FINANCIAL MANAGEMENT

CHAPTER 2

MC THEORIES
Number Answer Why
1 -
2 -
3 -
4 -
5 -
6 -
7 -
8 -
9 -
10 -
11 B - vertical analysis is used to compare the components of a
single statement
- horizontal analysis compares two periods
- capital analysis is used to assess the potential profitability
of a long-term investment
- profitability analysis is used to determine whether the firm
is profiting or not
12 A - capital analysis, not divided into broad categories
13 D - prior year serve as the base figure
15 A - choices b and d describe vertical analysis, choice c
describes ration analysis
16 C - the base year is usually the prior or earlier year
- solution: (%) = [(Amount in Comparison Year – Amount
in Base Year) / Amount in Base Year] * 100
17 C - trend percentages are used identify whether an account has
increased or decreased each year compared to the base
year
19 D - not arranged in a specific manner (choices a and b)
- used to determine trends and not errors
20 C - a, common size statements refer to vertical analysis
- b, refers to ratio analysis
- d, each item in financial statement (vertical analysis)
21 D - ratio is used to identify relationship between two
quantities
- trends, use comparative analysis
22 B - Solvency refers to an enterprise's capacity to meet its long-
term financial commitments. Liquidity refers to an
enterprise's ability to pay short-term obligations
23 B - Companies are more liquid the faster they can covert
their receivables into cash
- a, is an indicator of how profitable a company is relative to
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its total assets
- c, conveys the relative profitability of a firm
- D, used to evaluate a company's financial leverage
24 C - A, an indicator of a company's short-term liquidity
position
- B, indicates the ability of the business to pay
its current liabilities from its operations
- D, indicator of a company's financial leverage
25 A - A, cash debt coverage ratio measures a company's ability
to pay off all of its liabilities with cash from operations
- B, current ratio is a liquidity ratio that measures a
company's ability to pay short-term obligations or those
due within one year
- C, measures the efficiency of a company's assets in
generating revenue or sales
- D, measures the number of times inventory is sold or
consumed in each time period

Solvency- refers to an enterprise's capacity to meet its long-term

financial commitments
26 B - ROA, provides how much profit a company can generate
from its assets
- Profit margin, measure of a company's earnings (or
profits) relative to its revenue
- Asset turnover ratio, measures a company's ability to
generate sales from its assets 
27 D - Return on common stockholders’ equity,
return that common equity investors receive on their
investment
- Return or asset ratio, provides how much profit a company
can generate from its assets
- Debt to total asset ratio, shows how much of a business is
owned by creditors (people it has borrowed money from)
compared with how much of the company's assets are
owned by shareholders

C
- Times interest earned, measures a company's ability to
meet its debt obligations on a periodic basis
- Debt to stockholders’ equity ratio shows the percentage of
company financing that comes from creditors and
investors
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28 D - Solvency- refers to an enterprise's capacity to meet its

long-term financial commitments
29 D - A, how many times a business can collect its average
accounts receivable during the year
- B, compares the earnings of a business to the total assets
invested in it
- C, measures the relationship between net cash provided by
operating activities and the average current liabilities of
the company
- D, an indication of a company's financial leverage;
evaluates the total liabilities of a company as a percentage
of its total assets

Solvency- refers to an enterprise's capacity to meet its long-term

financial commitments
30 C - primary shareholder objective for a corporation is to
maximize the value of the corporation; wealth
maximization (profitability)
31 B -
32 C - Current ratio = Current Assets / Current Liabilities
Originally, 60,000/40,000 = 1.5
Paying a current liability,
Assets= 59,000
Liabilities= 39,000
59,000/39,000= 1.513

- Working capital= CA-CL

Originally, 60,000-40,000= 20,000
Change, 59,000-39,000= 20,000
33 B - Receivable turnover, measures how many times a business
can collect its average accounts receivable during the year
- Inventory turnover, how many times a company has sold
and replaced inventory during a given period

34 A -  efficient or aggressive with its collection practices;

indicate an excessively restrictive credit policy
35 B - efficiency ratio that measures a company's ability to
generate sales from its assets 
- c, debt to asset ratio
- d, return on assets2
36 D - profit margin, percentage of sales that a business retains
after all expenses have been deducted
37 D - shows how much of a business is owned by creditors
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(people it has borrowed money from) compared with how

much of the company's assets are owned by shareholders
38 C - Trading using leverage is trading on credit by depositing a
small amount of cash and then borrowing a more
substantial amount of cash
39 B - Leverage is an investment strategy of using borrowed
money—specifically, the use of various financial
instruments or borrowed capital—to increase the potential
return of an investment
40 B - Current ratio, measures a company's ability to cover its
short-term obligations with its current assets
Current assets:
 Cash and cash equivalents.
 Marketable securities
 Accounts receivable
 Prepaid expenses
 Inventory
Weakness: inclusion of the inventory in the calculation of
the current assets
41 C - A, measures the value of a company's sales or revenues
relative to the value of its asset
- B, compares profit to sales and tells you how well the
company is handling its finances overall
- C, measures a company's ability to pay short-term
obligations or those due within one year
- D, describing a public company's
profit per outstanding share of stock
42 C - A, measures a company's ability to pay short-term
obligations or those due within one year
- B, measures the number of times inventory is sold or
consumed
- C, how efficient a company is at generating revenue from
its assets
- D, efficiency ratio or activity ratio that measures how
many times a business can turn its accounts receivable into
cash
43 B - A, also used in financial analysis
- C, single ratio supported by other related additional ratios
becomes more understandable and meaningful
44 D - Current ratio, measures a company's ability to pay short-
term obligations or those due within one year
- Acid-test ratio, compares a company's most short-term
assets to its most short-term liabilities to see if a company
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has enough cash to pay its immediate liabilities

- Receivables turnover, measures how many times a
business can turn its accounts receivable into cash
- Inventory turnover, measures the number of
times inventory is sold or consumed
45 C - Current assets/ current liabilities
Originally,
250,000/90,000= 2.78
After
Assets= 310,000
Liabilities= 150,000
310,000/150,000= 2.07
46 C - Liquidity ratio, measures a company's ability to meet its
short-term obligations with its most liquid assets
47 B - Current ratio= Current assets/ current liabilities
- Example: assets- 200,000; liabilities- 100,000
CA= 2
Add 100,000 to both
300,000/200,000= 1.5
48 C -
49 D - Average collection period is a measure of how many days
it takes a firm, on average, to collects its receivables
- A, no fixed term
50 C - showing how many times a company has sold and
replaced inventory during a given period
- net sale/ average inventory at selling price

MC PROBLEMS
Nos. Answer Supporting Computation Other Notes
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