Chapter 2 & 3 Questions

Chapter 2 & 3 Questions - Chapter 2 and 3 Test...

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Chapter 2 and 3 Test Questions
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The following balance sheet and income statement should be used for questions #1 through #6: Windswept, Inc. 2005 Income Statement ($ in millions) 2004 2005 Net sales $7,180 $8,450 Less: Cost of goods sold 6,152 7,240 Less: Operating expenses 460 400 Earnings before interest and taxes 568 810 Less: Interest paid 50 70 Taxable Income $518 $740 Less: Taxes 181 259 Net income $337 $481 Windswept, Inc. 2004 and 2005 Balance Sheets ($ in millions) 2004 2005 2004 2005 Cash $ 120 $ 140 Accounts payable $1,110 $1,120 Accounts rec. 930 780 Long-term debt 840 1,210 Inventory 1,480 1,520 Common stock 3,200 3,000 Total $2,530 $2,440 Retained earnings 530 710 Net fixed assets 3,150 3,600 Total assets $5,680 $6,040 Total liabilities & equity $5,680 $6,040
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Question 1 A quick review glance at Windswept’s income statement reveals increasing profitability from 2004 to 2005. Which of the following statements is most likely correct with respect to the increasing net margin? a. Net margin increased because of increasing gross margins b. Net margin increased primarily because of declining interest rates c. Net margin increased because of higher sales in 2005 d. Net margin increased because of better operating expense control in 2005 e. None of the above
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Answer Question 1 As can be seen from the calculations below Gross Margins didn’t change but Operating Margins did increase by 2%. Thus we can see that the Net Margin likely increased because of better operating expense controls in 2005. Answer : D 2004 2005 Gross Margin 14% 14% Operating Margin 8% 10% Net Margin 5% 6%
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Question 2 Industry average liquidity ratios for Windswept’s industy are: Current ratio – 1.9 Quick ratio – 0.7 Which of the following best describes Windswept’s liquidity position: a. Better than the industry and improving b. Better than the industry, but declining c. Below industry average, but improving d. Below industry average and getting worse e. None of the above
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Answer Question 2 Current Ratio = Current Assets/Current Liabilities Current Ratio 2004 = 2,530/1,110 = 2.28 Current Ratio 2005 = 2,440/1,120 = 2.18 Quick Ratio = (CA – Inventory)/Current Liabilities Quick Ratio 2004 = 1,050/1,110 = .95 Quick Ratio 2005 = 920/1,120 = .82 Both the current ratio and the quick ratio are better than the industry but have been declining. Answer : B
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Question 3 Ryan Jones, an analyst with Goldhiem Soxs, observes that “the quality of Windswept’s accounts receivable seems to be going down”. Given the available information, would you agree with him? Why or why not? a. Agree – the declining accounts receivable indicates an inability to collect the debt b. Agree – the declining accounts receivable indicates managements lack of confidence c. Disagree – the average collection period is declining as sales increase d. Disagree – the average collection period is increase in proportion to sales growth e. None of the above
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Answer Question 3 First one should calculate the average collection period (AR/Daily Credit Sales).
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