Chapter 28 - Financial Analysis
Chapter 28
Financial Analysis
Multiple Choice Questions
1. The following groups are stakeholders of a public company:
I) Shareholders
II) The government
III) Suppliers
IV) Employees
V) Bondholders
VI) Management
A. I and II only
B. I, II, and III only
C. I, II, III, and IV only
D. I, II, III, IV, V, and VI
2. In the U.S.A. and the U.K. laws and accounting procedures are designed, generally, to
benefit the:
A. Shareholders
B. Managers
C. Creditors
D. Employees
3. German laws and accounting procedures are designed, generally, to protect interests of the:
A. Shareholders
B. Managers
C. Creditors
D. Employees
28-1
Chapter 28 - Financial Analysis
4. Assets are listed on the balance sheet in order of:
I) Decreasing liquidity
II) Decreasing size
III) Increasing size
IV) Relative life
A. I only
B. III and IV only
C. II only
D. IV only
5. The following are known as current assets:
I) Cash
II) Marketable securities
III) Receivables
IV) Inventories
V) Payables
A. I, II and III only
B. I, II, III and IV only
C. II, III, IV and V only
D. III, IV and V only
6. The difference between Total Assets of a firm and its Total Liabilities is called.
A. Net working capital
B. Net current assets
C. Net worth
D. None of the above
7. Inventory consists of:
A. finished goods
B. raw material and finished goods
C. raw material, work in process, and finished goods
D. none of the above
28-2
Chapter 28 - Financial Analysis
8. The difference between Current Assets of a firm and its Current Liabilities is called.
A. Net worth
B. Net working capital
C. Gross working capital
D. None of the above
9. Net working capital (NWC) is calculated as:
A. Total assets-total liabilities
B. Current assets + current liabilities
C. Current assets-current liabilities
D. None of the above
10. Earnings before interest and taxes is calculated as:
A. Total revenues-costs
B. Total revenues-costs-depreciation
C. Total revenues-costs-depreciation-taxes
D. None of the above
11. Total uses of funds are calculated as:
A. investments in net working capital + investments in fixed assets
B. investments in fixed assets + dividend paid to shareholders
C. investments in net working capital + investments in fixed assets + dividend paid to
shareholders
D. investments in net working capital + investments in fixed assets-dividend paid to
shareholders
12. Total sources of funds are calculated as:
A. operating cash flows + new issues of equity
B. operating cash flows + new issues of equity + new issues of long-term debt
C. operating cash flows + new issues of equity-new issues of long-term debt
D. operating cash flows + new issues of equity-dividend paid to shareholders
28-3
Chapter 28 - Financial Analysis
13. If the debt ratio is 0.5 what is the debt-equity ratio? (assume no leases)
A. 0.5
B. 1.0
C. 2.0
D. 4.0
14. Which of the following is an example of leverage ratios?
A. Debt-Equity ratio
B. Quick ratio
C. Payout ratio
D. Return on equity
15. Given the following data: Long term debt = 100; Value of leases = 20; Book value of
equity = 80; Market value of equity = 100, calculate the debt ratio.
A. 0.56
B. 0.50
C. 0.55
D. 0.60
16. Given the following data: Long term debt = 100; Value of leases = 20; Book value of
equity = 80; Market value of equity = 100, calculate the debt-equity ratio.
A. 0.50
B. 0.60
C. 1.50
D. 1.0
17. Given the following data: EBIT = 100; Depreciation = 40; Interest = 20; Dividends = 10;
calculate the Times Interest Earned (TIE) ratio.
A. 7.0
B. 5.0
C. 4.7
D. 14.0
28-4
Chapter 28 - Financial Analysis
18. Which of the following is an example of liquidity ratios?
A. Times interest earned (TIE)
B. P/E ratio
C. Return on equity
D. Quick ratio
19. Given the following data: Current assets = 500; Current liabilities = 250; Inventory = 200;
Account receivables = 200; calculate the current ratio:
A. 2.0
B. 1.0
C. 1.5
D. None of the above
20. Given the following data: Current assets = 500; Current liabilities = 250; Inventory = 200;
Account receivables = 200; calculate the quick ratio:
A. 1.0
B. 2.0
C. 1.2
D. None of the above
21. Given the following data: Current assets = 500; Current liabilities = 250; Inventory = 200;
Account receivables = 200; calculate the cash ratio: (assume that the firm has no marketable
securities)
A. 0.4
B. 2.0
C. 1.5
D. None of the above
22. Given the following data: Sales = 3200; Cost of goods sold = 1600; Average total assets =
1600; Average inventory = 200, calculate the asset turnover ratio:
A. 2.0
B. 0.9375
C. 1.33
D. None of the above
28-5
Chapter 28 - Financial Analysis
23. Given the following data: Sales = 3200; Cost of goods sold = 1600; Average total assets =
1600; Average inventory = 200, calculate the days in inventory:
A. 18.3
B. 45.6
C. 22.8
D. None of the above
24. Given the following data: Sales = 3200; Cost of good sold = 1600; Average receivables =
200, calculate the average collection period:
A. 24.3
B. 22.8
C. 137
D. None of the above
25. When a firm improves (lowers) its days in inventories it generally:
A. Requires additional cash investment in inventory
B. Releases cash locked up in inventory
C. Does not alter its cash position
D. A firm cannot reduce its inventories
26. When a firm improves (lowers) its average collection period it generally:
A. Requires additional cash investment in inventory
B. Releases cash locked up in accounts receivables
C. Does not alter its cash position
D. A firm cannot reduce its inventories
27. Given the following data: EBIT = 400; Tax = 100; Sales = 3000; Average Total Assets =
1500, calculate net profit margin:
A. 10%
B. 18.3%
C. 7.5%
D. None of the above
28-6
Chapter 28 - Financial Analysis
28. Given the following data: EBIT = 400; Tax = 100; Sales = 3000; Average Total Assets =
1500, calculate the ROA (Return on Assets):
A. 10%
B. 20%
C. 7.5%
D. None of the above
29. Net profit margin is calculated as:
A. (EBIT-tax)/Sales
B. Net income/sales
C. Net income/Cost of goods sold
D. none of the above
30. Given the following data: EBIT = 400; NI = 100; Average Equity = 1000, calculate the
ROE (Return on Equity):
A. 10%
B. 12%
C. 7.5%
D. None of the above
31. Given the following data: Earnings per share = $5; Dividends per share = $3; Price per
share = $50. calculate the dividend yield:
A. 10%
B. 5%
C. 60%
D. None of the above
32. Given the following data: Earnings per share = $6; Dividends per share = $3; Price per
share = $60, calculate the P/E ratio:
A. 16.7
B. 10
C. 25
D. None of the above
28-7
Chapter 28 - Financial Analysis
33. Given the following data: Earnings per share = $5; Dividends per share = $3; Price per
share = $50. Calculate the payout ratio:
A. 10%
B. 5%
C. 60%
D. None of the above
34. Which measure would be most useful in comparing the operating profitability of two
firms in different industries?
A. Net profit margin
B. Return on equity
C. Sales to total assets
D. Return on assets
35. Efficiency ratios indicate:
I) How productively is the firm utilizing its assets.
II) How liquid is the firm.
III) How profitable is the firm.
IV) How highly is the firm valued by investors.
A. I only
B. II only
C. III only
D. III and IV only
36. Profitability ratios indicate:
I) How productively is the firm utilizing its assets.
II) How liquid is the firm.
III) How profitable is the firm.
IV) How highly is the firm valued by the investors.
A. I only
B. II only
C. III only
D. III and IV only
28-8
Chapter 28 - Financial Analysis
37. Market value ratios indicate:
I) How productively is the firm utilizing its assets.
II) How liquid is the firm.
III) How profitable is the firm.
IV) How highly is the firm valued by the investors.
A. I only
B. II only
C. II and III only
D. IV only
38. Which of the following factors would be influential in a typical financial plan?
I) how a firm can generate superior long-term returns
II) choice of industry
III) position within the industry
A. I only
B. I and II only
C. II and III only
D. I, II and III
39. Given a book value per share of $10 and a market value of $24, what is the market
capitalization of a firm with 2,000,000 outstanding shares?
A. $2,000,000
B. $20,000,000
C. $28,000,000
D. $48,000,000
40. Given a book value per share of $5 and a market value of $12, what is the market value
added of a firm with 2,000,000 outstanding shares?
A. $1,000,000
B. $10,000,000
C. $14,000,000
D. $24,000,000
True / False Questions
28-9
Chapter 28 - Financial Analysis
41. Net working capital is equal to total assets minus total liabilities.
True False
42. Total uses of funds is equal to investments in net working capital plus investments in fixed
assets plus dividends paid to shareholders.
True False
43. Leverage ratios show how heavily the company is in debt.
True False
44. Ratios can help you to ask the right questions, they rarely answer these questions.
True False
45. Efficiency ratios indicate how productively the company is using its assets to generate
profits.
True False
46. Market value ratios indicate how highly the firm is valued by the managers.
True False
47. P/E ratio measures the price that investors are prepared to for each dollar of earnings.
True False
48. According to the Du Pont system:
True False
28-10
Chapter 28 - Financial Analysis
49. The calculation of market value added for a firm requires the use of the book value per
share.
True False
50. ROA can be increased by increasing asset turnover.
True False
Short Answer Questions
51. Briefly explain the relationship between accounting standards and the legal traditions.
52. What are the three basic financial statements?
53. How are "uses and sources" of funds are calculated?
28-11
Chapter 28 - Financial Analysis
54. What are the common ratios used to measure liquidity of a firm?
55. Briefly explain the different categories of financial ratios.
56. What are the primary reasons for a company to use debt in its capital structure?
57. Discuss the DuPont system.
28-12
Chapter 28 - Financial Analysis
58. Why is liquidity relevant?
28-13
Chapter 28 - Financial Analysis
Chapter 28 Financial Analysis Answer Key
Multiple Choice Questions
1. The following groups are stakeholders of a public company:
I) Shareholders
II) The government
III) Suppliers
IV) Employees
V) Bondholders
VI) Management
A. I and II only
B. I, II, and III only
C. I, II, III, and IV only
D. I, II, III, IV, V, and VI
Type: Easy
2. In the U.S.A. and the U.K. laws and accounting procedures are designed, generally, to
benefit the:
A. Shareholders
B. Managers
C. Creditors
D. Employees
Type: Medium
3. German laws and accounting procedures are designed, generally, to protect interests of the:
A. Shareholders
B. Managers
C. Creditors
D. Employees
Type: Medium
28-14
Chapter 28 - Financial Analysis
4. Assets are listed on the balance sheet in order of:
I) Decreasing liquidity
II) Decreasing size
III) Increasing size
IV) Relative life
A. I only
B. III and IV only
C. II only
D. IV only
Type: Easy
5. The following are known as current assets:
I) Cash
II) Marketable securities
III) Receivables
IV) Inventories
V) Payables
A. I, II and III only
B. I, II, III and IV only
C. II, III, IV and V only
D. III, IV and V only
Type: Easy
6. The difference between Total Assets of a firm and its Total Liabilities is called.
A. Net working capital
B. Net current assets
C. Net worth
D. None of the above
Type: Easy
28-15
Chapter 28 - Financial Analysis
7. Inventory consists of:
A. finished goods
B. raw material and finished goods
C. raw material, work in process, and finished goods
D. none of the above
Type: Easy
8. The difference between Current Assets of a firm and its Current Liabilities is called.
A. Net worth
B. Net working capital
C. Gross working capital
D. None of the above
Type: Easy
9. Net working capital (NWC) is calculated as:
A. Total assets-total liabilities
B. Current assets + current liabilities
C. Current assets-current liabilities
D. None of the above
Type: Medium
10. Earnings before interest and taxes is calculated as:
A. Total revenues-costs
B. Total revenues-costs-depreciation
C. Total revenues-costs-depreciation-taxes
D. None of the above
Type: Easy
28-16
Chapter 28 - Financial Analysis
11. Total uses of funds are calculated as:
A. investments in net working capital + investments in fixed assets
B. investments in fixed assets + dividend paid to shareholders
C. investments in net working capital + investments in fixed assets + dividend paid to
shareholders
D. investments in net working capital + investments in fixed assets-dividend paid to
shareholders
Type: Medium
12. Total sources of funds are calculated as:
A. operating cash flows + new issues of equity
B. operating cash flows + new issues of equity + new issues of long-term debt
C. operating cash flows + new issues of equity-new issues of long-term debt
D. operating cash flows + new issues of equity-dividend paid to shareholders
Type: Medium
13. If the debt ratio is 0.5 what is the debt-equity ratio? (assume no leases)
A. 0.5
B. 1.0
C. 2.0
D. 4.0
Debt ratio = D/(D + E) = 0.5, D/E = 1
Type: Medium
14. Which of the following is an example of leverage ratios?
A. Debt-Equity ratio
B. Quick ratio
C. Payout ratio
D. Return on equity
Type: Easy
28-17
Chapter 28 - Financial Analysis
15. Given the following data: Long term debt = 100; Value of leases = 20; Book value of
equity = 80; Market value of equity = 100, calculate the debt ratio.
A. 0.56
B. 0.50
C. 0.55
D. 0.60
Debt ratio = (100 + 20)/(100 + 20 + 80) = 0.6
Type: Medium
16. Given the following data: Long term debt = 100; Value of leases = 20; Book value of
equity = 80; Market value of equity = 100, calculate the debt-equity ratio.
A. 0.50
B. 0.60
C. 1.50
D. 1.0
D/E = 120/80 = 1.5
Type: Medium
17. Given the following data: EBIT = 100; Depreciation = 40; Interest = 20; Dividends = 10;
calculate the Times Interest Earned (TIE) ratio.
A. 7.0
B. 5.0
C. 4.7
D. 14.0
TIE = (100 + 40)/20 = 7
Type: Medium
28-18
Chapter 28 - Financial Analysis
18. Which of the following is an example of liquidity ratios?
A. Times interest earned (TIE)
B. P/E ratio
C. Return on equity
D. Quick ratio
Type: Easy
19. Given the following data: Current assets = 500; Current liabilities = 250; Inventory = 200;
Account receivables = 200; calculate the current ratio:
A. 2.0
B. 1.0
C. 1.5
D. None of the above
Current Ratio = 500/250 = 2.0
Type: Medium
20. Given the following data: Current assets = 500; Current liabilities = 250; Inventory = 200;
Account receivables = 200; calculate the quick ratio:
A. 1.0
B. 2.0
C. 1.2
D. None of the above
Quick ratio = (500 - 200)/250 = 1.2
Type: Medium
28-19
Chapter 28 - Financial Analysis
21. Given the following data: Current assets = 500; Current liabilities = 250; Inventory = 200;
Account receivables = 200; calculate the cash ratio: (assume that the firm has no marketable
securities)
A. 0.4
B. 2.0
C. 1.5
D. None of the above
Cash ratio = (500 - 200 - 200)/250 = 0.4
Type: Medium
22. Given the following data: Sales = 3200; Cost of goods sold = 1600; Average total assets =
1600; Average inventory = 200, calculate the asset turnover ratio:
A. 2.0
B. 0.9375
C. 1.33
D. None of the above
Asset turnover ratio = 3200/1600 = 2.0
Type: Medium
23. Given the following data: Sales = 3200; Cost of goods sold = 1600; Average total assets =
1600; Average inventory = 200, calculate the days in inventory:
A. 18.3
B. 45.6
C. 22.8
D. None of the above
Days in inventory = 200/(1600/365) = 45.6 days
Type: Medium
28-20
Chapter 28 - Financial Analysis
24. Given the following data: Sales = 3200; Cost of good sold = 1600; Average receivables =
200, calculate the average collection period:
A. 24.3
B. 22.8
C. 137
D. None of the above
Average collection period = 200/(3200/365) = 22.8 days
Type: Medium
25. When a firm improves (lowers) its days in inventories it generally:
A. Requires additional cash investment in inventory
B. Releases cash locked up in inventory
C. Does not alter its cash position
D. A firm cannot reduce its inventories
Type: Medium
26. When a firm improves (lowers) its average collection period it generally:
A. Requires additional cash investment in inventory
B. Releases cash locked up in accounts receivables
C. Does not alter its cash position
D. A firm cannot reduce its inventories
Type: Medium
28-21
Chapter 28 - Financial Analysis
27. Given the following data: EBIT = 400; Tax = 100; Sales = 3000; Average Total Assets =
1500, calculate net profit margin:
A. 10%
B. 18.3%
C. 7.5%
D. None of the above
Net profit margin = (400 - 100)/3000 = 0.1 = 10%
Type: Medium
28. Given the following data: EBIT = 400; Tax = 100; Sales = 3000; Average Total Assets =
1500, calculate the ROA (Return on Assets):
A. 10%
B. 20%
C. 7.5%
D. None of the above
ROA = (400 - 100)/1500 = 20%
Type: Medium
29. Net profit margin is calculated as:
A. (EBIT-tax)/Sales
B. Net income/sales
C. Net income/Cost of goods sold
D. none of the above
Type: Medium
28-22
Chapter 28 - Financial Analysis
30. Given the following data: EBIT = 400; NI = 100; Average Equity = 1000, calculate the
ROE (Return on Equity):
A. 10%
B. 12%
C. 7.5%
D. None of the above
ROE = NI/Average Equity = 100/1000 = 10%
Type: Medium
31. Given the following data: Earnings per share = $5; Dividends per share = $3; Price per
share = $50. calculate the dividend yield:
A. 10%
B. 5%
C. 60%
D. None of the above
Dividend yield = 3/60 = 5%
Type: Easy
32. Given the following data: Earnings per share = $6; Dividends per share = $3; Price per
share = $60, calculate the P/E ratio:
A. 16.7
B. 10
C. 25
D. None of the above
P/E ratio = 60/6 = 10
Type: Easy
28-23
Chapter 28 - Financial Analysis
33. Given the following data: Earnings per share = $5; Dividends per share = $3; Price per
share = $50. Calculate the payout ratio:
A. 10%
B. 5%
C. 60%
D. None of the above
Dividend yield = 3/5 = 60%
Type: Easy
34. Which measure would be most useful in comparing the operating profitability of two
firms in different industries?
A. Net profit margin
B. Return on equity
C. Sales to total assets
D. Return on assets
Type: Difficult
35. Efficiency ratios indicate:
I) How productively is the firm utilizing its assets.
II) How liquid is the firm.
III) How profitable is the firm.
IV) How highly is the firm valued by investors.
A. I only
B. II only
C. III only
D. III and IV only
Type: Easy
28-24
Chapter 28 - Financial Analysis
36. Profitability ratios indicate:
I) How productively is the firm utilizing its assets.
II) How liquid is the firm.
III) How profitable is the firm.
IV) How highly is the firm valued by the investors.
A. I only
B. II only
C. III only
D. III and IV only
Type: Easy
37. Market value ratios indicate:
I) How productively is the firm utilizing its assets.
II) How liquid is the firm.
III) How profitable is the firm.
IV) How highly is the firm valued by the investors.
A. I only
B. II only
C. II and III only
D. IV only
Type: Easy
38. Which of the following factors would be influential in a typical financial plan?
I) how a firm can generate superior long-term returns
II) choice of industry
III) position within the industry
A. I only
B. I and II only
C. II and III only
D. I, II and III
Type: Medium
28-25
Chapter 28 - Financial Analysis
39. Given a book value per share of $10 and a market value of $24, what is the market
capitalization of a firm with 2,000,000 outstanding shares?
A. $2,000,000
B. $20,000,000
C. $28,000,000
D. $48,000,000
24 x 2,000,000 = 48,000,000
Type: Medium
40. Given a book value per share of $5 and a market value of $12, what is the market value
added of a firm with 2,000,000 outstanding shares?
A. $1,000,000
B. $10,000,000
C. $14,000,000
D. $24,000,000
(12 - 5) x 2,000,000 = 14,000,000
Type: Medium
True / False Questions
41. Net working capital is equal to total assets minus total liabilities.
FALSE
Type: Easy
42. Total uses of funds is equal to investments in net working capital plus investments in fixed
assets plus dividends paid to shareholders.
TRUE
Type: Medium
28-26
Chapter 28 - Financial Analysis
43. Leverage ratios show how heavily the company is in debt.
TRUE
Type: Easy
44. Ratios can help you to ask the right questions, they rarely answer these questions.
TRUE
Type: Easy
45. Efficiency ratios indicate how productively the company is using its assets to generate
profits.
FALSE
Type: Difficult
46. Market value ratios indicate how highly the firm is valued by the managers.
FALSE
Type: Medium
47. P/E ratio measures the price that investors are prepared to for each dollar of earnings.
TRUE
Type: Medium
28-27
Chapter 28 - Financial Analysis
48. According to the Du Pont system:
TRUE
ROE = (assets/equity) × (sales/assets) × [(EBIT - Tax)/sales] × [(EBIT - Tax - Interest)/(EBIT
- Tax)]
Type: Medium
49. The calculation of market value added for a firm requires the use of the book value per
share.
TRUE
Type: Medium
50. ROA can be increased by increasing asset turnover.
TRUE
Type: Medium
Short Answer Questions
51. Briefly explain the relationship between accounting standards and the legal traditions.
Generally, companies from countries with English or Scandinavian legal traditions provide
more accounting information and have higher accounting standards than companies from
countries with French or German legal traditions.
Type: Medium
28-28
Chapter 28 - Financial Analysis
52. What are the three basic financial statements?
The three basic financial statements are the balance sheet, the income statement, and the
sources and uses of funds.
Type: Easy
53. How are "uses and sources" of funds are calculated?
Sources and uses of funds are calculated as follows: Total uses of funds = Investment in net
working capital + investment in fixed assets + dividends paid to shareholders Total sources of
funds = operating cash flow + new issues of long-term debt + new issues of equity
Type: Medium
54. What are the common ratios used to measure liquidity of a firm?
The ratios commonly used to measure liquidity are the current ratio, quick ratio, and cash
ratio.
Type: Medium
55. Briefly explain the different categories of financial ratios.
There are five categories of financial ratios. They are: leverage ratios, liquidity ratios,
efficiency ratios, profitability ratios, and market value ratios.
Type: Easy
28-29
Chapter 28 - Financial Analysis
56. What are the primary reasons for a company to use debt in its capital structure?
Companies use debt for two main reasons: (a) debt is less expensive due to the taxdeductibility of interest charges, and (b) the use of debt does not dilute shareholders' equity
position.
Type: Difficult
57. Discuss the DuPont system.
The DuPont system is a quick way of looking at the performance of a firm or a division. ROA
and ROE can be thought of as comprising of several ratios and hence provide some useful
information about the interaction of these ratios.
Type: Medium
58. Why is liquidity relevant?
Firms have a need to convert assets into cash quickly. This is necessary to meet short term
obligations. Without liquidity, even the most short term loans could force a company into
bankruptcy.
Type: Medium
28-30