Corporate Finance: Core Principles & Apps, 5e (Ross)
Chapter 3 Financial Statements Analysis and Financial Models
1) On a common-size income statement, depreciation will be
A) omitted since it is a noncash expense.
B) added back to convert net income to cash flows.
C) expressed as a percentage of total assets.
D) expressed as a percentage of sales.
E) expressed as a percentage of gross fixed assets.
2) A common-size balance sheet will express accounts receivable as a percentage of
A) sales.
B) current assets.
C) net working capital.
D) total assets.
E) total owners’ equity.
3) EBITDA is the abbreviation for earnings before
A) insurance, taxes, depreciation, and accounting expenses.
B) interest, taxes, depreciation, and accrued expenses.
C) insurance, taxes, depreciation, and accrued expenses.
D) interest, taxes, depreciation, and amortization.
E) interest, taxes, and deferred accounting overhead.
4) A common-size income statement expresses dividends as 3.6 percent. This means that
dividends represent 3.6 percent of
A) net income.
B) total assets.
C) sales.
D) taxable earnings.
E) total owners’ equity.
5) Financial ratios that measure a firm’s ability to pay its bills over the short run without undue
stress are often referred to as
A) asset management ratios.
B) liquidity measures.
C) leverage ratios.
D) profitability ratios.
E) utilization ratios.
6) The quick ratio is calculated as
A) current assets divided by current liabilities.
B) current assets minus inventory, divided by current liabilities.
C) net working capital divided by current liabilities.
D) cash on hand divided by current liabilities.
E) current liabilities divided by current assets.
7) Which one of these best measures a firm’s long-run ability to meet its obligations?
A) Cash ratio
B) Total asset turnover
C) EV multiple
D) Return on equity
E) Equity multiplier
8) Which one of the following statements is correct concerning ratio analysis?
A) Ratios cannot be used for comparison purposes over extended periods of time.
B) Ratios do not address the problem of size differences among firms.
C) Only a very limited number of ratios can be used for analytical purposes.
D) Each ratio has a specific formula that is used consistently by all analysts.
E) A single ratio is often computed differently by different individuals.
9) All of the following are financial leverage ratios except the
A) current ratio.
B) cash coverage ratio.
C) total debt ratio.
D) times interest earned ratio.
E) equity multiplier.
10) A decrease in which one of the following accounts increases a firm’s current ratio as well as its
quick ratio?
A) Accounts payable
B) Cash
C) Accounts receivable
D) Inventory
E) Fixed assets
11) A supplier, who requires payment this week, should be most concerned about which one of its
customer’s ratios?
A) Current ratio
B) Debt-equity ratio
C) Cash ratio
D) Quick ratio
E) Total debt ratio
12) A firm has a total debt ratio of 0.47. This means the firm has $0.47 in debt for every
A) $.53 in equity.
B) $1.47 in total assets.
C) $1.53 in total assets.
D) $1 in total equity.
E) $1.47 in total equity.
13) Which cash coverage ratio would a lender prefer its borrower have?
A) −1.5
B) −0.5
C) 0
D) 0.5
E) 1.5
14) From a cash flow position, which one of the following ratios best measures a firm’s ability to
pay the interest on its debts?
A) Times interest earned ratio
B) Cash coverage ratio
C) Cash ratio
D) Quick ratio
E) Debt-equity ratio
15) The lower a firm’s inventory turnover, the
A) longer it takes the firm to collect payment on its sales.
B) faster the firm collects payment on its sales.
C) faster the firm sells its inventory.
D) longer inventory sits on the firm’s shelves.
E) smaller the amount of inventory held by the firm.
16) Which one of the following statements is correct if a firm has an accounts receivable turnover
measure of 10?
A) It takes the firm 36.5 days to pay its creditors.
B) It takes the firm 36.5 days to sell its inventory and collect payment from the sale.
C) It takes the firm 36.5 days to collect payment for a sale.
D) The firm has 10 times more in accounts receivable than it does in cash.
E) It takes an average of 10 days to collect payment from the firm’s customers.
17) A total asset turnover measure of 0.84 means that a firm has $0.84 in
A) sales for every $1 in total assets.
B) total assets for every $1 in sales.
C) total assets for every $1 in total equity.
D) total assets for every $1 in cash.
E) long-term assets for every $1 in total assets.
18) If Brewster’s produces a return on assets of 14 percent and also a return on equity of 14 percent,
then the firm
A) has no net working capital.
B) is using its assets as efficiently as possible.
C) has no debt of any kind.
D) also has a current ratio of 14.
E) has an equity multiplier of 1.4.
19) If Textile Cloth stockholders want to know how much net profit the firm is making on a
percentage basis on their investment in that firm, the shareholders should refer to the
A) profit margin.
B) return on assets.
C) return on equity.
D) equity multiplier.
E) EV multiple.
20) Assume J. K. Lumber increases its operating efficiency such that costs decrease while sales
remain constant. As a result, given all else constant, the
A) equity multiplier will decrease.
B) return on assets will decrease.
C) profit margin will decline.
D) return on equity will increase.
E) total asset turnover will increase.
21) The only difference between Joe’s and Moe’s is that Joe’s has old, fully depreciated equipment.
Moe’s just purchased all new equipment that will be depreciated over 8 years. Assuming all else
equal,
A) Joe’s will have a lower profit margin.
B) Joe’s will have a lower return on equity.
C) Moe’s will have a higher net income.
D) Moe’s will have a lower profit margin.
E) Moe’s will have a higher return on assets.
22) Enterprise value is computed as
A) Price per share × Shares outstanding – Cash
B) Market capitalization + Market value of interest-bearing debt – Cash
C) Market capitalization – Market value of interest-bearing debt
D) Price per share × Number of shares outstanding
E) Market capitalization + Market value of all debt – Cash
23) Which one of these is calculated as: 365 / (Cost of goods sold / Inventory)?
A) Total asset turnover
B) Inventory turnover
C) Days sales in receivables
D) Days sales in inventory
E) Capital intensity ratio
24) Ratios that measure how efficiently a firm uses its assets to generate sales are known as
________ ratios.
A) profitability
B) long-term solvency
C) short-term solvency
D) utilization
E) market value
25) Which ratio measures the number of times a firm lends money to customers, collects that
money, and relends it within a year?
A) Total asset turnover
B) Days’ sales in receivables
C) Total debt ratio
D) Receivables turnover
E) Quick ratio
26) Which ratio calculates the amount of sales generated by each $1 of debt and equity invested in
the firm?
A) Total asset turnover
B) Return on equity
C) Return on assets
D) Equity multiplier
E) DuPont identity
27) Which ratio computes the amount of net income generated by each $1 of sales?
A) EV multiple
B) Return on assets
C) Return on equity
D) Profit margin
E) Price-earnings ratio
28) The amount shareholders are willing to pay for each $1 per share of annual earnings a firm
generates is indicated by the
A) equity multiplier.
B) return on equity.
C) price-earnings ratio.
D) DuPont identity.
E) return on assets.
29) Firms with high enterprise value multiples are most apt to have
A) high growth opportunities.
B) low market-to-book ratios.
C) low profit margins.
D) low inventory turnover rates.
E) a low price-earnings ratio.
30) The enterprise value estimates the
A) current market value of a firm’s entire outstanding shares of common and preferred stock.
B) cash required to purchase all of a firm’s outstanding stock and pay off the interest-bearing debt.
C) current market value of all a firm’s outstanding debt.
D) relationship between the current market value and the book value of a firm.
E) total current market value of a firm’s outstanding shares of common stock.
31) Last year, Bennett’s had a PE ratio of 5.4. This year, the PE ratio is 4.9. Based on this
information, it can be stated with absolute certainty that
A) the price per share increased.
B) the earnings per share decreased.
C) either the price per share, the earnings per share, or both, changed.
D) investors are receiving a lower rate of return this year.
E) investors are paying a lower price for each share of stock purchased.
32) Yesterday, ABC stock sold for $28 a share. Today, the overall market fell, and ABC stock is
now selling for $22 a share. Which of these ratios for ABC will be affected by this market
reaction? Assume all else is held constant.
A) Enterprise value multiple and price-earnings ratio
B) Earnings per share and price-earnings ratio
C) Return on equity and return on assets
D) Return on book equity and market-to-book ratio
E) Price-earnings ratio and return on book equity
33) If a firm decreases its operating costs, all else constant, then
A) the profit margin increases while the cash coverage ratio decreases.
B) the return on assets increases while the return on equity decreases.
C) both the return on assets and the return on equity increase.
D) both the profit margin and the equity multiplier increase.
E) the total asset turnover rate decreases while the profit margin increases.
34) Ratio analysis works best when evaluating the financial statements of two firms
A) in the same industry but located in different countries.
B) of differing sizes in the same industry.
C) with one being in a single line of business while the other is a conglomerate.
D) of the same size in differing industries.
E) when both are conglomerates with varying lines of business.
35) Which one of these measures a firm’s operating and asset use efficiency as well as its financial
leverage?
A) Equity multiplier
B) Capital intensity ratio
C) DuPont identity
D) Profit margin
E) Return on assets
36) The return on equity can be calculated as
A) Profit margin × 1 / Capital intensity ratio × Equity multiplier
B) Return on assets × b
C) Profit margin × Total asset turnover × Debt-equity ratio
D) Profit margin × 1 / Equity multiplier × (1 + Debt-equity ratio)
E) Return on assets × Debt-equity ratio
37) The return on equity can be calculated as
A) Profit margin × 1 / Total asset turnover × Equity multiplier
B) Return on assets × Profit margin
C) Profit margin × Capital intensity ratio × Debt-equity ratio
D) Profit margin × 1 / Equity multiplier × (1 + Debt-equity ratio)
E) Return on assets × (1 + Debt-equity ratio)
38) Which portion of the DuPont identity measures the financial leverage employed by a firm?
A) Both the profit margin and the equity multiplier
B) Equity multiplier
C) Total asset turnover
D) Both the capital intensity ratio and the total asset turnover
E) Both the capital intensity ratio and the debt-equity ratio
39) Which of the following represent problems encountered when comparing the financial
statements of one firm with those of another firm?
I. The firms may have unrelated lines of business.
II. The operations of the two firms may vary geographically.
III. The firms may use differing accounting methods.
IV. The two firms may be regulated differently.
A) I and II only
B) II and III only
C) I, III, and IV only
D) I, II, and III only
E) I, II, III, and IV
40) Assume a firm is operating at full capacity. Which one of these accounts is least apt to vary
directly with sales?
A) Inventory
B) Cash
C) Long-term debt
D) Accounts payable
E) Fixed assets
41) For a dividend paying firm, how is the projected addition to retained earnings calculated using
the percentage of sales approach?
A) Net income × (1 – Retention ratio)
B) Net income × (1 – Dividend payout ratio)
C) (Cash dividends / Net income) × (New sales / Old sales)
D) (Retained earnings / Sales) × (New Sales / Old Sales)
E) Net income × (New Sales / Old Sales)
42) If a non–dividend-paying firm bases its growth assumptions on the sustainable rate of growth
and shows positive net income, then the pro forma statement must reflect
A) an increase in fixed assets irrespective of the firm’s current operating capacity.
B) an increase in both sales and the debt-equity ratio.
C) both an increase in the total asset turnover and in the equity multiplier.
D) a constant debt-equity ratio and an increase in retained earnings.
E) increases in fixed assets, the debt-equity ratio, and the number of shares outstanding.
43) When creating pro forma statements, the changes in the liabilities and owners’ equity sections
depend primarily on the firm’s
A) financing policies.
B) interest rates and financing policies.
C) dividend and financing policies.
D) retained earnings policies.
E) rate of sales growth.
44) When creating pro forma statements, the external financing need will increase if you
A) increase the corporate tax rate.
B) decrease the dividend payout ratio.
C) increase the plowback ratio.
D) decrease the rate of sales growth.
E) decrease the projected level of sales.
45) Which one of these combinations will provide sufficient information to determine the
sustainable growth rate of a firm?
A) Profit margin, total asset turnover, and the price-earnings ratio
B) Profit margin, dividend payout ratio, debt-equity ratio, and total asset turnover
C) Return on assets and the retention ratio
D) Return on assets, capital intensity ratio, and the retention ratio
E) Profit margin, total asset turnover, return on assets, and debt-equity ratio
46) The sustainable rate of growth can be increased by
A) decreasing the equity multiplier.
B) increasing the profit margin.
C) decreasing the debt-equity ratio.
D) increasing the dividend payout ratio.
E) increasing the capital intensity ratio.
47) Financial planning, when properly executed
A) helps ensure that adequate financing is in place to support the desired level of growth.
B) ensures that the primary goals of senior management are fully achieved.
C) reduces the necessity of daily management oversight of the business operations.
D) ignores the normal restraints encountered by a firm.
E) eliminates the need to plan more than 1 year in advance.
48) The internal rate of growth is based on the assumption that
A) no dividends are paid.
B) no external funding of any type is obtained.
C) the return on equity is held constant.
D) the only additional outside capital obtained is long-term debt.
E) the debt-equity ratio is held constant.
49) Blue Mountain Foods has net fixed assets of $89,700 and current assets of $38,400, of which
$21,400 is inventory. What is the common-size statement value of inventory?
A) 23.86%
B) 18.56%
C) 16.71%
D) 55.73%
E) 24.71%
50) A firm has sales of $3,900, net income of $1,304, total assets of $4,200, and total equity of
$2,850. Interest expense is $80. What is the common-size statement value of the interest expense?
A) 1.90%
B) 5.10%
C) 2.05%
D) 8.18%
E) 6.13%
51) Jensen’s Boats has sales of $416,800, cost of goods sold of $234,600, depreciation of $41,200,
and selling and general costs of $37,900. The firm has a loan balance of $92,400 with an interest
rate of 6.7 percent. What is the value of EBITDA?
A) $103,100
B) $121,600
C) $144,300
D) $185,500
E) $162,900
52) The Golden Slipper has sales of $487,900, EBIT of $128,650, taxes of 35 percent, interest paid
of $12,400, and a dividend payout ratio of 40 percent. What is the common-size ratio of the
addition to retained earnings?
A) 10.31%
B) 9.29%
C) 14.43%
D) 11.74%
E) 6.87%
53) Lancaster Bakery has net fixed assets of $329,700, current assets of $87,200, a price-earnings
ratio of 12.8, a debt-equity ratio of 0.42, and earnings per share of $1.97. What is the
market-to-book ratio if there are 36,000 shares of stock outstanding?
A) 3.09 times
B) 2.79 times
C) 2.24 times
D) 3.46 times
E) 3.80 times
54) Jessica’s Boutique has cash of $687, accounts receivable of $1,419, accounts payable of
$1,308, and inventory of $2,609. What is the value of the quick ratio?
A) .53 times
B) 3.60 times
C) .48 times
D) 1.84 times
E) 1.61 times
55) A firm has a debt-equity ratio of 0.36. What is the total debt ratio?
A) 0.26
B) 0.29
C) 0.67
D) 0.71
E) 0.74
56) A firm has total debt of $2,200 and a debt-equity ratio of 0.32. What is the value of the total
assets?
A) $2,904
B) $4,675
C) $9,075
D) $6,875
E) $7,225