Question 1

If sales decrease and financial leverage increases, we can say with certainty that the profit margin on sales will decrease.

Accepted Answer

The answer of If sales decrease and financial leverage increases,...

Question 2

The inventory turnover and current ratios are related.The combination of a high current ratio and a low inventory turnover ratio relative to the industry norm might indicate that the firm is maintaining too high an inventory level or that part of the inventory is obsolete or damaged.

Accepted Answer

A high current ratio indicates good short-term liquidity, but if the inventory turnover ratio is low, it suggests that the company is not able to convert its inventory into sales quickly enough. This could be due to overstocking or holding outdated or damaged inventory. Therefore, the two ratios are related and a combination of a high current ratio and low inventory turnover ratio might indicate potential inventory problems.

Question 3

When a firm conducts a stock repurchase, it increases an equity account which is an example of a source of funds.

Accepted Answer

A stock repurchase reduces the firm's cash account and increases its treasury stock account, which is a deduction from equity. Therefore, it is not an example of a source of funds.

Question 4

Current cash flow from existing assets is highly relevant to the investor.However, the value of the firm depends primarily upon its growth opportunities.As a result, profit projections from those opportunities are the only relevant future flows with which investors are concerned.

Accepted Answer

While growth opportunities and their profit projections are crucial, investors also consider current cash flows from existing assets, as they provide a basis for evaluating the firm's present financial health and its ability to generate returns in the short term.

Question 5

Other things held constant, which of the following will not affect the quick ratio? (Assume that current assets equal current liabilities.)
A)Fixed assets are sold for cash.
B)Cash is used to purchase inventories.
C)Cash is used to pay off accounts payable.
D)Accounts receivable are collected.
E)Long-term debt is issued to payoff a short-term bank loan.

Accepted Answer

The quick ratio only considers assets that can be quickly converted to cash, so changes in long-term debt and fixed assets will not affect it. Option A would increase the quick ratio by adding cash to current assets. Option B would decrease the quick ratio by reducing cash and increasing inventories. Option C would have no effect on the quick ratio since both accounts payable and cash are current liabilities and assets, respectively. Option E would decrease the quick ratio by increasing long-term debt, which is not included in the calculation of quick ratio.

Question 6

In order to accurately estimate cash flow from operations, depreciation must be added back to net income.The reason for this is that even though depreciation is deducted from revenue it is really a non-cash charge.

Accepted Answer

Depreciation is a non-cash charge, meaning it does not actually involve the outflow of cash. Therefore, in order to accurately estimate cash flow from operations, it is necessary to add back depreciation to net income.

Question 7

Genzyme Corporation has seen its days sales outstanding (DSO) decline from 38 days last year to 22 days this implying that more of the firm's suppliers are being paid on time.

Accepted Answer

Days Sales Outstanding (DSO) measures the average number of days it takes a company to collect payment after a sale, not to pay suppliers. A decline in DSO indicates faster collection from customers, not payments to suppliers.

Question 8

A liquid asset is an asset that can be easily converted into cash without a significant loss of its original value.

Accepted Answer

A liquid asset is an asset that can be quickly and easily converted into cash without a significant loss of value. Examples of liquid assets include cash, stocks, and government bonds.

Question 9

In accounting, emphasis is placed on determining net income.In finance, the primary emphasis also is on net income because that is what investors use to value the firm.However, a secondary consideration is cash flow because that's what is used to run the business.

Accepted Answer

In finance, the primary emphasis is on cash flow because it determines a firm's ability to fund operations, invest, and return value to shareholders. Net income is important but considered secondary because it is an accounting measure that can be influenced by non-cash items.

Question 10

Suppose a firm wants to maintain a specific TIE ratio.If the firm knows the level of its debt, the interest rate it will pay on that debt and the applicable tax rate, the firm can then calculate the earnings level required to maintain its target TIE ratio.

Accepted Answer

This is true, as the TIE ratio (or interest coverage ratio) is a measure of a company's ability to meet its interest payments. It is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expenses. Therefore, if a firm wants to maintain a specific TIE ratio, it can calculate the required earnings level by using its debt level, interest rate, and tax rate information.

Question 11

The fixed charge coverage ratio recognizes that firms often lease equipment under contract and thus, some firms must meet more than just their scheduled interest payments out of earnings.Therefore, the fixed charge coverage is more inclusive than the TIE ratio.

Accepted Answer

The statement is true as the fixed charge coverage ratio takes into account all fixed charges that must be met by a company, including lease contracts, whereas the TIE ratio only considers scheduled interest payments.

Question 12

Funds supplied by common stockholders mainly includes capital stock, paid-in capital, and retained earnings, while total equity is comprised of common equity plus preferred stock.

Accepted Answer

Funds supplied by common stockholders include capital stock, paid-in capital, and retained earnings, which are all forms of common equity. Total equity includes common equity as well as preferred stock.

Question 13

Suppose two firms with the same amount of assets pay the same interest rate on their debt and earn the same rate of return on their assets, and that ROA is positive.However, one firm has a higher debt ratio.Under these conditions, the firm with the higher debt ratio will also have a higher rate of return on common equity.

Accepted Answer

This is because the higher debt ratio means that the firm is using more debt financing, which results in a higher financial leverage. Financial leverage amplifies the returns earned on common equity, meaning that a smaller change in the rate of return on assets can lead to a larger change in the rate of return on common equity. Therefore, the firm with the higher debt ratio will likely have a higher rate of return on common equity.

Question 14

If the current ratio of Firm A is greater than the current ratio of Firm B, we cannot be sure that the quick ratio of Firm A is greater than that of Firm B.However, if the quick ratio of Firm A exceeds that of Firm B, we can be assured that Firm A's current ratio also exceeds B's current ratio.

Accepted Answer

The answer of If the current ratio of Firm A...

Question 15

Retained earnings is the cash that has been generated by the firm through its operations which has not been paid out to stockholders as dividends.Retained earnings are kept in cash or near cash accounts and thus, these cash accounts, when added together, will always be equal to the total retained earnings of the firm.

Accepted Answer

The answer of Retained earnings is the cash that has...

Question 16

The financial position of companies whose business is seasonal can be dramatically different depending upon the
time of year chosen to construct financial statements.This time sensitivity is especially true with respect to the firm's balance sheet.

Accepted Answer

Seasonal businesses may have significant fluctuations in their assets and liabilities depending on the time of year, which can greatly affect the balance sheet. For example, a ski resort may have a large amount of inventory and accounts receivable in the winter season, but these may decrease significantly in the off-season, leading to a different financial position depending on when the balance sheet is constructed.

Question 17

We can use the fixed asset turnover ratio to legitimately compare firms in different industries as long as all the firms being compared are using the same proportion of fixed assets to total assets.

Accepted Answer

The fixed asset turnover ratio cannot be used to compare firms in different industries because industries have different requirements for fixed assets. For example, a manufacturing company will require significantly more fixed assets than a consulting firm, regardless of revenue or profits. Therefore, comparing the fixed asset turnover ratio between these two companies would not be a meaningful comparison.

Question 18

When a firm conducts a seasoned equity offering, it increases an equity account which is an example of a source of funds.

Accepted Answer

A seasoned equity offering is a method for a company to raise capital by issuing new shares of common or preferred stock to the public. The proceeds from the sale of these new shares are considered a source of funds and increase the equity account of the firm.

Question 19

Selling new stock is an equity transaction; it does not affect any asset or liability account and therefore, does not appear on the statement of cash flows.

Accepted Answer

Selling new stock is actually a financing activity and affects the equity section of the balance sheet, which is a component of the statement of cash flows.

Question 20

One would calculate changes in balance sheet accounts for
A)A typical ratio analysis.
B)Pro forma balance sheet construction.
C)Statement of cash flows construction.
D)Profit and loss analysis.
E)Pro forma income statement construction.

Accepted Answer

Changes in balance sheet accounts are used to construct the statement of cash flows, as they help determine cash inflows and outflows.

Quiz 2: Analysis of Financial Statements