CHAPTER 04 ANALYSIS OF FINANCIAL STATEMENTS

CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS To keep this chapter from involving too much memorization, we provide our students with a formula sheet for use on exams That makes a few of the questions trivially easy, but most require some thought, and some are downright challenging Even the very easy ones make students think about the ratios The challenging questions are labeled CHALLENGING, and most students will agree with that designation Some of these questions are just definitions, but others require real thought about the make-up of the ratios and relationships among the ratios We tell our students that to answer some of these questions it is useful (1) to write out the relevant ratio or ratios, (2) then to think about how the ratios would change if the accounting data changed, and (3) occasionally to make up illustrative data to test their conclusions Note that there is some overlap between the True/False and the multiple choice questions, as some T/F statements are used in the MC questions Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 4-1 Ratio Analysis Cengage Learning Testing, Powered by Cognero Page CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS LEARNING OBJ FOFM.BRIG.16.04.01 - Ratio Analysis ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDA United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash RDS: flows TOPICS: Ratio analysis KEYWORDS: Bloom’s: Knowledge The current and quick ratios both help us measure a firm's liquidity The current ratio measures the relationship of the firm's current assets to its current liabilities, while the quick ratio measures the firm's ability to pay off short-term obligations without relying on the sale of inventories a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY Cengage Learning Testing, Powered by Cognero Page CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS REFERENCES: 4-2 Liquidity Ratios LEARNING OBJ FOFM.BRIG.16.04.02 - Liquidity Ratios ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDA United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash RDS: flows TOPICS: Liquidity ratios KEYWORDS: Bloom’s: Knowledge Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easyto-use estimates of a firm's liquidity position a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY Cengage Learning Testing, Powered by Cognero Page CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS REFERENCES: 4-2 Liquidity Ratios LEARNING OBJ FOFM.BRIG.16.04.02 - Liquidity Ratios ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDA United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash RDS: flows TOPICS: Liquidity ratios KEYWORDS: Bloom’s: Knowledge High current and quick ratios always indicate that the firm is managing its liquidity position well a True b Fals e ANSWER: False RATIONALE: It might have too much liquidity Liquid assets generally provide low returns Cengage Learning Testing, Powered by Cognero Page CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS POINTS: DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios LEARNING OBJ FOFM.BRIG.16.04.02 - Liquidity Ratios ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDA United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash RDS: flows TOPICS: Current ratio KEYWORDS: Bloom's: Comprehension If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline a True b Fals e ANSWER: False Cengage Learning Testing, Powered by Cognero Page CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS POINTS: DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios LEARNING OBJ FOFM.BRIG.16.04.02 - Liquidity Ratios ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDA United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash RDS: flows TOPICS: Current and quick ratios KEYWORDS: Bloom's: Comprehension If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio would increase a True b Fals Cengage Learning Testing, Powered by Cognero Page CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios LEARNING OBJ FOFM.BRIG.16.04.02 - Liquidity Ratios ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDA United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash RDS: flows TOPICS: Current and quick ratios KEYWORDS: Bloom's: Comprehension If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change a True Cengage Learning Testing, Powered by Cognero Page CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS b Fals e ANSWER: False RATIONALE: The quick ratio would increase as receivables replaced inventory POINTS: DIFFICULTY: EASY REFERENCES: 4-2 Liquidity Ratios LEARNING OBJ FOFM.BRIG.16.04.02 - Liquidity Ratios ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDA United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash RDS: flows TOPICS: Current and quick ratios KEYWORDS: Bloom's: Comprehension The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a Cengage Learning Testing, Powered by Cognero Page CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS firm is managing its current assets a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios LEARNING OBJ FOFM.BRIG.16.04.03 - Asset Management Ratios ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDA United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash RDS: flows TOPICS: Asset management ratios KEYWORDS: Bloom’s: Knowledge Cengage Learning Testing, Powered by Cognero Page CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: 4-3 Asset Management Ratios LEARNING OBJ FOFM.BRIG.16.04.03 - Asset Management Ratios ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDA United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash RDS: flows TOPICS: Inventory turnover ratio KEYWORDS: Bloom's: Comprehension Cengage Learning Testing, Powered by Cognero Page 10 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS REFERENCES: 4-5 Profitability Ratios LEARNING OBJECTIV FOFM.BRIG.16.04.05 - Profitability Ratios ES: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Return on equity KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts 124 Refer to Exhibit 4.1 What is the firm's BEP? a 7.50 % b 7.90 % c 8.31 Cengage Learning Testing, Powered by Cognero Page 189 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS % d 8.73 % e 9.16 % ANSWER: c RATIONALE: BEP = EBIT/Total assets = 8.31% POINTS: DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios LEARNING OBJECTIV FOFM.BRIG.16.04.05 - Profitability Ratios ES: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Basic earning power Cengage Learning Testing, Powered by Cognero Page 190 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts 125 Refer to Exhibit 4.1 What is the firm's profit margin? a 1.51 % b 1.67 % c 1.86% d 2.07 % e 2.27 % ANSWER: d RATIONALE: Profit margin = Net income/Sales = 2.07% POINTS: DIFFICULTY: EASY Cengage Learning Testing, Powered by Cognero Page 191 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS REFERENCES: 4-5 Profitability Ratios LEARNING OBJECTIV FOFM.BRIG.16.04.05 - Profitability Ratios ES: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Profit margin KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts 126 Refer to Exhibit 4.1 What is the firm's return on invested capital? a 4.25% b 5.67% c 7.72% d 9.33% Cengage Learning Testing, Powered by Cognero Page 192 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS e 11.87% ANSWER: c RATIONALE: Return on invested capital = [EBIT(1 – T)]/Total invested capital = 7.72% POINTS: DIFFICULTY: MODERATE REFERENCES: 4-5 Profitability Ratios LEARNING OBJECTIV FOFM.BRIG.16.04.05 - Profitability Ratios ES: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Return on invested capital KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts Cengage Learning Testing, Powered by Cognero Page 193 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS 127 Refer to Exhibit 4.1 What is the firm's operating margin? a 3.12 % b 3.46 % c 3.85 % d 4.28 % e 4.75 % ANSWER: e RATIONALE: Operating margin = EBIT/Sales = 4.75% POINTS: DIFFICULTY: EASY REFERENCES: 4-5 Profitability Ratios LEARNING OBJECTIV FOFM.BRIG.16.04.05 - Profitability Ratios ES: Cengage Learning Testing, Powered by Cognero Page 194 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Operating margin KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts 128 Refer to Exhibit 4.1 What is the firm's dividends per share? a $1.14 b $1.27 c $1.39 d $1.53 e $1.68 ANSWER: b RATIONALE: DPS = Common dividends paid/Shares outstanding = $1.27 Cengage Learning Testing, Powered by Cognero Page 195 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS POINTS: DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios LEARNING OBJECTIV FOFM.BRIG.16.04.06 - Market Value Ratios ES: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: DPS KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts 129 Refer to Exhibit 4.1 What is the firm's EPS? a $3.26 Cengage Learning Testing, Powered by Cognero Page 196 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS b $3.43 c $3.62 d $3.80 e $3.99 ANSWER: c RATIONALE: EPS = Net income/Common shares outstanding = $3.62 POINTS: DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios LEARNING OBJECTIV FOFM.BRIG.16.04.06 - Market Value Ratios ES: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: EPS Cengage Learning Testing, Powered by Cognero Page 197 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts 130 Refer to Exhibit 4.1 What is the firm's P/E ratio? a 12.0 b 12.6 c 13.2 d 13.9 e 14.6 ANSWER: a RATIONALE: P/E ratio = Price per share/Earnings per share = 12.0 We actually fixed the P/E ratio at 12 in order to get a stock price Either the price or the P/E ratio must be fixed or the model becomes very complicated and a stock pricing equation is required POINTS: DIFFICULTY: EASY Cengage Learning Testing, Powered by Cognero Page 198 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS REFERENCES 4-6 Market Value Ratios : LEARNING O FOFM.BRIG.16.04.06 - Market Value Ratios BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash ARDS: flows TOPICS: P/E ratio KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts 131 Refer to Exhibit 4.1 What is the firm's book value per share? a $22.29 b $23.47 c $24.70 d $26.00 Cengage Learning Testing, Powered by Cognero Page 199 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS e $27.30 ANSWER: d RATIONALE: BVPS = Common equity/Shares outstanding = $26.00 POINTS: DIFFICULTY: MODERATE REFERENCES: 4-6 Market Value Ratios LEARNING OBJECTIV FOFM.BRIG.16.04.06 - Market Value Ratios ES: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Book value per share KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts Cengage Learning Testing, Powered by Cognero Page 200 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS 132 Refer to Exhibit 4.1 What is the firm's market-to-book ratio? a 0.87 b 1.02 c 1.21 d 1.42 e 1.67 ANSWER: e RATIONALE: Market/book ratio (M/B) = Price per share/BVPS = 1.67 POINTS: DIFFICULTY: EASY REFERENCES: 4-6 Market Value Ratios LEARNING OBJECTIV FOFM.BRIG.16.04.06 - Market Value Ratios ES: NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: Cengage Learning Testing, Powered by Cognero Page 201 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Market/Book ratio KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts 133 Refer to Exhibit 4.1 What is the firm's equity multiplier? a 3.85 b 4.04 c 4.24 d 4.45 e 4.68 ANSWER: a RATIONALE: Equity multiplier = Total assets/Common equity = 3.85 POINTS: Cengage Learning Testing, Powered by Cognero Page 202 CHAPTER 04—ANALYSIS OF FINANCIAL STATEMENTS DIFFICULTY: MODERATE REFERENCES: 4-7 Tying the Ratios Together: The DuPont Equation LEARNING OBJECTIV FOFM.BRIG.16.04.07 - Tying the Ratios Together: The DuPont ES: Equation NATIONAL STANDARD United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills S: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Equity multiplier KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Multiple Parts Cengage Learning Testing, Powered by Cognero Page 203