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Exam 4: Analysis of Financial Statements

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Question 41

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The inventory turnover ratio and days sales outstanding (DSO)are two ratios that are used to assess how effectively a firm is managing its current assets.

A) True
B) False

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Question 42

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Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. -Refer to Exhibit 4.1.What is the firm's quick ratio?

A) 0.51
B) 0.64
C) 0.76
D) 0.92
E) 1.10

F) All of the above
G) A) and D)

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Question 43

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Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. -Refer to Exhibit 4.1.What is the firm's market-to-book ratio?

The advantage of the basic earning power ratio (BEP)over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

If the CEO of a large,diversified,firm were filling out a fitness report on a division manager (i.e.,"grading" the manager) ,which of the following situations would be likely to cause the manager to receive a better grade? In all cases,assume that other things are held constant.

Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. -Refer to Exhibit 4.1.What is the firm's return on invested capital?

Helmuth Inc's latest net income was $1,250,000,and it had 225,000 shares outstanding.The company wants to pay out 45% of its income.What dividend per share should it declare?

A new firm is developing its business plan.It will require $615,000 of assets (which equals total invested capital) ,and it projects $450,000 of sales and $355,000 of operating costs for the first year.Management is reasonably sure of these numbers because of contracts with its customers and suppliers.It can borrow at a rate of 7.5%,but the bank requires it to have a TIE of at least 4.0,and if the TIE falls below this level the bank will call in the loan and the firm will go bankrupt.The firm will use only debt and common equity for financing.What is the maximum debt to capital ratio (measured as debt/total invested capital) the firm can use? (Hint: Find the maximum dollars of interest,then the debt that produces that interest,and then the related debt to capital ratio.)

Other things held constant,the more debt a firm uses,the lower its operating margin will be.

The days sales outstanding tells us how long it takes,on average,to collect after a sale is made.The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time.

Which of the following would indicate an improvement in a company's financial position,holding other things constant?

One problem with ratio analysis is that relationships can be manipulated.For example,we know that if our current ratio is less than 1.0,then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.

Which of the following statements is CORRECT?

If a firm sold some inventory on credit as opposed to cash,there is no reason to think that either its current or quick ratio would change.

Suppose Firms A and B have the same amount of assets,total assets are equal to total invested capital,pay the same interest rate on their debt,have the same basic earning power (BEP),finance with only debt and common equity,and have the same tax rate.However,Firm A has a higher debt to capital ratio.If BEP is greater than the interest rate on debt,Firm A will have a higher ROE as a result of its higher debt ratio.

If a firm's ROE is equal to 9% and its ROA is equal to 6%,its equity multiplier must be 1.5.

A good bit of relatively simple algebra is involved in these problems, and although the calculations are simple, it will take students some time to set up the problems and do the arithmetic. We allow for this when assigning problems for a timed test. Also, note that students must know the definitions of a number of ratios to answer the questions. We provide our students with a formula sheet on exams, using the relevant sections of Appendix C at the then of the text. Otherwise, they spend too much time trying to memorize thing rather than trying to understand the issues. The difficulty of the problems depends on (1) whether or not students are provided with a formula sheet and (2) the amount of time they have to work the problems. Out difficulty assessments assume that they have a formula sheet and a "reasonable" amount of time for the test. Note that a few of the problems are trivially easy if students have formula sheets. To work some of the problems, students must transpose equations and solve for items that are normally inputs. For example, the equation for the profit margin is given as Profit margin = Net income/Sales. We might have a problem where sales and the profit margin are given and then require students to find the firm's net income. We explain to our students in class before the exam that they will have to transpose terms in the formulas to work some problems. Problems 84 through 114 are all stand-along problems with individualized data. Problems 115 through 133 are all based on a common set of financial statements, and they require students to calculate ratios and find items like EPS, TIE, and the like using this data set. The financial statements can be changed algorithmically, and this changes the calculated ratios and other items. -Beranek Corp has $720,000 of assets (which equal total invested capital) ,and it uses no debt: it is financed only with common equity.The new CFO wants to employ enough debt to raise the total debt to total capital ratio to 40%,using the proceeds from borrowing to buy back common stock at its book value.How much must the firm borrow to achieve the target debt ratio?

The current and quick ratios both help us measure a firm's liquidity.The current ratio measures the relationship of the firm's current assets to its current liabilities,while the quick ratio measures the firm's ability to pay off short-term obligations without relying on the sale of inventories.

Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. -Refer to Exhibit 4.1.What is the firm's total assets turnover?

Meyer Inc's total invested capital is $625,000,and its total debt outstanding is $185,000.The new CFO wants to establish a total debt to total capital ratio of 55%.The size of the firm will not change.How much debt must the company add or subtract to achieve the target debt to capital ratio?