Reading 21: financial analysis techniques Flashcards
To study trends in a firm’s cost of goods sold (COGS), the analyst should standardize the cost of goods sold numbers to a common-sized basis by dividing COGS by:
assets.
sales.
net income.
With a vertical common-size income statement, all income statement accounts are divided by sales. (Module 21.1, LOS 21.a)
Which of the following is least likely a limitation of financial ratios?
Data on comparable firms are difficult to acquire.
Determining the target or comparison value for a ratio requires judgment.
Different accounting treatments require the analyst to adjust the data before comparing ratios.
Company and industry data are widely available from numerous private and public sources. The other statements describe limitations of financial ratios. (Module 21.1, LOS 21.a)
RGB, Inc.’s purchases during the year were $100,000. The balance sheet shows an average accounts payable balance of $12,000. RGB’s payables payment period is closest to:
37 days.
44 days.
52 days.
payables turnover = (purchases / avg. AP) = 100 / 12 = 8.33
payables payment period = 365 / 8.33 = 43.8 days
(Module 21.2, LOS 21.b)
RGB, Inc., has a gross profit of $45,000 on sales of $150,000. The balance sheet shows average total assets of $75,000 with an average inventory balance of $15,000. RGB’s total asset turnover and inventory turnover are closest to:
total asset turnover = (sales / total assets) = 150 / 75 = 2 times
inventory turnover = (COGS / avg. inventory) = (150 – 45) / 15 = 7 times
(Module 21.2, LOS 21.b)
If RGB, Inc., has annual sales of $100,000, average accounts payable of $30,000, and average accounts receivable of $25,000, RGB’s receivables turnover and average collection period are closest to:
receivables turnover = (S / avg. AR) = 100 / 25 = 4
average collection period = 365 / 4 = 91.25 days
(Module 21.2, LOS 21.b)
A company’s current ratio is 1.9. If some of the accounts payable are paid off from the cash account, the:
numerator would decrease by a greater percentage than the denominator, resulting in a lower current ratio.
denominator would decrease by a greater percentage than the numerator, resulting in a higher current ratio.
Current ratio = current assets / current liabilities. If cash (a current asset) and AP (a current liability) decrease by the same amount and the current ratio is greater than 1, then the numerator decreases less in percentage terms than the denominator, and the current ratio increases. (Module 21.2, LOS 21.b)
A company’s quick ratio is 1.2. If inventory were purchased for cash, the:
numerator would decrease more than the denominator, resulting in a lower quick ratio.
denominator would decrease more than the numerator, resulting in a higher current ratio.
numerator and denominator would decrease proportionally, leaving the current ratio unchanged
Quick ratio = (cash + marketable securities + AR) / current liabilities. If cash decreases, the quick ratio will also decrease. The denominator is unchanged. (Module 21.2, LOS 21.b)
All other things held constant, which of the following transactions will increase a firm’s current ratio if the ratio is greater than one?
Accounts receivable are collected and the funds received are deposited in the firm’s cash account.
Fixed assets are purchased from the cash account.
Accounts payable are paid with funds from the cash account.
Current ratio = current assets / current liabilities. If CR is > 1, then if CA and CL both fall, the overall ratio will increase. (Module 21.2, LOS 21.b)
RGB, Inc.’s receivable turnover is ten times, the inventory turnover is five times, and the payables turnover is nine times. RGB’s cash conversion cycle is closest to:
69 days.
104 days.
150 days.
(365 / 10 + 365 / 5 – 365 / 9) = 69 days
(Module 21.2, LOS 21.b)
An analyst who is interested in a company’s long-term solvency would most likely examine the:
return on total capital.
defensive interval ratio.
fixed charge coverage ratio.
Fixed charge coverage is a solvency ratio. Return on total capital is a measure of profitability and the defensive interval ratio is a liquidity measure. (Module 21.3, LOS 21.b)
RGB, Inc.’s income statement shows sales of $1,000, cost of goods sold of $400, pre-interest operating expense of $300, and interest expense of $100. RGB’s interest coverage ratio is closest to:
2 times.
3 times.
4 times.
Interest coverage ratio = EBIT / I = (1,000 – 400 – 300) / 100 = 3 times
(Module 21.3, LOS 21.b)
Return on equity using the traditional DuPont formula equals:
(net profit margin) (interest component) (solvency ratio).
(net profit margin) (total asset turnover) (tax retention rate).
(net profit margin) (total asset turnover) (financial leverage multiplier).
This is the correct formula for the three-ratio DuPont model for ROE. (LOS 21.d)
RGB, Inc., has a net profit margin of 12%, a total asset turnover of 1.2 times, and a financial leverage multiplier of 1.2 times. RGB’s return on equity is closest to:
12.0%.
14.2%.
17.3%.
ROE=(net income/sales)(sales/assets)(assets/equity)= (0.12)(1.2)(1.2)= 17.28%
Use the following information for RGB, Inc.:
EBIT / revenue = 10%
Tax retention rate = 60%
Revenue / assets = 1.8 times
Current ratio = 2 times
EBT / EBIT = 0.9 times
Assets / equity = 1.9 times
RGB, Inc.’s return on equity is closest to:
10.5%.
14.0%.
18.5%.
Tax burden = (1 – tax rate) = tax retention rate = 0.6.
ROE = 0.6 × 0.9 × 0.1 × 1.8 × 1.9 = 0.1847 = 18.47%.
(LOS 21.d)
Which of the following equations least accurately represents return on equity?
(net profit margin)(equity turnover).
(net profit margin)(total asset turnover)(assets / equity).
(ROA)(interest burden)(tax retention rate).
(ROA)(interest burden)(tax retention rate) is not one of the DuPont models for calculating ROE. (LOS 21.d)
