CHAPTER 4 ANALYSIS OF FINANCIAL STATEMENTS

# CHAPTER 4 ANALYSIS OF FINANCIAL STATEMENTS - ANALYSIS OF...

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1. A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio? a. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable. b. Issue new common stock and use the proceeds to increase inventories. c. Speed up the collection of receivables and use the cash generated to increase inventories. d. Use some of its cash to purchase additional inventories. e. Issue new common stock and use the proceeds to acquire additional fixed assets. Answer: a 2. Amram Company’s current ratio is 2.0. Considered alone, which of the following actions would lower the current ratio? a. Borrow using short-term notes payable and use the proceeds to reduce accruals. b. Borrow using short-term notes payable and use the proceeds to reduce long-term debt. c. Use cash to reduce accruals. d. Use cash to reduce short-term notes payable. e. Use cash to reduce accounts payable. Answer: b A quick scan of the alternatives would indicate that b is obviously correct—it would lower the CR. Since there is only one correct answer, b must be the right answer. The following equation can also be used. If you add equal amounts to the numerator and denominator, then if Orig CR = or > 1.0, CR will decline, but if Orig CR < 1.0, CR will increase. Obviously, if you add to one but not the other, CR will increase or decrease in a predictable manner. This is the situation with choice b. CR = (Orig CA +/- ∆)/(Orig CL +/- ∆). a is false; it would leave the QR unchanged. b would obviously reduce the CR—CA remain constant and CL would increase. c is false, given that the initial CR > 1.0. d is false, given that the initial CR > 1.0. e is false, given that the initial CR > 1.0. ANALYSIS OF FINANCIAL STATEMENTS

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3. Which of the following statements is CORRECT? a. If a security analyst saw that a firm’s days’ sales outstanding (DSO) was higher than the industry average, and was increasing and trending still higher, this would be interpreted as a sign of strength. b. A high average DSO indicates that none of its customers are paying on time. In addition, it makes no sense to evaluate the firm's DSO with the firm's credit terms. c. There is no relationship between the days’ sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things. d. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio. e. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days’ sales outstanding will decline.
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CHAPTER 4 ANALYSIS OF FINANCIAL STATEMENTS - ANALYSIS OF...

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