Question 1

The average days' supply in inventory is computed by dividing the days in the year by the ending balance of inventory.

Accepted Answer

The average days' supply in inventory is computed by dividing the ending balance of inventory by the cost of goods sold per day.

Question 2

A high inventory turnover ratio indicates a large supply of inventory.

Accepted Answer

A high inventory turnover ratio actually indicates that inventory is selling quickly and efficiently, resulting in less inventory on hand. Therefore, a low inventory turnover ratio would indicate a large supply of inventory.

Question 3

Return on assets (ROA)is usually viewed as a realistic measure of management's performance in using all of the resources available to the company regardless of how the assets are financed.

Accepted Answer

ROA is a measure of how effectively a company is using its assets, regardless of how those assets are financed (e.g., through equity or debt). It is a key metric for evaluating management's performance in deploying the company's resources.

Question 4

Market test ratios relate the current price per share to the return that accrues to investors.

Accepted Answer

Market test ratios, such as the price-to-earnings ratio (P/E ratio) and price-to-book ratio (P/B ratio), compare the current market price per share of a company to its earnings or book value. These ratios help investors determine whether a company's stock is overvalued or undervalued relative to its earnings or assets.

Question 5

Positive financial leverage benefits the common shareholders.

Accepted Answer

Positive financial leverage refers to the situation where the rate of return earned on the assets purchased with borrowed funds exceeds the interest rate paid on the borrowed funds. This results in an increase in the earnings per share and a higher return on equity for common shareholders, thereby benefiting them.

Question 6

Profitability ratios are evaluated by comparing them over time for a single company or by comparing them with ratios for similar companies.

Accepted Answer

Profitability ratios are commonly used to evaluate a company's financial performance over time and to compare it with the ratios of other similar companies to determine its relative strength or weakness.

Question 7

Solvency ratios are evaluated by comparing them over time for a single company or by comparing them with ratios for similar companies.

Accepted Answer

Solvency ratios are used to evaluate a company's ability to meet its long-term financial obligations. These ratios are best evaluated over time to identify trends and changes in a company's solvency. Additionally, they can be compared with ratios for similar companies to benchmark a company's solvency against its peers in the industry.

Question 8

If an increase in ROA is the result of borrowing at high interest rates,investors could well interpret negative leverage as reflecting good news.

Accepted Answer

Negative leverage means the company is not using debt to finance its operations, which could potentially limit its growth prospects. Investors may view this as a negative sign, rather than good news, even if the ROA has increased.

Question 9

Ratios can best be interpreted only by comparing them to other ratios or to some threshold value.

Accepted Answer

Ratios alone do not provide much information, but when compared to other ratios or to some benchmark value, they become meaningful and useful for analysis. Therefore, ratios must always be interpreted in context.

Question 10

A price/earnings ratio is viewed as a good measure of a company's dividend paying ability.

Accepted Answer

A price/earnings ratio is a measure of a company's stock valuation, not its dividend paying ability. A higher P/E ratio does not necessarily indicate a better dividend paying company.

Question 11

The fixed asset turnover ratio measures management's ability to generate sales with the use of fixed assets.It is especially valuable for capital intensive companies.

Accepted Answer

The statement is true. The fixed asset turnover ratio is calculated by dividing net sales by the total value of fixed assets. It measures how efficiently a company is using its fixed assets to generate revenue. This ratio is particularly important for companies that heavily rely on large, long-term assets such as property, plant, and equipment. By comparing the fixed asset turnover ratio over time or against industry benchmarks, investors and analysts can gain insights into management's ability to optimize the use of these assets to generate income.

Question 12

Financial leverage is positive when the return on equity (ROE)is higher than the return on assets (ROA).

Accepted Answer

Financial leverage is positive when the return on equity (ROE), which is the return to shareholders, is higher than the return on assets (ROA), which is the return to both shareholders and creditors. This indicates that the firm is using debt to increase its equity returns, resulting in a higher ROE. However, if the ROA is higher than the cost of debt, the firm could also experience negative financial leverage if the amount of interest paid on debt is greater than the increased returns from equity.

Question 13

Since inventory is a significant current asset for most retail organizations,the inventory turnover ratio would be of significance to investors and analysts in terms of assessing liquidity.

Accepted Answer

Inventory turnover ratio is a measure of how efficiently a company can sell and replace its inventory. A higher inventory turnover ratio indicates that the company is selling its inventory quickly and efficiently, which is a positive sign for investors and analysts when assessing the company's liquidity. Therefore, the statement is true.

Question 14

The current ratio is widely regarded as the one most fundamental measures of the performance of the management.

Accepted Answer

The current ratio is a liquidity measure, not a direct measure of management performance. It assesses a company's ability to pay short-term obligations, not management effectiveness.

Question 15

The current ratio is a less stringent test of liquidity than is the quick ratio.

Accepted Answer

The current ratio includes all current assets in the calculation, while the quick ratio only includes the most liquid current assets (such as cash and marketable securities). Therefore, the quick ratio provides a more conservative measure of liquidity.

Question 16

Companies typically want the highest cash ratio possible.

Accepted Answer

A very high cash ratio may indicate that a company is not effectively using its assets to generate returns, as it holds too much cash instead of investing in growth opportunities.

Question 17

The quick ratio of a company will always be less than or equal to the current ratio (working capital ratio).

Accepted Answer

The quick ratio only includes the most liquid assets (cash, marketable securities, and accounts receivable) while the current ratio includes all current assets. Therefore, the quick ratio will always be lower than the current ratio.

Question 18

Negative financial leverage occurs when a company has more debt than shareholders' equity.

Accepted Answer

Negative financial leverage occurs when the cost of debt exceeds the return on investment, not merely when debt exceeds equity.

Question 19

When computing return on equity (ROE),it is best to divide profit by the year-end shareholders' equity amount rather than using an average shareholders' equity amount.

Accepted Answer

Using the average shareholders' equity provides a more accurate reflection of the equity base over the period, accounting for any changes throughout the year.

Question 20

Liquidity ratios are evaluated by comparing them over time for a single company or by comparing them with ratios for similar companies.

Accepted Answer

Liquidity ratios are often used to assess a company's ability to meet short-term obligations. They can be compared over time to identify trends, as well as with ratios for similar companies to gauge relative performance.

Quiz 13: Analyzing Financial Statements