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New Era University


College of Business Administration

FINANCIAL MANAGEMENT / MANAGEMENT ACCOUNTING
Financial Statement Analysis

1. Pepsi Corporations current ratio is 0.5, while Coke Companys current ratio is 1.5. Both firms want to window
dress their coming end-of-year financial statements. As part of its window dressing strategy, each firm will double its
current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the
statements below best describes the actual results of these transactions?
a. The current ratios of both firms will be increased.
b. The current ratios of both firms will be decreased.
c. Only Pepsi Corporations current ratio will be increased.
d. Only Coke Companys current ratio will be increased.

2. Which of the following could potentially result in a net increase in a companys cash flow for the current year?
a. Reduce the days sales outstanding ratio.
b. Increase the number of years over which fixed assets are depreciated.
c. Decrease the accounts payable balance.
d. Statements a and b are correct.

3. Stennett Corp.s CFO has proposed that the company issue new debt and use the proceeds to buy back common stock.
Which of the following are likely to occur if this proposal is adopted? (Assume that the proposal would have no
effect on the companys operating income.)
a. Return on assets (ROA) will decline.
b. The times interest earned ratio (TIE) will increase.
c. Taxes paid will decline.
d. Statements a and c are correct.

4. Amazon Electric wants to increase its debt ratio, which will also increase its interest expense. Assume that the higher
debt ratio will have no effect on the companys operating income, total assets, or tax rate. Also, assume that the basic
earning power ratio exceeds the before-tax cost of debt financing. Which of the following will occur if the company
increases its debt ratio?
a. Its return on assets (ROA) will fall.
b. Its return on equity (ROE) will increase.
c. Its basic earning power (BEP) will stay unchanged.
d. All of the statements above are correct.

5. Which of the following statements is most correct?
a. A company that has positive net income must also have positive EVA.
b. If a companys ROE is greater than its cost of equity, its EVA is positive.
c. If a company increases its EVA, its ROE must also increase.
d. All of the above statements are correct.

6. Company J and Company K each recently reported the same earnings per share (EPS). Company Js stock, however,
trades at a higher price. Which of the following statements is most correct?
a. Company J must have a higher price to earnings ratio.
b. Company J must have a higher market to book ratio.
c. Company J must be riskier.
d. Company J must have fewer growth opportunities.

7. Company As ROE is 20 percent, while Company Bs ROE is 15 percent. Which of the following statements is most
correct?
a. Company A must have a higher ROA than Company B.
b. Company A must have a higher EVA than Company B.
c. Company A must have a higher net income than Company B.
d. None of the statements above is correct.

8. Company A and Company B have the same total assets, return on assets (ROA), and profit margin. However,
Company A has a higher debt ratio and interest expense than Company B. Which of the following statements is most
correct?
a. Company A has a higher ROE (return on equity) than Company B.
b. Company A has a higher total assets turnover than Company B.
c. Company A has a higher operating income (EBIT) than Company B.
d. Statements a and c are correct.

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9. Nelson Company is thinking about issuing new common stock. The proceeds from the stock issue will be used to
reduce the companys outstanding debt and interest expense. The stock issue will have no effect on the companys
total assets, EBIT, or tax rate. Which of the following is likely to occur if the company goes ahead with the stock
issue?
a. The companys net income will increase.
b. The companys times interest earned ratio will increase.
c. The companys ROA will increase.
d. All of the above statements are correct.

10. Van Company has a current ratio of 1.9. Which of the following actions will increase the companys current ratio?
a. Use cash to reduce short-term notes payable.
b. Use cash to reduce accounts payable.
c. Issue long-term bonds to repay short-term notes payable.
d. All of the statements above are correct.

11. As a short-term creditor concerned with a companys ability to meet its financial obligation to you, which one of the
following combinations of ratios would you most likely prefer?
Current ratio Times interest earned Debt ratio
a. 0.5 0.5 0.33
b. 1.5 1.5 0.5
c. 2.0 1.0 0.67
d. 2.5 0.5 0.71

12. Drysdale Financial Company and Commerce Financial Company have the same total assets, the same total assets
turnover, and the same return on equity. However, Drysdale has a higher return on assets than Commerce. Which of
the following can explain these ratios?
a. Drysdale has a higher profit margin and a higher debt ratio than Commerce.
b. Drysdale has a lower profit margin and a lower debt ratio than Commerce.
c. Drysdale has a higher profit margin and a lower debt ratio than Commerce.
d. Drysdale has lower net income but more common equity than Commerce.

13. You observe that a firms profit margin is below the industry average, while its return on equity and debt ratio exceed
the industry average. What can you conclude?
a. Return on assets must be above the industry average.
b. Total assets turnover must be above the industry average.
c. Total assets turnover must be below the industry average.
d. Statements a and b are correct.

14. Company A and Company B have the same tax rate, total assets, and basic earning power. Both companies have
positive net incomes. Company A has a higher debt ratio, and therefore, higher interest expense than Company B.
Which of the following statements is true?
a. Company A has a higher ROA than Company B.
b. Company A has a higher times interest earned (TIE) ratio than Company B.
c. Company A has a higher net income than Company B.
d. Company A pays less in taxes than Company B.

15. Which of the following statements is most correct?
a. An increase in a firms debt ratio, with no changes in its sales and operating costs, could be expected to lower its
profit margin on sales.
b. An increase in the DSO (days sales outstanding), other things held constant, would generally lead to an increase in
the total assets turnover ratio.
c. An increase in the DSO, other things held constant, would generally lead to an increase in the ROE.
d. In a competitive economy, where all firms earn similar returns on equity, one would expect to find lower profit
margins for airlines, which require a lot of fixed assets relative to sales, than for fresh fish markets.

16. Which of the following statements is/are true?
I. Vertical analysis of financial statements is accomplished through the preparation of common-size
financial statements.
II. The gross margin percentage is computed by dividing the gross margin by EBIT.
a. Both statements are true.
b. Both statements are false.
c. Only statement I is true.
d. Only statement II is true.

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17. 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?
Short-term
borrowing
Collection of
receivable
a. Increase No effect
b. Increase Increase
c. Decrease No effect
d. Decrease Decrease

18. Division A has a higher ROE than Division B, yet Division B creates more value for shareholders and has a higher
EVA than Division A. Both divisions, however, have positive ROEs and EVAs. What could explain these
performance measures?
a. Division A is riskier than Division B.
b. Division A is much larger (in terms of equity capital employed) than Division B.
c. Division A has less debt than Division B.
d. Statements a and b are correct.

19. You are an analyst following two companies, Company X and Company Y. You have collected the following
information:
The two companies have the same total assets.
Company X has a higher total assets turnover than Company Y.
Company X has a higher profit margin than Company Y.
Company Y has a higher inventory turnover ratio than Company X.
Company Y has a higher current ratio than Company X.
Which of the following statements is most correct?
a. Company X must have a higher net income.
b. Company X must have a higher ROE.
c. Company Y must have a higher ROA.
d. All of the statements above are correct.

20. You have collected the following information regarding Companies C and D:
The two companies have the same total assets.
The two companies have the same operating income (EBIT).
The two companies have the same tax rate.
Company C has a higher debt ratio and interest expense than Company D.
Company C has a lower profit margin than Company D.
On the basis of this information, which of the following statements is most correct?
a. Company C must have a higher level of sales.
b. Company C must have a lower ROE.
c. Company C must have a higher times interest earned (TIE) ratio.
d. Company C must have a lower ROA.


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COMPREHENSIVE PROBLEM

Financial statements for Solo Company appear below:

Solo Company
Statement of Financial Position
December 31, Year 2 and 1
(in thousands)

Year 2 Year 1
Current assets:
Cash and marketable securities
Accounts receivable, net
Inventory
Prepaid expenses
Total current assets
Noncurrent assets:
Plant and equipment, net
Total assets

P 130
180
170
20
500

2,000
2,500

P 120
150
180
50
500

1,930
2,430

Current liabilities:
Accounts payable
Accrued liabilities
Notes payable, short-term
Total current liabilities
Noncurrent liabilities:
Bonds payable
Total liabilities
Stockholders equity:
Preferred stock, P10 par, 10%
Common stock, P10 par
Additional paid-in capital CS
Retained earnings
Total stockholders equity
Total liabilities and stockholders equity

P 130
30
130
290

310
600

100
180
160
1,460
1,900
2,500

P 160
60
130
350

300
650

100
180
160
1,340
1,780
2,430

Solo Company
Statement of Comprehensive Income
For the Year Ended December 31, Year 2
(in thousands)

Sales (all on account)
Cost of goods sold
Gross margin
Operating expenses
Net operating income
Interest expense
Net income before taxes
Income taxes (30%)
Net income
P 2,300
1,610
690
270
420
30
390
117
P 273

Dividends during Year 2 totaled P153 ,000, of which P10,000 were preferred dividends. The market price of a share of
common stock on December 31, Year 2 was P210.

Compute the following for Year 2:
1. Earnings per share of common stock
2. Price-earnings ratio
3. Dividend payout ratio
4. Dividend yield ratio
5. Return on total assets
6. Return on common stockholders' equity
7. Book value per share
8. Market-book ratio
9. Working capital
10. Current ratio
11. Acid-test (quick) ratio
12. Accounts receivable turnover
13. Average collection period (age of receivables)
14. Inventory turnover
15. Average sale period (turnover in days)
16. Times interest earned
17. Debt-to-equity ratio
18. Total asset turnover