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Financial Statement Analysis

FINANCIAL STATEMENT ANALYSIS


THEORIES:
1.
Management is a user of financial analysis. Which of the following comments does not represent a fair statement as to the management perspective?
A. Management is always interested in maximum profitability.
B. Management is interested in the view of investors.
C. Management is interested in the financial structure of the entity.
D. Management is interested in the asset structure of the entity.
Limitations
2.
A limitation in calculating ratios in financial statement analysis is that
A. it requires a calculator.
B. no one other than the management would be interested in them.
C. some account balances may reflect atypical data at year end.
D. they seldom identify problem areas in a company.
3.

Which of the following is not a limitation of financial statement analysis?


A. The cost basis.
C. The diversification of firms.
B. The use of estimates.
D. The availability of information.

4.

Which of the following does not represent a problem with financial analysis?
A. Financial statement analysis is an art; it requires judgment decisions on the part of the analyst.
B. Financial analysis can be used to detect apparent liquidity problems.
C. There are as many ratios for financial analysis as there are pairs of figures.
D. Some industry ratio formulas vary from source to source.

5.

The use of alternative accounting methods:


A. is not a problem in ratio analysis because the footnotes disclose the method used.
B. may be a problem in ratio analysis even if disclosed.
C. is not a problem in ratio analysis since eventually all methods will lead to the same end.
D. is only a problem in ratio analysis with respect to inventory.

Industry Analysis
6.
Suppose you are comparing two firms in the steel industry. One firm is large and the other is small. Which type of numbers would be most meaningful for statement
analysis?
A. Absolute numbers would be most meaningful for both the large and small firm.
B. Absolute numbers would be most meaningful in the large firm; relative numbers would be most meaningful in the small firm.
C. Relative numbers would be most meaningful for the large firm; absolute numbers would be most meaningful for the small firm.
D. Relative numbers would be most meaningful for both the large and small firm, especially for interfirm comparisons.
7.

Which of these statements is false?


A. Many companies will not clearly fit into any one industry.
B. A financial service uses its best judgment as to which industry the firm best fits.
C. The analysis of an entity's financial statements can be more meaningful if the results are compared with industry averages and with results of competitors.
D. A company comparison should not be made with industry averages if the company does not clearly fit into any one industry.

Common-sized financial statements


8.
Which of the following generally is the most useful in analyzing companies of different sizes?
A. comparative statements
C. price-level accounting
B. common-sized financial statements
D. profitability index
9.

Statements in which all items are expressed only in relative terms (percentages of a base) are termed:
A. Vertical statements
C. Funds Statements
B. Horizontal Statements
D. Common-Size Statements

10.

The percent of property, plant and equipment to total assets is an example of:
A. vertical analysis
C. profitability analysis
B. solvency analysis
D. horizontal analysis

11.

Vertical analysis is a technique that expresses each item in a financial statement


A. in pesos and centavos.
B. as a percent of the item in the previous year.
C. as a percent of a base amount.
D. starting with the highest value down to the lowest value.

12.

In performing a vertical analysis, the base for prepaid expenses is


A. total current assets.
C.
B. total assets.
D.

total liabilities.
prepaid expenses in a previous year.

Horizontal analysis
13. The percentage analysis of increases and decreases in individual items in comparative financial statements is called:
A. vertical analysis
C. profitability analysis
B. solvency analysis
D. horizontal analysis
14.

Horizontal analysis is also known as


A. linear analysis.
B. vertical analysis.

C.
D.

trend analysis.
common size analysis.

15.

In which of the following cases may a percentage change be computed?


A. The trend of the amounts is decreasing but all amounts are positive.
B. There is no amount in the base year.
C. There is a negative amount in the base year and a negative amount in the subsequent year.
D. There is a negative amount in the base year and a positive amount in the subsequent year.

16.

Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time
A. that has been arranged from the highest number to the lowest number.
B. that has been arranged from the lowest number to the highest number.
C. to determine which items are in error.

Financial Statement Analysis


D.

to determine the amount and/or percentage increase or decrease that has taken place.

Trend analysis
17. Trend analysis allows a firm to compare its performance to:
A. other firms in the industry
B. other time periods within the firm

C.
D.

other industries
none of the above

Risk and return


18. The present and prospective stockholders are primarily concerned with a firm
A. profitability
C. leverage
B. liquidity
D. risk and return
19.

Which suppliers of funds bear the greatest risk and should therefore earn the greatest return?
A. common stockholders
C. preferred shareholders
B. general creditors such as banks
D. bondholders

Measures of Risk
20. The following groups of ratios primarily measure risk:
A. liquidity, activity, and common equity
B. liquidity, activity, and profitability

C.
D.

liquidity, activity, and debt


activity, debt, and profitability

Financial ratios
21. Ratios are used as tools in financial analysis
A. instead of horizontal and vertical analyses.
B. because they can provide information that may not be apparent from inspection of the individual components of a particular ratio.
C. because even single ratios by themselves are quite meaningful.
D. because they are prescribed by GAAP.
22.

In the near term, the important ratios that provide the information critical to the short-run operation of the firm are:
A. liquidity, activity, and profitability
C. liquidity, activity, and equity
B. liquidity, activity, and debt
D. activity, debt, and profitability

23.

The ability of a business to pay its debts as they come due and to earn a reasonable amount of income is referred to as:
A. solvency and leverage
C. solvency and liquidity
B. solvency and profitability
D. solvency and equity

Liquidity ratios
Interested parties
24. The primary concern of short-term creditors when assessing the strength of a firm is the entitys
A. short-term liquidity
C. market price of stock
B. profitability
D. leverage
25.

Short-term creditors are usually most interested in assessing


A. solvency.
C.
B. liquidity.
D.

marketability.
profitability.

26.

The two categories of ratios that should be utilized to asses a firms true liquidity are the
A. current and quick ratios
C. liquidity and profitability ratios
B. liquidity and debt ratios
D. liquidity and activity ratios

27.

Which of the following is the most of interest to a firms suppliers?


A. profitability
C.
B. debt
D.

asset utilization
liquidity

Measures of liquidity
28. The ratios that are used to determine a companys short-term debt paying ability are
A. asset turnover, times interest earned, current ratio, and receivables turnover.
B. times interest earned, inventory turnover, current ratio, and receivables turnover.
C. times interest earned, acid-test ratio, current ratio, and inventory turnover.
D. current ratio, acid-test ratio, receivables turnover, and inventory turnover.
29.

Which of the following is a measure of the liquidity position of a corporation?


A. earnings per share
B. inventory turnover
C. current ratio
D. number of times interest charges earned

30.

Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company?
A. Current ratio
C. Asset turnover
B. Acid-test ratio
D. Receivables turnover

31.

Which of the following ratios would be least helpful in appraising the liquidity of current assets?
A. Accounts Receivable turnover
C. Current Ratio
B. Days sales in inventory
D. Days sales in accounts receivable

32.

Which ratio is most helpful in appraising the liquidity of current assets?


A. current ratio
C. acid-test ratio
B. debt ratio
D. accounts receivable turnover

Not a measure of liquidity


33. Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company?
A. accounts receivable turnover.
C. acid test ratio.
B. asset turnover.
D. current ratio.
Current ratio
34. Typically, which of the following would be considered to be the most indicative of a firm's short-term debt paying ability?
A. working capital
C. acid test ratio

Financial Statement Analysis


B.

current ratio

D.

days sales in receivables

35.

The current ratio is


A. calculated by dividing current liabilities by current assets.
B. used to evaluate a companys liquidity and short-term debt paying ability.
C. used to evaluate a companys solvency and long-term debt paying ability.
D. calculated by subtracting current liabilities from current assets.

36.

Which of the following ratios is rated to be a primary measure of liquidity and considered of highest significance rating of the liquidity ratios a bank analyst?
A. Debt/Equity
B. Current ratio
C. Degree of Financial Leverage
D. Accounts Receivable Turnover in Days

37.

A weakness of the current ratio is


A. the difficulty of the calculation.
B. that it does not take into account the composition of the current assets.
C. that it is rarely used by sophisticated analysts.
D. that it can be expressed as a percentage, as a rate, or as a proportion.

Acid-test or quick ratio


38. A measure of a companys immediate short-term liquidity is the
A. current ratio.
B. current cash debt coverage ratio.
C. cash debt coverage ratio.
D. acid-test ratio.
39.

The acid-test or quick ratio


A. is used to quickly determine a companys solvency and long-term debt paying ability.
B. relates cash, short-term investments, and net receivables to current liabilities.
C. is calculated by taking one item from the income statement and one item from the balance sheet.
D. is the same as the current ratio except it is rounded to the nearest whole percent.

Not a liquidity ratio


40. Which one of the following would not be considered a liquidity ratio?
A. Current ratio.
C.
B. Inventory turnover.
D.

Quick ratio.
Return on assets.

Activity ratios
Days receivable & receivable turnover
Quality of receivables
41. Which of the following does not bear on the quality of receivables?
A. shortening the credit terms
B. lengthening the credit terms
C. lengthening the outstanding period
D. all of the above bear on the quality of receivables
Days receivable
42. A general rule to use in assessing the average collection period is
A. that is should not exceed 30 days.
B. it can be any length as long as the customer continues to buy merchandise.
C. that it should not greatly exceed the discount period.
D. that it should not greatly exceed the credit term period.
Asset utilization ratios
Performance measures
43. All of the following are asset utilization ratios except:
A. average collection period
B. inventory turnover

C.
D.

receivables turnover
return on assets

Asset turnover
44. Asset turnover measures
A. how often a company replaces its assets.
B. how efficiently a company uses its assets to generate sales.
C. the portion of the assets that have been financed by creditors.
D. the overall rate of return on assets.
45.

Total asset turnover measures the ability of a firm to:


A. generate profits on sales
B. generate sales through the use of assets
C. cover long-term debt
D. buy new assets

46.

A measure of how efficiently a company uses its assets to generate sales is the
A. asset turnover ratio.
C. profit margin ratio.
B. cash return on sales ratio.
D. return on assets ratio.

Solvency ratios
Interested parties
47. Long-term creditors are usually most interested in evaluating
A. liquidity.
C.
B. marketability.
D.
Financial Leverage
48. Trading on the equity (leverage) refers to the
A. amount of working capital.
B. amount of capital provided by owners.

profitability.
solvency.

Financial Statement Analysis


C.
D.

use of borrowed money to increase the return to owners.


earnings per share.

49.

The tendency of the rate earned on stockholders' equity to vary disproportionately from the rate earned on total assets is sometimes referred to as:
A. leverage
C. yield
B. solvency
D. quick assets

50.

Using financial leverage is a good financial strategy from the viewpoint of stockholders of companies having:
A. a high debt ratio
C. a steadily declining current ratio
B. steady or rising profits
D. cyclical highs and lows

51.

The ratio that indicates a companys degree of financial leverage is the


A. cash debt coverage ratio.
C. free cash flow ratio.
B. debt to total assets.
D. times-interest earned ratio.

52.

Interest expense creates magnification of earnings through financial leverage because:


A. while earnings available to pay interest rise, earnings to residual owners rise faster
B. interest accompanies debt financing
C. interest costs are cheaper than the required rate of return to equity owners
S. the use of interest causes higher earnings

Measures of solvency
53. The set of ratios that is most useful in evaluating solvency is
A. debt ratio, current ratio, and times interest earned
B. debt ratio, times interest earned, and return on assets
C. debt ratio, times interest earned, and quick ratio
D. debt ratio, times interest earned, and cash flow to debt
54.

Which of the following ratios is most relevant to evaluating solvency?


A. Return on assets
C. Days purchases in accounts payable
B. Debt ratio
D. Dividend yield

Fixed assets to long-term liabilities


55. Which of the following ratios provides a solvency measure that shows the margin of safety of noteholders or bondholders and also gives an indication of the potential
ability of the business to borrow additional funds on a long-term basis?
A. ratio of fixed assets to long-term liabilities
B. ratio of net sales to assets
C. number of days' sales in receivables
D. rate earned on stockholders' equity
Debt ratio
56. The debt ratio indicates:
A. a comparison of liabilities with total assets
B. the ability of the firm to pay its current obligations
C. the efficiency of the use of total assets
D. the magnification of earnings caused by leverage
57.

The debt to total assets ratio measures


A. the companys profitability.
B. whether interest can be paid on debt in the current year.
C. the proportion of interest paid relative to dividends paid.
D. the percentage of the total assets provided by creditor.

Debt-to-equity ratio
58. Which of the following statements best compares long-term borrowing capacity ratios?
A. The debt/equity ratio is more conservative than the debt ratio.
B. The debt to tangible net worth ratio is more conservative than the debt/equity ratio.
C. The debt/equity ratio is more conservative than the debt to tangible net worth ratio.
D. The debt ratio is more conservative than the debt/equity ratio.
Times interest earned
59. A times interest earned ratio of 0.90 to 1 means that
A. the firm will default on its interest payment
B. net income is less than the interest expense
C. the cash flow is less than the net income
D. the cash flow exceeds the net income
Fixed charge coverage
60. A fixed charge coverage:
A. is a balance sheet indication of debt carrying ability
B. is an income statement indication of debt carrying ability
C. frequently includes research and development
D. computation is standard from firm to firm
Off-balance sheet liabilities
61. If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in the financial statements, then the
A. times interest earned ratio will be overstated, based upon the financial statements
B. debt ratio will be understated
C. working capital will be understated
D. fixed charge ratio will be overstated, based upon the financial statements
Profitability ratios
Interested parties
62. The return on assets ratio is affected by the
A. asset turnover ratio.
B. debt to total assets ratio.
C. profit margin ratio.
D. asset turnover and profit margin ratios.

Financial Statement Analysis


63.

Stockholders are most interested in evaluating


A. liquidity.
B. solvency.

C.
D.

Performance measures
64. The set of ratios that are most useful in evaluating profitability is
A. ROA, ROE, and debt to equity ratio
C.
B. ROA, ROE, and dividend yield
D.

profitability.
marketability.

ROA, ROE, and acid-test ratio


ROA, ROE, and cash flow to debt

Earnings per share


65. Which of the following ratios appears most frequently in annual reports?
A. Earnings per Share
C. Profit Margin
B. Return on Equity
D. Debt/Equity
Return on assets
66. Return on assets
A.
can be determined by looking at a balance sheet
B.
should be smaller than return on sales
C. can be affected by the companys choice of a depreciation method
D. should be larger than return on equity
Return on investments
67. Return on investment measures:
A. return to all suppliers of funds
B. return to all long-term creditors

C.
D.

return to all long-term suppliers of funds


return to stockholders

Market test ratios


Price-earnings ratio
68. The price/earnings ratio
A. measures the past earning ability of the firm
B. is a gauge of future earning power as seen by investors
C. relates price to dividends
D. relates
69.

Which of the following ratios usually reflects investors opinions of the future prospects for the firm?
A. dividend yield
C. book value per share
B. price/earnings ratio
D. earnings per share

Dividend yield
70. Which of the following ratios represents dividends per common share in relation to market price per common share?
A. dividend payout
C. price/earnings
B. dividend yield
D. book value per share
Financial Statement Analysis
Accounts Receivable
71. Which of the following reasons should not be considered in order to explain why the receivables appear to be abnormally high?
A. Sales volume decreases materially late in the year.
B. Receivables have collectibility problems and possibly some should have been written off.
C. Material amount of receivables are on the installment basis.
D. Sales volume expanded materially late in the year.
72.

An acceleration in the collection of receivables will tend to cause the accounts receivable turnover to:
A. decrease
C. either increase or decrease
B. remain the same
D. increase

Inventories
73. Which of the following would best indicate that the firm is carrying excess inventory?
A. a decline in the current ratio
B. stable current ratio with declining quick ratios
C. a decline in days' sales in inventory
D. a rise in total asset turnover
74.

When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an average quick ratio, and a low inventory turnover. What might you assume
about Tri-C?
A. Its cash balance is too low.
C. Its current liabilities are too low.
B. Its cost of goods sold is too low.
D. Its average inventory is too high.

Current ratio
75. Which of the following would be most detrimental to a firm's current ratio if that ratio is currently 2.0?
A. Buy raw materials on credit
B. Sell marketable securities at cost
C. Pay off accounts payable with cash
D. Pay off a portion of long-term debt with cash
Fixed asset turnover ratio
76. Which of the following circumstances will cause sales to fixed assets to be abnormally high?
A. A labor-intensive industry.
B. The use of units-of-production depreciation.
C. A highly mechanized facility.
D. High direct labor costs from a new union contract.
Total asset turnover
77. A firm with a total asset turnover lower than the industry standard and a current ratio which meets industry standard might have excessive:
A. Accounts receivable
C. Debt
B. Fixed assets
D. Inventory
Profitability analysis

Financial Statement Analysis


78.

Denver Dynamics has net income of P2,000,000. Oakland Enterprises has net income of P2,500,000. Which of the following best compares the profitability of Denver
and Oakland?
A. Oakland Enterprises is 25% more profitable than Denver Dynamics.
B. Oakland Enterprises is more profitable than Denver Dynamics, but the comparison can't be quantified.
C. Oakland Enterprises is only more profitable if it is smaller than Denver Dynamics.
D. Further information is needed for a reasonable comparison.

Debt ratio
79. Companies A and B are in the same industry and have similar characteristics except that Company A is more leveraged than Company B. Both companies have
the same income before interest and taxes and the same total assets. Based on this information we could conclude that
A. Company A has higher net income than Company B
B. Company A has a lower return on assets than company B
C. Company A is more risky than Company B.
D. Company A has a lower debt ratio than company B
Sensitivity Analysis
Current ratio
80. A firm has a current ratio of 1:1. In order to improve its liquidity ratios, this firm should
A. improve its collection practices, thereby increasing cash and increasing its current and quick ratios.
B. improve its collection practices and pay accounts payable, there decreasing current liabilities and increasing the current and quick ratios.
C. decrease current liabilities by utilizing more long-term debt, thereby increasing the current and quick ratios.
D. increase inventory, thereby increasing current assets and the current and quick ratios.
81.

Recently the M&M Company has been having problems. As a result, its financial situation has deteriorated. M&M approached the First National Bank for a badly
needed loan, but the loan officer insisted that the current ratio (now 0.5) be improved to at least 0.8 before the bank would even consider granting the credit. Which of
the following actions would do the most to improve the ratio in the short run?
A. Using some cash to pay off some current liabilities.
B. Collecting some of the current accounts receivable.
C. Paying off some long-term debt.
D. Purchasing additional inventory on credit (accounts payable).

82.

Tyner Company had P250,000 of current assets and P90,000 of current liabilities before borrowing P60,000 from the bank with a 3-month note payable. What
effect did the borrowing transaction have on Tyner Company's current ratio?
A. The ratio remained unchanged.
B. The change in the current ratio cannot be determined.
C. The ratio decreased.
D. The ratio increased.

83.

Which of the following actions will increase a firm's current ratio if it is now less than 1.0?
A. Convert marketable securities to cash.
B. Pay accounts payable with cash.
C. Buy inventory with short term credit (i.e. accounts payable).
D. Sell inventory at cost.

Acid-test ratio
84. If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of cash by short-term debt and collection of accounts receivable have on
the ratio?
A.
B.
C.
D.
Short-term borrowing
Increase
Increase
Decrease
Decrease
Collection of receivable
No effect
Increase
No effect
Decrease
Profit margin
85. Which of the following would most likely cause a rise in net profit margin?
A. increased sales
C. decreased operating expenses
B. decreased preferred dividends
D. increased cost of sales
Return on assets
86. Return on assets cannot fall under which of the following circumstances?
A.
B.
Net profit margin
Decline
Rise
Total asset turnover
Rise
Decline

C.
Rise
Rise

D.
Decline
Decline

Debt ratio
87. Jones Company has long-term debt of P1,000,000, while Smith Company, Jones' competitor, has long-term debt of P200,000. Which of the following statements best
represents an analysis of the long-term debt position of these two firms?
A. Jones obviously has too much debt when compared to its competitor.
B. Smith Company's times interest earned should be lower than Jones.
C. Smith has five times better long-term borrowing ability than Jones.
D. Not enough information to determine if any of the answers are correct.
Times interest earned
88. Which of the following will not cause times interest earned to drop? Assume no other changes than those listed.
A. A rise in preferred stock dividends.
B. A drop in sales with no change in interest expense.
C. An increase in interest rates.
D. An increase in bonds payable with no change in operating income.
DuPont Analysis
89. Which of the following could cause return on assets to decline when net profit margin is increasing?
A. sale of investments at year-end
C. purchase of a new building at year-end
B. increased turnover of operating assets
D. a stock split
90.

A firm with a lower net profit margin can improve its return on total assets by
A. increasing its debt ratio
C. increasing its total asset turnover
B. decreasing its fixed assets turnover
D. decreasing its total asset turnover

Financial Statement Analysis

PROBLEMS:
Horizontal analysis
i

ii

Kline Corporation had net income of P2 million in 2006. Using the 2006 financial elements as the base data, net income decreased by 70 percent in 2007 and
increased by 175 percent in 2008. The respective net income reported by Kline Corporation for 2007 and 2008 are:
A. P 600,000 and P5,500,000
C. P1,400,000 and P3,500,000
B. P5,500,000 and P 600,000
D. P1,400,000 and P5,500,000
.

Assume that Axle Inc. reported a net loss of P50,000 in 2006 and net income of P250,000 in 2007. The increase in net income of P300,000:
A. can be stated as 0%
C. cannot be stated as a percentage
B. can be stated as 100% increase
D. can be stated as 200% increase

Liquidity ratios
iii
. The following financial data have been taken from the records of Ratio Company:
Accounts receivable
P200,000
Accounts payable
80,000
Bonds payable, due in 10 years
500,000
Cash
100,000
Interest payable, due in three months
25,000
Inventory
440,000
Land
800,000
Notes payable, due in six months
250,000
What will happen to the ratios below if Ratio Company uses cash to pay 50 percent of its accounts payable?
A.
B.
C.
D.
Current ratio
Increase
Decrease
Increase
Decrease
Acid-test ratio
Increase
Decrease
Decrease
Increase
Question Nos. 4 through 6 are based on the data taken from the balance sheet of Nomad Company at the end of the current year:
Accounts payable
P145,000
Accounts receivable
110,000
Accrued liabilities
4,000
Cash
80,000
Income tax payable
10,000
Inventory
140,000
Marketable securities
250,000
Notes payable, short-term
85,000
Prepaid expenses
15,000
iv

vi

The amount of working capital for the company is:


A. P351,000
B. P361,000

C.
D.

P211,000
P336,000

The companys current ratio as of the balance sheet date is:


A. 2.67:1
B. 2.44:1

C.
D.

2.02:1
1.95:1

The companys acid-test ratio as of the balance sheet date is:


A. 1.80:1
B. 2.40:1

C.
D.

2.02:1
1.76:1

Activity ratios
Receivables turnover
vii

Pine Hardware Store had net credit sales of P6,500,000 and cost of goods sold of P5,000,000 for the year. The Accounts Receivable balances at the beginning
and end of the year were P600,000 and P700,000, respectively. The receivables turnover was
A. 7.7 times.
C. 9.3 times.
B. 10.8 times.
D. 10.0 times.

viii

. Milward Corporations books disclosed the following information for the year ended December 31, 2007:
Net credit sales
Net cash sales
Accounts receivable at beginning of year
Accounts receivable at end of year
Milwards accounts receivable turnover is
A. 3.75 times
C. 5.00 times
B. 4.35 times
D. 5.80 times

P1,500,000
240,000
200,000
400,000

Days receivable
ix

Batik Clothing Store had a balance in the Accounts Receivable account of P390,000 at the beginning of the year and a balance of P410,000 at the end of the year. The
net credit sales during the year amounted to P4,000,000. Using 360-day year, what is the average collection period of the receivables?
A. 30 days
C. 73 days
B. 65 days
D. 36 days

Cash collection
x

Deity Company had sales of P30,000, increase in accounts payable of P5,000, decrease in accounts receivable of P1,000, increase in inventories of P4,000, and
depreciation expense of P4,000. What was the cash collected from customers?
A. P31,000
C. P34,000
B. P35,000
D. P25,000

Financial Statement Analysis


Inventory turnover
xi

xii

During 2007, Tarlac Company purchased P960,000 of inventory. The cost of goods sold for 2007 was P900,000, and the ending inventory at December 31, 2007
was P180,000. What was the inventory turnover for 2007?
A. 6.4
C. 5.3
B. 6.0
D. 5.0
.

Selected information from the accounting records of Petals Company is as follows:


Net sales for 2007
P900,000
Cost of goods sold for 2007
600,000
Inventory at December 31, 2006
180,000
Inventory at December 31, 2007
156,000
Petals inventory turnover for 2007 is
A. 5.77 times
C. 3.67 times
B. 3.85 times
D. 3.57 times

xiii

. The Moss Company presents the following data for 2007.


Net Sales, 2007
Net Sales, 2006
Cost of Goods Sold, 2007
Cost of Goods Sold, 2007
Inventory, beginning of 2007
Inventory, end of 2007
The merchandise inventory turnover for 2007 is:
A. 5.6
B. 15.6

P3,007,124
P 930,247
P2,000,326
P1,000,120
P 341,169
P 376,526
C.
D.

7.5
7.7

xiv

. Based on the following data for the current year, what is the inventory turnover?
Net sales on account during year
Cost of merchandise sold during year
Accounts receivable, beginning of year
Accounts receivable, end of year
Inventory, beginning of year
Inventory, end of year
A. 3.3
C. 3.7
B. 8.3
D. 3.0

P 500,000
330,000
45,000
35,000
90,000
110,000

Days inventory
xv

Selected information from the accounting records of Eternity Manufacturing Company follows:
Net sales
Cost of goods sold
Inventories at January 1
Inventories at December 31
What is the number of days sales in average inventories for the year?
A. 102.2
C. 87.6
B. 94.9
D. 68.1

P3,600,000
2,400,000
672,000
576,000

Turnover ratios
Asset turnover
Asset
xvi

. Net sales are P6,000,000, beginning total assets are P2,800,000, and the asset turnover is 3.0. What is the ending total asset balance?
A. P2,000,000.
C. P2,800,000.
B. P1,200,000.
D. P1,600,000.

Solvency ratios
Debt ratio
xvii

. Jordan Manufacturing reports the following capital structure:


Current liabilities
Long-term debt
Deferred income taxes
Preferred stock
Common stock
Premium on common stock
Retained earnings
What is the debt ratio?
A. 0.48
B. 0.49

P100,000
400,000
10,000
80,000
100,000
180,000
170,000
C.
D.

0.93
0.96

Times interest earned


xviii

xix

. House of Fashion Company had the following financial statistics for 2006:
Long-term debt (average rate of interest is 8%)
Interest expense
Net income
Income tax
Operating income
What is the times interest earned for 2006?
A. 11.4 times
C. 3.1 times
B. 3.3 times
D. 3.7 times

P400,000
35,000
48,000
46,000
107,000

. Brava Company reported the following on its income statement:


Income before taxes
P400,000
Income tax expense
100,000
Net income
P300,000
An analysis of the income statement revealed that interest expense was P100,000. Brava Companys times interest earned (TIE) was
A. 5 times
C. 3.5 times

Financial Statement Analysis


B.
xx

4 times

D.

3 times

The balance sheet and income statement data for Candle Factory indicate the following:
Bonds payable, 10% (issued 1998 due 2022)
P1,000,000
Preferred 5% stock, P100 par (no change during year)
300,000
Common stock, P50 par (no change during year)
2,000,000
Income before income tax for year
350,000
Income tax for year
80,000
Common dividends paid
50,000
Preferred dividends paid
15,000
Based on the data presented above, what is the number of times bond interest charges were earned (round to one decimal point)?
A. 3.7
C. 4.5
B. 4.4
D. 3.5

xxi

. The following data were abstracted from the records of Johnson Corporation for the year:
Sales
Bond interest expense
Income taxes
Net income
How many times was bond interest earned?
A. 7.67
C. 12.67
B. 11.67
D. 13.67

P1,800,000
60,000
300,000
400,000

Net income
xxii
. The times interest earned ratio of Mikoto Company is 4.5 times. The interest expense for the year was P20,000, and the companys tax rate is 40%. The
companys net income is:
A. P22,000
C. P54,000
B. P42,000
D. P66,000
Profitability Ratios
Return on Common Equity
xxiii

. Selected information for Ivano Company as of December 31 is as follows:


2006

2007

Preferred stock, 8%, par P100, nonconvertible, noncumulative


P250,000
Common stock
600,000
Retained earnings
150,000
Dividends paid on preferred stock for the year
20,000
Net income for the year
120,000
Ivanos return on common stockholders equity, rounded to the nearest percentage point, for 2007 is
A. 17%
C. 21%
B. 19%
D. 23%

P250,000
800,000
370,000
20,000
240,000

Dividend yield
xxiv

. The following information is available for Duncan Co.:


2006
Dividends per share of common stock
P 1.40
Market price per share of common stock
17.50
Which of the following statements is correct?
A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market price of their stocks.
B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns on their investments.
C. The dividend yield is 12.5%, which is of interest to bondholders.
D. The dividend yield is 8.0 times the market price, which is important in solvency analysis.

Market Test Ratios


Market/Book value ratio
Price per share
xxv

. What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book value of equity of P3,000,000, and a market/book ratio of 3.5?
A. P8.57
C. P85.70
B. P30.00
D. P105.00

P/E ratio
xxvi

. Orchard Companys capital stock at December 31 consisted of the following:

Common stock, P2 par value; 100,000 shares authorized, issued, and outstanding.

10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares authorized, issued, and outstanding.
Orchards common stock, which is listed on a major stock exchange, was quoted at P4 per share on December 31. Orchards net income for the year ended
December 31 was P50,000. The yearly preferred dividend was declared. No capital stock transactions occurred. What was the price earnings ratio on Orchards
common stock at December 31?
A. 6 to 1
C. 10 to 1
B. 8 to 1
D. 16 to 1

xxvii

. On December 31, 2006 and 2007, Renegade Corporation had 100,000 shares of common stock and 50,000 shares of noncumulative and nonconvertible preferred
stock issued and outstanding.
Additional information:
Stockholders equity at 12/31/07
P4,500,000
Net income year ended 12/31/07
1,200,000
Dividends on preferred stock year ended 12/31/07
300,000
Market price per share of common stock at 12/31/07
144
The price-earnings ratio on common stock at December 31, 2007, was
A. 10 to 1
C. 14 to 1
B. 12 to 1
D. 16 to 1

Payout ratio
xxviii

Selected financial data of Alexander Corporation for the year ended December 31, 2007, is presented below:

Financial Statement Analysis


Operating income
Interest expense
Income before income taxes
Income tax
Net income
Preferred stock dividend
Net income available to common stockholders
Common stock dividends were P120,000. The payout ratio is:
A. 42.9 percent
B. 66.7 percent

P900,000
(100,000)
800,000
(320,000)
480,000
(200,000)
280,000
C.
D.

25.0 percent
71.4 percent

P/E ratio & Payout ratio


Use the following information for question Nos. 33 and 34:
Terry Corporation had net income of P200,000 and paid dividends to common stockholders of P40,000 in 2007. The weighted-average number of shares outstanding in
2007 was 50,000 shares. Terry Corporations common stock is selling for P60 per share in the local stock exchange.
xxix

. Terry Corporations price-earnings ratio is


A. 3.8 times
B. 15 times

C.
D.

18.8 times
6 times

. Terry Corporations payout ratio for 2007 is


A. P4 per share
B. 12.5 percent

C.
D.

20.0 percent
25.0 percent

xxx

DuPont Model
Debt ratio
xxxi

. The Board of Directors is dissatisfied with last year's ROE of 15%. If the profit margin and asset turnover remain unchanged at 8% and 1.25 respectively, by how much
must the total debt ratio increase to achieve 20% ROE?
A. Total debt ratio must increase by .5
B. Total debt ratio must increase by 5
C. Total debt ratio must increase by 5%
D. Total debt ratio must increase by 50%

xxxii

. Assume you are given the following relationships for the Orange Company:
Sales/total assets
Return on assets (ROA)
Return on equity (ROE)
The Orange Companys debt ratio is
A. 40%
C. 35%
B. 60%
D. 65%

1.5X
3%
5%

Leverage Ratio
Degree of financial leverage
xxxiii

A summarized income statement for Leveraged Inc. is presented below.


Sales
Cost of Sales
Gross Profit
Operating Expenses
Operating Income
Interest Expense
Earnings Before Tax
Income Tax
Net Income
The degree of financial leverage is:
A. P 150,000 P 30,000
C. P1,000,000 P400,000
B. P 150,000 P120,000
D. P 150,000 P 80,000

P1,000,000
600,000
P 400,000
250,000
P 150,000
30,000
P 120,000
40,000
P 80,000

Other Ratios
Book value per share
xxxiv

.M Corporations stockholders equity at December 31, 2007 consists of the following:


6% cumulative preferred stock, P100 par, liquidating value
was P110 per share; issued and outstanding 50,000 shares
Common stock, par, P5 per share; issued and
outstanding, 400,000 shares
Retained earnings
Total
Dividends on preferred stock have been paid through 2006.
At December 31, 2007, M Corporations book value per share was
A. P5.50
C. P6.75
B. P6.25
D. P7.50

P5,000,000
2,000,000
1,000,000
P8,000,000

xxxv

. The following data were gathered from the annual report of Desk Products.
Market price per share
Number of common shares
Preferred stock, 5% P100 par
Common equity
The book value per share is:
A. P30.00
C. P14.00
B. P15.00
D. P13.75

Integrated ratios
Liquidity & activity ratios
Inventory

P30.00
10,000
P10,000
P140,000

Financial Statement Analysis


xxxvi

.The current assets of Mayon Enterprise consists of cash, accounts receivable, and inventory. The following information is available:
Credit sales
75% of total sales
Inventory turnover
5 times
Working capital
P1,120,000
Current ratio
2.00 to 1
Quick ratio
1.25 to 1
Average Collection period
42 days
Working days
360
The estimated inventory amount is:
A. 840,000
C. 720,000
B. 600,000
D. 550,000

xxxvii

. The following data were obtained from the records of Salacot Company:
Current ratio (at year end)
Inventory turnover based on sales and ending inventory
Inventory turnover based on cost of goods sold and ending inventory
Gross margin for 2007
What was Salacot Companys December 31, 2007 balance in the Inventory account?
A. P120,000
C. P 80,000
B. P 54,000
D. P 95,000

1.5 to 1
15 times
10.5 times
P360,000

Net sales
xxxviii
.
Selected data from Mildred Companys year-end financial statements are presented below. The difference between average and ending inventory is
immaterial.
Current ratio
2.0
Quick ratio
1.5
Current liabilities
P120,000
Inventory turnover (based on cost of sales)
8 times
Gross profit margin
40%
Mildreds net sales for the year were
A. P 800,000
C. P 480,000
B. P 672,000
D. P1,200,000
Gross margin
xxxix

.Selected information from the accounting records of the Blackwood Co. is as follows:
Net A/R at December 31, 2006
Net A/R at December 31, 2007
Accounts receivable turnover
Inventories at December 31, 2006
Inventories at December 31, 2007
Inventory turnover
What was the gross margin for 2007?
A. P150,000
C. P300,000
B. P200,000
D. P400,000

P 900,000
P1,000,000
5 to 1
P1,100,000
P1,200,000
4 to 1

Market Test Ratio


Dividend yield
xl

xli

Recto Co. has a price earnings ratio of 10, earnings per share of P2.20, and a pay out ratio of 75%. The dividend yield is
A. 25.0%
C. 7.5%
B. 22.0%
D. 10.0%
.

The following were reflected from the records of Salvacion Company:


Earnings before interest and taxes
Interest expense
Preferred dividends
Payout ratio
Shares outstanding throughout 2006
Preferred
Common
Income tax rate
Price earnings ratio
The dividend yield ratio is
A. 0.50
C. 0.40
B. 0.12
D. 0.08

P1,250,000
250,000
200,000
40 percent
20,000
25,000
40 percent
5 times

Comprehensive
xlii

. The balance sheets of Magdangal Company at the end of each of the first two years of operations indicate the following:
2007
2006
Total current assets
P600,000
P560,000
Total investments
60,000
40,000
Total property, plant, and equipment
900,000
700,000
Total current liabilities
150,000
80,000
Total long-term liabilities
350,000
250,000
Preferred 9% stock, P100 par
100,000
100,000
Common stock, P10 par
600,000
600,000
Paid-in capital in excess of par-common stock
60,000
60,000
Retained earnings
300,000
210,000

Financial Statement Analysis


Net income is P115,000 and interest expense is P30,000 for 2007.
What is the rate earned on total assets for 2007 (round percent to one decimal point)?
A.
9.3 percent
C.
8.9 percent
B. 10.1 percent
D.
7.4 percent
xliii

. What is the rate earned on stockholders' equity for 2007 (round percent to one decimal point)?
A. 10.6 percent
C. 12.4 percent
B. 11.2 percent
D. 15.6 percent

xliv

. What is the earnings per share on common stock for 2007, (round to two decimal places)?
A. P1.92
C. P1.77
B. P1.89
D. P1.42

xlv

. If the market price is P30, what is the price-earnings ratio on common stock for 2007 (round to one decimal point)?
A. 17.0
C. 12.4
B. 12.1
D. 15.9

i.Answer: A2007:

P2,000,000 (1 0.7) = P600,000


2008: P2,000,000 (1 + 1.75) = P5,500,000
Note: For 2007 & 2008, 2006 was used as a base year.

ii.Answer:

iii.Answer:

CCurrent Assets:
Cash
Accounts receivable
Total liquid assets
Inventory
Total current assets
Current Liabilities:
Accounts payable
Notes payable, due in 6 months
Interest payable
Total current liabilities
Current Ratio (740,000 355,000)2.08:1.00
Acid-test Ratio (300,000 355,000)

P100,000
200,000
300,000
440,000
P740,000
P 80,000
250,000
25,000
P355,000
0.85:1.00

Before any payment, the current ratio is above 1:1 and acid test ratio is below 1:1. Therefore, the current ratio shall rise but acid test ratio shall go down. If any
of these two ratios is below 1:1, the equal change in current assets and current liabilities brings direct effect on the ratio, that is, equal increase in current assets
and current liabilities causes the ratio to rise.

iv.Answer: AWorking capital equals the difference between the total current assets and total current liabilities.
Current Assets:
Cash
Marketable securities
Accounts receivable
Total liquid assets
Inventory
Prepaid expense
Total Current Assets
Current Liabilities:
Accounts payable
Income tax payable
Notes payable, short-term 85,000
Accrued liabilities

P 80,000
250,000
110,000
440,000
140,000
15,000
P595,000
P145,000
10,000
4,000

Working Capital

244,000
P351,000

v.Answer:

BCurrent Ratio: Current Assets Current Liabilities


(P595,000 P244,000) = 2.44:1.00

vi.Answer: AAcid-Test Ratio: Liquid Assets Current Liabilities


(P440,000 P244,000) = 1.80:1.00
vii.Answer:

DAR Turnover: Credit sales Average AR


6,500,000/650,000 = 10.0 times

viii.Answer:

CAccounts Receivable Turnover: Net Credit Sales Average Accounts Receivable


P1,500,000 [(P200,000 + P400,000) 2] = 5.0 times

ix.Answer:

DAverage Daily Sales: Annual credit sales Days Year


P4 million 360 days = P11,111

Average Collection Period: Average Accounts Receivable Average Daily Sales


[(P390,000 + P410,000) 2] P11,111 = 36 days

x.Answer: ASales
Add decrease in Accounts Receivable
Cash collected from sales

P30,000
1,000
P31,000

xi.Answer:

BInventory Turnover: Cost of Goods Sold Average Inventory


Cost of goods sold
Add Ending inventory
Total cost available for sales
Deduct cost of purchases

P 900,000
180,000
1,080,000
960,000

Beginning inventory
Average Inventory: (P120,000 + P180,000) 2
Inventory Turnover: (P900,000 P150,000)
An alternative computation of the inventory turnover is to use Net Sales instead of Cost of Goods Sold.

xii.Answer:

DAverage inventory: (P180,000 + P156,000) 2


Inventory Turnover: (P600,000 P168,000)

P 120,000
P150,000
6 times

P168,000
3.57 times

xiii.Answer: AAverage Inventory:

P358,847.50
5.6 times

xiv.Answer: AAverage Inventory:

P100,000
3.3 times

(P341,169 + P376,526) 2
Inventory Turnover: (P2,000,326 P358,847.50)

(P90,000 + P110,000) 2
Inventory Turnover: (P330,000 P100,000)

xv.Answer:

BAverage Inventory: (P672,000 + P576,000) 2


Inventory Turnover: (P2,400,000 P624,000)
Inventory Turnover in Days: 365 days 3.846

P624,000
3.846 times
94.9 days

Alternative Computation:
Average daily cost of goods sold: = (P2,400,000 365)
Turnover in Days: P624,000 P6,575.34

xvi.Answer: AAverage Accounts Receivable:

P6,575.34
94.9 days

Average inventory; (P1.1M + P1.2M) 2

(P900,000 P1,000,000) 2

P 950,000
P1,150,000

Net sales: (P950,000 x 5)


Cost of goods sold (P1,150,000 x 4)
Gross margin

P4,750,000
4,600,000
P 150,000

xvii.Answer:

P 100,000
400,000
10,000
510,000

BCurrent liabilities
Long-term debt
Deferred income tax
Total Liabilities
Stockholders Equity
Preferred stock
Common stock
Premium on common stock
Retained earnings
Total Assets

P 80,000
100,000
180,000
170,000

530,000
P1,040,000

Debt Ratio: P510,000 P1,040,000 = 0.49

xviii.Answer:

DTimes interest earned: Earnings before interest Interest


Income before tax (P48,000 + P46,000)
Add Interest expense
Income before Interest expense

P 94,000
35,000
P129,000

TIE: P129,000 P35,000

3.7 times

xix.Answer: ATIE:

Income before interest expense Interest expense


Income before income tax
Add back Interest expense
Income before interest expense

P400,000
100,000
P500,000

TIE: P500,000 P100,000

5 times

xx.Answer:

CInterest Expense: P1M x 0.1


Income before interest expense: P350,000 + P100,000
Times interest earned: (P450,000 P100,000)

P100,000
P450,000
4.5 times

xxi.Answer:

CNet income
Add: Income taxes
Interest
Income before interest
TIE: P760,000 P60,000

P400,000
P300,000
60,000

360,000
P760,000
12.67 times

xxii.Answer:

BEarnings before interest expense (P20,000 x 4.5)


Deduct interest expense
Income before income tax
Deduct income tax (P70,000 x 0.4)
Net income

P90,000
20,000
P70,000
28,000
P42,000

xxiii.Answer:

DIncome to Common; (P240,000 P20,000)


Average Common Equity: (P750,000 + P1,170,000) 2
Return on Common Equity: (P220 P960)

P220,000
P960,000
23 percent

xxiv.Answer:

BThe dividend yield is 8 percent (P1.40 P17.50)


The dividend yield measures the return of investment in terms of dividends received. The total expected returns consists of Dividend Yield and the Appreciation
in market price and dividend

xxv.Answer:

DMarket Value of Equity (P3M x 3.5)


Market price per share: (P10.5M 100,000)

P10,500,000
P105

xxvi.Answer:

BEPS: P50,000 100,000 shares


P/E Ratio: P4.00 P0.50

P0.50
8 to 1

xxvii.Answer:

P9.00
16

DEPS: (P1,200,000 P300,000) 100,000


P/E Ratio: 144 9

xxviii.Answer: APayout Ratio:

Common Dividends Income Available to Common


P120,000 P280,000 = 42.9%

xxix.Answer:

BPrice-earnings ratio: Market price EPS


EPS: Net income /Weighted-average common shares
EPS: P200,000 50,000 shares
P4.00
P/E Ratio: P60 P4
15.0X

xxx.Answer:

CPayout Ratio: Dividends Income to Common


P40,000 P200,000 = 20.0%

xxxi.Answer:

DROE: (8% x 1.25)


Last years Debt Ratio 1 (10% 15%)
Proposed Debt Ratio 1 (10% 20%)
Increase in debt ratio: (50.00% - 33.33%) 33.33%

xxxii.Answer: A1 (0.03
xxxiii.Answer:

10.00%
33.33%
50.00%
50.00%

0.05) = 40%

BDegree of Financial Leverage: Operating Income Interest Expense

xxxiv.Answer: ATotal stockholders equity


Deduct:
Liquidation value of Preferred Stock (50,000 s P110)
Unpaid Preferred Dividends (P5M x 6%)
Common Equity
Book Value per Share: P2.2M 400,000 shares

P8,000,000
P5,500,000
300,000

5,800,000
P2,200,000
P5.50

xxxv.Answer:

CBook Value per Share: Common Equity Outstanding Shares


P140,000 10,000 shares = P14.00

xxxvi.Answer: AThe inventory amount can be calculated as follows:


Current liabilities: Working Capital = current liabilities based on 2:1 current ratio. At 2:1 current ratio, the amount of working capital and current liabilities are

both P1,120,000.
Inventory: Current liabilities x (Current ratio Acid test ratio)
P1,120,000 x (2.0 1.25)
A detailed computation can be made as follows:
Current assets: P1,120,000 x 2
Liquid assets: P1,120,000 x 1.25
Inventory

P840,000
P2,240,000
1,400,000
P 840,000

xxxvii.Answer:

CInventory balance: Gross profit (Difference between 2 inventory turnovers)


360,000/(15 10.5) = P80,000

xxxviii.Answer: AInventory balance

(P120,000 x (2.0 1.5)

Cost of goods sold 60,000 x 8


Sales (P480,000 0.60)

xxxix.Answer: AAverage Accounts Receivable:

(P900,000 P1,000,000) 2

P 60,000
P480,000
P800,000

Average inventory; (P1.1M + P1.2M) 2

P 950,000
P1,150,000

Net sales: (P950,000 x 5)


Cost of goods sold (P1,150,000 x 4)
Gross margin

P4,750,000
4,600,000
P 150,000

xl.Answer:

CDividend per share: 0.75 x P2.20


Market price: 10 x 2.20
Dividend yield: P1.65 P22.00 = 7.5%

xli.Answer:

DEBIT
Less interest expense
Earnings before tax
Less Income tax 40%
Net income
Less Preferred dividends
Earnings to Common Stock
Earnings per share 400,000/25,000
Dividend per share: 400,000 x 0.40 25,000
Dividend yield 6.4 (16 x 5)

P1.65
22.00

1,250,000
250,000
1,000,000
400,000
600,000
200,000
400,000
16.00
6.40
8.0%

xlii.Answer:

BROA: Operating income Average Total Assets


P145,000 P1,430,000 = 10.1%

xliii.Answer:

BReturn on stockholders equity: Net income Average stockholders equity


P115,000 P1,027,500 = 11.2%

xliv.Answer:

CNet income
Deduct Preferred Dividends
Income available to common shares
EPS: (P106,000 60,000)

xlv.Answer: AP/E Ratio:

P30 1.766 = 17.0 times

P115,000
9,000
P106,000
P1.77