Company j and company k each recently reported the same earnings per

Ch. 3





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 correct?





A. a. Company J must have a higher P/E ratio.


B. b. Company J must have a higher market to book ratio.


C. c. Company J must be riskier


D. d. Company J must have fewer growth opportunities.


E. e. All of the statements above are correct.


Question 2 of 20



Which of the following statements is correct?





A. a. Many large firms operate different divisions in different industries, and this makes it hard to develop a meaningful set of industry benchmarks for these types of firms.


B. b. Financial ratios should be interpreted with caution because there exist seasonal and accounting differences that can reduce their comparability.


C. c. Financial ratios should be interpreted with caution because it may be difficult to say with certainty what is a “good” value. For example, in the case of the current ratio, a “good” value is neither high nor low.


D. d. Ratio analysis facilitates comparisons by standardizing numbers.


E. e. All of the statements above are correct.


Question 3 of 20



Which of the following actions can a firm take to increase its current ratio?





A. a. Issue short-term debt and use the proceeds to buy back long-term debt with a maturity of more than one year.


B. b. Reduce the company’s days sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.


C. c. Use cash to purchase additional inventory.


D. d. Statements a and b are correct.


E. e. None of the statements above is correct.


Question 4 of 20



Which of the following actions will cause an increase in the quick ratio in the short run?





A. a. $1,000 worth of inventory is sold, and an account receivable is created. The receivable exceeds the inventory by the amount of profit on the sale, which is added to retained earnings.


B. b. A small subsidiary which was acquired for $100,000 two years ago and which was generating profits at the rate of 10 percent is sold for $100,000 cash. (Average company profits are 15 percent of assets.)


C. c. Marketable securities are sold at cost.


D. d. All of the answers above.


E. e. Answers a and b above.




Question 5 of 20



Company A is financed with 90 percent debt, whereas Company B, which has the same amount of total assets, is financed entirely with equity. Both companies have a marginal tax rate of 35 percent. Which of the following statements is correct?





A. a. If the two companies have the same basic earning power (BEP), Company B will have a higher return on assets.


B. b. If the two companies have the same return on assets, Company B will have a higher return on equity.


C. c. If the two companies have the same level of sales and basic earning power (BEP), Company B will have a lower profit margin.


D. d. All of the answers above are correct.


E. e. None of the answers above is correct.



Question 6 of 20



The Wilson Corporation has the following relationships:


Sales/Total assets


Return on assets (ROA)


Return on equity (ROE)



What is Wilson’s profit margin and debt ratio?





A. a. 2% and 0.33


B. b. 4% and 0.33


C. c. 4% and 0.67


D. d. 2% and 0.67


E. e. 4% and 0.50



Reset Selection





Q Corp. has a basic earnings power (BEP) ratio of 15 percent, and has a times interest earned (TIE) ratio of 6. Total assets are $100,000. The corporate tax rate is 40 percent. What is Q Corp.’s return on assets (ROA)?





A. a. 7.5%


B. b. 10.0%


C. c. 12.2%


D. d. 13.1%


E. e. 14.5%






Kansas Office Supply had $24,000,000 in sales last year. The company’s net income was $400,000. Its total assets turnover was 6.0. The company’s ROE was 15 percent. The company is financed entirely with debt and common equity. What is the company’s debt ratio?





A. a. 0.20


B. b. 0.30


C. c. 0.33


D. d. 0.60


E. e. 0.66





Question 9 of 20= Inc.


Net income = $200,000


Earnings per share = $2.00


Stockholders’ equity = $2,000,000


Market/Book ratio = 0.20





A. a. $20.00


B. b. $ 8.00


C. c. $ 4.00


D. d. $ 2.00


E. e. $ 1.00






Taft Technologies has the following relationships:


annual sales


current liabilities


days sales outstanding(DSO)(360-day year)


Inventory Turnover Ratio


current ratio



The company’s current assets consist of cash, inventories, and accounts receivable. How much cash does Taft have on its balance sheet?





A. -$ 8,333


B. $ 66,667


C. $125,000


D. $200,000


E. $316,667






Info Technics Inc. has an equity multiplier of 2.50. The company’s assets are financed with some combination of long-term debt and common equity. What is the company’s debt ratio?





A. a. 51.20%


B. b. 26.00%


C. c. 39.36%


D. d. 65.00%


E. e. 60.00%






Cutler Enterprises has current assets equal to $5 million. The company’s current ratio is 1.25, and its quick ratio is 0.75. What is the firm’s level of current liabilities (in millions)?





A. a. $2.85


B. b. $3.0


C. c. $4.0


D. d. $0.9


E. e. 1.9


Question 13 of 20



Lewis Inc. has sales of $3,600,000 per year, all of which are credit sales. Its days sales outstanding is 42 days. What is its average accounts receivable balance? Assume 360 days per year.





A. a. $238,090


B. b. $420,000


C. c. $280,000


D. d. $386,000


E. e. $400,000






A firm has total interest charges of $20,000 per year, sales of $2,800,000, a tax rate of 40 percent, and a profit margin of 6 percent. What is the firm’s times-interest-earned ratio?





A. a. 15


B. b. 12.5


C. c. 11.5


D. d. 15.8


E. e. 16






A fire has destroyed many of the financial records at Anderson Associates. You are assigned to piece together information to prepare a financial report. You have found that the firm’s return on equity is 12 percent and its debt ratio is 0.20. What is its return on assets?





A. a. 6.40%


B. b. 4.85%


C. c. 9.60%


D. d. 8.50%


E. e. 6.90%






Rowe and Company has a debt ratio of 0.20, a total assets turnover of 0.25, and a profit margin of 10 percent. The president is unhappy with the current return on equity, and he thinks it could be doubled. This could be accomplished (1) by increasing the profit margin to 14 percent and (2) by increasing debt utilization. Total assets turnover will not change. What new debt ratio, along with the 14 percent profit margin, is required to double the return on equity?





A. a. 0.50


B. b. 0.56


C. c. 0.88


D. d. 0.78


E. e. 0.44






Pinkerton Packaging’s ROE last year was 4.5 percent, but its management has developed a new operating plan designed to improve things. The new plan calls for a total debt ratio of 50 percent, which will result in interest charges of $240 per year. Management projects an EBIT of $800 on sales of $8,000, and it expects to have a total assets turnover ratio of 1.6. Under these conditions, the federal-plus-state tax rate will be 40 percent. If the changes are made, what return on equity will Pinkerton earn?





A. a. 2.50%


B. b. 13.44%


C. c. 13.00%


D. d. 14.02%


E. e. 14.57%






Examining the ratios of a particular firm against the same measures for a small group of firms from the same industry, at a point in time, is an example of





A. a. Trend analysis.


B. b. Benchmarking.


C. c. Du Pont analysis.


D. d. Simple ratio analysis.


E. e. Industry analysis.






Which of the following statements is correct?





A. a. Having a high current ratio and a high quick ratio is always a good indication that a firm is managing its liquidity position well.


B. b. A decline in the inventory turnover ratio suggests that the firm’s liquidity position is improving.


C. c. If a firm’s times-interest-earned ratio is relatively high, then this is one indication that the firm should be able to meet its debt obligations.


D. d. Since ROA measures the firm’s effective utilization of assets (without considering how these assets are financed), two firms with the same EBIT must have the same ROA.


E. e. If, through specific managerial actions, a firm has been able to increase its ROA, then, because of the fixed mathematical relationship between ROA and ROE, it must also have increased its ROE.






Which of the following statements is correct?





A. a. Suppose two firms with the same amount of assets pay the same interest rate on their debt and earn the same rate of return on their assets and that ROA is positive. However, one firm has a higher debt ratio. Under these conditions, the firm with the higher debt ratio will also have a higher rate of return on common equity.


B. b. One of the problems of ratio analysis is that the relationships are subject to manipulation. For example, we know that if we use some cash to pay off some of our current liabilities, the current ratio will always increase, especially if the current ratio is weak initially, for example, below 1.0.


C. c. Generally, firms with high profit margins have high asset turnover ratios and firms with low profit margins have low turnover ratios; this result is exactly as predicted by the extended Du Pont equation.


D. d. Firms A and B have identical earnings and identical dividend payout ratios. If Firm A’s growth rate is higher than Firm Bs, then Firm A’s P/E ratio must be greater than Firm B’s P/E ratio.


E. e. Each of the above statements is false.





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