Chapter 6
1. The return from investing in the shares of common stock has two components: cash dividends and the change
in the market price of the common stock.
2. Theoretical and empirical research has shown that the expected return from investing in a firm relates, in part,
to the expected profitability of the firm.
3. An analyst examines changes in a firm’s ratios over the three-year period—a so-called cross-section analysis
4. Three measures of profitability for a firm engaging in operations selling merchandise in its stores, to generate
net income are: (1) Rate of return on assets, (2) Rate of return on common shareholders’ equity, and (3)
Earnings per share of common stock.
5. ROA has particular relevance to the lenders, or creditors, of a firm.
6. To study changes in ROA, the analyst can disaggregate ROA into the product of two other ratios: the profit
margin for ROA ratio and the total assets turnover ratio.
7. In theory, the numerator of the accounts receivable turnover ratio should include only sales made on account
if the objective is to measure how quickly a firm collects its accounts receivable.
8. The accounts receivable turnover ratio indicates how quickly a firm collects its accounts receivable.
9. If the firm offers terms of “net 45 days,” a days receivable outstanding of 45 days indicates that the firm
handles accounts receivable well.
10. Inventory turnover equals cost of goods sold divided by the average inventory during the period.
11. Some analysts calculate the inventory turnover ratio by dividing sales, rather than cost of goods sold, by the
average inventory. Using sales in the numerator will lead to correct measures of the inventory turnover ratio for
calculating the average number of days that inventory is on hand until sale.
12. Some analysts find the reciprocal of the fixed asset turnover ratio helpful in comparing the operating
characteristics of different firms, because it measures dollars of fixed assets required to generate one dollar of
sales.
13. Both U.S. GAAP and IFRS require firms to report certain information about each of their operating
segments.
14. Total assets turnover reflects the effects of turnover ratios for accounts receivable, inventory, and fixed
assets.
15. The rate of return on common shareholders’ equity (ROCE) measures a firm’s performance in using and
financing assets to generate earnings.
16. Common shareholders have a residual claim on all income after creditors and preferred shareholders receive
amounts contractually owed them.,
17. The term financial leverage describes financing with debt and preferred stock to increase the potential return
to the residual common shareholders’ equity.
18. When a firm has securities outstanding that, if exchanged for shares of common stock, would decrease basic
earnings per share by 30% or more, generally accepted accounting principles require a dual presentation: basic
earnings per share and diluted earnings per share.
19. Four measures for assessing short-term liquidity risk are (1) Current ratio, (2) Quick ratio, (3) Cash flow
from operations to current liabilities ratio, and (4) Working capital turnover ratios.
20. A quick ratio approximately one-half of the current ratio is typical, although this varies by industry.
21. Most firms want to extend their payables as long as they can, but they also want to maintain their relations
with suppliers. Businesses, therefore, negotiate hard for favorable payment terms and then delay paying until
just before the last agreed moment.
22. Analysts use measures of long-term liquidity risk to evaluate a firm’s ability to meet interest and principal
payments on long-term debt and similar obligations as they come due. If a firm cannot make the payments on
time, it becomes insolvent and may have to reorganize or liquidate.
23. Financial statement ratios alone provide direct indicators of good or poor management.
24. The typical first step in financial statement analysis and valuation (after selecting assumptions) are:
25. The typical last step in financial statement analysis and valuation (after selecting assumptions) are:
26. The typical steps in financial statement analysis and valuation include all of the following, except
27. The typical steps in financial statement analysis and valuation include:
28. The return from investing in the shares of common stock includes:
29. The value of common stock investments will likely change between the time the shares are purchased and
the time in the future when they are sold. The difference between the eventual selling price and the purchase
price, is often called
30. What affects the market price of common stock shares?
31. Most individuals prefer _____ to _____ and they will want a _____ expected return if they purchase
common stock shares than if they invest in a certificate of deposit.
32. Most financial statement analysis explores some aspect of a firm’s
33. Ratios provide little information unless the analyst places them in a context. After calculating the ratios, the
analyst must compare them with some standard. Which of the following is/are possible standard(s):
34. Ratios provide little information unless the analyst places them in a context. After calculating the ratios, the
analyst must compare them with some standard. Which of the following is not a possible standard:
35. An analyst examines changes in a firm’s various ratios over a three-year period—a so-called _____ analysis
and performs a _____ analysis comparing a given firm’s ratios with those of other firms for a specific period.
36. Measures of profitability for a firm engaging in operations selling merchandise in its stores to generate net
income do not include:
37. The following ratio relates the results of operating performance to the investments (assets) of a firm without
regard to how the firm financed those investments.
Net Income + Interest Expense Net of Income Tax Savings
———————————————————————–
Average Total Assets
The ratio is called a rate of return on:
38. The rate of return on assets relates the results of operating performance to the investments of a firm without
regard to how the firm financed those investments. The ratio is calculated as follows:
39. Analysis of the Return on Assets has particular relevance to the
40. To study changes in ROA, the analyst can disaggregate ROA into the product of two other ratios:
41. What is calculated as follows:
Profit Margin for ROA Total Assets
? = (before interest expense x Turnover
and related income Ratio
tax savings) Ratio
42. The rate which indicates how quickly a firm collects cash is the _____ turnover ratio.
43. The _____ turnover ratio equals sales revenue divided by average accounts receivable during the period.
44. The rate at which _____ turn(s) over measures how quickly a firm collects cash.
45. The accounts receivable turnover ratio equals
46. Most firms that sell to other businesses, as opposed to consumers, sell on account and collect within 30 to
90 days. Interpreting any particular firm’s accounts receivable turnover and days receivable outstanding
requires knowing the terms of sale. If a firm’s terms of sale are “net 30 days” and the firm collects its accounts
receivable in 45 days, then the
47. Many firms sell to customers on account as a strategy to stimulate sales. Comparing accounts receivable
turnovers over time or between firms requires an analysis of
48. The _____ ratio indicates how fast firms sell their inventory items, measured in terms of the rate of
movement of goods into and out of the firm.
49. Managing inventory turnover involves balancing which of the following consideration(s) in setting the
optimum level of inventory and, thus, the rate of inventory turnover.
50. Some analysts calculate the inventory turnover ratio by dividing sales, rather than cost of goods sold, by the
average inventory. Which of the following regarding the inventory turnover ratio is not true.
51. _____ measures the amount of sales generated from a particular level of investments in fixed assets.
52. Which of the following could affect the fixed asset turnover ratio?
53. U.S. GAAP and IFRS define a(n) _____ segment as a unit within a firm for which management prepares
separate financial information and which management regularly evaluates in allocating resources and assessing
performance.
54. As a practical matter, most firms report segment information by _____ indicating that most firms appear to
be organized on these same lines.
55. A firm computes ROA, profit margin for ROA, and total assets turnover for each segment using the segment
disclosures. The amounts for these ratios computed at a segment level differ from those at a corporate level for
which of the following reasons?
56. The calculation of Rate of Return on Common Shareholders’ Equity (ROCE) is as follows:
Rate of Return on Common = Shareholders’ Equity
57. To calculate the amount of net income assignable to common shareholders’ equity, the analyst does not
58. The capital provided by common shareholders during the period includes
59. The capital provided by common shareholders during the period used for calculating the return on common
equity equals
60. ROCE will exceed ROA whenever ROA exceeds the after-tax cost of borrowing plus any dividends
required for preferred shareholders. Which of the following is true?
61. The term _____ describes financing with debt and preferred stock to increase the potential return to the
residual common shareholders’ equity.
62. ROCE disaggregates into the following components:
63. The profit margin ratio for ROCE indicates
64. The total assets turnover ratio indicates
65. The capital structure leverage ratio indicates
66. The higher the capital structure leverage ratio, the _____ is the proportion of financing that common
shareholders provide and the _____ is the proportion that creditors and preferred shareholders provide. Thus,
the _____ the capital structure leverage ratio, the _____ is financial leverage.
67. Earnings per share equals
68. A firm with securities outstanding that holders can convert into, or exchange for, shares of common stock
may report two earnings-per-share amounts:
69. When a firm has securities outstanding that, if exchanged for shares of common stock, would decrease basic
earnings per share by _____ or more, generally accepted accounting principles require a dual presentation:
basic earnings per share and diluted earnings per share.
70. Accountants and financial analysts criticize earnings per share as a measure of profitability because it does
71. One firm may have a lower earnings per share simply because it has a
72. Which of the following is true regarding the price-earnings ratio?
73. Analysts deciding between investments must consider the comparative risks. Which of the following factors
affect the risk of business firms:
74. Analysts deciding between investments must consider the comparative risks. Which of the following are
economy-wide factors that affect the risk of business firms?
75. Analysts deciding between investments must consider the comparative risks. Which of the following are not
economy-wide factors that affect the risk of business firms?
76. Analysts deciding between investments must consider the comparative risks. Which of the following
areindustry-wide factors that affect the risk of business firms?
77. Analysts deciding between investments must consider the comparative risks. Which of the following are not
industry-wide factors that affect the risk of business firms?
78. Analysts deciding between investments must consider the comparative risks. Which of the following
arefirm-specific factors that affect the risk of business firms?
79. Analysts deciding between investments must consider the comparative risks. Which of the following are not
firm-specific factors that affect the risk of business firms?
80. Measures for assessing short-term liquidity risk include all of the following except:
81. The current ratio equals
82. The current ratio indicates a firm’s ability to meet its short-term obligations. Analysts prefer a current ratio
that at least exceeds
83. How can management take deliberate steps to produce a financial statement that presents a better current
ratio at the balance sheet date than the average, or normal, current ratio during the rest of the year. Analysts
refer to such actions as window dressing.
84. What ratio customarily includes in the numerator cash, marketable securities, and accounts receivable; and
the denominator includes all current liabilities.
85. Healthy mature firms typically have a cash flow from operations to current liabilities ratio of
86. The accounts payable turnover ratio uses purchases on account in its computation. Although firms do not
disclose their purchases, the analyst can calculate the purchase amount as follows:
87. Analysts use measures of long-term _____ to evaluate a firm’s ability to meet interest and principal
payments on long-term debt and similar obligations as they come due. If a firm cannot make the payments on
time, it becomes insolvent and may have to reorganize or liquidate.
88. In assessing the debt ratios, analysts customarily vary the standard in relation to the stability of the firm’s
earnings and cash flows from operations. Public utilities have liabilities to assets ratios frequently on the order
of
89. In assessing the debt ratios, analysts customarily vary the standard in relation to the stability of the firm’s
earnings and cash flows from operations. Banks have liabilities to assets ratios, typically
90. A mature, financially healthy company typically has a cash flow from operations to total liabilities ratio of
91. Which of the following are limitations of ratio analysis?
92. The traditional use of the term _____ financial statements refers to projected financial statements based on
some set of assumptions about the future. One set of assumptions might be that historical patterns (for example,
growth rates or rates of return) will continue.
93. The preparation of pro forma financial statements typically begins with the _____, followed by the _____
and then the _____.
94. What is the first step in preparing pro forma financial statements?
95. What is the last step in preparing pro forma financial statements?
96. Why would a firm prepare pro forma financial statements?
97. Which of the following ratios is not a measure of profitability?
98. Which ratio measures a firm’s performance in using assets to generate earnings independent of how the firm
financed acquisition of those assets?