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Financial Statement Analysis

FINANCIAL STATEMENT ANALYSIS


THEORIES:
6. Management is a user of financial analysis. Which of the following comments does not represent a
fair statement as to the management perspective?
A. Management is always interested in maximum profitability.
B. Management is interested in the view of investors.
C. Management is interested in the financial structure of the entity.
D. Management is interested in the asset structure of the entity.
Limitations
1. A limitation in calculating ratios in financial statement analysis is that
A. it requires a calculator.
B. no one other than the management would be interested in them.
C. some account balances may reflect atypical data at year end.
D. they seldom identify problem areas in a company.
2. Which of the following is not a limitation of financial statement analysis?
A. The cost basis.
C. The diversification of firms.
B. The use of estimates.
D. The availability of information.
5. Which of the following does not represent a problem with financial analysis?
A. Financial statement analysis is an art; it requires judgment decisions on the part of the analyst.
B. Financial analysis can be used to detect apparent liquidity problems.
C. There are as many ratios for financial analysis as there are pairs of figures.
D. Some industry ratio formulas vary from source to source.
77. The use of alternative accounting methods:
A. is not a problem in ratio analysis because the footnotes disclose the method used.
B. may be a problem in ratio analysis even if disclosed.
C. is not a problem in ratio analysis since eventually all methods will lead to the same end.
D. is only a problem in ratio analysis with respect to inventory.
Industry Analysis
3. Suppose you are comparing two firms in the steel industry. One firm is large and the other is small.

Which type of numbers would be most meaningful for statement analysis?


A. Absolute numbers would be most meaningful for both the large and small firm.
B. Absolute numbers would be most meaningful in the large firm; relative numbers
would be most meaningful in the small firm.
C. Relative numbers would be most meaningful for the large firm; absolute numbers
would be most meaningful for the small firm.
D. Relative numbers would be most meaningful for both the large and small firm,
especially for interfirm comparisons.
4. Which of these statements is false?
A. Many companies will not clearly fit into any one industry.
B. A financial service uses its best judgment as to which industry the firm best fits.
C. The analysis of an entity's financial statements can be more meaningful if the results
are compared with industry averages and with results of competitors.
D. A company comparison should not be made with industry averages if the company
does not clearly fit into any one industry.
Common-sized financial statements
9. Which of the following generally is the most useful in analyzing companies of different
sizes?
A. comparative statements
C. price-level accounting
B. common-sized financial statements
D. profitability index
12. Statements in which all items are expressed only in relative terms (percentages of a base)
are termed:
A. Vertical statements
C. Funds Statements
B. Horizontal Statements
D. Common-Size Statements
10. The percent of property, plant and equipment to total assets is an example of:
A. vertical analysis
C. profitability analysis
B. solvency analysis
D. horizontal analysis
15. Vertical analysis is a technique that expresses each item in a financial statement
A. in pesos and centavos.
B. as a percent of the item in the previous year.
C. as a percent of a base amount.

Financial Statement Analysis

D. starting with the highest value down to the lowest value.


17. In performing a vertical analysis, the base for prepaid expenses is
A. total current assets.
C. total liabilities.
B. total assets.
D. prepaid expenses in a previous year.
Horizontal analysis
8. The percentage analysis of increases and decreases in individual items in comparative financial
statements is called:
A. vertical analysis
C. profitability analysis
B. solvency analysis
D. horizontal analysis
11. Horizontal analysis is also known as
A. linear analysis.
B. vertical analysis.

C. trend analysis.
D. common size analysis.

13. In which of the following cases may a percentage change be computed?


A. The trend of the amounts is decreasing but all amounts are positive.
B. There is no amount in the base year.
C. There is a negative amount in the base year and a negative amount in the subsequent year.
D. There is a negative amount in the base year and a positive amount in the subsequent year.
14. Horizontal analysis is a technique for evaluating a series of financial statement data over a period
of time
A. that has been arranged from the highest number to the lowest number.
B. that has been arranged from the lowest number to the highest number.
C. to determine which items are in error.
D. to determine the amount and/or percentage increase or decrease that has taken place.
Trend analysis
16. Trend analysis allows a firm to compare its performance to:
A. other firms in the industry
C. other industries
B. other time periods within the firm
D. none of the above
Risk and return
29. The present and prospective stockholders are primarily concerned with a firm

A. profitability
B. liquidity

C. leverage
D. risk and return

69. Which suppliers of funds bear the greatest risk and should therefore earn the greatest
return?
A. common stockholders
C. preferred shareholders
B. general creditors such as banks
D. bondholders
Measures of Risk
54. The following groups of ratios primarily measure risk:
A. liquidity, activity, and common equity
C. liquidity, activity, and debt
B. liquidity, activity, and profitability
D. activity, debt, and profitability
Financial ratios
7. Ratios are used as tools in financial analysis
A. instead of horizontal and vertical analyses.
B. because they can provide information that may not be apparent from inspection of the
individual components of a particular ratio.
C. because even single ratios by themselves are quite meaningful.
D. because they are prescribed by GAAP.
18. In the near term, the important ratios that provide the information critical to the short-run
operation of the firm are:
A. liquidity, activity, and profitability
C. liquidity, activity, and equity
B. liquidity, activity, and debt
D. activity,debt, and profitability
75. The ability of a business to pay its debts as they come due and to earn a reasonable
amount of income is referred to as:
A. solvency and leverage
C. solvency and liquidity
B. solvency and profitability
D. solvency and equity
Liquidity ratios
Interested parties
19. The primary concern of short-term creditors when assessing the strength of a firm is the
entitys
A. short-term liquidity
C. market price of stock

Financial Statement Analysis

B. profitability

D. leverage

35. Short-term creditors are usually most interested in assessing


A. solvency.
C. marketability.
B. liquidity.
D. profitability.
36. The two categories of ratios that should be utilized to asses a firms true liquidity are the
A. current and quick ratios
C. liquidity and profitability ratios
B. liquidity and debt ratios
D. liquidity and activity ratios
47. Which of the following is the most of interest to a firms suppliers?
A. profitability
C. asset utilization
B. debt
D. liquidity
Measures of liquidity
21. The ratios that are used to determine a companys short-term debt paying ability are
A. asset turnover, times interest earned, current ratio, and receivables turnover.
B. times interest earned, inventory turnover, current ratio, and receivables turnover.
C. times interest earned, acid-test ratio, current ratio, and inventory turnover.
D. current ratio, acid-test ratio, receivables turnover, and inventory turnover.
20. Which of the following is a measure of the liquidity position of a corporation?
A. earnings per share
B. inventory turnover
C. current ratio
D. number of times interest charges earned
37. Which one of the following ratios would not likely be used by a short-term creditor in evaluating
whether to sell on credit to a company?
A. Current ratio
C. Asset turnover
B. Acid-test ratio
D. Receivables turnover
51. Which of the following ratios would be least helpful in appraising the liquidity of current assets?
A. Accounts Receivable turnover
C. Current Ratio
B. Days sales in inventory
D. Days sales in accounts receivable

53. Which ratio is most helpful in appraising the liquidity of current assets?
A. current ratio
C. acid-test ratio
B. debt ratio
D. accounts receivable turnover
Not a measure of liquidity
79. Which one of the following ratios would not likely be used by a short-term creditor in
evaluating whether to sell on credit to a company?
A. accounts receivable turnover.
C. acid test ratio.
B. asset turnover.
D. current ratio.
Current ratio
24. Typically, which of the following would be considered to be the most indicative of a firm's
short-term debt paying ability?
A. working capital
C. acid test ratio
B. current ratio
D. days sales in receivables
22. The current ratio is
A. calculated by dividing current liabilities by current assets.
B. used to evaluate a companys liquidity and short-term debt paying ability.
C. used to evaluate a companys solvency and long-term debt paying ability.
D. calculated by subtracting current liabilities from current assets.
30. Which of the following ratios is rated to be a primary measure of liquidity and considered
of highest significance rating of the liquidity ratios a bank analyst?
A. Debt/Equity
B. Current ratio
C. Degree of Financial Leverage
D. Accounts Receivable Turnover in Days
41. A weakness of the current ratio is
A. the difficulty of the calculation.
B. that it does not take into account the composition of the current assets.
C. that it is rarely used by sophisticated analysts.
D. that it can be expressed as a percentage, as a rate, or as a proportion.
Acid-test or quick ratio

Financial Statement Analysis

42. A measure of a companys immediate short-term liquidity is the


A. current ratio.
B. current cash debt coverage ratio.
C. cash debt coverage ratio.
D. acid-test ratio.
23. The acid-test or quick ratio
A. is used to quickly determine a companys solvency and long-term debt paying ability.
B. relates cash, short-term investments, and net receivables to current liabilities.
C. is calculated by taking one item from the income statement and one item from the balance
sheet.
D. is the same as the current ratio except it is rounded to the nearest whole percent.
Not a liquidity ratio
28. Which one of the following would not be considered a liquidity ratio?
A. Current ratio.
C. Quick ratio.
B. Inventory turnover.
D. Return on assets.
Activity ratios
Days receivable & receivable turnover
Quality of receivables
25. Which of the following does not bear on the quality of receivables?
A. shortening the credit terms
B. lengthening the credit terms
C. lengthening the outstanding period
D. all of the above bear on the quality of receivables

65. All of the following are asset utilization ratios except:


A. average collection period
C. receivables turnover
B. inventory turnover
D. return on assets
Asset turnover
63. Asset turnover measures
A. how often a company replaces its assets.
B. how efficiently a company uses its assets to generate sales.
C. the portion of the assets that have been financed by creditors.
D. the overall rate of return on assets.
66. Total asset turnover measures the ability of a firm to:
A. generate profits on sales
B. generate sales through the use of assets
C. cover long-term debt
D. buy new assets
76. A measure of how efficiently a company uses its assets to generate sales is the
A. asset turnover ratio.
C. profit margin ratio.
B. cash return on sales ratio.
D. return on assets ratio.
Solvency ratios
Interested parties
50. Long-term creditors are usually most interested in evaluating
A. liquidity.
C. profitability.
B. marketability.
D. solvency.

Days receivable
27. A general rule to use in assessing the average collection period is
A. that is should not exceed 30 days.
B. it can be any length as long as the customer continues to buy merchandise.
C. that it should not greatly exceed the discount period.
D. that it should not greatly exceed the credit term period.

Financial Leverage
45. Trading on the equity (leverage) refers to the
A. amount of working capital.
B. amount of capital provided by owners.
C. use of borrowed money to increase the return to owners.
D. earnings per share.

Asset utilization ratios


Performance measures

90. The tendency of the rate earned on stockholders' equity to vary disproportionately from
the rate earned on total assets is sometimes referred to as:

Financial Statement Analysis

A. leverage
B. solvency

C. yield
D. quick assets

55. Using financial leverage is a good financial strategy from the viewpoint of stockholders of
companies having:
A. a high debt ratio
C. a steadily declining current ratio
B. steady or rising profits
D. cyclical highs and lows
46. The ratio that indicates a companys degree of financial leverage is the
A. cash debt coverage ratio.
C. free cash flow ratio.
B. debt to total assets.
D. times-interest earned ratio.
73. Interest expense creates magnification of earnings through financial leverage because:
A. while earnings available to pay interest rise, earnings to residual owners rise faster
B. interest accompanies debt financing
C. interest costs are cheaper than the required rate of return to equity owners
S. the use of interest causes higher earnings
Measures of solvency
34. The set of ratios that is most useful in evaluating solvency is
A. debt ratio, current ratio, and times interest earned
B. debt ratio, times interest earned, and return on assets
C. debt ratio, times interest earned, and quick ratio
D. debt ratio, times interest earned, and cash flow to debt
49. Which of the following ratios is most relevant to evaluating solvency?
A. Return on assets
C. Days purchases in accounts payable
B. Debt ratio
D. Dividend yield
Fixed assets to long-term liabilities
44. Which of the following ratios provides a solvency measure that shows the margin of safety of
noteholders or bondholders and also gives an indication of the potential ability of the business to
borrow additional funds on a long-term basis?
A. ratio of fixed assets to long-term liabilities
B. ratio of net sales to assets
C. number of days' sales in receivables

D. rate earned on stockholders' equity


Debt ratio
59. The debt ratio indicates:
A. a comparison of liabilities with total assets
B. the ability of the firm to pay its current obligations
C. the efficiency of the use of total assets
D. the magnification of earnings caused by leverage
78. The debt to total assets ratio measures
A. the companys profitability.
B. whether interest can be paid on debt in the current year.
C. the proportion of interest paid relative to dividends paid.
D. the percentage of the total assets provided by creditor.
Debt-to-equity ratio
60. Which of the following statements best compares long-term borrowing capacity ratios?
A. The debt/equity ratio is more conservative than the debt ratio.
B. The debt to tangible net worth ratio is more conservative than the debt/equity ratio.
C. The debt/equity ratio is more conservative than the debt to tangible net worth ratio.
D. The debt ratio is more conservative than the debt/equity ratio.
Times interest earned
74. A times interest earned ratio of 0.90 to 1 means that
A. the firm will default on its interest payment
B. net income is less than the interest expense
C. the cash flow is less than the net income
D. the cash flow exceeds the net income
Fixed charge coverage
61. A fixed charge coverage:
A. is a balance sheet indication of debt carrying ability
B. is an income statement indication of debt carrying ability
C. frequently includes research and development
D. computation is standard from firm to firm

Financial Statement Analysis

Off-balance sheet liabilities


62. If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in the
financial statements, then the
A. times interest earned ratio will be overstated, based upon the financial statements
B. debt ratio will be understated
C. working capital will be understated
D. fixed charge ratio will be overstated, based upon the financial statements
Profitability ratios
Interested parties
39. The return on assets ratio is affected by the
A. asset turnover ratio.
B. debt to total assets ratio.
C. profit margin ratio.
D. asset turnover and profit margin ratios.
52. Stockholders are most interested in evaluating
A. liquidity.
C. profitability.
B. solvency.
D. marketability.
Performance measures
48. The set of ratios that are most useful in evaluating profitability is
A. ROA, ROE, and debt to equity ratio
C. ROA, ROE, and acid-test ratio
B. ROA, ROE, and dividend yield
D. ROA, ROE, and cash flow to debt
Earnings per share
82. Which of the following ratios appears most frequently in annual reports?
A. Earnings per Share
C. Profit Margin
B. Return on Equity
D. Debt/Equity
Return on assets
64. Return on assets
A. can be determined by looking at a balance sheet
B. should be smaller than return on sales
C. can be affected by the companys choice of a depreciation method
D. should be larger than return on equity

Return on investments
72. Return on investment measures:
A. return to all suppliers of funds
funds
B. return to all long-term creditors

C. return to all long-term suppliers of


D. return to stockholders

Market test ratios


Price-earnings ratio
56. The price/earnings ratio
A. measures the past earning ability of the firm
B. is a gauge of future earning power as seen by investors
C. relates price to dividends
D. relates
58. Which of the following ratios usually reflects investors opinions of the future prospects for
the firm?
A. dividend yield
C. book value per share
B. price/earnings ratio
D. earnings per share
Dividend yield
57. Which of the following ratios represents dividends per common share in relation to market
price per common share?
A. dividend payout
C. price/earnings
B. dividend yield
D. book value per share
Financial Statement Analysis
Accounts Receivable
26. Which of the following reasons should not be considered in order to explain why the
receivables appear to be abnormally high?
A. Sales volume decreases materially late in the year.
B. Receivables have collectibility problems and possibly some should have been written
off.
C. Material amount of receivables are on the installment basis.
D. Sales volume expanded materially late in the year.

Financial Statement Analysis

31. An acceleration in the collection of receivables will tend to cause the accounts receivable turnover
to:
A. decrease
C. either increase or decrease
B. remain the same
D. increase
Inventories
32. Which of the following would best indicate that the firm is carrying excess inventory?
A. a decline in the current ratio
B. stable current ratio with declining quick ratios
C. a decline in days' sales in inventory
D. a rise in total asset turnover
89. When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an average
quick ratio, and a low inventory turnover. What might you assume about Tri-C?
A. Its cash balance is too low.
C. Its current liabilities are too low.
B. Its cost of goods sold is too low.
D. Its average inventory is too high.
Current ratio
33. Which of the following would be most detrimental to a firm's current ratio if that ratio is currently
2.0?
A. Buy raw materials on credit
B. Sell marketable securities at cost
C. Pay off accounts payable with cash
D. Pay off a portion of long-term debt with cash
Fixed asset turnover ratio
68. Which of the following circumstances will cause sales to fixed assets to be abnormally high?
A. A labor-intensive industry.
B. The use of units-of-production depreciation.
C. A highly mechanized facility.
D. High direct labor costs from a new union contract.
Total asset turnover
81. A firm with a total asset turnover lower than the industry standard and a current ratio which meets
industry standard might have excessive:
A. Accounts receivable
C. Debt

B. Fixed assets

D. Inventory

Profitability analysis
84. Denver Dynamics has net income of P2,000,000. Oakland Enterprises has net income of
P2,500,000. Which of the following best compares the profitability of Denver and
Oakland?
A. Oakland Enterprises is 25% more profitable than Denver Dynamics.
B. Oakland Enterprises is more profitable than Denver Dynamics, but the comparison
can't be quantified.
C. Oakland Enterprises is only more profitable if it is smaller than Denver Dynamics.
D. Further information is needed for a reasonable comparison.
Debt ratio
86. Companies A and B are in the same industry and have similar characteristics except
that Company A is more leveraged than Company B. Both companies have the same
income before interest and taxes and the same total assets. Based on this information
we could conclude that
A. Company A has higher net income than Company B
B. Company A has a lower return on assets than company B
C. Company A is more risky than Company B.
D. Company A has a lower debt ratio than company B
Sensitivity Analysis
Current ratio
40. A firm has a current ratio of 1:1. In order to improve its liquidity ratios, this firm should
A. improve its collection practices, thereby increasing cash and increasing its current
and quick ratios.
B. improve its collection practices and pay accounts payable, there decreasing current
liabilities and increasing the current and quick ratios.
C. decrease current liabilities by utilizing more long-term debt, thereby increasing the
current and quick ratios.
D. increase inventory, thereby increasing current assets and the current and quick
ratios.
43. Recently the M&M Company has been having problems. As a result, its financial situation
has deteriorated. M&M approached the First National Bank for a badly needed loan, but

Financial Statement Analysis

the loan officer insisted that the current ratio (now 0.5) be improved to at least 0.8 before the bank
would even consider granting the credit. Which of the following actions would do the most to
improve the ratio in the short run?
A. Using some cash to pay off some current liabilities.
B. Collecting some of the current accounts receivable.
C. Paying off some long-term debt.
D. Purchasing additional inventory on credit (accounts payable).
87. Tyner Company had P250,000 of current assets and P90,000 of current liabilities before
borrowing P60,000 from the bank with a 3-month note payable. What effect did the borrowing
transaction have on Tyner Company's current ratio?
A. The ratio remained unchanged.
B. The change in the current ratio cannot be determined.
C. The ratio decreased.
D. The ratio increased.
88. Which of the following actions will increase a firm's current ratio if it is now less than 1.0?
A. Convert marketable securities to cash.
B. Pay accounts payable with cash.
C. Buy inventory with short term credit (i.e. accounts payable).
D. Sell inventory at cost.
Acid-test ratio
38. If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of cash by
short-term debt and collection of accounts receivable have on the ratio?
A.
B.
C.
D.
Short-term borrowing
Increase
Increase
Decrease
Decrease
Collection of receivable
No effect
Increase
No effect
Decrease
Profit margin
70. Which of the following would most likely cause a rise in net profit margin?
A. increased sales
C. decreased operating expenses
B. decreased preferred dividends
D. increased cost of sales
Return on assets
67. Return on assets cannot fall under which of the following circumstances?

Net profit margin


Total asset turnover

A.
Decline
Rise

B.
Rise
Decline

C.
Rise
Rise

D.
Decline
Decline

Debt ratio
83. Jones Company has long-term debt of P1,000,000, while Smith Company, Jones'
competitor, has long-term debt of P200,000. Which of the following statements best
represents an analysis of the long-term debt position of these two firms?
A. Jones obviously has too much debt when compared to its competitor.
B. Smith Company's times interest earned should be lower than Jones.
C. Smith has five times better long-term borrowing ability than Jones.
D. Not enough information to determine if any of the answers are correct.
Times interest earned
85. Which of the following will not cause times interest earned to drop? Assume no other
changes than those listed.
A. A rise in preferred stock dividends.
B. A drop in sales with no change in interest expense.
C. An increase in interest rates.
D. An increase in bonds payable with no change in operating income.
DuPont Analysis
71. Which of the following could cause return on assets to decline when net profit margin is
increasing?
A. sale of investments at year-end
C. purchase of a new building at yearend
B. increased turnover of operating assets
D. a stock split
80. A firm with a lower net profit margin can improve its return on total assets by
A. increasing its debt ratio
C. increasing its total asset turnover
B. decreasing its fixed assets turnover
D. decreasing its total asset turnover
PROBLEMS:
Horizontal analysis
i
.Kline Corporation had net income of P2 million in 2006. Using the 2006 financial elements as

Financial Statement Analysis

the base data, net income decreased by 70 percent in 2007 and increased by 175 percent in 2008.
The respective net income reported by Kline Corporation for 2007 and 2008 are:
A. P 600,000 and P5,500,000
C. P1,400,000 and P3,500,000
B. P5,500,000 and P 600,000
D. P1,400,000 and P5,500,000
ii

.Assume that Axle Inc. reported a net loss of P50,000 in 2006 and net income of P250,000 in 2007.
The increase in net income of P300,000:
A. can be stated as 0%
C. cannot be stated as a percentage
B. can be stated as 100% increase
D. can be stated as 200% increase

Liquidity ratios
iii
.The following financial data have been taken from the records of Ratio Company:
Accounts receivable
P200,000
Accounts payable
80,000
Bonds payable, due in 10 years
500,000
Cash
100,000
Interest payable, due in three months
25,000
Inventory
440,000
Land
800,000
Notes payable, due in six months
250,000
What will happen to the ratios below if Ratio Company uses cash to pay 50 percent of its
accounts payable?
A.
B.
C.
D.
Current ratio
Increase
Decrease
Increase
Decrease
Acid-test ratio
Increase
Decrease
Decrease
Increase
Question Nos. 4 through 6 are based on the data taken from the balance sheet of Nomad Company at
the end of the current year:
Accounts payable
P145,000
Accounts receivable
110,000
Accrued liabilities
4,000
Cash
80,000
Income tax payable
10,000
Inventory
140,000
Marketable securities
250,000
Notes payable, short-term
85,000

Prepaid expenses

15,000

iv

.The amount of working capital for the company is:


A. P351,000
C. P211,000
B. P361,000
D. P336,000

.The companys current ratio as of the balance sheet date is:


A. 2.67:1
C. 2.02:1
B. 2.44:1
D. 1.95:1

vi

.The companys acid-test ratio as of the balance sheet date is:


A. 1.80:1
C. 2.02:1
B. 2.40:1
D. 1.76:1

Activity ratios
Receivables turnover
vii
.Pine Hardware Store had net credit sales of P6,500,000 and cost of goods sold of
P5,000,000 for the year. The Accounts Receivable balances at the beginning and end of
the year were P600,000 and P700,000, respectively. The receivables turnover was
A. 7.7 times.
C. 9.3 times.
B. 10.8 times.
D. 10.0 times.
viii

.Milward Corporations books disclosed the following information for the year ended
December 31, 2007:
Net credit sales
P1,500,000
Net cash sales
240,000
Accounts receivable at beginning of year
200,000
Accounts receivable at end of year
400,000
Milwards accounts receivable turnover is
A. 3.75 times
C. 5.00 times
B. 4.35 times
D. 5.80 times

Days receivable
ix
.Batik Clothing Store had a balance in the Accounts Receivable account of P390,000 at the
beginning of the year and a balance of P410,000 at the end of the year. The net credit
sales during the year amounted to P4,000,000. Using 360-day year, what is the average

Financial Statement Analysis

collection period of the receivables?


A. 30 days
B. 65 days

B. 15.6
C. 73 days
D. 36 days

xiv

Cash collection
x
.Deity Company had sales of P30,000, increase in accounts payable of P5,000, decrease in accounts
receivable of P1,000, increase in inventories of P4,000, and depreciation expense of P4,000. What
was the cash collected from customers?
A. P31,000
C. P34,000
B. P35,000
D. P25,000
Inventory turnover
xi
.During 2007, Tarlac Company purchased P960,000 of inventory. The cost of goods sold for 2007
was P900,000, and the ending inventory at December 31, 2007 was P180,000. What was the
inventory turnover for 2007?
A. 6.4
C. 5.3
B. 6.0
D. 5.0
xii

.Selected information from the accounting records of Petals Company is as follows:


Net sales for 2007
P900,000
Cost of goods sold for 2007
600,000
Inventory at December 31, 2006
180,000
Inventory at December 31, 2007
156,000
Petals inventory turnover for 2007 is
A. 5.77 times
C. 3.67 times
B. 3.85 times
D. 3.57 times

xiii

.The Moss Company presents the following data for 2007.


Net Sales, 2007
Net Sales, 2006
Cost of Goods Sold, 2007
Cost of Goods Sold, 2007
Inventory, beginning of 2007
Inventory, end of 2007
The merchandise inventory turnover for 2007 is:
A. 5.6
C. 7.5

D. 7.7

P3,007,124
P 930,247
P2,000,326
P1,000,120
P 341,169
P 376,526

.Based on the following data for the current year, what is the inventory turnover?
Net sales on account during year
P 500,000
Cost of merchandise sold during year
330,000
Accounts receivable, beginning of year
45,000
Accounts receivable, end of year
35,000
Inventory, beginning of year
90,000
Inventory, end of year
110,000
A. 3.3
C. 3.7
B. 8.3
D. 3.0

Days inventory
xv
.Selected information from the accounting records of Eternity Manufacturing Company
follows:
Net sales
P3,600,000
Cost of goods sold
2,400,000
Inventories at January 1
672,000
Inventories at December 31
576,000
What is the number of days sales in average inventories for the year?
A. 102.2
C. 87.6
B. 94.9
D. 68.1
Turnover ratios
Asset turnover
Asset
xvi
.Net sales are P6,000,000, beginning total assets are P2,800,000, and the asset turnover is
3.0. What is the ending total asset balance?
A. P2,000,000.
C. P2,800,000.
B. P1,200,000.
D. P1,600,000.
Solvency ratios
Debt ratio
xvii
.Jordan Manufacturing reports the following capital structure:
Current liabilities
Long-term debt

P100,000
400,000

Financial Statement Analysis

Deferred income taxes


Preferred stock
Common stock
Premium on common stock
Retained earnings
What is the debt ratio?
A. 0.48
B. 0.49

10,000
80,000
100,000
180,000
170,000
C. 0.93
D. 0.96

Times interest earned


xviii
.House of Fashion Company had the following financial statistics for 2006:
Long-term debt (average rate of interest is 8%)
Interest expense
Net income
Income tax
Operating income
What is the times interest earned for 2006?
A. 11.4 times
C. 3.1 times
B. 3.3 times
D. 3.7 times
xix

xx

Preferred dividends paid


15,000
Based on the data presented above, what is the number of times bond interest charges
were earned (round to one decimal point)?
A. 3.7
C. 4.5
B. 4.4
D. 3.5
xxi

P400,000
35,000
48,000
46,000
107,000

.Brava Company reported the following on its income statement:


Income before taxes
P400,000
Income tax expense
100,000
Net income
P300,000
An analysis of the income statement revealed that interest expense was P100,000. Brava
Companys times interest earned (TIE) was
A. 5 times
C. 3.5 times
B. 4 times
D. 3 times

.The balance sheet and income statement data for Candle Factory indicate the following:
Bonds payable, 10% (issued 1998 due 2022)
P1,000,000
Preferred 5% stock, P100 par (no change during year)
300,000
Common stock, P50 par (no change during year)
2,000,000
Income before income tax for year
350,000
Income tax for year
80,000
Common dividends paid
50,000

.The following data were abstracted from the records of Johnson Corporation for the year:
Sales
P1,800,000
Bond interest expense
60,000
Income taxes
300,000
Net income
400,000
How many times was bond interest earned?
A. 7.67
C. 12.67
B. 11.67
D. 13.67

Net income
xxii
.The times interest earned ratio of Mikoto Company is 4.5 times. The interest expense for
the year was P20,000, and the companys tax rate is 40%. The companys net income
is:
A. P22,000
C. P54,000
B. P42,000
D. P66,000
Profitability Ratios
Return on Common Equity
xxiii
.Selected information for Ivano Company as of December 31 is as follows:
2006
2007
Preferred stock, 8%, par P100, nonconvertible,
P250,000
P250,000
noncumulative
Common stock
600,000
800,000
Retained earnings
150,000
370,000
Dividends paid on preferred stock for the year
20,000
20,000
Net income for the year
120,000
240,000
Ivanos return on common stockholders equity, rounded to the nearest percentage point,
for 2007 is
A. 17%
C. 21%
B. 19%
D. 23%

Financial Statement Analysis

Additional information:
Stockholders equity at 12/31/07
Net income year ended 12/31/07
Dividends on preferred stock year ended 12/31/07
Market price per share of common stock at 12/31/07
The price-earnings ratio on common stock at December 31, 2007, was
A. 10 to 1
C. 14 to 1
B. 12 to 1
D. 16 to 1

Dividend yield
xxiv
.The following information is available for Duncan Co.:
2006
Dividends per share of common stock
P 1.40
Market price per share of common stock
17.50
Which of the following statements is correct?
A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market price
of their stocks.
B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns on
their investments.
C. The dividend yield is 12.5%, which is of interest to bondholders.
D. The dividend yield is 8.0 times the market price, which is important in solvency analysis.
Market Test Ratios
Market/Book value ratio
Price per share
xxv
.What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book value
of equity of P3,000,000, and a market/book ratio of 3.5?
A. P8.57
C. P85.70
B. P30.00
D. P105.00
P/E ratio
xxvi
.Orchard Companys capital stock at December 31 consisted of the following:

Common stock, P2 par value; 100,000 shares authorized, issued, and outstanding.

10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares
authorized, issued, and outstanding.
Orchards common stock, which is listed on a major stock exchange, was quoted at P4 per share
on December 31. Orchards net income for the year ended December 31 was P50,000. The
yearly preferred dividend was declared. No capital stock transactions occurred. What was the
price earnings ratio on Orchards common stock at December 31?
A. 6 to 1
C. 10 to 1
B. 8 to 1
D. 16 to 1
xxvii

. On December 31, 2006 and 2007, Renegade Corporation had 100,000 shares of common stock
and 50,000 shares of noncumulative and nonconvertible preferred stock issued and outstanding.

P4,500,000
1,200,000
300,000
144

Payout ratio
xxviii
.Selected financial data of Alexander Corporation for the year ended December 31, 2007,
is presented below:
Operating income
P900,000
Interest expense
(100,000)
Income before income taxes
800,000
Income tax
(320,000)
Net income
480,000
Preferred stock dividend
(200,000)
Net income available to common stockholders
280,000
Common stock dividends were P120,000. The payout ratio is:
A. 42.9 percent
C. 25.0 percent
B. 66.7 percent
D. 71.4 percent
P/E ratio & Payout ratio
Use the following information for question Nos. 33 and 34:
Terry Corporation had net income of P200,000 and paid dividends to common stockholders
of P40,000 in 2007. The weighted-average number of shares outstanding in 2007 was
50,000 shares. Terry Corporations common stock is selling for P60 per share in the local
stock exchange.
xxix

.Terry Corporations price-earnings ratio is


A. 3.8 times
B. 15 times

C. 18.8 times
D. 6 times

.Terry Corporations payout ratio for 2007 is


A. P4 per share

C. 20.0 percent

xxx

Financial Statement Analysis

B. 12.5 percent

D. 25.0 percent

DuPont Model
Debt ratio
xxxi
. The Board of Directors is dissatisfied with last year's ROE of 15%. If the profit margin and asset
turnover remain unchanged at 8% and 1.25 respectively, by how much must the total debt ratio
increase to achieve 20% ROE?
A. Total debt ratio must increase by .5
B. Total debt ratio must increase by 5
C. Total debt ratio must increase by 5%
D. Total debt ratio must increase by 50%
xxxii

.Assume you are given the following relationships for the Orange Company:
Sales/total assets
Return on assets (ROA)
Return on equity (ROE)
The Orange Companys debt ratio is
A. 40%
C. 35%
B. 60%
D. 65%

Leverage Ratio
Degree of financial leverage
xxxiii
.A summarized income statement for Leveraged Inc. is presented below.
Sales
Cost of Sales
Gross Profit
Operating Expenses
Operating Income
Interest Expense
Earnings Before Tax
Income Tax
Net Income
The degree of financial leverage is:
A. P 150,000 P 30,000
C. P1,000,000 P400,000
B. P 150,000 P120,000
D. P 150,000 P 80,000

1.5X
3%
5%

P1,000,000
600,000
P 400,000
250,000
P 150,000
30,000
P 120,000
40,000
P 80,000

Other Ratios
Book value per share
xxxiv
.M Corporations stockholders equity at December 31, 2007 consists of the following:
6% cumulative preferred stock, P100 par, liquidating value
was P110 per share; issued and outstanding 50,000 shares
P5,000,000
Common stock, par, P5 per share; issued and
outstanding, 400,000 shares
2,000,000
Retained earnings
1,000,000
Total
P8,000,000
Dividends on preferred stock have been paid through 2006.
At December 31, 2007, M Corporations book value per share was
A. P5.50
C. P6.75
B. P6.25
D. P7.50
xxxv

.The following data were gathered from the annual report of Desk Products.
Market price per share
Number of common shares
Preferred stock, 5% P100 par
Common equity
The book value per share is:
A. P30.00
C. P14.00
B. P15.00
D. P13.75

P30.00
10,000
P10,000
P140,000

Integrated ratios
Liquidity & activity ratios
Inventory
xxxvi
.The current assets of Mayon Enterprise consists of cash, accounts receivable, and
inventory. The following information is available:
Credit sales
75% of total sales
Inventory turnover
5 times
Working capital
P1,120,000
Current ratio
2.00 to 1
Quick ratio
1.25 to 1
Average Collection period
42 days
Working days
360
The estimated inventory amount is:

Financial Statement Analysis

A. 840,000
B. 600,000

C. 720,000
D. 550,000

.The following data were obtained from the records of Salacot Company:
Current ratio (at year end)
1.5 to 1
Inventory turnover based on sales and ending inventory
15 times
Inventory turnover based on cost of goods sold and ending inventory
10.5 times
Gross margin for 2007
P360,000
What was Salacot Companys December 31, 2007 balance in the Inventory account?
A. P120,000
C. P 80,000
B. P 54,000
D. P 95,000

xxxvii

Net sales
xxxviii
.Selected data from Mildred Companys year-end financial statements are presented below. The
difference between average and ending inventory is immaterial.
Current ratio
2.0
Quick ratio
1.5
Current liabilities
P120,000
Inventory turnover (based on cost of sales)
8 times
Gross profit margin
40%
Mildreds net sales for the year were
A. P 800,000
C. P 480,000
B. P 672,000
D. P1,200,000
Gross margin
xxxix
.Selected information from the accounting records of the Blackwood Co. is as follows:
Net A/R at December 31, 2006
P 900,000
Net A/R at December 31, 2007
P1,000,000
Accounts receivable turnover
5 to 1
Inventories at December 31, 2006
P1,100,000
Inventories at December 31, 2007
P1,200,000
Inventory turnover
4 to 1
What was the gross margin for 2007?

A. P150,000
B. P200,000

C. P300,000
D. P400,000

Market Test Ratio


Dividend yield
xl
.Recto Co. has a price earnings ratio of 10, earnings per share of P2.20, and a pay out
ratio of 75%. The dividend yield is
A. 25.0%
C. 7.5%
B. 22.0%
D. 10.0%
xli

.The following were reflected from the records of Salvacion Company:


Earnings before interest and taxes
Interest expense
Preferred dividends
Payout ratio
Shares outstanding throughout 2006
Preferred
Common
Income tax rate
Price earnings ratio
The dividend yield ratio is
A. 0.50
C. 0.40
B. 0.12
D. 0.08

P1,250,000
250,000
200,000
40 percent
20,000
25,000
40 percent
5 times

Comprehensive
xlii
.The balance sheets of Magdangal Company at the end of each of the first two years of
operations indicate the following:
2007
2006
Total current assets
P600,000
P560,000
Total investments
60,000
40,000
Total property, plant, and equipment
900,000
700,000
Total current liabilities
150,000
80,000
Total long-term liabilities
350,000
250,000
Preferred 9% stock, P100 par
100,000
100,000
Common stock, P10 par
600,000
600,000
Paid-in capital in excess of par-common stock
60,000
60,000

Financial Statement Analysis

Retained earnings
300,000
210,000
Net income is P115,000 and interest expense is P30,000 for 2007.
What is the rate earned on total assets for 2007 (round percent to one decimal point)?
A. 9.3 percent
C. 8.9 percent
B. 10.1 percent
D. 7.4 percent
xliii

.What is the rate earned on stockholders' equity for 2007 (round percent to one decimal point)?
A. 10.6 percent
C. 12.4 percent
B. 11.2 percent
D. 15.6 percent

xliv

.What is the earnings per share on common stock for 2007, (round to two decimal places)?
A. P1.92
C. P1.77
B. P1.89
D. P1.42

xlv

.If the market price is P30, what is the price-earnings ratio on common stock for 2007 (round
to one decimal point)?
A. 17.0
C. 12.4
B. 12.1
D. 15.9

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