Foundations of Financial Management 11Th Canadian Edition By Stanley B. Block

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Sample Test

Chapter 03

Financial Analysis

Multiple Choice Questions

1. Ratio analysis is not useful for:
A.historical trend analysis within a firm.
B. comparison of ratios within a single industry.
C. measuring the effects of financing.
D. measuring employee satisfaction.

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Learning Objective: 03-02 Assess a company’s source of profitability using the DuPont system of analysis.
Topic: 03-05 The Analysis

2. Industries most sensitive to inflation-induced profits are those with:
A.seasonal products.
B. cyclical products.
C. consumer products.
D. high-profit products.

3. Using ASPE, the ______________ method of inventory costing is most likely to lead to inflation-induced profits.
A.FIFO
B. Specific item
C. Weighted average
D. Lower of cost or market

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Learning Objective: 03-03 Examine the ratios in comparison to industry averages.
Topic: 03-08 Inflationary Impact

4. In addition to comparison with industry ratios, it is also helpful to analyze ratios using:
A.ethical behaviour.
B. comparison of industry benchmarks.
C. focus groups.
D. trend analysis.

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Learning Objective: 03-03 Examine the ratios in comparison to industry averages.
Learning Objective: 03-04 Examine the ratios and company performance by means of trend analysis.
Topic: 03-06 Interpretation of Ratios by Trend Analysis

5. In examining the liquidity ratios, the primary emphasis is the firm’s:
A.ability to effectively employ its resources.
B. overall debt position.
C. ability to pay short-term obligations on time.
D. ability to earn an adequate return.

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Learning Objective: 03-01 Calculate 13 financial ratios that measure profitability; asset utilization; liquidity; and debt utilization.
Topic: 03-03 DuPont Analysis

6. Which of the following is not an asset utilization ratio?
A.Inventory turnover
B. Return on assets
C. Capital asset turnover
D. Average collection period

7. Which two ratios are used in the DuPont system to create return on assets?
A.Return on assets and asset turnover
B. Profit margin and asset turnover
C. Return on total capital and the profit margin
D. Inventory turnover and return on capital assets

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Learning Objective: 03-02 Assess a company’s source of profitability using the DuPont system of analysis.
Topic: 03-04 Classification System

8. Total asset turnover indicates the firm’s:
A.liquidity.
B. debt position.
C. ability to use its assets to generate sales.
D. profitability.

9. A short-term creditor would be most interested in:
A.profitability ratios.
B. asset utilization ratios.
C. liquidity ratios.
D. debt utilization ratios.

10. If a firm has both interest expense and lease payments:
A.times interest earned will be smaller than fixed charge coverage.
B. times interest earned will be greater than fixed charge coverage.
C. times interest earned will be the same as fixed charge coverage.
D. fixed charge coverage cannot be compute

11. ABC Co. has an average collection period of 60 days. Total credit sales for the year were $3,285,000. What is the balance in accounts receivable at year-end? (Use 365 days in a year.)
A.$54,750
B. $109,500
C. $540,000
D. $547,500

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Medium
Learning Objective: 03-02 Assess a company’s source of profitability using the DuPont system of analysis.
Topic: 03-04 Classification System

12. A firm has operating profit of $120,000 after deducting lease payments of $20,000. Interest expense is $40,000. What is the firm’s fixed charge coverage?
A.6.00x
B. 4.00x
C. 3.50x
D. 2.33x

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Hard
Learning Objective: 03-02 Assess a company’s source of profitability using the DuPont system of analysis.
Topic: 03-04 Classification System

13. A firm has current assets of $75,000 and total assets of $375,000. The firm’s sales are $900,000. The firm’s capital asset turnover is:
A.3.0x.
B. 12.0x.
C. 2.4x.
D. 5.0x.

14. Asset utilization ratios:
A.relate the balance sheet assets to the income statement sales.
B. measure how much cash is available for reinvestment into current assets.
C. are most important to shareholders.
D. measures the firm’s ability to generate a profit on sales.

15. Which of the following is a potential problem of utilizing ratio analysis?
A.Trends and industry averages are futuristic in nature
B. Financial data is identical due to price-level changes
C. Firms within an industry use similar accounting principles and application
D. Firms within an industry may not use similar accounting methods

16. Replacement cost accounting (current cost method) will usually:
A.increase assets, decrease net income before taxes, and lower the return on equity.
B. increase assets, increase net income before taxes, and increase the return on equity.
C. decrease assets, increase net income before taxes, and increase the return on equity.
D. increase assets, increase net income before taxes, and lower the return on equity.

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Learning Objective: 03-06 Identify sources of distortion in reported income.
Topic: 03-08 Inflationary Impact

17. Income can be distorted by factors other than inflation. The most important causes of distortion for inter-industry comparisons are:
A.accounting trends.
B. application of IFRS.
C. timing of revenue receipts and nonrecurring gains or losses.
D. cash reinvestment.

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Learning Objective: 03-06 Identify sources of distortion in reported income.
Topic: 03-07 Distortion In Financial Reporting

18. Disinflation may cause:
A.an increase in the value of gold, silver, and gems.
B. a reduced required return demanded by investors on financial assets.
C. increased return demanded by investors on non-financial assets.
D. additional profits through rising inventory costs.

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Learning Objective: 03-06 Identify sources of distortion in reported income.
Topic: 03-09 Disinflation Effect

19. A quick ratio much smaller than the current ratio reflects:
A.a small portion of current assets is in inventory.
B. a large portion of current assets is in inventory.
C. that the firm will have a high inventory turnover.
D. that the firm will have a high return on assets.

20. During inflation, replacement cost accounting will:
A.decrease the value of assets.
B. raise the debt to asset ratio.
C. increase incomes.
D. reduce incomes.

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Learning Objective: 03-05 Interpret ratios and identify corrective action for abnormal results.
Learning Objective: 03-06 Identify sources of distortion in reported income.
Topic: 03-08 Inflationary Impact

21. A firm’s long term assets = $75,000, total assets = $200,000, inventory = $25,000 and current liabilities = $50,000. Calculate the current ratio and quick ratio.
A.Current ratio = 0.5; Quick ratio = 1.5
B. Current ratio = 1.0; Quick ratio = 2.0
C. Current ratio = 1.5; Quick ratio = 2.0
D. Current ratio = 2.5; Quick ratio = 2.0

22. The Bubba Corp. had net income before taxes of $300,000 and sales of $2,000,000. If it is in the 50% tax bracket its after tax profit margin is:
A.7.5%
B. 10%
C. 12.5%
D. 15%

23. XYZ’s receivables turnover is 10x. The accounts receivable at year-end are $600,000. What was the sales figure for the year?
A.$60,000
B. $6,000,000
C. $7,200,000
D. $6,600,000

24. A firm has total assets of $2,000,000. It has $900,000 in long-term debt. The shareholders’ equity is $900,000. What is the total debt to asset ratio?
A.45%
B. 40%
C. 55%
D. 100%

25. A firm has a debt to equity ratio of 50%, debt of $300,000, and net income of $90,000. The return on equity is:
A.60%
B. 15%
C. 30%
D. not enough information.

26. A firm has a debt to asset ratio of 75%, $240,000 in debt, and net income of $48,000. Calculate return on equity.
A.60%
B. 20%
C. 26%
D. Not enough information

27. If government bonds pay 8.5% interest and CDIC insured savings accounts pay 5.5% interest, shareholders in a moderately risky firm would expect return-on-equity values of:
A.5.5%.
B. 8.5%.
C. 12.0%.
D. above 8.5%, but the exact amount is uncertain.

28. The most rigorous test of a firm’s ability to pay its short-term obligations is its:
A.current ratio.
B. quick ratio.
C. debt-to-assets ratio.
D. times-interest-earned ratio.

29. Investors and financial analysts wanting to evaluate the operating efficiency of a firm’s, managers would probably look primarily at the firm’s:
A.debt utilization ratios.
B. liquidity ratios.
C. asset utilization ratios.
D. profitability ratios.

30. The higher a firm’s debt utilization ratios, excluding debt-to-total assets, the:
A.less risky the firm’s financial position.
B. more risky the firm’s financial position.
C. more easily the firm will be able to pay dividends.
D. less easily the firm will be able to pay dividends.

31. For a given level of profitability as measured by profit margin, the firm’s return on equity will:
A.increase as its debt-to-assets ratio decreases.
B. decrease as its current ratio increases.
C. increase as its debt-to assets ratio increases.
D. decrease as its times-interest-earned ratio decreases.

32. Which of the following is not considered to be a profitability ratio?
A.Profit margin
B. Times interest earned
C. Return on equity
D. Return on assets (investment)

33. Which industry places the most value on intangible assets?
A.Professional services
B. Manufacturing industry
C. Production facility
D. Assembly facility

MEGAFRAME COMPUTER COMPANY Balance Sheet As at December 31, 20X5 ASSETS
Cash	$40,000
Accounts receivable	60,000
Inventory	90,000
New plant and equipment	220,000
Total Assets	$410,000

LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable	$60,000
Accrued expenses	40,000
Long-term debt	130,000
Common stock	80,000
Retained earnings	100,000
Total Liabilities and Shareholders’ Equity	$410,000

MEGAFRAME COMPUTER COMPANY Income Statement For the year ended December 31, 20X5
Sales (all on credit)	$700,000
Cost of goods sold	400,000
Gross profit	300,000
Selling and administrative expense	100,000
Operating profit	200,000
Interest expense	40,000
Net income before taxes	160,000
Taxes (50%)	80,000
Net income	80,000

34. Using the DuPont method, return on assets (investment) for Megaframe Computer is approximately:
A.15%.
B. 25%.
C. 29%.
D. 20%.

35. The firm’s average collection period is:
(Use 365 days in a year.)
A.31 days.
B. 25 days.
C. 12 days.
D. 20 days.

36. Times interest earned for Megaframe Computer is:
A.2x.
B. 5x.
C. 4x.
D. 10x.

37. Megaframe’s quick ratio is:
A.1:1.
B. 1:2.
C. 1.6:1.
D. 3:1.

38. Megaframe’s current ratio is:
A.1.9:1.
B. 0.6:1.
C. 1:1.
D. 0.86:1.

39. Megaframe’s debt to asset ratio is:
A.56.1%.
B. 75.61%.
C. 80.49%.
D. 90.62%

40. What is Megaframe Computer’s total asset turnover?
A.3.68x.
B. 3.18x.
C. 2.00x.
D. 1.71x.

41. Compute Megaframe’s after tax profit margin.
A.10.0%
B. 14.29%
C. 11.43%
D. 46.34%

42. Megaframe’s return on equity is:
A.44.44%.
B. 80.00%.
C. 50.05%.
D. 100.0%.

43. Megaframe’s receivable turnover is:
A.4.4x.
B. 10x.
C. 11.67x.
D. 14.4x.

44. If a company’s accounts receivable turnover is increasing, the average collection period:
A.is going up slightly.
B. is going down.
C. could be moving in either direction.
D. is going up by a significant amount.

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Easy
Learning Objective: 03-02 Assess a company’s source of profitability using the DuPont system of analysis.
Topic: 03-04 Classification System

45. An increasing average collection period indicates:
A.the firm is generating more income.
B. accounts receivable is going down.
C. the company is becoming more efficient in its collection policy.
D. the company is becoming less efficient in its collection policy.

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Easy
Learning Objective: 03-03 Examine the ratios in comparison to industry averages.
Learning Objective: 03-04 Examine the ratios and company performance by means of trend analysis.
Topic: 03-06 Interpretation of Ratios by Trend Analysis

46. A decreasing average collection period could be associated with:
A.increasing sales.
B. decreasing sales.
C. increasing accounts receivable.
D. increasing profits.

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Medium
Learning Objective: 03-03 Examine the ratios in comparison to industry averages.
Learning Objective: 03-04 Examine the ratios and company performance by means of trend analysis.
Topic: 03-06 Interpretation of Ratios by Trend Analysis

47. Disinflation as compared to inflation would normally be good for investments in:
A.bonds.
B. gold.
C. collectible antiques.
D. text books.

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Learning Objective: 03-05 Interpret ratios and identify corrective action for abnormal results.
Learning Objective: 03-06 Identify sources of distortion in reported income.
Topic: 03-10 Valuation Basics with Changing Prices

48. A non-Canadian company experiencing rapid price increases for its product would take the most conservative approach by using:
A.FIFO accounting.
B. LIFO accounting.
C. average cost accounting.
D. weighted average.

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Easy
Learning Objective: 03-05 Interpret ratios and identify corrective action for abnormal results.
Learning Objective: 03-06 Identify sources of distortion in reported income.
Topic: 03-11 Accounting Discretion

49. Historical cost based amortization tends to ________ immediately when there is inflation.
A.lower taxes
B. decrease profits
C. increase profits
D. increase assets

50. What happens if lease payments are reduced?
A.Times interest earned goes up.
B. Fixed charge coverage goes up.
C. Fixed charge coverage stays the same.
D. Fixed charge coverage goes down.

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Medium
Learning Objective: 03-02 Assess a company’s source of profitability using the DuPont system of analysis.
Topic: 03-04 Classification System

51. A large extraordinary loss has what effect on cost of goods sold?
A.It raises it.
B. It lowers it.
C. It has no effect.
D. Need more information.

52. If accounts receivable stays the same, and credit sales go up:
A.the average collection period will go up.
B. the average collection period will go down.
C. accounts receivable turnover will decrease.
D. no changes will occur.

53. Which of the following is a profitability ratio?
A.Quick ratio
B. Return on assets
C. Inventory turnover
D. Capital asset turnover

54. Which of the following is an asset utilization ratio?
A.Profit margin
B. Inventory turnover
C. Return on equity
D. Return on assets

55. Which of the following is not a debt utilization ratio?
A.Debt to total assets
B. Times interest earned
C. Current ratio
D. Fixed charge coverage

56. According the DuPont system, which of the following is not a factor in achieving a satisfactory return on assets?
A.Use of debt
B. Low inventory levels
C. Rapid turnover of assets
D. High profit margins

57. A firm has current assets of $150,000 and total assets of $750,000. The firm’s sales are $1,800,000. The firm’s capital asset turnover is:
A.3.0x
B. 12.0x
C. 2.4x
D. 5.0x

58. Return on assets (ROA) can be distorted by:
A.current liabilities.
B. noncurrent liabilities.
C. bond principle payments.
D. bond interest payments.

59. In examining the debt utilization ratios, the primary purpose is to measure:
A.ability to effectively employ its resources.
B. overall debt position.
C. ability to pay short-term obligations on time.
D. ability to generate timely cash flows.

60. What do coverage ratios demonstrate?
A.How a firm is expected to handle current asset balances.
B. Debt management of the firm and ability to meet financial obligations.
C. Profit margin of the firm.
D. The return on assets of the firm.

61. Flounders Co. has an average collection period of 60 days. Total credit sales for the year were $9,855,000. What is the balance in accounts receivable at year-end? (Use 365 days in a year.)
A.$164,250
B. $328,500
C. $1,620,000
D. $1,642,500

62. A firm has operating profit of $200,000 after deducting lease payments of $40,000. Interest expense is $60,000. What is the firm’s fixed charge coverage?
A.5.00x
B. 4.00x
C. 3.33x
D. 2.40x

63. A firm’s long term assets = $150,000, total assets = $400,000, inventory = $50,000, and current liabilities = $100,000. Calculate the current ratio and quick ratio.
A.Current ratio = 0.5; Quick ratio = 1.5
B. Current ratio = 1.0; Quick ratio = 2.0
C. Current ratio = 1.5; Quick ratio = 2.0
D. Current ratio = 2.5; Quick ratio = 2.0

64. If the company’s accounts receivable turnover is decreasing, the average collection period:
A.is going up.
B. is going down.
C. could be moving in either direction.
D. is going down slightly.

65. A decreasing average collection period indicates:
A.the firm is generating more income.
B. accounts receivable is going up.
C. the company is becoming more efficient in its collection policy.
D. the company is becoming less efficient in its collection policy.

66. An increasing average collection period could be associated with:
A.decreasing average daily cash sales.
B. increasing average daily credit sales.
C. decreasing accounts receivable.
D. increasing accounts receivable.

67. A firm has a Debt-to-Asset ratio of 35% and Total Assets of $350,000. What is the firm’s Total Debt?
A.$122,500
B. $650,000
C. $100,000
D. $60,000

68. Juniper, Ltd. report total sales of $10,000,000 in the prior year. If these sales were 15.50X total capital assets what was the company’s capital asset position in the year?
A.$15,000,000
B. $155,000,000
C. $645,161
D. $6,451,613

69. Jones and Co., reported average receivables of $550,000 in its most recent annual report. If total credit sales were $3,000,000 what was Jones and Co.’s average collection period? (Use 365 days in a year.)
A.67 days
B. 29 days
C. 82 days
D. 21 days

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Easy
Learning Objective: 03-02 Assess a company’s source of profitability using the DuPont system of analysis.
Topic: 03-04 Classification System

70. If a company’s profit margin was 32%, what were its reported sales if its reported net income was $650,000?
A.$10,000,000
B. $9,758,982
C. $1,008,332
D. $2,031,250

71. If a company has a return on investment of 17%, and its equity multiplier is 1.75, its ROE would be _______.
A.64.75%
B. 29.75%
C. 18.25%
D. 16.50%

True / False Questions

72. Absolute values taken from financial statements are more useful than relative values.
FALSE

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Learning Objective: 03-01 Calculate 13 financial ratios that measure profitability; asset utilization; liquidity; and debt utilization.
Topic: 03-05 The Analysis

73. Heavy use of long-term debt can be of benefit to a firm.
TRUE

74. The stock market tends to move up when inflation goes up.
FALSE

75. Under International Financial Reporting Standards, two companies with identical operating results may not report identical net incomes.
TRUE

76. A current ratio of 2 to 1 is always acceptable, for a company in any industry.
FALSE

77. In analyzing ratios, the age of the firm’s assets need not be considered.
FALSE

78. As long as prices continue to rise faster than costs in an inflationary environment, reported profits will generally continue to rise.
TRUE

79. To compute the quick ratio, accounts receivable are not included in current assets.
FALSE

80. Ratios are used to compare different firms in the same industry.
TRUE

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Learning Objective: 03-03 Examine the ratios in comparison to industry averages.
Learning Objective: 03-04 Examine the ratios and company performance by means of trend analysis.
Topic: 03-06 Interpretation of Ratios by Trend Analysis

81. Liquidity ratios indicate how fast a firm can generate cash to pay bills.
TRUE

82. Asset utilization ratios describe how capital is being utilized to buy assets.
FALSE

83. Return on equity will be higher than return on assets if there is debt in the capital structure.
TRUE

84. The DuPont system of profitability analysis emphasizes that profit generated by assets can be derived by various combinations of profit margins and asset turnover.
TRUE

85. Ratios are not distorted by inflation.
FALSE

86. Profitability ratios are distorted by inflation because profits are stated in current dollars and assets and equity are stated in historical dollars.
TRUE

87. Higher debt utilization ratios will always increase a firm’s return on equity given a positive return on assets.
TRUE

88. The term “inventory profits” refers to profits made in the process of selling finished goods at prices higher than their cost of goods sol
TRUE

89. Profitability ratios allow one to measure the ability of the firm to earn an adequate return on sales, total assets, and invested capital.
TRUE

90. Asset utilization ratios measure the returns on various assets such as return on total assets.
FALSE

91. A banker or trade creditor is most concerned about a firm’s profitability ratios.
FALSE

92. Ratios are only useful for those areas of business that involve investment decisions.
TRUE

93. LIFO inventory pricing does a better job than FIFO in equating current costs with current revenue.
TRUE

94. Financial ratios are used to weigh and evaluate the operational performance of the firm.
TRUE

95. FIFO will cause inflated profits during deflation.
FALSE

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Hard
Learning Objective: 03-05 Interpret ratios and identify corrective action for abnormal results.
Learning Objective: 03-06 Identify sources of distortion in reported income.
Topic: 03-11 Accounting Discretion

96. Fiercely competitive industries such as the computer industry have had lower profit margins and return on equity in recent years even though they are under extreme pressure to maintain high profitability.
TRUE

97. Asset utilization ratios relate balance sheet assets to income statement sales.
TRUE

98. A firm with heavy long-term debt can benefit during inflationary times, as debt can be repaid with “cheaper” dollars.
TRUE

99. During disinflation, stock prices tend to go up because the investor’s required rate of return goes down.
TRUE

100. Analysts agree that extraordinary gains/losses should be excluded from ratio analysis because they are one-time events, and do not measure annual operating performance.
TRUE

101. Return on equity for a very risky firm should be higher than return on equity for a less risky firm.
TRUE

102. The current ratio is a more severe test of a firm’s liquidity than the quick ratio.
FALSE

103. Asset utilization ratios can be used to measure the effectiveness of a firm’s managers.
TRUE

104. FIFO inventory valuation is responsible for much of the inventory profits caused by inflation.
TRUE

105. Debt utilization ratios are used to evaluate the firm’s debt position with regard to its asset base and earning power.
TRUE

106. Satisfactory return on assets may be achieved through high profit margins or rapid turnover of assets, but not a combination of both.
FALSE

107. Intangible assets are becoming an important part of the assets in company financial statements because accountants are recognizing the growing impact of brand names.
FALSE

108. Industries most sensitive to inflation-induced profits are those with cyclical products such as lumber, copper, et
TRUE

109. The use of capital assets will affect the equity multiplier.
TRUE

110. Receivables turnover is the reciprocal of the collection period times 365.
TRUE

111. Return on equity (ROE) will not change if the firm increases its use of debt.
FALSE

112. Big Bath Accounting is the tendency of firms to write off significant portions of assets during “troubled” times with the effect of allowing management to start over when times get better.
TRUE

113. “Big baths” are usually taken after a corporate reorganization.
FALSE

114. Accrual accounting can result in wide variations in operating result within an industry.
TRUE

115. FIFO is a system that includes inventory into cost of goods sold in which the items purchased first are written off first.
TRUE

Short Answer Questions

116. What are the 3 main uses of financial ratios?

Financial ratios are used to

• Weigh and evaluate the operating performance of the firm now and for its past
• Judge comparative performance between firms
• Determine relative as opposed to absolute performance

117. Return on equity (ROE) indicates a return to the owners of the firm and is closely followed by investment analysts. What 4 deficiencies does this ratio have?

Focuses on past results not future expected results

• Does not focus on share price, the goal of the firm
• Relies on book value and not the actual market value of the investment
• Doesn’t capture the firm’s assumed risk to generate earnings

118. As defined by the text, list each of the 3 profitability ratios and explain the information they provide about a firm.

Profitability ratios:

Profit margin, return on assets (investment), return on equity (common shareholders)
Profitability ratios measure return (profit) on sales, total assets, and shareholders’ capital

• Examine the effective employment of resources
• Are usually dependent on an adequate sales level
• Influence share price performance, and thus are important to equity investors and security analysts

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Hard
Learning Objective: 03-01 Calculate 13 financial ratios that measure profitability; asset utilization; liquidity; and debt utilization.
Topic: 03-03 DuPont Analysis

119. As defined by the text, list each of the 8 asset utilization ratios and explain the information they provide about a firm.

Asset utilization ratios:

Receivable turnover, average collection period (days sales outstanding), inventory turnover, inventory holding period, accounts payable turnover, accounts payable period, capital asset turnover, total asset turnover

• Measure the speed or efficiency of turning over assets constructing the cash conversion cycle
• Identify the times per year inventory is sold, the accounts receivable collected, or the productivity of capital assets in generating sales
• Are a primary responsibility of management

120. As defined by the text, list each of the 2 liquidity ratios and explain the information they provide about a firm.

Current ratio, quick ratio

• Emphasize the ability to pay off short-term obligations as they fall due
• Quickly impact day-to-day operations
• Focus bankers and creditors on the ability to generate timely cash flows

121. As defined by the text, list each of the 3 debt utilization ratios and explain the information they provide about a firm.

Debt utilization ratios.
Debt to total assets, times interest earned, fixed charge coverage

• Evaluate the overall debt position of the firm in light of the asset base and earning power
• Are examined by debt holders in light of security behind debt obligations

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Hard
Learning Objective: 03-01 Calculate 13 financial ratios that measure profitability; asset utilization; liquidity; and debt utilization.
Topic: 03-03 DuPont Analysis

122. Complete the following balance sheet for the Range Company using the following information:

Debt to Assets = 60%
Quick Ratio = 1.1
Asset Turnover = 5x
Capital Asset Turnover = 12.037x
Current Ratio = 2
Average Collection Period = 17.0708 days

Cash		Current liabilities
Receivables		Bonds payable
Inventory		Total liabilities
Total current assets		Net worth
Plant and Equipment		Total liabilities
Total Assets	$325,000	And Net Worth

Assume all sales are on credit.

1. A) Total asset turnover = Sales/Total Assets = 5 = X/$325,000
Sales = X = $1,625,000
B) Deb to total assets = Deb/Total Assets = 0.60 = X/$325,000
Debt = X = $195,000
C) Capital asset turnover = Sales/Capital Assets = 12, 037 = $1,625,000/X
Capital assets = X = $135,000
D) Total assets – capital assets = Current assets
$325,000 – $135,000 = $190,000
E) Current ratio = Current Assets/Current Liabilities = 2 = $190,000/X
Current Liabilities = X = $95,000
F) Total liabilities – current liabilities = bonds payable
$195,000 – $95,000 = $100,000
G) Total assets – total liabilities = net worth
$325,000 – $195,000 = $130,000
H) Average collection period = Receivables/Averages daily credit sales = $17.0708 = X/($6,625,000/365)
I) Quick ratio = (Current assets – inventory) Current Liabilities = 2 = $190,000/X
Current assets – Inventory = Receivables + Cash
= ($76,000 + X)/$95,000
Cash = X = $28,500
J) Inventory = Current assets – cash – receivables
Inventory = $190,000 – $28,500 – $76,000
Inventory = $85,500

123. Given the balance sheet and income statement for Simmons Maintenance Company, compute the ratios below. The “right answer” refers to the question of whether a particular ratio for Simmons is better or worse than the industry average.

SIMMONS MAINTENANCE COMPANY Balance Sheet
Assets		Liabilities
Cash	$15,000	Accounts Payable	$21,000
Accts. Receivable	22,000	Notes Payable	20,000
Inventory	30,000	Accrued Expenses	5,000
Current Assets	67,000	Current Liabilities	46,000
Net Capital Assets	73,000	Long-term Debt	30,000
		Shareholders’ Equity	64,000
Total Liabilities & Total Assets	$140,000	Shareholders’ Equity	$140,000

	Income Statement
Sales: (80% credit)		$120,000
Less: Cost of Goods Sold		45,000
Gross Profit		75,000
Selling and Administrative Expense	20,000
Rent Expense (Lease)	8,000	28,000
EBIT		47,000
Interest Expense		5,000
Earnings before taxes		42,000
Taxes (@ 25%)		10,500
Net Income		$31,500

Common shares outstanding
EPS

Common shares outstanding 15,000

EPS $2.10

Ratio	Ratios for Simmons	Industry Average	Circle the right answer
Profit margin		17.5%	Better worse
Return on investment		20.8%	Better worse
Return on equity		35%	Better worse
Receivables turnover		4.4x	Better worse
Avg. collection period		68.0 days	Better worse
Inventory turnover		3.5x	Better worse
Capital asset turnover		2.4x	Better worse
Total asset turnover		.76x	Better worse
Current ratio		1.28	Better worse
Quick ratio		.85	Better worse
Debt to total assets		.45	Better worse
Times interest earned		12.0x	Better worse
Fixed charge coverage		3.6x	Better worse

Ratio	Ratios for Simmons	Industry Average	Circle the right answer
Profit margin	26.25%	17.5%	Better
Return on investment	22.50%	20.8%	Better
Return on equity	49.22%	35%	Better
Receivables turnover	4.36x	4.4x	Better
Avg. collection period	83.6 days	68.0 days	Better
Inventory turnover	4.0x	3.5x	Better
Capital asset turnover	1.64x	2.4x	Better
Total asset turnover	.86x	.76x	Better
Current ratio	1.46	1.28	Better
Quick ratio	.80	.85	Better
Debt to total assets	.54	.45	Better
Times interest earned	9.4x	12.0x	Better
Fixed charge coverage	4.23x	3.6x	Better

CALCULATIONS

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