Question 1

Which of the following statements is CORRECT?
A) if a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.
B) if a security analyst saw that a firm's days' sales outstanding (dso) was higher than the industry average and was also increasing and trending still higher, this would be interpreted as a sign of strength.
C) if a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding (dso) will increase.
D) there is no relationship between the days' sales outstanding (dso) and the average collection period (acp). these ratios measure entirely different things.
E) a reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 2

If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?
A) other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.
B) the lower the company's ebitda coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.
C) other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.
D) other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.
E) the lower the company's tie ratio, other things held constant, the lower the interest rate the bank would charge the firm.

Accepted Answer

When a bank loan officer is considering a company's request for a loan, they are looking for indicators that will determine the risk associated with lending to the company. The debt ratio is a key indicator that measures how much of the company's assets are financed by debt as opposed to equity. The lower the debt ratio, the less risky the company is perceived to be and therefore, the lower the interest rate the bank would charge. Therefore, option D is correct. The current ratio, ebitda coverage ratio, and tie ratio are also important indicators, but they do not have a direct impact on the interest rate charged by the bank.

Question 3

Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.

Accepted Answer

Debt management ratios, such as debt-to-equity ratio or interest coverage ratio, indicate how much debt a firm has taken on to generate profits. By using financial leverage, a company can potentially increase returns to shareholders, but it also increases risks. Therefore, debt management ratios provide insight into a company's strategy for capitalizing on financial leverage.

Question 4

The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its assets.

Accepted Answer

The inventory turnover ratio and days sales outstanding (DSO) are both commonly used ratios to evaluate the efficiency of a company's asset management. The inventory turnover ratio measures how many times a company sells and replaces its inventory in a given period, while DSO measures the average number of days it takes a company to collect payment after a sale.

Question 5

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.
 
-Refer to the data for Pettijohn Inc.What is the firm's days sales outstanding?Assume a 360-day year for this calculation.
A) 48.17
B) 50.71
C) 53.38
D) 56.19
E) 59.14

Accepted Answer

DSO = Accounts receivable/(Sales/360) = 59.14

Question 6

The times-interest-earned ratio is one, but not the only, indication of a firm's ability to meet its long-term and short-term debt obligations.

Accepted Answer

The times-interest-earned ratio is a commonly used measure of a company's ability to service its debt, but there are other factors that need to be considered as well, such as cash flow, liquidity, and overall financial stability. Therefore, while a low times-interest-earned ratio may raise concerns about a company's ability to meet its debt obligations, it is not the only factor that needs to be taken into account.

Question 7

Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000. What was its total assets turnover ratio (TATO)?
A) 2.03
B) 2.13
C) 2.25
D) 2.36
E) 2.48

Accepted Answer

$\begin{array}{lr}
\text { Sales } & \$ 52,000 \
\text { Total assets } & \$ 22,000 \
\text { TATO } & 236
\end{array}$

Question 8

Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required to achieve its target TIE ratio.

Accepted Answer

TIE = EBIT/Interest = (Sales - Op cost)/(Debt × Interest rate). If we know the op. costs, the amount of debt, and the interest rate, then we can solve for the sales level required to achieve the target TIE.

Question 9

Aziz Industries has sales of $100,000 and accounts receivable of $11,500, and it gives its customers 30 days to pay. The industry average DSO is 27 days, based on a 365-day year. If the company changes its credit and collection policy sufficiently to cause its DSO to fall to the industry average, and if it earns 8.0% on any cash freed-up by this change, how would that affect its net income, assuming other things are held constant?
A) $267.34
B) $281.41
C) $296.22
D) $311.81
E) $328.22

Accepted Answer

$\begin{array}{lr}
\text { Rate of return on cash generated } & 8.0 \% \
\text { Sales } & \$ 100,000 \
\text { A/R } & \$ 11,500 \
\text { Days in year } & 365 \
\text { Sales/day } & \$ 273.97 \
\text { Company DSO } & 42.0 \
\text { Industiy DSO } & \underline{27.0} \
\text { Excess DSO } & 15.0\
\text { Cash flow from reducing the DSO  } & \$ 4,102.74\
\text { Alternative calculation: }\
\text { A / R at inclustiyDSO}&\$ 7,397.26\
\text { Change inA / R }&\$ 4,102.74\
\text { Additional Net Income}&\$ 328,22\
\end{array}$

Question 10

A decline in a firm's inventory turnover ratio suggests that it is managing its inventory more efficiently and also that its liquidity position is improving, i.e., it is becoming more liquid.

Accepted Answer

A decline in inventory turnover ratio suggests that the firm is selling products less frequently, which could indicate lower demand or excess inventory. This can lead to a less efficient use of resources and lower liquidity position.

Question 11

Harper Corp.'s sales last year were $395,000, and its year-end receivables were $42,500. Harper sells on terms that call for customers to pay 30 days after the purchase, but many delay payment beyond Day 30. On average, how many days late do customers payσ Base your answer on this equation: DSO - Allowed credit period = Average days late, and use a 365-day year when calculating the DSO.
A) 7.95
B) 8.37
C) 8.81
D) 9.27
E) 9.74

Accepted Answer

$\begin{array} { l } 
\text { Sales } & \$ 393,000  \
\text { Srles/Dey } &\$ 1,082 \
\text { Receivables } & \$ 42,500\
\text { DSO } &39.27 \
\text { Crekit period } & 30\
\text { Credit period - DSO = Days late }&9.27
\end{array}$

Question 12

Bonner Corp.'s sales last year were $415,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.4. Bonner's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average, holding sales constant?
A) $164,330
B) $172,979
C) $182,083
D) $191,188
E) $200,747

Accepted Answer

$\begin{array} { l r } 
\text { Sales } & \text { 415,000 } \
\text { Tatal assets } & \text { 355,000 } \
\text { Taret TATO } & 2.40 \
\text { Taret assets } = \text { Sales/Taret TATO } & \$ 172,917\
\text { Asset reduction }&\$ 182,083
\end{array}$

Question 13

Heaton Corp. sells on terms that allow customers 45 days to pay for merchandise. Its sales last year were $425,000, and its year-end receivables were $60,000. If its DSO is less than the 45-day credit period, then customers are paying on time. Otherwise, they are paying late. By how much are customers paying early or lateσ Base your answer on this equation: DSO - Credit period = days early or late, and use a 365-day year when calculating the DSO. A positive answer indicates late payments, while a negative answer indicates early payments.
A) 6.20
B) 6.53
C) 6.86
D) 7.20
E) 7.56

Accepted Answer

$\begin{array}{lclrl}
\text { Credit period} & 45\
\text { Sales }& \$ 425,000 \
\text { Sales/Day} & \$ 1,164 \
\text { Receivables }& \$ 60,000 \
\text { DSO} & 51.53 \
\text { Credit period }-\text { DSO }=\text { Days early }(+) \text { or late }(-)&6.53
\end{array}$

Question 14

Which of the following statements is CORRECT?
A) if a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.
B) a reduction in inventories held would have no effect on the current ratio.
C) an increase in inventories would have no effect on the current ratio.
D) if a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
E) a reduction in the inventory turnover ratio will generally lead to an increase in the roe.

Accepted Answer

The inventory turnover ratio measures how many times a company sells and replaces its inventory during a certain period. A higher inventory turnover ratio indicates that a company is selling its inventory more frequently, which is generally considered a positive sign. Therefore, if a firm increases its sales and cost of goods sold while holding its inventories constant, its inventory turnover ratio will increase, as it is selling its inventory more frequently.

Question 15

Other things held constant, which of the following alternatives would increase a company's cash flow for the current year?
A) increase the number of years over which fixed assets are depreciated for tax purposes.
B) pay down the accounts payables.
C) reduce the days' sales outstanding (dso) without affecting sales or operating costs.
D) pay workers more frequently to decrease the accrued wages balance.
E) reduce the inventory turnover ratio without affecting sales or operating costs.

Accepted Answer

a. Lengthening depreciable lives would lower depreciation, increase taxable income and taxes, and thus lower cash flow.
b. Paying down accounts payable would use cash and thus reduce cash flow.
c. Reducing the DSO would require collecting receivables faster, which would indeed increase cash flow.
d. Decreasing accruals would lower cash flow.
e. Reducing inventory turnover would mean increasing inventories, which would use cash.

Question 16

It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

Accepted Answer

The FA turnover is Sales/FA, and it gives an indication of how effectively the firm utilizes its FA. The proportion of FA to TA is not relevant to this usage.

Question 17

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.
 
-Refer to the data for Pettijohn Inc.What is the firm's inventory turnover ratio?
A) 4.17
B) 4.38
C) 4.59
D) 5.82
E) 5.07

Accepted Answer

Inventory turnover ratio = (Cost of goods sold except depreciation + Depreciation)/Inventory = 4.17

Question 18

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.
 
-Refer to the data for Pettijohn Inc.What is the firm's total assets turnover?
A) 0.90
B) 1.12
C) 1.40
D) 1.68
E) 2.02

Accepted Answer

Total assets turnover ratio = Sales/Total assets = 1.40

Question 19

The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.

Accepted Answer

A high current ratio is consistent with a lot of inventory. A low inventory turnover is also consistent with a lot of inventory. If the CR exceeds industry norms and the turnover is below the norms, then the firm has more inventory than most other firms, given its sales. It could just be carrying a lot of good inventory, but it might also have a normal amount of "good" inventory plus some "bad" inventory that has not been written off. So the statement is true.

Question 20

Muscarella Inc. has the following balance sheet and income statement data: 
$\begin{array}{l}
\begin{array} { l } 
\text { Cash} & \$14,000 \
\text {  Receivables} & 70,000 \
\text { Inventories } &210,000 \
\text { Total CA } & \$ 294,000 \
\text { Net fixed assets } &126,000 \
\text {  Total assets } &\$ 420,000 \
\text { Sales } &\$ 280,000 \
\text {Net income  } &\$ 21,000
\end{array}
\begin{array} { l } 
\text { Accounts payable } & \$ 42,000 \
\text { Other current liabilities } & 28,000 \
 \text { Total CL } & \$ 70,000 \
\text { Long-term debt } & 70,000 \
\text { Common equity } & 280,000 \
\text { Total liab. and equity } & \$ 420,000\
\
\
\end{array}
\end{array}$

The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.70, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change?
A) 4.28%
B) 4.50%
C) 4.73%
D) 4.96%
E) 5.21%

Accepted Answer

$\begin{array}{lr}
\text { Sales } & \$ 280,000 \
\text { Net income } & \$ 21,000 \
\text { Actual current ratio } & 420\
\text { Target current ratio }&2.70
\end{array}$ 
 $\begin{array}{lll}
\text { Cash } & \$ 14,000& \text { Accounts payable } & \$ 42,000 \
\text { Receivables } & \$ 70,000 &\text { Other current liablities } & \$ 28,000 \
\text { Inventories } & \$ 210,000 &\text { Long-term debt } & \$ 70,000 \
\text { Net fixed assets } & \$ 126,000 &\text { Common equity } & \$ 280,000 \
\text { Totalassets } & \$ 420000 &\text { Thtal liab and equity } & \$ 420000\
\text { NI/Equity = ROE: } & 7.50 \% \
\text { Inv. at target CR } & \$ 105,000 \
\text { Reduction in inv \& equity } & \$ 105,000 &\text { = inventories and common equity decrease by this amount}\
& \$ 175,000 \
\text { New common equity } & 12.00 \%\
ΔROE&4.50\%
\end{array}$

Quiz 7: Analysis of Financial Statements

Which of the following statements is CORRECT?

If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?