark firms.
D) All of the above are true statements.
Ans: C
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
54. Peer group analysis can be performed by
A) management choosing a set of firms that are similar in size or sales, or who
compete in the same market.
B) using the average ratios of this peer group, which would then be used as the
benchmark.
C) identifying firms in the same industry that are grouped by size, sales, and product
lines in order to establish benchmark ratios.
D) Only a and b relate to peer group analysis.
Ans: D
Learning Objective: LO 6 Level of Difficulty: Hard
55. Limitations of ratio analysis include all but
A) Ratios depend on accounting data based on historical costs.
B) Differences in accounting practices like FIFO versus LIFO make comparison
difficult.
C) Trend analysis could be distorted by financial statements affected by inflation. D) All of the above are limitations of ratio analysis. Ans: D
Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium
56. Liquidity ratio: Lionel, Inc., has current assets of $623,122, including inventory of
$241,990, and current liabilities of 378,454. What is the quick ratio? A) 1.65 B) 0.64 C) 1.01
D) None of the above Ans: C Feedback:
Current assets = $623,122 Current liabilities = $378,454 Inventory = $241,990
C urrent assets - Inventory
Q uick ratio C urrent liabilities $623,122$241,990
$378,454
=
-=
=1.01
Learning Objective: LO 3 Level of Difficulty: Medium
57. Liquidity ratio: Bathez Corp. has receivables of $334,227, inventory of $451,000,
cash of $73,913, and accounts payables of $469,553. What is the firm's current ratio? A) 1.83 B) 0.73 C) 1.67
D) None of the above Ans: A Feedback:
Current assets = $73,913 + $451,000 +$334,227 = $859,140 Current liabilities = $469,553
C urrent assets C urrent ratio C urrent liabilities $859,140$469,553
=
=
=1.83
Learning Objective: LO 3 Level of Difficulty: Medium
58. Liquidity ratio: Zidane Enterprises has a current ratio of 1.92, current liabilities of
$272,934, and inventory of 197,333. What is the firm's quick ratio? A) 0.72 B) 1.20 C) 1.92
D) None of the above Ans: B Feedback:
Current ratio = 1.92
Current liabilities = $272,934 Inventory = $197,333
assets ratio C urrent liabilites assets 1.92C urrent liabilites
assets 1.92$272,934$524,033C urrent C urrent C urrent C urrent =
=
=?= C urrent assets - Inventory
Q uick ratio C urrent liabilities $524,033$197,333
$272,934
=
-=
=1.20
Learning Objective: LO 3
Level of Difficulty: Hard
59. Liquidity ratio: Ronaldinho Trading Co. is required by its bank to maintain a current
ratio of at least 1.75, and its current ratio now is 2.1. The firm plans to acquire
additional inventory to meet an unexpected surge in the demand for its products and will pay for the inventory with short-term debt. How much inventory can the firm purchase without violating its debt agreement if their total current assets equal $3.5 million?
A) $0
B) $777,777
C) $1 million
D) None of the above
Ans: B
Feedback:
Let X represent the additional borrowing against the firm's line of credit (which also equals the addition to current assets). We can solve for that level of X that forces the firm's current ratio to be at 1.75
$3,500,000/ Current liabilities = 2.1
Current liabilities = $1,666,667
1.75 = ($3,500,000 + X) / ($1,666,667 + X)
(1.75 * $1,666,667) + 1.75X = $3,500,000 + X
0.75X = $3,500,000 - $2,916,667
X = $777,777
Learning Objective: LO 3 Level of Difficulty: Medium
60. Efficiency ratio: If Randolph Corp. has accounts receivables of $654,803 and net sales
of $1,932,349, what is its accounts receivable turnover? A) 0.34 times B) 1.78 times C) 2.95 times
D) None of the above Ans: C Feedback:
Accounts receivables = $654,803 Net sales = $1,932,349
N et sales receivables turnover Accounts receivables $1,932,349$654,803
Accounts =
=
=2.95 tim es
Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium
61. Efficiency ratio: If Viera, Inc., has an accounts receivable turnover of 3.9 times and
net sales of $3,436,812, what is its level of receivables? A) $881,234 B) $13,403,567 C) $1,340,357 D) $81,234 Ans: A Feedback:
Accounts receivables turnover = 3.9x Net sales = $3,436,812
N et sales receivables turnover Accounts receivables
$3,436,8123.9 receivables $3,436,812
receivables 3.9
Accounts x Accounts Accounts =
=
=
=$881,234