Old Exam Questions - Analysis of Financial Statements - SolutionsPage4of52Pages*A.In an inflationary environment, a firm’s use of FIFO rather than LIFO can leadto higher reported earnings, higher taxes, and lower cash flows.In the samemanner, basing depreciation expense on historical costs rather than actualreplacement values in an inflationary environment may lead to lower reportedearnings, lower taxes, and higher cash flows.B.Financial ratio analysis is conducted by managers, equity investors, long-termcreditors, and short-term creditors.However, it is not unusual for them to beconcerned about different aspects of the firm.For instance, equity investorsmay be more concerned about the strength of the firm’s income statement,while long-term creditors may be more concerned about the strength of thefirm’s balance sheet.C.We must be concerned about seasonal factors when comparing two firms or afirm against the industry average.For instance, it may be inappropriate todirectly compare the year-end balance sheets of two toy companies if theyhave differing fiscal year ends.D.A firm that faces pure competition might wish to increase its ROA by increasingits profit margin, but may find itself constrained to increasing its asset turnover.In any event, the firm may be able to increase its ROE by increasing its degreeof debt financing (that is, financial leverage).
