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Chapter 4 Analysis Of Financial Statements

3744 words - 15 pages

1. A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?

a. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.
b. Issue new common stock and use the proceeds to increase inventories.
c. Speed up the collection of receivables and use the cash generated to increase inventories.
d. Use some of its cash to purchase additional inventories.
e. Issue new common stock and use the proceeds to acquire ...view middle of the document...

e is false, given that the initial CR > 1.0.

3. Which of the following statements is CORRECT?

a. If a security analyst saw that a firm’s days’ sales outstanding (DSO) was higher than the industry average, and was increasing and trending still higher, this would be interpreted as a sign of strength.
b. A high average DSO indicates that none of its customers are paying on time. In addition, it makes no sense to evaluate the firm's DSO with the firm's credit terms.
c. There is no relationship between the days’ sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things.
d. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.
e. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days’ sales outstanding will decline.
Answer: e

4. Which of the following statements is CORRECT?

a. If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses.
b. A firm’s use of debt will have no effect on its profit margin.
c. If two firms differ only in their use of debt--i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates--but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales and a lower return on assets.
d. The debt ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable.
e. If two firms differ only in their use of debt--i.e., they have identical assets, sales, operating costs, and tax rates--but one firm has a higher debt ratio, the firm that uses more debt will have a higher operating margin and return on assets.
Answer: c
a is false, because the TIE also depends on the interest rate and EBIT.
b is false, because interest affects the profit margin.
c is correct, because the more interest the lower the profits, hence the lower the profit margin and ROE.
d is simply incorrect.
e is incorrect. Operating margin would be identical because EBIT is in the numerator and return on assets would be lower.

5. Which of the following statements is CORRECT?

a. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be equal.
b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.
c. If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price/earnings ratio.
d. If Firm X’s P/E ratio exceeds that of Firm Y, then Y is likely to be less...

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