There are those that believe that the analysis of financial statements has limitations. Which of the statements below would qualify as a limitation of financial statement analysis?

There are those that believe that the analysis of financial statements has limitations. Which of the statements below would qualify as a limitation of financial statement analysis?

A) Ratio analysis requires the analyst to evaluate a firm's performance over too many years to be of any value.
B) Proper ratio analysis requires the analyst to rely upon audited financial statements, which can be easily manipulated.
C) Thorough ratio analysis requires the analyst to refer to benchmarking, which is very easy to misinterpret.
D) Ratio analysis requires the analyst to utilize accounting data that is based on historical costs instead of current market values.

Answer: D

Which of the following is not a method of "benchmarking"?

Which of the following is not a method of "benchmarking"?

A) Conduct an industry group analysis.
B) Utilize the DuPont system to analyze a firm's performance.
C) Evaluating a single firm's performance over time.
D) Identify a group of firms that compete with the company being analyzed.

Answer: B

Why is the quick ratio considered by some to be a better measure of liquidity than the current ratio?

Why is the quick ratio considered by some to be a better measure of liquidity than the current ratio?

A) The quick ratio more accurately reflects a firm's profitability.
B) It omits the least liquid current asset from the numerator of the ratio.
C) The current ratio does not include accounts receivable.
D) It measures how "quickly" cash flows through the firm.

Answer: B

Which of the following is a benefit of a common-size income statement?

Which of the following is a benefit of a common-size income statement?

A) It is very useful to assess how effectively a firm collected its accounts receivable.
B) It reveals a great deal of information about the adequacy of a firm's net working capital.
C) It can tell the analyst a great deal about the firm's efficiency and profitability.
D) It reveals how effectively a firm has increased its sales.

Answer: C

Limitations of ratio analysis include all but

Limitations of ratio analysis include all but

A) Ratios depend on accounting data based on historical costs.
B) Differences in accounting practices like FIFO versus LIFO make comparison difficult.
C) Trend analysis could be distorted by financial statements affected by inflation.
D) All of the above are limitations of ratio analysis.

Answer: D

Peer group analysis can be performed by

Peer group analysis can be performed by

A) management choosing a set of firms that are similar in size or sales, or who compete in the same market.
B) using the average ratios of this peer group, which would then be used as the benchmark.
C) identifying firms in the same industry that are grouped by size, sales, and product lines in order to establish benchmark ratios.
D) Only a and b relate to peer group analysis.

Answer: D

Which one of the following statements about trend analysis is NOT correct?

Which one of the following statements about trend analysis is NOT correct?

A) This benchmark is based on a firm's historical performance.
B) It allows management to examine each ratio over time and determine whether the trend is good or bad for the firm.
C) The Standard Industrial Classification (SIC) System is used to identify benchmark firms.
D) All of the above are true statements.

Answer: C

Which one of the following is NOT an advantage of using ROE as a goal?

Which one of the following is NOT an advantage of using ROE as a goal?

A) ROE is highly correlated with shareholder wealth maximization.
B) ROE and the DuPont analysis allow management to break down the performance and identify areas of strengths and weaknesses.
C) ROE does not consider risk.
D) All of the above are advantages of using ROE as a goal.

Answer: C

Which one of the following is a criticism of equating the goals of maximizing the ROE of a firm and maximizing the firm's shareholder wealth?

Which one of the following is a criticism of equating the goals of maximizing the ROE of a firm and maximizing the firm's shareholder wealth?

A) ROE is based on after-tax earnings, not cash flows.
B) ROE does not consider risk.
C) ROE ignores the size of the initial investment as well as future cash flows.
D) All of the above are criticisms of ROE as a goal.

Answer: D

The DuPont equation shows that a firm's ROE is determined by three factors:

The DuPont equation shows that a firm's ROE is determined by three factors:

A) net profit margin, total asset turnover, and the equity multiplier
B) operating profit margin, ROA, and the ROE
C) net profit margin, total asset turnover, the ROA
D) ROA, total assets turnover, and the equity multiplier

Answer: A

Which one of the following statements is NOT correct?

Which one of the following statements is NOT correct?

A) The DuPont system is based on two equations that relate a firm's ROA and ROE.
B) The DuPont system is a set of related ratios that links the balance sheet and the income statement.
C) Both management and shareholders can use this tool to understand the factors that drive a firm's ROE.
D) All of the above are correct.

Answer: D

For a firm that has both debt and equity,

For a firm that has both debt and equity,

A) ROE > ROA.
B) ROE < ROA.
C) ROE = ROA
D) None of the above.

Answer: A

For a firm that has no debt in its capital structure,

For a firm that has no debt in its capital structure,

A) ROE > ROA.
B) ROE < ROA.
C) ROE = ROA.
D) None of the above.

Answer: C

Coverage ratios, like times interest earned and cash coverage ratio, allow

Coverage ratios, like times interest earned and cash coverage ratio, allow

A) a firm's management to assess how well they meet short-term liabilities.
B) a firm's shareholders to assess how well the firm will meet its short-term liabilities.
C) a firm's creditors to assess how well the firm will meet its interest obligations.
D) a firm's creditors to assess how well the firm will meet its short-term liabilities other than interest expense.

Answer: C

Which one of the following statements is NOT correct?

Which one of the following statements is NOT correct?

A) A leveraged firm is more risky than a firm that is not leveraged.
B) A leveraged firm is less risky than a firm that is not leveraged.
C) A firm that uses debt magnifies the return to its shareholders.
D) All of the above statements are correct.

Answer: B

If firm A has a higher debt-to-equity ratio than firm B, then

If firm A has a higher debt-to-equity ratio than firm B, then

A) firm A has a lower equity multiplier than firm B.
B) firm B has a lower equity multiplier than firm A.
C) firm B has lower financial leverage than firm A.
D) None of the above.

Answer: A

Which one of the following statements is correct?

Which one of the following statements is correct?

A) The lower the level of a firm's debt, the higher the firm's leverage.
B) The lower the level of a firm's debt, the lower the firm's equity multiplier.
C) The lower the level of a firm's debt, the higher the firm's equity multiplier.
D) The tax benefit from using debt financing reduces a firm's risk.

Answer: B

One of the following statements is NOT true of asset turnover ratios.

One of the following statements is NOT true of asset turnover ratios.

A) Asset turnover ratios measure the level of sales per dollar of assets that the firm has.
B) The fixed assets turnover ratio is less significant for equipment-intensive manufacturing industry firms than the total assets turnover ratio.
C) The higher the total asset turnover, the more efficiently management is using total assets.
D) All of the above are true.

Answer: B

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) The accounts receivables turnover ratio measures how quickly the firm collects on its credit sales.
B) One ratio that measures the efficiency of a firm's collection policy is days' sales outstanding.
C) The more days that it takes the firm to collect on its receivables, the more efficient the firm is.
D) DSO measures in days, the time the firm takes to convert its receivables into cash.

Answer: C

All but one of the following is true about the inventory turnover ratio.

All but one of the following is true about the inventory turnover ratio.

A) It is calculated by dividing inventory by cost of goods sold.
B) It measures how many times the inventory is turned over into saleable products.
C) The more times a firm can turnover the inventory, the better.
D) Too high a turnover or too low a turnover could be a warning sign.

Answer: A