Chapter 13 Analyzing Financial Statements Answer Key
True / False Questions
1.
A primary objective of financial statements is to provide information to current and potential
investors and creditors.
2.
Return on equity (ROE) by the DuPont model is a function of three ratios: net profit margin,
return on assets, and financial leverage.
3.
Return on equity (ROE) by the Du Pont model provides insight with respect to a company’s
use of its assets.
4.
Time series analysis is a comparison of information for a specific company over a period of
time to determine changes in operations.
5.
Finding comparable companies in order to compare performance is often difficult since no two
companies have identical products, markets, and operating strategies.
6.
Finding comparable companies in order to compare performance is important because ratios
in isolation are difficult to evaluate.
7.
Component percentages are used to express items on financial statements as a percentage of
a single base amount.
8.
Financial statement analysis is very precise and does not involve judgment.
9.
Purchasing treasury stock increases the return on equity ratio.
10.
The return on assets ratio is influenced significantly by a company’s relative debt and equity
financing of its assets.
11.
A negative financial leverage percentage occurs when a company has more debt than
stockholders’ equity.
12.
The financial leverage percentage is positive when return on assets is greater than return on
equity.
13.
Earnings per share (EPS) is affected by treasury stock transactions.
14.
The earnings quality ratio increases when net income increases.
15.
The net profit margin ratio considers the asset base utilized to earn income.
16.
The fixed asset turnover ratio increases when net income increases.
17.
Some analysts do not use the cash ratio because they see it as too stringent a test of liquidity
and the ratio is very sensitive to small events.
18.
A company that has a high level of inventory and other assets, in addition to its investment in
property, plant, and equipment, should broaden its analysis and calculate the total asset
turnover ratio as well as the fixed asset turnover ratio.
19.
When comparing a fixed asset turnover ratio to a total asset turnover ratio, a company with a
high amount of inventory will have a much lower fixed asset turnover ratio than total asset
turnover ratio.
20.
A higher current ratio is preferable for companies that do not have predictable cash flows.
21.
The quick ratio decreases when the adjusting entry to record bad debt expense is recorded.
22.
A very high current ratio and a low quick ratio may indicate the company is not collecting its
accounts receivable in a timely manner.
23.
The inventory turnover ratio is significantly affected by the choice of inventory accounting
method.
24.
The cash coverage ratio measures a firm’s ability to pay its current liabilities with its cash
flows from operating activities.
25.
The price/earnings ratio is affected by the amount of risk that investors are willing to take.
26.
The debt-to–equity ratio is a risk measure used by both investors and lenders.
27.
The dividend yield ratio decreases when earnings per share increases.
28.
Many companies use high levels of debt to finance their assets because financial leverage
benefits are provided to investors when return on assets exceeds the after-tax cost of
interest.
29.
Dividend yield is calculated by dividing dividends per share by earnings per share and
measures the current dividend return to investors.
30.
A high price/earnings ratio usually indicates the market is optimistic about the company’s
future earnings potential.
Multiple Choice Questions
31.
Which of the following ratios is not part of the DuPont model?
32.
When considering an investment, which of the following is not one of the three critical factors
used to evaluate future earnings potential of that investment?
33.
Which of the following statements is incorrect about fundamental business strategies?
34.
Which of the following statements is not correct?
35.
Which of the following statements is incorrect?
36.
Which of the following statements is correct?
37.
Home Depot’s operating strategy is to offer a broad assortment of high-quality merchandise
and services at competitive prices using highly knowledgeable service-oriented personnel and
aggressive advertising. Which of the following is not as critical to achieving Home Depot’s
strategy?
38.
Which of the following statements is false?
39.
Which of the following statements is correct?
40.
The base amount in preparing component percentages for an income statement is usually
which of the following?
41.
Which of the following statements is correct?
42.
Which of the following statements is incorrect?