Chapter 14 - Analyzing Financial Statements
Chapter 14
Analyzing Financial Statements
True / False Questions
1. A primary objective of financial statements is to provide information to current and
potential investors and creditors.
True False
2. Return on equity (ROE) is a function of three ratios: net profit margin, return on assets, and
financial leverage.
True False
3. Return on equity (ROE) provides insight with respect to a company's use of its assets.
True False
4. Time series analysis is where we compare information for a specific company over a period
of time to determine changes in operations.
True False
5. Finding comparable companies in order to compare performance is often difficult since no
two companies have identical products, markets and operating strategies.
True False
6. Finding comparable companies in order to compare performance is important because
ratios in isolation are difficult to evaluate.
True False
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Chapter 14 - Analyzing Financial Statements
7. Component percentages are used to express items on financial statements as a percentage of
a single base amount.
True False
8. Financial statement analysis is very precise and doesn't involve judgment.
True False
9. Purchasing treasury stock increases the return on equity ratio.
True False
10. The return on assets ratio is influenced significantly by a company's relative debt and
equity financing of its assets.
True False
11. Negative financial leverage occurs when a company has more debt than stockholders'
equity.
True False
12. The financial leverage percentage is positive when return on assets is greater than return
on equity.
True False
13. Earnings per share (EPS) is affected by treasury stock transactions.
True False
14. The quality of income ratio increases when net income increases.
True False
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Chapter 14 - Analyzing Financial Statements
15. The profit margin ratio considers the asset base utilized to earn income.
True False
16. The fixed asset turnover ratio increases when net income increases.
True False
17. The cash ratio is less sensitive to small transactions involving cash than is either the
current or quick ratios.
True False
18. A company that has a high level of inventory and other assets above their investment in
property, plant and equipment should calculate the total asset turnover ratio in addition to the
fixed asset turnover ratio.
True False
19. A company with a high amount of inventory will have a much lower fixed asset turnover
ratio when compared to its total asset turnover ratio.
True False
20. A higher current ratio is preferable for companies with variable cash flows.
True False
21. The quick ratio decreases when the adjusting entry to record bad debt expense is
recorded.
True False
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Chapter 14 - Analyzing Financial Statements
22. A very high current ratio and low quick ratio may indicate the company is not collecting
its accounts receivables in a timely manner.
True False
23. The inventory turnover ratio is significantly affected by the choice of inventory
accounting method.
True False
24. The cash coverage ratio measures a firm's ability to pay its current liabilities with its cash
flows from operating activities.
True False
25. The price earnings ratio is affected by the amount of risk that investors are willing to take.
True False
26. The debt to equity ratio is a risk measure used by both investors and lenders.
True False
27. The dividend yield ratio decreases when earnings per share increases.
True False
28. Many companies use high levels of debt to finance their assets because of financial
leverage benefits provided to investors when return on assets exceeds the after tax cost of
interest.
True False
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Chapter 14 - Analyzing Financial Statements
29. Dividend yield is calculated by dividing dividends per share by earnings per share and
measures the current dividend return to investors.
True False
30. A high price earnings ratio usually indicates the market is optimistic about the company's
future earnings potential.
True False
Multiple Choice Questions
31. There are several fundamental purposes decision makers consider when they use financial
data. Which of the following statements is not one of those fundamental purposes?
A. Measurement of the current condition of the business.
B. Measurement of past performance of the business.
C. Measurement of the book value of the assets.
D. Prediction of future potential of the business.
32. When considering an investment, which of the following is not one of the three critical
factors used to evaluate future earning potential of that investment?
A. Financial analysts' reports.
B. Economy wide factors.
C. Industry factors.
D. Individual company factors.
33. Which of the following statements is incorrect?
A. A company implementing a cost advantage strategy is attempting to reduce investment in
assets thereby improving the asset turnover ratio.
B. A company implementing a product differentiation strategy is attempting to improve its
profit margin through charging higher prices.
C. A company will attract a higher volume of customers and revenue by following a product
differentiation strategy versus a cost advantage strategy.
D. Financial leverage is a function of both total assets and stockholders' equity.
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Chapter 14 - Analyzing Financial Statements
34. Which of the following statements is correct?
A. Purchasing fixed assets through debt financing decreases financial leverage.
B. Accruing an expense does not affect the net profit margin ratio.
C. Return on equity increases when the financial leverage ratio decreases.
D. Purchasing treasury stock results in a decrease in asset turnover.
35. Which of the following statements is incorrect?
A. Purchasing fixed assets through equity financing decreases asset turnover.
B. Accruing an expense increases the financial leverage ratio.
C. The return on equity ratio increases when treasury stock is purchased.
D. The net profit margin ratio decreases when fixed assets are purchased.
36. Which of the following statements is correct?
A. Selling inventory for cost does not affect the net profit margin ratio.
B. Accruing sales revenue doesn't affect the net profit margin ratio.
C. The asset turnover ratio increases when fixed assets are sold for a loss.
D. The net profit margin ratio decreases when common stock is issued.
37. Home Depot's operating strategy is to offer a broad assortment of high-quality
merchandise and services at competitive prices using highly knowledgeable service-oriented
personnel and aggressive advertising. Which of the following is not as critical to achieving its
strategy?
A. Cost control
B. Product differentiation
C. High level of customer service
D. High sales volume
38. Which of the following statements is false?
A. When computing the component percentages for the income statement, net income is the
base figure.
B. Time series analysis examines a company's performance over time.
C. It is often useful to compare a company's performance with that of a competitor.
D. The North American Industry Classification System assigns industry codes based on
business operations.
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Chapter 14 - Analyzing Financial Statements
39. Which of the following statements is correct?
A. A ratio calculation is most relevant in isolation.
B. One of the advantages of ratio analysis is that it allows companies of different sizes to be
compared.
C. Finding benchmarks for comparison is a straight-forward task.
D. It is always preferable to compare a company's performance to industry-wide ratios rather
than to use a competitor's ratios.
40. The base amount in preparing a common-size income statement is usually which of the
following?
A. Income from operations
B. Gross profit
C. Net income
D. Net sales
41. Which of the following statements is correct?
A. When cost of goods sold as a percentage of sales increases the gross margin percentage
will increase.
B. It is possible for cost of goods sold in dollars to increase while cost of goods sold as a
percentage of sales decreases.
C. If gross margin percentage is the same for the current and past year, then sales and cost of
goods sold in dollars did not change.
D. If gross margin percentage increases from one year to the next, then the net income
percentage will also increase from one year to the next.
42. Which of the following statements is incorrect?
A. If selling and administrative expenses as a percentage of sales increases, then gross margin
percentage will decrease.
B. If the cost of goods sold percentage decreases and other expenses do not change, then
profit margin will increase as a percentage of sales.
C. If sales dollars decrease, a company might still report a higher gross profit percentage if
cost of goods sold decreases at a faster rate than the decrease in sales.
D. It is possible for selling and administrative expense in dollars to decrease, while selling and
administrative expenses as a percentage of sales to increase.
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Chapter 14 - Analyzing Financial Statements
43. During 2010, Home Style's cost of goods sold percentage was 68.2% and selling and store
operating costs was 19.3% of sales. During 2009, their cost of goods sold percentage was
68.9% while selling and store operating costs was 19.2% of sales. What effect would the
change in these percentages have on 2010's gross margin percentage and profit margin
percentage?
A. The decrease in the cost of goods sold percentage would increase both the gross margin
and profit margin percentages, but the increase in the selling and store operating costs
percentage would decrease both the gross margin and profit margin percentages.
B. The decrease in the cost of goods sold percentage would decrease both the gross margin
and profit margin percentages, but the increase in the selling and store operating costs would
increase both the gross margin and profit margin percentages.
C. The decrease in the cost of goods sold percentage would increase both the gross margin
and profit margin percentages and the decrease in the selling and store operating costs
percentage would decrease the profit margin percentage.
D. The decrease in the cost of goods sold percentage would decrease both the gross margin
and profit margin percentages, but selling and store operating costs would increase the profit
margin percentage.
44. Which of the following ratios is not considered to be a test of profitability?
A. Current ratio
B. Profit margin
C. Return on assets
D. Earnings per share
45. The records of Everyday Electronics Corporation for a particular period include the
following:
What is the return on equity ratio?
A. 13.2%.
B. 23.8%.
C. 24.0%.
D. 8.4%.
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Chapter 14 - Analyzing Financial Statements
46. The records of Marshall Company include the following:
The return on assets is (round to the nearest tenth of a percent)
A. 14.9%.
B. 18.3%.
C. 15.3%.
D. 14.7%.
47. The records of Marshall Company include the following:
The return on equity is (round to the nearest tenth of a percent)
A. 21.1%.
B. 10.2%.
C. 16.4%.
D. 17.1%.
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Chapter 14 - Analyzing Financial Statements
48. The records of Marshall Company include the following:
The financial leverage percentage is which of the following?
A. 1.8%
B. 2.8%.
C. 5.8%.
D. 6.4%.
49. Which of the following transactions decreases earnings per share?
A. Declaring cash dividends payable to the common stockholders.
B. Purchasing treasury stock.
C. The accrual of revenue.
D. Declaring and distributing a 10% common stock dividend.
50. Which of the following transactions decreases earnings per share?
A. Collection of an account receivable.
B. Selling treasury stock for an amount less than its cost.
C. A decrease in the market value per share.
D. Paying cash in advance for rent.
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Chapter 14 - Analyzing Financial Statements
51. Trenton Company has provided the following information:
 Net income, $240,000;
 Preferred shares issued, 6,000;
 Average common shares issued, 24,000;
 Common cash dividends declared and paid, $30,000;
 Market price per share, $36
 Average treasury shares of common stock, 4,000.
What were Trenton's earnings per share?
A. $8.00
B. $7.00
C. $10.50
D. $12.00
52. Trenton Company has provided the following information:
 Net income, $240,000;
 Preferred shares issued, 6,000;
 Average common shares issued, 24,000;
 Common cash dividends declared and paid, $30,000;
 Market price per share, $36
 Average treasury shares of common stock, 4,000.
What was Trenton's price earnings ratio?
A. 3.0
B. 5.1
C. 3.4
D. 4.5
53. Cecilia Company reported net income of $1,200,000. Their average total liabilities were
$4,300,000 and average total stockholders' equity was $5,200,000. Interest expense was
$100,000 and their tax rate was 40%. What was their return on assets ratio?
A. 13.7%.
B. 12.6%.
C. 11.6%.
D. 13.3%.
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Chapter 14 - Analyzing Financial Statements
54. Which of the following transactions will increase the quality of income ratio?
A. Paying cash to suppliers.
B. Accruing sales revenue.
C. Selling treasury stock for more than its cost.
D. Collecting an account receivable.
55. Negative financial leverage occurs when the
A. average net (after tax) interest rate on borrowed funds is less than the company's earnings
rate on its assets.
B. return on assets is more than return on equity.
C. return on equity is more than return on assets.
D. operating expenses exceed gross margin.
56. Which of the following transactions will increase a current ratio which is currently 2.5?
A. Receiving cash from signing a 6-month note payable.
B. Accruing an expense.
C. Using cash to pay an account payable.
D. Collecting an account receivable.
57. Which of the following transactions will not increase the cash ratio?
A. Receiving cash from a common stock issue.
B. Refinancing a current liability with long-term debt.
C. Using cash to purchase a two-month treasury bill.
D. Collecting an account receivable.
58. Which of the following ratios is not an indicator of a company's short-term financial
strength?
A. Price/earnings ratio
B. Receivable turnover ratio
C. Working capital
D. Quick ratio
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Chapter 14 - Analyzing Financial Statements
59. Teague Company's working capital was $40,000 and total current liabilities were 1/4 of
that amount. What was the current ratio?
A. 1
B. 3
C. 5
D. 7
60. Agnes Company reported the following data:
What was the current ratio?
A. 0.5
B. 1.5
C. 2.5
D. 0.75
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Chapter 14 - Analyzing Financial Statements
61. Agnes Company reported the following data:
What was the inventory turnover ratio?
A. 2.2
B. 1.8
C. 2.0
D. 3.0
62. Agnes Company reported the following data:
What was the average days' supply in inventory?
A. 165.9
B. 202.7
C. 182.5
D. 121.7
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Chapter 14 - Analyzing Financial Statements
63. If the current ratio is 2, the payment of a cash dividend, which was recorded as a liability
on the date of declaration, will result in which of the following?
A. An increase in the current ratio.
B. A decrease in the current ratio.
C. No effect on the current ratio.
D. A decrease in the cash coverage ratio
64. Which of the following transactions would increase the current ratio of a company if the
ratio is currently greater than 1?
A. Paid the principal on a long-term note payable.
B. Borrowed cash on a short-term note.
C. Sold inventory for more than cost.
D. Purchased supplies with cash.
65. Potaw Company reported the following data at the end of 2010:
What was the accounts receivable turnover ratio?
A. 30.0
B. 37.5
C. 36.5
D. 22.5
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Chapter 14 - Analyzing Financial Statements
66. Potaw Company reported the following data at the end of 2010:
What was the average number of days to collect receivables during 2010?
A. 16.2.
B. 14.3.
C. 36.5.
D. 21.9.
67. Cromwell Company began the year with a balance in inventory of $110,000 and ended the
year with a balance of $102,000. The net sales for the year were $983,000 with a gross profit
on sales of $295,000. What was the inventory turnover ratio?
A. 2.78
B. 9.27
C. 6.49
D. 2.89
68. Thomas Company had income before interest and taxes of $120,000. Interest expense for
the period was $17,000 and income taxes amounted to $28,500. The average stockholders'
equity was $680,000. What is Thomas' return on equity (ROE)?
A. 17.65%.
B. 15.15%.
C. 13.46%.
D. 10.96%.
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Chapter 14 - Analyzing Financial Statements
69. Wildlife Co. reported net income of $8.3 million, interest expense of $.5 million and they
are in a 30% tax rate bracket. Their average total assets are $65.8 million and average
stockholders' equity is $48.6 million. What is Wildlife's financial leverage percentage?
A. 3.7%
B. 4.5%
C. 4.0%
D. 4.7%
70. Which of the following is false?
A. The cash ratio is the most stringent and reliable test of liquidity.
B. A company with a high level of inventory will have a quick ratio significantly lower than
its current ratio.
C. A current ratio that is too high could indicate funds tied up in inventory and other working
capital assets.
D. Analysts consider a current ratio of 2 to be financially conservative.
71. Which of the following is false?
A. The major difference between the quick and current ratios is inventory.
B. Current liabilities are the denominator in the cash, quick, and current ratios.
C. Companies that sell expensive merchandise tend to have high inventory turnover ratios.
D. Some analysts do not use the cash ratio because it is very sensitive to small events.
72. Which of the following is not a measure of solvency?
A. Debt to equity ratio.
B. Cash coverage ratio.
C. Times interest earned ratio.
D. Earnings per share.
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Chapter 14 - Analyzing Financial Statements
73. Bailey Corporation reported the following information for 2010:
What is Bailey's debt-to-equity ratio?
A. 2
B. 1.25
C. 1.0
D. 3.0
74. The debt-to-equity ratio measures which of the following?
A. Liquidity
B. Solvency
C. Profitability
D. Market strength
75. Which of the accounting ratios considers the importance of cash flows relating to required
interest payments?
A. Times interest earned
B. Debt-to-equity
C. Cash coverage
D. Quick
76. Which of the following is correct?
A. The times interest earned ratio is considered a better test of the ability to cover interest
charges than the cash coverage ratio.
B. The debt to equity ratio shows the relative proportion of total assets financed by debt.
C. The higher the debt-to-equity ratio, the higher the potential return to the stockholders if
return on assets (ROA) exceeds the after tax cost of interest.
D. The cash coverage ratio compares the cash generated by a company to its cash obligations
for the prior period.
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Chapter 14 - Analyzing Financial Statements
77. Which ratio reflects the stock market's assessment of a company's future performance?
A. Price/earnings ratio
B. Dividend yield ratio
C. Fixed asset turnover ratio
D. Cash coverage ratio
78. The Apple Pie Company had net income of $47,500, earnings per share of $3.17 and
declared dividends per share of $2.00 during 2010. On December 31, 2010, the stock had a
market price of $18.50 per share. What is Apple Pie's price/earnings ratio?
A. 9.25
B. 8.11
C. 5.84
D. 0.17
79. Main Street Company paid out $2.30 in dividends per share and had earnings per share of
$5.00 during 2010. The market price of the stock on December 31, 2010 was $21.00 per
share. There were 15,000 shares of stock outstanding for the entire year. What was the
dividend yield as of December 31, 2010?
A. 16.43%.
B. 10.95%.
C. 9.13%.
D. 46.00%.
80. MusicPod's earnings per share ratios were $2.47 and $2.07 respectively for 2011 and
2010. MusicPod's stock was trading at $53.00 and $41.50 per share at the end of 2011 and
2010 respectively. The company paid cash dividends per share of $.85 in 2011 and $.63 in
2010. Total stockholders' equity was $13,572 million and $11,896 million in 2011 and 2010
respectively. The common shares outstanding were approximately 1,782,000 in both 2011 and
2010. What was MusicPod's price/earnings ratio for 2011?
A. 21.5
B. 62.4
C. 20.0
D. 2.9
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Chapter 14 - Analyzing Financial Statements
81. MusicPod's earnings per share ratios were $2.47 and $2.07 respectively for 2011 and
2010. MusicPod's stock was trading at $53.00 and $41.50 per share at the end of 2011 and
2010 respectively. The company paid cash dividends per share of $.85 in 2011 and $.63 in
2010. Total stockholders' equity was $13,572 million and $11,896 million in 2011 and 2010
respectively. The common shares outstanding were approximately 1,782,000 during both 2011
and 2010. What was MusicPod's dividend yield ratio for 2011?
A. 34.4%
B. 1.4%
C. 30.4%
D. 1.6%
82. Lee Company has provided the following information:
 Cash flow from operating activities, $240,000;
 Net income, $204,000;
 Interest expense, $20,000;
 Interest cash payments, $10,000;
 Income tax payments, $140,000;
 Income tax expense, $136,000.
What was Lee's cash coverage ratio?
A. 39.0
B. 20.0
C. 19.8
D. 39.6
83. Lee Company has provided the following information:
 Cash flow from operating activities, $240,000;
 Net income, $204,000;
 Interest expense, $20,000;
 Interest cash payments, $10,000;
 Income tax payments, $140,000;
 Income tax expense, $136,000.
What was Lee's times interest earned ratio?
A. 39.0
B. 18.0
C. 35.4
D. 17.7
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Chapter 14 - Analyzing Financial Statements
84. Lee Company has provided the following information:
 Cash flow from operating activities, $240,000;
 Net income, $204,000;
 Interest expense, $20,000;
 Interest cash payments, $10,000;
 Income tax payments, $140,000;
 Income tax expense, $136,000.
What was Lee's quality of income ratio?
A. 1.18
B. 0.85
C. 1.76
D. 0.74
85. Lucas Company has provided the following information:
 Cash flow from operating activities, $360,000;
 Net income, $306,000;
 Interest expense, $30,000;
 Interest cash payments, $20,000;
 Income tax payments, $240,000;
 Income tax expense, $246,000.
What was Lucas' cash coverage ratio?
A. 21.0
B. 31.8
C. 21.2
D. 31.0
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Chapter 14 - Analyzing Financial Statements
86. Lucas Company has provided the following information:
 Cash flow from operating activities, $360,000;
 Net income, $306,000;
 Interest expense, $30,000;
 Interest cash payments, $20,000;
 Income tax payments, $240,000;
 Income tax expense, $246,000.
What was Lucas' times interest earned ratio?
A. 18.9
B. 19.4
C. 28.3
D. 31.0
87. Lucas Company has provided the following information:
 Cash flow from operating activities, $360,000;
 Net income, $306,000;
 Interest expense, $30,000;
 Interest cash payments, $20,000;
 Income tax payments, $240,000;
 Income tax expense, $246,000.
What was Lucas' quality of income ratio?
A. 0.85
B. 0.74
C. 1.18
D. 0.93
88. Which of the following transactions doesn't affect earnings per share?
A. A 2-for-1 common stock split.
B. A 10% common stock dividend distribution.
C. Accruing revenue at year-end.
D. Issuing additional shares of preferred stock.
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Chapter 14 - Analyzing Financial Statements
89. Which of the following transactions increases both the quick and current ratios assuming
that both ratios are greater than 1?
A. Collecting an account receivable.
B. Purchasing inventory on account.
C. Accruing revenue earned at year-end.
D. Selling inventory on account at the cost of the inventory.
90. Which of the following correctly describes the effect of Mogul Company declaring and
distributing a 10% common stock dividend?
A. Mogul's current ratio decreased.
B. Mogul's return on equity ratio decreased.
C. Mogul's debt-to-equity ratio remained the same.
D. Mogul's return on assets decreased.
91. Which of the following does not correctly describe the effect of Mogul Company
declaring and distributing a 2-for-1 common stock split?
A. Mogul's current ratio remained the same.
B. Mogul's return on equity ratio remained the same.
C. Mogul's debt-to-equity ratio remained the same.
D. Mogul's earnings per share remained the same.
92. Which of the following ratios increases when inventory is sold on account for a price
equal to its original cost?
A. Current
B. Quick
C. Return on assets
D. Return on equity
93. Which of the following ratios increases when cash is collected on an account receivable?
A. Current
B. Quick
C. Return on assets
D. Receivable turnover ratio
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Chapter 14 - Analyzing Financial Statements
94. Which of the following ratios increases when a company switches from FIFO to LIFO
during a period of increasing prices?
A. Current
B. Inventory turnover
C. Profit margin
D. Debt-to-equity
95. Which of the following transactions decreases the quality of income ratio?
A. The accrual of interest expense.
B. Collecting cash on an account receivable.
C. Selling inventory on account for a profit.
D. Paying cash to a supplier.
96. The year-end adjusting entry to record bad debt expense will increase which of the
following ratios?
A. Current
B. Quality of income
C. Quick
D. Profit margin
97. The year-end adjusting entry to adjust the unearned revenue account for revenue earned,
decreases which of the following ratios?
A. Current
B. Debt-to-equity
C. Quick
D. Profit margin
98. Which of the following ratios are not affected by issuing long-term bonds payable in
exchange for cash?
A. Debt-to-equity
B. Current
C. Cash Ratio
D. Quality of income
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Chapter 14 - Analyzing Financial Statements
99. The journal entry to record depreciation expense decreases which of the following ratios?
A. Debt-to-equity
B. Earnings per share
C. Fixed asset turnover
D. Quality of income
100. The cash payment of a previously declared dividend increases which of the following
ratios?
A. Debt-to-equity
B. Earnings per share
C. Price earnings ratio
D. Asset turnover
Essay Questions
101. Complete the following income statement (both dollar amounts and component
percentages):
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Chapter 14 - Analyzing Financial Statements
102. Packers Corporation reported the following data for the year ended December 31, 2010:
Calculate each of the following ratios:
A. Profit margin
B. Return on assets
C. Return on equity
D. Earnings per share
E. Price/earnings ratio
F. Debt-to-equity ratio
G. Financial leverage percentage
H. Fixed asset turnover ratio
103. At the end of 2010, Jared Corporation reported a return on assets of 16%; net income of
$42,000; average total assets of $365,000, and average total liabilities of $165,000. What was
Jared's financial leverage percentage?
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Chapter 14 - Analyzing Financial Statements
104. At the end of 2010, Doran Corporation reported net income of $70,000, gross sales
revenue of $1,525,000, and sales returns of $125,000. Calculate the profit margin ratio.
105. The records of Washington Company showed the following:
Calculate each of the following ratios:
A. Return on assets
B. Return on equity
C. Financial leverage percentage
D. Is the financial leverage percentage positive or negative?
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Chapter 14 - Analyzing Financial Statements
106. The 2010 financial statements of Companies Y and Z showed the following:
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Chapter 14 - Analyzing Financial Statements
107. The following return on investment ratios were computed for Steven Company:
Requirements:
A. Compute financial leverage percentage for each year.
B. Explain briefly the stockholders' advantage or disadvantage for each year.
108. The following data were shown in the records of Victoria Company at the end of 2010:
Calculate each of the following ratios:
A. Quick ratio
B. Current ratio
C. Receivable turnover ratio
D. Inventory turnover ratio
E. Average age of receivables
F. Average days' supply in inventory
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Chapter 14 - Analyzing Financial Statements
109. The following data were available for Holiday Company:
Sales revenue, $225,000 (including $75,000 cash sales)
Cost of goods sold, $175,000
Average balance in inventory, $20,000
Average balance in accounts receivable, $20,000
Calculate each of the following ratios:
A. Inventory turnover ratio
B. Average days' supply in inventory
C. Receivable turnover ratio
D. Average age of receivables
110. Compete Corporation reported a quick ratio of 1.75, current assets of $50,000 and a
current ratio of 2.
Requirements:
A. Calculate the total amount of quick assets.
B. What is another name for the quick ratio?
C. Describe what type of assets are considered quick assets and give some examples.
D. How does the quick ratio compare to the current ratio?
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Chapter 14 - Analyzing Financial Statements
111. The following data were reported by Universe Company at year-end:
Calculate each of the following ratios:
A. Debt-to-equity
B. Current ratio
C. Quick ratio
D. Which, if any, of the above are liquidity ratios?
E. Which, if any, of the above are profitability ratios?
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Chapter 14 - Analyzing Financial Statements
112. Walkers World Company gathered the following information for 2010:
Calculate each of the following ratios:
A. Receivable turnover ratio
B. Average number of days to collect
C. Inventory turnover ratio
D. Average number of days' supply of inventory
14-32
Chapter 14 - Analyzing Financial Statements
113. Indicate the effect of each item on the ratios given below in the following manner: if an
item would cause an increase in the ratio, place a check in the + column; if a decrease place a
check in - column; and if no change, check the 0 column. Each item is independent of the
others.
14-33
Chapter 14 - Analyzing Financial Statements
114. Longhorn Company reported the following data at year-end:
Calculate each of the following ratios:
A. Debt to equity
B. Current ratio
115. Carolina Company computed the following ratios for a two year period:
14-34
Chapter 14 - Analyzing Financial Statements
116. The following financial data are available for Murphy Company:
Calculate each of the following ratios:
A. Return on equity
B. Price/earnings ratio
C. Dividend yield
117. The following data were reported for Favre Company:
Calculate each of the following ratios:
A. Dividend yield
B. Price/earnings ratio
C. Quality of income
14-35
Chapter 14 - Analyzing Financial Statements
118. Polk Corporation reported the following information related to its common stock (par
$10) outstanding and net income:
Calculate each of the following ratios:
A. Price/earnings ratio
B. Dividend yield
14-36
Chapter 14 - Analyzing Financial Statements
119. MNF Corporation gathered the following data at the end of the accounting period,
December 31, 2009:
Part 1: Calculate each of the following ratios:
A. Profit margin
B. Return on equity
C. Earnings per share
D. Dividend yield ratio
E. Price/earnings ratio
F. Return on assets
G. Financial leverage percentage
Part 2: Interpret the financial leverage percentage.
14-37
Chapter 14 - Analyzing Financial Statements
Chapter 14 Analyzing Financial Statements Answer Key
True / False Questions
1. A primary objective of financial statements is to provide information to current and
potential investors and creditors.
TRUE
A primary objective of financial reporting is to provide useful information to external decision
makers.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
2. Return on equity (ROE) is a function of three ratios: net profit margin, return on assets, and
financial leverage.
FALSE
ROE includes asset turnover rather than return on assets.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
14-38
Chapter 14 - Analyzing Financial Statements
3. Return on equity (ROE) provides insight with respect to a company's use of its assets.
TRUE
ROE includes asset turnover, which is a measurement of the efficient use of resources.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
4. Time series analysis is where we compare information for a specific company over a period
of time to determine changes in operations.
TRUE
A time series analysis compares information regarding a single company over time.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-02 Discuss how analysts use financial statements.
Topic Area: Financial Statement Analysis
5. Finding comparable companies in order to compare performance is often difficult since no
two companies have identical products, markets and operating strategies.
TRUE
Finding comparable companies is usually difficult.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-02 Discuss how analysts use financial statements.
Topic Area: Financial Statement Analysis
14-39
Chapter 14 - Analyzing Financial Statements
6. Finding comparable companies in order to compare performance is important because
ratios in isolation are difficult to evaluate.
TRUE
A ratio has more meaning when there are relevant comparisons.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-02 Discuss how analysts use financial statements.
Topic Area: Financial Statement Analysis
7. Component percentages are used to express items on financial statements as a percentage of
a single base amount.
TRUE
A component percentage expresses financial statement items relative to a single financial
statement amount.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-03 Compute and interpret component percentages.
Topic Area: Ratio and Percentage Analysis
8. Financial statement analysis is very precise and doesn't involve judgment.
FALSE
Financial statement analysis utilizes a lot of judgment.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-03 Compute and interpret component percentages.
Topic Area: Ratio and Percentage Analysis
14-40
Chapter 14 - Analyzing Financial Statements
9. Purchasing treasury stock increases the return on equity ratio.
TRUE
Purchasing treasury stock reduces average stockholders' equity, the ROE denominator,
therefore the ratio increases.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
10. The return on assets ratio is influenced significantly by a company's relative debt and
equity financing of its assets.
FALSE
Return on assets is not affected by the way in which the assets were financed.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
11. Negative financial leverage occurs when a company has more debt than stockholders'
equity.
FALSE
Negative financial leverage occurs when the return on assets is greater than return on equity.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-41
Chapter 14 - Analyzing Financial Statements
12. The financial leverage percentage is positive when return on assets is greater than return
on equity.
FALSE
Positive financial leverage occurs when the return on equity is greater than return on assets.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
13. Earnings per share (EPS) is affected by treasury stock transactions.
TRUE
Treasury stock transactions affect the number of common shares outstanding, which is the
EPS denominator.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14. The quality of income ratio increases when net income increases.
FALSE
The quality of income denominator is net income; an increase in net income therefore
decreases the ratio.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-42
Chapter 14 - Analyzing Financial Statements
15. The profit margin ratio considers the asset base utilized to earn income.
FALSE
The profit margin ratio is net income divided by net sales and doesn't consider the resources
(assets) used to earn income.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
16. The fixed asset turnover ratio increases when net income increases.
FALSE
The fixed asset turnover ratio is net sales revenue divided by average net fixed assets and is
therefore not affected by net income.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
17. The cash ratio is less sensitive to small transactions involving cash than is either the
current or quick ratios.
FALSE
The numerator in the cash ratio is cash plus cash equivalents and is therefore very sensitive to
cash transactions.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-43
Chapter 14 - Analyzing Financial Statements
18. A company that has a high level of inventory and other assets above their investment in
property, plant and equipment should calculate the total asset turnover ratio in addition to the
fixed asset turnover ratio.
TRUE
The total asset turnover ratio includes total assets in its denominator and should be calculated
for those companies with large amounts of inventory and accounts receivable in addition to
fixed assets.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
19. A company with a high amount of inventory will have a much lower fixed asset turnover
ratio when compared to its total asset turnover ratio.
FALSE
The total asset turnover ratio includes total assets in its denominator, whereas the fixed asset
turnover ratio only includes property, plant and equipment in its denominator. Therefore, the
fixed asset turnover ratio will exceed the total asset turnover ratio.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-44
Chapter 14 - Analyzing Financial Statements
20. A higher current ratio is preferable for companies with variable cash flows.
TRUE
Companies with variable cash flows need a higher current ratio in order to pay their current
liabilities as they become due.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
21. The quick ratio decreases when the adjusting entry to record bad debt expense is
recorded.
TRUE
The quick ratio numerator includes net accounts receivable, which decreases when bad debt
expense is recorded.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
22. A very high current ratio and low quick ratio may indicate the company is not collecting
its accounts receivables in a timely manner.
FALSE
Net accounts receivable is included in the denominator of both ratios.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-45
Chapter 14 - Analyzing Financial Statements
23. The inventory turnover ratio is significantly affected by the choice of inventory
accounting method.
TRUE
The inventory turnover ratio numerator (cost of goods sold) and denominator (average
inventory) are both influenced by the inventory accounting method used.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
24. The cash coverage ratio measures a firm's ability to pay its current liabilities with its cash
flows from operating activities.
FALSE
The cash coverage ratio measures the ability of a company to make its cash interest payments.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
25. The price earnings ratio is affected by the amount of risk that investors are willing to take.
TRUE
A high price earnings ratio means that investors are paying a high multiple of earnings per
share when purchasing stock, which therefore creates more risk.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
14-46
Chapter 14 - Analyzing Financial Statements
26. The debt to equity ratio is a risk measure used by both investors and lenders.
TRUE
The debt to equity measure assesses risk and is used by both lenders and investors.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Easy
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
27. The dividend yield ratio decreases when earnings per share increases.
FALSE
Dividend yield is calculated by dividing dividends per share by market price per share.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
28. Many companies use high levels of debt to finance their assets because of financial
leverage benefits provided to investors when return on assets exceeds the after tax cost of
interest.
TRUE
Debt financing can be advantageous when the return on assets exceeds the cost of the debt.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-47
Chapter 14 - Analyzing Financial Statements
29. Dividend yield is calculated by dividing dividends per share by earnings per share and
measures the current dividend return to investors.
FALSE
Dividend yield is calculated by dividing dividends per share by market price per share.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
30. A high price earnings ratio usually indicates the market is optimistic about the company's
future earnings potential.
TRUE
A high price earnings ratio occurs when investors are willing to pay a high multiple of the
current earnings per share, which is an indicator of optimism.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
Multiple Choice Questions
14-48
Chapter 14 - Analyzing Financial Statements
31. There are several fundamental purposes decision makers consider when they use financial
data. Which of the following statements is not one of those fundamental purposes?
A. Measurement of the current condition of the business.
B. Measurement of past performance of the business.
C. Measurement of the book value of the assets.
D. Prediction of future potential of the business.
The book value is reported and doesn't need to be measured.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
32. When considering an investment, which of the following is not one of the three critical
factors used to evaluate future earning potential of that investment?
A. Financial analysts' reports.
B. Economy wide factors.
C. Industry factors.
D. Individual company factors.
Financial analysts' reports aren't one of the three factors described in the textbook.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
14-49
Chapter 14 - Analyzing Financial Statements
33. Which of the following statements is incorrect?
A. A company implementing a cost advantage strategy is attempting to reduce investment in
assets thereby improving the asset turnover ratio.
B. A company implementing a product differentiation strategy is attempting to improve its
profit margin through charging higher prices.
C. A company will attract a higher volume of customers and revenue by following a
product differentiation strategy versus a cost advantage strategy.
D. Financial leverage is a function of both total assets and stockholders' equity.
One can't predict which decision will result in a higher volume of customers and revenue.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Reporting
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
34. Which of the following statements is correct?
A. Purchasing fixed assets through debt financing decreases financial leverage.
B. Accruing an expense does not affect the net profit margin ratio.
C. Return on equity increases when the financial leverage ratio decreases.
D. Purchasing treasury stock results in a decrease in asset turnover.
Purchasing treasury stock decreases average total assets, the asset turnover ratio denominator,
which therefore increases the ratio.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
14-50
Chapter 14 - Analyzing Financial Statements
35. Which of the following statements is incorrect?
A. Purchasing fixed assets through equity financing decreases asset turnover.
B. Accruing an expense increases the financial leverage ratio.
C. The return on equity ratio increases when treasury stock is purchased.
D. The net profit margin ratio decreases when fixed assets are purchased.
The net profit margin ratio is net income divided by net sales.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
36. Which of the following statements is correct?
A. Selling inventory for cost does not affect the net profit margin ratio.
B. Accruing sales revenue doesn't affect the net profit margin ratio.
C. The asset turnover ratio increases when fixed assets are sold for a loss.
D. The net profit margin ratio decreases when common stock is issued.
Selling fixed assets at a loss reduces average total assets, the asset turnover ratio denominator,
the ratio therefore increases.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
14-51
Chapter 14 - Analyzing Financial Statements
37. Home Depot's operating strategy is to offer a broad assortment of high-quality
merchandise and services at competitive prices using highly knowledgeable service-oriented
personnel and aggressive advertising. Which of the following is not as critical to achieving its
strategy?
A. Cost control
B. Product differentiation
C. High level of customer service
D. High sales volume
Product differentiation is not generally as critical as other factors for large mass market
retailers.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Decision Making
Bloom's: Understand
Difficulty: Easy
Learning Objective: 14-01 Explain how a company's business strategy affects financial analysis.
Topic Area: Understanding A Company's Strategy
38. Which of the following statements is false?
A. When computing the component percentages for the income statement, net income is
the base figure.
B. Time series analysis examines a company's performance over time.
C. It is often useful to compare a company's performance with that of a competitor.
D. The North American Industry Classification System assigns industry codes based on
business operations.
Net sales are the base figure.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-02 Discuss how analysts use financial statements.
Topic Area: Financial Statement Analysis
14-52
Chapter 14 - Analyzing Financial Statements
39. Which of the following statements is correct?
A. A ratio calculation is most relevant in isolation.
B. One of the advantages of ratio analysis is that it allows companies of different sizes to
be compared.
C. Finding benchmarks for comparison is a straight-forward task.
D. It is always preferable to compare a company's performance to industry-wide ratios rather
than to use a competitor's ratios.
A significant outcome of ratio analysis is the ability to compare different size firms.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-02 Discuss how analysts use financial statements.
Topic Area: Financial Statement Analysis
40. The base amount in preparing a common-size income statement is usually which of the
following?
A. Income from operations
B. Gross profit
C. Net income
D. Net sales
Net sales are the base figure.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Remember
Difficulty: Easy
Learning Objective: 14-03 Compute and interpret component percentages.
Topic Area: Ratio and Percentage Analysis
14-53
Chapter 14 - Analyzing Financial Statements
41. Which of the following statements is correct?
A. When cost of goods sold as a percentage of sales increases the gross margin percentage
will increase.
B. It is possible for cost of goods sold in dollars to increase while cost of goods sold as a
percentage of sales decreases.
C. If gross margin percentage is the same for the current and past year, then sales and cost of
goods sold in dollars did not change.
D. If gross margin percentage increases from one year to the next, then the net income
percentage will also increase from one year to the next.
If the percentage increase in sales is greater relative to the percentage increase in cost of
goods sold, cost of goods sold relative to sales will decrease.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-03 Compute and interpret component percentages.
Topic Area: Ratio and Percentage Analysis
42. Which of the following statements is incorrect?
A. If selling and administrative expenses as a percentage of sales increases, then gross
margin percentage will decrease.
B. If the cost of goods sold percentage decreases and other expenses do not change, then
profit margin will increase as a percentage of sales.
C. If sales dollars decrease, a company might still report a higher gross profit percentage if
cost of goods sold decreases at a faster rate than the decrease in sales.
D. It is possible for selling and administrative expense in dollars to decrease, while selling and
administrative expenses as a percentage of sales to increase.
Selling and administrative expenses do not affect the calculation of gross margin.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-03 Compute and interpret component percentages.
Topic Area: Ratio and Percentage Analysis
14-54
Chapter 14 - Analyzing Financial Statements
43. During 2010, Home Style's cost of goods sold percentage was 68.2% and selling and store
operating costs was 19.3% of sales. During 2009, their cost of goods sold percentage was
68.9% while selling and store operating costs was 19.2% of sales. What effect would the
change in these percentages have on 2010's gross margin percentage and profit margin
percentage?
A. The decrease in the cost of goods sold percentage would increase both the gross margin
and profit margin percentages, but the increase in the selling and store operating costs
percentage would decrease both the gross margin and profit margin percentages.
B. The decrease in the cost of goods sold percentage would decrease both the gross margin
and profit margin percentages, but the increase in the selling and store operating costs would
increase both the gross margin and profit margin percentages.
C. The decrease in the cost of goods sold percentage would increase both the gross
margin and profit margin percentages and the decrease in the selling and store
operating costs percentage would decrease the profit margin percentage.
D. The decrease in the cost of goods sold percentage would decrease both the gross margin
and profit margin percentages, but selling and store operating costs would increase the profit
margin percentage.
A decrease in the relative percentage of cost of goods sold to sales increases both the gross
margin and profit margin ratios; while the increase in the selling and store operating costs
percentage results in a decrease in the profit margin percentage.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-03 Compute and interpret component percentages.
Topic Area: Ratio and Percentage Analysis
14-55
Chapter 14 - Analyzing Financial Statements
44. Which of the following ratios is not considered to be a test of profitability?
A. Current ratio
B. Profit margin
C. Return on assets
D. Earnings per share
The current ratio measures liquidity.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Easy
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
45. The records of Everyday Electronics Corporation for a particular period include the
following:
What is the return on equity ratio?
A. 13.2%.
B. 23.8%.
C. 24.0%.
D. 8.4%.
The return on equity ratio (23.8%) = Net income ($200,500 - $135,000)  Average
stockholders' equity ($760,000 + $485,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-56
Chapter 14 - Analyzing Financial Statements
46. The records of Marshall Company include the following:
The return on assets is (round to the nearest tenth of a percent)
A. 14.9%.
B. 18.3%.
C. 15.3%.
D. 14.7%.
The return on assets ratio (15.3%) = Net income ($4,580,000 - $4,100,000) + Interest expense
net of tax [$90,000  (1 - .4)]  Average total assets ($3,500,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-57
Chapter 14 - Analyzing Financial Statements
47. The records of Marshall Company include the following:
The return on equity is (round to the nearest tenth of a percent)
A. 21.1%.
B. 10.2%.
C. 16.4%.
D. 17.1%.
The return on equity ratio (21.1%) = Net income ($4,580,000 - $4,100,000)  Average
stockholders' equity ($3,500,000 - $1,220,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-58
Chapter 14 - Analyzing Financial Statements
48. The records of Marshall Company include the following:
The financial leverage percentage is which of the following?
A. 1.8%
B. 2.8%.
C. 5.8%.
D. 6.4%.
The return on equity ratio (21.1%) = Net income ($4,580,000 - $4,100,000)  Average
stockholders' equity ($3,500,000 - $1,220,000)
The return on assets ratio (15.3%) = Net income ($4,580,000 - $4,100,000) + Interest expense
net of tax [$90,000  (1 - .4)]  Average total assets ($3,500,000)
Financial leverage percentage (5.8%) = Return on equity ratio (21.1%) - Return on assets ratio
(15.3%)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-59
Chapter 14 - Analyzing Financial Statements
49. Which of the following transactions decreases earnings per share?
A. Declaring cash dividends payable to the common stockholders.
B. Purchasing treasury stock.
C. The accrual of revenue.
D. Declaring and distributing a 10% common stock dividend.
Issuing additional shares of common stock via a stock dividend increases the number of
common shares outstanding and therefore decreases earnings per share.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
50. Which of the following transactions decreases earnings per share?
A. Collection of an account receivable.
B. Selling treasury stock for an amount less than its cost.
C. A decrease in the market value per share.
D. Paying cash in advance for rent.
Selling treasury increases the number of common shares outstanding and therefore decreases
earnings per share.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-60
Chapter 14 - Analyzing Financial Statements
51. Trenton Company has provided the following information:
 Net income, $240,000;
 Preferred shares issued, 6,000;
 Average common shares issued, 24,000;
 Common cash dividends declared and paid, $30,000;
 Market price per share, $36
 Average treasury shares of common stock, 4,000.
What were Trenton's earnings per share?
A. $8.00
B. $7.00
C. $10.50
D. $12.00
Earnings per share ($12) = Net income ($240,000)  Average number of common shares
outstanding (24,000 - 4,000).
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-61
Chapter 14 - Analyzing Financial Statements
52. Trenton Company has provided the following information:
 Net income, $240,000;
 Preferred shares issued, 6,000;
 Average common shares issued, 24,000;
 Common cash dividends declared and paid, $30,000;
 Market price per share, $36
 Average treasury shares of common stock, 4,000.
What was Trenton's price earnings ratio?
A. 3.0
B. 5.1
C. 3.4
D. 4.5
Earnings per share ($12) = Net income ($240,000)  Average number of common shares
outstanding (24,000 - 4,000).
Price earnings ratio (3) = Market price per share ($36)  Earnings per share ($12)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
53. Cecilia Company reported net income of $1,200,000. Their average total liabilities were
$4,300,000 and average total stockholders' equity was $5,200,000. Interest expense was
$100,000 and their tax rate was 40%. What was their return on assets ratio?
A. 13.7%.
B. 12.6%.
C. 11.6%.
D. 13.3%.
The return on assets ratio (13.3%) = Net income ($1,200,000) + Interest expense net of tax
[$100,000  (1 - .4)]  Average total assets ($4,300,000 + $5,200,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-62
Chapter 14 - Analyzing Financial Statements
54. Which of the following transactions will increase the quality of income ratio?
A. Paying cash to suppliers.
B. Accruing sales revenue.
C. Selling treasury stock for more than its cost.
D. Collecting an account receivable.
Collecting an account receivable increases cash flows from operating activities, the quality of
income numerator, the ratio therefore increases.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Financial Statement Analysis
55. Negative financial leverage occurs when the
A. average net (after tax) interest rate on borrowed funds is less than the company's earnings
rate on its assets.
B. return on assets is more than return on equity.
C. return on equity is more than return on assets.
D. operating expenses exceed gross margin.
Financial leverage percentage equals return on equity minus return on assets.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Remember
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Financial Statement Analysis
14-63
Chapter 14 - Analyzing Financial Statements
56. Which of the following transactions will increase a current ratio which is currently 2.5?
A. Receiving cash from signing a 6-month note payable.
B. Accruing an expense.
C. Using cash to pay an account payable.
D. Collecting an account receivable.
Using cash to pay an account payable decreases current liabilities more so percentage wise
than the decrease in current assets. As a result, the current ratio increases.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
57. Which of the following transactions will not increase the cash ratio?
A. Receiving cash from a common stock issue.
B. Refinancing a current liability with long-term debt.
C. Using cash to purchase a two-month treasury bill.
D. Collecting an account receivable.
Using cash to purchase a two month treasury bill decreases cash and increases cash
equivalents; therefore the cash ratio doesn't change.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
14-64
Chapter 14 - Analyzing Financial Statements
58. Which of the following ratios is not an indicator of a company's short-term financial
strength?
A. Price/earnings ratio
B. Receivable turnover ratio
C. Working capital
D. Quick ratio
The P/E ratio is a market test ratio.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Financial Statement Analysis
59. Teague Company's working capital was $40,000 and total current liabilities were 1/4 of
that amount. What was the current ratio?
A. 1
B. 3
C. 5
D. 7
Current liabilities ($10,000) = Working capital ($40,000)  ¼
Current assets ($50,000) - Current liabilities ($10,000) = Working capital ($40,000)
Current ratio (5) = Current assets ($50,000)  Current liabilities ($10,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
14-65
Chapter 14 - Analyzing Financial Statements
60. Agnes Company reported the following data:
What was the current ratio?
A. 0.5
B. 1.5
C. 2.5
D. 0.75
Current ratio (1.5) = Current assets ($150,000)  Current liabilities ($300,000 - $200,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
14-66
Chapter 14 - Analyzing Financial Statements
61. Agnes Company reported the following data:
What was the inventory turnover ratio?
A. 2.2
B. 1.8
C. 2.0
D. 3.0
Inventory turnover ratio (2.0) = Cost of goods sold ($84,000)  Average inventory ($38,000 +
$46,000)  2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
14-67
Chapter 14 - Analyzing Financial Statements
62. Agnes Company reported the following data:
What was the average days' supply in inventory?
A. 165.9
B. 202.7
C. 182.5
D. 121.7
Inventory turnover ratio (2.0) = Cost of goods sold ($84,000)  Average inventory ($38,000 +
$46,000)  2 Average days' supply in inventory (182.5) = 365 days  Inventory turnover (2.0)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
14-68
Chapter 14 - Analyzing Financial Statements
63. If the current ratio is 2, the payment of a cash dividend, which was recorded as a liability
on the date of declaration, will result in which of the following?
A. An increase in the current ratio.
B. A decrease in the current ratio.
C. No effect on the current ratio.
D. A decrease in the cash coverage ratio
The current ratio increases because the decrease in current liabilities (the denominator) is
greater relative to the decrease in current assets (the numerator).
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
64. Which of the following transactions would increase the current ratio of a company if the
ratio is currently greater than 1?
A. Paid the principal on a long-term note payable.
B. Borrowed cash on a short-term note.
C. Sold inventory for more than cost.
D. Purchased supplies with cash.
Selling inventory for a profit increases current assets and therefore the current ratio.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
14-69
Chapter 14 - Analyzing Financial Statements
65. Potaw Company reported the following data at the end of 2010:
What was the accounts receivable turnover ratio?
A. 30.0
B. 37.5
C. 36.5
D. 22.5
Accounts receivable turnover ratio (22.5) = Net credit sales ($300,000  .75)  Average
accounts receivable ($12,000 + $8,000)  2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
14-70
Chapter 14 - Analyzing Financial Statements
66. Potaw Company reported the following data at the end of 2010:
What was the average number of days to collect receivables during 2010?
A. 16.2.
B. 14.3.
C. 36.5.
D. 21.9.
Accounts receivable turnover ratio (22.5) = Net credit sales ($300,000  .75)  Average
accounts receivable ($12,000 + $8,000)  2
Average days number of days to collect receivables (16.2) = 365 days  Accounts receivable
turnover (22.5)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
14-71
Chapter 14 - Analyzing Financial Statements
67. Cromwell Company began the year with a balance in inventory of $110,000 and ended the
year with a balance of $102,000. The net sales for the year were $983,000 with a gross profit
on sales of $295,000. What was the inventory turnover ratio?
A. 2.78
B. 9.27
C. 6.49
D. 2.89
Inventory turnover ratio (6.49) = Cost of goods sold ($983,000 - $295,000)  Average
inventory ($110,000 + $102,000)  2
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Financial Statement Analysis
68. Thomas Company had income before interest and taxes of $120,000. Interest expense for
the period was $17,000 and income taxes amounted to $28,500. The average stockholders'
equity was $680,000. What is Thomas' return on equity (ROE)?
A. 17.65%.
B. 15.15%.
C. 13.46%.
D. 10.96%.
The return on equity ratio (10.96%) = Net income ($120,000 - $17,000 - $28,500)  Average
stockholders' equity ($680,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-72
Chapter 14 - Analyzing Financial Statements
69. Wildlife Co. reported net income of $8.3 million, interest expense of $.5 million and they
are in a 30% tax rate bracket. Their average total assets are $65.8 million and average
stockholders' equity is $48.6 million. What is Wildlife's financial leverage percentage?
A. 3.7%
B. 4.5%
C. 4.0%
D. 4.7%
The return on equity ratio (17.1%) = Net income ($8.3)  Average stockholders' equity
($48.6)
Return on assets ratio (13.1%) = Net income ($8.3) + Interest expense net of tax [$.5  (1 - .
3)]  Average total assets ($65.8)
Financial leverage percentage (4.0%) = Return on equity ratio (17.1%) - Return on assets ratio
(13.1%)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
70. Which of the following is false?
A. The cash ratio is the most stringent and reliable test of liquidity.
B. A company with a high level of inventory will have a quick ratio significantly lower than
its current ratio.
C. A current ratio that is too high could indicate funds tied up in inventory and other working
capital assets.
D. Analysts consider a current ratio of 2 to be financially conservative.
One measure of liquidity isn't necessarily more reliable than another.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-73
Chapter 14 - Analyzing Financial Statements
71. Which of the following is false?
A. The major difference between the quick and current ratios is inventory.
B. Current liabilities are the denominator in the cash, quick, and current ratios.
C. Companies that sell expensive merchandise tend to have high inventory turnover ratios.
D. Some analysts do not use the cash ratio because it is very sensitive to small events.
Companies selling more expensive merchandise tend to have higher inventory dollar levels
and less frequent sales, and therefore have lower inventory turnover ratios.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
72. Which of the following is not a measure of solvency?
A. Debt to equity ratio.
B. Cash coverage ratio.
C. Times interest earned ratio.
D. Earnings per share.
EPS is a measure of profitability.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-74
Chapter 14 - Analyzing Financial Statements
73. Bailey Corporation reported the following information for 2010:
What is Bailey's debt-to-equity ratio?
A. 2
B. 1.25
C. 1.0
D. 3.0
Debt-to-equity ratio (1) = Debt ($16,000 - $8,000)  Stockholders' equity ($8,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
74. The debt-to-equity ratio measures which of the following?
A. Liquidity
B. Solvency
C. Profitability
D. Market strength
Debt-to-equity is a measure of solvency.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Easy
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-75
Chapter 14 - Analyzing Financial Statements
75. Which of the accounting ratios considers the importance of cash flows relating to required
interest payments?
A. Times interest earned
B. Debt-to-equity
C. Cash coverage
D. Quick
The cash coverage ratio considers the relationship between operating cash flows before
interest and taxes relative to interest payments.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
76. Which of the following is correct?
A. The times interest earned ratio is considered a better test of the ability to cover interest
charges than the cash coverage ratio.
B. The debt to equity ratio shows the relative proportion of total assets financed by debt.
C. The higher the debt-to-equity ratio, the higher the potential return to the stockholders if
return on assets (ROA) exceeds the after tax cost of interest.
D. The cash coverage ratio compares the cash generated by a company to its cash obligations
for the prior period.
A high debt-to-equity ratio means that there is a lot of debt financing relative to equity
financing. If the ROA exceeds the after tax cost of financing, the excess represents a return to
stockholders, which increases the return on their investment.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-76
Chapter 14 - Analyzing Financial Statements
77. Which ratio reflects the stock market's assessment of a company's future performance?
A. Price/earnings ratio
B. Dividend yield ratio
C. Fixed asset turnover ratio
D. Cash coverage ratio
The price/earnings ratio is a measure of investor confidence with respect to future earnings.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
78. The Apple Pie Company had net income of $47,500, earnings per share of $3.17 and
declared dividends per share of $2.00 during 2010. On December 31, 2010, the stock had a
market price of $18.50 per share. What is Apple Pie's price/earnings ratio?
A. 9.25
B. 8.11
C. 5.84
D. 0.17
Price/earnings ratio (5.84) = Market price per share ($18.50)  Earnings per share ($3.17)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
14-77
Chapter 14 - Analyzing Financial Statements
79. Main Street Company paid out $2.30 in dividends per share and had earnings per share of
$5.00 during 2010. The market price of the stock on December 31, 2010 was $21.00 per
share. There were 15,000 shares of stock outstanding for the entire year. What was the
dividend yield as of December 31, 2010?
A. 16.43%.
B. 10.95%.
C. 9.13%.
D. 46.00%.
Dividend yield (10.95%) = Dividends per share ($2.30)  Market price per share ($21)
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
80. MusicPod's earnings per share ratios were $2.47 and $2.07 respectively for 2011 and
2010. MusicPod's stock was trading at $53.00 and $41.50 per share at the end of 2011 and
2010 respectively. The company paid cash dividends per share of $.85 in 2011 and $.63 in
2010. Total stockholders' equity was $13,572 million and $11,896 million in 2011 and 2010
respectively. The common shares outstanding were approximately 1,782,000 in both 2011 and
2010. What was MusicPod's price/earnings ratio for 2011?
A. 21.5
B. 62.4
C. 20.0
D. 2.9
Price/earnings ratio (21.5) = Market price per share ($53.00)  Earnings per share ($2.47)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
14-78
Chapter 14 - Analyzing Financial Statements
81. MusicPod's earnings per share ratios were $2.47 and $2.07 respectively for 2011 and
2010. MusicPod's stock was trading at $53.00 and $41.50 per share at the end of 2011 and
2010 respectively. The company paid cash dividends per share of $.85 in 2011 and $.63 in
2010. Total stockholders' equity was $13,572 million and $11,896 million in 2011 and 2010
respectively. The common shares outstanding were approximately 1,782,000 during both 2011
and 2010. What was MusicPod's dividend yield ratio for 2011?
A. 34.4%
B. 1.4%
C. 30.4%
D. 1.6%
Dividend yield ratio (1.6%) = Dividends per share ($.85)  Market price per share ($53)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
14-79
Chapter 14 - Analyzing Financial Statements
82. Lee Company has provided the following information:
 Cash flow from operating activities, $240,000;
 Net income, $204,000;
 Interest expense, $20,000;
 Interest cash payments, $10,000;
 Income tax payments, $140,000;
 Income tax expense, $136,000.
What was Lee's cash coverage ratio?
A. 39.0
B. 20.0
C. 19.8
D. 39.6
Cash coverage ratio (39.0) = [Cash flow from operating activities ($240,000) + Interest
payments ($10,000) + Income tax payments ($140,000)]  Interest payments ($10,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-80
Chapter 14 - Analyzing Financial Statements
83. Lee Company has provided the following information:
 Cash flow from operating activities, $240,000;
 Net income, $204,000;
 Interest expense, $20,000;
 Interest cash payments, $10,000;
 Income tax payments, $140,000;
 Income tax expense, $136,000.
What was Lee's times interest earned ratio?
A. 39.0
B. 18.0
C. 35.4
D. 17.7
Times interest earned ratio (39.0) = [Net income ($204,000) + Interest expense ($20,000) +
Income tax expense ($136,000)]  Interest expense ($20,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-81
Chapter 14 - Analyzing Financial Statements
84. Lee Company has provided the following information:
 Cash flow from operating activities, $240,000;
 Net income, $204,000;
 Interest expense, $20,000;
 Interest cash payments, $10,000;
 Income tax payments, $140,000;
 Income tax expense, $136,000.
What was Lee's quality of income ratio?
A. 1.18
B. 0.85
C. 1.76
D. 0.74
Quality of income ratio (1.18) = Cash Flow from operating activities ($240,000)  Net
income ($204,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-82
Chapter 14 - Analyzing Financial Statements
85. Lucas Company has provided the following information:
 Cash flow from operating activities, $360,000;
 Net income, $306,000;
 Interest expense, $30,000;
 Interest cash payments, $20,000;
 Income tax payments, $240,000;
 Income tax expense, $246,000.
What was Lucas' cash coverage ratio?
A. 21.0
B. 31.8
C. 21.2
D. 31.0
Cash coverage ratio (31.0) = [Cash flow from operating activities ($360,000) + Interest
payments ($20,000) + Income tax payments ($240,000)]  Interest payments ($20,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-83
Chapter 14 - Analyzing Financial Statements
86. Lucas Company has provided the following information:
 Cash flow from operating activities, $360,000;
 Net income, $306,000;
 Interest expense, $30,000;
 Interest cash payments, $20,000;
 Income tax payments, $240,000;
 Income tax expense, $246,000.
What was Lucas' times interest earned ratio?
A. 18.9
B. 19.4
C. 28.3
D. 31.0
Times interest earned ratio (19.4) = [Net income ($306,000) + Interest expense ($30,000) +
Income tax expense ($246,000)]  Interest expense ($30,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-84
Chapter 14 - Analyzing Financial Statements
87. Lucas Company has provided the following information:
 Cash flow from operating activities, $360,000;
 Net income, $306,000;
 Interest expense, $30,000;
 Interest cash payments, $20,000;
 Income tax payments, $240,000;
 Income tax expense, $246,000.
What was Lucas' quality of income ratio?
A. 0.85
B. 0.74
C. 1.18
D. 0.93
Quality of income ratio (1.18) = Cash Flow from operating activities ($360,000)  Net
income ($306,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
88. Which of the following transactions doesn't affect earnings per share?
A. A 2-for-1 common stock split.
B. A 10% common stock dividend distribution.
C. Accruing revenue at year-end.
D. Issuing additional shares of preferred stock.
Earnings per share is calculated by dividing net income by the average number of shares of
common stock. Issuing additional shares of preferred stock doesn't affect the ratio.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Hard
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-85
Chapter 14 - Analyzing Financial Statements
89. Which of the following transactions increases both the quick and current ratios assuming
that both ratios are greater than 1?
A. Collecting an account receivable.
B. Purchasing inventory on account.
C. Accruing revenue earned at year-end.
D. Selling inventory on account at the cost of the inventory.
Accruing revenue earned increases both quick assets and current assets; therefore both ratios
increase.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
90. Which of the following correctly describes the effect of Mogul Company declaring and
distributing a 10% common stock dividend?
A. Mogul's current ratio decreased.
B. Mogul's return on equity ratio decreased.
C. Mogul's debt-to-equity ratio remained the same.
D. Mogul's return on assets decreased.
Stock dividends do not affect debt or total stockholders' equity; therefore the debt to equity
ratio remained the same.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-86
Chapter 14 - Analyzing Financial Statements
91. Which of the following does not correctly describe the effect of Mogul Company
declaring and distributing a 2-for-1 common stock split?
A. Mogul's current ratio remained the same.
B. Mogul's return on equity ratio remained the same.
C. Mogul's debt-to-equity ratio remained the same.
D. Mogul's earnings per share remained the same.
Earnings per share decreased because the number of shares of common stock outstanding is
doubled.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
92. Which of the following ratios increases when inventory is sold on account for a price
equal to its original cost?
A. Current
B. Quick
C. Return on assets
D. Return on equity
The quick ratio increases because of the creation of the account receivable.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-87
Chapter 14 - Analyzing Financial Statements
93. Which of the following ratios increases when cash is collected on an account receivable?
A. Current
B. Quick
C. Return on assets
D. Receivable turnover ratio
The receivable turnover ratio increases because the ratio denominator (accounts receivable)
decreases.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
94. Which of the following ratios increases when a company switches from FIFO to LIFO
during a period of increasing prices?
A. Current
B. Inventory turnover
C. Profit margin
D. Debt-to-equity
The inventory turnover ratio increases because the ratio numerator (cost of goods sold)
increases and the denominator (average inventory) decreases.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-88
Chapter 14 - Analyzing Financial Statements
95. Which of the following transactions decreases the quality of income ratio?
A. The accrual of interest expense.
B. Collecting cash on an account receivable.
C. Selling inventory on account for a profit.
D. Paying cash to a supplier.
The quality of income ratio decreases because the ratio denominator (net income) increases.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
96. The year-end adjusting entry to record bad debt expense will increase which of the
following ratios?
A. Current
B. Quality of income
C. Quick
D. Profit margin
The quality of income ratio increases because the ratio denominator (net income) decreases.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-89
Chapter 14 - Analyzing Financial Statements
97. The year-end adjusting entry to adjust the unearned revenue account for revenue earned,
decreases which of the following ratios?
A. Current
B. Debt-to-equity
C. Quick
D. Profit margin
The debt-to-equity ratio decreases because the ratio denominator (equity) increases and the
ratio numerator (total debt) decreases.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
98. Which of the following ratios are not affected by issuing long-term bonds payable in
exchange for cash?
A. Debt-to-equity
B. Current
C. Cash Ratio
D. Quality of income
The quality of income ratio remains the same because the ratio numerator (cash flows from
operating activities) and denominator (net income) aren't affected by the transaction.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-90
Chapter 14 - Analyzing Financial Statements
99. The journal entry to record depreciation expense decreases which of the following ratios?
A. Debt-to-equity
B. Earnings per share
C. Fixed asset turnover
D. Quality of income
The earnings per share ratio decreased because the numerator (net income) decreases.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
100. The cash payment of a previously declared dividend increases which of the following
ratios?
A. Debt-to-equity
B. Earnings per share
C. Price earnings ratio
D. Asset turnover
The asset turnover ratio increased because the denominator (average total assets) decreases.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
Essay Questions
14-91
Chapter 14 - Analyzing Financial Statements
101. Complete the following income statement (both dollar amounts and component
percentages):
Answers will vary
Feedback:
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-03 Compute and interpret component percentages.
Topic Area: Ratio and Percentage Analysis
14-92
Chapter 14 - Analyzing Financial Statements
102. Packers Corporation reported the following data for the year ended December 31, 2010:
Calculate each of the following ratios:
A. Profit margin
B. Return on assets
C. Return on equity
D. Earnings per share
E. Price/earnings ratio
F. Debt-to-equity ratio
G. Financial leverage percentage
H. Fixed asset turnover ratio
Answers will vary
Feedback: A. $25,000 ¸ $400,000 = 6.25%
B. ($25,000 + $3,000) ¸ $200,000 = 14%
C. $25,000 ¸$160,000 = 15.6%
D. $25,000 ¸15,000 shares = $1.67
E. $16 ¸$1.67 = 9.58
F. ($200,000 - $160,000) ¸ $160,000 = 25%
G. 15.6% - 14% = 1.6% (positive)
H. $400,000 ¸$100,000 = 4 times
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
14-93
Chapter 14 - Analyzing Financial Statements
103. At the end of 2010, Jared Corporation reported a return on assets of 16%; net income of
$42,000; average total assets of $365,000, and average total liabilities of $165,000. What was
Jared's financial leverage percentage?
Answers will vary
Feedback: The return on equity ratio (21%) = Net income ($42,000)  Average stockholders'
equity ($200,000)
Financial leverage percentage (5.0%) = Return on equity ratio (21%) - Return on assets ratio
(16%)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
104. At the end of 2010, Doran Corporation reported net income of $70,000, gross sales
revenue of $1,525,000, and sales returns of $125,000. Calculate the profit margin ratio.
Answers will vary
Feedback: Profit margin (5%) = Net income ($70,000)  Net sales ($1,525,000 - $125,000)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-94
Chapter 14 - Analyzing Financial Statements
105. The records of Washington Company showed the following:
Calculate each of the following ratios:
A. Return on assets
B. Return on equity
C. Financial leverage percentage
D. Is the financial leverage percentage positive or negative?
Answers will vary
Feedback: A. [$17,000 + ($2,000 x .70)] ÷ $230,000 = 8%
B. $17,000 ÷ $100,000 = 17%
C. 17% - 8% = 9%
D. Positive
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-95
Chapter 14 - Analyzing Financial Statements
106. The 2010 financial statements of Companies Y and Z showed the following:
Answers will vary
Feedback:
Part B: Company Y appears to be a better investment. Company Y's return on equity and
return on assets are both higher than Company Z's. Also, financial leverage is greater for
Company Y. The fact that Company Y's net income is lower is not necessarily a critical factor.
14-96
Chapter 14 - Analyzing Financial Statements
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-03 Compute and interpret component percentages.
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
107. The following return on investment ratios were computed for Steven Company:
Requirements:
A. Compute financial leverage percentage for each year.
B. Explain briefly the stockholders' advantage or disadvantage for each year.
Answers will vary
Feedback: A. 2010: 15% - 12% = +3% positive
2009: 15% - 15% = -0- neither
2008: 11% - 15% = (4%) negative
2007: 20% - 18% = +2% positive
B. 2010: Positive leverage of 3% means the stockholders gained because of the use of debt.
2009: The return on assets increased to 15% but the return on equity did not increase.
Stockholders did not gain from the use of debt because leverage was zero.
2008: Negative leverage of 4% means the stockholders lost because of the use of debt.
2007: The increase in the return on equity and the positive leverage of 2% are both favorable
to stockholders.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Topic Area: Ratio and Percentage Analysis
14-97
Chapter 14 - Analyzing Financial Statements
108. The following data were shown in the records of Victoria Company at the end of 2010:
Calculate each of the following ratios:
A. Quick ratio
B. Current ratio
C. Receivable turnover ratio
D. Inventory turnover ratio
E. Average age of receivables
F. Average days' supply in inventory
Answers will vary
Feedback: A. $180,000 ¸ $50,000 = 3.6 to 1
B. $225,000 ¸$50,000 = 4.5 to 1
C. $120,000 ¸$10,000 = 12 times
D. $84,000 ¸$42,000 = 2 times
E. 365 ¸ 12 = 30 days
F. 365 ¸ 2 = 183 days
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-98
Chapter 14 - Analyzing Financial Statements
109. The following data were available for Holiday Company:
Sales revenue, $225,000 (including $75,000 cash sales)
Cost of goods sold, $175,000
Average balance in inventory, $20,000
Average balance in accounts receivable, $20,000
Calculate each of the following ratios:
A. Inventory turnover ratio
B. Average days' supply in inventory
C. Receivable turnover ratio
D. Average age of receivables
Answers will vary
Feedback: A. $175,000 ¸ 20,000 = 8.75 times
B. 365 ¸8.75 = 42 days
C. $150,000 ¸$20,000 = 7.5 times
D. 365 ¸ 7.5 = 49 days
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-99
Chapter 14 - Analyzing Financial Statements
110. Compete Corporation reported a quick ratio of 1.75, current assets of $50,000 and a
current ratio of 2.
Requirements:
A. Calculate the total amount of quick assets.
B. What is another name for the quick ratio?
C. Describe what type of assets are considered quick assets and give some examples.
D. How does the quick ratio compare to the current ratio?
Answers will vary
Feedback: A. $50,000 ¸ 2 = $25,000 current liabilities; $25,000 x 1.75 = $43,750 quick assets
B. Acid-test ratio
C. Quick assets are assets able to be readily converted to cash usually at their book values.
Quick assets often include cash, short-term investments, and net accounts receivable.
D. The quick ratio test of liquidity is a more stringent test of short-term liquidity than the
current ratio. It compares quick assets (cash or one step away from cash) to total current
liabilities. The quick ratio is less than the current ratio for most companies.
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-100
Chapter 14 - Analyzing Financial Statements
111. The following data were reported by Universe Company at year-end:
Calculate each of the following ratios:
A. Debt-to-equity
B. Current ratio
C. Quick ratio
D. Which, if any, of the above are liquidity ratios?
E. Which, if any, of the above are profitability ratios?
Answers will vary
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-101
Chapter 14 - Analyzing Financial Statements
112. Walkers World Company gathered the following information for 2010:
Calculate each of the following ratios:
A. Receivable turnover ratio
B. Average number of days to collect
C. Inventory turnover ratio
D. Average number of days' supply of inventory
Answers will vary
Feedback: A. [$432,000 x 65%) - $44,000] ¸[($100,000 - $7,000) + ($70,000 - $5,000)] = 3.0
B. 365 days ¸ 3 = 122 average days' to collect
C. $231,000 ¸($28,000 + $38,000)/2 = 7 times
D. 365 days ¸ 7 = 52 average days' supply
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
14-102
Chapter 14 - Analyzing Financial Statements
113. Indicate the effect of each item on the ratios given below in the following manner: if an
item would cause an increase in the ratio, place a check in the + column; if a decrease place a
check in - column; and if no change, check the 0 column. Each item is independent of the
others.
Answers will vary
Feedback: A. + (current assets increased)
B. - (decrease quick assets by the difference)
C. - (amount of average accounts receivable increased)
D. - (increases shares outstanding)
E. + (increase in current assets)
F. - (decrease in quick assets)
G. -0- (current assets are unchanged)
14-103
Chapter 14 - Analyzing Financial Statements
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Hard
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Topic Area: Ratio and Percentage Analysis
114. Longhorn Company reported the following data at year-end:
Calculate each of the following ratios:
A. Debt to equity
B. Current ratio
Answers will vary
Feedback: A. ($350,000 - $200,000) ¸$200,000 = .75 or 75%
B. $80,000 ¸$75,000 = 1.07 to 1
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-05 Compute and interpret liquidity ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-104
Chapter 14 - Analyzing Financial Statements
115. Carolina Company computed the following ratios for a two year period:
Answers will vary
Feedback: A. The current ratio has decreased to half of the 2009 ratio. The company's
liquidity is taking a down turn. Currently due bills may not be able to be paid in a timely
manner.
B. ROE decreased. The profitability of the company may be of concern.
C. The quality of income ratio went from above one to below one. The 2010 earnings are of
lower quality than those of 2009.
D. Cash coverage has plummeted. One might be concerned about the declining amount of
cash from operations to pay interest payments.
E. Since the profit margin declined from 2009 to 2010, less of each sales dollar is realized in
income.
Note: Overall, the company is experiencing unfavorable trends.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Understand
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-06 Compute and interpret solvency ratios.
Topic Area: Ratio and Percentage Analysis
14-105
Chapter 14 - Analyzing Financial Statements
116. The following financial data are available for Murphy Company:
Calculate each of the following ratios:
A. Return on equity
B. Price/earnings ratio
C. Dividend yield
Answers will vary
Feedback: A. Return on equity 19.93% ($196,300/$985,000)
B. Price earnings ratio 10 ($24.50/$2.45)
C. Dividend yield 5.10% ($1.25/$24.50)
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
14-106
Chapter 14 - Analyzing Financial Statements
117. The following data were reported for Favre Company:
Calculate each of the following ratios:
A. Dividend yield
B. Price/earnings ratio
C. Quality of income
Answers will vary
Feedback: A. 3.0% (.60/20)
B. EPS = $275,000 ¸ 175,000 shares = $1.57
PE = $20 ¸$1.57 = 12.74
C. $280,000 ¸275,000 = 1.02
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
14-107
Chapter 14 - Analyzing Financial Statements
118. Polk Corporation reported the following information related to its common stock (par
$10) outstanding and net income:
Calculate each of the following ratios:
A. Price/earnings ratio
B. Dividend yield
Answers will vary
Feedback: A. $40 ¸ [($35,000) ¸ ($40,000 ¸$10)] = 4.57
B. ($10,000 ¸4,000 shares) ¸ $40 = 6.25%
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
14-108
Chapter 14 - Analyzing Financial Statements
119. MNF Corporation gathered the following data at the end of the accounting period,
December 31, 2009:
Part 1: Calculate each of the following ratios:
A. Profit margin
B. Return on equity
C. Earnings per share
D. Dividend yield ratio
E. Price/earnings ratio
F. Return on assets
G. Financial leverage percentage
Part 2: Interpret the financial leverage percentage.
Answers will vary
Feedback: Part 1:
A. $60,000 ¸$1,200,000 = 5%
B. $60,000 ¸ $300,000 = 20%
C. $60,000 ¸ 50,000 shares = $1.20
D. ($22,500 ¸50,000 shares) ¸ $9 = 5%
E. $9.00 ¸ $1.20 = 7.5
F. [$60,000 + ($25,000 x .60)] ¸$500,000 = 15%
G. 20% - 15% = 5%
Part 2: The advantage is favorable to the stockholders if the ratio is positive, and it is
unfavorable to the stockholders if the ratio is negative because of the difference between
earnings on total assets and the cost of debt (interest expense net of income tax). For MNF
Corporation, the company's stockholders are benefiting from financial leverage because the
cost of borrowing is less than the return to the shareholders.
14-109
Chapter 14 - Analyzing Financial Statements
AACSB: Analytic
AICPA BB: Critical Thinking
AICPA FN: Measurement
Bloom's: Apply
Difficulty: Medium
Learning Objective: 14-04 Compute and interpret profitability ratios.
Learning Objective: 14-07 Compute and interpret market test ratios.
Topic Area: Ratio and Percentage Analysis
14-110