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of University Houston-Victoria FIN 6352 Financial Management (Extra Credit) Review Quiz for Chapter 4 Analysis of Financial Statements True-False 1. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position. a. True b. False High current and quick ratios always indicate that a firm is managing its liquidity position well. a. True b. False The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its assets. a. True b. False 2. 3. Multiple Choice: Concepts 4. Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both companies have positive net incomes. Company HD has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT? a. Company HD pays less in taxes. b. Company HD has a lower equity multiplier. c. Company HD has a higher ROA. d. Company HD has a higher times interest earned (TIE) ratio. e. Company HD has more net income. Which of the following statements is CORRECT? a. If a firm has the highest price/earnings ratio of any firm in its industry, then, other things b. c. d. e. held constant, this suggests that the board of directors should fire the president. If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president. Other things held constant, the higher a firms expected future growth rate, the lower its P/E ratio is likely to be. The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA). If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average. 5. FIN 6352 Financial Management FMQuiz04 Dr. Xavier Garza Gmez 6. Walter Industries current ratio is 0.5. Considered alone, which of the following actions would increase the companys current ratio? a. Borrow using short-term notes payable and use the cash to increase inventories. b. Use cash to reduce accruals. c. Use cash to reduce accounts payable. d. Use cash to reduce short-term notes payable. e. Use cash to reduce long-term bonds outstanding. Multiple Choice: Problems 7. Nikko Corp.'s total common equity at the end of last year was $305,000 and its net income after taxes was $60,000. What was its ROE? a. 16.87% b. 17.75% c. 18.69% d. 19.67% e. 20.66% Last year Urbana Corp. had $197,500 of assets, $307,500 of sales, $19,575 of net income, and a debt-to-total-assets ratio of 37.5%. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $33,000. Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE? a. 9.32% b. 9.82% c. 10.33% d. 10.88% e. 11.42% Last year Mason Inc. a had total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were $195,000 and its net income was $10,549. The CFO believes that the company could have operated more efficiently, lowered its costs, and increased its net income by $5,250 without changing its sales, assets, or capital structure. Had it cut costs and increased its net income in this amount, by how much would the ROE have changed? a. b. c. d. e. 5.66% 5.95% 6.27% 6.58% 6.91% 8. 9. FIN 6352 Financial Management FMQuiz04 Dr. Xavier Garza Gmez 10. Bonner Corp.'s sales last year were $415,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.4. Bonner's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average, holding sales constant? a. b. c. d. e. $164,330 $172,979 $182,083 $191,188 $200,747 FIN 6352 Financial Management FMQuiz04 Dr. Xavier Garza Gmez Chapter 4 Analysis of Financial Statements Review Quiz Answer Section 1. 2. 3. 4. (4.2) Liquidity ratios (4.2) Current ratio (4.3) Asset management ratios (Comp: 4.4,4.5,4.8) Leverage, taxes, and ratios Register to View AnswerRegister to View AnswerRegister to View AnswerRegister to View Answer Under the stated conditions, HD would have more interest charges, thus lower taxable income and taxes. Thus, a is correct. All of the other statements are incorrect. 5. 6. (4.6) Market value ratios (4.2) Current ratio Register to View AnswerRegister to View Answer The key here is to recognize that if the CR is less than 1.0, then a given increase in both current assets and current liabilities would lead to an increase in the CR. The reverse would hold if the initial CR were greater than 1.0. Here the initial CR is less than 1.0, so borrowing on a short-term basis to build inventories would increase the CR. For example: Original CA/CL 1/2 1.0 New CA/CL 2/3 Plus $1 1/1 Old CR 0.50 New CR 0.67 CR rises if initial CR is less than All of the other statements are incorrect, although b, c, and d would be correct if the initial CR had been >1.0. 7. (4.5) Return on equity (ROE) Register to View Answer Common equity Net income ROE 8. $305,000 $60,000 19.67% Register to View Answer (4.5) Effect of reducing costs on the ROE Assets Debt ratio Debt Equity Sales Old net income FIN 6352 Financial Management $197,500 37.5% $74,063 $123,438 $307,500 $19,575 FMQuiz04 Dr. Xavier Garza Gmez New net income New ROE Old ROE Increase in ROE $33,000 26.734% 15.858% 10.88% Register to View Answer 9.(4.8) Du Pont eqn: effect of reducing costs on ROE Sales Original net income Increase in net income New net income Profit margin TATO Equity multiplier ROE Change in ROE 10. Old $195,000 $ 10,549 $0 $ 10,549 5.41% 1.33 1.75 12.59% New $195,000 $ 10,549 $ 5,250 $ 15,799 8.10% 1.33 1.75 18.86% 6.27% Register to View Answer (4.3) Total assets turnover ratio (TATO) Sales $415,000 Total assets $355,000 Target TATO 2.40 Target assets = Sales / Target TATO$172,917 Asset reduction $182,083 FIN 6352 Financial Management FMQuiz04 Dr. Xavier Garza Gmez ... 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