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Chapter 3 Assignment
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Assignment:

Ratios True and False (next page)

Using the financial information from Problem 42 (page 96-97) (also included in this document),
1. Calculate the 12 ratios listed in the outline (use the form provided or reproduce the form in
Excel). In your calculation of ratios, use end of year amounts rather than average amounts.
2. Answer the following questions:
a) If you were being asked to determine whether your company should grant short-term
credit to Wizard Industries, which ratios would you consider as most important?
b) Based on these ratios, would you grant short-term credit to Wizard?
c) If you were being asked to determine whether your company should grant longt-term
credit to Wizard Industries, which ratios would you consider as most important?
d) Based on these ratios, would you grant long-term credit to Wizard?
e) If you were being asked to determine whether your company should purchase shares in
Wizard Industries as an investment, which ratios would you consider as most important?
f) Based on these ratios, would you recommend purchasing shares of Wizard?
g) Consider Wizard’s dividend policy – do you consider it to be reasonable?
h) Where is the money likely coming from to pay the dividends?
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Chapter 3 Assignment
Profitability Ratios
_____1. Earnings per share measures the dollar amounted earned and distributed to shareholders. F
_____2. A high price-earnings ratio indicates that investors have confidence in a company. T
_____3. Investors are highly interested in the profitability ratios. T
_____4. A company has $700,000 in assets and $200,000 in debt. It reports income of $140,000. It
has an ROA of 20%. T
_____5. The company in #4 above has an ROE of 28%. T
_____6. In 2007, Costco’s stock price dropped when Costco reported increased profits, but a lower
profit margin. A lower profit margin is due to lower sales. F
Asset Utilization Ratios
_____7. A high inventory turnover ratio is usually better than a low inventory ratio. T
_____8. A company that is regularly stocking-out would have a very high inventory turnover ratio.
T
_____9. A company has extended its credit terms to allow customers to pay in 60 days instead of
30 days. Receivables turnover will be lower. T
_____10. A firm has sales of $1,000,000 and average accounts receivable of $100,000. The average
collection period is 36.5 days. T
_____11. An increasing average collection period indicates that the company is becoming more
efficient in its collection activities. F
_____12. Investors and analysts wanting to evaluate the operating efficiency of a firm’s managers
would probably look closely at the firm’s asset utilization ratios. T
Liquidity Ratios
_____13. A higher current ratio is always better. F
_____14. In computing the quick ratio, accounts receivable are not included in current assets. F
_____15. Liquidity measures the ability to pay long-term debts. F
_____16. A company with a high current ratio and a much smaller quick ratio has a large amount of
inventory. T
_____17. A supplier would be very interested in the liquidity ratios of a new major customer. T
_____18. Net working capital is current assets divided by current liabilities. F
_____19. The current ratio is a more rigorous test of liquidity than the quick ratio. F
_____20. In 2003, Danier Leather reported a current ratio of 4.4 and quick ratio of .9. The industry
average is 2.2 and 1.0. Danier Leather was carrying less inventory than the rest of the
industry. F
Debt Utilization Ratios
_____21. A high “times interest earned” ratio means a company can easily cover its interest
payments. T
_____22. Company X has EBIT of $500,000, interest expense of $100,000 and EBT of $400,000. It
has a times interest earned ratio of 4. F
_____23. Company A has a debt to assets ratio of 60%, Company B is at 75%. Company A is
riskier. F
_____24. A high degree of financial leverage means a company has a high degree of debt. T
_____25. High financial leverage increases risk and potential return for shareholders. T
_____26. Danier Leather’s debt to asset ratio was 34% in 2005 and 42% in 2006. This shows
improvement from 2005 to 2006. F
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Chapter 3 Assignment
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Chapter 3 Assignment
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Chapter 3 Assignment
20XX
20XW
20XV
Industry
0.1%
0.1%
0.4%
5.1%
10.2%
29.6%
0.4%
0.7%
1.8%
5.8%
8.1%
20.3%
3.9X
93
4.9X
9.9X
1.8X
5.1X
72
4.2X
10.6X
2.0X
5.2X
70
4.1X
8.4X
1.9X
6.3X
58.3 days
4.3X
8.0X
1.7X
1.72
1.08
1.71
93
1.55
0.82
1.6
1.1
71.4%
1.02X
65.3%
3.42X
64.7%
1.15X
60.0%
4.3X
Profitability Ratios
Profit Margin
Return on Assets
Return on Equity
Asset Utilization Ratios
Receivables Turnover
Average Collection Period
Inventory Turnover
Capital Asset Turnover
Total Asset Turnover
Liquidity Ratios
Current Ratio
Quick Ratio
Debt Utilization Ratios
Debt to Total Assets
Times Interest Earned