12) Profit margin is equal to ________.
A) net income divided by total assets
B) net income divided by total owners’ equity
C) net income divided by sales
D) none of these
13) ________ is the percentage of sales dollars that reaches net income on the common-size
statements.
A) The return on assets
B) The income margin
C) The profit margin
D) The return on equity
14) Earnings per share is the ________.
A) price per share divided by the earnings per share
B) net income divided by the number of outstanding shares
C) market value per shares divided by the book value per share
D) P/E ratio divided by the earnings growth rate times 100
15) ________ break(s) down the return-on-equity into three components.
A) The DuPont identity
B) Market value ratios
C) Profitability ratios
D) Asset management ratios
16) The DuPont identity measures ROE by multiplying ________.
A) the current ratio × total asset turnover × the equity multiplier
B) the profitability ratio × times interest earned × the equity multiplier
C) the profitability ratio × total asset turnover × the equity multiplier
D) the current ratio × times interest earned × the equity multiplier
17) Return on equity can increase as a result of an increase in which of the following ratios?
A) Net income/ sales
B) Sales/ total assets
C) Total assets/ equity
D) All of the above will have a positive influence on the ROE.
18) Ace Engineering Inc. has a profitability ratio of 0.16, an asset turnover ratio of 1.5, a debt to
equity ratio of 0.40, and a total asset to equity ratio of 1.40. What is the firm’s ROE?
A) 14.28%
B) 29.85%
C) 33.60%
D) 38.08%
19) Which of the statements below is TRUE?
A) DuPont analysis shows that ROE is × × .
B) DuPont analysis shows that ROE is × × .
C) DuPont analysis shows that ROE is × × .
D) DuPont analysis shows that ROE is × × .
20) ACME Inc. has a profitability ratio of 0.11, an asset turnover ratio of 1.7, a price to earnings
ratio of 17.4, and a total asset to equity ratio of 1.50. What is the firm’s ROE?
A) 18.64%
B) 27.17%
C) 28.05%
D) 32.35%
21) Great Plains Inc. has a profitability ratio of 0.23, an asset turnover ratio of 1.45, a gross
margin of 32%, and a total asset to equity ratio of 1.60. What is the firm’s ROE?
A) 17.96%
B) 23.27%
C) 31.75%
D) 53.36%
22) The higher the current ratio, the better.
23) Liquidity ratios address the question of whether a company can meet its obligations over the
long term, and financial leverage ratios address the question of whether a company can meet its
obligations over the short term.
24) The current ratio, the quick ratio, and the cash ratio are asset management ratios.
25) To determine market value for a company, we cannot rely exclusively on its financial
statements for our information.
26) If the stock price is $20, earnings per share is $1, and the earnings growth rate is 5%, then
the PEG ratio is four.
27) A PEG ratio of 0.5 indicates that a firm is overvalued.
28) A standard interpretation of the P/E ratio is that firms with high P/E ratios need to have high
growth rates to justify the current price.
29) Only firms with P/E ratios below 50 have great growth and earnings potential not yet
demonstrated in current earnings.
30) The net income is $100, sales are $200, total assets are $500, and total equity is $300.
According to the DuPont method of financial ratio analysis, ROE is about 33.33%.
31) For potential investors, what question can be answered by market value ratios? Do financial
statements contain all of the necessary information to answer this question? Explain in terms of
the P/E (price earnings) ratio.
32) Describe the three components of the DuPont ratio.
33) Name and describe three of the five classes of financial ratios.
19
Copyright © 2019 Pearson Education, Inc.
14.3 External Uses of Financial Statements and Industry Averages
1) Once financial statements are made public, the external analysis of the company begins by
________.
A) financial analysts
B) certified tax planners
C) the advertising department
D) all of these
2) Financial analysts provide recommendations to their clients about what company ________.
A) to buy
B) to invest in
C) to sell or divest
D) all of these
3) The debt-to-equity ratios for Firm 1, Firm 2, Firm 3, and Firm 4 are 0.2, 0.3, 0.35, and 0.4,
respectively. The earnings per share for Firm 1, Firm 2, Firm 3, and Firm 4 are $4, $3, $2.5, and
$2, respectively. Everything else equal, which firm is placing more burdens on its borrowing?
A) Firm 1
B) Firm 2
C) Firm 3
D) Firm 4
4) The debt-to-equity ratios for Firm 1, Firm 2, Firm 3, and Firm 4 are 0.25, 0.35, 0.35, and 0.45,
respectively. The earnings per share for Firm 1, Firm 2, Firm 3, and Firm 4 are $4.5, $3.5, $3,
and $2.5, respectively. Generally speaking, which firm is placing fewer burdens on its
borrowing?
A) Firm 1
B) Firm 2
C) Firm 3
D) Firm 4
5) Financial ratios ________ industries.
A) can vary across
B) are unchanging across
C) are homogeneous across
D) are always different across
6) Because financial ratios can vary across industries, it is ________ these ratios by industry.
A) not necessary to study
B) unimportant to benchmark
C) important to benchmark
D) futile to examine
7) Which industry has the highest average industry debt-to-equity ratio?
A) Oil and gas
B) Airlines
C) Auto
D) Drugs
8) Which industry has the lowest average industry debt-to-equity ratio?
A) Auto
B) Retail
C) Oil and gas
D) Airlines
9) Industries operate differently in terms of ________.
A) labor intensity
B) cash management
C) capital intensity
D) all of these
10) Everything else equal, an industry with more leverage will have a ________.
A) higher return on assets
B) higher return on equity
C) lower return on equity
D) Both A and B
11) The oil and gas industry, with its very high leverage, is usually able to produce a higher
return on equity.
12) When one begins to compare companies from different industries without considering the
norms of the different industries, the evaluation may lead to a poor buy or sell decision.
13) Financial analysts provide recommendations to their clients about what company to buy
(invest) but not what company to sell (divest).
14) When performing financial ratio analysis, we need to know not only what the ratios are but
also what the trends are over time.
15) Financial ratio analysis is designed to help the user to ask better questions rather than to
provide answers to problems.
16) Cross sectional ratio analysis compares the firm of interest with other firms or an industry
benchmark whereas time-series ratio analysis typically compares the firm with itself over time.
17) One simplifying characteristic of ratio analysis is that once we have created common size
statements, the benchmarking of industry ratios becomes redundant because all industries have
the same ratios when using common size values.
18) What does it mean to benchmark by industry? Why is this needed when conducting a
financial ratio analysis?
19) Describe why firms in the oil and gas industry have so much debt compared to other
industries. What industry has the lowest profit margin? What industry converts the greatest
amount of sales dollars into profit?