Question 1

A current ratio of 2 to 1 is always acceptable, for a company in any industry.

Accepted Answer

A current ratio of 2 to 1 may not be acceptable for a company in certain industries. For example, companies in industries where inventory turnover or accounts receivable turnover is low, such as the automobile industry, may require a higher current ratio to remain financially stable. On the other hand, companies in industries where inventory turnover or accounts receivable turnover is high, such as the retail industry, may be able to operate with a lower current ratio. Therefore, the acceptability of a current ratio depends on the specific industry and the company's unique financial situation.

Question 2

Higher debt utilization ratios will always increase a firm's return on equity given a positive return on assets.

Accepted Answer

Higher debt utilization ratios increase a firm's financial leverage, which amplifies the return on equity (ROE) if the return on assets (ROA) is positive. This is because the cost of debt is typically lower than the cost of equity, so using debt financing magnifies the return attributable to equity holders. However, if the ROA is negative, higher debt utilization ratios can decrease the ROE.

Question 3

The current ratio is a more severe test of a firm's liquidity than the quick ratio.

Accepted Answer

The quick ratio is a more severe test of a firm's liquidity than the current ratio because it excludes inventory, which may not be easily converted to cash in the short term. Therefore, if the quick ratio is lower than the current ratio, it indicates that the firm may have difficulty meeting its short-term obligations.

Question 4

Asset utilization ratios describe how capital is being utilized to buy assets.

Accepted Answer

The answer of Asset utilization ratios describe how capital is...

Question 5

Asset utilization ratios measure the returns on various assets such as return on total assets.

Accepted Answer

The answer of Asset utilization ratios measure the returns on...

Question 6

Return on equity will be higher than return on assets if there is debt in the capital structure.

Accepted Answer

Return on equity is calculated by dividing net income by shareholders' equity. Since debt is included in the calculation of total assets, the presence of debt in the capital structure reduces the amount of equity financing required, resulting in a higher return on equity when compared to return on assets.

Question 7

Ratios are only useful for those areas of business that involve investment decisions.

Accepted Answer

Ratios are useful in various areas of business such as financial analysis, performance evaluation, and comparison with industry averages. Investment decisions are just one of the areas where ratios are used.

Question 8

Financial ratios are used to weigh and evaluate the operational performance of the firm.

Accepted Answer

Financial ratios are used to analyze and assess a firm's financial performance, including profitability, liquidity, efficiency, and solvency. These ratios help stakeholders such as investors, creditors, and management to make informed decisions regarding the company's overall health and profitability.

Question 9

The DuPont system of analysis emphasizes that profit generated by assets can be derived by various combinations of profit margins and asset turnover.

Accepted Answer

The DuPont system of analysis is based on the idea that the return on equity can be broken down into three components: profit margin, asset turnover, and financial leverage. The system emphasizes that profit generated by assets can be derived by various combinations of profit margins and asset turnover.

Question 10

Satisfactory return on assets may be achieved through high profit margins or rapid turnover of assets, but not a combination of both.

Accepted Answer

A satisfactory return on assets can be achieved through a combination of both high profit margins and rapid turnover of assets. A company with high profit margins is able to generate more income per dollar of assets, while a company with rapid turnover is able to use its assets more efficiently to generate income. A combination of both strategies can lead to a higher return on assets.

Question 11

In analyzing ratios, the age of the firm's assets need not be considered.

Accepted Answer

The age of the firm's assets should be considered when analyzing ratios as it can affect their current value and depreciation rates.

Question 12

Heavy use of long-term debt can be of benefit to a firm.

Accepted Answer

Heavy use of long-term debt can lower a firm's cost of capital, as debt is typically cheaper than equity financing due to the tax-deductibility of interest payments. This can increase a firm's profitability and return on equity. However, it also increases financial risk, as the firm must continue to make interest and principal payments even during periods of financial difficulty. Therefore, the appropriate level of debt for a firm depends on its specific situation and goals.

Question 13

Return on equity will not change if the firm increases its use of debt.

Accepted Answer

Return on equity (ROE) is calculated as net income divided by shareholders' equity, and the inclusion of debt in the capital structure will increase the leverage ratio, and potential increases the firm's risk. Therefore, the return on equity is likely to change.

Question 14

Profitability ratios allow one to measure the ability of the firm to earn an adequate return on sales, total assets, and invested capital.

Accepted Answer

Profitability ratios such as gross profit margin, operating profit margin, return on assets (ROA), and return on equity (ROE) are used to measure the firm's ability to generate profits in relation to different factors such as sales, assets, and capital invested.

Question 15

A banker or trade creditor is most concerned about a firm's profitability ratios.

Accepted Answer

The answer of A banker or trade creditor is most...

Question 16

To compute the quick ratio, accounts receivable are not included in current assets.

Accepted Answer

The answer of To compute the quick ratio, accounts receivable...

Question 17

Liquidity ratios indicate how fast a firm can generate cash to pay bills.

Accepted Answer

Liquidity ratios, such as the current ratio and quick ratio, measure a company's ability to meet short-term obligations and can give insight into how easily a company can generate cash to pay bills.

Question 18

Debt utilization ratios are used to evaluate the firm's debt position with regard to its asset base and earning power.

Accepted Answer

Debt utilization ratios such as debt-to-assets ratio and debt-to-equity ratio are commonly used to determine how much debt a company is using relative to its total assets and equity. These ratios help evaluate the company's ability to pay back its debt and manage financial risk.

Question 19

Asset utilization ratios relate balance sheet assets to income statement sales.

Accepted Answer

Asset utilization ratios measure how efficiently a company is using its assets to generate revenue. They compare the balance sheet assets, such as inventory or property, with the income statement sales. Examples of asset utilization ratios include inventory turnover and fixed asset turnover.

Question 20

Ratios are used to compare different firms in the same industry.

Accepted Answer

Ratios provide a standardized way to compare the performance of different firms in the same industry. By comparing ratios such as profitability, liquidity, and efficiency, investors and analysts can gain insight into how well a company is performing relative to its peers.

Quiz 3: Financial Analysis