Finance Test 2

Ratios help us make better comparisons between the operations of firms that differ in size and other aspects. True or false? true
The easier it is to convert an asset to cash at close to a given value, the more liquid the asset. True or false? true
The asset management ratios measure how effectively a firm is managing its assets relative to sales. True or false? true
Firms that use a lot of debt are said to have a great deal of financial leverage
Bauer Inc. has $2,050 of assets and $2,995 of sales. Its operating costs are $2,701, including $31 of lease payments, $450 of depreciation, and $500 of amortization charges. Its total current liabilities are $315, consisting of $265 of accruals and $50 of notes payable. Its long-term debt is $850, and its interest charges are $125. The firm’s debt includes all short-term and long-term interest-bearing debt, but it does not include operating items such as accounts payable and accruals. What is Bauer’s debt-to-capital ratio? 50.4%
The average firm in each industry must have an M/B ratio that is equal to 1.0. True or false? false – Average M/Bs will exceed 1.0 in “good” industries and be lower in “bad” industries.
If a firm used more debt, this would increase its interest costs and lower its profit margin, and that would almost certainly cause its ROE to decline. True or false? false
If a firm takes steps that increase its expected future ROE, this means that its shareholders’ wealth must also increase. True or false? false
Suppose a firm’s managers receive bonuses that increase with the size of the firm’s ROE, which was 30% last year and is forecasted to remain at this level during the coming year provided the firm takes on no new expansion projects. Its cost of capital is 10%. Now the firm has the opportunity to make a new investment that promises a 20% return on the invested capital. Which of the following statements is not correct?a. The new project should be rejected because, if it is accepted, the firm’s ROE will decline from 30% because the new ROE will be a weighted average of the old 30% and the 20% returns on the new investment. b. The example in this question demonstrates the serious weakness in using ROE as the primary criterion in setting executive compensation. c. The new project should be accepted because its expected return exceeds the cost of the capital that will be used to finance it. a. The new project should be rejected because, if it is accepted, the firm’s ROE will decline from 30% because the new ROE will be a weighted average of the old 30% and the 20% returns on the new investment.
Suppose a firm’s P/E ratio showed a rising trend over the last 5 years. This would suggest that the firm’s image was getting better
Suppose two firms have identical sales, operating costs, employee competence, assets, and financing policies. These firms would have to report the same amount of profits, and their ratios would all be the same, provided they both followed generally accepted accounting principles in their financial reporting. True or false? false
An analysis based on ratios should be supplemented with judgmental considerations such as the possible effects of new competitors like the Internet on newspapers, labor problems such as those experienced by the U.S. auto industry, environmental problems such as those facing the U.S. electric utilities, and the like. If the fundamentals of an industry change, then strong historical ratios won’t help its future performance. True or false? true
Which of the following statements regarding the DuPont Equation is CORRECT? a. The DuPont Equation is used to provide more information about the makeup of a firm’s return on equity. The DuPont Equation looks at the firm’s operating margin, inventory turnover, and the debt ratio to explain how the interaction among these ratios impact the firm’s ROE. b. The DuPont Equation is used to provide more information about the makeup of a firm’s return on equity. The DuPont Equation looks at the firm’s return on assets, fixed assets turnover, and equity multiplier to explain how the interaction among these ratios impact the firm’s ROE. c. The DuPont Equation is used to provide more information about the makeup of a firm’s return on equity. The DuPont Equation looks at the firm’s gross margin, return on assets, and the debt ratio to explain how the interaction among these ratios impact the firm’s ROE. d. The DuPont Equation is used to provide more information about the makeup of a firm’s return on equity. The DuPont Equation looks at the firm’s profit margin, total assets turnover, and equity multiplier to explain how the interaction among these ratios impact the firm’s ROE. e. The DuPont Equation is used to provide more information about the makeup of a firm’s return on equity. The DuPont Equation looks at the firm’s operating margin, total assets turnover, and the times-interest-earned ratio to explain how the interaction among these ratios impact the firm’s ROE. d. The DuPont Equation is used to provide more information about the makeup of a firm’s return on equity. The DuPont Equation looks at the firm’s profit margin, total assets turnover, and equity multiplier to explain how the interaction among these ratios impact the firm’s ROE.
The “cost” referred to in the concept of opportunity cost is always monetary. false
The concept of opportunity cost is described in which of the following statements? a. The monetary value of an exchange of goods for services or the opportunity to do something b. The value of what certain resources could have produced had they been used in the best alternative way c. The cost of choosing between two alternatives d. Both B and C d. Both B and C
A dollar today is worth less than a dollar tomorrow. false
What is discounting? Reducing the value of future cash flows
Which of the following statements is FALSE? a. Cash flows do not have to occur for every period shown on the time line. A lump sum cash flow can be depicted as easily as annuities on a time line. b. Time lines put verbal information into a diagram that is useful for seeing the cash flows that occur, when they occur, and the interest rate used in the analysis. c. Time lines typically show dollars below the line and years above the line. d. Time lines can show cash flows that occur over years, quarters, or any other periods. e. The FV as shown on a time line is always the cash flow at Time = 1 e. The FV as shown on a time line is always the cash flow at Time = 1
Which of the following statements is TRUE? a. A deposit will grow faster if simple interest rather than compound interest is paid. b. It would be better to both lend and borrow money at a rate of 6%, simple interest, rather than at a rate of 6%, compound interest. c. Compound interest means that interest in future periods is earned on the interest earned in the past, whereas under simple interest, interest is earned only on the original investment. c. Compound interest means that interest in future periods is earned on the interest earned in the past, whereas under simple interest, interest is earned only on the original investment.
Your father is now planning to retire, and his employer has promised him a guaranteed, but fixed, income of $50,000 per year for the rest of his life. If the rate of inflation is 5% per year, how much in current dollars will the payment at the end of 20th year be worth? 18,844.47
Is this statement true or false? A rational person should choose to receive cash flows from an annuity due of $1,000 per year rather than from a similar ordinary annuity. true
Is this statement true or false? If one set up time lines for an ordinary annuity of $1,000 per year for 3 years and a 3-year, $1,000 annuity due, the primary difference between the two time lines is that the $1,000 payments for the annuity due would begin at t = 0 and end at t = 2, whereas the ordinary annuity’s payments would begin at t = 1 and end at t = 3. true
Assume that you just received an ordinary annuity with 5 annual payments of $1,000 each. You plan to invest the payments at a 6% annual interest rate. What will the value of the first payment be at the end of the 5th year? $1,262.48
Is this statement true or false? If you calculated the value of an ordinary annuity, you could find the value of the corresponding annuity due by multiplying the FV of the ordinary annuity by (1 + I), because this would take into account that each annuity due payment occurs one year earlier. true
Analyzing financial statements to help appraise a firm’s financial position and strength is called “ratio analysis.” t/f true
The fact that relationships can sometimes be manipulated is one problem with ratio analysis. If our current ratio is greater than 1.5, then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to INCREASE. t/f false
The basic earning power ratio (BEP) is a better means of judging a company’s operating efficiency than the return on total assets because the BEP does not reflect the effects of debt and taxes.
Two companies—Davis & Associates and Matrix Enterprises—each reported the same earnings per share (EPS), but Davis & Associates’ stock trades at a higher price. Which of the following statements is CORRECT? Davis & Associates is probably judged by investors to be riskier. Davis & Associates probably has fewer growth opportunities. Davis & Associates must pay a lower dividend. Davis & Associates must have a higher market-to-book ratio. Davis & Associates trades at a higher P/E ratio. Davis & Associates trades at a higher P/E ratio.
International Appliances has a current ratio of 1.2. Which of the following actions would improve (increase) this ratio? Use cash to pay off some long-term debt. Collect some of the current accounts receivable. Use cash to pay for some fixed assets. Purchase additional inventory on credit (accounts payable). Use cash to pay off current liabilities. Use cash to pay off current liabilities.
International Appliances Inc. has a current ratio of 0.5. Which of the following actions would improve (increase) this ratio? Use cash to pay off some long-term debt. Collect some of the current accounts receivable. Sell some of the existing inventory at cost. Purchase additional inventory on credit (accounts payable). Use cash to pay off current liabilities. Use cash to pay off current liabilities.
Companies with high P/E and high M/B ratios generally are regarded as being relatively risky and/or having relatively poor growth prospects, according to investors. True False false
You are looking at two firms in the same industry. High Performance Tire Co. has a profit margin of 10% and All-Year Tires has a profit margin of 8%. High Performance Tire Co.’s total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is 70% versus one of 20% for All-Year Tires. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of High Performance Tire Co.’s higher profit margin. True False false
Days sales outstanding (DSO) can be used to determine how long it takes, on average, to collect payment after a sale is made. The DSO can be compared with the firm’s credit terms to get an idea of whether customers are paying on time. True False true
A high current ratio is always a good indication of a well-managed liquidity position. True False false
Due to significant variations in accounting methods among firms, meaningful ratio comparisons between firms is more difficult than it would be if all firms used the same or similar accounting methods. True False true
Which of the following statements about ratio analysis is CORRECT? Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of “window dressing.” “Window dressing” is any action that does not improve a firm’s fundamental long-run position and thus increases its intrinsic value. Using some of the firm’s cash to reduce long-term debt is an example of “window dressing.” Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase fixed assets is an example of “window dressing.” Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of “window dressing.” Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of “window dressing.”
The equity multiplier can be found as ROE/ROA. True False false
Trend analysis is one method of examining changes in a firm’s performance over time, which the analysis of only one year’s ratios will not show. True False true
If the current ratio is high and the inventory turnover ratio is low, relative to industry norms, then the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged. True False true

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