MODULE 10
FINANCIAL STATEMENT ANALYSIS THEORIES:
6. Management is a user of financial analysis. Which of the following comments does not represent a fair statement as to the management perspective?
A. Management is always interested in maximum profitability. B. Management is interested in the view of investors.
C. Management is interested in the financial structure of the entity. D. Management is interested in the asset structure of the entity. Limitations
1. A limitation in calculating ratios in financial statement analysis is that
A. it requires a calculator.
B. no one other than the management would be interested in them.
C. some account balances may reflect atypical data at year end. D. they seldom identify problem areas in a company.
2. Which of the following is not a limitation of financial statement analysis?
A. The cost basis. C. The diversification of firms. B. The use of estimates. D. The availability of
information.
5. Which of the following does not represent a problem with financial analysis?
A. Financial statement analysis is an art; it requires judgment decisions on the part of the analyst.
B. Financial analysis can be used to detect apparent liquidity problems.
C. There are as many ratios for financial analysis as there are pairs of figures.
D. Some industry ratio formulas vary from source to source.
77.The use of alternative accounting methods:
A. is not a problem in ratio analysis because the footnotes disclose the method used.
B. may be a problem in ratio analysis even if disclosed.
C. is not a problem in ratio analysis since eventually all methods will lead to the same end.
D. is only a problem in ratio analysis with respect to inventory. Industry Analysis
3. Suppose you are comparing two firms in the steel industry. One firm is large and the other is small. Which type of numbers would be most meaningful for statement analysis?
A. Absolute numbers would be most meaningful for both the large and small firm.
B. Absolute numbers would be most meaningful in the large firm; relative numbers would be most meaningful in the small firm. C. Relative numbers would be most meaningful for the large firm;
absolute numbers would be most meaningful for the small firm. D. Relative numbers would be most meaningful for both the large
and small firm, especially for interfirm comparisons. 4. Which of these statements is false?
A. Many companies will not clearly fit into any one industry.
B. A financial service uses its best judgment as to which industry the firm best fits.
C. The analysis of an entity's financial statements can be more meaningful if the results are compared with industry averages and with results of competitors.
D. A company comparison should not be made with industry averages if the company does not clearly fit into any one industry.
Common-sized financial statements
9. Which of the following generally is the most useful in analyzing companies of different sizes?
A. comparative statements C. price-level accounting
12.Statements in which all items are expressed only in relative terms (percentages of a base) are termed:
A. Vertical statements C. Funds Statements
B. Horizontal Statements D. Common-Size Statements 10.The percent of property, plant and equipment to total assets is an
example of:
A. vertical analysis C. profitability analysis B. solvency analysis D. horizontal analysis
15.Vertical analysis is a technique that expresses each item in a financial statement
A. in pesos and centavos.
B. as a percent of the item in the previous year. C. as a percent of a base amount.
D. starting with the highest value down to the lowest value.
17.In performing a vertical analysis, the base for prepaid expenses is A. total current assets. C. total liabilities.
B. total assets. D. prepaid expenses in a previous year.
Horizontal analysis
8. The percentage analysis of increases and decreases in individual items in comparative financial statements is called:
A. vertical analysis C. profitability analysis B. solvency analysis D. horizontal analysis 11.Horizontal analysis is also known as
A. linear analysis. C. trend analysis.
B. vertical analysis. D. common size analysis.
13.In which of the following cases may a percentage change be computed?
A. The trend of the amounts is decreasing but all amounts are positive.
B. There is no amount in the base year.
C. There is a negative amount in the base year and a negative
amount in the subsequent year.
D. There is a negative amount in the base year and a positive amount in the subsequent year.
14.Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time
A. that has been arranged from the highest number to the lowest number.
B. that has been arranged from the lowest number to the highest number.
C. to determine which items are in error.
D. to determine the amount and/or percentage increase or decrease that has taken place.
Trend analysis
16.Trend analysis allows a firm to compare its performance to: A. other firms in the industry C. other industries
B. other time periods within the firmD. none of the above Risk and return
29.The present and prospective stockholders are primarily concerned with a firm’
A. profitability C. leverage B. liquidity D. risk and return
69.Which suppliers of funds bear the greatest risk and should therefore earn the greatest return?
A. common stockholders C. preferred shareholders B. general creditors such as banks D. bondholders Measures of Risk
54.The following groups of ratios primarily measure risk:
A. liquidity, activity, and common equity C. liquidity, activity, and debt
B. liquidity, activity, and profitability D. activity, debt, and profitability
7. Ratios are used as tools in financial analysis A. instead of horizontal and vertical analyses.
B. because they can provide information that may not be apparent from inspection of the individual components of a particular ratio.
C. because even single ratios by themselves are quite meaningful. D. because they are prescribed by GAAP.
18.In the near term, the important ratios that provide the information critical to the short-run operation of the firm are:
A. liquidity, activity, and profitability C. liquidity, activity, and equity
B. liquidity, activity, and debt D. activity, debt, and profitability 75.The ability of a business to pay its debts as they come due and to
earn a reasonable amount of income is referred to as: A. solvency and leverage C. solvency and liquidity B. solvency and profitability D. solvency and equity Liquidity ratios
Interested parties
19.The primary concern of short-term creditors when assessing the strength of a firm is the entity’s
A. short-term liquidity C. market price of stock B. profitability D. leverage
35.Short-term creditors are usually most interested in assessing A. solvency. C. marketability.
B. liquidity. D. profitability.
36.The two categories of ratios that should be utilized to asses a firm’s true liquidity are the
A. current and quick ratios C. liquidity and profitability ratios B. liquidity and debt ratios D. liquidity and activity ratios 47.Which of the following is the most of interest to a firm’s suppliers?
A. profitability C. asset utilization
B. debt D. liquidity
Measures of liquidity
21.The ratios that are used to determine a company’s short-term debt paying ability are
A. asset turnover, times interest earned, current ratio, and receivables turnover.
B. times interest earned, inventory turnover, current ratio, and receivables turnover.
C. times interest earned, acid-test ratio, current ratio, and inventory turnover.
D. current ratio, acid-test ratio, receivables turnover, and inventory turnover.
20.Which of the following is a measure of the liquidity position of a corporation?
A. earnings per share B. inventory turnover C. current ratio
D. number of times interest charges earned
37.Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company?
A. Current ratio C. Asset turnover
B. Acid-test ratio D. Receivables turnover
51.Which of the following ratios would be least helpful in appraising the liquidity of current assets?
A. Accounts Receivable turnoverC. Current Ratio
B. Days’ sales in inventory D. Days’ sales in accounts receivable
53.Which ratio is most helpful in appraising the liquidity of current assets?
A. current ratio C. acid-test ratio
B. debt ratio D. accounts receivable turnover
79.Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company?
A. accounts receivable turnover. C. acid test ratio. B. asset turnover. D. current ratio.
Current ratio
24.Typically, which of the following would be considered to be the most indicative of a firm's short-term debt paying ability?
A. working capital C. acid test ratio
B. current ratio D. days’ sales in receivables 22.The current ratio is
A. calculated by dividing current liabilities by current assets.
B. used to evaluate a company’s liquidity and short-term debt paying ability.
C. used to evaluate a company’s solvency and long-term debt paying ability.
D. calculated by subtracting current liabilities from current assets. 30.Which of the following ratios is rated to be a primary measure of
liquidity and considered of highest significance rating of the liquidity ratios a bank analyst?
A. Debt/Equity B. Current ratio
C. Degree of Financial Leverage
D. Accounts Receivable Turnover in Days 41.A weakness of the current ratio is
A. the difficulty of the calculation.
B. that it does not take into account the composition of the current assets.
C. that it is rarely used by sophisticated analysts.
D. that it can be expressed as a percentage, as a rate, or as a proportion.
Acid-test or quick ratio
42.A measure of a company’s immediate short-term liquidity is the
A. current ratio.
B. current cash debt coverage ratio. C. cash debt coverage ratio.
D. acid-test ratio.
23.The acid-test or quick ratio
A. is used to quickly determine a company’s solvency and long-term debt paying ability.
B. relates cash, short-term investments, and net receivables to current liabilities.
C. is calculated by taking one item from the income statement and one item from the balance sheet.
D. is the same as the current ratio except it is rounded to the nearest whole percent.
Not a liquidity ratio
28.Which one of the following would not be considered a liquidity ratio? A. Current ratio. C. Quick ratio.
B. Inventory turnover. D. Return on assets. Activity ratios
Days receivable & receivable turnover
Quality of receivables
25.Which of the following does not bear on the quality of receivables? A. shortening the credit terms
B. lengthening the credit terms
C. lengthening the outstanding period
D. all of the above bear on the quality of receivables
Days receivable
27.A general rule to use in assessing the average collection period is A. that is should not exceed 30 days.
B. it can be any length as long as the customer continues to buy merchandise.
C. that it should not greatly exceed the discount period. D. that it should not greatly exceed the credit term period. Asset utilization ratios
Performance measures
65.All of the following are asset utilization ratios except: A. average collection period C. receivables turnover B. inventory turnover D. return on assets Asset turnover
63.Asset turnover measures
A. how often a company replaces its assets.
B. how efficiently a company uses its assets to generate sales. C. the portion of the assets that have been financed by creditors. D. the overall rate of return on assets.
66.Total asset turnover measures the ability of a firm to: A. generate profits on sales
B. generate sales through the use of assets C. cover long-term debt
D. buy new assets
76.A measure of how efficiently a company uses its assets to generate sales is the
A. asset turnover ratio. C. profit margin ratio. B. cash return on sales ratio. D. return on assets ratio. Solvency ratios
Interested parties
50.Long-term creditors are usually most interested in evaluating A. liquidity. C. profitability.
B. marketability. D. solvency. Financial Leverage
45.Trading on the equity (leverage) refers to the A. amount of working capital.
B. amount of capital provided by owners.
C. use of borrowed money to increase the return to owners. D. earnings per share.
90.The tendency of the rate earned on stockholders' equity to vary disproportionately from the rate earned on total assets is
sometimes referred to as:
A. leverage C. yield
B. solvency D. quick assets
55.Using financial leverage is a good financial strategy from the viewpoint of stockholders of companies having:
A. a high debt ratio C. a steadily declining current ratio
B. steady or rising profits D. cyclical highs and lows
46.The ratio that indicates a company’s degree of financial leverage is the
A. cash debt coverage ratio. C. free cash flow ratio.
B. debt to total assets. D. times-interest earned ratio. 73.Interest expense creates magnification of earnings through
financial leverage because:
A. while earnings available to pay interest rise, earnings to residual owners rise faster
B. interest accompanies debt financing
C. interest costs are cheaper than the required rate of return to equity owners
S. the use of interest causes higher earnings Measures of solvency
34.The set of ratios that is most useful in evaluating solvency is A. debt ratio, current ratio, and times interest earned
B. debt ratio, times interest earned, and return on assets C. debt ratio, times interest earned, and quick ratio
D. debt ratio, times interest earned, and cash flow to debt
49.Which of the following ratios is most relevant to evaluating solvency?
A. Return on assets C. Days’ purchases in accounts payable
B. Debt ratio D. Dividend yield
44.Which of the following ratios provides a solvency measure that shows the margin of safety of noteholders or bondholders and also gives an indication of the potential ability of the business to borrow additional funds on a long-term basis?
A. ratio of fixed assets to long-term liabilities B. ratio of net sales to assets
C. number of days' sales in receivables D. rate earned on stockholders' equity Debt ratio
59.The debt ratio indicates:
A. a comparison of liabilities with total assets
B. the ability of the firm to pay its current obligations C. the efficiency of the use of total assets
D. the magnification of earnings caused by leverage 78.The debt to total assets ratio measures
A. the company’s profitability.
B. whether interest can be paid on debt in the current year. C. the proportion of interest paid relative to dividends paid. D. the percentage of the total assets provided by creditor. Debt-to-equity ratio
60.Which of the following statements best compares long-term borrowing capacity ratios?
A. The debt/equity ratio is more conservative than the debt ratio. B. The debt to tangible net worth ratio is more conservative than
the debt/equity ratio.
C. The debt/equity ratio is more conservative than the debt to tangible net worth ratio.
D. The debt ratio is more conservative than the debt/equity ratio. Times interest earned
74.A times interest earned ratio of 0.90 to 1 means that A. the firm will default on its interest payment
B. net income is less than the interest expense C. the cash flow is less than the net income D. the cash flow exceeds the net income
Fixed charge coverage 61.A fixed charge coverage:
A. is a balance sheet indication of debt carrying ability B. is an income statement indication of debt carrying ability C. frequently includes research and development
D. computation is standard from firm to firm Off-balance sheet liabilities
62.If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in the financial statements, then the
A. times interest earned ratio will be overstated, based upon the financial statements
B. debt ratio will be understated C. working capital will be understated
D. fixed charge ratio will be overstated, based upon the financial statements
Profitability ratios Interested parties
39.The return on assets ratio is affected by the A. asset turnover ratio.
B. debt to total assets ratio. C. profit margin ratio.
D. asset turnover and profit margin ratios. 52.Stockholders are most interested in evaluating
A. liquidity. C. profitability. B. solvency. D. marketability. Performance measures
48.The set of ratios that are most useful in evaluating profitability is A. ROA, ROE, and debt to equity ratio C. ROA, ROE, and
acid-test ratio
B. ROA, ROE, and dividend yield D. ROA, ROE, and cash flow to debt
82.Which of the following ratios appears most frequently in annual reports?
A. Earnings per Share C. Profit Margin B. Return on Equity D. Debt/Equity Return on assets
64.Return on assets
A. can be determined by looking at a balance sheet B. should be smaller than return on sales
C. can be affected by the company’s choice of a depreciation method
D. should be larger than return on equity Return on investments
72.Return on investment measures:
A. return to all suppliers of funds C. return to all long-term suppliers of funds
B. return to all long-term creditors D. return to stockholders Market test ratios
Price-earnings ratio
56.The price/earnings ratio
A. measures the past earning ability of the firm
B. is a gauge of future earning power as seen by investors C. relates price to dividends
D. relates
58.Which of the following ratios usually reflects investors opinions of the future prospects for the firm?
A. dividend yield C. book value per share B. price/earnings ratio D. earnings per share Dividend yield
57.Which of the following ratios represents dividends per common share in relation to market price per common share?
A. dividend payout C. price/earnings
B. dividend yield D. book value per share
Financial Statement Analysis Accounts Receivable
26.Which of the following reasons should not be considered in order to explain why the receivables appear to be abnormally high?
A. Sales volume decreases materially late in the year.
B. Receivables have collectibility problems and possibly some should have been written off.
C. Material amount of receivables are on the installment basis. D. Sales volume expanded materially late in the year.
31.An acceleration in the collection of receivables will tend to cause the accounts receivable turnover to:
A. decrease C. either increase or decrease B. remain the same D. increase
Inventories
32.Which of the following would best indicate that the firm is carrying excess inventory?
A. a decline in the current ratio
B. stable current ratio with declining quick ratios C. a decline in days' sales in inventory
D. a rise in total asset turnover
89.When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an average quick ratio, and a low inventory turnover. What might you assume about Tri-C?
A. Its cash balance is too low. C. Its current liabilities are too low.
B. Its cost of goods sold is too low. D. Its average inventory is too high.
Current ratio
33.Which of the following would be most detrimental to a firm's current ratio if that ratio is currently 2.0?
A. Buy raw materials on credit B. Sell marketable securities at cost C. Pay off accounts payable with cash
Fixed asset turnover ratio
68.Which of the following circumstances will cause sales to fixed assets to be abnormally high?
A. A labor-intensive industry.
B. The use of units-of-production depreciation. C. A highly mechanized facility.
D. High direct labor costs from a new union contract. Total asset turnover
81.A firm with a total asset turnover lower than the industry standard and a current ratio which meets industry standard might have excessive:
A. Accounts receivable C. Debt
B. Fixed assets D. Inventory
Profitability analysis
84.Denver Dynamics has net income of P2,000,000. Oakland Enterprises has net income of P2,500,000. Which of the following best compares the profitability of Denver and Oakland?
A. Oakland Enterprises is 25% more profitable than Denver Dynamics.
B. Oakland Enterprises is more profitable than Denver Dynamics, but the comparison can't be quantified.
C. Oakland Enterprises is only more profitable if it is smaller than Denver Dynamics.
D. Further information is needed for a reasonable comparison. Debt ratio
86.Companies A and B are in the same industry and have similar characteristics except that Company A is more leveraged than Company B. Both companies have the same income before interest and taxes and the same total assets. Based on this information we could conclude that
A. Company A has higher net income than Company B B. Company A has a lower return on assets than company B C. Company A is more risky than Company B.
D. Company A has a lower debt ratio than company B
Sensitivity Analysis Current ratio
40.A firm has a current ratio of 1:1. In order to improve its liquidity ratios, this firm should
A. improve its collection practices, thereby increasing cash and increasing its current and quick ratios.
B. improve its collection practices and pay accounts payable, there decreasing current liabilities and increasing the current and quick ratios.
C. decrease current liabilities by utilizing more long-term debt, thereby increasing the current and quick ratios.
D. increase inventory, thereby increasing current assets and the current and quick ratios.
43.Recently the M&M Company has been having problems. As a result, its financial situation has deteriorated. M&M approached the First National Bank for a badly needed loan, but the loan officer insisted that the current ratio (now 0.5) be improved to at least 0.8 before the bank would even consider granting the credit. Which of the following actions would do the most to improve the ratio in the short run?
A. Using some cash to pay off some current liabilities. B. Collecting some of the current accounts receivable. C. Paying off some long-term debt.
D. Purchasing additional inventory on credit (accounts payable). 87.Tyner Company had P250,000 of current assets and P90,000 of
current liabilities before borrowing P60,000 from the bank with a 3-month note payable. What effect did the borrowing transaction have on Tyner Company's current ratio?
A. The ratio remained unchanged.
B. The change in the current ratio cannot be determined. C. The ratio decreased.
D. The ratio increased.
88.Which of the following actions will increase a firm's current ratio if it is now less than 1.0?
A. Convert marketable securities to cash. B. Pay accounts payable with cash.
C. Buy inventory with short term credit (i.e. accounts payable). D. Sell inventory at cost.
Acid-test ratio
38.If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of cash by short-term debt and collection of accounts receivable have on the ratio?
A. B. C. D.
Short-term borrowing
Increase Increase Decrease Decrease Collection of
receivable No effect Increase No effect Decrease Profit margin
70.Which of the following would most likely cause a rise in net profit margin?
A. increased sales C. decreased operating expenses B. decreased preferred dividends D. increased cost of sales
Return on assets
67.Return on assets cannot fall under which of the following circumstances?
A. B. C. D.
Net profit
margin Decline Rise Rise Decline
Total asset
turnover Rise Decline Rise Decline
Debt ratio
83.Jones Company has long-term debt of P1,000,000, while Smith Company, Jones' competitor, has long-term debt of P200,000. Which of the following statements best represents an analysis of the long-term debt position of these two firms?
A. Jones obviously has too much debt when compared to its competitor.
B. Smith Company's times interest earned should be lower than Jones.
C. Smith has five times better long-term borrowing ability than Jones.
D. Not enough information to determine if any of the answers are correct.
Times interest earned
85.Which of the following will not cause times interest earned to drop? Assume no other changes than those listed.
A. A rise in preferred stock dividends.
B. A drop in sales with no change in interest expense. C. An increase in interest rates.
D. An increase in bonds payable with no change in operating income.
DuPont Analysis
71.Which of the following could cause return on assets to decline when net profit margin is increasing?
A. sale of investments at year-end C. purchase of a new building at year-end
B. increased turnover of operating assets D. a stock split
80.A firm with a lower net profit margin can improve its return on total assets by
A. increasing its debt ratio C. increasing its total asset turnover
B. decreasing its fixed assets turnover D. decreasing its total asset turnover
PROBLEMS:
Horizontal analysis
1. Kline Corporation had net income of P2 million in 2006. Using the
2006 financial elements as the base data, net income decreased by 70 percent in 2007 and increased by 175 percent in 2008. The respective net income reported by Kline Corporation for 2007 and 2008 are:
A. P 600,000 and P5,500,000 C. P1,400,000 and P3,500,000 B. P5,500,000 and P 600,000 D. P1,400,000 and P5,500,000
2. Assume that Axle Inc. reported a net loss of P50,000 in 2006 and
net income of P250,000 in 2007. The increase in net income of P300,000:
A. can be stated as 0% C. cannot be stated as a percentage
B. can be stated as 100% increase D. can be stated as 200% increase
Liquidity ratios
3. The following financial data have been taken from the records of
Ratio Company:
Accounts receivable P200,000
Accounts payable 80,000
Bonds payable, due in 10 years 500,000
Cash 100,000
Interest payable, due in three months 25,000
Inventory 440,000
Land 800,000
Notes payable, due in six months 250,000 What will happen to the ratios below if Ratio Company uses cash to pay 50 percent of its accounts payable?
A. B. C. D.
Current ratio
Increase Decrease Increase Decrease Acid-test
ratio Increase Decrease Decrease Increase Question Nos. 4 through 6 are based on the data taken from the balance sheet of Nomad Company at the end of the current year:
Accounts payable P145,000
Accounts receivable 110,000
Accrued liabilities 4,000
Cash 80,000
Income tax payable 10,000
Inventory 140,000
Marketable securities 250,000
Notes payable, short-term 85,000
Prepaid expenses 15,000
4. The amount of working capital for the company is:
A. P351,000 C. P211,000
B. P361,000 D. P336,000
5. The company’s current ratio as of the balance sheet date is:
A. 2.67:1 C. 2.02:1
B. 2.44:1 D. 1.95:1
6. The company’s acid-test ratio as of the balance sheet date is:
A. 1.80:1 C. 2.02:1
B. 2.40:1 D. 1.76:1
Activity ratios Receivables turnover
7. Pine Hardware Store had net credit sales of P6,500,000 and cost of
goods sold of P5,000,000 for the year. The Accounts Receivable balances at the beginning and end of the year were P600,000 and P700,000, respectively. The receivables turnover was
A. 7.7 times. C. 9.3 times. B. 10.8 times. D. 10.0 times.
8. Milward Corporation’s books disclosed the following information for
the year ended December 31, 2007:
Net credit sales P1,500,000
Net cash sales 240,000
Accounts receivable at beginning of year 200,000 Accounts receivable at end of year 400,000 Milward’s accounts receivable turnover is
A. 3.75 times C. 5.00 times B. 4.35 times D. 5.80 times Days receivable
9. Batik Clothing Store had a balance in the Accounts Receivable
P410,000 at the end of the year. The net credit sales during the year amounted to P4,000,000. Using 360-day year, what is the average collection period of the receivables?
A. 30 days C. 73 days
B. 65 days D. 36 days
Cash collection
10. Deity Company had sales of P30,000, increase in accounts payable
of P5,000, decrease in accounts receivable of P1,000, increase in inventories of P4,000, and depreciation expense of P4,000. What was the cash collected from customers?
A. P31,000 C. P34,000
B. P35,000 D. P25,000
Inventory turnover
11. During 2007, Tarlac Company purchased P960,000 of inventory.
The cost of goods sold for 2007 was P900,000, and the ending inventory at December 31, 2007 was P180,000. What was the inventory turnover for 2007?
A. 6.4 C. 5.3
B. 6.0 D. 5.0
12. Selected information from the accounting records of Petals
Company is as follows:
Net sales for 2007 P900,000
Cost of goods sold for 2007 600,000 Inventory at December 31, 2006 180,000
Inventory at December 31, 2007 156,000 Petals’ inventory turnover for 2007 is
A. 5.77 times C. 3.67 times B. 3.85 times D. 3.57 times
13. The Moss Company presents the following data for 2007.
Net Sales, 2007 P3,007,124
Net Sales, 2006 P 930,247
Cost of Goods Sold, 2007 P2,000,326 Cost of Goods Sold, 2007 P1,000,120 Inventory, beginning of 2007 P 341,169
Inventory, end of 2007 P 376,526
The merchandise inventory turnover for 2007 is:
A. 5.6 C. 7.5
B. 15.6 D. 7.7
14. Based on the following data for the current year, what is the
inventory turnover?
Net sales on account during year P 500,000 Cost of merchandise sold during year 330,000 Accounts receivable, beginning of year 45,000 Accounts receivable, end of year 35,000 Inventory, beginning of year 90,000
Inventory, end of year 110,000
A. 3.3 C. 3.7
B. 8.3 D. 3.0
Days inventory
15. Selected information from the accounting records of Eternity
Manufacturing Company follows:
Net sales P3,600,000
Cost of goods sold 2,400,000
Inventories at January 1 672,000 Inventories at December 31 576,000 What is the number of days’ sales in average inventories for the year? A. 102.2 C. 87.6 B. 94.9 D. 68.1 Turnover ratios Asset turnover Asset
16. Net sales are P6,000,000, beginning total assets are P2,800,000,
and the asset turnover is 3.0. What is the ending total asset balance?
A. P2,000,000. C. P2,800,000.
B. P1,200,000. D. P1,600,000.
Debt ratio
17. Jordan Manufacturing reports the following capital structure:
Current liabilities P100,000
Long-term debt 400,000
Deferred income taxes 10,000
Preferred stock 80,000
Common stock 100,000
Premium on common stock 180,000
Retained earnings 170,000
What is the debt ratio?
A. 0.48 C. 0.93
B. 0.49 D. 0.96
Times interest earned
18. House of Fashion Company had the following financial statistics for
2006:
Long-term debt (average rate of interest is 8%) P400,000
Interest expense 35,000
Net income 48,000
Income tax 46,000
Operating income 107,000
What is the times interest earned for 2006? A. 11.4 times C. 3.1 times
B. 3.3 times D. 3.7 times
19. Brava Company reported the following on its income statement:
Income before taxes P400,000
Income tax expense 100,000
Net income P300,000
An analysis of the income statement revealed that interest expense was P100,000. Brava Company’s times interest earned (TIE) was
A. 5 times C. 3.5 times
B. 4 times D. 3 times
20. The balance sheet and income statement data for Candle Factory
indicate the following:
Bonds payable, 10% (issued 1998 due 2022) P1,000,000 Preferred 5% stock, P100 par (no change during year)300,000
Common stock, P50 par (no change during year) 2,000,000 Income before income tax for year 350,000
Income tax for year 80,000
Common dividends paid 50,000
Preferred dividends paid 15,000
Based on the data presented above, what is the number of times bond interest charges were earned (round to one decimal point)?
A. 3.7 C. 4.5
B. 4.4 D. 3.5
21. The following data were abstracted from the records of Johnson
Corporation for the year:
Sales P1,800,000
Bond interest expense 60,000
Income taxes 300,000
Net income 400,000
How many times was bond interest earned?
A. 7.67 C. 12.67
B. 11.67 D. 13.67
Net income
22. The times interest earned ratio of Mikoto Company is 4.5 times.
The interest expense for the year was P20,000, and the company’s tax rate is 40%. The company’s net income is:
A. P22,000 C. P54,000
B. P42,000 D. P66,000
Profitability Ratios Return on Common Equity
23. Selected information for Ivano Company as of December 31 is as
follows:
2006 2007
Preferred stock, 8%, par P100,
nonconvertible, noncumulative P250,000 P250,000
Common stock 600,000 800,000
Retained earnings 150,000 370,000 Dividends paid on preferred stock for
Net income for the year 120,000 240,000 Ivano’s return on common stockholders’ equity, rounded to the nearest percentage point, for 2007 is
A. 17% C. 21%
B. 19% D. 23%
Dividend yield
24. The following information is available for Duncan Co.:
2006 Dividends per share of common stock P 1.40 Market price per share of common stock 17.50 Which of the following statements is correct?
A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market price of their stocks.
B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns on their investments.
C. The dividend yield is 12.5%, which is of interest to bondholders. D. The dividend yield is 8.0 times the market price, which is
important in solvency analysis. Market Test Ratios
Market/Book value ratio
Price per share
25. What is the market price of a share of stock for a firm with 100,000
shares outstanding, a book value of equity of P3,000,000, and a market/book ratio of 3.5?
A. P8.57 C. P85.70
B. P30.00 D. P105.00
P/E ratio
26. Orchard Company’s capital stock at December 31 consisted of the
following:
• Common stock, P2 par value; 100,000 shares authorized, issued, and outstanding.
• 10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares authorized, issued, and outstanding. Orchard’s common stock, which is listed on a major stock exchange, was quoted at P4 per share on December 31. Orchard’s
net income for the year ended December 31 was P50,000. The yearly preferred dividend was declared. No capital stock transactions occurred. What was the price earnings ratio on Orchard’s common stock at December 31?
A. 6 to 1 C. 10 to 1
B. 8 to 1 D. 16 to 1
27. On December 31, 2006 and 2007, Renegade Corporation had
100,000 shares of common stock and 50,000 shares of noncumulative and nonconvertible preferred stock issued and outstanding.
Additional information:
Stockholders’ equity at 12/31/07 P4,500,000 Net income year ended 12/31/07 1,200,000 Dividends on preferred stock year ended 12/31/07 300,000 Market price per share of common stock at 12/31/07 144 The price-earnings ratio on common stock at December 31, 2007, was
A. 10 to 1 C. 14 to 1
B. 12 to 1 D. 16 to 1
Payout ratio
28. Selected financial data of Alexander Corporation for the year ended
December 31, 2007, is presented below:
Operating income P900,000
Interest expense (100,000)
Income before income taxes 800,000
Income tax (320,000)
Net income 480,000
Preferred stock dividend (200,000) Net income available to common stockholders 280,000 Common stock dividends were P120,000. The payout ratio is:
A. 42.9 percent C. 25.0 percent
B. 66.7 percent D. 71.4 percent P/E ratio & Payout ratio
Use the following information for question Nos. 33 and 34:
common stockholders of P40,000 in 2007. The weighted-average number of shares outstanding in 2007 was 50,000 shares. Terry Corporation’s common stock is selling for P60 per share in the local stock exchange.
29. Terry Corporation’s price-earnings ratio is
A. 3.8 times C. 18.8 times
B. 15 times D. 6 times
30. Terry Corporation’s payout ratio for 2007 is
A. P4 per share C. 20.0 percent B. 12.5 percent D. 25.0 percent DuPont Model
Debt ratio
31. The Board of Directors is dissatisfied with last year's ROE of 15%. If
the profit margin and asset turnover remain unchanged at 8% and 1.25 respectively, by how much must the total debt ratio increase to achieve 20% ROE?
A. Total debt ratio must increase by .5 B. Total debt ratio must increase by 5 C. Total debt ratio must increase by 5% D. Total debt ratio must increase by 50%
32. Assume you are given the following relationships for the Orange
Company:
Sales/total assets 1.5X
Return on assets (ROA) 3%
Return on equity (ROE) 5%
The Orange Company’s debt ratio is
A. 40% C. 35%
B. 60% D. 65%
Leverage Ratio
Degree of financial leverage
33. A summarized income statement for Leveraged Inc. is presented
below. Sales P1,000,000 Cost of Sales 600,000 Gross Profit P 400,000 Operating Expenses 250,000 Operating Income P 150,000 Interest Expense 30,000
Earnings Before Tax P 120,000
Income Tax 40,000
Net Income P 80,000
The degree of financial leverage is:
A. P 150,000 ÷ P 30,000 C. P1,000,000 ÷ P400,000 B. P 150,000 ÷ P120,000 D. P 150,000 ÷ P 80,000 Other Ratios
Book value per share
34. M Corporation’s stockholders’ equity at December 31, 2007
consists of the following:
6% cumulative preferred stock, P100 par, liquidating value was P110 per share; issued and outstanding 50,000 shares
P5,000,000 Common stock, par, P5 per share; issued and
outstanding, 400,000 shares 2,000,000
Retained earnings 1,000,000
Total P8,000,000
Dividends on preferred stock have been paid through 2006. At December 31, 2007, M Corporation’s book value per share was
A. P5.50 C. P6.75
B. P6.25 D. P7.50
35. The following data were gathered from the annual report of Desk
Products.
Market price per share P30.00
Number of common shares 10,000
Preferred stock, 5% P100 par P10,000
Common equity P140,000
The book value per share is:
A. P30.00 C. P14.00
Integrated ratios
Liquidity & activity ratios
Inventory
36. The current assets of Mayon Enterprise consists of cash, accounts
receivable, and inventory. The following information is available:
Credit sales 75% of total sales
Inventory turnover 5 times
Working capital P1,120,000
Current ratio 2.00 to 1
Quick ratio 1.25 to 1
Average Collection period 42 days
Working days 360
The estimated inventory amount is:
A. 840,000 C. 720,000
B. 600,000 D. 550,000
37. The following data were obtained from the records of Salacot
Company:
Current ratio (at year end) 1.5 to 1 Inventory turnover based on sales and ending inventory 15 times
Inventory turnover based on cost of goods sold and ending
inventory 10.5 times
Gross margin for 2007 P360,000
What was Salacot Company’s December 31, 2007 balance in the Inventory account?
A. P120,000 C. P 80,000
B. P 54,000 D. P 95,000
Net sales
38. Selected data from Mildred Company’s year-end financial
statements are presented below. The difference between average and ending inventory is immaterial.
Current ratio 2.0
Quick ratio 1.5
Current liabilities P120,000
Inventory turnover (based on cost of sales) 8 times
Gross profit margin 40%
Mildred’s net sales for the year were
A. P 800,000 C. P 480,000
B. P 672,000 D. P1,200,000
Gross margin
39. Selected information from the accounting records of the Blackwood
Co. is as follows:
Net A/R at December 31, 2006 P 900,000 Net A/R at December 31, 2007 P1,000,000
Accounts receivable turnover 5 to 1
Inventories at December 31, 2006 P1,100,000 Inventories at December 31, 2007 P1,200,000
Inventory turnover 4 to 1
What was the gross margin for 2007?
A. P150,000 C. P300,000
B. P200,000 D. P400,000
Market Test Ratio
Dividend yield
40. Recto Co. has a price earnings ratio of 10, earnings per share of
P2.20, and a pay out ratio of 75%. The dividend yield is
A. 25.0% C. 7.5%
B. 22.0% D. 10.0%
41. The following were reflected from the records of Salvacion
Company:
Earnings before interest and taxes P1,250,000
Interest expense 250,000
Preferred dividends 200,000
Payout ratio 40 percent
Shares outstanding throughout 2006
Preferred 20,000
Common 25,000
Income tax rate 40 percent
Price earnings ratio 5 times The dividend yield ratio is
A. 0.50 C. 0.40
Comprehensive
42. The balance sheets of Magdangal Company at the end of each of
the first two years of operations indicate the following:
2007 2006 Total current assets P600,00
0
P560,00 0
Total investments 60,000 40,000
Total property, plant, and equipment 900,000 700,000 Total current liabilities 150,000 80,000 Total long-term liabilities 350,000 250,000 Preferred 9% stock, P100 par 100,000 100,000 Common stock, P10 par 600,000 600,000 Paid-in capital in excess of
par-common stock 60,000 60,000
Retained earnings 300,000 210,000 Net income is P115,000 and interest expense is P30,000 for 2007. What is the rate earned on total assets for 2007 (round percent to one decimal point)?
A. 9.3 percent C. 8.9 percent
B. 10.1 percent D. 7.4 percent
43. What is the rate earned on stockholders' equity for 2007 (round
percent to one decimal point)?
A. 10.6 percent C. 12.4 percent
B. 11.2 percent D. 15.6 percent
44. What is the earnings per share on common stock for 2007, (round
to two decimal places)?
A. P1.92 C. P1.77
B. P1.89 D. P1.42
45. If the market price is P30, what is the price-earnings ratio on
common stock for 2007 (round to one decimal point)?
A. 17.0 C. 12.4
2007: P2,000,000 (1 – 0.7) = P600,000 2008: P2,000,000 (1 + 1.75) = P5,500,000
Note: For 2007 & 2008, 2006 was used as a base year.
2 . Answer: C 3 . Answer: C
Current Assets:
Cash P100,000
Accounts receivable 200,000
Total liquid assets 300,000
Inventory 440,000
Total current assets P740,000
Current Liabilities:
Accounts payable P 80,000
Notes payable, due in 6 months 250,000
Interest payable 25,000
Total current liabilities P355,000 Current Ratio (740,000 ÷ 355,000) 2.08:1.00
Acid-test Ratio (300,000 ÷ 355,000) 0.85:1.00
Before any payment, the current ratio is above 1:1 and acid test ratio is below 1:1. Therefore, the current ratio shall rise but acid test ratio shall go down. If any of these two ratios is below 1:1, the equal change in current assets and current liabilities brings direct effect on the ratio, that is, equal increase in current assets and current liabilities causes the ratio to rise.
4 . Answer: A
Working capital equals the difference between the total current assets and total current liabilities.
Current Assets:
Cash P 80,000
Marketable securities 250,000
Accounts receivable 110,000
Total liquid assets 440,000
Inventory 140,000
Prepaid expense 15,000
Total Current Assets P595,000
Current Liabilities:
Accounts payable P145,000
Income tax payable 10,000 Notes payable, short-term 85,000
Accrued liabilities 4,000 244,000
Working Capital P351,000
5 . Answer: B
Current Ratio: Current Assets ÷ Current Liabilities (P595,000 ÷ P244,000) = 2.44:1.00
Acid-Test Ratio: Liquid Assets ÷ Current Liabilities (P440,000 ÷ P244,000) = 1.80:1.00
7 . Answer: D
AR Turnover: Credit sales ÷ Average AR 6,500,000/650,000 = 10.0 times 8 . Answer: C
Accounts Receivable Turnover: Net Credit Sales ÷ Average Accounts Receivable P1,500,000 ÷ [(P200,000 + P400,000) ÷ 2] = 5.0 times
9 . Answer: D
Average Daily Sales: Annual credit sales ÷ Days’ Year P4 million ÷ 360 days = P11,111
Average Collection Period: Average Accounts Receivable ÷ Average Daily Sales [(P390,000 + P410,000) ÷ 2] ÷ P11,111 = 36 days
10 . Answer: A
Sales P30,000
Add decrease in Accounts Receivable 1,000
Cash collected from sales P31,000
11 . Answer: B
Inventory Turnover: Cost of Goods Sold ÷ Average Inventory
Cost of goods sold P 900,000
Add Ending inventory 180,000 Total cost available for sales 1,080,000 Deduct cost of purchases 960,000
Beginning inventory P 120,000
Average Inventory: (P120,000 + P180,000) ÷ 2 P150,000 Inventory Turnover: (P900,000 ÷ P150,000) 6 times
An alternative computation of the inventory turnover is to use Net Sales instead of Cost of Goods Sold.
12 . Answer: D
Average inventory: (P180,000 + P156,000) ÷ 2 P168,000 Inventory Turnover: (P600,000 ÷ P168,000) 3.57 times
13 . Answer: A
Average Inventory: (P341,169 + P376,526) ÷ 2 P358,847.50 Inventory Turnover: (P2,000,326 ÷ P358,847.50) 5.6 times
14 . Answer: A
Average Inventory: (P90,000 + P110,000) ÷ 2 P100,000 Inventory Turnover: (P330,000 ÷ P100,000) 3.3 times
15 . Answer: B
Average Inventory: (P672,000 + P576,000) ÷2 P624,000 Inventory Turnover: (P2,400,000 ÷ P624,000) 3.846 times
Alternative Computation:
Average daily cost of goods sold: = (P2,400,000 ÷ 365)P6,575.34 Turnover in Days: P624,000 ÷ P6,575.34 94.9 days
16 . Answer: A
Average Accounts Receivable: (P900,000 ÷ P1,000,000) ÷ 2P 950,000 Average inventory; (P1.1M + P1.2M) ÷ 2 P1,150,000
Net sales: (P950,000 x 5) P4,750,000 Cost of goods sold (P1,150,000 x 4) 4,600,000
Gross margin P 150,000
17 . Answer: B
Current liabilities P 100,000
Long-term debt 400,000
Deferred income tax 10,000
Total Liabilities 510,000 Stockholders’ Equity
Preferred stock P 80,000
Common stock 100,000
Premium on common stock 180,000
Retained earnings 170,000 530,000
Total Assets P1,040,000
Debt Ratio: P510,000 ÷ P1,040,000 = 0.49
18 . Answer: D
Times interest earned: Earnings before interest ÷ Interest Income before tax (P48,000 + P46,000) P 94,000
Add Interest expense 35,000
Income before Interest expense P129,000 TIE: P129,000 ÷ P35,000 3.7 times
19 . Answer: A
TIE: Income before interest expense ÷ Interest expense
Income before income tax P400,000
Add back Interest expense 100,000 Income before interest expense P500,000 TIE: P500,000 ÷ P100,000 5 times
20 . Answer: C
Interest Expense: P1M x 0.1 P100,000 Income before interest expense: P350,000 + P100,000 P450,000 Times interest earned: (P450,000 ÷ P100,000) 4.5 times
21 . Answer: C
Net income P400,000
Income before interest P760,000 TIE: P760,000 ÷ P60,000 12.67 times
22 . Answer: B
Earnings before interest expense (P20,000 x 4.5) P90,000
Deduct interest expense 20,000
Income before income tax P70,000
Deduct income tax (P70,000 x 0.4) 28,000
Net income P42,000
23 . Answer: D
Income to Common; (P240,000 – P20,000) P220,000 Average Common Equity: (P750,000 + P1,170,000) ÷ 2P960,000 Return on Common Equity: (P220 ÷ P960) 23 percent
24 . Answer: B
The dividend yield is 8 percent (P1.40 ÷ P17.50)
The dividend yield measures the return of investment in terms of dividends received. The total expected returns consists of Dividend Yield and the Appreciation in market price and dividend
25 . Answer: D
Market Value of Equity (P3M x 3.5) P10,500,000 Market price per share: (P10.5M ÷ 100,000) P105
26 . Answer: B EPS: P50,000 ÷ 100,000 shares P0.50 P/E Ratio: P4.00 ÷ P0.50 8 to 1 27 . Answer: D EPS: (P1,200,000 – P300,000) ÷ 100,000 P9.00 P/E Ratio: 144 ÷ 9 16 28 . Answer: A
Payout Ratio: Common Dividends ÷ Income Available to Common P120,000 ÷ P280,000 = 42.9%
29 . Answer: B
Price-earnings ratio: Market price ÷ EPS
EPS: Net income ÷ /Weighted-average common shares EPS: P200,000 ÷ 50,000 sharesP4.00
P/E Ratio: P60 ÷ P4 15.0X
30 . Answer: C
Payout Ratio: Dividends ÷ Income to Common P40,000÷ P200,000 = 20.0%
31 . Answer: D
ROE: (8% x 1.25) 10.00%
Increase in debt ratio: (50.00% - 33.33%) ÷ 33.33% 50.00%
32 . Answer: A
1 – (0.03 ÷ 0.05) = 40% 33 . Answer: B
Degree of Financial Leverage: Operating Income ÷ Interest Expense
34 . Answer: A
Total stockholders’ equity P8,000,000 Deduct:
Liquidation value of Preferred Stock (50,000 s P110) P5,500,000 Unpaid Preferred Dividends (P5M x 6%) 300,000 5,800,000
Common Equity P2,200,000
Book Value per Share: P2.2M ÷ 400,000 shares P5.50
35 . Answer: C
Book Value per Share: Common Equity ÷ Outstanding Shares P140,000 ÷ 10,000 shares = P14.00
36 . Answer: A
The inventory amount can be calculated as follows:
Current liabilities: Working Capital = current liabilities based on 2:1 current ratio. At 2:1 current ratio, the amount of working capital and current liabilities are both P1,120,000.
Inventory: Current liabilities x (Current ratio – Acid test ratio) P1,120,000 x (2.0 – 1.25) P840,000 A detailed computation can be made as follows:
Current assets: P1,120,000 x 2 P2,240,000 Liquid assets: P1,120,000 x 1.25 1,400,000
Inventory P 840,000
37 . Answer: C
Inventory balance: Gross profit ÷ (Difference between 2 inventory turnovers) 360,000/(15 – 10.5) = P80,000
38 . Answer: A
Inventory balance (P120,000 x (2.0 – 1.5) P 60,000 Cost of goods sold 60,000 x 8 P480,000 Sales (P480,000 ÷ 0.60) P800,000
39 . Answer: A
Average Accounts Receivable: (P900,000 ÷ P1,000,000) ÷ 2P 950,000 Average inventory; (P1.1M + P1.2M) ÷ 2 P1,150,000
Net sales: (P950,000 x 5) P4,750,000 Cost of goods sold (P1,150,000 x 4) 4,600,000
Dividend per share: 0.75 x P2.20 P1.65
Market price: 10 x 2.20 22.00
Dividend yield: P1.65 ÷ P22.00 = 7.5%
41 . Answer: D
EBIT 1,250,000
Less interest expense 250,000
Earnings before tax 1,000,000
Less Income tax 40% 400,000
Net income 600,000
Less Preferred dividends 200,000 Earnings to Common Stock 400,000 Earnings per share 400,000/25,000 16.00 Dividend per share: 400,000 x 0.40 ÷ 25,000 6.40 Dividend yield 6.4 ÷ (16 x 5) 8.0%
42 . Answer: B
ROA: Operating income ÷ Average Total Assets P145,000 ÷ P1,430,000 = 10.1%
43 . Answer: B
Return on stockholders’ equity: Net income ÷ Average stockholders’ equity P115,000 ÷ P1,027,500 = 11.2%
44 . Answer: C
Net income P115,000
Deduct Preferred Dividends 9,000 Income available to common shares P106,000
EPS: (P106,000 ÷ 60,000) P1.77
45 . Answer: A
