CHAPTER 11

1. Which of the following does not belong to the list?

a. Common-size financial statements
b. Peso and percentage changes on financial statements
c. Financial ratios
d. Long-form report
ANS. d

2. When a balance sheet amount is related to an income statement amount in

computing a ratio.
a. The income statement amount should be converted to an average for the
year.
b. Comparison with industry ratios is not meaningful.
c. The balance sheet amount should be converted to an average for the
year.
d. The ratio loses its historical perspective because a beginning of the year
amount is combined with an end of the year amount.
ANS. c

3. A major problem in comparing profitability measures among companies is

the
a. Lack of general agreement over which profitability.
b. Differences in the size of the companies.
c. Differences in the accounting methods used by the companies.
d. Differences in the dividend policies in the companies.
ANS. c

Horizontal and trend analysis

4. In 2005, MJP Corp.’s net income was P800,000 and in 2006 it was
P200,000. What percentage increase in net income must MJP achieve in
2007 to offset the 2006 decline in net income?
a. 60%
b. 600%
c. 400%
d. 300%
ANS. d

5. The following common size income statement are available for Sparky
Corporation for the two years ended December 31, 2006, and 2005:
2006 2005
Sales 100% 100%
Cost of sales 55 70
Gross profit on sales 45 30
Operating expenses (including
 income tax expense) 20 18
Net income 25% 12%

The trend percentages for sales are as follows:

2004 – 130%
2003 – 100%

What should be the trend percentage for gross profit on sales for 2006
a. 58.50%
b. 130%
c. 150%
d. 195%
ANS. c

Questions 6 and 7 are based on the following information: Nory Company is

preparing its common-size financial statements and revealed the following
information.
(in thousands of pesos)
Accounts receivable 10,000
Inventory 20,000
Total current assets 35,000
Total assets 84,000
Bonds payable 21,000
Retained earnings 7,000
Sales revenue 75,000
Cost of goods sold 62,000
Income taxes expense 22,000

6. How would Nory’s inventory appear on a common-size balance sheet?

a. 11.9%
b. 23.8%
c. 57.15%
d. 65.3%
ANS. b

7. How would Nory’s retained earnings appear on a common-size balance

sheet?
a. 8.3%
b. 9.4%
c. 20.0%
d. 33.3%
ANS. a

8. Index numbers would probably be most interested in which ratio?

a. Trend analysis
 b. Ratio analysis
c. Vertical analysis
d. Common-size statements
ANS. a

Vertical analysis
9. An income statement showing only component percentages is known as
a. Common pesos statement
b. Condensed income statement
c. Common-size income statement
d. Comparative income statement
ANS. c

10. Horizontal, vertical, and common-size analyses are techniques that are
used by analysts in understanding the financial statements of companies.
Which of the following is an example of vertical, common-size analysis?
a. Commission expense in 2006 is 10% greater than it was in 2005
b. A comparison in financial ratio between two or more firms in the same
industry
c. A comparison in financial form between two or more firms in different
industries
d. Commission expense in 2006 is 5% of sales
ANS. d

Leverage ratios (Financing ratios)

11. It refers to the practice of financing assets with borrowed capital. Its
extensive use may impact on the return on common stockholders’ equity to
be above or below the rate or return on total assets.
a. Discounting
b. Mortgage
c. Leverage
d. Arbitrage
ANS. c

12. Securing of funds for investment at a fixed rate of return to fund suppliers
to enhance the well being of the common stockholders is known as:
a. Financial leverage
b. Fund management
c. Prudent borrowing
d. Financial arbitrage
ANS. a

13. In the process of investing of surplus cash, the term “riding the yield
curve” refers to
 a. Diversifying securities portfolio so that the firm has an equal balance of
long-term versus short-term securities
b. Swapping different maturities of similar quality debt securities in order
to obtain higher yield
c. Purchasing only the longest maturities for given rates of return
d. Adherence to the liquidity preference theory of securities investment
ANS. b

14. When compared to a debt-to-asset ratio, a debt-to-equity ratio would

a. Be lower than the debt-to-asset ratio
b. Be higher than the debt-to-asset ratio
c. Be about the same as the debt-to-asset ratio
d. Have no relationship at all to the debt-to-asset ratio
ANS. b

15. If the ratio of total liabilities to stockholders equity increases, a ratio that
must also increase is
a. Time interest ratio
b. The current ratio
c. Total liabilities to total assets
d. Return on stockholders’ equity
ANS. c

16. A measure of the company’s long-term debt paying ability is

a. Return on assets
b. Times interest earned
c. Dividend payout
d. Length of the operating cycle
ANS. b

17. All of the following statements are correct except:

a. The matching of asset and liability maturities is considered desirable
because this strategy minimizes interest rate risk.
b. Default risk refers to the inability of the firm to pay off its maturing
obligations.
c. The matching of assets and liability maturities lowers default risk.
d. An increase in the payables deferral period will lead to reduction in the
need to non-spontaneous funding.
ANS. d

18. The following situations are descriptive of SBD Corporation. Which would
be considered as the most favourable for the common stockholders?
a. Book value per share of common stock is substantially higher than
market value per share; return on common stockholders’ equity is less
than the rate of interest paid to creditors.
 b. Equity ratio is high; return on assets exceeds the cost of borrowing.
c. SBD stops paying dividends on its cumulative preferred stock; the price
earnings ratio of common stock is low.
d. Equity ratio is low; return on assets exceeds the cost of borrowing.
ANS. d

Questions 19 and 20 are based on the following data:

Gold Corporation
Selected Financial Data
For The Year Ended, December 31, 2006
Operating income P 900,000
Interest expense 100,000
Income before income tax 800,000
Income tax expense 320,000
Net income 480,000
Preferred stock dividends 200,000
Net income available to common stockholders 280,000
Common stock dividends 120,000
Increase in retained earnings P 160,000

19. The times interest earned ratio is

a. 2.8 to 1
b. 4.8 to 1
c. 8.0 to 1
d. 9.0 to 1
ANS. d

20. The times preferred dividend earned ratio is

a. 1.4 to 1
b. 1.7 to 1
c. 2.4 to 1
d. 4.0 to 1
ANS. c

Profitability ratios
21. Which of these ratios are measures of a company’s profitability
1. Earnings per share 5. Return on assets
2. Current ratio 6. Inventory turnover
3. Return on sales 7. Receivables turnover
4. Debt-equity ratio 8. Price earnings ratio

a. All eight ratios

b. 1, 3, 5, and 8 only
c. 1, 3, 5, 6, 7, and 8 only
d. 1, 3, and 5 only
 ANS. d

22. Cebu Corporation’s books disclosed the following information as of and for
the year ended December 31, 2006:
Net credit sales P 2,000,000
Net cash sales 500,000
Merchandise purchases 1,000,000
Inventory at beginning 600,000
Inventory at end 200,000
Accounts receivable at beginning 300,000
Accounts receivable at end 700,000
Net income 100,000

Marble’s percent of net income on sales is

a. 4%
b. 9%
c. 44%
d. 56%
ANS. a

Questions 23 to 25 are based on the following information: Northern

Division reported the following results for 2006:
Annual sales P500,000
Net earnings 80,000
Investment 250,000

23. What is the Northern Division’s return on sales?

a. 16%
b. 20%
c. 25%
d. 32%
ANS. a

24. What is the Northern Division’s asset turnover?

a. 0.5 to 1
b. 1 to 1
c. 2 to 1
d. 3.125 to 1
ANS. c

25. What is the Northern Division’s return on investment?

a. 10%
b. 16%
c. 24%
d. 32%
 ANS. d

26. Which of the following is an appropriate computation for return on

investment?
a. Income divided by total assets
b. Income divided by sales
c. Sales divided by total assets
d. Sales divided by stockholders’ equity
ANS. a

27. If the return on total assets is 10% and if the return on common
stockholders’ equity is 12% then
a. The after-tax cost of long-term debt is probably greater than 10%
b. The after-tax cost of long-term debt is 12%
c. Leverage is negative
d. The after-tax cost of long-term debt is probably less than 10%
ANS. d

28. Selected information for Bohol Co. is as follows:

December 31
2005 2006
Preferred stock P180,000 P180,000
Common stock 648,000 840,000
Retained earnings 192,000 360,000
Net income for year ended 144,000 240,000

What is Bohol’s rate of return on average stockholders’ equity for 2006?

a. 16.0%
b. 20.0%
c. 23.5%
d. 26.0%
ANS. b

29. Selected information for Palawan Company is as follows:

December 31
2005 2006
Preferred stock, 8% par P100,
nonconvertible, noncumulative P125,000 P125,000
Common stock 300,000 400,000
Retained earnings 75,000 185,000
Net income 91,200 120,000
Dividends paid on preferred
stock for the year ended 50,000 120,000
 Palawan Company’s return on common stockholders’ equity, rounded to the
nearest percentage point, for 2006 is
a. 16%
b. 19%
c. 32%
d. 25%
ANS. b

30. Real Estates Corporation has stockholders’ equity equal to 60% of total
liabilities and stockholders’ equity of P120 million. If the return on total
assets invested registers at 9%, what is the return on stockholders’ equity?
a. 10%
b. 6%
c. 15%
d. 12%
ANS. c

31. Financial ratios, which assess the profitability of a company, include all of
the following except the
a. Dividend yield ratio
b. Gross profit percentage
c. Earnings per share ratio
d. Return on sales ratio
ANS. a

32. Which of the following statements is incorrect?

a. Profitability evaluation ratios have a higher power than solvency
determination ratios predicting for performance for both income and
solvency.
b. Gross profit percentages do not vary a great deal among industries.
c. It is appropriate to compare a company’s current financial ratio with
same financial ratio for (1) that company is prior years and/or (2) the
ratio for the industry in which the company is affiliated.
d. Companies where product costs present a high percentage of total costs
could be expected to have a low gross profit percentage.
ANS. b

33. This ratio of analytical measurement measures the productivity of assets

regardless of capital structures.
a. Return on total assets
b. Quick ratio
c. Current ratio
d. Debt ratio
ANS. a
34. MP Goods, Inc. has a total asset turnover of 0.30 and a profit margin of 10
percent. The president is unhappy with the current return on assets; and he
thinks it could be doubled. This could be accomplished (1) by increasing the
profit margin to 15% and (2) by increasing the total assets turnover. What
new asset turnover ratio, along with the 15% profit margin, is required to
double the return on assets?
a. 35%
b. 45%
c. 40%
d. 50%
ANS. c

35. A fire has destroyed many of the financial records of R. Son & Company.
You are assigned to put together a financial report. You have found the
return on equity to be 12% and the debt ratio was 0.40. What was the
return on assets?
a. 5.35%
b. 8.40%
c. 6.60%
d. 7.20%
ANS. d

36. Clik & Company has a debt ratio of 0.50, a total assets turnover of 0.25,
and a profit margin of 10%. The president is unhappy with the current
return on equity, and he thinks it could be doubled. This could be
accomplished (1) by increasing the profit margin to 14% and (2) by
increasing the debt utilization. Total assets turnover will not change. What
new debt ratio, along with the 14% profit margin, is required to double the
return on equity?
a. 0.75
b. 0.70
c. 0.65
d. 0.55
ANS. c

37. Selected information for Brain Corporation is as follows:

December 31
2005 2006
Preferred stock P180,000 P180,000
Common stock 648,000 840,000
Retained earnings 192,000 360,000
Net income for the year ended 144,000 240,000

What is Brain’s rate of return on average stockholders’ equity for 2006?

a. 16%
 b. 20%
c. 23.5%
d. 26%
ANS. b

Questions 38 to 41 are based on the following information: The

management of Melanie Corporation is preparing its plans for the year
2006. The average assets to be employed for the year are estimated at
P2,600,000 with 20% of this amount borrowed at no interest cost. Materials
and labor cost for the year is budgeted at P4,000,000, while operating costs
is estimated at P1,500,000. All sales are to be billed at 162.5% of materials
and labor cost. Income taxes are at an average of 35% on income before
income tax.

38. The estimated rate of return on sales for 2006 is

a. 10%
b. 12.5%
c. 14.29%
d. 27.86%
ANS. a

39. The estimated rate of return on average total assets for 2006 is
a. 20%
b. 25%
c. 31.25%
d. 40.5%
ANS. b

40. The expected asset turnover for 2006 is

a. 1.5 times
b. 2.5 times
c. 3.36 times
d. 3.75 times
ANS. b