Chapter 4—EVALUATION OF FIRM PERFORMANCE
MULTIPLE CHOICE
1. Which of the following financial ratios are market-based ratios?
a.
debt-to-equity
b.
price-to-earnings
c.
return on investment
d.
all of the above
2. The appropriate standard for comparison of financial ratios probably should be the
a.
best firm in the industry
b.
worst firm in the industry
c.
industry average
d.
better performing firms in the industry
3. ____ indicate the ability of the firm to meet its short-term financial obligations
a.
Activity ratios
b.
Liquidity ratios
c.
Leverage ratios
d.
Profitability ratios
4. ____ indicate the firm’s capacity to meet its debt obligations, both short-term and long-term.
a.
Liquidity ratios
b.
Activity ratios
c.
Financial leverage ratios
d.
Profitability ratios
5. The primary weakness of the current ratio is
a.
it is difficult to calculate
b.
it includes some items, such as inventory, that may not be readily liquid
c.
it requires many years of past data
d.
it includes many non-current items in its calculation
6. The quick ratio is the same as current ratio except it does not consider
a.
cash
b.
accounts receivable
c.
prepaid items
d.
inventories
7. The fixed asset turnover ratio is influenced by
a.
the age of the assets employed
b.
the depreciation method used by the firm
c.
the firm’s choice of a production technology
d.
all of these answers are correct
8. The greater the amount of financial leverage used by a firm, the greater its ____, all other things being
equal.
a.
profitability
b.
liquidity
c.
risk
d.
size
9. The best accounting-based measure of a firm’s profitability is
a.
gross profit margin
b.
net profit margin
c.
return on fixed assets
d.
return on total assets
10. Financial ratio analysis is most often performed as a
a.
comparative analysis
b.
trend analysis
c.
point in time analysis
d.
both comparative and trend analysis
11. A firm’s return on equity is a function of its net profit margin, ____ and equity multiplier.
a.
current ratio
b.
cost of goods
c.
total asset turnover
d.
fixed asset turnover
12. Primary sources of comparative financial data include
a.
Dun and Bradstreet
b.
New York Times
c.
Richard Moore, Inc.
d.
None of these are correct.
13. The data from ____ is especially useful when analyzing small firms.
a.
Prentice-Hall
b.
Robert Morris Associates
c.
Dan Bradbury Ltd.
d.
Securities and Exchange Commission
14. In an inflationary period, a firm is likely to show temporary profit increases because
a.
accounts receivable collections increase
b.
cash balances decline
c.
inventory profits are realized
d.
all of these are correct
15. Financial ratios can be used to analyze a firm’s performance from
a.
day to day
b.
period to period
c.
purchase to purchase
d.
sale to sale
16. The earnings per share figure
a.
is a comparative ratio
b.
is the best measure of a firm’s profitability
c.
can only be computed if a firm has no debt
d.
None of these answers are correct.
17. The retained earnings figure represents
a.
a pool of cash readily available to the firm and its stockholders
b.
an accounting of that portion of a firm’s assets that were financed from past earnings
c.
a permanent part of the firm’s equity base
d.
a deferred liability owed to preferred stockholders
18. Which ratio is frequently used in conjunction with the analysis of a bond’s quality?
a.
times interest earned
b.
deferred liability ratio
c.
receivables turnover
d.
dividend coverage ratio
19. The current ratio would normally be increased by
a.
paying off some current liabilities with cash
b.
selling bonds and investing the proceeds in marketable securities
c.
buying treasury stock
d.
paying off some current liabilities with cash, and selling bonds and investing the proceeds
in marketable securities
20. Which of the following policies is (are) consistent with an increase in a firm’s return on total assets?
a.
costs increase more than revenues
b.
the firm’s net working capital (current assets minus current liabilities) position declines
c.
the firm sells off some unused assets and pays the proceeds to existing stockholders in the
form of an extra dividend
d.
net working capital position declines, and he firm sells off some unused assets to provide
an extra dividend
21. If a firm wishes to retain the same return on equity when its net profit margin and total asset turnover
has declined, it must
a.
decrease its equity multiplier
b.
increase its equity multiplier
c.
increase sales and increase assets
d.
reduce sales and increase assets
22. A fresh fruit wholesaler would normally be expected to have
a.
high profit margin and high asset turnover
b.
low profit margin and low asset turnover
c.
low profit margin and high asset turnover
d.
high profit margin and low asset turnover
23. The ratio group most likely to be used to indicate a firm’s ability to meet short-term financial
obligations would be
a.
liquidity ratios
b.
financial leverage ratios
c.
activity ratios
d.
profitability ratios
24. Which of the following ratios would probably not be used to assess the profitability of a firm?
a.
return on stockholders’ equity
b.
return on total assets
c.
times interest earned
d.
return on stockholders’ equity, and total assets
25. In general, firms with ____ risk and ____ earnings growth prospects will have higher P/E multiples.
a.
low, low
b.
high, low
c.
low, high
d.
high, high
26. The quality of a firm’s balance sheet may be reduced by
a.
uninsured losses arising from pending lawsuits
b.
large amounts of obsolete inventory
c.
having equipment whose book value is greater than its market value
d.
All of these answers are correct.
27. The analysis of financial statements is affected by inflation because
a.
the value of long-term debt will increase
b.
the value of fixed assets may be understated
c.
the life of long-term assets are decreased
d.
inventory increases
28. An increase in the average collection period may suggest all of the following except
a.
easing of credit terms
b.
customers are not paying their bills on time
c.
sales have decreased
d.
firm could have a liquidity problem in the future
29. Asset management ratios indicate
a.
how well a firm is using its assets to support sales
b.
how efficiently a firm is allocating its liabilities
c.
the return on assets
d.
the profitability of the firm
30. Christy would like to improve the current ratio of her firm, which is now 0.5, so that she will have a
better chance of obtaining a working capital loan. Which of the following options would improve her
current ratio?
a.
use cash to pay off notes payable
b.
collect some of her accounts receivables
c.
purchase additional inventory on credit
d.
borrow short-term funds to pay off some payables
31. The major types of financial ratios include all of the following except
a.
market-based
b.
liquidity
c.
financial leverage
d.
equity
32. Financial leverage ratios measure the
a.
amount of interest paid by the firm
b.
firm’s use of fixed-charge financing
c.
amount of equity funds retired by the firm
d.
static ratio
33. ____ ratios indicate how efficiently a firm is using its assets to generate sales.
a.
Liquidity
b.
Asset management
c.
Financial leverage
d.
none of these answers are correct
34. A common-size balance sheet shows the firm’s assets and liabilities as a percentage of ____.
a.
stockholders’ equity
b.
industry averages
c.
total assets
d.
net sales
35. A common-size income statement shows the firm’s income and expense items as a percentage of ____.
a.
stockholders’ equity
b.
net sales
c.
industry averages
d.
total assets
36. The ____ ratio, sometimes called the “acid test,” is a more stringent measure of ____ than the current
ratio.
a.
quick; liquidity
b.
fixed-asset turnover; activity
c.
net profit margin; gross profit margin
d.
none of these answers are correct
37. Return on stockholders’ equity is equal to ____ times ____ times ____.
a.
net profit margin; fixed asset turnover; equity multiplier ratio
b.
gross profit margin; total asset turnover; equity multiplier ratio
c.
net profit margin; total asset turnover; equity multiplier ratio
d.
net profit margin; total asset turnover; debt-to-equity ratio
38. When considering the quality of a firm’s earnings, high quality earnings tend to be ____.
a.
cash earnings
b.
earnings derived from regularly recurring transactions
c.
cash earnings and earnings derived from regularly recurring transactions
d.
none of these answers are correct
39. The fixed charge coverage ratio includes all of the following except ____ in the denominator.
a.
lease payments
b.
preferred dividends before tax
c.
before tax sinking fund
d.
common stock dividends
40. The ____ ratio is a more severe measure of a firm’s ability to meet fixed financial obligations than is
the times interest earned ratio.
a.
acid test
b.
debt
c.
fixed charge coverage
d.
debt to equity
41. If a firm’s current ratio is 1.5,
a.
its current liabilities exceed its current assets
b.
it is possible for its quick ratio to be 2.0
c.
it is possible for its quick ratio to be 1.0
d.
its current assets equal its current liabilities
42. If a firm’s total asset turnover ratio is 2.0,
a.
its annual sales are less than its total assets
b.
it is possible that its fixed asset turnover ratio is 1.5
c.
its total assets are two times its annual sales
d.
its annual sales are two times its total assets
43. If a firm’s return on investment, i.e., earnings after taxes divided by total assets, is 7%, and the firm has
no preferred stock financing,
a.
it is possible that its return on stockholders’ equity is 10%
b.
it is possible that its return on stockholders’ equity is 5%
c.
it is not possible for its debt-to–equity ratio to be 1.0
d.
it is not possible for its net profit margin to be 7%
44. If a firm’s price to earnings (P/E) ratio is 10,
a.
it is not possible for it to be paying dividends also
b.
its market to book ratio has to be at least 2.0
c.
its net profit margin is positive
d.
its return on stockholders’ equity is negative
45. The analysis of the financial performance and condition of a firm with sizable international operations
is generally more complicated than analyzing a firm whose operations are largely domestic for all of
the following reasons except:
a.
problems with the translation of foreign operating results
b.
problems with definition of capital
c.
fluctuating exchange rates
d.
all of these are correct reasons
46. The Market Value Added (MVA) is the ____.
a.
indicator of how successful a firm has been at increasing its financing its assets
b.
return on total capital minus cost of capital
c.
indication of an increase in operating efficiency
d.
positively related to the present value of all expected future EVA
47. Economic value added (EVA) is a measure of operating performance that indicates how successful a
firm has been at:
a.
increasing the growth in earnings
b.
increasing the MVA of the enterprise in any given year
c.
increasing the rate of return on investment
d.
all of these are correct
48. Firms with a positive economic value added (EVA):
a.
have increasing growth in earnings
b.
have an increasing rate of return on investment
c.
have a return on capital greater than their cost of capital
d.
have a high return on book value
49. The ____ ratio indicates the percentage of a firm’s earnings that are distributed as dividends.
a.
dividend yield
b.
payout
c.
return on earnings
d.
earnings
50. Firms with ____ growth rates would be expected to have ____ payout ratios.
a.
high, low
b.
high, high
c.
low, low
d.
low, high
51. Stocks with ____ dividend yield often indicate ____ expected future growth.
a.
high, high
b.
low, low
c.
low, high
d.
high, low
52. To increase the return on stockholders’ equity, management could increase the ____.
a.
current ratio
b.
price-to-earnings ratio
c.
dividend yield
d.
equity multiplier
53. Although ratios can provide valuable information, they can also be misleading for the following
reason(s):
a.
ratios are only as reliable as the accounting data on which they are based.
b.
compilation of industry norms often do not report information about the distribution of
values.
c.
comparative analysis depends on the availability of data for appropriately defined
industries.
d.
all of these are correct.
54. CVD, Inc. has a debt ratio of 50%, and an equity multiplier of 2. What is CVD’s stockholders’ equity if
total debt is $100,000?
a.
$100,000
b.
$150,000
c.
$200,000
d.
$50,000
55. Given the following information, calculate the inventory for J&C videos: Quick ratio = 1.2; Current
assets = $12,000; Current ratio = 2.5
a.
$4,800
b.
$6,240
c.
$7,200
d.
$5,660
56. A firm with an equity multiplier of 4.0, will have a debt ratio of
a.
0.25
b.
1.00
c.
0.75
d.
4.00
57. A firm with a debt ratio of 0.75, will have an equity multiplier of
a.
0.25
b.
1.00
c.
0.75
d.
4.00
58. What is the market price of a share of stock for a firm that pays dividends of $1.20 per share, has a P/E
of 14, and a dividend payout ratio of 0.4?
a.
$16.80
b.
$42
c.
$3
d.
$28
59. What is the return on investment for a firm that has a debt ratio of 0.65, a net profit margin of 6.5%,
sales of $740,000, and a total asset turnover of 4?
a.
26.0%
b.
16.9%
c.
6.5%
d.
26.5%
60. What is the return on stockholders’ equity for a firm with a net profit margin of 5.2 percent, sales of
$620,000, an equity multiplier of 1.8, and total assets of $380,000?
a.
8.48%
b.
5.74%
c.
15.27%
d.
9.36%
61. What is the cost of sales for a firm with a gross profit margin of 30 percent, a net profit margin of 4
percent, and earnings after taxes of $20,000?
a.
$200,000
b.
$350,000
c.
$150,000
d.
$500,000
62. If a firm has a total asset turnover of 8 times and a return on total assets of 15%, its net profit margin
must be
a.
1.875%
b.
1.95%
c.
2.05%
d.
1.5%
63. A firm’s current ratio is 1.5, and its quick ratio is 1.0. If its current liabilities are $10,000, what are its
inventories?
a.
$ 5,000
b.
$10,000
c.
$15,000
d.
$12,500
64. A firm’s price to earnings ratio is 8, and its market to book ratio is 2. If its earnings per share are $4.00,
what is the book value per share?
a.
$ 8.00
b.
$32.00
c.
$64.00
d.
$16.00
65. Wilson Manufacturing Company is considering the issuance of additional long-term debt to finance
expansion. At the present time the company has $160 million of 10% debentures outstanding. Its after-
tax net income is $48 million, and the company’s (marginal) income tax rate is 40%. The company is
required by the debenture holders to maintain its coverage ratio at 4.0 or greater. Determine Wilson’s
present coverage ratio.
a.
3.33
b.
2.78
c.
5.00
d.
6.00
66. If a firm has interest expenses of $10,000 per year, sales of $700,000, a tax rate of 40%, and a net
profit margin of 7%, what is the firm’s times interest earned ratio?
a.
8.17
b.
4.90
c.
13.25
d.
9.17
67. How much cash and marketable securities does Gray Computer Co. have if the firm has a current ratio
of 2.5, a quick ratio of 1.2, and current liabilities of $12,000. Gray’s credit sales are $98,000 and its
average collection period is 40 days? (Assume 365 days per year.)
a.
$3,660
b.
$14,440
c.
$10,740
d.
$15,600
68. What is the market price per share of Budget Busters, Inc. if the firm had net income of $200,000,
earnings per share of $2.70, total equity of $800,000, and a market to book ratio of 1.5?
a.
$16.20
b.
$10.80
c.
$7.20
d.
$12.30
69. If Power-On has a total asset turnover of 1.8, a fixed asset turnover of 3.2, a debt ratio of 0.5 and a
total debt of $200,000, then fixed assets are
a.
$56,250
b.
$711,111
c.
$225,000
d.
$720,000
70. What is Babcock’s times interest earned, if its total interest charges are $20,000, sales are $220,000,
and its net profit margin is 6 percent? Assume a tax rate of 40 percent.
a.
2.65
b.
1.1
c.
2.1
d.
1.2
71. Determine the cost of sales for a firm with the following financial ratios and data:
Current ratio = 3.0; Quick ratio = 2.0; Current liabilities $1,000,000; Inventory turnover 6 times
a.
$2,000,000
b.
$6,000,000
c.
$3,000,000
d.
$1,000,000
72. AK, Inc. is considering issuing additional long-term debt to finance an expansion. The company
currently has $20 million in 5% debt outstanding. Its earnings after-tax (EAT) are $3.0 million, and its
marginal and average tax rate is 40 percent. The company is required by the debt holders to maintain
its times interest earned ratio at 3.0 or greater. How much additional 10 percent debt can the company
issue now and maintain its times interest earned ratio at 3.0? Assume for this calculation that earnings
before interest and taxes remains at its present level.
a.
$10 million
b.
$ 6 million
c.
$ 1 million
d.
None of these are correct
73. Given the following information, determine Salem Company’s fixed assets.
Sales = $10,000,000
Total asset turnover = 4 times
Current ratio = 2.40
Current liabilities = $500,000
Total assets = current assets + fixed assets
a.
$1,200,000
b.
$4,800,000
c.
$1,300,000
d.
Cannot be determined
74. Given the following information, determine Taylor Company’s cash balance.
Sales = $10,000,000 (all on credit)
Current ratio = 3.0
Current liabilities = $800,000
Average collection period = 36.5 days (Assume 365 days/year)
Quick ratio = 1.50
Current assets = cash + accounts receivable + inventory
a.
$200,000
b.
$1,400,000
c.
$2,400,000
d.
none of the above
75. What is the net profit margin for TJX Inc. if the current ratio = 2; total asset turnover =1.5;
total assets = $100,000; and EBIT = $30,000? Assume the marginal tax rate for TJX is 40% and that
interest expenses are $10,000.
a.
20%
b.
8%
c.
12%
d.
6%
76. Your current assets consist of cash, accounts receivable, and inventory. Total current liabilities equal
$200,000. The average collection period is 20 days on average daily credit sales of $2,500. The current
ratio is 1.3 and the quick ratio is 0.625. What is the balance in the cash account?
a.
$ 75,000
b.
$ 65,000
c.
$135,000
d.
$ 50,000
77. If the Foggy Future Company has a net profit margin of 10% and its inventory turnover is 9, what is its
annual cost of sales? You also know that Foggy Future’s average inventory is $96,700 and its annual
sales are $1,000,000.
a.
$870,000
b.
$850,000
c.
$870,300
d.
$790,000
78. Greg is interested in investing in a small company, and he thinks Allen, Co. might be a good
investment. He has been given the following information and would like to know the return on
stockholder’s equity. Assume Allen’s marginal tax rate is 40%.
Earning before taxes
$3 million
Net profit margin
3.6%
Total liabilities
$15.0 million
Total stockholder’s equity
$10.0 million
a.
12%
b.
20%
c.
15%
d.
18%
79. Given the following information, calculate the return on equity for Huffin Puffin Muffin Bakeries,
Inc.:
Net Profit margin = 5%
Total asset turnover = 2
Debt ratio = 0.73
a.
14%
b.
7.3%
c.
37%
d.
21%
ESSAY
1. How does management use financial ratios and what do they measure?
2. What are the inherent problems with using ratios as a comparative tool?