Debt-to-equity

C. Quick

D. Profit margin

The debt-to-equity ratio decreases because the ratio denominator (equity) increases and the ratio numerator (total debt) decreases.

AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Understand Difficulty: Medium Learning Objective: 14-04 Compute and interpret profitability ratios. Learning Objective: 14-06 Compute and interpret solvency ratios. Libby - Chapter 14 #97 Topic Area: Ratio and Percentage Analysis

98. Which of the following ratios are not affected by issuing long-term bonds payable in exchange for cash?

A. Debt-to-equity

B. Current

C. Cash Ratio

D. Quality of income

The quality of income ratio remains the same because the ratio numerator (cash flows from operating activities) and denominator (net income) aren't affected by the transaction.

99. The journal entry to record depreciation expense decreases which of the following ratios?

A. Debt-to-equity B. Earnings per share

C. Fixed asset turnover

D. Quality of income

The earnings per share ratio decreased because the numerator (net income) decreases.

100. The cash payment of a previously declared dividend increases which of the following ratios?

A. Debt-to-equity

B. Earnings per share

C. Price earnings ratio D. Asset turnover

The asset turnover ratio increased because the denominator (average total assets) decreases.

AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Understand Difficulty: Medium Learning Objective: 14-04 Compute and interpret profitability ratios. Learning Objective: 14-06 Compute and interpret solvency ratios. Learning Objective: 14-07 Compute and interpret market test ratios. Libby - Chapter 14 #100 Topic Area: Ratio and Percentage Analysis

101. Complete the following income statement (both dollar amounts and component percentages):

Answers will vary

Feedback:

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Hard Learning Objective: 14-03 Compute and interpret component percentages. Libby - Chapter 14 #101 Topic Area: Ratio and Percentage Analysis

102. Packers Corporation reported the following data for the year ended December 31, 2010:

Calculate each of the following ratios: A. Profit margin

B. Return on assets C. Return on equity D. Earnings per share E. Price/earnings ratio F. Debt-to-equity ratio

G. Financial leverage percentage H. Fixed asset turnover ratio Answers will vary

Feedback: A. $25,000 ÷ $400,000 = 6.25% B. ($25,000 + $3,000) ÷ $200,000 = 14% C. $25,000 ÷ $160,000 = 15.6% D. $25,000 ÷ 15,000 shares = $1.67 E. $16 ÷ $1.67 = 9.58 F. ($200,000 - $160,000) ÷ $160,000 = 25% G. 15.6% - 14% = 1.6% (positive) H. $400,000 ÷ $100,000 = 4 times AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-04 Compute and interpret profitability ratios. Learning Objective: 14-07 Compute and interpret market test ratios. Libby - Chapter 14 #102 Topic Area: Ratio and Percentage Analysis

103. At the end of 2010, Jared Corporation reported a return on assets of 16%; net income of $42,000; average total assets of $365,000, and average total liabilities of $165,000. What was Jared's financial leverage percentage?

Answers will vary

Feedback: The return on equity ratio (21%) = Net income ($42,000) ÷ Average stockholders' equity ($200,000)

Financial leverage percentage (5.0%) = Return on equity ratio (21%) - Return on assets ratio (16%)

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-04 Compute and interpret profitability ratios. Libby - Chapter 14 #103 Topic Area: Ratio and Percentage Analysis

104. At the end of 2010, Doran Corporation reported net income of $70,000, gross sales revenue of $1,525,000, and sales returns of $125,000. Calculate the profit margin ratio.

Answers will vary

Feedback: Profit margin (5%) = Net income ($70,000) ÷ Net sales ($1,525,000 - $125,000)

105. The records of Washington Company showed the following:

Calculate each of the following ratios: A. Return on assets

B. Return on equity

C. Financial leverage percentage

D. Is the financial leverage percentage positive or negative? Answers will vary

Feedback: A. [$17,000 + ($2,000 x .70)] ÷ $230,000 = 8% B. $17,000 ÷ $100,000 = 17%

C. 17% - 8% = 9% D. Positive

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Hard Learning Objective: 14-04 Compute and interpret profitability ratios. Libby - Chapter 14 #105 Topic Area: Ratio and Percentage Analysis

106. The 2010 financial statements of Companies Y and Z showed the following:

Answers will vary

Feedback:

Part B: Company Y appears to be a better investment. Company Y's return on equity and return on assets are both higher than Company Z's. Also, financial leverage is greater for Company Y. The fact that Company Y's net income is lower is not necessarily a critical factor.

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-03 Compute and interpret component percentages. Learning Objective: 14-04 Compute and interpret profitability ratios. Libby - Chapter 14 #106 Topic Area: Ratio and Percentage Analysis

107. The following return on investment ratios were computed for Steven Company:

Requirements:

A. Compute financial leverage percentage for each year.

B. Explain briefly the stockholders' advantage or disadvantage for each year. Answers will vary

Feedback: A. 2010: 15% - 12% = +3% positive 2009: 15% - 15% = -0- neither

2008: 11% - 15% = (4%) negative 2007: 20% - 18% = +2% positive

B. 2010: Positive leverage of 3% means the stockholders gained because of the use of debt.

2009: The return on assets increased to 15% but the return on equity did not increase. Stockholders did not gain from the use of debt because leverage was zero.

2008: Negative leverage of 4% means the stockholders lost because of the use of debt.

2007: The increase in the return on equity and the positive leverage of 2% are both favorable to stockholders.

108. The following data were shown in the records of Victoria Company at the end of 2010:

Calculate each of the following ratios: A. Quick ratio

B. Current ratio

C. Receivable turnover ratio D. Inventory turnover ratio E. Average age of receivables

F. Average days' supply in inventory Answers will vary

Feedback: A. $180,000 ÷ $50,000 = 3.6 to 1 B. $225,000 ÷ $50,000 = 4.5 to 1 C. $120,000 ÷ $10,000 = 12 times D. $84,000 ÷ $42,000 = 2 times E. 365 ÷ 12 = 30 days F. 365 ÷ 2 = 183 days AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-05 Compute and interpret liquidity ratios. Libby - Chapter 14 #108 Topic Area: Ratio and Percentage Analysis

109. The following data were available for Holiday Company: Sales revenue, $225,000 (including $75,000 cash sales) Cost of goods sold, $175,000

Average balance in inventory, $20,000

Average balance in accounts receivable, $20,000 Calculate each of the following ratios:

A. Inventory turnover ratio

B. Average days' supply in inventory C. Receivable turnover ratio

D. Average age of receivables Answers will vary

Feedback: A. $175,000 ÷ 20,000 = 8.75 times B. 365 ÷ 8.75 = 42 days

C. $150,000 ÷ $20,000 = 7.5 times D. 365 ÷ 7.5 = 49 days

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-05 Compute and interpret liquidity ratios. Libby - Chapter 14 #109 Topic Area: Ratio and Percentage Analysis

110. Compete Corporation reported a quick ratio of 1.75, current assets of $50,000 and a current ratio of 2. Requirements:

A. Calculate the total amount of quick assets. B. What is another name for the quick ratio?

C. Describe what type of assets are considered quick assets and give some examples. D. How does the quick ratio compare to the current ratio?

Answers will vary

Feedback: A. $50,000 ÷ 2 = $25,000 current liabilities; $25,000 x 1.75 = $43,750 quick assets B. Acid-test ratio

C. Quick assets are assets able to be readily converted to cash usually at their book values. Quick assets often include cash, short-term investments, and net accounts receivable.

D. The quick ratio test of liquidity is a more stringent test of short-term liquidity than the current ratio. It compares quick assets (cash or one step away from cash) to total current liabilities. The quick ratio is less than the current ratio for most companies.

111. The following data were reported by Universe Company at year-end:

Calculate each of the following ratios: A. Debt-to-equity

B. Current ratio C. Quick ratio

D. Which, if any, of the above are liquidity ratios? E. Which, if any, of the above are profitability ratios? Answers will vary

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-05 Compute and interpret liquidity ratios. Learning Objective: 14-06 Compute and interpret solvency ratios. Libby - Chapter 14 #111 Topic Area: Ratio and Percentage Analysis

112. Walkers World Company gathered the following information for 2010:

Calculate each of the following ratios: A. Receivable turnover ratio

B. Average number of days to collect C. Inventory turnover ratio

D. Average number of days' supply of inventory Answers will vary

Feedback: A. [$432,000 x 65%) - $44,000] ÷ [($100,000 - $7,000) + ($70,000 - $5,000)] = 3.0 B. 365 days ÷ 3 = 122 average days' to collect

C. $231,000 ÷ ($28,000 + $38,000)/2 = 7 times D. 365 days ÷ 7 = 52 average days' supply

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Hard Learning Objective: 14-05 Compute and interpret liquidity ratios. Libby - Chapter 14 #112 Topic Area: Ratio and Percentage Analysis

113. Indicate the effect of each item on the ratios given below in the following manner: if an item would cause an increase in the ratio, place a check in the + column; if a decrease place a check in - column; and if no change, check the 0 column. Each item is independent of the others.

Answers will vary

Feedback: A. + (current assets increased) B. - (decrease quick assets by the difference)

C. - (amount of average accounts receivable increased) D. - (increases shares outstanding)

E. + (increase in current assets) F. - (decrease in quick assets)

G. -0- (current assets are unchanged)

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Hard Learning Objective: 14-04 Compute and interpret profitability ratios. Learning Objective: 14-05 Compute and interpret liquidity ratios. Libby - Chapter 14 #113 Topic Area: Ratio and Percentage Analysis

114. Longhorn Company reported the following data at year-end:

Calculate each of the following ratios: A. Debt to equity

B. Current ratio Answers will vary

Feedback: A. ($350,000 - $200,000) ÷ $200,000 = .75 or 75% B. $80,000 ÷ $75,000 = 1.07 to 1

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-05 Compute and interpret liquidity ratios. Learning Objective: 14-06 Compute and interpret solvency ratios. Libby - Chapter 14 #114 Topic Area: Ratio and Percentage Analysis

115. Carolina Company computed the following ratios for a two year period:

Answers will vary

Feedback: A. The current ratio has decreased to half of the 2009 ratio. The company's liquidity is taking a down turn. Currently due bills may not be able to be paid in a timely manner.

B. ROE decreased. The profitability of the company may be of concern.

C. The quality of income ratio went from above one to below one. The 2010 earnings are of lower quality than those of 2009.

D. Cash coverage has plummeted. One might be concerned about the declining amount of cash from operations to pay interest payments.

E. Since the profit margin declined from 2009 to 2010, less of each sales dollar is realized in income. Note: Overall, the company is experiencing unfavorable trends.

116. The following financial data are available for Murphy Company:

Calculate each of the following ratios: A. Return on equity

B. Price/earnings ratio C. Dividend yield Answers will vary

Feedback: A. Return on equity 19.93% ($196,300/$985,000) B. Price earnings ratio 10 ($24.50/$2.45)

C. Dividend yield 5.10% ($1.25/$24.50)

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-04 Compute and interpret profitability ratios. Learning Objective: 14-07 Compute and interpret market test ratios. Libby - Chapter 14 #116 Topic Area: Ratio and Percentage Analysis

117. The following data were reported for Favre Company:

Calculate each of the following ratios: A. Dividend yield

B. Price/earnings ratio C. Quality of income Answers will vary

Feedback: A. 3.0% (.60/20)

B. EPS = $275,000 ÷ 175,000 shares = $1.57 PE = $20 ÷ $1.57 = 12.74

C. $280,000 ÷ 275,000 = 1.02

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-04 Compute and interpret profitability ratios. Learning Objective: 14-07 Compute and interpret market test ratios. Libby - Chapter 14 #117 Topic Area: Ratio and Percentage Analysis

118. Polk Corporation reported the following information related to its common stock (par $10) outstanding and net income:

Calculate each of the following ratios: A. Price/earnings ratio

B. Dividend yield Answers will vary

Feedback: A. $40 ÷ [($35,000) ÷ ($40,000 ÷ $10)] = 4.57 B. ($10,000 ÷ 4,000 shares) ÷ $40 = 6.25%

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-07 Compute and interpret market test ratios. Libby - Chapter 14 #118 Topic Area: Ratio and Percentage Analysis

119. MNF Corporation gathered the following data at the end of the accounting period, December 31, 2009:

Part 1: Calculate each of the following ratios: A. Profit margin

B. Return on equity C. Earnings per share D. Dividend yield ratio E. Price/earnings ratio F. Return on assets

G. Financial leverage percentage

Part 2: Interpret the financial leverage percentage. Answers will vary

Feedback: Part 1: A. $60,000 ÷ $1,200,000 = 5% B. $60,000 ÷ $300,000 = 20% C. $60,000 ÷ 50,000 shares = $1.20 D. ($22,500 ÷ 50,000 shares) ÷ $9 = 5% E. $9.00 ÷ $1.20 = 7.5 F. [$60,000 + ($25,000 x .60)] ÷ $500,000 = 15% G. 20% - 15% = 5%

Part 2: The advantage is favorable to the stockholders if the ratio is positive, and it is unfavorable to the stockholders if the ratio is negative because of the difference between earnings on total assets and the cost of debt (interest expense net of income tax). For MNF Corporation, the company's stockholders are benefiting from financial leverage because the cost of borrowing is less than the return to the shareholders.

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Blooms: Apply Difficulty: Medium Learning Objective: 14-04 Compute and interpret profitability ratios. Learning Objective: 14-07 Compute and interpret market test ratios. Libby - Chapter 14 #119 Topic Area: Ratio and Percentage Analysis

ch14 Summary

Category # of Questions

AACSB: Analytic 57

AACSB: Reflective Thinking 62

AICPA BB: Critical Thinking 119

AICPA FN: Decision Making 1

AICPA FN: Measurement 114 AICPA FN: Reporting 4 Blooms: Apply 57 Blooms: Remember 12 Blooms: Understand 50 Difficulty: Easy 15 Difficulty: Hard 15 Difficulty: Medium 89

Learning Objective: 14-01 Explain how a companys business strategy affects financial analysis. 10 Learning Objective: 14-02 Discuss how analysts use financial statements. 5 Learning Objective: 14-03 Compute and interpret component percentages. 8 Learning Objective: 14-04 Compute and interpret profitability ratios. 50 Learning Objective: 14-05 Compute and interpret liquidity ratios. 33 Learning Objective: 14-06 Compute and interpret solvency ratios. 20 Learning Objective: 14-07 Compute and interpret market test ratios. 18

Libby - Chapter 14 119

Topic Area: Financial Statement Analysis 19

Topic Area: Ratio and Percentage Analysis 90

In document ch14 (Page 64-80)