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Chapter 014: Analyzing Financial Statements

True / False Questions


1. A primary objective of financial statements is to provide information to current and
potential investors and creditors.
TRUE

AACSB Tag: Communications


Difficulty: Easy
L.O.: 1

2. The only way an investor will get a return on stock while they own the shares is for the
corporation to distribute a dividend.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

3. Return on equity (ROE) is a function of three ratios: net profit margin, return on assets, and
financial leverage.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 1

4. Time series analysis is where we compare information for a specific company over a period
of time to determine changes in operations.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

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Chapter 014: Analyzing Financial Statements

5. Finding comparable companies in order to compare performance is often difficult since no


two companies have identical products, markets and operating strategies.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

6. Component percentages are used to express items on financial statements as a percentage of


a base amount.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

7. Negative financial leverage occurs when a company has more debt than stockholders'
equity.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

8. Positive financial leverage benefits the common stockholders.


TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

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Chapter 014: Analyzing Financial Statements

9. A company that has a high level of inventory and other assets above their investment in
property, plant and equipment, should calculate the total asset turnover ratio in addition to the
fixed asset turnover ratio.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

10. A company with a high amount of inventory will have a much lower fixed asset turnover
ratio when compared to its total asset turnover ratio.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

11. The current ratio is sometimes called the working capital ratio.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 5

12. The average days' supply in inventory is computed by dividing the days in the year by the
ending balance of inventory.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

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Chapter 014: Analyzing Financial Statements

13. A very high current ratio and low quick ratio may indicate the company is not collecting
its accounts receivables in a timely manner.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

14. The current ratio is a more stringent test of liquidity than the quick ratio.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 5

15. A low inventory turnover ratio can indicate high sales and/or low inventory levels.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

16. The quality of income computation is a test of the solvency of the company.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 6

17. Times interest earned gives an indication of the margin of protection for creditors.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 6

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Chapter 014: Analyzing Financial Statements

18. Many companies use high levels of debt to finance their assets because of financial
leverage benefits provided to investors when return on assets (ROA) exceeds the after tax cost
of interest.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 6

19. Dividend yield is calculated by dividing dividends per share by earnings per share and
measures the current dividend return to investors.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

20. A high price earnings ratio usually indicates the market is optimistic about the company's
future earnings potential.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

Multiple Choice Questions


21. Ratios are most useful for analysis when
A. used alone.
B. compared with historical ratios of the same company.
C. compared with ratios for other companies of the same size.
D. compared with ratios of other companies in the same locations.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

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Chapter 014: Analyzing Financial Statements

22. There are several fundamental purposes decision makers consider when they use financial
data. Which of the following statements is not one of those fundamental purposes?
A. Measurement of the current condition of the business.
B. Measurement of past performance of the business.
C. Measurement of the book value of the assets of the business to predict future dividends.
D. Prediction of future potential of the business.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

23. When considering an investment, which of the following is not one of the three critical
factors used to evaluate future earning potential of that investment?
A. Financial analysts' reports.
B. Economy wide factors.
C. Industry factors.
D. Individual company factors.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 1

24. Which of the following statements is false?


A. A company implementing a cost advantage strategy is attempting to reduce investment in
assets thereby improving the asset turnover ratio.
B. A company implementing a product differentiation strategy is attempting to improve its
profit margin through charging higher prices.
C. A company will attract a higher volume of customers and revenue by following a product
differentiation strategy versus a cost advantage strategy.
D. All of the other answers are false.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 1

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Chapter 014: Analyzing Financial Statements

25. Which of the following companies is most likely pursuing a product differentiation
strategy?
A. Wal-Mart
B. Kia
C. McDonalds
D. Cadillac

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 1

26. Which of the following is most likely pursuing a cost advantage strategy?
A. Cadillac
B. Tiffany
C. Wal-Mart
D. Mercedes

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 1

27. Home Depot's operating strategy is to offer a broad assortment of high-quality


merchandise and services at competitive prices using highly knowledgeable service-oriented
personnel and aggressive advertising. Which of the following is not critical to achieving its
strategy?
A. Cost control
B. Product differentiation
C. High level of customer service
D. High sales volume

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 1

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Chapter 014: Analyzing Financial Statements

28. Which of the following statements is false?


A. When computing the component percentages for the income statement, net income is the
base figure.
B. Time series analysis examines a company's performance over time.
C. It is often useful to compare a company's performance with that of a competitor.
D. The North American Industry Classification System assigns industry codes based on
business operations.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

29. Which of the following statements is true?


A. It is usually not difficult to find similar companies for financial performance comparisons.
B. One of the advantages of ratio analysis is that it allows companies of different sizes to be
compared.
C. Ratios compare items from the same financial statement.
D. It is preferable to compare a company's performance to industry-wide ratios rather than to
use a competitor's ratios.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

30. The base amount in preparing a common-size income statement is usually


A. cost of goods sold.
B. gross profit.
C. net income.
D. net sales.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 3

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Chapter 014: Analyzing Financial Statements

31. Which of the following statements is true?


A. When cost of goods sold as a percentage of sales increases the gross margin percentage
will increase.
B. It is possible for cost of goods sold in dollars to increase while cost of goods sold as a
percentage of sales decreases.
C. If gross margin percentage is the same for the current and past year, then sales and cost of
goods sold in dollars did not change.
D. If gross margin percentage increases, then the net income percentage will also increase.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

32. Which of the following statements is false?


A. If selling and administrative expenses as a percentage of sales increases, then gross margin
percentage will decrease.
B. If cost of goods sold percentage decreases, then profit margin will increase as a percentage
of sales.
C. If sales dollars decrease, we might still report a higher gross profit percentage if cost of
goods sold decreases at a faster rate than the decrease in sales.
D. It is possible for selling and administrative expense in dollars to decrease, while selling and
administrative expenses as a percentage of sales to increase.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

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Chapter 014: Analyzing Financial Statements

33. In 2010, Home Style's cost of goods sold percentage was 68.2% and its selling and store
operating costs was 19.3% of sales. In 2009, their cost of goods sold percentage was 68.9%
while its selling and store operating costs was 19.2% of sales. What effect would the change
in these percentages have on 2010's gross margin percentage and profit margin percentage?
A. Cost of goods sold would increase gross margin and profit margin percentages but selling
and store operating costs would decrease gross margin and profit margin percentages.
B. Cost of goods sold would decrease gross margin and profit margin percentages but selling
and store operating costs would increase gross margin and profit margin percentages.
C. Cost of goods sold would increase gross margin and profit margin percentages but selling
and store operating costs would decrease the profit margin percentage.
D. Cost of goods sold would decrease gross margin and profit margin percentages but selling
and store operating costs would increase profit margin percentage.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 3

34. Which of the following ratios usually is not considered to be a test of profitability?
A. Current ratio.
B. Profit margin.
C. Return on assets.
D. Earnings per share.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 4

35. Which of the following items is not a category of commonly used financial ratios?
A. Tests of solvency.
B. Tests of liquidity.
C. Tests of timing.
D. Tests of profitability.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 4

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Chapter 014: Analyzing Financial Statements

36. Financial leverage will always be


A. Positive.
B. Negative.
C. Either positive or negative.
D. Positive, negative, or zero.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 4

37. The records of Everyday Electronics Corporation include the following:

The return on equity is (round to the nearest percent)


A. 13%.
B. 6%.
C. 25%.
D. 8%.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 014: Analyzing Financial Statements

38. The records of Marshall Company include the following:

The return on assets is (round to the nearest tenth of a percent)


A. 14.9%.
B. 18.3%.
C. 15.3%.
D. 14.7%.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 4

39. Maxwell Company's return on equity was 18% and the financial leverage percentage was
13% (positive). Return on assets was
A. 31%.
B. 18%.
C. 13%.
D. 5%.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 014: Analyzing Financial Statements

40. Trenton Company has outstanding shares as follows: common stock, no par, 150,000
shares and preferred stock, par $10, 25,000 shares. The number of shares that should be used
in the denominator to compute earnings per share should be
A. 150,000.
B. 175,000.
C. 125,000.
D. 100,000.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

41. Cecilia Company reported net income of $1,200,000. Their average total liabilities were
$4,300,000 and average total stockholders' equity was $5,200,000. Interest expense was
$100,000 and they are in a 30% tax bracket. Their return on assets is
A. 12.6%.
B. 16.3%.
C. 13.3%.
D. 13.7%.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

42. The use of borrowed funds to enhance the return to the stockholders is known as
A. liquidity.
B. factoring.
C. discounting.
D. financial leverage.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 4

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Chapter 014: Analyzing Financial Statements

43. Negative financial leverage occurs when the


A. average net (after tax) interest rate on borrowed funds is less than the return on assets.
B. return on assets is more than the return on equity.
C. return on equity is more than the return on assets.
D. two of the other answers are correct.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 4

44. A quality of income ratio higher than one is an indicator


A. of a company's high debt position.
B. that fixed assets are the company's most important resources.
C. that a company has cash earnings generated by operations higher than the amount of net
income.
D. that a company has too many extraordinary items.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

45. A company with a very high gross profit ratio would most likely be
A. an advertising agency.
B. a CPA firm.
C. a local grocery store.
D. a Porsche dealership.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

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Chapter 014: Analyzing Financial Statements

46. If a company's return on equity (ROE) ratio increases from one year to the next, the most
likely cause is
A. an increase in net income.
B. a reduction in total expenses as a percentage of sales.
C. an increase in stockholders' equity.
D. an increase in net income and/or a reduction in total expenses as a percentage of sales.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

47. If a company's return on assets (ROA) stays the same from one year to the next but its
financial leverage ratio increases, then the most likely cause is
A. an increase in the debt to equity ratio.
B. a decrease in net income.
C. an increase in total assets.
D. an increase in stockholders' equity.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 4

48. Which of the following statements is true?


A. We add in the after tax cost of interest to net income when calculating return on equity
(ROE).
B. Return on assets (ROA) shows the return generated on the use of all the company's assets
but return on equity (ROE) shows the return generated on the financing provided by the
common stockholders only.
C. Both return on assets (ROA) and return on equity (ROE) always use net income in the
numerator.
D. Both A and B are true

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 4

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Chapter 014: Analyzing Financial Statements

49. Which of the following ratios is not an indicator of a company's liquidity?


A. Price/earnings ratio
B. Receivable turnover ratio
C. Working capital ratio
D. Quick ratio

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 5

50. An important measure of the average movement of goods "on and off the shelf" of a
company is the
A. profit margin.
B. price/earnings ratio.
C. inventory turnover ratio.
D. gross inventory ratio.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 6

51. Teague Company's working capital was $40,000 and total current liabilities were 1/4 of
that amount. The current ratio was
A. 1 to 1.
B. 3 to 1.
C. 5 to 1.
D. 7 to 1.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 5

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Chapter 014: Analyzing Financial Statements

52. Agnes Company reported the following data:

The current ratio was


A. 0.5 to 1.
B. 1.5 to 1.
C. 2.5 to 1.
D. 0.75 to 1.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 5

53. If the current ratio is 2 to 1, the payment of a cash dividend, which was recorded as a
liability on the date of declaration, will
A. increase the current ratio.
B. decrease the current ratio.
C. have no effect on the current ratio.
D. invalidate earnings per share.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

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Chapter 014: Analyzing Financial Statements

54. Which of the following transactions would increase the current ratio of a company if the
ratio is currently more than 1 to 1?
A. Paid the principal on a long-term note payable.
B. Borrowed cash on a short-term note.
C. Sold inventory for more than cost.
D. Purchased supplies with cash.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

55. Potaw Company reported the following data at the end of 2010:

The average number of days to collect receivables during 2010 was


A. 16.2.
B. 14.3.
C. 36.5.
D. 21.9.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 5

56. The ratio of quick assets to current liabilities is known as the


A. working capital.
B. current ratio.
C. acid-test ratio.
D. cash coverage.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 5

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Chapter 014: Analyzing Financial Statements

57. If accounts receivable are collected quickly,


A. the accounts receivable turnover is low.
B. the company's credit policies may be overly stringent.
C. credit is often granted to poor credit risks.
D. liquidity is poor.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

58. Cromwell Company began the year with a balance in inventory of $110,000 and ended the
year with a balance of $102,000. The net sales for the year were $983,000 with a gross profit
on sales of $295,000. What was the inventory turnover ratio?
A. 2.78 times.
B. 9.27 times.
C. 6.49 times.
D. 2.89 times.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 5

59. Thomas Company had income before interest and taxes of $120,000. Interest expense for
the period was $17,000 and income taxes amounted to $28,500. The average stockholders'
equity was $680,000. What is Thomas Company's return on equity (ROE)?
A. 17.65%.
B. 15.15%.
C. 13.46%.
D. 10.96%.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 5

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Chapter 014: Analyzing Financial Statements

60. Wildlife Co. reported net income of $8.3 million, interest expense of $.5 million and they
are in a 30% tax rate bracket. Their average total assets are $65.8 million and average
stockholders' equity is $48.6 million. What is Wildlife Co.'s financial leverage percentage?
A. 3.7%
B. 4.5%
C. 4.0%
D. 4.7%

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 5

61. Which of the following is false?


A. The cash ratio is the most stringent and reliable test of liquidity.
B. A company with a high level of inventory will have a quick ratio significantly lower than
its current ratio.
C. A current ratio that is too high could indicate funds tied up in inventory and other working
capital assets.
D. Analysts consider a current ratio of 2 to be financially conservative.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

62. Which of the following is false?


A. The major difference between the quick and current ratios is whether or not inventory is
included.
B. Current liabilities are the denominator in the cash, quick, and current ratios.
C. Companies that sell expensive merchandise tend to have high inventory turnover ratios.
D. Some analysts do not use the cash ratio because it is very sensitive to small events.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

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Chapter 014: Analyzing Financial Statements

63. Which of the following companies is most likely to have the highest inventory turnover
ratio?
A. Taco Bell franchises.
B. Publix food supermarkets.
C. Wal-Mart.
D. Mercedes Benz dealership.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

64. Which of the following ratios is not a test of solvency?


A. Debt to equity ratio.
B. Cash coverage ratio.
C. Times interest earned.
D. Earnings per share ratio.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 6

65. Bailey Corporation reported the following information for 2009

Bailey Corporation's debt/equity ratio was


A. 33 .0
B. 1.25
C. 1.0
D. 3.0

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 6

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Chapter 014: Analyzing Financial Statements

66. The following ratio would be used to evaluate the long-term risk and capital structure of a
company:
A. debt/equity ratio.
B. quick ratio.
C. profit margin.
D. cash ratio.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 6

67. The accounting ratio which considers the importance of cash flows relating to required
interest payments is the
A. times interest earned ratio.
B. debt/equity ratio.
C. cash coverage ratio.
D. receivable turnover ratio.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 6

68. Which of the following is true?


A. The times interest earned ratio is considered a better test of the ability to cover interest
charges than the cash coverage ratio.
B. The debt to equity ratio shows the relative proportion of total assets financed by debt.
C. The higher the debt to equity ratio, the higher the potential return to the stockholders if
return on assets (ROA) exceeds the after tax cost of interest.
D. The cash coverage ratio compares the cash generated by a company to its cash obligations
for the prior period.

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Chapter 014: Analyzing Financial Statements

69. Which of the following statements is true?


A. Tests of profitability focus on measuring the adequacy of income.
B. Liquidity focuses on the ability of a company to pay their long- and short-term debts.
C. The inventory turnover ratio is an important solvency test for retail companies.
D. Growth in total sales volume always indicates that a company is successful.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 7

70. Which ratio reflects the stock market's assessment of a company's future performance?
A. price/earnings ratio.
B. dividend yield ratio.
C. book value per share.
D. cash coverage ratio.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 7

71. The Apple Pie Company had net income of $47,500 and earnings per share of $3.17
during 2010. On December 31, 2010, the stock had a market price of $18.50 per share. What
is Apple Pie Company's price/earnings ratio?
A. 25.70.
B. 8.11.
C. 5.84.
D. 0.17.

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Chapter 014: Analyzing Financial Statements

72. Main Street Company paid out $2.30 in dividends per share during 2010. The market
price of the stock on December 31, 2010 was $21.00 per share. There were 15,000 shares of
stock outstanding for the entire year. The dividend yield as of December 31, 2010 was
A. 16.43%.
B. 10.95%.
C. 9.13%.
D. 913.04%.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 7

73. MusicPod's earnings per share ratios were $2.47 and $2.07 respectively for 2010 and
2009. MusicPod's stock was trading at $53.00 and $41.50 per share in 2010 and 2009
respectively. The company paid cash dividends per share of $.85 in 2010 and $.63 in 2009.
Total stockholders' equity was $13,572 million and $11,896 million in 2010 and 2009
respectively. The common shares outstanding were approximately 1,782,000 in both 2010 and
2009.
Calculate MusicPod's price earnings ratio for 2010 and 2009 respectively.
A. 21.5 and 0.20 times.
B. 1.0% and 2.9%.
C. 21.5% and 20.0%.
D. 21.5 and 20.0 times.

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Chapter 014: Analyzing Financial Statements

74. MusicPod's earnings per share ratios were $2.47 and $2.07 respectively for 2010 and
2009. MusicPod's stock was trading at $53.00 and $41.50 per share in 2010 and 2009
respectively. The company paid cash dividends per share of $.85 in 2010 and $.63 in 2009.
Total stockholders' equity was $13,572 million and $11,896 million in 2010 and 2009
respectively. The common shares outstanding were 1,782,000 in both 2010 and 2009.
Calculate MusicPod's dividend yield for 2010 and 2009 respectively.
A. 39.1% and 39.1%.
B. 39.3% and 33.8%.
C. 1.6% and 1.5%.
D. 3.2% and 1.1%.

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Difficulty: Medium
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75. A new company with a high property, plant, and equipment balance would most likely be
A. a cell phone retailer.
B. a hotel.
C. a pizza take-out company.
D. a hot dog vendor on an airport concourse.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

76. A company with a high merchandise inventory balance would most likely be
A. a hotel.
B. a travel agency.
C. a jewelry store.
D. a law firm.

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Chapter 014: Analyzing Financial Statements

77. In 2010, Price's Pizzas return on owners' equity (ROE) was 32.3%, and return on assets
(ROA) was 17.0%. In 2010, Carlos' Calzones return on owners' equity (ROE) was 33.1%
while return on assets (ROA) was 16.3%. Which of the following statements is true?
A. Price's Pizzas return on assets (ROA) indicates better performance than does Carlos'
Calzones ROA.
B. Price's Pizzas ROE was 103% greater than their ROA while Carlos' Calzones ROE was
only 90% greater than their ROA. This difference is caused by Price's Pizzas higher use of
debt financing to leverage their assets.
C. Carlos' Calzones provided higher positive financial leverage for their stockholders
compared to Price's Pizzas.
D. None of the other answers are true.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 7

78. In 2010, Carlos' Calzones gross profit percentage was 65.2% and their profit margin was
22.1%. In 2010, Price's Pizzas gross profit percentage was 54.2% and their profit margin was
14.4%. Which of the following is false?
A. Carlos' Calzones cost of goods sold was a lower percentage of sales than Price's Pizzas.
B. In 2010, Carlos' Calzones profit margin was 53% greater than Price's Pizzas which would
contribute to a higher return on total investment.
C. The major reason for Price's Pizzas lower profit margin is that their selling, general and
administrative expenses were double the percentage of sales compared to Carlos' Calzones
percentage.
D. All of these are false.

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Chapter 014: Analyzing Financial Statements

79. In 2010, Carlos' Calzones accounts receivable turnover ratio and days' sales in receivables
was 10.31 times and 35.4 days. In 2010, Price's Pizzas accounts receivable turnover ratio and
days' sales in receivables was 10.04 times and 36.4 days. Which of the following statements is
true?
A. Both companies have a similar turnover ratio.
B. Price's Pizzas higher turnover ratio has a direct relationship to its days' sales tied up in
receivables.
C. Price's Pizzas management has done a better job of managing their receivables.
D. All of the answers are true.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 7

80. Information which is known by accountants or other employees of a company prior to its
public release is called
A. insider information.
B. public information.
C. financial information.
D. secure information.

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Chapter 014: Analyzing Financial Statements

Essay Questions
81. Complete the following income statement (both dollar amounts and component percents):

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 3

82. List four categories of accounting ratios described in the text.


1. Profitability; 2. Liquidity; 3.Solvency; 4. Market tests

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Chapter 014: Analyzing Financial Statements

83. Packers Corporation reported the following data for the year ended December 31, 2009:

Compute the following ratios:


A. Profit margin
B. Return on assets
C. Return on equity
D. Earnings per share
E. Price/earnings ratio
F. Debt/equity ratio
G. Financial leverage percentage
H. Fixed asset turnover ratio
A. $25,000
$400,000 = 6.25%
B. ($25,000 + $3,000)
$200,000 = 14%
C. $25,000
$160,000 = 15.6%
D. $25,000
15,000 shares = $1.67
E. $16
$1.67 = 9.58
F. $40,000
$160,000 = 25%
G. 15.6%
14% = 1.6% (positive)
H. $400,000
$100,000 = 4 times

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Chapter 014: Analyzing Financial Statements

84. At the end of 2009, Jagged Corporation reported a return on assets of 16%; net income of
$42,000; average total assets of $365,000, and average total liabilities of $165,000. Compute
the financial leverage percentage.
$42,000

($365,000

$165,000) = 21% and 21%

16% = 5% positive

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

85. At the end of 2010, Doran Corporation reported net income of $70,000, gross sales
revenue of $1,525,000, and sales returns of $125,000. Compute profit margin.
$70,000

($1,525,000

$125,000) = 5%

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Chapter 014: Analyzing Financial Statements

86. The records of Washington Company showed the following:

*10,000 average number of shares outstanding; current market price, $30


**Including income tax; income tax rate, 30%
Compute the following:
A. Return on assets
B. Return on equity
C. Financial leverage percentage
D. Is the financial leverage percentage positive or negative?
A. $17,000 + ($2,000
.70)
$230,000 = 8%
B. $17,000
$100,000 = 17%
C. 17%
8% = 9%
D. Positive

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Chapter 014: Analyzing Financial Statements

87. The 2010 financial statements of Companies Y and Z showed the following:

Part A: For each company, compute the items listed in the following tabulation.

Part B: Assuming both Company Y and Company Z are in the same industry, which company
(Y or Z) appears to be the better investment and why?
Part A:

Part B: Company Y appears to be a better investment. Company Y's return on equity and
return on assets are both higher than Company Z's. Also, financial leverage is greater for
Company Y. The fact that Company Y's net income is lower is not necessarily a critical
factor.

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Chapter 014: Analyzing Financial Statements

88. The following return on investment ratios were computed for Steven Company:

Required:
A. Compute financial leverage percentage for each year.
B. Explain briefly the stockholders' advantage or disadvantage for each year.
A. 2010: 15%
12% = +3% positive
2009: 15%
15% = -0- neither
2008: 11%
15% = (4%) negative
2007: 20%
18% = +2% positive
B. 2010: Positive leverage of 3% means the stockholders gained because of the use of debt.
2009: The return on assets increased to 15% but the return on equity did not increase.
Stockholders did not gain from the use of debt because leverage was zero.
2008: Negative leverage of 4% means the stockholders lost because of the use of debt.
2007: The increase in the return on assets and the positive leverage of 2% are both favorable
to stockholders.

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Chapter 014: Analyzing Financial Statements

89. The following data were shown in the records of Victoria Company at the end of 2010:

Assume 365 days in the year


Compute the following ratios:
A. Quick ratio
B. Current ratio
C. Receivable turnover ratio
D. Inventory turnover ratio
E. Average age of receivables
F. Average days' supply in inventory
A. $180,000
$50,000 = 3.6 to 1
B. $225,000
$50,000 = 4.5 to 1
C. $120,000
$10,000 = 12 times
D. $84,000
$42,000 = 2 times
E. 365
12 = 30 days
F. 365
2 = 183 days

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Chapter 014: Analyzing Financial Statements

90. The following data were available for Holiday Company:


Sales revenue, $225,000 (including $75,000 cash sales)
Cost of goods sold, $175,000
Average inventory, $20,000
Average net accounts receivable, $20,000
Assume 365 days in the year
Compute the following ratios:
A. Inventory turnover ratio
B. Average days' supply in inventory
C. Receivable turnover ratio
D. Average age of receivables
A. $175,000
$20,000 = 8.75 times
B. 365
8.75 = 42 days
C. ($225,000
$75,000)
$20,000 = 7.5 times
D. 365
7.5 = 49 days

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 5

91. Compete Corporation reported a quick ratio of 1.75, current assets of $50,000 and a
current ratio of 2.
A. Compute the total amount of quick assets.
B. What is another name for the quick ratio?
C. Describe what type of assets is considered quick assets and give some examples.
D. How does the quick ratio compare to the current ratio?
A. $50,000
2 = $25,000 current liabilities $25,000
1.75 = $43,750 quick assets
B. Acid-test ratio
C. Quick assets are assets able to be readily converted to cash usually at their book values.
Quick assets often include cash, short-term investments, and net accounts receivable.
D. The quick ratio test of liquidity is a more stringent test of short-term liquidity than the
current ratio. It compares quick assets (cash or one step away from cash) to total current
liabilities. The quick ratio is less than the current ratio for a company.

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Chapter 014: Analyzing Financial Statements

92. The following data were reported by Universe Company at year-end:

Compute the following:


A. Debt to equity ratio
B. Current ratio
C. Quick ratio
D. Which, if any, of the above are liquidity ratios?
E. Which, if any, of the above are profitability ratios?
A. $150,000
$375,000 = .40 or 40%
B. $150,000
$75,000 = 2.0 to 1.
C. $105,000
$75,000 = 1.4 to 1.
D. Current ratio and quick ratio.
E. None of the ratios listed are profitability ratios.

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Chapter 014: Analyzing Financial Statements

93. Walkers World Company gathered the following information for 2010:

Compute the following:


A. Receivable turnover ratio
B. Average number of days to collect receivables
C. Inventory turnover ratio
D. Average number of days' supply of inventory
A. [$432,000
B. 365 days
C. $231,000
D. 365 days

65%)
$44,000]
($100,000
3 = 122 average days' to collect.
($28,000 + $38,000)/2 = 7 times.
7 = 52 average days' supply.

$7,000) + ($70,000

$5,000) = 3.0

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Chapter 014: Analyzing Financial Statements

94. De Carlo Company had the following data available from the balance sheets and income
statements:

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Chapter 014: Analyzing Financial Statements


95. Indicate the effect of each item on the ratios given below in the following manner: if an
item would cause an increase in the ratio, place a check in the + column; if a decrease place a
check in - column; and if no change, check the 0 column. Each item is independent of the
others.

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Chapter 014: Analyzing Financial Statements


A. + (current assets increased)
B.
(decrease quick assets by the difference)
C.
(amount of average accounts receivable increased)
D.
(increases shares outstanding)
E. + (increase in current assets by the gain)
F.
(decrease in quick assets by the loss)
G. -0- (current assets are unchanged)

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 4, 5

96. Longhorn Company reported the following data at year-end:

Compute the following:


A. Debt to equity
B. Current ratio
A. ($350,000
$200,000)
$200,000 = 75%
B. $80,000
$75,000 = 1.07 to 1

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Chapter 014: Analyzing Financial Statements

97. Carolina Company computed the following ratios for a two year period:

Required:
Comment on the trend of each of the ratios from 2009 to 2010. State concerns or possible
implications for the future of each.
A. The current ratio has decreased to half of the 2009 ratio. The company's liquidity is taking
a down turn. Currently due bills may not be able to be paid in a timely manner.
B. ROE decreased. The profitability of the company may be of concern.
C. The quality of income ratio went from above one to below one. The 2010 earnings are of
lower quality than those of 2009.
D. Cash coverage has plummeted. One might be concerned about the declining amount of
cash from operations to pay interest payments.
E. Since the profit margin declined from 2009 to 2010, less of each sales dollar is realized in
income.
Note: Overall, the company is experiencing unfavorable trends.

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Chapter 014: Analyzing Financial Statements

98. The following financial data are available for Murphy Company:

Compute the following:


A. Return on equity
B. Price/earnings ratio
C. Dividend yield
A. Return on equity 19.93% ($196,300/$985,000)
B. Price earnings ratio 10 ($24.50/$2.45)
C. Dividend yield 5.10% ($1.25/$24.50)

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Chapter 014: Analyzing Financial Statements

99. The following data were reported for Favre Company:

Compute the following:


A. Dividend yield
B. Price/earnings ratio
C. Quality of earnings
A. 3.0% (.60/20)
B. EPS = $275,000
175,000 shares = $1.57
PE = $20
$1.57 = 12.74
C. $280,000
275,000 = 1.02

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Chapter 014: Analyzing Financial Statements

100. Polk Corporation reported the following information related to its common stock (par
$10) outstanding and net income:

Compute the following:


A. Price/earnings ratio
B. Dividend yield
A. $40
[($35,000)
($40,000
$10)] = 4.57
B. ($10,000
4,000 shares)
$40 = 6.25%

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Chapter 014: Analyzing Financial Statements

101. MNF Corporation gathered the following data at the end of the accounting period,
December 31, 2009:

Part 1. Compute the following:


A. Profit margin
B. Return on equity
C. Earnings per share
D. Dividend yield ratio
E. Price-earnings ratio
F. Return on assets
G. Financial leverage percentage
Part 2. Interpret the financial leverage percentage.
Part 1.
A. $60,000
$1,200,000 = 5%
B. $60,000
$300,000 = 20%
C. $60,000
50,000 shares = $1.20
D. ($22,500
50,000 shares)
$9 = 5%
E. $9.00
$1.20 = 7.5
F. [$60,000 + ($25,000
.60)]
$500,000 = 15%
G. 20%
15% = 5%
Part 2. The advantage is favorable to the stockholders if the ratio is positive, and it is
unfavorable to the stockholders if the ratio is negative because of the difference between
earnings on total assets and the cost of debt (interest expense net of income tax). For MNF
Corporation, the company's stockholders are benefiting from financial leverage because the
cost of borrowing is less than the return to the shareholders.

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Chapter 014: Analyzing Financial Statements

Matching Questions
102. Indicate the proper category for each ratio.
1. Return on equity
2. Earnings per share
3. Owners' equity to total equities
4. Inventory turnover ratio
5. Cash ratio
6. Quality of income
7. Profit margin
8. Dividend yield ratio
9. Current ratio
10. Return on assets
11. Financial leverage
12. Fixed asset turnover ratio
13. Debt/equity ratio
14. Creditors' equity to total equities
15. Quick ratio
16. Receivable turnover ratio
17. Cash coverage
18. Price/earnings ratio
19. Times interest earned

Profitability
Liquidity
Solvency
Market
Liquidity
Profitability
Market
Solvency
Profitability
Liquidity
Solvency
Liquidity
Profitability
Profitability
Profitability
Profitability
Solvency
Liquidity
Solvency

2
9
13
8
16
1
18
14
7
4
3
15
10
11
6
12
17
5
19

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4, 5, 6, 7

14-46
2009 McGraw-Hill Inc. Test Bank to accompany Libby Financial Accounting 6/e

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Chapter 014: Analyzing Financial Statements

103. Match the ratio computation with the ratio.


1. Profit margin
2. Return on assets
3. Financial leverage
4. Return on equity
5. Quality of income
6. Times interest earned
7. EPS
8. Dividend yield ratio
9. Debt/equity ratio
10. Quick ratio
11. Fixed asset turnover
ratio
12. Inventory turnover
ratio
13. Current ratio
14. Price/earnings ratio
15. Receivable turnover
ratio
16. Cash ratio
17. Cash coverage ratio

Net Income Average stockholders' equity


(Net Income + After-tax interest expense)
Average total assets
Return on equity Return on assets
Net Income Average number of shares of
common stock outstanding
Net Income Net sales revenue
Current assets Current liabilities
Quick assets Current liabilities
Net credit sales Average net receivables
Cost of goods sold Average inventory
Total liabilities Stockholders' Equity
Market price per share

4
2
3
7
1
13
10
15
12
9

EPS 14

Dividends per share Market price per share


Cash flows from operating activities (before
interest and tax expense) Interest Paid
(Cash + Cash equivalents) Current liabilities
Cash flows from operating activities Net
Income
(Net Income + Interest + Income tax expense)
Interest Expense
Net sales revenue Average net fixed assets

8
17
16
5
6
11

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4, 5, 6, 7

104. Match the characteristic that is reflected best by the indicators.


1. Debt/equity ratio
2. Earnings per share
3. Working capital
4. Return on assets
5. Current ratio
6. Financial leverage
7. Price/earnings ratio

Liquidity
Solvency
Profitability
Profitability
Liquidity
Market performance
Profitability

3
1
2
4
5
7
6

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4, 5, 6, 7

14-47
2009 McGraw-Hill Inc. Test Bank to accompany Libby Financial Accounting 6/e