When analyzing the liquidity of a company, the current ratio is a better indicator of
liquidity than short-term cash forecasts.
The current rate method should be used to translate foreign currency into the parent
currency when the functional currency is deemed to be the parent currency.
The LIFO conformity rule states that if a company uses LIFO for tax purposes, it must
also use it for financial reporting purposes.
Evaluating risk of long-term creditors (e.g. bondholders) involves more detail than
evaluating the risk of equity holders.
If accounts payable turnover decreases, this could be an indication that suppliers are
cutting off credit to the company.
A company’s return on assets will equal its return on equity if there is no debt.
It is possible for a profitable company to go out of business because of severe
short-term liquidity problems.
When comparing two companies, the company with the highest net income should
normally have the highest stock price.
One reason many companies do not fund their postretirement obligations other than
pensions is because they are not required to do so by law.
Operating earnings includes all revenue and expense components that pertain to the
company’s operating business, regardless of whether they are recurring or nonrecurring.
When a security is reclassified from available-for-sale to trading, it is transferred at fair
market value, and any unrealized gains or losses must be recognized in the income
statement.
Return on net operating assets will always be greater than or equal to the pretax return
on equity.
An analyst should treat preferred stock on a firm’s balance sheet as debt when
calculating leverage ratios if the preferred stock is convertible into common stock.
A company which leases a piece of machinery (the lessee) will record it as a sales-type
lease if the lessor makes a profit on the lease.
Investing in equity is considered to be more risky than investing in bonds.
Sensitivity analysis is used to examine the assumptions used in the preparation of
projected financial statements.
If the functional currency of a foreign-based subsidiary of an American company is the
local currency, the current rate method of translation should be used for consolidation
purposes.
Two popular techniques of comparative analysis are year-to-year change analysis and
index-number trend analysis.
Projected accounts receivable can be calculated by dividing projected sales by accounts
receivable turnover rate.
ROE is defined as net income divided by total assets.
An SPE investor may secure its investment with a guarantee so that the SPE remains
unconsolidated.
A deferred tax liability imposes an obligation on the business to pay taxes.
The two components of RNOA, net operating profit margin and NOA turnover, are
independent of each other.
Goodwill recorded as the result of an acquisition is defined as the purchase price less
the book value of net assets.
Reported sales in US dollars of revenues from a foreign subsidiary will be the same
regardless of the functional currency.
Gains are earned inflows that arise from a company’s ongoing business activities.
Gains and losses from the sale of property, plant, and equipment should be included in
cost of goods sold as in reality they reflect the cost of producing goods for sale.
If the lease term is 75% or more of the economic life of the asset, the lease needs to be
classified as a capital lease.
Timing is one of the few revenue recognition issues that are seldom a concern in
financial analysis.
Earnings management uses acceptable accounting reporting principles for purposes of
reporting specific results.
A company issues a $100,000, 9% bond and receives $99,000 (ignoring transaction
costs). This implies that the effective interest rate is less than 9%.
If a company’s days receivables outstanding increases, this could be an indication that
there are problems with the quality of the company’s products.
Accrual accounting overcomes both the timing and the matching problems that are
inherent in cash accounting.
As a general rule, revenue is normally recognized when it is:
A. measurable and earned.
B. measurable and received.
C. realizable and earned.
D. realizable and measurable.
Which of the following statements is most correct?
A. If two companies have the same ROE and the same risk, they must have the same
residual income (abnormal earnings) for the year.
B. If two companies have the same net book value and the same residual income this
year, then their stock prices must be the same.
C. If two companies have the same ROE and the same stock price, their earnings must
be the same for the year.
D. If two companies have the same ROE, net book value, and cost of capital, then their
residual income must be the same for the year.
Which of the following situations is most likely to explain an accounts receivable
turnover that is lower than the industry norm?
A. The company makes less credit sales than industry.
B. The company gives customers less time to pay than its competitors.
C. The company has been selling inferior products to competitors.
D. The company is systematically under-estimating bad debts.
If Harms had decreased its compensation growth rate to 4.5% in 2006, the effect would
have been:
A. an increased ABO.
B. an increased PBO.
C. a decreased ABO.
D. a decreased PBO.
The Management Discussion and Analysis Section of an annual report:
A. is required by the SEC.
B. is optional but normally included in the annual report.
C. is required by the SEC only if the company has suffered from unfavorable trends or
there are significant uncertainty concerning liquidity of the company.
D. is required by the SEC only if they have a qualified audit opinion.
Hupta Corporation reports for the year ended December 31, 2005, sales of $9,430 and
cost of goods sold of $6,500. Other information as of December 31 is as follows:
Cash paid to suppliers for year ended December 31, 2005, is:
A. $6,480.
B. $6,440.
C. $5,520.
D. $6,560.
Which of the following is likely to be the most informative source if you were
interested in a company’s business plan or strategy?
A. Auditor’s letter
B. Management discussion and analysis
C. Proxy statement
D. Footnotes
Due to competitive pressures, Gertup has had to increase credit terms to customers to
maintain sales. This resulted in Gertup’s accounts receivable doubling from 12/31/04 to
12/31/05. The average accounts receivable turnover was 30 days. Without the increased
credit terms, accounts receivable turnover would have remained at 12/31/04 levels. The
impact of the change in credit policy was:
A. none as sales remained the same.
B. decreased liquidity and decreased available cash.
C. increased current ratio and liquidity of the company.
D. current ratio stayed the same and liquidity remained constant.
Voluntary disclosure by managers is becoming an increasingly important source of
information. Which of the following is least likely to be a reason for this increased
disclosure?
A. Protection under Safe Harbor Rules
B. To manage investors’ expectations
C. To communicate information to investors
D. To respond to increased demands by labor unions
Below is information for year ended 12/31/05 for Company A and Company B.
Return on assets for Company A and B for 2005 are:
A. Option A
B. Option B
C. Option C
D. Option D
If Manufacturer used FIFO, its net income for fiscal 2006 would be:
A. $165,000.
B. $149,000.
C. $135,000.
D. $131,000.
Which of the following is not included in the computation of Altman’s Z-score?
A. Liquidity
B. Trendline
C. Capital turnover rate
D. Profitability
Which of the following would require the filing of Form 8-K?
I. Major acquisition
II. Audited financial statements
III. Bankruptcy
IV. Change in management control
A. I and III
B. II and IV
C. I, III, and IV
D. I, II, III, and IV
Parent Company Inc. successfully bids for Child Company Inc. in year X1. Parent
Company Inc. has purchased all of Child’s shares outstanding for $8,500. Following are
excerpts from both companies’ financial statements for year X1, prior to the acquisition.
Also assume the following information: the acquisition was accounted for using the
purchase method. $1,500 of the excess price relates to depreciable assets, and those
assets have an additional useful life of 10 years at the time of the acquisition. Parent
Company Inc. uses the straight line depreciation method and has a 34% tax rate. The
combined net income for both companies for year X2 (excluding any expenses that
need to be recorded as a result of the purchase method accounting for the merger) was
$1,560.
What would be total liabilities in the consolidated financial statements for the date on
which the merger became effective?
A. $28,221
B. $27,231
C. $27,741
D. $25,462
Beginning accounts receivable are $76,000. Sales for the period total $384,000, of
which $40,000 was directly for cash. $418,000 was collected from making sales and
collecting accounts receivable. What is the ending balance for accounts receivable?
A. $42,000
B. $62,000
C. $82,000
D. $68,000
Preparation of Statement of Cash Flows
The following cash flow data of Signet Sales for the year ended December 31, 2005 are
as follows:
a. Prepare a statement of cash flows for Signet Sales in accordance using the direct
method.
b. Discuss, from an analyst’s viewpoint, the purpose of classifying cash flows into the
categories required by GAAP
Which of the following statements is the most plausible explanation of the difference in
observed net operating profit margins?
A. Widget Co’s lower financial leverage
B. Widget Co uses LIFO and Tools uses FIFO
C. Widget Co’s lower tax rate
D. Widget Co’s net operating asset turnover
Current ratio for 2005 is:
A. 1.55.
B. 1.51.
C. 1.50.
D. 1.14.
How much sales would have been reported by the company in 2006 if Byfort used cash
accounting and not accrual accounting?
A. $445,389
B. $454,611
C. $484,289
D. $488,900
Motivation to Manipulate Financial Results
There are many ways in which the management of a company can manage the reported
earnings. Give three reasons why management may want to manage earnings being sure
to explain your answer in full.
What is Dell’s asset turnover for 2006?
A. 2.12
B. 3.58
C. 3.65
D. 2.31
Financing
a. Niglow Corporation produces metal castings. In the past year it earned a 10% return
on its net operating assets base of $10 million. Niglow needs $10 million to expand its
operations, and has the option of obtaining none, some, or all of the proceeds from the
bank. Currently the company is all equity financed. It expects to be able to maintain its
return on net operating assets after the expansion. The bank has indicated that the
amount it will charge on the loan will be dependent upon the resultant debt/equity ratio.
Specifically, the rates will be 8%, 9%, 10%, and 12% for debt-to- equity ratios less than
or equal to 0.25, 0.5, 1.0, and over 1.0, respectively. Niglow’s tax rate is 40%.
b. Calculate Niglow’s return on common equity if the expansion is financed:
i. using all equity
ii. 50% debt, 50% equity
iii. all debt
c. What would Niglow’s return on net operating assets need to be for the return on
equity to be decreased by financing the expansion using all debt?
Analysts’ expected earnings for Alexas for next two years are:
2006: $2.00
2007: $2.23
Cost of equity is 15%. Return on equity is expected to equal cost of equity from 2008
onwards. Dividend payout ratio is expected to remain the same for 2006 and 2007.
Price per share at the end of 2005 would be closest to:
A. $9.45.
B. $9.81.
C. $9.89.
D. Not determinable
Imagine FASB passes a new rule that required the capitalization of R&D. The effect for
a drug company would be to:
A. increase its current ratio.
B. decrease debt to equity ratio.
C. decrease working capital.
D. improve asset turnover.
What would be total assets in the consolidated financial statements for the date on
which the merger became effective?
A. $50,008
B. $49,498
C. $41,508
D. $44,113
Which of the following is not a measure of a company’s solvency?
A. Total debt to equity capital ratio
B. Short-term debt to total debt ratio
C. Sales to assets ratio
D. Long-term debt to equity capital ratio
Which of the following statements is correct?
A. Widget has higher RNOA than Tools.
B. Widget has lower RNOA than Tools.
C. Widget has same RNOA as Tools.
D. Insufficient information to calculate RNOA.
Economic income includes:
A. recurring components only.
B. nonrecurring components only.
C. both recurring and nonrecurring components.
D. neither recurring nor nonrecurring components.
If a company engages in off-balance sheet financing, generally the effect is:
I. to cause assets to be understated.
II. to increase leverage ratios.
III. to increase cash flows.
IV. to cause liabilities to be understated.
A. I, II, III, and IV
B. I, III, and IV
C. I only
D. IV only
Wal-Mart
Refer to Wal-Mart’s financial statements, below.
a. Calculate: total debt to equity ratio and times interest earned ratio for fiscal X6 and
X7. Comment on your results.
b. Analysis of Wal-Mart’s footnotes reveals the existence of significant operating leases.
Explain whether this would change your answer in part a) and how you would make the
changes.
Which of the following is considered part of GAAP?
A. Statements of Financial Accounting Standards (SFAS)
B. International Accounting Standards (IAS)
C. International Financial Reporting Standards (IFRS)
D. Internal Revenue Services (IRS)