Business Finance Chapter 3

Business Finance Chapter 3 1. Although accounting numbers are often poor reflections of reality, they are often the best information available. 2. At the most fundamental level, firms generate cash and spend it. 3. Which of the following are sources of cash? a. An increase in notes payable b. A decrease in accounts receivable 4. True: There is only one method for preparing the statement of cash flows. (Reason: The exact form differs from one preparer to the next.) 5. Standardized financial statements provide for comparison of firms that differ in size and currency type. 6. Because we are almost always unable to obtain all of the market information we want, we rely on accounting numbers for much of our financial information. 7. At the most fundamental level, firms generate cash and: spend it. 8. Which one of the following is one way in which financial managers use a common-size balance sheet? To track changes in a firm's capital structure 9. Which of the following are uses of cash? a. Decreases in accounts payable b. Increases in property, plant and equipment c. Increases in inventory 10. The statement of cash flows summarizes the sources and uses of cash, though which of the following is true of the statement? There are different methods of preparing it. 11. Which one of the following equations defines the total asset turnover ratio? Sales/Total assets 12. Return on assets (ROA) is a measure of profitability. 13. Common-size statements are used for comparing firms with differing sizes. 14. A useful way of standardizing financial statements is to choose a base year and then express each item relative to the base amount. 15. When combining common-size and common-base year analysis, the effect of overall growth in assets can be eliminated by first forming the: common-size statements 16. Which of the following are traditional financial ratio categories? a. Asset management ratios b. Market value ratios c. Profitability ratios 17. What is the impact on the total asset turnover ratio if sales increase significantly while there is no change in any of the other variables? The total asset turnover ratio will increase. 18. What will happen to the current ratio if current assets increase, while everything else remains unchanged? It will increase. 19. What does it mean when a company reports ROA of 12 percent? The company generates $12 in net income for every $100 invested in assets. 20. Which of the following items are among the items used to compute the current ratio? a. Cash b. Accounts payable 21. A common-base year financial statement presents items relative to a certain base, which is the dollar amount of each item during a common base year. 22. What does a current ratio of 1.2 mean? The firm has $1.20 in current assets for every $1 in current liabilities. 23. By combining common-size and base year analysis, we eliminate the effect of the overall growth. 24. If a company has inventory, the quick ratio will always be less than the current ratio, because the quick ratio eliminates “inventory”. 25. The quick ratio is computed just like the current ratio, except that inventory is omitted. 26. The five categories of financial ratios include short-term solvency, long-term solvency, asset management, profitability, and market value ratios. 27. The cash ratio is found by dividing cash by current liabilities. 28. Which one of the following equations defines the total asset turnover ratio? Sales/Total assets 29. The current ratio shows the relationship between current assets and current liabilities. 30. True: The interval measure indicates how long a start-up company can operate until it needs more financing. 31. A firm has a total debt ratio of 0.30 times. This means the firm has $0.30 in total debt for every $1 in total assets. 32. The cash ratio is found by dividing cash by: current liabilites 33. The debt-equity ratio expresses the total debt divided by total equity, while the equity multiplier expresses the total assets divided by the total equity. 34. The formula for total equity is the total equity plus long-term debt. 35. A times interest earned (TIE) ratio of 3.5 times means a firm has earnings before interest and taxes that is(are) 3.5 times greater than the firm's interest expense. 36. Which of the following is the correct representation of the cash coverage ratio? (EBIT+ Non-cash expenses)/Interest expense 37. Which of the following is the correct representation of the total debt ratio? (Total assets Total equity)/(Total assets) 38. The inventory turnover is calculated as the COGS divided by the inventory. 39. Both the debt-equity ratio and the equity multiplier are calculated using total equity in the denominator. 40. If sales increase while there is no change in accounts receivable, the receivables turnover ratio will increase. 41. Total capitalization equals total equity plus total: long-term debt 42. The times interest earned ratio equals EBIT divided by interest. 43. The profit margin is equal to net income divided by sales. 44. The cash coverage ratio adds depreciation to operating earnings (EBIT) for a better of measure of how much cash is available to meet interest obligations. 45. The price-earnings (PE) ratio is a market value ratio. 46. How is the price-earnings (PE) ratio computed? Market price per share/Earnings per share 47. When the typical stock in the S&P 500 Index has a PE ratio 12, a company with a PE ratio of 15 may have higher than average growth prospects, given similar earnings per share. 48. Which of the following represents the receivables turnover ratio? Sales/Accounts receivable 49. How is market-to-book ratio measured? Market value per share/Book value per share 50. The formula for total equity is the total equity plus long-term debt. 51. A firm with a profit margin of 6.8 percent generates 6.8 cents in net income for every one dollar in sales. 52. False: Enterprise value equals total market value of the stock plus the book value of the liabilities plus cash. Enterprise value equals total market value of the stock plus the book value of the liabilities minus cash. 53. A higher PE ratio may indicate that investors believe a company has better prospects for future growth in earnings. 54. EBITDA multiple is equal to the enterprise value divided by EBITDA. 55. A firm with a market-to-book ratio that is greater than 1 is said to have created value for shareholders. 56. Which one of the following does not affect ROE according to the DuPont identity? Investor sentiment 57. The information needed to compute the profit margin can be found on the income statement. 58. A(n) increase in net profit margin will increase ROE. 59. Financial statements are the prime source of information about a firm's financial health. 60. The EBITDA ratio is similar in spirit to: the PE ratio 61. The inventory turnover ratios for Proctor and Gamble over the past three years are 5.09, 5.72, and 5.92 times, respectively. Explaining the upward trend in the inventory turnover ratio requires: further investigation 62. The DuPont identity can help to explain why two firms with the same return on equity may not be operating in the same way. 63. True: In one way or another, the basic problem with financial statement analysis is that there is no underlying theory to help us identify which quantities to look at and to use in establishing benchmarks. 64. The ROE equals the net profit margin multiplied by the total asset turnover multiplied by the equity multiplier. 65. Whenever market information is available, it should be used instead of accounting data. 66. False: A deteriorating time trend in a financial ratio is always a bad sign. (It may not be a bad sign, but it does merit investigation.) 67. Which three of the following are most apt to create problems when comparing financial statements for multiple firms? Seasonality, Differing accounting methods, Differing fiscal years 68. A(n) increase in net profit margin will increase ROE. 69. The three parts of the Dupont equation are: Profit margin, Total asset turnover, & Equity Multiplier. 70. Return on equity can be calculated as ROA × Equity multiplier. What is another way to express this equation? ROE = ROA × (1 + Debt − Equity Ratio) Explanation: Return on equity can be calculated as ROA × Equity multiplier. What is another way to express this equation? Another way to express this equation is ROE = ROA × (1 + Debt − Equity Ratio). 71. Davis Company has provided the following financial data: Total Asset Turnover = .245 Net Income = $400,000 Equity Multiplier = 1.20 Net Sales = $1,300,000 What is the Return on Equity? 9.1% Total asset turnover=Sales/Total asset Total asset=(1,300,000/0.245)=5,306,122.449(Approx). Equity multiplier=Total asset/equity equity=5,306,122.449/1.2 =4,421,768.707(Approx). ROE=net income/equity =400,000/4,421,768.707 =9.05%(Approx). Explanation: Total Asset Turnover = .245 Net Income = $400,000 Equity Multiplier = 1.20 Net Sales = $1,300,000 Profit Margin = Net Income/Net Sales Profit Margin = $400,000/$1,300,000 = .31 ROE = Profit Margin × Total Asset Turnover × Equity Multiplier ROE = .31 × .245 × 1.20 = .0911 72. A useful way of standardizing financial statements is to choose a base year and then express each item relative to that amount. 73. American Corporation has the following financial information. Year 1 Cash A/R Inventory Year 2 $202.95 $245.90 398.02 485.34 785.12 648.54 If Year 1 is the base year, what is the percentage increase/decrease of each current asset amount? Cash = 21% increase, A/R = 22% increase, Inventory = 17% decrease Explanation Year 1 Year 2 Cash $202.95 $245.90 $245.90/$202.95=1.212 21% increase A/R 398.02 485.34 $485.34/$398.02= 1.22 22% increase Inventory 785.12 648.54 $648.54/$785.12= .83 17% decrease 74. The Statement of Cash Flows has all of the following categories, except: Standard Includes: Operating, Financing, Investment 75. You are analyzing the Statement of Cash flows for Coffey Corporation. You have the following information: Beginning Cash: Ending Cash: $285 Net cash increase: $102 Calculate the Beginning Cash. $285 - $102 = $183 76. You are analyzing the Statement of Cash flows for Coffey Corporation. You have the following information: Beginning Cash: $220 Operating Activity: $497 Investment Activity $598 Financing Activity: −$212 Calculate the Net cash increase/decrease: Net cash provided by operating activities = $497 Net cash used by investing activities = $598 Net cash used by financing activities = ($212) Net increase in cash = $497 + $598 - $212 = $883