Module 6 (Analyzing Financial Statments) Flashcards
How does the equity multiplier measure the impact of debt for a company if the formula does not include debt at all under the DuPont Framework?
A - ROE calculation does not consider the amount of leverage
B - DuPont Framework allows us to use Debt/Equity instead
C - The debt is implied in the numerator (total assets)
D - It includes the impact of convertible bonds that are usually relevant
C - The debt is implied in the numerator (total assets) As liabilities (including debt) increase, the equity multiplier will be higher than one. Increasing leverage has the potential of higher returns but the investment become riskier too.
Company A has a higher Inventory Turnover Ratio than Company B. Which of the following statements is true regarding these two companies?
A - Company A has a lower average inventory level than Company B.
B - Company A has more inventory than Company B.
C - Company A is more efficient in using its inventory to generate revenue.
C - Company A is more efficient in using its inventory to generate revenue.
Inventory Turnover measures the number of times inventory is sold or used in a time period. It is an indicator of operating efficiency.
Which of the following measures does not reflect a company’s profitability?
A - Gross Profit Margin
B - Day Sales in Accounts Receivable
C - EBIAT
D - Profit Margin
B - Day Sales in Accounts Receivable
Company A has a shorter Average Collection Period than Company B using the formula 365 / (Credit Sales / Average AR Balance). Which of the following statements is true regarding these two companies?
A - Company A has a lower percentage of credit sales than Company B.
B - Company A is more efficient in collecting receivables from customers than Company B.
C - Company A is more efficient in generating revenue than Company B.
B - Company A is more efficient in collecting receivables from customers than Company B.
Accounts Receivable Turnover is an indicator of a business’ ability and efficiency in collecting receivables from customers.
Company A has a higher Accounts Payable Turnover Ratio than Company B. Which of the following statements is true regarding these two companies?
A - Company A has a longer Average Collection Period than Company B.
B - Company A has a lower percentage of credit purchases than Company B.
C - Company A is paying suppliers at a faster rate than Company B.
C - Company A is paying suppliers at a faster rate than Company B.
Accounts Payable Turnover measures the number of times a company can pay off its average account payable balance during a time period.
Which of the following items is NOT related to a company’s ability to pay off its debts?
A - Current Ratio
B - Quick Ration
C - Debt to Equity Ratio
C - Debt to Equity Ratio
Debt to Equity Ratio measures a company’s leverage, not ability to pay off debts.
Based on the breakdown of the DuPont framework, which of the following statements is true regarding Company X?
A - Company X is more profitable in 2013 than in 2012.
B - Company X has more assets in 2013 than in 2012
C - Company X has a lower assets to equity ratio in 2013 than in 2012.
C - Company X has a lower assets to equity ratio in 2013 than in 2012.
The Equity Multiplier decreased from 2012 to 2013.
At the end of the third quarter, a department store is showing lower cash flows and lower sales on its financial statements compared to the average of the previous four quarters. It also shows an increase in inventory compared to the second quarter.
Which of the following options is MOST likely to be the cause?
A - Seasonality
B - Depreciation
C - In Decline Stage
D - Efficiency
A - Seasonality
Seasonality is causing the department store to build up its inventory for the holiday season and would anticipate a lower inventory and increased sales and cash flows for the 4th quarter financial statement.
Which of the following is measured by the DuPont Framework?
A - The return that a business generates during a period on equity invested in the business by the owners of the business.
B - The return or profit received as a result of investing funds.
C - The number of days between when a company pays for inventory purchases and when a company collects from customers.
D - The number of times a company can cover its interest expense only using its earnings before interest and tax.
A - The return that a business generates during a period on equity invested in the business by the owners of the business.
This is the definition of ROE (Return on Equity), which is measured by the DuPont Framework.
Which ratio measures the ability of a company to make a profit relative to revenue generated during a period?
A - Gross Profit Margin
B - Days Sales in Receivable
C - Profit Margin
D - Days Purchases Outstanding
C - Profit Margin
Profit Margin (Net Income/Sales) measures the ability of a company to make a profit relative to revenue generated during a period.
Initech finances their business using a combination of equity and liabilities. Which of the following numbers is most likely Initech’s equity multiplier?
A: -1
B: 0
C: 1
D: 1.5
D: 1.5
A company that finances using only equity will have an equity multiplier of 1. Any amount over 1 shows the proportion financed using liabilities. Since Initech uses a combination of equity and liabilities to finance operations, the only option that would most likely be their equity multiplier is option 4, 1.5.
A company that finances using only equity will have an equity multiplier of what?
1
Which of the following companies is most likely to have a negative Cash Conversion Cycle?
A - A discount retailer
B - A farmer who grows corn and sells to a distributor
C - A manufacturer who makes high-quality steam evaporators for nuclear power plants
D - A car dealership that provides their own in-house financing
A - A discount retailer
A discount retailer sells most of its inventory quickly and for cash, while delaying payments to suppliers.
Which of the following companies would likely have the LEAST difficulty making the interest payments on its debts?
A - Company A with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $15,000
B - Company B with Net Income of $100,000, Interest Expense of $30,000, and Tax Expense of $10,000
C - Company C with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $20,000
C - Company C with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $20,000
Company C will likely have the least difficulty making interest payments on its debt, because it has the highest Interest Coverage Ratio.
The Interest Coverage Ratio can be calculated as ( EBIT / Interest Expense )
Company A has an EBIT of $140,000 ( $100,000 + $25,000 + $15,000 )
Company A’s Interest Coverage Ratio is 5.6 ( $140,000 / $25,000 )
Company B has an EBIT of $140,000 ( $100,000 + $30,000 + $10,000 )
Company B’s Interest Coverage Ratio is 4.7 ( $140,000 / $30,000 )
Company C has an EBIT of $145,000 ( $100,000 + $25,000 + $20,000 )
Company C’s Interest Coverage Ratio is 5.8 ( $145,000 / $25,000 )
Which of the following companies would likely have the LEAST difficulty making the interest payments on its debts?
A - Company A with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $15,000
B - Company B with Net Income of $100,000, Interest Expense of $30,000, and Tax Expense of $10,000
C - Company C with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $20,000
C - Company C with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $20,000
Company C will likely have the least difficulty making interest payments on its debt, because it has the highest Interest Coverage Ratio.
The Interest Coverage Ratio can be calculated as ( EBIT / Interest Expense )
Company A has an EBIT of $140,000 ( $100,000 + $25,000 + $15,000 )
Company A’s Interest Coverage Ratio is 5.6 ( $140,000 / $25,000 )
Company B has an EBIT of $140,000 ( $100,000 + $30,000 + $10,000 )
Company B’s Interest Coverage Ratio is 4.7 ( $140,000 / $30,000 )
Company C has an EBIT of $145,000 ( $100,000 + $25,000 + $20,000 )
Company C’s Interest Coverage Ratio is 5.8 ( $145,000 / $25,000 )
