Chap 014 Testbank Financial Statement Analysis 2x3g6x

Chapter 14 Financial Statement Analysis

Chapter 14 Financial Statement Analysis True / False Questions

1. Vertical analysis compares the results of financial information with a business in the same industry for a number of consecutive periods of time. True False

2. The quick ratio is especially useful in evaluating the liquidity of a company with fast moving inventories. True False

3. Deducting the cost of goods sold from net income gives us operating income. True False

4. The gross profit rate is gross profit expressed as a percentage of net sales. True False

5. The gross profit rate usually is lowest on fast moving merchandise and highest on specialty and novelty products True False

6. When an income statement does not show gross profit or operating income it is called a consolidated statement. True False

7. ROE - return on equity - is measured by dividing net income by average number of shares outstanding. True False

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8. The yield rate on stock is measured by dividing dividends per share by market price per share. True False

9. The trend in ratios is usually more useful than looking at a single year's ratio. True False

10. The acid test ratio includes marketable securities but does not include s receivable. True False

11. Comparative financial statements show side-by-side financial data for two or more companies. True False

12. The quality of earnings tends to be higher for a company that uses straight-line depreciation and defers costs whenever possible than for a company which uses accelerated depreciation and defers costs only when necessary. True False

13. If total current assets are $140,000 at the end of Year 1, increase by $50,000 by the end of Year 2, and increase by $50,000 in Year 3, the percentage increase over the preceding year is less in Year 3 than in Year 2. True False

14. Working capital is the excess of current assets over current liabilities. True False

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15. A company's liquidity refers to its ability to remain profitable. True False

16. Inventory is an example of a quick asset. True False

17. Current assets are those assets that can be converted into cash within a year and never longer. True False

18. The debt ratio is computed by dividing total liabilities by current assets. True False

19. The lower the current ratio, the more liquid the company appears. True False

20. The owners of a corporation are not personally responsible for the debts of the business. True False

21. A single-step and multiple-step income statement are different in form and in the amount of net income reported. True False

22. A company whose sales are growing at less than the rate of inflation may actually be selling less merchandise every year. True False

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23. A company cannot be increasing its market share if its net sales are declining. True False

24. Net income stated as a percentage of sales is one means of evaluating a company's ability to control its expenses. True False

25. A company whose future earnings are expected to rise substantially is likely to have a higher price/earnings ratio than a company whose future earnings are expected to decline. True False

26. From a creditor's point of view, the lower the debt ratio; the safer the creditors' position. True False

27. The price/earnings ratio is calculated by dividing earnings per share by the current market price of a share of the company's stock. True False

28. If the return on total assets ratio is substantially below the cost of borrowing, common stockholders will benefit from a high debt ratio. True False

29. The return on equity ratio may be either higher or lower than the return on assets ratio. True False

30. The current ratio may be less than, equal to, or greater than the quick ratio. True False

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31. The inventory turnover rate indicates how quickly inventory sells. True False

32. In a single-step income statement, all revenue items are listed then all expense items are combined and deducted from total revenue. True False

33. In a classified balance sheet, assets are subdivided into current assets, plant and equipment and other assets, while liabilities are all classified as current. True False

34. The more pessimistic investors' expectations regarding a company's future performance the lower the price/earnings ratio is likely to be. True False

35. A company should carry the amount of working capital necessary to conduct operations not necessarily maximize its working capital. True False

Multiple Choice Questions

36. In order for investors and creditors to decide whether to invest in a company or loan a company funds they may A. Analyze financial statements. B. Focus on corporate governance. C. Both of the above. D. Neither of the above.

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37. A comparative financial statement A. Places the balance sheet, the income statement and the statement of cash flows side by side in order to compare the results. B. Places two or more years of a financial statement side by side in order to compare results. C. Places the financial statements of two or more companies side by side in order to compare results. D. Places the dollar amounts next to the percentage amounts of a given year for the income statement.

38. The changes in financial statement items from a base year to following years are called: A. Money changes B. Trend percentages C. Component percentages D. Ratios

39. The measurement of the relative size of each item included in a total is called: A. Money changes B. Trend percentages C. Component percentages D. Ratios

40. One number expressed as a percentage of another is called: A. Money changes B. Trend percentages C. Component percentages D. Ratios

41. The excess of current assets over current liabilities is called: A. Current ratio B. Working capital C. Debt ratio D. Quick ratio

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42. Quick assets include which of the following? A. Cash, marketable securities and receivables. B. Cash, marketable securities and inventories. C. Cash, inventories and receivables. D. Market securities, receivables and inventories.

43. The ratio which measures total liabilities as a percentage of total assets is called: A. Current ratio B. Working capital C. Debt ratio D. Quick ratio

44. The price/earnings ratio is measured by dividing A. Book value by earnings per share. B. Par value by earnings per share. C. Market value by earnings per share. D. Market value by total net income.

45. The principle factors affecting the quality of working capital are: A. The nature of the current assets. B. The length of time to convert current assets into cash. C. Both A and B. D. Neither A nor B.

46. All of the following ratios are considered measures of profitability except: A. Earnings per share B. Gross profit rate C. Price earnings ratio D. Return on assets

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47. All of the following ratios are considered measures of liquidity except: A. Quick ratio B. Debt ratio C. Current ratio D. Receivables turnover rate

48. The term classified financial statements refers: A. To the financial statements of all companies working on government projects. B. Only to the financial statements of defense contractors working on secret projects. C. To financial statements prepared for use by management, but not for distribution outside of the organization. D. To financial statements in which items with certain characteristics are placed together in a group in an effort to develop useful subtotals.

49. Comparative financial statements compare the company's current statements with: A. Those of prior periods. B. Those of other companies in the same industry. C. Those of the company's principal competitor. D. The budgeted level of performance for the period.

50. Which of the following is not a measure of short-term liquidity? A. Quick ratio. B. Working capital. C. Current ratio. D. Debt ratio.

51. The current ratio will be _______________ the quick ratio. A. Less than. B. Greater than or equal to. C. The same as. D. Always different than.

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52. Which of the following is not a measure of long-term credit risk? A. Quick ratio. B. Debt ratio. C. Interest coverage ratio. D. Trend in net cash provided by operating activities.

53. A high quality of earnings is indicated by: A. Earnings derived largely from newly introduced products. B. Declaration of both cash and stock dividends. C. Use of the FIFO method of inventory during sustained inflation. D. A history of increasing earnings and conservative ing methods.

54. In evaluating the quality of a company's earnings, which of the following factors is least important? A. The ing methods used by management. B. The trend of the company's earnings over a period of years. C. The dollar amount of earnings per share. D. The stability and sources of the company's earnings.

55. The measures most often used in evaluating solvency--the current ratio, quick ratio, and amount of working capital are developed from amounts appearing in the: A. Balance sheet. B. Income statement. C. Statement of retained earnings. D. Statement of cash flows.

56. Which of the following is not a measure of profitability? A. EPS. B. ROI. C. ROE. D. NLR.

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57. Which American industry would tend to have the greatest debt ratio? A. Auto. B. Retail clothing. C. Manufacturing. D. Banking.

58. The current ratio: A. Is computed by dividing current assets by current liabilities. B. Is computed by subtracting current liabilities from current assets. C. Remains unchanged throughout the operating cycle. D. Is a measure of short-term profitability.

59. Component percentages indicate the relative size of each item included in a total. Which of the following statements is true? A. Income statement items are expressed as a percentage of net income and balance sheet items as a percentage of total assets. B. Income statement items are expressed as a percentage of sales and balance sheet items as a percentage of total assets. C. Income statement items are expressed as a percentage of net income and balance sheet items as a percentage of net worth. D. Both income statement and balance sheet items are expressed as a percentage of net worth.

60. How would a company's working capital be affected if a substantial amount of s payable were paid in cash? A. It would be unaffected. B. It would fall. C. It would increase. D. The change would depend on the relationship between the payables liquidated and current liabilities.

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61. Current assets are those assets that can be converted into cash within: A. One year and never longer. B. One year or the operating cycle, whichever is longer. C. One year or the operating cycle, whichever is shorter. D. Management's discretion.

62. The current ratio is calculated by: A. Dividing current assets by total assets. B. Dividing current assets by total liabilities. C. Dividing current assets by stockholders' equity. D. Dividing current assets by current liabilities.

63. The quick ratio: A. Is computed by dividing current assets by current liabilities. B. Is always higher than the current ratio. C. Cannot be higher than the current ratio. D. May be higher or lower than the current ratio.

64. Short-term creditors are most likely to use the quick ratio instead of the current ratio in evaluating the solvency of a company with large, slow-moving: A. Plant and equipment. B. Receivables. C. Inventories. D. Employees.

65. Which of the following is considered a quick asset? A. s receivable. B. Inventory. C. Automobiles. D. Prepaid expenses.

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66. Which of the following transactions would cause a change in the amount of a company's working capital? A. Collection of an receivable. B. Payment of an payable. C. Borrowing cash over a 60-day period. D. Selling merchandise at a price above its cost.

67. The debt ratio indicates the percentage of: A. Total assets financed by long-term mortgages. B. Revenue consumed by interest expense. C. Total assets financed by creditors. D. Total liabilities classified as current.

68. The debt ratio is used primarily as a measure of: A. Short-term liquidity. B. Creditors' long-term risk. C. Profitability. D. Return on Investment.

69. Generally speaking, which appears to be a desirable current ratio? A. 20 to 1. B. 1 to 20. C. 2 to 1. D. 1 to 2.

70. All of the following captions or subtotals are typical of a multiple-step income statement except for: A. Net sales. B. Gross profit. C. Total costs and expenses. D. Operating income.

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71. When comparing the current ratio to the quick ratio: A. The current ratio will always be greater B. The quick ratio will always be greater C. The quick ratio is sometimes greater and sometimes less than the current ratio D. They always will be the same

72. The gross profit rate represents: A. Total sales revenue. B. The percentage change in net sales from the prior period. C. The percentage of sales revenue remaining after providing for the cost of the merchandise sold. D. Net income stated as a percentage of total sales revenue.

73. A rising gross profit rate most strongly suggests: A. An increase in physical sales volume. B. Strong consumer demand for the company's products. C. Intense competition. D. Increased short-term solvency.

74. Operating income excludes each of the following, except: A. Interest expense. B. Income taxes. C. Depreciation. D. Prepaid expenses.

75. Assume that net sales are increasing faster than the rate of inflation, and that the company's gross profit rate is rising. Of the following, the most logical conclusion is that: A. The company's cost of purchasing merchandise is rising rapidly. B. Operating expenses are falling. C. Demand for the company's products is very strong. D. The company has achieved an increase in sales volume by reducing its sales prices.

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76. In calculating earnings per share, the denominator of the equation includes: A. Only common stock outstanding. B. Common stock plus preferred stock. C. Common stock less preferred stock. D. The total shares of authorized common stock.

77. On common size income statements, each component in the income statement is represented as a percentage of: A. Net income. B. Sales. C. Total assets. D. Profit.

78. In a multiple-step income statement, interest expense usually is not classified as an operating expense because interest charges: A. Do not contribute to the production of revenue. B. Stem from the manner in which assets are financed, not the manner in which they are used in business operations. C. Relate directly to the cost of goods sold. D. The statement is incorrect. Interest usually is classified as an operating expense.

79. In a multiple-step income statement, income taxes are not classified as operating expenses because: A. Income taxes do not contribute to the production of revenue. B. Income taxes stem from the manner in which assets are financed, not the manner in which they are used in business operations. C. Not all forms of business organization are subject to income taxes. D. The statement is incorrect; income taxes are classified as operating expenses.

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80. Traditionally, stock of financially sound companies with stable earnings usually have a price/earnings ratio of: A. 90. B. 12. C. 1/4. D. 3.

81. Return on equity computations are used in evaluating: A. Liquidity. B. Profitability. C. Gross profit. D. Whether a ratio is improving or deteriorating over time.

82. The financial ratio intended to measure the effectiveness with which management has utilized the resources of the business, regardless of how these resources are financed, is: A. Gross profit rate. B. Current ratio. C. Return on assets. D. Return on equity.

83. The return on assets ratio usually is computed as: A. Net sales divided by average total assets. B. Gross profit divided by average total assets. C. Operating income divided by average total assets. D. Net income divided by average total assets.

84. If a company has a current ratio of 2 to 1, and purchases inventory on credit, what will this do to its current ratio? A. Increase the current ratio. B. Decrease the current ratio. C. Does not change the current ratio. D. Cannot be determined.

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85. The return on equity ratio usually is computed as: A. Net income divided by average total assets. B. Operating income divided by average total stockholders' equity. C. Gross profit divided by average total stockholders' equity. D. None of the above answers is correct.

86. The measurement that best reflects investors' expectations about future earnings is: A. Earnings per share. B. Return on assets. C. The price/earnings ratio. D. Return on equity.

87. The interest coverage ratio is computed by dividing: A. Operating income by annual interest expense. B. Net income by annual interest expense. C. Carrying value of bonds by cash interest payments. D. Earnings per share by the prime interest rate.

88. Amalgamated Corporation's net income was $2,400,000 in 2009 and $800,000 in 2010. What percentage increase in net income must Amalgamated achieve in 2011 to offset the decline in profits in 2010? A. 75%. B. 300%. C. 33.33%. D. 800%.

89. If a retail store has a current ratio of 2.5 and current assets of $195,000, the amount of working capital is: A. $78,000. B. $380,000. C. $330,000. D. $117,000.

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90. The Plaza Company has working capital of $540,000 and a current ratio of 3 to 1. The amount of current assets is: A. $405,000. B. $540,000. C. $810,000. D. $270,000.

91. During the years 2009 through 2011, Powers, Inc., reported the following amounts of net income (dollars in thousands):

Relative to the prior year, the percentage change in net income: A. Was the same in 2010 and 2011. B. Was larger in 2011 than in 2010. C. Was smaller in 2011 than in 2010. D. Cannot be determined without knowing how many shares of stock were outstanding.

Shown below are selected data from the balance sheet of Compros, a small electronics store (dollar amounts are in thousands):

92. Refer to the above data. What is the quick ratio? A. 1.5 to 1. B. .7 to 1. C. .45 to 1. D. Some other amount.

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93. Refer to the above data. What is the current ratio? A. 5.0 to 1. B. 1.5 to 1. C. .7 to 1. D. Some other amount.

94. Refer to the above data. What is working capital amounts to: A. $225,000. B. $300,000. C. $150,000. D. Some other amount.

95. Refer to the above data. What is Compro's debt ratio? A. 75%. B. 25%. C. 60%. D. Some other amount.

Shown below are selected data from the balance sheet of Bill's Auto Parts, a retail store (dollar amounts are in thousands):

96. Refer to the above data. What is the quick ratio? A. 5%. B. 1.5 to 1. C. 20%. D. Some other amount.

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97. Refer to the above data. What is the current ratio? A. 1.2 to 1. B. Less than 2 to 1, but not 1.2 to 1. C. 2.6 to 1. D. More than 2 to 1, but not 2.6 to 1.

98. Refer to the above data. Working capital amounts to: A. $560,000 B. $530,000 C. $270,000 D. Some other amount.

99. Refer to the above data. Bill's debt ratio is: A. 22%. B. 27%. C. 57%. D. Some other amount.

Shown below are selected data from the financial statements of Supreme Co. Dollar amounts are in millions (except for the per share data).

Per share data (these amounts stated in actual dollars, not millions): Supreme reported earnings per share for the year of $4 and paid cash dividends of $1 per share. At year end, the Wall Street Journal listed Supreme's capital stock as trading at $88 per share.

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100. Refer to the above data. Supreme's gross profit rate was: A. 42.9%. B. 57.7%. C. 20.0%. D. Some other amount.

101. Refer to the above data. What was Supreme's operating income? (in millions): A. $710. B. $390. C. $270. D. Some other amount.

102. Refer to the above data. Supreme's return on assets was: A. 10%. B. 6.75%. C. 15%. D. Some other percentage.

103. Refer to the above data. Supreme's return on equity was: A. 11%. B. 25%. C. 7.5%. D. 16.3%.

104. Refer to the above data. Supreme's price/earnings ratio at year end was: A. 25. B. 22. C. 100. D. Some other amount.

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Shown below are selected data from the financial statements of Noble Computers. (Dollar amounts are in millions, except for the per share data.)

Per share data (these amounts stated in actual dollars, not millions): Noble reported earnings per share for the year of $6 and paid cash dividends of $2.00 per share. At year end, the Wall Street Journal listed Noble's capital stock as trading at $81 per share.

105. Refer to the above data. Noble's price/earnings ratio at year end was: A. .7. B. 13.5. C. 17. D. Some other amount.

106. Refer to the above data. Noble's gross profit rate was: A. 18%. B. 46%. C. 50%. D. Some other amount.

107. Refer to the above data. Noble's operating income was: A. $1,610. B. $675 C. $935. D. Some other amount.

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108. Refer to the above data. Noble's return on assets was: A. 2.6% B. 21%. C. 26%. D. Some other amount.

109. Refer to the above data. Noble's return on equity was: A. 10%. B. 13%. C. 21%. D. Some other amount.

Given below are comparative balance sheets and an income statement for Claret Corporation

All sales were made on . Cash dividends declared during the year totaled $11,492

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110. Refer to the above data. Claret Corporation's s receivable turnover for 2009 is: A. 4.6 times. B. 2.9 times. C. 5.4 times. D. 68 days.

111. Refer to the above data. Claret Corporation's inventory turnover for 2009 is: A. 6.6 times. B. 3.9 times. C. 4.1 times. D. 94 days.

112. Refer to the above data. Claret Corporation's gross profit rate for 2009 is: A. 60.1%. B. 39.9%. C. 33%. D. 68%.

113. Refer to the above data. Claret Corporation's return on assets for 2009 rounded to the nearest tenth of a percent is: A. 9.9%. B. 4.1%. C. 5.9%. D. 16.9%.

114. Refer to the above data. Claret Corporation's return on common stockholders' equity for 2009, rounded to the nearest tenth of a percent, is: A. 5.9%. B. 6.05%. C. 14.4%. D. 9.4%.

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115. In an attempt to standardize financial practices worldwide, two areas of particular interest to the International ing Standards Committee are: A. Capitalizing and expensing B. Segments and consolidations C. Pensions and Leases D. Partnerships and corporation

116. An organization that provides ratings of corporate governance services is: A. SEC B. ISS C. IRS D. IBM

Essay Questions

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117. ing terminology Listed below are eight technical ing introduced in this chapter:

Each of the following statements may (or may not) describe one of these technical . For each statement, indicate the term described, or answer "None" if the statement does not correctly describe any of the . (a) The percentage of total assets financed by creditors. (b) A measure of the effectiveness with which management utilizes a company's resources, regardless of how those resources are financed. (c) A company's percentage share of total dollar sales within its industry. (d) Current assets less current liabilities. (e) A measure reflecting investors expectations of future profitability. (f) A measure of short-term solvency often used when a company has large inventories that cannot be quickly converted into cash. (g) A ratio that helps individual stockholders relate the net income of a large corporation to their equity investment.

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118. Current ratio and working capital The balance sheet of Red Missile Company contained the following items, among others:

(a) From the above information compute: (1) Current assets: $_______ (2) Current liabilities: $______ (3) The current ratio: ______ to 1 (4) Working capital: $______ (b) Assume that Red Missile Company pays the note payable of $163,000, thus reducing cash to $17,000. Compute the following after the completion of this transaction: (1) The current ratio: ______ to 1 (2) Working capital: $______

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119. Measures of solvency and credit risk Shown below are selected items appearing in a recent balance sheet of Grant Products. (Dollar amounts are in thousands.)

(a) Compute the following: (1) Total quick assets $____________ (2) Total current assets $____________ (3) Total current liabilities $____________ (4) Quick ratio ______ to 1 (5) Current ratio ______ to 1 (b) Research indicates an industry average quick ratio is 1.3 to 1, and a current ratio of 2.3 to 1. Based upon this information, does Grant Products appear more or less solvent than the average company in its industry? Explain briefly.

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120. Multiple-step income statement Shown below is a recent income statement for Phaeton, Inc.:

Prepare an income statement for the year in a multiple-step format. (Use the grid provided below.)

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121. Return on investment Shown below are selected data from a recent annual report of Quality Service. (Dollar amounts are in millions.)

Compute for the year:

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122. Computation of profitability ratios Shown below are selected data from a recent annual report of Tall Oaks Co. (Dollar amounts are in thousands.)

Compute for the year the company's:

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123. Profitability measures Shown below is a recent income statement for B-D Electric.

Assume that comparative balance sheets for B-D Electric indicate average total assets for the year of $2,500,000, and average total equity of $2,050,000. Compute the following:

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124. Percentage changes Selected information from the financial statements of Perfectly Baked Cake Co. appears below:

(a) Compute the percentage change in each of the above items from 2010 to 2011. Use a + or to indicate increase or decrease.

(b) Compute net income as a percentage of net sales in each year. (Round to the nearest onetenth of 1%)

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125. Percentage changes; p/e ratios and investors' expectations Shown below are Gamma, Inc.'s earnings per share for a four-year period, along with the pershare market price of the company's stock at each year-end. The earnings in 2011 were the highest in the company's history.

(a) Compute the percentage change in earnings per share in 2009, 2010, and 2011. (Place your answers in the spaces provided above.) (b) Compute the p/e ratio of stock at the end of each of the four years. (Place your answers in the spaces provided above.) (c) What does the p/e ratio at the end of 2011 indicate about investors' expectations of earnings per share for the coming year? Explain your reasoning.

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126. Effects of events on financial measurements Indicate the probable effects of each of the following strategies or events upon the financial measurements of Lindsay Corp. listed below. Use the code letters I = Increase, D = Decrease, and NE = No Effect.

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127. Financial ratios Shown below are some key figures from the balance sheets of Minuteman Gas Company for two successive years:

Dividends of $96,000 were declared and paid in 2010. Compute the following:

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128. Financial ratios Given below are comparative balance sheets and an income statement for the Excellent Corporation:

All sales were made on . Cash dividends declared during the year totaled $58,550. Compute the following:

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129. Effects of transactions upon analytical measurements Determine the immediate effect of each of the transactions described below on the ratio listed beside each transaction. In the blank space to the left of each statement, you are to indicate the effect by writing the appropriate code letter. The code letters are as follows: I = increase the ratio, D = decrease the ratio, and NE = no effect on this ratio.

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130. Use and interpretation of financial measurements Shown below are various financial measurements for two companies which are similar in size and sell similar products:

Instructions: You are to enter code letters in the spaces provided in the two right-hand columns. In the first column, indicate which of the following three groups probably would be most interested in the specified financial measurement. Identify one group, using the following code letters: STC = indicating short-term creditors, LTC = indicating long-term creditors, and S = indicating stockholders. In the second column, enter an X or a Y to indicate whether your "most interested group" would prefer the measurement results reported by Co. X or Co. Y. Consider each financial measurement independently of the others.

131. Evaluating the adequacy of net income Assume that Delta Corp. earns net income of $1,000,000 in the current year. Identify two important factors that investors should consider in evaluating the reasonableness of this dollar amount. Explain what investors may learn from each of these considerations.

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132. ROI: What and why? In general , what do all "ROI" ratios measure? Why are such computations useful?

133. Income statement classifications Simon Hardware and Garfunkel Foods are sole proprietorships with similar amounts of total assets. Also, both businesses earn similar amounts of revenue, incur similar amounts of operating expenses, and report similar net incomes. However, Simon has a higher cost of goods sold, while Garfunkel Foods has higher interest expense. Indicate which of these companies has the higher (a) gross profit rate, and (b) return on assets. In each case, explain the reasons for each answer.

134. Improving the current ratio Carter Corporation financed construction of a new addition to its facilities with a large longterm note payable. As a condition of obtaining the loan, Carter agreed to maintain a current ratio at year-end of at least 1.7 to 1. If Carter fails to maintain this ratio, the lender may demand immediate repayment of the principal amount of the note and all unpaid accrued interest. As the end of the year approaches, Carter is concerned about the magnitude of its current ratio. Suggest some actions that the company might take to increase the magnitude of the current ratio.

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135. Below is a number of ratios. Match the computation to one of the ratios. If there is no match fill in "none"

(a.) Net income - preferred dividends divided by average number of common shares outstanding. (b.) Net sales divided by average s receivable (c.) Operating income divided by average total assets (d.) Current assets divided by current liabilities (e.) Annual dividend divided by current stock price (f.) Current assets minus current liabilities (g.) Total liabilities divided by total assets (h.) Net income divided by average total equity (i.) Common stockholder's equity divided by shares of common stock outstanding. (j.) Current stock price divided by earnings per share

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136. The following information is available for the Grant Company for 2010:

Required: What are earnings per share for the current year? What is the P/E ratio? What is the book value per share of common stock? What is the dividend yield on common stock? What is the net profit ratio? What is the return on equity?

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Chapter 14 Financial Statement Analysis Answer Key

True / False Questions

1. Vertical analysis compares the results of financial information with a business in the same industry for a number of consecutive periods of time. FALSE

AACSB: Reflective Thinking AIA BB: Industry AIA FN: Measurement Learning Objective: 1

2. The quick ratio is especially useful in evaluating the liquidity of a company with fast moving inventories. FALSE

AACSB: Reflective Thinking AIA BB: Resource Management AIA FN: Measurement Learning Objective: 4

3. Deducting the cost of goods sold from net income gives us operating income. FALSE

AACSB: Reflective Thinking AIA BB: Critical Thinking AIA FN: Measurement Learning Objective: 5

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4. The gross profit rate is gross profit expressed as a percentage of net sales. TRUE


5. The gross profit rate usually is lowest on fast moving merchandise and highest on specialty and novelty products TRUE

AACSB: Analytic AIA BB: Critical Thinking AIA FN: Measurement Learning Objective: 5

6. When an income statement does not show gross profit or operating income it is called a consolidated statement. FALSE

AACSB: Reflective Thinking AIA BB: Critical Thinking AIA FN: Measurement Learning Objective: 1 Learning Objective: 5

7. ROE - return on equity - is measured by dividing net income by average number of shares outstanding. FALSE

AACSB: Reflective Thinking AIA BB: Resource Management AIA FN: Measurement Learning Objective: 5 Learning Objective: 7

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8. The yield rate on stock is measured by dividing dividends per share by market price per share. TRUE


9. The trend in ratios is usually more useful than looking at a single year's ratio. TRUE


10. The acid test ratio includes marketable securities but does not include s receivable. FALSE


11. Comparative financial statements show side-by-side financial data for two or more companies. FALSE


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12. The quality of earnings tends to be higher for a company that uses straight-line depreciation and defers costs whenever possible than for a company which uses accelerated depreciation and defers costs only when necessary. FALSE


13. If total current assets are $140,000 at the end of Year 1, increase by $50,000 by the end of Year 2, and increase by $50,000 in Year 3, the percentage increase over the preceding year is less in Year 3 than in Year 2. TRUE


14. Working capital is the excess of current assets over current liabilities. TRUE


15. A company's liquidity refers to its ability to remain profitable. FALSE


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16. Inventory is an example of a quick asset. FALSE


17. Current assets are those assets that can be converted into cash within a year and never longer. FALSE


18. The debt ratio is computed by dividing total liabilities by current assets. FALSE


19. The lower the current ratio, the more liquid the company appears. FALSE

AACSB: Analytic AIA BB: Resource Management AIA FN: Risk Analysis Learning Objective: 4

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20. The owners of a corporation are not personally responsible for the debts of the business. TRUE


21. A single-step and multiple-step income statement are different in form and in the amount of net income reported. FALSE


22. A company whose sales are growing at less than the rate of inflation may actually be selling less merchandise every year. TRUE


23. A company cannot be increasing its market share if its net sales are declining. FALSE

AACSB: Analytic AIA BB: Marketing AIA FN: Measurement Learning Objective: 6

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24. Net income stated as a percentage of sales is one means of evaluating a company's ability to control its expenses. TRUE


25. A company whose future earnings are expected to rise substantially is likely to have a higher price/earnings ratio than a company whose future earnings are expected to decline. TRUE


26. From a creditor's point of view, the lower the debt ratio; the safer the creditors' position. TRUE


27. The price/earnings ratio is calculated by dividing earnings per share by the current market price of a share of the company's stock. FALSE

AACSB: Reflective Thinking AIA BB: Industry AIA FN: Measurement Learning Objective: 5

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28. If the return on total assets ratio is substantially below the cost of borrowing, common stockholders will benefit from a high debt ratio. FALSE


29. The return on equity ratio may be either higher or lower than the return on assets ratio. TRUE


30. The current ratio may be less than, equal to, or greater than the quick ratio. FALSE


31. The inventory turnover rate indicates how quickly inventory sells. TRUE


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32. In a single-step income statement, all revenue items are listed then all expense items are combined and deducted from total revenue. TRUE


33. In a classified balance sheet, assets are subdivided into current assets, plant and equipment and other assets, while liabilities are all classified as current. FALSE


34. The more pessimistic investors' expectations regarding a company's future performance the lower the price/earnings ratio is likely to be. TRUE


35. A company should carry the amount of working capital necessary to conduct operations not necessarily maximize its working capital. TRUE

AACSB: Analytic AIA BB: Resource Management AIA FN: Measurement Learning Objective: 4

Multiple Choice Questions

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36. In order for investors and creditors to decide whether to invest in a company or loan a company funds they may A. Analyze financial statements. B. Focus on corporate governance. C. Both of the above. D. Neither of the above.


37. A comparative financial statement A. Places the balance sheet, the income statement and the statement of cash flows side by side in order to compare the results. B. Places two or more years of a financial statement side by side in order to compare results. C. Places the financial statements of two or more companies side by side in order to compare results. D. Places the dollar amounts next to the percentage amounts of a given year for the income statement.


38. The changes in financial statement items from a base year to following years are called: A. Money changes B. Trend percentages C. Component percentages D. Ratios


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39. The measurement of the relative size of each item included in a total is called: A. Money changes B. Trend percentages C. Component percentages D. Ratios


40. One number expressed as a percentage of another is called: A. Money changes B. Trend percentages C. Component percentages D. Ratios


41. The excess of current assets over current liabilities is called: A. Current ratio B. Working capital C. Debt ratio D. Quick ratio


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42. Quick assets include which of the following? A. Cash, marketable securities and receivables. B. Cash, marketable securities and inventories. C. Cash, inventories and receivables. D. Market securities, receivables and inventories.


43. The ratio which measures total liabilities as a percentage of total assets is called: A. Current ratio B. Working capital C. Debt ratio D. Quick ratio


44. The price/earnings ratio is measured by dividing A. Book value by earnings per share. B. Par value by earnings per share. C. Market value by earnings per share. D. Market value by total net income.


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45. The principle factors affecting the quality of working capital are: A. The nature of the current assets. B. The length of time to convert current assets into cash. C. Both A and B. D. Neither A nor B.


46. All of the following ratios are considered measures of profitability except: A. Earnings per share B. Gross profit rate C. Price earnings ratio D. Return on assets


47. All of the following ratios are considered measures of liquidity except: A. Quick ratio B. Debt ratio C. Current ratio D. Receivables turnover rate


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48. The term classified financial statements refers: A. To the financial statements of all companies working on government projects. B. Only to the financial statements of defense contractors working on secret projects. C. To financial statements prepared for use by management, but not for distribution outside of the organization. D. To financial statements in which items with certain characteristics are placed together in a group in an effort to develop useful subtotals.


49. Comparative financial statements compare the company's current statements with: A. Those of prior periods. B. Those of other companies in the same industry. C. Those of the company's principal competitor. D. The budgeted level of performance for the period.


50. Which of the following is not a measure of short-term liquidity? A. Quick ratio. B. Working capital. C. Current ratio. D. Debt ratio.


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51. The current ratio will be _______________ the quick ratio. A. Less than. B. Greater than or equal to. C. The same as. D. Always different than.


52. Which of the following is not a measure of long-term credit risk? A. Quick ratio. B. Debt ratio. C. Interest coverage ratio. D. Trend in net cash provided by operating activities.


53. A high quality of earnings is indicated by: A. Earnings derived largely from newly introduced products. B. Declaration of both cash and stock dividends. C. Use of the FIFO method of inventory during sustained inflation. D. A history of increasing earnings and conservative ing methods.


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54. In evaluating the quality of a company's earnings, which of the following factors is least important? A. The ing methods used by management. B. The trend of the company's earnings over a period of years. C. The dollar amount of earnings per share. D. The stability and sources of the company's earnings.

AACSB: Analytic AIA BB: Critical Thinking AIA FN: Risk Analysis Learning Objective: 2

55. The measures most often used in evaluating solvency--the current ratio, quick ratio, and amount of working capital are developed from amounts appearing in the: A. Balance sheet. B. Income statement. C. Statement of retained earnings. D. Statement of cash flows.


56. Which of the following is not a measure of profitability? A. EPS. B. ROI. C. ROE. D. NLR.


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57. Which American industry would tend to have the greatest debt ratio? A. Auto. B. Retail clothing. C. Manufacturing. D. Banking.

AACSB: Analytic AIA BB: Industry AIA FN: Measurement Learning Objective: 4

58. The current ratio: A. Is computed by dividing current assets by current liabilities. B. Is computed by subtracting current liabilities from current assets. C. Remains unchanged throughout the operating cycle. D. Is a measure of short-term profitability.


59. Component percentages indicate the relative size of each item included in a total. Which of the following statements is true? A. Income statement items are expressed as a percentage of net income and balance sheet items as a percentage of total assets. B. Income statement items are expressed as a percentage of sales and balance sheet items as a percentage of total assets. C. Income statement items are expressed as a percentage of net income and balance sheet items as a percentage of net worth. D. Both income statement and balance sheet items are expressed as a percentage of net worth.


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60. How would a company's working capital be affected if a substantial amount of s payable were paid in cash? A. It would be unaffected. B. It would fall. C. It would increase. D. The change would depend on the relationship between the payables liquidated and current liabilities.

AACSB: Analytic AIA BB: Resource Management AIA FN: Measurement Learning Objective: 4

61. Current assets are those assets that can be converted into cash within: A. One year and never longer. B. One year or the operating cycle, whichever is longer. C. One year or the operating cycle, whichever is shorter. D. Management's discretion.


62. The current ratio is calculated by: A. Dividing current assets by total assets. B. Dividing current assets by total liabilities. C. Dividing current assets by stockholders' equity. D. Dividing current assets by current liabilities.


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63. The quick ratio: A. Is computed by dividing current assets by current liabilities. B. Is always higher than the current ratio. C. Cannot be higher than the current ratio. D. May be higher or lower than the current ratio.


64. Short-term creditors are most likely to use the quick ratio instead of the current ratio in evaluating the solvency of a company with large, slow-moving: A. Plant and equipment. B. Receivables. C. Inventories. D. Employees.


65. Which of the following is considered a quick asset? A. s receivable. B. Inventory. C. Automobiles. D. Prepaid expenses.


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66. Which of the following transactions would cause a change in the amount of a company's working capital? A. Collection of an receivable. B. Payment of an payable. C. Borrowing cash over a 60-day period. D. Selling merchandise at a price above its cost.


67. The debt ratio indicates the percentage of: A. Total assets financed by long-term mortgages. B. Revenue consumed by interest expense. C. Total assets financed by creditors. D. Total liabilities classified as current.


68. The debt ratio is used primarily as a measure of: A. Short-term liquidity. B. Creditors' long-term risk. C. Profitability. D. Return on Investment.


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69. Generally speaking, which appears to be a desirable current ratio? A. 20 to 1. B. 1 to 20. C. 2 to 1. D. 1 to 2.


70. All of the following captions or subtotals are typical of a multiple-step income statement except for: A. Net sales. B. Gross profit. C. Total costs and expenses. D. Operating income.


71. When comparing the current ratio to the quick ratio: A. The current ratio will always be greater B. The quick ratio will always be greater C. The quick ratio is sometimes greater and sometimes less than the current ratio D. They always will be the same


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72. The gross profit rate represents: A. Total sales revenue. B. The percentage change in net sales from the prior period. C. The percentage of sales revenue remaining after providing for the cost of the merchandise sold. D. Net income stated as a percentage of total sales revenue.


73. A rising gross profit rate most strongly suggests: A. An increase in physical sales volume. B. Strong consumer demand for the company's products. C. Intense competition. D. Increased short-term solvency.


74. Operating income excludes each of the following, except: A. Interest expense. B. Income taxes. C. Depreciation. D. Prepaid expenses.


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75. Assume that net sales are increasing faster than the rate of inflation, and that the company's gross profit rate is rising. Of the following, the most logical conclusion is that: A. The company's cost of purchasing merchandise is rising rapidly. B. Operating expenses are falling. C. Demand for the company's products is very strong. D. The company has achieved an increase in sales volume by reducing its sales prices.


76. In calculating earnings per share, the denominator of the equation includes: A. Only common stock outstanding. B. Common stock plus preferred stock. C. Common stock less preferred stock. D. The total shares of authorized common stock.


77. On common size income statements, each component in the income statement is represented as a percentage of: A. Net income. B. Sales. C. Total assets. D. Profit.


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78. In a multiple-step income statement, interest expense usually is not classified as an operating expense because interest charges: A. Do not contribute to the production of revenue. B. Stem from the manner in which assets are financed, not the manner in which they are used in business operations. C. Relate directly to the cost of goods sold. D. The statement is incorrect. Interest usually is classified as an operating expense.


79. In a multiple-step income statement, income taxes are not classified as operating expenses because: A. Income taxes do not contribute to the production of revenue. B. Income taxes stem from the manner in which assets are financed, not the manner in which they are used in business operations. C. Not all forms of business organization are subject to income taxes. D. The statement is incorrect; income taxes are classified as operating expenses.


80. Traditionally, stock of financially sound companies with stable earnings usually have a price/earnings ratio of: A. 90. B. 12. C. 1/4. D. 3.


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81. Return on equity computations are used in evaluating: A. Liquidity. B. Profitability. C. Gross profit. D. Whether a ratio is improving or deteriorating over time.


82. The financial ratio intended to measure the effectiveness with which management has utilized the resources of the business, regardless of how these resources are financed, is: A. Gross profit rate. B. Current ratio. C. Return on assets. D. Return on equity.

AACSB: Reflective Thinking AIA BB: Resource Management AIA FN: Measurement Learning Objective: 5 Learning Objective: 7

83. The return on assets ratio usually is computed as: A. Net sales divided by average total assets. B. Gross profit divided by average total assets. C. Operating income divided by average total assets. D. Net income divided by average total assets.


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84. If a company has a current ratio of 2 to 1, and purchases inventory on credit, what will this do to its current ratio? A. Increase the current ratio. B. Decrease the current ratio. C. Does not change the current ratio. D. Cannot be determined.

AACSB: Analytic AIA BB: Critical Thinking AIA FN: Measurement Learning Objective: 4 Learning Objective: 7

85. The return on equity ratio usually is computed as: A. Net income divided by average total assets. B. Operating income divided by average total stockholders' equity. C. Gross profit divided by average total stockholders' equity. D. None of the above answers is correct.


86. The measurement that best reflects investors' expectations about future earnings is: A. Earnings per share. B. Return on assets. C. The price/earnings ratio. D. Return on equity.


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87. The interest coverage ratio is computed by dividing: A. Operating income by annual interest expense. B. Net income by annual interest expense. C. Carrying value of bonds by cash interest payments. D. Earnings per share by the prime interest rate.


88. Amalgamated Corporation's net income was $2,400,000 in 2009 and $800,000 in 2010. What percentage increase in net income must Amalgamated achieve in 2011 to offset the decline in profits in 2010? A. 75%. B. 300%. C. 33.33%. D. 800%. $2,400,000/$800,000 = 3 or 300%


89. If a retail store has a current ratio of 2.5 and current assets of $195,000, the amount of working capital is: A. $78,000. B. $380,000. C. $330,000. D. $117,000. $195,000 - ($195,000/2.5) = $117,000


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90. The Plaza Company has working capital of $540,000 and a current ratio of 3 to 1. The amount of current assets is: A. $405,000. B. $540,000. C. $810,000. D. $270,000. 3CL - CL = $540,000: CL = $270,000; CA = $810,000


91. During the years 2009 through 2011, Powers, Inc., reported the following amounts of net income (dollars in thousands):

Relative to the prior year, the percentage change in net income: A. Was the same in 2010 and 2011. B. Was larger in 2011 than in 2010. C. Was smaller in 2011 than in 2010. D. Cannot be determined without knowing how many shares of stock were outstanding. 20/150 = 13% while 30/120 = 25%


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Shown below are selected data from the balance sheet of Compros, a small electronics store (dollar amounts are in thousands):

92. Refer to the above data. What is the quick ratio? A. 1.5 to 1. B. .7 to 1. C. .45 to 1. D. Some other amount. ($75 + $135)/$300 = .7


93. Refer to the above data. What is the current ratio? A. 5.0 to 1. B. 1.5 to 1. C. .7 to 1. D. Some other amount. ($75 + $135 + $240)/$300 = 1.5


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94. Refer to the above data. What is working capital amounts to: A. $225,000. B. $300,000. C. $150,000. D. Some other amount. $450 - $300 = $150

AACSB: Analytic AIA BB: Industry AIA FN: Measurement Learning Objective: 4 Learning Objective: 7

95. Refer to the above data. What is Compro's debt ratio? A. 75%. B. 25%. C. 60%. D. Some other amount. $675/$900 = 75%


Shown below are selected data from the balance sheet of Bill's Auto Parts, a retail store (dollar amounts are in thousands):

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96. Refer to the above data. What is the quick ratio? A. 5%. B. 1.5 to 1. C. 20%. D. Some other amount. ($130 + $370)/$340 = 1.47


97. Refer to the above data. What is the current ratio? A. 1.2 to 1. B. Less than 2 to 1, but not 1.2 to 1. C. 2.6 to 1. D. More than 2 to 1, but not 2.6 to 1. ($130 + $370 + $400) /$340 = 2.65


98. Refer to the above data. Working capital amounts to: A. $560,000 B. $530,000 C. $270,000 D. Some other amount. ($130 + $370 + $400) - $340 = $560


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99. Refer to the above data. Bill's debt ratio is: A. 22%. B. 27%. C. 57%. D. Some other amount. ($340 + $280)/$1260 = 49%


Shown below are selected data from the financial statements of Supreme Co. Dollar amounts are in millions (except for the per share data).

Per share data (these amounts stated in actual dollars, not millions): Supreme reported earnings per share for the year of $4 and paid cash dividends of $1 per share. At year end, the Wall Street Journal listed Supreme's capital stock as trading at $88 per share.

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100. Refer to the above data. Supreme's gross profit rate was: A. 42.9%. B. 57.7%. C. 20.0%. D. Some other amount. $1,230 - $520 = $710; $710/$1,230 = 57.7%

AACSB: Analytic AIA BB: Critical Thinking AIA FN: Measurement Learning Objective: 5 Learning Objective: 6 Learning Objective: 7

101. Refer to the above data. What was Supreme's operating income? (in millions): A. $710. B. $390. C. $270. D. Some other amount. $1,230 - $520 - $440 = $270


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102. Refer to the above data. Supreme's return on assets was: A. 10%. B. 6.75%. C. 15%. D. Some other percentage. $230/$4,000 = .6%


103. Refer to the above data. Supreme's return on equity was: A. 11%. B. 25%. C. 7.5%. D. 16.3%. $390/$2,400 = 16.3%


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104. Refer to the above data. Supreme's price/earnings ratio at year end was: A. 25. B. 22. C. 100. D. Some other amount. $88/$4 = 22


Shown below are selected data from the financial statements of Noble Computers. (Dollar amounts are in millions, except for the per share data.)

Per share data (these amounts stated in actual dollars, not millions): Noble reported earnings per share for the year of $6 and paid cash dividends of $2.00 per share. At year end, the Wall Street Journal listed Noble's capital stock as trading at $81 per share.

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105. Refer to the above data. Noble's price/earnings ratio at year end was: A. .7. B. 13.5. C. 17. D. Some other amount. $81/$6 = 13.5


106. Refer to the above data. Noble's gross profit rate was: A. 18%. B. 46%. C. 50%. D. Some other amount. ($3,500 - $1,890)/$3,500 = 46%


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107. Refer to the above data. Noble's operating income was: A. $1,610. B. $675 C. $935. D. Some other amount. $3,500 - $1,890 - $675 = $935

AACSB: Analytic AIA BB: Industry AIA FN: Measurement Learning Objective: 5 Learning Objective: 6 Learning Objective: 7

108. Refer to the above data. Noble's return on assets was: A. 2.6% B. 21%. C. 26%. D. Some other amount. $935/$4,400 = 21%


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109. Refer to the above data. Noble's return on equity was: A. 10%. B. 13%. C. 21%. D. Some other amount. $115/$540 = 21%


Given below are comparative balance sheets and an income statement for Claret Corporation

All sales were made on . Cash dividends declared during the year totaled $11,492

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110. Refer to the above data. Claret Corporation's s receivable turnover for 2009 is: A. 4.6 times. B. 2.9 times. C. 5.4 times. D. 68 days. $228,800/ [($46,800 + $37,700)/2] = 5.4


111. Refer to the above data. Claret Corporation's inventory turnover for 2009 is: A. 6.6 times. B. 3.9 times. C. 4.1 times. D. 94 days. 137,540/[(32,500 + 36,400)/2] = 3.99


112. Refer to the above data. Claret Corporation's gross profit rate for 2009 is: A. 60.1%. B. 39.9%. C. 33%. D. 68%. $91,260/$228,800 = 39.9%


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113. Refer to the above data. Claret Corporation's return on assets for 2009 rounded to the nearest tenth of a percent is: A. 9.9%. B. 4.1%. C. 5.9%. D. 16.9%. $15,392/[(($152,100 + $156,000)/2)] = 9.9%


114. Refer to the above data. Claret Corporation's return on common stockholders' equity for 2009, rounded to the nearest tenth of a percent, is: A. 5.9%. B. 6.05%. C. 14.4%. D. 9.4%. $6,292/[($104,000 + $109,200)/2] = 5.9%


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115. In an attempt to standardize financial practices worldwide, two areas of particular interest to the International ing Standards Committee are: A. Capitalizing and expensing B. Segments and consolidations C. Pensions and Leases D. Partnerships and corporation


116. An organization that provides ratings of corporate governance services is: A. SEC B. ISS C. IRS D. IBM

AACSB: Reflective Thinking AIA BB: Legal AIA FN: Reporting Learning Objective: 4 Learning Objective: 7

Essay Questions

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117. ing terminology Listed below are eight technical ing introduced in this chapter:

Each of the following statements may (or may not) describe one of these technical . For each statement, indicate the term described, or answer "None" if the statement does not correctly describe any of the . (a) The percentage of total assets financed by creditors. (b) A measure of the effectiveness with which management utilizes a company's resources, regardless of how those resources are financed. (c) A company's percentage share of total dollar sales within its industry. (d) Current assets less current liabilities. (e) A measure reflecting investors expectations of future profitability. (f) A measure of short-term solvency often used when a company has large inventories that cannot be quickly converted into cash. (g) A ratio that helps individual stockholders relate the net income of a large corporation to their equity investment. (a) Debt ratio, (b) Return on assets, (c) Market share, (d) Working capital, (e) Price/earnings ratio, (f) Quick ratio, (g) Earnings per share

AACSB: Reflective Thinking AIA BB: Critical Thinking AIA FN: Measurement Learning Objective: 1 - 8

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118. Current ratio and working capital The balance sheet of Red Missile Company contained the following items, among others:

(a) From the above information compute: (1) Current assets: $_______ (2) Current liabilities: $______ (3) The current ratio: ______ to 1 (4) Working capital: $______ (b) Assume that Red Missile Company pays the note payable of $163,000, thus reducing cash to $17,000. Compute the following after the completion of this transaction: (1) The current ratio: ______ to 1 (2) Working capital: $______


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119. Measures of solvency and credit risk Shown below are selected items appearing in a recent balance sheet of Grant Products. (Dollar amounts are in thousands.)

(a) Compute the following: (1) Total quick assets $____________ (2) Total current assets $____________ (3) Total current liabilities $____________ (4) Quick ratio ______ to 1 (5) Current ratio ______ to 1 (b) Research indicates an industry average quick ratio is 1.3 to 1, and a current ratio of 2.3 to 1. Based upon this information, does Grant Products appear more or less solvent than the average company in its industry? Explain briefly.

(b.) Grant Products' current ratio and quick ratio both are below the industry averages. This means that Grant Products has less liquid assets in relation to its current liabilities, and therefore appears less solvent, than the average company in the industry.

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Chapter 14 Financial Statement Analysis AACSB: Analytic AIA BB: Critical Thinking AIA FN: Measurement Learning Objective: 4 Learning Objective: 7

120. Multiple-step income statement Shown below is a recent income statement for Phaeton, Inc.:

Prepare an income statement for the year in a multiple-step format. (Use the grid provided below.)

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121. Return on investment Shown below are selected data from a recent annual report of Quality Service. (Dollar amounts are in millions.)

Compute for the year:


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122. Computation of profitability ratios Shown below are selected data from a recent annual report of Tall Oaks Co. (Dollar amounts are in thousands.)

Compute for the year the company's:


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123. Profitability measures Shown below is a recent income statement for B-D Electric.

Assume that comparative balance sheets for B-D Electric indicate average total assets for the year of $2,500,000, and average total equity of $2,050,000. Compute the following:


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124. Percentage changes Selected information from the financial statements of Perfectly Baked Cake Co. appears below:

(a) Compute the percentage change in each of the above items from 2010 to 2011. Use a + or to indicate increase or decrease.

(b) Compute net income as a percentage of net sales in each year. (Round to the nearest onetenth of 1%)


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125. Percentage changes; p/e ratios and investors' expectations Shown below are Gamma, Inc.'s earnings per share for a four-year period, along with the pershare market price of the company's stock at each year-end. The earnings in 2011 were the highest in the company's history.

(a) Compute the percentage change in earnings per share in 2009, 2010, and 2011. (Place your answers in the spaces provided above.) (b) Compute the p/e ratio of stock at the end of each of the four years. (Place your answers in the spaces provided above.) (c) What does the p/e ratio at the end of 2011 indicate about investors' expectations of earnings per share for the coming year? Explain your reasoning.

(c) The p/e ratio of 8.5 is low by historical standards, indicating that investors do not expect the rapid earnings growth of recent years to continue. The sharp declines in stock price and price/earnings ratio occurring during Gamma's "record year" suggest that investors may be expecting earnings to decline from current levels. The current price/earnings ratio of 8.5 is even less than that at the end of 2008 which was preceded by a decline in earnings per share.


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126. Effects of events on financial measurements Indicate the probable effects of each of the following strategies or events upon the financial measurements of Lindsay Corp. listed below. Use the code letters I = Increase, D = Decrease, and NE = No Effect.


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127. Financial ratios Shown below are some key figures from the balance sheets of Minuteman Gas Company for two successive years:

Dividends of $96,000 were declared and paid in 2010. Compute the following:


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128. Financial ratios Given below are comparative balance sheets and an income statement for the Excellent Corporation:

All sales were made on . Cash dividends declared during the year totaled $58,550. Compute the following:

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AACSB: Analytic AIA BB: Industry AIA FN: Measurement Learning Objective: 1 Learning Objective: 4 Learning Objective: 5 Learning Objective: 7

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129. Effects of transactions upon analytical measurements Determine the immediate effect of each of the transactions described below on the ratio listed beside each transaction. In the blank space to the left of each statement, you are to indicate the effect by writing the appropriate code letter. The code letters are as follows: I = increase the ratio, D = decrease the ratio, and NE = no effect on this ratio.


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130. Use and interpretation of financial measurements Shown below are various financial measurements for two companies which are similar in size and sell similar products:

Instructions: You are to enter code letters in the spaces provided in the two right-hand columns. In the first column, indicate which of the following three groups probably would be most interested in the specified financial measurement. Identify one group, using the following code letters: STC = indicating short-term creditors, LTC = indicating long-term creditors, and S = indicating stockholders. In the second column, enter an X or a Y to indicate whether your "most interested group" would prefer the measurement results reported by Co. X or Co. Y. Consider each financial measurement independently of the others.


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131. Evaluating the adequacy of net income Assume that Delta Corp. earns net income of $1,000,000 in the current year. Identify two important factors that investors should consider in evaluating the reasonableness of this dollar amount. Explain what investors may learn from each of these considerations. Students are to identify two important factors to be considered in the evaluation of a company's earnings, and to explain what investors may learn from these considerations. Most students identify two of the following factors: -The resources invested in the effort to generate the company's earnings (i.e., size of the company). This consideration indicates the efficiency with which economic resources are employed. -The earnings of the company in prior periods. The trend in earnings indicates whether performance is improving or deteriorating. -The earnings of comparable companies (in size, as well as in the nature of operations). This comparison provides an indication of the company's ability to compete.

AACSB: Reflective Thinking AIA BB: Critical Thinking AIA FN: Decision Making Learning Objective: 6

132. ROI: What and why? In general , what do all "ROI" ratios measure? Why are such computations useful? "ROI" ratios measure an investor's "return" as a percentage of the average amount of the required investment. Such computations provide investors with a basis for comparing the profitability of alternative investment opportunities.

AACSB: Communications AIA BB: Critical Thinking AIA FN: Measurement Learning Objective: 5

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133. Income statement classifications Simon Hardware and Garfunkel Foods are sole proprietorships with similar amounts of total assets. Also, both businesses earn similar amounts of revenue, incur similar amounts of operating expenses, and report similar net incomes. However, Simon has a higher cost of goods sold, while Garfunkel Foods has higher interest expense. Indicate which of these companies has the higher (a) gross profit rate, and (b) return on assets. In each case, explain the reasons for each answer. (a) Both companies earn similar amounts of revenue, but Simon Hardware has the higher cost of goods sold. Therefore, Garfunkel Foods must have the higher total gross profit and also the higher gross profit rate. (b) Garfunkel Foods has the higher return on assets. Return on assets usually is computed by expressing operating income as a percentage of average total assets. As both companies have similar amounts of total assets, the company with the higher operating income will have the higher return on assets. Garfunkel Foods probably has the higher operating income. As both companies earn similar amounts of revenue and net income, their total costs and expenses also must be similar. Simon however, has a higher cost of goods sold, which is deducted in arriving at operating income. Garfunkel Foods has higher interest expense, but interest is deducted after the determination of operating income. Therefore, Garfunkel Foods probably has the higher operating income of the two businesses. Note to instructor: Income taxes is another "non-operating item" which may cause two businesses with similar net incomes to have different levels of operating income. However, both Simon Hardware and Garfunkel Foods are organized as sole proprietorships, and, therefore, do not include income taxes expense in their income statements.

AACSB: Communications AIA BB: Critical Thinking AIA FN: Reporting Learning Objective: 6 Learning Objective: 8

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134. Improving the current ratio Carter Corporation financed construction of a new addition to its facilities with a large longterm note payable. As a condition of obtaining the loan, Carter agreed to maintain a current ratio at year-end of at least 1.7 to 1. If Carter fails to maintain this ratio, the lender may demand immediate repayment of the principal amount of the note and all unpaid accrued interest. As the end of the year approaches, Carter is concerned about the magnitude of its current ratio. Suggest some actions that the company might take to increase the magnitude of the current ratio. Paying any current liabilities will increase the current ratio. The company could also consider postponing until after year-end any routine transactions that would reduce current assets, such as the acquisition of equipment or scheduled maintenance and repair expenditures. The sale of existing inventory (or any other current asset) for a price above cost would also cause the current ratio to increase.

AACSB: Analytic AIA BB: Critical Thinking AIA FN: Decision Making Learning Objective: 4

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135. Below is a number of ratios. Match the computation to one of the ratios. If there is no match fill in "none"

(a.) Net income - preferred dividends divided by average number of common shares outstanding. (b.) Net sales divided by average s receivable (c.) Operating income divided by average total assets (d.) Current assets divided by current liabilities (e.) Annual dividend divided by current stock price (f.) Current assets minus current liabilities (g.) Total liabilities divided by total assets (h.) Net income divided by average total equity (i.) Common stockholder's equity divided by shares of common stock outstanding. (j.) Current stock price divided by earnings per share (a.) Earnings per share (b.) A/R turnover rate (c.) Return on assets (d.) Current ratio (e.) none s/b dividend yield (f.) Working capital (g.) Debt ratio (h.) Return on equity (i) none s/b book value per share (j.) Price/earnings ratio


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136. The following information is available for the Grant Company for 2010:

Required: What are earnings per share for the current year? What is the P/E ratio? What is the book value per share of common stock? What is the dividend yield on common stock? What is the net profit ratio? What is the return on equity? Earnings per share $600,000 - $2,100/50,000 = $11.96 Price/Earnings ratio $32/$11.96 = $2.68 Book value ($160,000 - $30,000)/ 50,000 = $2.60 Dividend yield $1.80/$32 = 5.63% Net profit rate $600,000/$1,200,000 = 50% Return on equity $600,000/$160,000 = 375%


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Chapter 14 Financial Statement Analysis CHAPTER 14

NAME

10-MINUTE QUIZ A

SECTION

#

Indicate the best answer to each question in the space provided. 1

The quick ratio is considered more useful than the current ratio for: a Evaluating the profitability of a business that sells inventory very quickly, such as a restaurant. b Evaluating the solvency of a business that turns inventory into cash very slowly, such as a shipbuilder. c Evaluating long-term credit risk. d Evaluating investors’ expectations concerning future earnings.

2

The debt ratio is a measure of: a Net cash flows relating to financing activities. b Long-term credit risk. c Short-term solvency. d Profitability, independent of the manner in which assets are financed.

3

In the long-run, it is most important for a business to generate an inflow of cash from its: a Operating activities. b Stockholders. c Investing activities. d Creditors.

4

Return on assets measures the efficiency with which management: a Generates earnings from the assets under its control, regardless of how these assets are financed. b Generates earnings from the assets under its control, giving consideration to any costs of financing these assets. c Generates cash from the assets under its control, regardless of accrual-based measures of profitability. d Converts its current assets into cash.

5

A transaction that will increase the quick ratio but cause the current ratio to decline is: a Short-term borrowing. b Investing cash in plant assets. c Sale of inventory at a price below cost. d Collection of an receivable.

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CHAPTER 14

NAME

10-MINUTE QUIZ B

SECTION

#

Shown below are data taken from a recent annual report of Falcon Co. (Dollar amounts in millions.) Beginning End of Year of Year Balance sheet data: Current assets............................................................. Total assets................................................................. Current liabilities........................................................ Total liabilities............................................................ Total stockholders’ equity...........................................

$1,034 $1,532 $379 $546 $1,000

Income statement data: Net sales..................................................................... Gross profit................................................................. Operating income....................................................... Net income.................................................................

41,120 $1,822 $318 $477 41,217 $2,759 $1,264 $574 $421

. Based upon the above information, indicate the best answer in the space provided. 1

The current ratio at year-end (rounded to the nearest tenth) is: a 2.3 to 1. c 3.5 to 1. b .6 to 1. d Some other answer.

2

The amount of working capital at the beginning of the year (in millions) was: a $785 c $479. b $1,193. d Some other answer.

3

The gross profit rate for the year (rounded to the nearest 1 percent) was: a 46%. c 69%. b 54%. d Some other answer

4

The return on average total assets during the year (rounded to the nearest percent) was: a 24%. c 79%. b 34%. d Some other answer.

5

The return on average total stockholders’ equity during the year (rounded to the nearest 1 percent) was: a 50%. c 38%. b 41%. d Some other answer.

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CHAPTER 14

NAME

10-MINUTE QUIZ C

SECTION

#

Shown below are data taken from a recent annual report of, Topaz, Inc. (Dollar amounts in millions.) Beginning End of Year of Year Balance sheet data: Current assets............................................................. Total assets................................................................. Current liabilities........................................................ Total liabilities............................................................ Total stockholders’ equity........................................... Income statement data: Net sales..................................................................... Gross profit................................................................. Operating income....................................................... Net income.................................................................

$ 625 $1,050 $275 $500 $575

$700 $1,200 $175 $600 $725 $1,900 $900 $450 $300

. Instructions Compute the following: a Current ratio at year-end (round to nearest tenth).........

b Working capital at the beginning of the year (in millions)

c

________ to 1

$____________

Gross profit rate for the year (round to the nearest 1 percent)

______%

d Return on average total assets for the year (round to the nearest 1 percent)

______%

e

Return on average total equity for the year (round to the nearest 1 percent)

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______%


CHAPTER 14

NAME

10-MINUTE QUIZ D

SECTION

#

Given below are comparative balance sheets and an income statement for the Copper Corporation:

Cash

Copper Corporation Balance Sheets – Current Year Dec. 31 Jan. 1 $ 31,600 $ 26,900

Copper Corporation Income Statement for the Current Year Sales $936,000

s receivable

252,000

216,000

Cost of goods sold

(515,000)

Inventory

173,000

178,000

Gross profit on sales

$421,000

Equipment (net)

129,000

152,000

Operating expenses

(332,000)

$585,600

$572,900

$135,000

$147,000

18,000

14,000

90,000 342,600

90,000 321,900

$585,600

$572,900

s payable Dividends payable Capital stock, $9 par Retained earnings

Operating income Interest expense and income taxes Net income

$ 89,000 (39,000) $ 50.000

All sales were made on . Cash dividends declared during the year totaled $29,300. Compute the following: a

Average s receivable turnover

times

b

Book value per share at the end of the current year

$______________

c

Earnings per share of capital stock

$______________

d

Return on assets

e

Return on common stockholders’ equity is computed by dividing $ ____________ by $______________

%

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CHAPTER 14 SELF-TEST QUESTIONS FROM TEXTBOOK Choose the best answer for each of the following questions and insert the identifying letter in the space provided. 1

Which of the following usually is least important as a measure of short-term liquidity? a Quick ratio. b Debt ratio. c Current ratio. d Cash flow from operating activities.

2

In each of the last five years, the net sales of Plaza Co. have increased at about half the rate of inflation, but net income has increased at approximately twice the rate of inflation. During this period, the company’s total assets, liabilities, and equity have remained almost unchanged; dividends are approximately equal to net income. These relationships suggest (indicate all correct answers): a Management is successfully controlling costs and expenses. b The company is selling more merchandise every year. c The annual return on assets has been increasing. d Financing activities are likely to result in a net use of cash.

3

From the viewpoint of a stockholder, which of the following relationships do you consider of the least significance? a The return on assets consistently is higher than the industry average. b The return on equity has increased in each of the past five years. c Net income is greater than the amount of working capital. d The return on assets is greater than the rate of interest being paid to creditors.

4

The following data are available from the annual report of Frixall Motors: Current assets...................... $ 480,000 Average total assets............. 2,000,000 Average total equity............. 800,000

Current liabilities.............. $300,000 Operating income.............. 240,000 Net income....................... 80,000

Which of the following statements are correct? (More than one statement may be correct.) a The return on equity exceeds the return on assets. b The current ratio is .625 to 1. c Working capital is $1,200,000. d None of the above answers are correct.

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5

Hart Corporation’s net income was $400,000 in 2004 and $160,000 in 2005. What percentage increase in net income must Hart achieve in 2006 to offset the decline in profits in 2005? a 60%. b 150%. c 600%. d 67%.

6

If a company’s current ratio declined in a year during which its quick ratio improved, which of the following is the most likely explanation? a Inventory is increasing. b Inventory is declining. c Receivables are being collected more rapidly than in the past. d Receivables are being collected more slowly than in the past.

7

In financial statement analysis, the most difficult of the following items to predict is whether: a The company will be liquid in six months. b The company’s market share is increasing or declining. c Profits will increase in the coming year. d The market price of capital stock will rise or fall over the next two months.

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SOLUTIONS TO CHAPTER 14 10-MINUTE QUIZZES QUIZ A 1 B 2 B 3 A 4 A 5 C

QUIZ B 1 C 2 D ($1,034 - 379 = $662) 3 A 4 B 5 C

QUIZ C a

Current ratio at year-end $700  $175 = 4

4 to 1

b

Working capital at the beginning of the year (in millions) $625 - $275 = $350

$350

c

Gross profit rate $900  $1,900 = 47.4%

d

Return on average total assets $450  [($1,050 + $1,200)  2] = 40%

e

Return on average total stockholders’ equity $300  [($575 + $725)  2] = 46.2%

47.4%

40%

QUIZ D a b c d e

s receivable turnover ($936,000  $234,000) = 4 times Book value per share at the end of the current year = ($432,600  10,000 shares) = $43.26 Earnings per share of capital stock ($50,000  10,000 shares) = $5.00 Return on assets ($89,000 [ ($585,600 + $572,900)/2] = 15% Return on common stockholders’ equity is computed by dividing $50,000 by $422,250. [($432,600 + $411,900)  2]

.

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46.2%


SOLUTIONS TO CHAPTER 14 SELF-TEST QUESTIONS FROM TEXTBOOK 1 b 2 a, c, d 3 c 4 d (see below) 5 b (see below) 6 b 7 d Why answers A, B, and C in question 4 are incorrect: A The return on assets, 12% ($240,000  $2,000,000), exceeds the return on equity, which is 10% ($80,000  $800,000). B The current ratio is 1.6 to 1 ($480,000  $300,000). C Working capital amounts to $180,000 ($480,000 - $300,000). Increase in net income required in question 5: ($400,000 - $160,000)  $160,000 = 150%

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