5-1
Chapter 5—Risk Analysis
MULTIPLE CHOICE
1. Economic theory teaches that differences in market returns must relate to differences in
a.
book value
b.
perceived risk
c.
price-earnings ratio
d.
bankruptcy risk
2. Market equity beta measures the covariability of a firm’s returns with the return’s of
a.
all industry competitors in the market.
b.
risk free securities.
c.
all securities in the market.
d.
all firms of comparable market value.
3. The Johnson company has a current ratio of 1.45. The company has just sold $600,000 worth of
merchandise on credit. What will the current ratio be after the sales on credit?
a.
greater than 1.45
b.
1.45
c.
less than 1.45
d.
unable to determine without more information
4. One common problem with the current ratio is that it is susceptible to “window dressing.” If prior to
the end of the accounting period Saxon Company has a current ratio of 1.5 and management wishes to
boost its current ratio it may decide to
a.
pay off accounts payable prior to year end.
b.
purchase more inventory on account.
c.
purchase short-term investments with cash.
d.
purchase more inventory with cash.
Mobile Company
Mobile Company manufactures computer technology devices. Selected financial data for Mobile is
presented below, use the information to answer the following questions:
Current Assets
As of Dec. 31, 2010
Dec. 31, 2009
Cash and short-term investments
$1,267,038
$ 616,604
Accounts Receivable (net)
490,816
665,828
Inventories
338,599
487,505
Prepaid Expenses and other current assets
292,511
291,915
Total Current Assets
$2,388,964
$2,061,852
Current Liabilities
Short-term borrowings
$ 25,190
$ 38,108
Current portion of long-term debt
182,295
210,090
Accounts payable
296,307
334,247
Accrued liabilities
941,912
743,999
Income taxes payable
203,049
239,793
Total Current Liabilities
1,648,753
1,566,237
Selected Income Statement Data – for the year ending December 31, 2010:
Net Sales
$4,885,340
Cost of Goods Sold
2,542,353
Operating Income
733,541
Net Income
230,101
Selected Statement of Cash Flow Data – for the year ending December 31, 2010:
Cash Flows from Operations
$1,156,084
5. Refer to the information for Mobile Company. Mobile’s current ratio in 2010 was
a.
1.07
b.
1.45
c.
1
d.
.69
6. Refer to the information for Mobile Company. Mobile’s quick ratio changed by what percentage from
2009 to 2010?
a.
30%
b.
107%
c.
25%
d.
82%
7. Refer to the information for Mobile Company. Mobile’s Operating Cash Flow to Current Liabilities
ratio in 2010 was
a.
.70
b.
1.39
c.
1.00
d.
.72
8. Refer to the information for Mobile Company. Mobile’s days receivables outstanding at the end of
2010 was
a.
43.20 days
b.
40.50 days
c.
45.25 days
d.
8.50 days
9. Refer to the information for Mobile Company. Mobile’s days accounts payable outstanding at the end
of 2010 is
a.
7.53 days
b.
48.09 days
c.
45.51 days
d.
50 days
10. Refer to the information for Mobile Company. Days of other financing required by Mobile at the end
of 2010 would be
a.
54.36 days
b.
75.36 days
c.
102.94 days
d.
5.27 days
11. Refer to the information for Mobile Company. Mobile’s 2010 Inventory Turnover ratio is
a.
7.46
b.
11.83
c.
6.16
d.
5.62
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12. The best indicator for assessing a firm’s long-term solvency risk is its ability to generate what over a
period of years?
a.
Sales
b.
Earnings
c.
Positive cash flows
d.
Income from continuing operations
13. Which of the following ratios is not a measure of long-term solvency risk?
a.
Debt /Equity Ratio
b.
Interest Coverage Ratio
c.
Operating Cash Flows to Current Liabilities Ratio
d.
Liabilities to Assets Ratio
14. Univariate bankruptcy prediction models help identify factors related to bankruptcy, but they do not
provide information about
a.
specific ratios that are important.
b.
the amount of Type I and Type II errors.
c.
which specific company will go bankrupt.
d.
the relative importance of individual financial statement ratios.
15. Bankruptcy prediction research has identified three broad factors influencing long-term solvency risk,
which of the following is not one of the factors?
a.
Investment factors
b.
Financing factors
c.
Operating factors
d.
Credit factors
16. Which of the following is not one of the three explanatory variables that determines a firm’s market
beta?
a.
Degree of investing leverage.
b.
Degree of operating leverage.
c.
Degree of financial leverage.
d.
Variability of sales.
17. Here are several ratios calculated from Midas Company’s financial statements:
Days in Receivables = 45
Days in Payables = 36
Days in Inventory = 30
How many days of working capital financing does Midas need to obtain from other sources?
a.
39 days
b.
36 days
c.
56 days
d.
26 days
5-5
18. Which of the following states of financial distress would be considered the most troubling for an
investor or creditor?
a.
failing to make a required interest payment on time
b.
paying an accounts payable after the billing date
c.
restructuring debt
d.
defaulting on a principal payment on debt
19. If a customer wanted to obtain bank financing which of the following will the bank inquire about
before granting a loan?
a.
Firms credit history
b.
financial position of the firms creditors
c.
firms cash flow
d.
a and c
20. Doran Corp. has a current ratio of 6. Under which of the following scenarios might this indicate a
problem?
a.
inventories are increasing due to the introduction of a new product
b.
the company is holding cash in expectation of making a large investment in equipment
c.
receivables are increasing due to increasing sales
d.
inventories are increasing and the industry in which Doran Corp. operates is experiencing
a recession
Below is selected information from Marker’s 2012 financial statements:
As of Dec. 31, 2012
Dec. 31, 2011
Cash and short-term investments
$ 958,245
$ 745,800
Accounts Receivable (net)
125,850
135,400
Inventories
195,650
175,840
Prepaid Expenses and other current assets
45,300
30,860
Total Current Assets
$1,325,045
$1,087,900
Plant, Property and Equipment, net
1,478,320
1,358,700
Intangible Assets
125,600
120,400
Total Assets
$2,928,965
$2,567,000
Short-term borrowings
$ 25,190
$ 38,108
Current portion of long-term debt
45,000
40,000
Accounts payable
285,400
325,900
Accrued liabilities
916,722
705,891
Income taxes payable
125,400
115,600
Total Current Liabilities
$1,397,712
$1,225,499
Long-term Debt
450,000
430,000
Total Liabilities
$1,847,712
$1,655,499
Shareholders’ Equity
$1,081,253
$ 911,501
Total Liabilities and Shareholders’ Equity
$2,928,965
$2,567,000
Selected Income Statement Data – for the year ending December 31, 2012:
Net Sales
$3,210,645
Cost of Goods Sold
(2,310,210)
Operating Income
$ 900,435
Net Income
$ 324,850
Selected Statement of Cash Flow Data – for the year ending December 31, 2012:
Cash Flows from Operations
$584,750
Interest Expense
42,400
Income Tax Expense
114,200
21. Marker’s Liabilities to Assets Ratio for 2012 is
a.
105.1%
b.
63.1%
c.
78.3%
d.
100.0%
22. Marker’s 2012 Liabilities to Shareholders’ Equity ratio is
a.
100.0%
b.
170.9%
c.
63.1%
d.
129.3%
23. Marker’s 2012 Long-term Debt to Long-Term Capital ratio is
a.
31.4%
b.
29.4%
c.
34.0%
d.
25.4%
24. Marker’s 2012 Long-term Debt to Shareholders’ Equity ratio is
a.
31.4%
b.
29.4%
c.
34.0%
d.
45.8%
25. Marker’s 2012 Interest Coverage ratio is
a.
7.66
b.
1.00
c.
11.35
d.
4.35
26. The quick acid test ratio contains all of the following except:
a.
cash
b.
accounts receivable
c.
marketable securities
d.
prepaid assets
27. All of the following are common industry risks faced by companies except:
a.
litigation
b.
technology
c.
regulation
d.
competition
28. All of the following are common domestic risks faced by companies except:
a.
recessions
b.
technology
c.
inflation
d.
demographic shifts
29. All of the following are common international risks faced by companies except:
a.
asset expropriation
b.
exchange rate changes
c.
political unrest
d.
dependence on one or a few suppliers
30. All of the following typically drive firm-specific risks except:
a.
the nature of the business
b.
competition
c.
supplier relationships
d.
demographic shifts
31. Which of the following can companies use as collateral for a loan?
a.
prepaid insurance
b.
prepaid rent
c.
property, plant, and equipment
d.
retained earnings
32. Changes in foreign exchange rates can affect a firm in all of the following ways except:
a.
The prices a firm pays to acquire raw materials from suppliers abroad.
b.
The amount of cash a firm receives when it collects an account receivable, a loan
receivable, or another receivable denominated in a currency other than its own.
c.
The value of domestic liabilities with fixed interest rates.
d.
The prices a firm charges for products sold to customers abroad.
33. Changes in interest rates can typically affect firms in all of the following ways except:
a.
The value of investments in bonds or other investment securities with fixed interest
rates.
b.
The value of liabilities with fixed interest rates.
c.
The returns a firm generates from pension fund investments.
d.
The cash-equivalent value of assets invested abroad.
34. Below are various states of financial distress:
1. defaulting on a principal payment on debt
2. restructuring debt
3. liquidating a firm
4. filing for bankruptcy
5. failing to make a required interest payment on time
What is the order of increasing gravity that analysts typically consider when assessing credit risk and
bankruptcy risk according to a continuum of financial distress?
a.
5, 1, 2, 3, 4
b.
5, 2, 1, 4, 3
c.
1, 5, 2, 4, 3
d.
1, 5, 2, 3, 4
35. Which of the following properly links the factors affecting a firm’s ability to generate cash with its
need to use cash in operations?
Ability to generate cash Need to use cash
a.
Profitability of goods and services sold Working capital requirements
b.
Sales of existing plant assets Plant capacity requirements
c.
Borrowing capacity Debt service requirements
d.
Profitability of goods and services sold Debt service requirements
36. Which of the following properly links the factors affecting a firm’s ability to generate cash with its
need to use cash in investing?
Ability to generate cash Need to use cash
a.
Profitability of goods and services sold Working capital requirements
b.
Sales of existing plant assets Plant capacity requirements
c.
Borrowing capacity Debt service requirements
d.
Profitability of goods and services sold Debt service requirements
37. Which of the following properly links the factors affecting a firm’s ability to generate cash with its
need to use cash in financing?
Ability to generate cash Need to use cash
a.
Profitability of goods and services sold Working capital requirements
b.
Sales of existing plant assets Plant capacity requirements
c.
Borrowing capacity Debt service requirements
d.
Profitability of goods and services sold Debt service requirements
COMPLETION
1. Short-term ____________________________ represents a firm’s near-term ability to generate cash to
service working capital needs and debt service requirements.
2. Long-term ______________________________ represents the longer-term ability of the firm to
generate cash internally or from external sources to satisfy plant capacity and debt repayment needs.
3. The source of risk related to political unrest and exchange rate changes are
_________________________.
4. The source of risk related interest rate changes and demographic changes is ____________________.
5. The source of risk related to technology, regulation and availability of raw materials is
____________________.
6. The source of risk related to management competence, strategic direction and lawsuits is
_________________________.
7. The operating cycle must not only generate cash to supply
________________________________________ needs, it must generate sufficient cash to service
debt.
8. When management takes deliberate steps at a balance sheet date to produce a better current ratio than
is normal it is called ______________________________.
9. By adding the number of days that inventory is held to the number of days that accounts receivable is
outstanding an analyst can calculate the number of days of
_____________________________________________ the firm requires.
10. In general, the shorter the number of days of needed financing, the ____________________ is the cash
flow from operations to average current liabilities.
11. Common shareholders benefit with increasing proportions of debt in the capital structure as long as the
firm maintains an excess of ____________________ over the after-tax cost of debt
12. One problem with debt ratios is that they provide no information about the ability of the firm to
generate ________________________________________ to service debt.
13. In bankruptcy prediction analysis a type ____________________ error is classifying a firm as
nonbankrupt when it ultimately goes bankrupt.
14. In bankruptcy prediction analysis a type ____________________ error is classifying a firm as
bankrupt and it ultimately survives.
15. The beta coefficient measures the ____________________ of a firm’s returns with those of all shares
traded in the market (in excess of the risk-free interest rate).
16. The current ratio is one of the measures of__________ of the firm.
17. _________________________ concerns a firm’s ability to make interest and principal payments on
borrowings as they become due.
18. The analysis of short-term liquidity risk requires an understanding of the
_________________________ of a firm.
19. Financially healthy firms frequently close any cash flow gaps in their operating cycles with
________________________________________.
20. Large current ratios indicate the availability of cash and near cash assets to repay
____________________ coming due within the next year.
21. When calculating the quick ratio, an analyst would include in the numerator cash,
________________________________________, and receivables.
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22. Cash flow from operations indicates the amount of cash that the firm derived from operations after
funding ______________________________.
23. An analyst can view the revenues to cash ratio as a ________________________________________.
24. When the excess of ROA over the after-tax cost of borrowing declines, additional
________________________________________ begins to reduce the return to common shareholders.
25. The ________________________________________ ratio indicates the number of times that net
income before interest expense and income taxes exceeds interest expense.
26. When a company wants to calculate the current ratio the would divide the current assets by the
___________
27. Working capital is defined as ______________________ minus _____________________.
SHORT ANSWER
1. The current risk-free rate of return in the economy is 6%. In addition, the market rate of return is
currently 8.5%
A. Given this information, what would be the expected return on common stock for a company with a
systemic risk level (Beta) of 1.3? Show your calculations.
B. Describe systemic risk.
2. A. What are the three measures that are used to analyze long term solvency risk?
B- describe each measure briefly
3. When a financial analyst examines the credit risk of a company, it is common that he or she uses a set
of factors that all begin with the letter “C.” Each factor provides a consideration that enters into the
lending decision. List and discuss how each of the factors affects a company’s credit risk.
ANS:
4. Bankruptcy analysis research has gone through many iterations, from univariate bankruptcy prediction
models to sophisticated logit models. However, after examining the results of the research there appear
to be a number of common factors that consistently explain bankruptcy. These factors can be grouped
into investment factors, financing factors, operating factors. For each of the three groups discuss
specific factors that have been found to significantly explain bankruptcy.
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5. In the empirical research on earnings manipulation discussed in the chapter a number of firm
characteristics are found to be associated with the likelihood of engaging in earnings manipulation. For
each of the characteristics listed below, discuss the rationale for their inclusion in the model:
a.
Gross Margin Index
b.
Asset Quality Index
c.
Sales Growth Index
d.
Depreciation Index
e.
Leverage Index
engage in earnings manipulation in the future.
in the capital structure, the more likely the company will experience bankruptcy.
may extend beyond the point of safety.