Unit 4 ANALYSIS OF FS

Question 1

All else being equal, which of the following will increase a company’s current ratio?
a. An increase in accounts receivable.
b. An increase in accounts payable.
c. An increase in net fixed assets.
d. Statements a and b are correct.
e. All of the statements above are correct.

Answer 1

A

Question 2

Pepsi Corporation’s current ratio is 0.5, while Coke Company’s current ratio is 1.5. Both firms want to “window dress” their coming end-of-year financial statements. As part of its window dressing strategy, each firm will double its current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the statements below best describes the actual results of these transactions?
a. The transactions will have no effect on the current ratios.
b. The current ratios of both firms will be increased.
c. The current ratios of both firms will be decreased.
d. Only Pepsi Corporation’s current ratio will be increased.
e. Only Coke Company’s current ratio will be increased

Answer 2

D

Question 3

Which of the following alternatives could potentially result in a net increase in a company’s cash flow for the current year?
a. Reduce the days sales outstanding ratio.
b. Increase the number of years over which fixed assets are depreciated.
c. Decrease the accounts payable balance.
d. Statements a and b are correct.
e. All of the statements above are correct.

Answer 3

A

Question 4

Stennett Corp.’s CFO has proposed that the company issue new debt and use the proceeds to buy back common stock. Which of the following are likely to occur if this proposal is adopted? (Assume that the proposal would have no effect on the company’s operating income.)
a. Return on assets (ROA) will decline.
b. The times interest earned ratio (TIE) will increase.
c. Taxes paid will decline.
d. Statements a and c are correct.
e. None of the statements above is correct.

Answer 4

D

Question 5

Amazon Electric wants to increase its debt ratio, which will also increase its interest expense. Assume that the higher debt ratio will have no effect on the company’s operating income, total assets, or tax rate. Also, assume that the basic earning power ratio exceeds the beforetax cost of debt financing. Which of the following will occur if the company increases its debt ratio?
a. Its ROA will fall.
b. Its ROE will increase.
c. Its basic earning power (BEP) will stay unchanged.
d. Statements a and c are correct.
e. All of the statements above are correct.

Answer 5

E

Question 6

Which of the following statements is most correct?
a. A company that has positive net income must also have positive EVA.
b. If a company’s ROE is greater than its cost of equity, its EVA is positive.
c. If a company increases its EVA, its ROE must also increase.
d. Statements a and b are correct.
e. All of the above statements are correct.

Answer 6

B

Question 7

Which of the following statements is most correct about Economic Value Added (EVA)?
a. If a company has no debt, its EVA equals its net income.
b. If a company has positive ROE, its EVA must also be positive.
c. A company’s EVA will be positive whenever the cost of equity exceeds the ROE.
d. All of the statements above are correct.
e. None of the statements above is correct.

Answer 7

E

Question 8

Devon Inc. has a higher ROE than Berwyn Inc. (17 percent compared to 14 percent), but it has a lower EVA than Berwyn. Which of the following factors could explain the relative performance of these two companies?
a. Devon is much larger than Berwyn.
b. Devon is riskier, has a higher WACC, and a higher cost of equity.
c. Devon has a higher operating income (EBIT).
d. Statements a and b are correct.
e. All of the statements above are correct.

Answer 8

B

Question 9

Bedford Hotels and Breezewood Hotels both have $100 million in total assets and a 10 percent return on assets (ROA). Each company has a 40 percent tax rate. Bedford, however, has a higher debt ratio and higher interest expense. Which of the following statements is most correct?
a. The two companies have the same basic earning power (BEP).
b. Bedford has a higher return on equity (ROE).
c. Bedford has a lower level of operating income (EBIT).
d. Statements a and b are correct.
e. All of the statements above are correct.

Answer 9

B

Question 10

Company J and Company K each recently reported the same earnings per share (EPS). Company J’s stock, however, trades at a higher price. Which of the following statements is most correct?
a. Company J must have a higher P/E ratio.
b. Company J must have a higher market to book ratio.
c. Company J must be riskier.
d. Company J must have fewer growth opportunities.
e. All of the statements above are correct.

Answer 10

A

Question 11

Company A’s ROE is 20 percent, while Company B’s ROE is 15 percent. Which of the following statements is most correct?
a. Company A must have a higher ROA than Company B.
b. Company A must have a higher EVA than Company B.
c. Company A must have a higher net income than Company B.
d. All of the statements above are correct.
e. None of the statements above is correct.

Answer 11

E

Question 12

Company A and Company B have the same total assets, return on assets (ROA), and profit margin. However, Company A has a higher debt ratio and interest expense than Company B. most correct?Which of the following statements is
a. Company A has a higher ROE (return on equity) than Company B.
b. Company A has a higher total assets turnover than Company B.
c. Company A has a higher operating income (EBIT) than Company B.
d. Statements a and b are correct.
e. Statements a and c are correct.

Answer 12

E

Question 13

Nelson Company is thinking about issuing new common stock. The proceeds from the stock issue will be used to reduce the company’s outstanding debt and interest expense. The stock issue will have no effect on the company’s total assets, EBIT, or tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?
a. The company’s net income will increase.
b. The company’s times interest earned ratio will increase.
c. The company’s ROA will increase.
d. All of the above statements are correct.
e. None of the above statements is correct.

Answer 13

D

Question 14

Companies A and B have the same profit margin and debt ratio. However, Company A has a higher return on assets and a higher return on equity than Company B. Which of the following can explain these observed ratios?
a. Company A must have a higher total assets turnover than Company B.
b. Company A must have a higher equity multiplier than Company B.
c. Company A must have a higher current ratio than Company B.
d. Statements b and c are correct.
e. All of the statements above are correct.

Answer 14

A

Question 15

Bichette Furniture Company recently issued new common stock and used the proceeds to reduce its short-term notes payable and accounts payable. This action had no effect on the company’s total assets or operating income. Which of the following effects did occur as a result of this action?
a. The company’s current ratio decreased.
b. The company’s basic earning power ratio increased.
c. The company’s time interest earned ratio decreased.
d. The company’s debt ratio increased.
e. The company’s equity multiplier decreased.

Answer 15

E

Question 16

Van Buren Company has a current ratio = 1.9. Which of the following actions will increase the company’s current ratio?
a. Use cash to reduce short-term notes payable.
b. Use cash to reduce accounts payable.
c. Issue long-term bonds to repay short-term notes payable.
d. All of the statements above are correct.
e. Statements b and c are correct.

Answer 16

D

Question 17

Which of the following actions can a firm take to increase its current ratio?
a. Issue short-term debt and use the proceeds to buy back long-term debt with a maturity of more than one year.
b. Reduce the company’s days sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
c. Use cash to purchase additional inventory
d. Statements a and b are correct.
e. None of the statements above is correct.

Answer 17

E

Question 18

As a short-term creditor concerned with a company’s ability to meet its financial obligation to you, which one of the following combinations of ratios would you most likely prefer? Current ratio, TIE Debt ratio
a. 0.5, 0.5, 0.33
b. 1.0, 1.0, 0.50
c. 1.5, 1.5, 0.50
d. 2.0, 1.0, 0.67
e. 2.5, 0.5, 0.71

Answer 18

C

Question 19

Drysdale Financial Company and Commerce Financial Company have the same total assets, the same total assets turnover, and the same return on equity. However, Drysdale has a higher return on assets than Commerce. Which of the following can explain these ratios?
a. Drysdale has a higher profit margin and a higher debt ratio than Commerce.
b. Drysdale has a lower profit margin and a lower debt ratio than Commerce.
c. Drysdale has a higher profit margin and a lower debt ratio than Commerce.
d. Drysdale has lower net income but more common equity than Commerce
e. Drysdale has a lower price earnings ratio than Commerce.

Answer 19

C

Question 20

You are an analyst following two companies, Company X and Company Y. You have collected the following information:
• The two companies have the same total assets.
• Company X has a higher total assets turnover than Company Y.
• Company X has a higher profit margin than Company Y.
• Company Y has a higher inventory turnover ratio than Company X.
• Company Y has a higher current ratio than Company X.

Which of the following statements is most correct?

a. Company X must have a higher net income.
b. Company X must have a higher ROE.
c. Company Y must have a higher ROA.
d. Statements a and b are correct.
e. Statements a and c are correct.

Answer 20

A

Question 21

Which of the following statements is most correct?.
a. A firm with financial leverage has a larger equity multiplier than an otherwise identical firm with no debt in its capital structure.
b. The use of debt in a company’s capital structure results in tax benefits to the investors who purchase the company’s bonds.
c. All else equal, a firm with a higher debt ratio will have a lower basic earning power ratio.
d. All of the statements above are correct.
e. Statements a and c are correct.

Answer 21

A

Question 22

Which of the following statements is most correct?

a. An increase in a firm’s debt ratio, with no changes in its sales and operating costs, could be expected to lower its profit margin on sales.
b. An increase in the DSO, other things held constant, would generally lead to an increase in the total assets turnover ratio.
c. An increase in the DSO, other things held constant, would generally lead to an increase in the ROE.
d. In a competitive economy, where all firms earn similar returns on equity, one would expect to find lower profit margins for airlines, which require a lot of fixed assets relative to sales, than for fresh fish markets.
e. It is more important to adjust the debt ratio than the inventory turnover ratio to account for seasonal fluctuations.

Answer 22

A

Question 23

Harte Motors and Mills Automotive each have the same total assets, the same level of sales, and the same return on equity (ROE). Harte Motors, however, has less equity and a higher debt ratio than does Mills Automotive. Which of the following statements is most correct?
a. Mills Automotive has a higher net income than Harte Motors.
b. Mills Automotive has a higher profit margin than Harte Motors.
c. Mills Automotive has a higher return on assets (ROA) than Harte Motors.
d. All of the statements above are correct.
e. None of the statements above is correct.

Answer 23

D

Question 24

Company A and Company B have the same total assets, tax rate, and net income. Company A, however, has a lower profit margin than Company B. Company A also has a higher debt ratio and, therefore, higher interest expense than Company B. Which of the following statements is most correct?
a. Company A has a higher total assets turnover.
b. Company A has a higher return on equity.
c. Company A has a higher basic earning power ratio.
d. Statements a and b are correct.
e. All of the statements above are correct.

Answer 24

E

Question 25

Company A and Company B have the same tax rate, total assets, and basic earning power. Both companies have positive net incomes. Company A has a higher debt ratio, and therefore, higher interest expense than Company B. Which of the following statements is true?
a. Company A has a higher ROA than Company B.
b. Company A has a higher times interest earned (TIE) ratio than Company B.
c. Company A has a higher net income than Company B.
d. Company A pays less in taxes than Company B.
e. Company A has a lower equity multiplier than Company B.

Answer 25

D

Question 26

You observe that a firm’s profit margin is below the industry average, while its return on equity and debt ratio exceed the industry average. What can you conclude?
a. Return on assets must be above the industry average.
b. Total assets turnover must be above the industry average.
c. Total assets turnover must be below the industry average.
d. Statements a and b are correct.
e. None of the statements above is correct.

Answer 26

B

Question 27

Huxtable Medical’s CFO recently estimated that the company’s EVA for the past year was zero. The company’s cost of equity capital is 14 percent, its cost of debt is 8 percent, and its debt ratio is 40 percent. Which of the following statements is most correct?

a. The company’s net income was zero.
b. The company’s net income was negative.
c. The company’s ROA was 14 percent.
d. The company’s ROE was 14 percent.
e. The company’s after-tax operating income was less than the total dollar cost of capital.

Answer 27

D

Question 28

Which of the following statements is most correct?
a. If two firms have the same ROE and the same level of risk, they must also have the same EVA.
b. If a firm has positive EVA, this implies that its ROE exceeds its cost of equity.
c. If a firm has positive ROE, this implies that its EVA is also positive.
d. Statements b and c are correct.
e. All of the statements above are correct.

Answer 28

B

Question 29

Which of the following statements is most correct?
a. If Firms A and B have the same earnings per share and market to book ratio, they must have the same price earnings ratio.
b. Firms A and B have the same net income, taxes paid, and total assets. If Firm A has a higher interest expense, its basic earnings power ratio (BEP) must be greater than that of Firm B.
c. Firms A and B have the same net income. If Firm A has a higher interest expense, its return on equity (ROE) must be greater than that of Firm B.
d. All of the statements above are correct.
e. None of the statements above is correct.

Answer 29

B

Question 30

Reeves Corporation forecasts that its operating income (EBIT) and total assets will remain the same as last year, but that the company’s debt ratio will increase this year. What can you conclude about the company’s financial ratios? (Assume that there will be no change in the company’s tax rate.)
a. The company’s basic earning power (BEP) will fall.
b. The company’s return on assets (ROA) will fall.
c. The company’s equity multiplier (EM) will increase.
d. All of the statements above are correct.
e. Statements b and c are correct.

Answer 30

E

Question 31

Company X has a higher ROE than Company Y, but Company Y has a higher ROA than Company X. Company X also has a higher total assets turnover ratio than Company Y; however, the two companies have the same total assets. Which of the following statements is most correct?
a. Company X has a lower debt ratio than Company Y.
b. Company X has a lower profit margin than Company Y.
c. Company X has a lower net income than Company Y.
d. Statements b and c are correct.
e. All of the statements above are correct.

Answer 31

D

Question 32

Division A has a higher ROE than Division B, yet Division B creates more value for shareholders and has a higher EVA than Division A. Both divisions, however, have positive ROEs and EVAs. What could explain these performance measures?
a. Division A is riskier than Division B.
b. Division A is much larger (in terms of equity capital employed) than Division B.
c. Division A has less debt than Division B.
d. Statements a and b are correct.
e. All of the statements above are correct.

Answer 32

A

Question 33

You have collected the following information regarding Companies C and D:
• The two companies have the same total assets.
• The two companies have the same operating income (EBIT).
• The two companies have the same tax rate.
• Company C has a higher debt ratio and interest expense than Company D.
• Company C has a lower profit margin than Company D.

On the basis of this information, which of the following statements is most correct?

a. Company C must have a higher level of sales.
b. Company C must have a lower ROE.
c. Company C must have a higher times interest earned (TIE) ratio.
d. Company C must have a lower ROA.
e. Company C must have a higher basic earning power (BEP) ratio.

Answer 33

D

Question 34

An analyst has obtained the following informatiom regarding two companies, Company X and Company Y:
• Company X and Company Y have the same total assets.
• Company X has a higher interest expense than Company Y.
• Company X has a lower operating income (EBIT) than Company Y.
• Company X and Company Y have the same return on equity (ROE).
• Company X and Company Y have the same total assets turnover (TATO).
• Company X and Company Y have the same tax rate.

On the basis of this information, which of the following statements is most correct?

a. Company X has a higher times interest earned (TIE) ratio.
b. Company X and Company Y have the same debt ratio.
c. Company X has a higher return on assets (ROA).
d. Company X has a lower profit margin.
e. Company X has a higher basic earning power (BEP) ratio.

Answer 34

D

Question 35

Lancaster Co. and York Co. both have the same return on assets (ROA). However, Lancaster has a higher total assets turnover and a higher equity multiplier than York. Which of the following statements is most correct?
a. Lancaster has a lower profit margin than York.
b. Lancaster has a lower debt ratio than York.
c. Lancaster has a higher return on equity (ROE) than York.
d. Statements a and c are correct.
e. All of the statements above are correct.

Answer 35

D

Question 36

Blair Company has $5 million in total assets. The company’s assets are financed with $1 million of debt and $4 million of common equity. The company’s income statement is summarized below:
Operating income (EBIT) 1,000,000
Interest 100,000
Earnings before taxes (EBT) 900,000
Taxes (40%) 360,000
Net Income 540,000

The company wants to increase its assets by $1 million, and it plans to finance this increase by issuing $1 million in new debt. This action will double the company’s interest expense but its operating income will remain at 20 percent of its total assets, and its average tax rate will remain at 40 percent. If the company takes this action, which of the following will occur:

a. The company’s net income will increase.
b. The company’s return on assets will fall.
c. The company’s return on equity will remain the same.
d. Statements a and b are correct.
e. All of the statements above are correct.

Answer 36

D

Question 37

Some key financial data and ratios are reported in the table below for Hemmingway Hotels and for its competitor, Fitzgerald Hotels: Ratio, Hemmingway Hotels, Fitzgerald Hotels.
Profit margin 4%, 3%
ROA 9%, 8%
Total assets 2.0 billiom, 1.5 billion
BEP 20%, 20%
ROE 18%, 24%

On the basis of the information above, which of the following statements is most correct?

a. Hemmingway has a higher total assets turnover than Fitzgerald.
b. Hemmingway has a higher debt ratio than Fitzgerald.
c. Hemmingway has higher net income than Fitzgerald.
d. Statements a and b are correct.
e. All of the statements above are correct.

Answer 37

C