Financial Management: Principles and Applications, 11e (Titman)
Chapter 4 Financial Analysis-Sizing Up Firm Performance
1) Discuss why debt is considered a two-edged sword.
Topic: 4.1 Why Do We Analyze Financial Statements?
Keywords: debt
Principles: Principle 2: There Is a Risk-Return Tradeoff
2) List the four ways that improvement can be made in return on equity.
1) Increase in sales without a disproportionate increase in costs and expenses.
2) Reduce the firm’s cost of goods sold or operating expenses.
3) Increase the sales relative to the asset base, either by increasing sales or by reducing the
amounts invested in company assets.
4) Increase the use of debt relative to equity, but only to the extent that it does not unduly
jeopardize the firm’s financial position.
Topic: 4.1 Why Do We Analyze Financial Statements?
Keywords: return on equity
Principles: Principle 3: Cash Flows Are the Source of Value
1) On a common size balance sheet, total assets are equal to 100%.
Topic: 4.2 Common Size Statements: Standardizing Financial Information
Keywords: balance sheet
Principles: Principle 3: Cash Flows Are the Source of Value
2) On a common size income statement, EBIT is equal to 100%.
Topic: 4.2 Common Size Statements: Standardizing Financial Information
Keywords: income statement
Principles: Principle 3: Cash Flows Are the Source of Value
1
Copyright © 2011 Pearson Education, Inc.
3) By using common size income statements, firms can determine how various expenses as a
percentage of total sales changed from period to period.
Topic: 4.2 Common Size Statements: Standardizing Financial Information
Keywords: financial management
Principles: Principle 3: Cash Flows Are the Source of Value
4) What is the purpose of using common size balance sheets and common size income
statements?
Topic: 4.2 Common Size Statements: Standardizing Financial Information
Keywords: financial management
Principles: Principle 3: Cash Flows Are the Source of Value
1) If you were given the components of current assets and of current liabilities, what ratio(s)
could you compute?
A) Quick ratio
B) Average collection period
C) Current ratio
D) Both A and C
E) All of the above
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
2) The debt ratio is a measure of a firm’s:
A) leverage.
B) profitability.
C) liquidity.
D) efficiency.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
2
Copyright © 2011 Pearson Education, Inc.
3) Which of the following statements is true?
A) Current assets consist of cash, accounts receivable, inventory, and net plant, property, and
equipment.
B) The quick ratio is a more restrictive measure of a firm’s liquidity than the current ratio.
C) For the average firm, inventory is considered to be more “liquid” than accounts receivable.
D) A successful firm’s current liabilities should always be greater than its current assets.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
4) Which of the following transactions does NOT affect the quick ratio?
A) Land held for investment is sold for cash.
B) Equipment is purchased and is financed by a long-term debt issue.
C) Inventories are sold for cash.
D) Inventories are sold on a credit basis.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
5) Given an accounts receivable turnover of 8 and annual credit sales of $362,000, the average
collection period (360-day year) is:
A) 90 days.
B) 45 days.
C) 75 days.
D) 60 days.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
6) The question “Did the common stockholders receive an adequate return on their investment?”
is answered through the use of:
A) liquidity ratios.
B) profitability ratios.
C) coverage ratios.
D) leverage ratios.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
3
Copyright © 2011 Pearson Education, Inc.
Table 1
Smith Company Balance Sheet
Assets:
Cash and marketable securities $300,000
Accounts receivable 2,215,000
Inventories 1,837,500
Prepaid expenses 24,000
Total current assets $3,286,500
Fixed assets 2,700,000
Less: accumulated depreciation 1,087,500
Net fixed assets $1,612,500
Total assets $4,899,000
Liabilities:
Accounts payable $240,000
Notes payable 825,000
Accrued taxes 42,500
Total current liabilities $1,107,000
Long-term debt 975,000
Owner’s equity 2,817,000
Total liabilities and owner’s equity $4,899,000
Net sales (all credit) $6,375,000
Less: Cost of goods sold 4,312,500
Selling and administrative expense 1,387,500
Depreciation expense 135,000
Interest expense 127,000
Earnings before taxes $412,500
Income taxes 225,000
Net income $187,500
Common stock dividends $97,500
Change in retained earnings $90,000
7) Based on the information in Table 1, the current ratio is:
A) 2.97.
B) 1.46.
C) 2.11.
D) 2.23.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
4
Copyright © 2011 Pearson Education, Inc.
8) Based on the information in Table 1, and using a 360-day year, the average collection period
is:
A) 71 days.
B) 84 days.
C) 64 days.
D) 125 days.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
9) Based on the information in Table 1, the debt ratio is:
A) 0.70.
B) 0.20.
C) 0.74.
D) 0.42.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
10) Based on the information in Table 1, the net profit margin is:
A) 4.61%.
B) 2.94%.
C) 1.97%.
D) 5.33%.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
11) Based on the information in Table 1, the inventory turnover ratio is:
A) 0.29 times.
B) 2.35 times.
C) 0.43 times.
D) 3.47 times.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
5
Copyright © 2011 Pearson Education, Inc.
12) Marshall Networks, Inc. has a total asset turnover of 2.5 and a net profit margin of 3.5%. The
firm has a return on equity of 17.5%. Calculate Marshall’s debt ratio.
A) 30%
B) 40%
C) 50%
D) 60%
Topic: 4.3 Using Financial Ratios
Keywords: DuPont ratios
Principles: Principle 3: Cash Flows Are the Source of Value
13) The accounting rate of return on stockholders’ investments is measured by:
A) return on assets.
B) return on equity.
C) operating income return on investment.
D) realized rate of inflation.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
14) A firm’s average collection period has decreased significantly from the previous year. Which
of the following could possibly explain the results?
A) Customers are paying off their accounts quicker.
B) Customers are taking longer to pay for purchases.
C) The firm has a strict collection policy.
D) Both A and C.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
15) An increase in ________ will increase common equity.
A) paid in capital
B) retained earnings
C) dividends paid
D) both A and C
E) all of the above
Topic: 4.3 Using Financial Ratios
Keywords: balance sheet
Principles: Principle 3: Cash Flows Are the Source of Value
6
Copyright © 2011 Pearson Education, Inc.
16) Another name for the acid test ratio is the:
A) current ratio.
B) quick ratio.
C) inventory turnover ratio.
D) average collection period.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
17) Which of the following financial ratios is the best measure of the operating effectiveness of a
firm’s management?
A) Current ratio
B) Gross profit margin
C) Quick ratio
D) Return on investment
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
18) Which of the following is included in the denominator of the times-interest-earned ratio?
A) Lease payments
B) Principal payments
C) Interest expense
D) Gross profit
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
19) The quick ratio is a better measure of liquidity than the current ratio if the firm has current
assets composed primarily of:
A) cash.
B) work in process inventory.
C) marketable securities.
D) accruals.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
7
Copyright © 2011 Pearson Education, Inc.
20) If a company’s average collection period is higher than the industry average, then the
company might be:
A) enforcing credit conditions upon its customers which are too stringent.
B) allowing its customers too much time to pay their bills.
C) too tough in collecting its accounts.
D) too liquid.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
21) Why is the quick ratio a more refined measure of liquidity than the current ratio?
A) It measures how quickly cash and other liquid assets flow through the company.
B) Inventories are omitted from the numerator of the ratio because they are generally the least
liquid of the firm’s current assets.
C) It is a quicker calculation to make.
D) Cash is the most liquid current asset.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
2.6. What is Smith’s acid test ratio?
A) 1.69
B) 0.54
C) 0.74
D) 1.35
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
8
Copyright © 2011 Pearson Education, Inc.
23) Kingsbury Associates has current assets as follows:
Cash $3,000
Accounts receivable $4,500
Inventories $8,000
If Kingsbury has a current ratio of 3.2, what is its quick ratio?
A) 2.07
B) 1.55
C) 0.48
D) 0.96
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
24) Water Works, Inc. has a current ratio of 1.33, current liabilities of $540,000, and inventory of
$400,000. What is Water Works, Inc.’s quick ratio?
A) 1.11
B) 0.86
C) 1.90
D) 0.59
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
25) Which of the following ratios indicates how rapidly the firm’s credit accounts are being
collected?
A) Debt ratio
B) Gross profit margin
C) Accounts receivable turnover ratio
D) Fixed asset turnover
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
9
Copyright © 2011 Pearson Education, Inc.
26) Smart and Smiley Incorporated has an average collection period of 74 days. What is the
accounts receivable turnover ratio for Smart and Smiley? You may use a 360-day year.
A) 4.86
B) 2.47
C) 2.66
D) 1.68
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
27) Billing’s Pit Corporation has an accounts receivable turnover ratio of 3.4. What is Billing’s
Pit Corporation’s average collection period? You may use a 360-day year.
A) 106 days
B) 102 days
C) 73 days
D) 55 days
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
28) Which of the following statements is true?
A) As a general rule, management would want to reduce the firm’s average collection period.
B) As a general rule, management would want to reduce the firm’s accounts receivable turnover
ratio.
C) As a general rule, management would want to increase the firm’s average collection period.
D) As a general rule, a firm is not financially affected by the amount of time required to collect
its accounts receivable.
Topic: 4.3 Using Financial Ratios
Keywords: financial ratios
Principles: Principle 3: Cash Flows Are the Source of Value
29) Millers Metalworks, Inc. has a total asset turnover of 2.5 and a net profit margin of 3.5%.
The total debt ratio for the firm is 50%. Calculate Millers’s return on equity.
A) 17.5%
B) 19.5%
C) 21.5%
D) 23.5%
Topic: 4.3 Using Financial Ratios
Keywords: DuPont ratios
Principles: Principle 3: Cash Flows Are the Source of Value
10