Question 1

What best explains why a firm's ratio of long-term debt/total capital is lower than the industry average, while the ratio of income before interest and taxes/debt interest charges is higher than the industry average?

Accepted Answer

A)  The firm pays lower interest on long-term debt than the average firm. 
B)  The firm has more short-term debt than average. 
C)  The firm has a high ratio of current assets/current liabilities. 
D)  The firm has a high ratio of total cash flow/long term debt. 
E)  None of the options are correct.

Question 2

Which of the following are issues when dealing with the financial statements of international firms? I) Many countries allow firms to set aside larger contingency reserves than the amounts allowed for U.S. firms.
II) Many firms outside the U.S. use accelerated depreciation methods for reporting purposes, whereas most U.S. firms use straight-line depreciation for reporting purposes.
III) Intangibles, such as goodwill, may be amortized over different periods or may be expensed rather than capitalized.
IV) There is no way to reconcile the financial statements of non-U.S. firms to GAAP.

Accepted Answer

A)  I and II 
B)  II and IV 
C)  I, II, and III 
D)  I, III, and IV 
E)  I, II, III, and IV

Question 3

If a firm has a positive tax rate, a positive ROA, and the interest rate on debt is the same as ROA, then ROA will be

Accepted Answer

A)  greater than the ROE. 
B)  equal to the ROE. 
C)  less than the ROE. 
D)  greater than zero, but it is impossible to determine how ROA will compare to ROE. 
E)  negative in all cases.

Question 4

A firm has a P/E ratio of 12, an ROE of 13%, and a market-to-book value of

Accepted Answer

A)  0.64. 
B)  0.92. 
C)  1.08. 
D)  1.56.

Question 5

To create a common size income statement, ____________ all items on the income statement by ____________.

Accepted Answer

A)  multiply; net income 
B)  multiply; total revenue 
C)  divide; net income 
D)  divide; total revenue 
E)  multiply; COGS

Question 6

Ferris Corp. wants to increase its current ratio from the present level of 1.5 when it closes the books next week. The action of __________ will have the desired effect.

Accepted Answer

A)  payment of current payables from cash 
B)  sales of current marketable securities for cash 
C)  write-down of impaired assets 
D)  delay of next payroll 
E)  None of the options are correct.

Question 7

The financial statements of Black Barn Company are given below. $\begin{array}{c}
 
\text { Black Barn Company } \
\text { Income Statement (2009) }\
\begin{array}{lrr} 
\hline \text { Sales } & \$ 8,000,000 \
\text { Cost of goods sold } &   \underline {5,260,000} \
\text { Gross profit } & 2,740,000 \
\text { Selling \& administrative expenses } &  \underline {1,500,000} \
\text { Operating profit } & 1,240,000 \
\text { Interest expense } &  \underline {140,000 }\
\text { Income before tax } & 1,100,000 \
\text { Tax expense } &  \underline {440,000} \
 \text { Net income } &  \underline {\$ 660,000} \
\end{array} 
\end{array}$ \(\begin{array}{c}
\begin{array}{lll}
 \text { Balance Sheet } &2009\
\
 \text {  Cash } &\$ 200,000 \
 \text {  Accounts receivable } & 1,200,000 \
 \text {   Inventory } &  \underline {1,840,000} \
 \text {Total current assets  } &\$ 3,240,000 \
 \text {Fixed assets  } &  \underline {3,200,000} \
 \text { Total assets } &  \underline {\$  6,440,000} \
\
 \text { Accounts Payable } &\$ 800,000 \
 \text { Bank loan } & \underline {600,000} \
 \text { Total current liabilities } & \$ 1,400,000 \
 \text {Bond payable  } & \underline { 900,000} \
 \text {  Total liabilities } & \underline {\$  2,300,000 }\
 \text { Common stock ( 130,000 shares) } & \$ 300,000 \
 \text {Retained earnings  } & \underline {3,840,000}\
 \text { Total liabilities \& equity } &  \underline {\$ 6,440,000} \
\end{array}
\begin{array}{lll}
2008\
\
\$ 50,000 \
 950,000 \
 \underline { 1,500,000 }\
 \$  2,500,000 \
 \underline { 3,000,000} \
 \underline { \$ 5,500,000 }\
\

\$ 720,000 \
 \underline { 100,000} \
 \$  820,000 \
 \underline {1,000,000} \
 \underline {\$  1,820,000 }\
\$ 300,000\
 \underline { 3,380,000} \
 \underline { \$ 5,500,000} \
\end{array}
\end{array}\) Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's fixed asset turnover ratio for 2009 is

Accepted Answer

A)  2.04. 
B)  2.58. 
C)  2.97. 
D)  1.58. 
E)  None of the options are correct.

Question 8

The financial statements of Midwest Tours are given below. $\begin{array}{c}
 
\text {  Midwest Tours } \
\text { Income Statement (2009) }\
\begin{array}{lrr} 
\hline \text { Sales } & \$  2,500,000 \
\text { Cost of goods sold } &   \underline {1,260,000} \
\text { Gross profit } & 1,240,000  \
\text { Selling \& administrative expenses } &  \underline { 700,000} \
\text { Operating profit } & 540,000 \
\text { Interest expense } &  \underline {160,000 }\
\text { Income before tax } & 380,000 \
\text { Tax expense } &  \underline {152,000} \
 \text { Net income } &  \underline {\$ 228,000} \
\end{array} 
\end{array}$ \(\begin{array}{c}
\begin{array}{lll}
 \text { Balance Sheet } &2009\
\
 \text {  Cash } &\$ 60,000 \
 \text {  Accounts receivable } &  500,000  \
 \text {   Inventory } &  \underline {300,000} \
 \text {Total current assets  } &\$ 860,000  \
 \text {Fixed assets  } &  \underline {2,180,000} \
 \text { Total assets } &  \underline {\$  3,040,000} \
\
 \text { Accounts Payable } &\$ 200,000 \
 \text { Bank loan } & \underline {460,000} \
 \text { Total current liabilities } & \$ 660,000 \
 \text {Bond payable  } & \underline { 860,000} \
 \text {  Total liabilities } & \underline {\$  1,520,000  }\
 \text { Common stock ( 130,000 shares) } & \$ 120,000 \
 \text {Retained earnings  } & \underline {1,400,000}\
 \text { Total liabilities \& equity } &  \underline {\$  3,040,000} \
\end{array}
\begin{array}{lll}
2008\
\
\$ 50,000 \
450,000 \
 \underline { 270,000  }\
 \$  770,000 \
 \underline { 2,000,000} \
 \underline { \$ 2,770,000 }\
\

\$ 170,000 \
 \underline { 440,000} \
 \$  610,000  \
 \underline {860,000} \
 \underline {\$  1,470,000 }\
\$  120,000\
 \underline {1,300,000} \
 \underline { \$ 2,890,000 } \
\end{array}
\end{array}\) Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's inventory turnover ratio for 2009 is

Accepted Answer

A)  2.86. 
B)  1.23. 
C)  5.96. 
D)  4.42. 
E)  4.86.

Question 9

Common size financial statements make it easier to compare firms

Accepted Answer

A)  of different sizes. 
B)  in different industries. 
C)  with different degrees of leverage. 
D)  that use different inventory valuation methods (FIFO vs. LIFO).

Question 10

Which of the following would best explain a situation where the ratio of net income/total equity of a firm is higher than the industry average, while the ratio of net income/total assets is lower than the industry average?

Accepted Answer

A)  The firm's net profit margin is higher than the industry average. 
B)  The firm's asset turnover is higher than the industry average. 
C)  The firm's equity multiplier must be lower than the industry average. 
D)  The firm's debt ratio is higher than the industry averagE. 
E)  None of the options are correct.

Question 11

The financial statements of Midwest Tours are given below. $\begin{array}{c}
 
\text {  Midwest Tours } \
\text { Income Statement (2009) }\
\begin{array}{lrr} 
\hline \text { Sales } & \$  2,500,000 \
\text { Cost of goods sold } &   \underline {1,260,000} \
\text { Gross profit } & 1,240,000  \
\text { Selling \& administrative expenses } &  \underline { 700,000} \
\text { Operating profit } & 540,000 \
\text { Interest expense } &  \underline {160,000 }\
\text { Income before tax } & 380,000 \
\text { Tax expense } &  \underline {152,000} \
 \text { Net income } &  \underline {\$ 228,000} \
\end{array} 
\end{array}$ \(\begin{array}{c}
\begin{array}{lll}
 \text { Balance Sheet } &2009\
\
 \text {  Cash } &\$ 60,000 \
 \text {  Accounts receivable } &  500,000  \
 \text {   Inventory } &  \underline {300,000} \
 \text {Total current assets  } &\$ 860,000  \
 \text {Fixed assets  } &  \underline {2,180,000} \
 \text { Total assets } &  \underline {\$  3,040,000} \
\
 \text { Accounts Payable } &\$ 200,000 \
 \text { Bank loan } & \underline {460,000} \
 \text { Total current liabilities } & \$ 660,000 \
 \text {Bond payable  } & \underline { 860,000} \
 \text {  Total liabilities } & \underline {\$  1,520,000  }\
 \text { Common stock ( 130,000 shares) } & \$ 120,000 \
 \text {Retained earnings  } & \underline {1,400,000}\
 \text { Total liabilities \& equity } &  \underline {\$  3,040,000} \
\end{array}
\begin{array}{lll}
2008\
\
\$ 50,000 \
450,000 \
 \underline { 270,000  }\
 \$  770,000 \
 \underline { 2,000,000} \
 \underline { \$ 2,770,000 }\
\

\$ 170,000 \
 \underline { 440,000} \
 \$  610,000  \
 \underline {860,000} \
 \underline {\$  1,470,000 }\
\$  120,000\
 \underline {1,300,000} \
 \underline { \$ 2,890,000 } \
\end{array}
\end{array}\) Note: The common shares are trading in the stock market for $36 each. Refer to the financial statements of Midwest Tours. The firm's current ratio for 2009 is

Accepted Answer

A)  1.82. 
B)  1.03. 
C)  1.30. 
D)  1.65. 
E)  None of the options are correct.

Question 12

Assuming continued inflation, a firm that uses LIFO will tend to have a(n) ________current ratio than a firm using FIFO, and the difference will tend to __________ as time passes.

Accepted Answer

A)  higher; increase 
B)  higher; decrease 
C)  lower; decrease 
D)  lower; increase 
E)  identical; remain the same

Question 13

If the interest rate on debt is lower than ROA, then a firm will __________ by increasing the use of debt in the capital structurE.

Accepted Answer

A)  increase the ROE 
B)  not change the ROE 
C)  decrease the ROE 
D)  change the ROE in an indeterminable manner

Question 14

The financial statements of Snapit Company are given below. 
$\begin{array}{c}
\text { Snapit Company }  \
\text {  Income Statement (2009) }\
\begin{array}{lrr} 
\hline \text { Sales } & \$  4,000,000\
\text { Cost of goods sold } &   \underline {3,040,000 } \
\text { Gross profit } & 960,000  \
\text { Selling \& administrative expenses } &  \underline { 430,000 } \
\text { Operating profit } &  530,000  \
\text { Interest expense } &  \underline {160,000  }\
\text { Income before tax } & 370,000 \
\text { Tax expense } &  \underline {148,000} \
 \text { Net income } &  \underline {\$ 222,000} \
\end{array} 
\end{array}$
 \(\begin{array}{c}
\begin{array}{lll}
 \text { Balance Sheet } &2009\
\
 \text {  Cash } &\$ 60,000 \
 \text {  Accounts receivable } &  550,000  \
 \text {   Inventory } &  \underline {690,000} \
 \text {Total current assets  } &\$ 1,300,000 \
 \text {Fixed assets  } &  \underline {1,300,000} \
 \text { Total assets } &  \underline {\$  2,600,000} \
\
 \text { Accounts Payable } &\$ 270,000  \
 \text { Bank loan } & \underline {580,000} \
 \text { Total current liabilities } & \$ 850,000 \
 \text {Bond payable  } & \underline { 900,000} \
 \text {  Total liabilities } & \underline {\$  1,750,000  }\
 \text { Common stock ( 130,000 shares) } & \$ 250,000 \
 \text {Retained earnings  } & \underline {600,000}\
 \text { Total liabilities \& equity } &  \underline {\$   2,600,000} \
\end{array}
\begin{array}{lll}
2008\
\
\$ 50,000 \
500,000 \
\underline {620,000} \
\$  1,170,000 \
\underline {1,230,000} \
\underline {\$  2,400,000} \
\
\$  250,000 \
\underline {500,000} \
\$   750,000 \
\underline {1,000,000} \
\underline {\$  1,750,000 }\
\$   250,000 \
\underline {400,000 }\
\underline {\$   2,400,000} \
\end{array}
\end{array}\)
 Note: The common shares are trading in the stock market for $100 each. Refer to the financial statements of Snapit Company. The firm's quick ratio for 2009 is

Accepted Answer

A)  1.68. 
B)  1.12. 
C)  0.72. 
D) 1.92. 
E)  None of the options are correct.

Question 15

A study by Speidell and Bavishi (1992) found that when accounting statements of foreign firms were restated on a common accounting basis,

Accepted Answer

A)  the original and restated P/E ratios were quite similar. 
B)  the original and restated P/E ratios varied considerably. 
C)  most variation was explained by tax differences. 
D)  most firms were consistent in their treatment of goodwill.

Question 16

__________ is a true statement.

Accepted Answer

A)  During periods of inflation, LIFO makes the balance sheet less representative of the actual inventory values than if FIFO were used 
B)  During periods of inflation, FIFO makes the balance sheet less representative of actual inventory values than if LIFO were used 
C)  After inflation ends, distortion due to LIFO will disappear as inventory is sold 
D)  During periods of inflation, LIFO overstates earnings relative to FIFO

Question 17

The financial statements of Black Barn Company are given below. $\begin{array}{c}
 
\text { Black Barn Company } \
\text { Income Statement (2009) }\
\begin{array}{lrr} 
\hline \text { Sales } & \$ 8,000,000 \
\text { Cost of goods sold } &   \underline {5,260,000} \
\text { Gross profit } & 2,740,000 \
\text { Selling \& administrative expenses } &  \underline {1,500,000} \
\text { Operating profit } & 1,240,000 \
\text { Interest expense } &  \underline {140,000 }\
\text { Income before tax } & 1,100,000 \
\text { Tax expense } &  \underline {\$ 440,000} \
 \text { Net income } &  \underline {\$ 660,000} \
\end{array} 
\end{array}$ \(\begin{array}{c}
\begin{array}{lll}
 \text { Balance Sheet } &2009\
\
 \text {  Cash } &\$ 200,000 \
 \text {  Accounts receivable } & 1,200,000 \
 \text {   Inventory } &  \underline {1,840,000} \
 \text {Total current assets  } &\$ 3,240,000 \
 \text {Fixed assets  } &  \underline {3,200,000} \
 \text { Total assets } &  \underline {\$  6,440,000} \
\
 \text { Accounts Payable } &\$ 800,000 \
 \text { Bank loan } & \underline {600,000} \
 \text { Total current liabilities } & \$ 1,400,000 \
 \text {Bond payable  } & \underline { 900,000} \
 \text {  Total liabilities } & \underline {\$  2,300,000 }\
 \text { Common stock ( 130,000 shares) } & \$ 300,000 \
 \text {Retained earnings  } & \underline {3,840,000}\
 \text { Total liabilities \& equity } &  \underline {\$ 6,440,000} \
\end{array}
\begin{array}{lll}
2008\
\
\$ 50,000 \
 950,000 \
 \underline { 1,500,000 }\
 \$  2,500,000 \
 \underline { 3,000,000} \
 \underline { \$ 5,500,000 }\
\

\$ 720,000 \
 \underline { 100,000} \
 \$  820,000 \
 \underline {1,000,000} \
 \underline {\$  1,820,000 }\
\$ 300,000\
 \underline { 3,380,000} \
 \underline { \$ 5,500,000} \
\end{array}
\end{array}\) Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Black Barn Company. The firm's leverage ratio for 2009 is

Accepted Answer

A)  1.65. 
B)  1.89. 
C)  2.64. 
D)  1.31. 
E)  1.56.

Question 18

A firm has a (net profit/pretax profit) ratio of 0.6, a leverage ratio of 2, a (pretax profit/EBIT) of 0.6, an asset turnover ratio of 2.5, a current ratio of 1.5, and a return on sales ratio of 4%. The firm's ROE is

Accepted Answer

A)  4.2%. 
B)  5.2%. 
C)  6.2%. 
D)  7.2%. 
E)  None of the options are correct.

Question 19

Common size balance sheets make it easier to compare firms

Accepted Answer

A)  with different degrees of leverage. 
B)  of different sizes. 
C)  in different industries. 
D)  that use different inventory valuation methods (FIFO vs. LIFO).

Question 20

A firm has a market to book value ratio that is equivalent to the industry average and an ROE that is less than the industry average, which implies

Accepted Answer

A)  the firm has a higher P/E ratio than other firms in the industry. 
B)  the firm is more likely to avoid insolvency in the short run than other firms in the industry. 
C)  the firm is more profitable than other firms in the industry. 
D)  the firm is utilizing its assets more efficiently than other firms in the industry.

Exam 19: Financial Statement Analysis