Question 1

An increase in which one of the following will have no effect on the cash coverage ratio?

Accepted Answer

The cash coverage ratio is a measure of a company's ability to repay its debt obligations using cash generated from operations. It is calculated by dividing the company's earnings before interest and taxes (EBIT) by its interest expense. Since depreciation is a non-cash expense and does not impact a company's ability to generate cash, an increase in depreciation will have no effect on the cash coverage ratio. On the other hand, increases in interest, sales, and cost of goods sold could all potentially impact a company's ability to generate cash, and therefore could affect the cash coverage ratio.

Question 2

A firm's operating profit margin is 20% with an EBIT of $1.5 million and sales of $5 million.If it has no debt,how much did the firm pay in taxes?

Accepted Answer

Without any interest expense, the operating profit margin can be computed as:Operating profit margin = (EBIT − taxes) / sales0.20 = ($1,500,000 − taxes) / $5,000,000Taxes = $500,000

Question 3

What is primarily responsible for the potential distortion among the ROA of different firms when net income is used in the numerator of ROA?

Accepted Answer

Financial leverage, which is the use of debt financing, can vary among firms and can result in differences in ROA even if net income is used in the numerator. This is because firms with higher financial leverage will have a lower equity base, which will result in a higher ROA even if their net income is similar to firms with lower financial leverage. Therefore, financial leverage is primarily responsible for the potential distortion among the ROA of different firms when net income is used in the numerator.

Question 4

XYZ Corp.has an operating profit margin of 7%,a debt burden of .8,and has financed two-thirds of its assets through equity.What asset turnover ratio is necessary to achieve an ROE of 18%?

Accepted Answer

ROE = leverage ratio × asset turnover × operating profit margin × debt burden0.18 = (1 / 0.67) × asset turnover × 0.07 × 0.8Asset turnover = 2.14

Question 5

What is the ROE for a firm with a times interest earned ratio of 2,a tax liability of $1 million,and interest expense of $1.5 million if equity equals $1.5 million?

Accepted Answer

Times interest earned = EBIT / Interest2 = EBIT / $1,500,000EBIT = $3,000,000Net income = EBIT − interest − taxesNet income = $3,000,000 − 1,500,000 − 1,000,000Net income = $500,000ROE = net income / equityROE = $500,000 / $1,500,000ROE = 0.3333, or 33.33%

Question 6

Last year's asset turnover ratio was 2.0.Sales have increased by 25% and total assets have increased by 10% since that time.What is the current asset turnover ratio?

Accepted Answer

Asset turnover = sales / total assets = 22 × 1.25 / 1.1 = 2.27

Question 7

By how much must a firm reduce its assets in order to improve ROA from 10% to 12% if the firm's operating profit margin is 5% on sales of $4 million? Assume that the reduction in assets has no effect on sales or profit margin

Accepted Answer

ROA = (sales / assets) × operating profit margin0.10 = ($4,000,000 / assets) × 0.05Assets = $2,000,0000.12 = ($4,000,000 / assets) × 0.05Assets = $1,666,667Reduction in assets = $2,000,000 − 1,666,667Reduction in assets = $333,333

Question 8

Efficiency ratios:

Accepted Answer

Efficiency ratios are used to measure how well a company is using its assets. The quick ratio, asset turnover ratio, and return on equity are not necessarily all efficiency ratios, as the quick ratio is a liquidity ratio and return on equity is a profitability ratio.

Question 9

Which of the following choices would be guaranteed to increase a firm's ROE if the ROA is currently 10% and the leverage ratio equals 1?

Accepted Answer

Since the leverage ratio already equals 1, decreasing it (option A) would not increase the ROE. Decreasing assets (option C) would decrease the ROA and thus decrease the ROE. Decreasing the debt burden (option D) would decrease the leverage ratio and also decrease the ROE. Therefore, increasing the debt burden from its current level (option B) would be the only guaranteed way to increase the ROE, as it would increase the leverage ratio, which amplifies the ROA's impact on the overall ROE.

Question 10

A deficiency of the standard measures of liquidity is that the measures:

Accepted Answer

The standard measures of liquidity, such as the current ratio and quick ratio, only consider a firm's current assets and liabilities. They do not take into account the reserve borrowing capacity, which could be used to address short-term liquidity needs. A firm may have unused credit lines or other sources of financing that could be used to address liquidity issues, but these are not reflected in the standard measures of liquidity.

Question 11

What is the inventory turnover ratio for ABC Corp.if cost of goods sold equals $5,000,current ratio equals 3,quick ratio equals 1.5,and the firm has $1,800 in current assets?

Accepted Answer

Current ratio = current assets / current liabilities3 = $1,800 / current liabilitiesCurrent liabilities = $600Quick ratio = (current assets − inventory) / current liabilities1.5 = ($1,800 − inventory) / $600Inventory = $900Inventory turnover = cost of goods sold / inventoryInventory turnover = $5,000 / $900Inventory turnover = 5.56 times

Question 12

A retail store with zero net working capital has:

Accepted Answer

The answer of A retail store with zero net working...

Question 13

If a company has a healthy current ratio but a significantly lower quick ratio,then you can assume that:

Accepted Answer

A healthy current ratio indicates that the company has enough current assets to cover its current liabilities. However, if the quick ratio is significantly lower, it means that a large portion of the current assets is tied up in inventory, which cannot be easily converted into cash. Therefore, option D is the best choice.

Question 14

Which one of the following would be most detrimental to a firm's current ratio if that ratio is currently 2?

Accepted Answer

Purchasing inventory on credit would increase the firm's current liabilities (accounts payable), without affecting current assets, thereby reducing the current ratio.

Question 15

What is the book value per share for a firm with 2 million shares outstanding at a price of $50,a market-to-book ratio of 0.75,and a dividend-payout ratio of 50%?

Accepted Answer

Market-to-book ratio = stock price / book value per share0.75 = $50 / book value per shareBook value per share = $66.67

Question 16

What is the residual income for a firm that is entirely equity-financed with $1 million in capital,$300,000 in net income,and a 20% cost of capital?

Accepted Answer

Residual income = net income − (cost of capital × total capitalization)Residual income = $300,000 − (0.20 × $1,000,000)Residual income = $100,000

Question 17

Which one of the following changes will provide an increase in a firm's ROE?

Accepted Answer

A decrease in the tax rate will increase net income, which in turn increases the return on equity (ROE), as ROE is calculated as net income divided by equity.

Question 18

The use of financial leverage will be detrimental to a firm's ROE if the:

Accepted Answer

Financial leverage is detrimental to a firm's ROE when the cost of debt (interest rate) is higher than the return on assets (ROA), as it reduces the overall profitability available to equity holders.

Question 19

A firm has average daily expenses of $2.13 million and average accounts payable of $112.7 million.On average,how many days does it take the firm to pay its bills?

Accepted Answer

$112.7m / $2.13m = 52.91 days

Question 20

Assume BDS acquired its main supplier,ABC.As a result of the acquisition,BDS finds that its profit margin increased but its ROA remained constant.A decrease in which one of these ratios is most apt to be the reason why the ROA did not increase with the increase in the profit margin?

Accepted Answer

The increase in profit margin indicates that BDS is earning a higher profit on each unit of sales. However, if the asset turnover ratio, which measures how efficiently the company uses its assets to generate revenue, remains constant or decreases, it means that BDS is not using its assets effectively to increase sales. Thus, an unchanged ROA despite an increase in profit margin suggests a decrease in the asset turnover ratio. The other options - A) Leverage ratio, B) Market-to-book ratio, and D) Debt burden - may indirectly affect ROA but are not directly related to the cause of the problem in this scenario.

Quiz 4: Measuring Corporate Performance