ch04

Chapter 4Analyzing Financial Statements

LEARNING OBJECTIVES

1. Explain the three perspectives from which financial statements can be viewed.

Financial statements can be viewed from the owners’, managers’, or creditors’ perspective. All three

groups are ultimately interested in a firm’s profitability, but each group takes a different view.

Shareholders want to know how much cash they can expect to receive for their stocks, what their return

on investment will be, and/or how much their stock is worth in the market. Managers should have the

same perspective as shareholders when analyzing financial statements. However, managers are concerned

with maximizing the firm’s long-term value through a series of day-to-day decisions as they manage the

firm; thus, they need to see the short-term impact of their decisions on the financial statements to confirm

that things are indeed going as planned. Finally, creditors monitor the company’s use of debt and are

particularly concerned with how much debt the firm is using: Is the firm generating enough cash to pay its

short-term obligations, and will the firm have enough money to cover interest and principal payments on

long-term debt as it comes due?

2. Describe common-size financial statements, explain why they are used, and be able to prepare

and use them to analyze the historical performance of a firm.

Common-size financial statements are financial statements in which each number has been scaled by a

common measure of firm size: balance sheets are expressed as a percentage of total assets, and income

statements are expressed as a percentage of net sales. Common-size financial statements are necessary

when comparing firms that are significantly different in size.

1

3. Discuss how financial ratios facilitate financial analysis, and be able to compute and use them to

analyze a firm’s performance.

A financial ratio is simply one number from a financial statement divided by another. Ratios are used in

financial analysis because they eliminate the size problem when comparing two or more companies of

different size or when looking at the same company over time as the size changes. Financial ratios can be

divided into five categories: liquidity, efficiency, leverage, profitability, and market-value ratios.

Liquidity ratios measure the ability of a company to cover its current bills. Efficiency ratios tell how

efficiently the firm uses its assets and how quickly the firm converts current assets into cash. Leverage

ratios tell how much debt a firm has in its capital structure and whether the firm can meet its long-term

financial obligations, such as interest payments on debt or lease payments. Profitability ratios focus on the

firm’s earnings. Finally, market-value indicators look at a company based on market data as opposed to

historical data used in traditional financial statements.

4. Describe the DuPont system of analysis and be able to use it to evaluate a firm’s performance

and identify corrective actions that may be necessary.

The DuPont system of analysis is a diagnostic tool that uses financial ratios to assess a firm’s financial

strength. Once the assessment is complete, management focuses on correcting the problems within the

context of maximizing the firm’s ROE. For analysis, the DuPont system breaks ROE into three

components: net profit margin, which measures operating efficiency; total asset turnover, which measures

how efficiently the firm deploys its assets; and the equity multiplier, which measures financial leverage.

Exhibit 4.5 summarizes the structure of the DuPont system of analysis and shows how it links the balance

sheet and income statement together.

5. Explain what benchmarks are, describe how they are prepared, and discuss why they are

important in financial statement analysis.

2

Once we have calculated financial ratios, we need some way to evaluate them. A benchmark provides a

standard for comparison. In financial statement analysis, a number of benchmarks are used. Most often,

benchmark comparisons involve competitors that are roughly the same size and that offer a similar range

of products. The data for these benchmark samples may be obtained from national data banks maintained

by the U.S. Department of Commerce, trade associations, or private firms, such as Dun & Bradstreet.

Alternatively, the firm’s major competitors can be identified, and financial data on these firms can be

collected from their annual reports. Another form of benchmarking is trend analysis, which compares a

firm’s current financial ratios against the same ratios from past years. Trend analysis tells us whether a

ratio is increasing or decreasing over time.

6. Identify the major limitations in using financial statement analysis.

The major limitations of financial statement and ratio analysis are the use of historical accounting data

and the lack of theory to guide the decision maker. The lack of theory explains, in part, why there are so

many rules of thumb. Although rules of thumb are useful, and they may work under certain conditions,

they may lead to poor decisions if circumstances or the economic environment has changed.

I. True or False Questions

1. Financial statement analysis can help us determine why a firm’s cash flows are increasing

or decreasing

a. True

b. False

3

2. Shareholders focus on the value of their stock but not on how much cash they can expect

to receive from dividends and/or capital appreciation.

a. True

b. False

3. Managers’ decisions regarding financing, investment, and working capital are reflected in

the financial statements.

a. True

b. False

4. A financial statement analysis conducted over a three- to five-year period is called trend

analysis.

a. True

b. False

5. A benchmark for a financial statement analysis is the performance of a multinational firm

in the same industry from another country.

a. True

b. False

4

6. A typical way common size income statement is constructed is by dividing all expense

items in an income statement by net income.

a. True

b. False

7. The most frequent method of adjusting balance sheets to a common-size basis is to divide

each of the accounts by total assets, expressing each account as a percentage of total

assets.

a. True

b. False

8. Liquidity ratios are concerned with the firm’s ability to pay its current bills without

putting the firm in financial difficulty.

a. True

b. False

9. A firm’s current ratio changed from 1.4 times in the previous year to 1.6 times this year.

Concluding that the firm’s liquidity improved is ___________.

5

a. True

b. False

10. A company can improve its liquidity by increasing its accounts payable, while holding all

else constant.

a. True

b. False

11. The purchase of additional inventory by a firm should decrease a firm’s quick ratio.

a. True

b. False

12. Turnover ratios are used by managers to identify operational inefficiencies.

a. True

b. False

13. A firm increased its days’ sales outstanding from 35 days to 43 days. This implies the

firm is more efficient.

6

a. True

b. False

14. Total asset turnover is more relevant for service industry firms, while the fixed asset

turnover ratio is more relevant for manufacturing industry firms.

a. True

b. False

15. Financial leverage refers to the use of preferred stock in a firm’s capital structure.

a. True

b. False

16. The equity multiplier is computed by dividing equity by total assets.

a. True

b. False

17. The higher the times interest earned ratio, the more comfortable are a firm’s creditors in

the ability of the firm to meet its interest obligations.

a. True

7

b. False

18. A firm that has no debt will have its ROA equal to its ROE.

a. True

b. False

19. For a given level of after-tax income, the lower the level of equity a firm has, the higher

the return on equity its shareholders will earn.

a. True

b. False

20. For a given share price of a firm’s stock, the lower the EPS the lower the price-earnings

ratio.

a. True

b. False

21. The DuPont equation relates a firm’s net profit margin, total asset turnover ratio, and

equity multiplier to determine its return on equity.

a. True

8

b. False

22. Firms with a lower ROA and higher leverage will always have a lower ROE than firms

with a higher ROA and lower leverage.

a. True

b. False

23. In doing an industry group analysis, you form the comparison group by choosing firms

that are larger than the firm being compared.

a. True

b. False

24. The Standard Industry Classification (SIC) system is a federal government established

system in which the last two digits indicate the business or industry in which the firm is

engaged.

a. True

b. False

25. The use of inflation-adjusted balance sheets serves to correct a weakness of ratio analysis.

9

a. True

b. False

10

II. Multiple-Choice Questions

26. Financial statements can be analyzed from the following three different perspectives:

a. management, regulator, and bondholder

b. management, shareholder, and creditor

c. regulator, shareholder, and creditor

d. shareholder, creditor, and regulator

27. Shareholders analyze financial statements in order to:

a. assess the cash flows that the firm will generate from operations/

b. determine the firm’s profitability, their return for that period, and the dividend

they are likely to receive.

c. focus on the value of the stock they hold.

d. All of the above.

28. The creditors of a firm analyze financial statements so that they can focus on

a. the firm’s amount of debt.

11

b. the firm’s ability to generate sufficient cash flows to meet all legal obligations

first and still have sufficient cash flows to meet debt repayment and interest

payments.

c. the firm’s ability to meet its short-term obligations.

d. All of the above.

29. A firm’s management analyzes financial statement’s so that:

a. they can get feedback on their investing, financing, and working capital decisions

by identifying trends in the various accounts that are reported in the financial

statements.

b. similar to shareholders, they can focus on profitability, dividend, capital

appreciation, and return on investment.

c. they can get more stock options.

d. a and b.

30. Anyone analyzing a firm’s financial statements should

a. use audited financial statements only.

b. do a trend analysis.

c. perform a benchmark analysis.

d. All of the above.

12

31. An individual analyzing a firm’s financial statements should do all but one of the

following:

a. Use unaudited financial statements.

b. Do a trend analysis.

c. Perform a benchmark analysis.

d. Compare the firm’s performance to that of its direct competitors.

32. All but one of the following is true of common-size balance sheets.

a. Each asset and liability item on the balance sheet is standardized by dividing it by

total assets.

b. Balance sheet accounts are represented as percentages of total assets.

c. Each asset and liability item on the balance sheet is standardized by dividing it by

sales.

d. Common-size financial statements allow us to make meaningful comparisons

between the financial statements of two firms that are different in size.

33. All but one of the following is true of common-size income statements.

a. Each income statement item is standardized by dividing it by total assets.

b. Income statement accounts are represented as percentages of sales.

c. Each income statement item is standardized by dividing it by sales.

13

d. Common-size financial statement analysis is a specialized application of ratio

analysis.

34. Common-size financial statements:

a. are a specialized application of ratio analysis.

b. allow us to make meaningful comparisons between the financial statements of

two firms that are different in size.

c. are prepared by having each financial statement item expressed as a percentage of

some base number, such as total assets or total revenues.

d. All of the above are true.

35. Which of the following is true of ratio analysis?

a. A ratio is computed by dividing one balance sheet or income statement item by

another.

b. The choice of the scale determines the story that can be garnered from the ratio.

c. Ratios can be calculated based on the type of firm being analyzed or the kind of

analysis being performed.

d. All of the above are true.

36. Which of the following is NOT true of liquidity ratios?

14

a. They measure the ability of the firm to meet short-term obligations with short-

term assets without putting the firm in financial trouble.

b. There are two commonly used ratios to measure liquidity—current ratio and quick

ratio.

c. For manufacturing firms, quick ratios will tend to be much larger than current

ratios.

d. The higher the number, the more liquid the firm and the better its ability to pay its

short-term bills.

37. All but one of the following is true about quick ratios.

a. The quick ratio is calculated by dividing the most liquid of current assets by

current liabilities.

b. Service firms that tend not to carry too much inventory will see significantly

higher quick ratios than current ratios.

c. Inventory, being not very liquid, is subtracted from total current assets to

determine the most liquid assets.

d. Quick ratios will tend to be much smaller than current ratio for manufacturing

firms or other industries that have a lot of inventory.

38. Which one of the following does NOT change a firm’s current ratio?

a. The firm collects on its accounts receivables.

15

b. The firm purchases inventory by taking a short-term loan.

c. The firm pays down its accounts payables.

d. None of the above.

39. All else being equal, which one of the following will decrease a firm’s current ratio?

a. a decrease in the net fixed assets

b. a decrease in depreciation

c. an increase in accounts payable

d. None of the above

40. All but one of the following is true about the inventory turnover ratio.

a. It is calculated by dividing inventory by cost of goods sold.

b. It measures how many times the inventory is turned over into saleable products.

c. The more times a firm can turnover the inventory, the better.

d. Too high a turnover or too low a turnover could be a warning sign.

41. Which one of the following statements is NOT true?

a. The accounts receivables turnover ratio measures how quickly the firm collects on

its credit sales.

16

b. One ratio that measures the efficiency of a firm’s collection policy is days’ sales

outstanding.

c. The more days that it takes the firm to collect on its receivables, the more efficient

the firm is.

d. DSO measures in days, the time the firm takes to convert its receivables into cash.

42. One of the following statements is NOT true of asset turnover ratios.

a. Asset turnover ratios measure the level of sales per dollar of assets that the firm

has.

b. The fixed assets turnover ratio is less significant for equipment-intensive

manufacturing industry firms than the total assets turnover ratio.

c. The higher the total asset turnover, the more efficiently management is using total

assets.

d. All of the above are true.

43. Which one of the following statements is correct?

a. The lower the level of a firm’s debt, the higher the firm’s leverage.

b. The lower the level of a firm’s debt, the lower the firm’s equity multiplier.

c. The lower the level of a firm’s debt, the higher the firm’s equity multiplier.

d. The tax benefit from using debt financing reduces a firm’s risk.

17

44. If firm A has a higher equity ratio than firm B, then

a. firm A has a lower equity multiplier than firm B.

b. firm B has a lower equity multiplier than firm A.

c. firm B has lower financial leverage than firm A.

d. None of the above.

18

45. Which one of the following statements is NOT correct?

a. A leveraged firm is more risky than a firm that is not leveraged.

b. A leveraged firm is less risky than a firm that is not leveraged.

c. A firm that uses debt magnifies the return to its shareholders.

d. All of the above statements are correct.

46. Coverage ratios, like times interest earned and cash coverage ratio, allow

a. a firm’s management to assess how well they meet short-term liabilities.

b. a firm’s shareholders to assess how well the firm will meet its short-term

liabilities.

c. a firm’s creditors to assess how well the firm will meet its interest obligations.

d. a firm’s creditors to assess how well the firm will meet its short-term liabilities

other than interest expense.

47. For a firm that has no debt in its capital structure,

a. ROE > ROA.

b. ROE < ROA.

c. ROE = ROA.

d. None of the above.

19

48. For a firm that has both debt and equity,

a. ROE > ROA.

b. ROE < ROA.

c. ROE = ROA

d. None of the above.

49. Which one of the following statements is NOT correct?

a. The DuPont system is based on two equations that relate a firm’s ROA and ROE.

b. The DuPont system is a set of related ratios that links the balance sheet and the

income statement.

c. Both management and shareholders can use this tool to understand the factors that

drive a firm’s ROE.

d. All of the above are correct.

50. The DuPont equation shows that a firm’s ROE is determined by three factors:

a. net profit margin, total asset turnover, and the equity multiplier

b. operating profit margin, ROA, and the ROE

c. net profit margin, total asset turnover, the ROA

d. ROA, total assets turnover, and the equity multiplier

20

51. Which one of the following is a criticism of equating the goals of maximizing the ROE of

a firm and maximizing the firm’s shareholder wealth?

a. ROE is based on after-tax earnings, not cash flows.

b. ROE does not consider risk.

c. ROE ignores the size of the initial investment as well as future cash flows.

d. All of the above are criticisms of ROE as a goal.

52. Which one of the following is NOT an advantage of using ROE as a goal?

a. ROE is highly correlated with shareholder wealth maximization.

b. ROE and the DuPont analysis allow management to break down the performance

and identify areas of strengths and weaknesses.

c. ROE does not consider risk.

d. All of the above are advantages of using ROE as a goal.

53. Which one of the following statements about trend analysis is NOT correct?

a. This benchmark is based on a firm’s historical performance.

b. It allows management to examine each ratio over time and determine whether the

trend is good or bad for the firm.

c. The Standard Industrial Classification (SIC) System is used to identify

benchmark firms.

21

d. All of the above are true statements.

54. Peer group analysis can be performed by

a. management choosing a set of firms that are similar in size or sales, or who

compete in the same market.

b. using the average ratios of this peer group, which would then be used as the

benchmark.

c. identifying firms in the same industry that are grouped by size, sales, and product

lines in order to establish benchmark ratios.

d. Only a and b relate to peer group analysis.

55. Limitations of ratio analysis include all but

a. Ratios depend on accounting data based on historical costs.

b. Differences in accounting practices like FIFO versus LIFO make comparison

difficult.

c. Trend analysis could be distorted by financial statements affected by inflation.

d. All of the above are limitations of ratio analysis.

56. Liquidity ratio: Lionel, Inc., has current assets of $623,122, including inventory of

$241,990, and current liabilities of 378,454. What is the quick ratio?

22

a. 1.65

b. 0.64

c. 1.01

d. None of the above

57. Liquidity ratio: Bathez Corp. has receivables of $334,227, inventory of $451,000, cash

of $73,913, and accounts payables of $469,553. What is the firm’s current ratio?

a. 1.83

b. 0.73

c. 1.67

d. None of the above

58. Liquidity ratio: Zidane Enterprises has a current ratio of 1.92, current liabilities of

$272,934, and inventory of 197,333. What is the firm’s quick ratio?

a. 0.72

b. 1.20

c. 1.92

d. None of the above

59. Liquidity ratio: Ronaldinho Trading Co. is required by its bank to maintain a current

ratio of at least 1.75, and its current ratio now is 2.1. The firm plans to acquire additional

23

inventory to meet an unexpected surge in the demand for its products and will pay for the

inventory with short-term debt. How much inventory can the firm purchase without

violating its debt agreement if their total current assets equal $3.5 million?

a. $0

b. $777,777

c. $1 million

d. None of the above

60. Efficiency ratio: If Randolph Corp. has accounts receivables of

$654,803 and net sales of $1,932,349, what is its accounts receivable turnover?

a. 0.34 times

b. 1.78 times

c. 2.95 times

d. None of the above

61. Efficiency ratio: If Viera, Inc., has an accounts receivable turnover of 3.9 times and net

sales of $3,436,812, what is its level of receivables?

a. $881,234

b. $13,403,567

c. $1,340,357

24

d. $81,234

62. Efficiency ratio: Jason Traders has sales of $833,587, a gross profit margin of 32.4

percent, and inventory of $178,435. What is the company’s inventory turnover ratio?

a. 4.67 times

b. 3.16 times

c. 4.1 times

d. None of the above

63. Efficiency ratio: Gateway Corp. has an inventory turnover ratio of 5.6. What is the

firm’s days’ sales in inventory?

a. 65.2 days

b. 64.3 days

c. 61.7 days

d. 57.9 days

64. Efficiency ratio: Jet, Inc., has net sales of $712,478 and accounts receivables of

$167,435. What are the firm’s accounts receivables turnover and days’ sales outstanding?

a. 0.24 times; 78.5 days

b. 4.26 times; 85.7 days

25

c. 5.2 times; 61.3 days

d. None of the above

65. Efficiency ratio: Ellicott City Manufacturers, Inc., has sales of $6,344,210, and a gross

profit margin of 67.3 percent. What is the firm’s cost of goods sold?

a. $2,074,557

b. $2,745,640

c. $274,560

d. None of the above

66. Efficiency ratio: Deutsche Bearings has total sales of $9,745,923, inventories of

$2,237,435, cash and equivalents of $755,071, and days’ sales outstanding of 49 days. If

the firm’s management wanted its DSO to be 35 days, by how much will the accounts

receivable have to change?

a. $373,816.23

b. -$373,816.23

c. -$379,008.12

d. $379,008.12

67. Coverage ratio: Trident Corp. has debt of $3.35 million with an interest rate of 6.875

percent. The company has an EBIT of $2,766,009. What is its times interest earned?

26

a. 13 times

b. 12 times

c. 11 times

d. None of the above

68. Coverage ratios: Sectors, Inc., has an EBIT of $7,221,643 and interest expense of

$611,800. Its depreciation for the year is $1,434,500. What is its cash coverage ratio?

a. 15.42 times

b. 18.34 times

c. 14.15 times

d. None of the above

69. Coverage ratios: Fahr Company had depreciation expenses of $630,715, interest

expenses of $112,078, and an EBIT of $1,542,833 for the year ended June 30, 2006.

What are the times interest earned and cash coverage ratios for this company?

a. 19.4 times; 12.7 times

b. 17.3 time; 11.4 times

c. 13.8 times; 19.4 times

d. None of the above

27

70. Leverage ratio: Your firm has an equity multiplier of 2.47. What is its debt-to-equity

ratio?

a. 0.60

b. 1.47

c. 1.74

d. 0

71. Leverage ratio: What will be a firm’s equity multiplier given a debt ratio of 0.45?

a. 1.82

b. 1.28

c. 2.22

d. None of the above

72. Leverage ratio: Dreisen Traders has total debt of $1,233,837 and total assets of

$2,178,990. What are the firm’s equity multiplier and debt-to-equity ratio?

a. 2.31; 1.31

b. 1.75; 0.75

c. 0.75; 1.75

d. 1.31; 2.31

28

73. Market-value ratio: RTR Corp. has reported a net income of $812,425 for the year. The

company’s share price is $13.45, and the company has 312,490 shares outstanding.

Compute the firm’s price-earnings ratio.

a. 4.87 times

b. 8.12 times

c. 5.17 times

d. None of the above

74. Market-value ratios: Perez Electronics Corp. has reported that its net income for 2006 is

$1,276,351. The firm has 420,000 shares outstanding and a P-E ratio of 11.2 times. What

is the firm’s share price?

a. $34.05

b. $3.68

c. $11.20

d. $36.80

75. Profitability ratio: Juventus Corp has total assets of $4,744,288, total debt of

$2,912,000, and net sales of $7,212,465. Their net profit margin for the year is 18

percent. What is Juventus’s ROA?

a. 25.6%

29

b. 18%

c. 27.4%

d. None of the above

76. DuPont equation: GenTech Pharma has reported the following information:

Sales/Total assets = 2.89; ROA = 10.74%; ROE = 20.36%

What are the firm’s profit margin and equity multiplier?

a. 7.1%; 0.53

b. 7.1%; 1.90

c. 3.7%; 0.53

d. 3.7%; 1.90

77. Profitability ratios: Tigger Corp. has reported the financial results for year-end 2006.

Based on the information given, calculate the firm’s gross profit margin and operating

profit margin.

Net sales = $4,156,700 Net income = $778,321

Cost of goods sold = $2,715,334 EBIT = $1,356,098

a. 34.7%; 32.6%

b. 32.6%; 18.72%

c. 34.7%; 18.72%

30

d. None of the above

78. DuPont equation: Andrade Corp has debt of $2,834,950, total assets of $5,178,235,

sales of $8,234,121, and net income of $812,355. What is the firm’s return on equity?

a. 7.1%t

b. 34.7%

c. 28.1%

d. 43.2%

79. DuPont equation: Saunders, Inc., has a ROE of 18.7 percent, an equity multiplier of

2.53, sales of $2.75 million, and a total assets turnover of 2.7 times. What is the firm’s

net income?

a. $75,281.80

b. $514,250.00

c. $51,425.00

d. $7,528.10

80. DuPont equation: Sorenstam Corp has an equity multiplier of 2.34 times, total assets of

$4,512,895, a ROE of 17.5 percent, and a total assets turnover of 3.1 times. Calculate the

firm’s ROA.

31

a. 6.23%

b. 4.53%

c. 7.48%

d. 5.79%

32

III. Essay Questions

81. Compare how a firm’s creditor would analyze a firm’s financial statements relative to

those of a firm’s shareholders.

Answer: A firm’s creditors’ primary concern is the ability of the firm to repay their loans

with interest on a timely manner. Toward this end they would analyze the firm’s financial

statements to gauge the ability of the firm to generate sufficient cash flows to meet not

only their legal financial obligations but also their debt obligations. Shareholders, on the

other hand, want to know how much cash they can expect to receive for their stocks, what

their return on investment will be, and/or how much their stock is worth in the market.

82. Explain the different ways that a firm’s ratios can be benchmarked.

Answer: Benchmark data can be obtained in one of three different ways—trend analysis,

industry average analysis, and peer group analysis. Trend analysis involves evaluating a

single firm’s performance over time. This sort of analysis allows management to see

whether a given ratio value has increased or decreased over time and whether there has

been any significant changes in the value of the ratios being analyzed. A ratio value that

is changing typically is a signal to the financial manager to take a closer look at the ratio

and to make decisions depending on whether the change is favorable or unfavorable to

the firm.

33

A second way to establish a benchmark is to conduct an industry group analysis.

We do this by identifying a group of firms that have the same product line, compete in

the same market, and are about the same size. The average ratio values for the group will

be our benchmarks.

The third way to establish benchmark information is to identify a group of firms

that compete with the company you are analyzing. Ideally, the firms are in similar lines

of business, are about the same size, and are direct competitors of the target firm. These

firms form a peer group of firms in the same industry. Once a peer group has been

identified, you can obtain their annual reports and compute average ratio values against

which your firm can compare its performance.

83. What are some of the main limitations of ratio analysis?

Answer: While financial ratio analysis can provide management with useful information

to improve the firm’s performance, there are some serious limitations to its usefulness.

First, ratio analysis depends on accounting data based on historical costs. Management or

investors will get a truer picture of a firm’s financial condition if market value was the

basis of the analysis.

Second, there is no theoretical backing in making judgments based on financial

statement and ratio analysis. Judgment calls made based on experience or common sense

work only some of the time. Third, when doing industry or peer group analysis you are

often confronted with large, diversified firms that do not fit into any one SIC code or

classification. Fourth, trend analysis could be distorted by financial statements affected

34

by inflation. Finally, multinational firms deal with many accounting standards. Financial

reports that are created based on different accounting standards make it difficult to

compare. Even among domestic firms, differences in accounting practices, like FIFO

versus LIFO, make comparison difficult.

35

IV. Answers to True or False Questions

1. True

2. False

3. True

4. True

5. False

6. False

7. True

8. True

9. True

10. False

11. True

12. True

13. False

14. True

15. False

16. False

17. True

18. True

19. True

20. False

21. True

36

22. False

23. False

24. False

25. True

37

V. Answers to Multiple-Choice Questions

26. b

27. d

28. d

29. d

30. d

31. a

32. c

33. a

34. d

35. d

36. c

37. b

38. a

39. c

40. a

41. c

42. b

43. b

44. a

45. b

46. c

38

47. c

48. a

49. d

50. a

51. d

52. c

53. c

54. d

55. d

56. c

57. a

58. b

59. b

60. c

61. a

62. b

63. a

64. b

65. a

66. b

67. b

68. c

69. c

39

70. b

71. a

72. a

73. c

74. a

75. c

76. d

77. a

78. b

79. a

80. c

VI. Solutions to Multiple-Choice Questions

56. Solution:

Current assets = $623,122

Current liabilities = $378,454

Inventory = $241,990

40

57. Solution:

Current assets = $73,913 + $451,000 +$334,227 = $859,140

Current liabilities = $469,553

58. Solution:

Current ratio = 1.92

Current liabilities = $272,934

Inventory = $197,333

59. Solution:

41

Let X represent the additional borrowing against the firm’s line of credit (which also

equals the addition to current assets). We can solve for that level of X that forces the

firm’s current ratio to be at 1.75

$3,500,000/ Current liabilities = 2.1

Current liabilities = $1,666,667

1.75 = ($3,500,000 + X) / ($1,666,667 + X)

(1.75 * $1,666,667) + 1.75X = $3,500,000 + X

0.75X = $3,500,000 - $2,916,667

X = $777,777

60. Solution:

Accounts receivables = $654,803

Net sales = $1,932,349

61. Solution:

Accounts receivables turnover = 3.9x

42

Net sales = $3,436,812

62. Solution:

Sales = $833,587

Gross profit margin = 32.4%

Inventory = $178,435

63. Solution:

64. Solution:

43

Net sales = $712,478

Accounts receivables = $167,435

65. Solution:

66. Solution:

Sales = $9,745,923; Inventory = $2,237,435 Cash = 755,071;

DSO = 49 Days

44

67. Solution:

Interest expense = $3,350,000 x 0.06875 = $230,312.50

68. Solution:

Depreciation = $1,434,500

Interest expenses = $611,800

EDIT = $7,221,643

45

69. Solution:

Depreciation = $630,715

Interest expenses = $112,078

EDIT= $1,542,833

70. Solution:

Equity multiplier = 1 + Debt to equity

Debt to equity = Equity multiplier –1

= 2.47 – 1

= 1.47

71. Solution:

46

72. Solution:

Debt ratio = $1,233,837 / $2,178,990 = 0.57

73. Solution:

Net income = $812,425

Share price = $13.45

EPS = $812,425 / 312, 490 = $2.60

74. Solution:

Net income = $1,276,351

47

Share outstanding= 420,000

EPS = $1,276,351 / 420,000 = $3.04

P-E ratio = 11.2 times

75. Solution:

Total assets= $4,744,288; Total debt= $2,912,000

Net sales= $7,212,465; Net profit margin= 18%

76. Solution:

Total assets turnover = 2.89

ROA = 10.74%

ROE = 20.36%

48

ROA = Profit margin x Total assets turnover

ROE = ROA x Equity multiplier

77. Solution:

Net sales = $4,156,700

Net income = $778,321

Cost of goods sold = $2,715,334

EBIT = $1,356,098

78. Solution:

49

79. Solution:

80. Solution:

50

51