Financial Statement Analysis 4.

__________ a snapshot of the financial condition of the firm at a particular

Multiple Choice Questions time. 
A. The balance sheet provides
B. The income statement provides
1. A firm has a higher quick (or acid test) ratio than the industry average, which C. The statement of cash flows provides
implies.  D. All of the above provide
A. the firm has a higher P/E ratio than other firms in the industry. E. None of the above provides
B. the firm is more likely to avoid insolvency in short run than other firms in the
industry. The balance sheet is statement of assets, liabilities, and equity at one point in time.
C. the firm may be less profitable than other firms in the industry.
5. __________ of the cash flow generated by the firm's operations, investments
D. A and B.
and financial activities. 
E. B and C.
A. The balance sheet is a report
Current assets earn less than fixed assets; thus, a firm with a relatively high level of B. The income statement is a report
current assets may be less profitable than other firms. However, its high level of C. The statement of cash flows is a report
current assets makes it more liquid. D. the auditor's statement of financial condition
E. None of the above is a report
2. A firm has a lower quick (or acid test) ratio than the industry average, which
implies.  Only statement C is correct; the balance sheet reports assets, liabilities, and equity
A. the firm has a lower P/E ratio than other firms in the industry. at a point in time; the income statement is a summary of earnings over a period of
B. the firm is less likely to avoid insolvency in short run than other firms in the time.
industry.
6. A firm has a higher asset turnover ratio than the industry average, which
C. the firm may be more profitable than other firms in the industry.
implies 
D. A and B.
A. the firm has a higher P/E ratio than other firms in the industry.
E. B and C.
B. the firm is more likely to avoid insolvency in the short run than other firms in
Current assets earn less than fixed assets; thus, a firm with a relatively low level of the industry.
current assets may be more profitable than other firms. However, its low level of C. the firm is more profitable than other firms in the industry.
current assets makes it less liquid. D. the firm is utilizing assets more efficiently than other firms in the industry.
E. the firm has higher spending on new fixed assets than other firms in the
3. Current assets earn less than fixed assets; thus, a firm with a relatively low level industry.
of current assets may be more profitable than other firms. However, its low
level of current assets makes it less liquid. An example of a liquidity ratio is The higher the asset turnover ratio the more efficiently the firm is using assets. 
_______. 
7. A firm has a lower asset turnover ratio than the industry average, which
A. fixed asset turnover
implies 
B. current ratio
A. the firm has a lower P/E ratio than other firms in the industry.
C. acid test or quick ratio
B. the firm is less likely to avoid insolvency in the short run than other firms in
D. A and C
the industry.
E. B and C
C. the firm is less profitable than other firms in the industry.
Both B and C are measures of liquidity; A relates to fixed assets. D. the firm is utilizing assets less efficiently than other firms in the industry.
E. the firm has lower spending on new fixed assets than other firms in the
industry.
The lower the asset turnover ratio the less efficiently the firm is using assets. Although Graham said in 1976 that markets were so efficient that one could not
expect to identify undervalued securities consistently as he had done throughout his
8. If you wish to compute economic earnings and are trying to decide how to
career, he continued to find this one variable useful.
account for inventory, _______. 
A. FIFO is better than LIFO 12. A study by Speidell and Bavishi (1992) found that when accounting statements
B. LIFO is better than FIFO of foreign firms were restated on a common accounting basis, 
C. FIFO and LIFO are equally good A. the original and restated P/E ratios were quite similar.
D. FIFO and LIFO are equally bad B. the original and restated P/E ratios varied considerably.
E. none of the above C. most variation was explained by tax differences.
D. most firms were consistent in their treatment of goodwill.
LIFO reflects the current cost of goods sold, and thus is a better determinant of
E. none of the above.
economic earnings.
This study found that restated P/E ratios varied considerably from those originally
9. __________ of the profitability of the firm over a period of time such as a year. 
reported.
A. The balance sheet is a summary
B. The income statement is a summary 13. If the interest rate on debt is higher than ROA, then a firm will __________ by
C. That statement of cash flows is a summary increasing the use of debt in the capital structure. 
D. The audit report is a summary A. increase the ROE
E. None of the above is a summary B. not change the ROE
C. decrease the ROE
The income statement summarizes revenues and expenses over a period of time.
D. change the ROE in an indeterminable manner
10. Given the results of the study by Clayman, you would __________ the stocks of E. none of the above
firms with high ROEs and __________ the stocks of firms with low ROEs. 
If ROA is less than the interest rate, then ROE will decline by an amount that
A. want to buy, want to buy
depends on the debt to equity ratio.
B. want to buy, not want to buy
C. not want to buy, want to buy 14. If the interest rate on debt is lower than ROA, then a firm will __________ by
D. not want to buy, not want to buy increasing the use of debt in the capital structure. 
E. be unable to buy, want to buy A. increase the ROE
B. not change the ROE
Clayman found that investing in firms with high ROEs produced results inferior to
C. decrease the ROE
those obtained by investing in stocks with lower ROEs.
D. change the ROE in an indeterminable manner
11. Over a period of thirty-odd years in managing investment funds, Benjamin E. none of the above
Graham used the approach of investing in the stocks of companies where the
If ROA is higher than the interest rate, then ROE will increase by an amount that
stocks were trading at less than their working capital value. The average return
depends on the debt to equity ratio.
from using this strategy was approximately ______. 
A. 5% 15. A firm has a market to book value ratio that is equivalent to the industry
B. 10% average and an ROE that is less than the industry average, which implies
C. 15% _______. 
D. 20% A. the firm has a higher P/E ratio than other firms in the industry
E. none of the above B. the firm is more likely to avoid insolvency in the short run than other firms in
the industry
 C. the firm is more profitable than other firms in the industry The financial statements of Black Barn Company are given below.
D. the firm is utilizing its assets more efficiently than other firms in the industry
E. none of the above

The relationship P/E = (P/B) / ROE indicates that A is possible.

16. In periods of inflation, accounting depreciation is __________ relative to

replacement cost and real economic income is ________. 
A. overstated, overstated
B. overstated, understated
C. understated, overstated
D. understated, understated
E. correctly, correctly

Fixed assets are depreciated based on historical costs and, as a result, are
understated relative to replacement costs during periods of inflation; as a result,
real economic income is overstated.

17. If a firm has a positive tax rate, a positive ROA, and the interest rate on debt is
the same as ROA, then ROA will be ________. 
A. greater than the ROE
B. equal to the ROE
C. less than the ROE
D. greater than zero but it is impossible to determine how ROA will compare to
ROE
E. negative in all cases

If interest rate = ROA; ROE = (1 - tax rate)ROA; ROA > ROE.

18. A firm has a P/E ratio of 12 and a ROE of 13% and a market to book value of
__________. 
A. 0.64
B. 0.92
C. 1.08
D. 1.56
E. none of the above

E/P = ROE / (P/B); 1/12 = (0.13) P/B; 0.0833 = 0.13/(P/B); 0.0833(P/B) = 0.13; P/B =
1.56.    

19. Refer to the financial statements of Black Barn Company. The firm's current
ratio for 2007 is _____. 
A. 2.31
B. 1.87
 C. 2.22 AR Turnover = $8,000,000 / [($1,200,000 + $950,000) / 2] = 7.44; ACP = 365 / 7.44 =
D. 2.46 49.05 days
E. none of the above
24. Refer to the financial statements of Black Barn Company. The firm's inventory
$3,240,000/$1,400,000 = 2.31. turnover ratio for 2007 is _____. 
A. 3.15
20. Refer to the financial statements of Black Barn Company. The firm's quick ratio
B. 3.63
for 2007 is _____. 
C. 3.69
A. 1.69
D. 2.58
B. 1.52
E. 4.20
C. 1.23
D. 1.07 $5,260,000/[($1,840,000 + $1,500,000) / 2] = 3.15.
E. 1.00
25. Refer to the financial statements of Black Barn Company. The firm's fixed asset
($3,240,000 - $1,840,000)/$1,400,000 = 1.00. turnover ratio for 2007 is _____. 
A. 2.04
21. Refer to the financial statements of Black Barn Company. The firm's leverage
B. 2.58
ratio for 2007 is _____. 
C. 2.97
A. 1.65
D. 1.58
B. 1.89
E. none of the above
C. 2.64
D. 1.31 $8,000,000/[($3,200,000 + $3,000,000) / 2] = 2.58.
E. 1.56
26. Refer to the financial statements of Black Barn Company. The firm's asset
$6,440,000/$4,140,000 = 1.56. turnover ratio for 2007 is _____. 
A. 1.79
22. Refer to the financial statements of Black Barn Company. The firm's times
B. 1.63
interest earned ratio for 2007 is _____. 
C. 1.34
A. 8.86
D. 2.58
B. 7.17
E. none of the above
C. 9.66
D. 6.86 $8,000,000/[($6,440,000 + $5,500,000) / 2] = 1.34. 
E. none of the above
27. Refer to the financial statements of Black Barn Company. The firm's return on
$1,240,000/$140,000 = 8.86. sales ratio for 2007 is _____ percent. 
A. 15.5
23. Refer to the financial statements of Black Barn Company. The firm's average
B. 14.6
collection period for 2007 is _____. 
C. 14.0
A. 59.31
D. 15.0
B. 55.05
E. 16.5
C. 61.31
D. 49.05 $1,240,000/$8,000,000 = 0.155 or 15.5%.
E. none of the above
28. Refer to the financial statements of Black Barn Company. The firm's return on B. 8.97%
equity ratio for 2007 is _____.  C. 11.54%
A. 16.90% D. 12.62%
B. 15.63% E. none of the above
C. 14.00%
ROE = (1 - 0.35)[14% + (14% - 10%)0.8] = 11.18%.
D. 15.00%
E. 16.24% 33. A firm has an ROE of -2%, a debt/equity ratio of 1.0, a tax rate of 0%, and an
interest rate on debt of 10%. The firm's ROA is ________. 
$660,000/[($4,140,000 + $3,680,000) / 2] = .169.
A. 2%
29. Refer to the financial statements of Black Barn Company. The firm's P/E ratio B. 4%
for 2007 is _____.  C. 6%
A. 8.88 D. 8%
B. 7.63 E. none of the above
C. 7.88
-2% = (1)[ROA + (ROA - 10%)1] = 4%.
D. 7.32
E. none of the above 34. A firm has a (net profit/pretax profit) ratio of 0.6, a leverage ratio of 2, a (pretax
profit/EBIT) of 0.6, an asset turnover ratio of 2.5, a current ratio of 1.5, and a
EPS = $660,000/130,000 = $5.08; $40/$5.08 = 7.88.
return on sales ratio of 4%. The firm's ROE is _________. 
30. Refer to the financial statements of Black Barn Company. The firm's market to A. 4.2%
book value for 2007 is _____.  B. 5.2%
A. 1.13 C. 6.2%
B. 1.62 D. 7.2%
C. 1.00 E. none of the above
D. 1.26
ROE = 0.6 X 0.6 X 4% X 2.5 X 2 = 7.2%.
E. none of the above
35. A measure of asset utilization is ________. 
$40/$31.85 = 1.26.
A. sales divided by working capital
31. A firm has a (net profit / pretax profit ratio) of 0.625, a leverage ratio of 1.2, a B. return on total assets
(pretax profit / EBIT) of 0.9, an ROE of 17.82%, a current ratio of 8, and a return C. return on equity capital
on sales ratio of 8%. The firm's asset turnover is _________.  D. operating profit divided by sales
A. 0.3 E. none of the above
B. 1.3
B measures how efficiently the firm is utilizing assets to generate returns.
C. 2.3
D. 3.3 36. During periods of inflation, the use of FIFO (rather than LIFO) as the method of
E. none of the above accounting for inventories causes ________. 
A. higher inventory turnover
17.82% = 0.625 X 0.9 X 8% X asset turnover X 1.2; asset turnover = 3.3.
B. higher incomes taxes
32. A firm has an ROA of 14%, a debt/equity ratio of 0.8, a tax rate of 35%, and the C. lower ending inventory
interest rate on the debt is 10%. The firm's ROE is _________.  D. higher reported sales
A. 11.18% E. none of the above
In inflationary periods, the use of FIFO causes overstated earnings, which result in D. Retained earnings/total assets
higher taxes. E. None of the above

37. Return on total assets is a function of _______.  Only retained earnings reflect profits reinvested over the years.
A. interest rates and pre-tax profits
41. Ferris Corp. wants to increase its current ratio from the present level of 1.5
B. the debt-equity ratio
when it closes the books next week. The action of Ferris Corp. will have the
C. the after-tax profit margin and the asset turnover ratio
desired effect. 
D. sales and fixed assets
A. payment of current payables from cash
E. none of the above
B. sales of current marketable securities for cash
ROA = Net profit margin X Total asset turnover. C. write down of impaired assets
D. delay of next payroll
38. FOX Company has a ratio of (total debt/total assets) that is above the industry
E. none of the above
average, and a ratio of (long term debt/equity) that is below the industry
average. These ratios suggest that the firm _________.  Example: CA = $150; CL = $100; current ratio = 1.5; Pay $50 of CL with cash; CA =
A. utilizes assets effectively $100; CL = $50; current ratio = 2. B has no effect on ratio (CA remain same); C does
B. has too much equity in the capital structure not affect current account; D would decrease ratio.
C. has relatively high current liabilities
42. Assuming continued inflation, a firm that uses LIFO will tend to have a(n)
D. has a relatively low dividend payout ratio
________ current ratio than a firm using FIFO, and the difference will tend to
E. none of the above
__________ as time passes. 
Total debt includes both current and long term debt; the above relationships could A. higher, increase
occur only if FOX Company has a higher than average level of current liabilities. B. higher, decrease
C. lower, decrease
39. A firm's current ratio is above the industry average; however, the firm's quick
D. lower, increase
ratio is below the industry average. These ratios suggest that the firm
E. identical, remain the same
_________. 
A. has relatively more total current assets and even more inventory than other A firm using LIFO will have lower priced inventory, thus resulting in a lower current
firms in the industry ratio. If inflation continues, these differences will increase over time.
B. is very efficient at managing inventories
43. Fundamental analysis uses __________. 
C. has liquidity that is superior to the average firm in the industry
A. earnings and dividends prospects
D. is near technical insolvency
B. relative strength
E. none of the above
C. price momentum
A is the only possible answer; total current assets are high, and inventory is a very D. A and B
large portion of total current assets, relative to other firms in the industry. E. A and C

40. Which of the following ratios gives information on the amount of profits Relative strength and price momentum are technical, not fundamental, tools.
reinvested in the firm over the years: 
44. __________ is a true statement. 
A. Sales/total assets
A. During periods of inflation, LIFO makes the balance sheet less representative
B. Debt/total assets
of the actual inventory values than if FIFO were used
C. Debt/equity
B. During periods of inflation, FIFO makes the balance sheet less representative
of actual inventory values than if LIFO were used
 C. After inflation ends, distortion due to LIFO will disappear as inventory is sold Assets are financed either by debt or equity. The situation described above could
D. During periods of inflation, LIFO overstates earnings relative to FIFO occur only if the firm is financing more assets with debt than are industry
E. None of the above competitors.

During periods of inflation, the use of LIFO results in lower priced inventory 48. If a firm's ratio of (total liabilities/total assets) is higher than the industry
remaining in stock; thus the balance sheet understates the actual inventory values. average while the total capitalization of the firm's stockholders' equity) is lower
than the industry average, the most likely assumption is that the firm
45. __________ is a false statement. 
________. 
A. During periods of inflation, LIFO makes the balance sheet less representative
A. has more current liabilities than the industry average
of the actual inventory values than if FIFO were used
B. has more leased assets than the industry average
B. During periods of inflation, FIFO makes the balance sheet less representative
C. will be more profitable than the industry average
of actual inventory values than if LIFO were used
D. has more current assets than the industry average
C. After inflation ends, distortion due to LIFO will disappear as inventory is sold
E. none of the above
D. During periods of inflation, LIFO overstates earnings relative to FIFO
E. B, C, and D The total capitalization of the firm reflects long-term capital; which is used to
purchase fixed assets, not current assets. Thus, the firm appears to have more
During periods of inflation, the use of LIFO results in lower priced inventory
current liabilities than the industry average.
remaining in stock; thus the balance sheet understates the actual inventory values.
49. What best explains why a firm's ratio of (long-term debt/total capital) is lower
46. The level of real income of a firm can be distorted by the reporting of
than the industry average, while the ratio of (income before interest and
depreciation and interest expense. During periods of high inflation, the level of
taxes/debt interest charges) is lower than the industry average. 
reported depreciation tends to __________ income, and the level of interest
A. The firm pays lower interest on long-term debt than the average firm
expense reported tends to __________ income. 
B. The firm has more short-term debt than average
A. understate, overstate
C. The firm has a high ratio of (current assets/current liabilities)
B. understate, understate
D. The firm has a high ratio of (total cash flow/long term debt)
C. overstate, understate
E. none of the above
D. overstate, overstate
E. There is no discernable pattern. The firm is using more short-term debt, possibly to finance fixed assets, than the
average firm. The coverage ratio includes only interest on long-term debt.
Depreciation is based on historic costs; thus during periods of inflation depreciation
is understated, which results in the overstatement of income. In periods of inflation, 50. __________ best explains a ratio of (sales/average net fixed assets) that
interest rates are high, and thus result in the understatement of the firm's long term exceeds the industry average. 
earning capacity. A. The firm expanded plant and equipment in the past few years
B. The firm makes less efficient use of assets than competing firms
47. Which of the following would best explain a situation where the ratio of (net
C. The firm has a substantial amount of old plant and equipment.
income/total equity) of a firm is higher than the industry average, while the
D. The firm uses straight-line depreciation
ratio of (net income/total assets) is lower than the industry average? 
E. None of the above
A. The firm's net profit margin is higher than the industry average.
B. The firm's asset turnover is higher than the industry average. If the firm has more old plant and equipment than competing firms, the
C. The firm's equity multiplier must be lower than the industry average. denominator is deflated thus producing a higher than average ratio.
D. The firm's debt ratio is higher than the industry average.
51. Given the following firm and market information, determine the value of the
E. None of the above.
firm.
 54. One problem with comparing financial ratios prepared by different reporting
agencies is 
A. some agencies receive financial information later than others.
B. agencies vary in their policies as to what is included in specific calculations.
C. some agencies are careless in their reporting.
D. some firms are more conservative in their accounting practices.
E. none of the above.

One problem with comparing financial ratios prepared by different reporting

     agencies is agencies vary in their policies as to what is included in specific
A. $28.42 calculations.
B. $18.42
55. One reason that capital markets are not truly global is 
C. $8.42
A. exchange rates are too volatile.
D. $38.42
B. investors are too timid.
E. none of the above
C. some firms are not allowed to sell their shares in other countries.
ROE = 3 X 1.5 X 1.5 = 6.75%; g = 0.5 X 6.75% = 3.375%; k = 5% + 1.2(8%) = 14.6%; 2 D. there is not a global standard for international financial reporting.
(1.03375) / (.146 - .03375) = $18.42 E. both C and D are true.

52. Firms will not have both relatively high profit margins and total asset turnover One reason that capital markets are not truly global is some firms are not allowed
for long periods of time because  to sell their shares in other countries.
A. if both variables are relatively high, more firms will be attracted into the
industry, which will result in lower profit margins.
B. excess economic profits will result (until equilibrium is restored).
C. high profit margins result in inefficiency.
D. A and B.
E. A and C.

The excess profits will attract more firms into the industry, which will eliminate
excess profits. 

53. Comparability problems arise because 

A. firms may use different generally accepted accounting principles.
B. inflation may affect firms differently due to accounting conventions used.
C. financial analysts do not know how to compare financial statements.
D. A and B.
E. A and C.

Firms often select specific generally accepted accounting principles for the desired
effect on the financial statements. The analyst must make adjustments in order to
compare firms using different account techniques. Often firms adopt specific
techniques to offset the negative effects of inflation on the firm.
 The financial statements of Midwest Tours are given below. $860,000/$660,000 = 1.30.

57. Refer to the financial statements of Midwest Tours. The firm's quick ratio for
2007 is __________. 
A. 1.71
B. 0.78
C. 0.85
D. 1.56
E. none of the above

($860,000 - $300,000)/$660,000 = 0.85.

58. Refer to the financial statements of Midwest Tours. The firm's leverage ratio for
2007 is __________. 
A. 1.62
B. 1.56
C. 2.00
D. 2.42
E. 2.17

$3,040,000/$1,520,000 = 2.00.

59. Refer to the financial statements of Midwest Tours. The firm's times interest
earned ratio for 2007 is __________. 
A. 2.897
B. 2.719
C. 3.375
D. 3.462
E. none of the above

$540,000 / 160,000 = 3.375.

60. Refer to the financial statements of Midwest Tours. The firm's average
collection period for 2007 is __________. 
A. 69.35
   
B. 69.73
56. Refer to the financial statements of Midwest Tours. The firm's current ratio for C. 68.53
2007 is _____.  D. 67.77
A. 1.82 E. 68.52
B. 1.03
AR Turnover = $2,500,000 / [($500,000 + $450,000)) 2] = 5.26; ACP = 365 / 5.26 =
C. 1.30
69.35 days
D. 1.65
E. none of the above
61. Refer to the financial statements of Midwest Tours. The firm's inventory C. 15.50%
turnover ratio for 2007 is __________.  D. 14.50%
A. 2.86 E. 16.9%
B. 1.23
$228,000/[($1,520,000 + $1,420,000)) 2] = .155.
C. 5.96
D. 4.42 66. Refer to the financial statements of Midwest Tours. The firm's P/E ratio for
E. 4.86 2007 is __________. 
A. 4.74
$1,260,000/[($300,000 + $270,000)) 2] = 4.42.
B. 6.63
62. Refer to the financial statements of Midwest Tours. The firm's fixed asset C. 5.21
turnover ratio for 2007 is __________.  D. 5.00
A. 1.45 E. none of the above
B. 1.63
EPS = $228,000/30,000 = $7.60; $36/$7.60 = 4.74.
C. 1.20
D. 1.58 67. Refer to the financial statements of Midwest Tours. The firm's market to book
E. none of the above value for 2007 is __________. 
A. 0.24
$2,500,000/[($2,180,000 + $2,000,000)) 2] = 1.20.
B. 0.95
63. Refer to the financial statements of Midwest Tours. The firm's asset turnover C. 0.71
ratio for 2007 is __________.  D. 1.12
A. 1.86 E. none of the above
B. 0.63
$36/[$1,520,000/30,000] = 0.71.
C. 0.86
D. 1.63
E. none of the above

$2,500,000/[($3,040,000 + $2,770,000)) 2] = 0.86.

64. Refer to the financial statements of Midwest Tours. The firm's return on sales
ratio for 2007 is __________ percent. 
A. 20.2
B. 21.6
C. 22.4
D. 18.0
E. none of the above

$540,000/$2,500,000 = 0.216 or 21.6%.

65. Refer to the financial statements of Midwest Tours. The firm's return on equity
ratio for 2007 is __________. 
A. 12.24%
B. 14.63%
 The financial statements of Snapit Company are given below. C. 0.65
D. 1.53
E. none of the above

$1,300,000/$850,000 = 1.53.

69. Refer to the financial statements of Snapit Company. The firm's quick ratio for
2007 is _______. 
A. 1.68
B. 1.12
C. 0.72
D. 1.92
E. none of the above

($1,300,000 - $690,000)/$850,000 = 0.72.

70. Refer to the financial statements of Snapit Company. The firm's leverage ratio
for 2007 is _________. 
A. 2.25
B. 3.53
C. 2.61
D. 3.06
E. none of the above

$2,600,000/$850,000 = 3.06. 

71. Refer to the financial statements of Snapit Company. The firm's times interest
earned ratio for 2007 is __________. 
A. 2.26
B. 3.16
C. 3.84
D. 3.31
E. none of the above

$530,000/$160,000 = 3.31.

72. Refer to the financial statements of Snapit Company. The firm's average
collection period for 2007 is _______ days. 
    A. 47.90
B. 48.53
68. Refer to the financial statements for Snapit Company. The firm's current ratio C. 46.06
for 2007 is ___________.  D. 47.65
A. 1.98 E. none of the above
B. 2.47
(525,000 / 4,000,000) (365) = 47.90.  A. 0.1235
B. 0.0296
73. Refer to the financial statements of Snapit Company. The firm's inventory
C. 0.2960
turnover ratio for 2007 is ________. 
D. 2.2960
A. 4.64
E. none of the above
B. 4.16
C. 4.41 $222,000/[($850,000 + $650,000) / 2] = 0.2960.
D. 4.87
78. Refer to the financial statements of Snapit Company. The firm's market to book
E. none of the above
value for 2007 is _____. 
$3,040,000/[($620,000 + $690,000) / 2] = 4.64. A. 0.7256
B. 1.5294
74. Refer to the financial statements of Snapit Company. The firm's fixed asset
C. 2.9400
turnover ratio for 2007 is _____. 
D. 3.6142
A. 4.60
E. none of the above
B. 3.61
C. 3.16 $100/[($850,000 / 25,000)] = 2.9400.
D. 5.46
79. ______ is a measure of what the firm would have earned if it didn't have any
E. none of the above
obligations to creditors or tax authorities. 
$4,000,000/[($1,300,000 + $1,230,000) / 2] = 3.16. A. Net Sales
B. Operating Income
75. Refer to the financial statements of Snapit Company. The firm's asset turnover
C. Net Income
ratio for 2007 is _____. 
D. Non-operating Income
A. 1.60
E. Earnings Before Interest and Taxes
B. 3.16
C. 3.31 Taxes and interest expense are subtracted from EBIT to find Net Income. If there are
D. 4.64 no taxes and no interest expense EBIT would equal Net Income.
E. none of the above
80. Proceeds from a company's sale of stock to the public are included in
$4,000,000/[($2,600,000 + $2,400,000) / 2] = 1.60. ________. 
A. par value
76. Refer to the financial statements of Snapit Company. The firm's return on sales
B. additional paid-in capital
ratio for 2007 is ________. 
C. retained earnings
A. 0.0133
D. A and B
B. 0.1325
E. A, B, and C
C. 1.325
D. 1.260 When a stock is sold, the par value goes into the Par account and any amount above
E. none of the above the par value goes into the Additional Paid-in Capital account.

$530,000/$4,000,000 = 0.1325. 81. Which of the financial statements recognizes only transactions in which cash
changes hands? 
77. Refer to the financial statements of Snapit Company. The firm's return on
A. Balance Sheet
equity ratio for 2007 is ________. 
B. Income Statement
 C. Statement of Cash Flows Economic value added measures the success of the firm relative to its return on
D. A and B projects vs. the rate investors could earn themselves in the capital markets. EVA =
E. A, B, and C ROA - k*Capital Invested.

The Balance Sheet and Income Statement are based on accrual accounting 85. Economic value added (EVA) is also known as 
methods. Revenues and expenses are recognized when they are incurred regardless A. excess capacity.
of whether cash is involved. B. excess income.
C. value of assets.
82. Suppose that Chicken Express, Inc. has a ROA of 7% and pays a 6% coupon on
D. accounting value added.
its debt. Chicken Express has a capital structure that is 70% equity and 30%
E. residual income
debt. Relative to a firm that is 100% equity-financed, Chicken Express's Net
Profit will be ________ and its ROE will be ________.  Stern Stewart, a consulting firm that works extensively with EVA, introduced this
A. lower, lower term.
B. higher, higher
86. Which of the following are issues when dealing with the financial statements of
C. higher, lower
international firms?
D. lower, higher
I) Many countries allow firms to set aside larger contingency reserves than the
E. It is impossible to predict.
amounts allowed for U.S. firms.
Chicken Express's Net Profit will be lower because it has to pay interest expense. But II) Many firms outside the U.S. use accelerated depreciation methods for
as long as Chicken Express's ROA exceeds the cost of its debt, leverage will have a reporting purposes, whereas most U.S. firms use straight-line depreciation for
positive impact on its ROE. reporting purposes.
III) Intangibles such as goodwill may be amortized over different periods or may
83. The P/E ratio that is based on a firm's financial statements and reported in the
be expensed rather than capitalized.
newspaper stock listings is different from the P/E ratio derived from the
IV) There is no way to reconcile the financial statements of non-U.S. firms to
dividend discount model (DDM) because 
GAAP. 
A. the DDM uses a different price in the numerator.
A. I and II
B. the DDM uses different earnings measures in the denominator.
B. II and IV
C. the prices reported are not accurate.
C. I, II, and III
D. the people who construct the ratio from financial statements have inside
D. I, III, and IV
information.
E. I, II, III, and IV
E. They are not different - this is a "trick" question.
The first three items are concerns. The fourth is not a factor because it is possible to
Both ratios use the same numerator - the market price of the stock. But P/Es from
reconcile the financial statements to GAAP.
financial statements use the most recent past accounting earnings, while the DDM
uses expected future economic earnings. 87. To create a common size income statement ____________ all items on the
income statement by ____________. 
84. The dollar value of a firm's return in excess of its opportunity costs is called its 
A. multiply; net income
A. profitability measure.
B. multiply; total revenue
B. excess return.
C. divide; net income
C. economic value added.
D. divide; total revenue
D. prospective capacity.
E. multiply; COGS
E. return margin.
To create a common size income statement divide all items on the income 92. If a firm has "goodwill" recorded on its balance sheet it must have
statement by total revenue. ____________. 
A. donated to charity
88. To create a common size balance sheet ____________ all items on the balance
B. participated in a benefit for a charitable cause
sheet by ____________. 
C. participated in a company-wide fund raising drive for a charity
A. multiply; owners’ equity
D. acquired another firm
B. multiply; total assets
E. none of the above
C. divide; owners’ equity
D. divide; total assets If a firm has "goodwill" recorded on its balance sheet it must have acquired another
E. multiply; debt firm.

To create a common size balance sheet divide all items on the balance sheet by total 93. Publicly traded firms must prepare audited financial statements according to
assets. generally accepted accounting principles (GAAP). How do comparability
problems arise? 
89. Common size financial statements make it easier to compare firms
____________.  Many accounts may be valued by more than one generally accepted accounting
A. of different sizes principle. As a result, firms often select the GAAP that presents the firm in the most
B. in different industries attractive position. Thus, the analyst trying to compare firms using different GAAPs
C. with different degree of leverage must be aware of these differences and make his or her own adjustments of the
D. that use different inventory valuation methods (FIFO vs. LIFO) financial statements in order to determine which firm is the more attractive
E. none of the above investment alternative. Generally accepted accounting principles for inventory
valuation and depreciation are two of the more common areas where comparability
Common size financial statements make it easier to compare firms of different sizes.
problems may arise.
90. Common size income statements make it easier to compare firms
Feedback: This question is designed to ascertain whether or not the student
____________. 
understands whether the analyst merely takes financial statements at "face value"
A. that use different inventory valuation methods (FIFO vs. LIFO)
or whether the analyst must perform considerable additional work with the
B. in different industries
financial statements in order to value the firms.
C. with different degree of leverage
D. of different sizes 94. In an increasingly globalized investment environment, comparability problems
E. none of the above become even greater. Discuss some of the problems for the investor who
wishes to have an internationally diversified portfolio. 
Common size income statements make it easier to compare firms of different sizes.
Firms in other countries are not required to prepare financial statement according
91. Common size balance sheets make it easier to compare firms ____________. 
to U.S. generally accepted accounting principles. Accounting practices in other
A. with different degree of leverage
countries vary from those of the U.S. In some countries, accounting standards may
B. of different sizes
be very lax or virtually nonexistent. Some of the major differences are: reserve
C. in different industries
practices, many countries allow more discretion in setting aside reserves for future
D. that use different inventory valuation methods (FIFO vs. LIFO)
contingencies than is typical in the U.S.; depreciation practices, in the U.S., firms
E. none of the above
often use accelerated depreciation for tax purposes, and straight line depreciation
Common balance sheets statements make it easier to compare firms of different for accounting purposes, while most other countries do not allow such dual
sizes. accounts, and finally, the treatment of intangibles varies considerably across
countries.
 Finally, the problem of obtaining financial information may be considerable for Feedback: This question tests whether the student understands the differences
some international investments, varying currency exchange rates present additional between the two types of earnings, why they differ, and how the difference
complications, translation of statements into English is another complication; influences the choice of earnings used in financial analysis.
potential government expropriation of assets and political unrest may be problems
97. The DuPont system decomposes ROE into the following components:
in some countries. In general, for the individual investor, investing in global or
 
international mutual funds is a less risky way to add diversification to the portfolio
than is attempting to value individual international securities.

Feedback: This question is designed to insure that the student understands the
comparability problems and additional risks of international investing.

95. Many different debt, or financial leverage, ratios are reported. Explain the 98. Enter the formula that corresponds to the description of each ratio into the
relationship between total assets/equity and debt/equity.  second column of the table. The third column gives a value for each ratio. Use
the fourth column to describe the meaning of the ratio's value.
Total assets/equity is the ratio used in computing the ROE in the "duPont breakout
formula". Assets may be purchased with either debt or equity or some combination
thereof. Thus, the sum of debt and equity financing equals total assets. If one is
given the debt/equity ratio and needs the total assets/equity ratio (for example, for
the above cited calculation), one merely adds the amounts of debt and equity in the
capital structure in order to obtain the amount of total assets. For example:
Debt = $50,000;
Equity = $50,000;
Debt/equity = 1;
$50,000 + $50,000 = $100,000 (total assets);
Total assets/Equity = $100,000/$50,000 = 2; or 1 + 1 = 2.

Feedback: This question is designed to see if the student understands the

relationship between basic balance sheet financial ratios.

96. Discuss the differences between economic earnings and accounting earnings.
Which is preferred in financial analysis? Which is most widely used, and why? 
Feedback: This question tests the students' understanding of various financial ratios
Economic earnings consist of the sustainable cash flow that can be paid out to and whether they can identify the ratios by their descriptive terms.
stockholders without impairing the productive capacity of the firm. The focus is on
the present value of expected cash flows. Accounting earnings are based on accrual  
methods and can be manipulated to a certain extent. They are subject to the firm's
decisions about its accounting methods such as inventory valuation and
amortization of capital expenditures. Net Income will be different in each case.
Financial analysis is based on economic earnings, which are often difficult to
measure, whereas accounting earnings are widely available. Annual and quarterly
reports contain a firm's financial statements. They do provide important
information about the health and prospects of the firm. Accounting earnings are
therefore most frequently used for analysis.