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Chap003 - test banks

Corporate Finance (American University of Beirut)

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Chapter 03 - Working with Financial Statements

Chapter 03

Chapter 03 Working with Financial Statements Answer Key

Multiple Choice Questions

1. Activities of a firm which require the spending of cash are known as:
A. sources of cash.
B. uses of cash.
C. cash collections.
D. cash receipts.
E. cash on hand.

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Uses of cash

2. The sources and uses of cash over a stated period of time are reflected on the:
A. income statement.
B. balance sheet.
C. tax reconciliation statement.
D. statement of cash flows.
E. statement of operating position.

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

3-1

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Chapter 03 - Working with Financial Statements

3. A common-size income statement is an accounting statement that expresses all of a firm's

expenses as percentage of:
A. total assets.
B. total equity.
C. net income.
D. taxable income.
E. sales.

Refer to section 3.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.2
Topic: Common-size statement

4. Which one of the following standardizes items on the income statement and balance sheet
relative to their values as of a common point in time?
A. statement of standardization
B. statement of cash flows
C. common-base year statement
D. common-size statement
E. base reconciliation statement

Refer to section 3.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.2
Topic: Common-base year statement

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Chapter 03 - Working with Financial Statements

5. Relationships determined from a firm's financial information and used for comparison
purposes are known as:
A. financial ratios.
B. identities.
C. dimensional analysis.
D. scenario analysis.
E. solvency analysis.

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Financial ratios

6. The formula which breaks down the return on equity into three component parts is referred
to as which one of the following?
A. equity equation
B. profitability determinant
C. SIC formula
D. Du Pont identity
E. equity performance formula

Refer to section 3.4

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

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Chapter 03 - Working with Financial Statements

7. The U.S. government coding system that classifies a firm by the nature of its business
operations is known as the:
A. NASDAQ 100.
B. Standard & Poor's 500.
C. Standard Industrial Classification code.
D. Governmental ID code.
E. Government Engineered Coding System.

Refer to section 3.5

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-4
Section: 3.5
Topic: SIC codes

8. Which one of the following is a source of cash?

A. increase in accounts receivable
B. decrease in notes payable
C. decrease in common stock
D. increase in accounts payable
E. increase in inventory

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Source of cash

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Chapter 03 - Working with Financial Statements

9. Which one of the following is a use of cash?

A. increase in notes payable
B. decrease in inventory
C. increase in long-term debt
D. decrease in accounts receivables
E. decrease in common stock

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Use of cash

10. Which one of the following is a source of cash?

A. repurchase of common stock
B. acquisition of debt
C. purchase of inventory
D. payment to a supplier
E. granting credit to a customer

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Source of cash

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Chapter 03 - Working with Financial Statements

11. Which one of the following is a source of cash?

A. increase in accounts receivable
B. decrease in common stock
C. decrease in long-term debt
D. decrease in accounts payable
E. decrease in inventory

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Source of cash

12. On the Statement of Cash Flows, which of the following are considered financing
activities?
I. increase in long-term debt
II. decrease in accounts payable
III. interest paid
IV. dividends paid
A. I and IV only
B. III and IV only
C. II and III only
D. I, III, and IV only
E. I, II, III, and IV

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

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Chapter 03 - Working with Financial Statements

13. On the Statement of Cash Flows, which of the following are considered operating
activities?
I. costs of goods sold
II. decrease in accounts payable
III. interest paid
IV. dividends paid
A. I and III only
B. III and IV only
C. I, II, and III only
D. I, III, and IV only
E. I, II, III, and IV

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

14. According to the Statement of Cash Flows, a decrease in accounts receivable will _____
the cash flow from _____ activities.
A. decrease; operating
B. decrease; financing
C. increase; operating
D. increase; financing
E. increase; investment

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

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Chapter 03 - Working with Financial Statements

15. According to the Statement of Cash Flows, an increase in interest expense will _____ the
cash flow from _____ activities.
A. decrease; operating
B. decrease; financing
C. increase; operating
D. increase; financing
E. increase; investment

Refer to section 3.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

16. On a common-size balance sheet all accounts are expressed as a percentage of:
A. sales for the period.
B. the base year sales.
C. total equity for the base year.
D. total assets for the current year.
E. total assets for the base year.

Refer to section 3.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.2
Topic: Common-size balance sheet

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Chapter 03 - Working with Financial Statements

17. On a common-base year financial statement, accounts receivables will be expressed

relative to which one of the following?
A. current year sales
B. current year total assets
C. base-year sales
D. base-year total assets
E. base-year accounts receivables

Refer to section 3.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.2
Topic: Common-base year statement

18. A firm uses 2008 as the base year for its financial statements. The common-size, base-year
statement for 2009 has an inventory value of 1.08. This is interpreted to mean that the 2009
inventory is equal to 108 percent of which one of the following?
A. 2008 inventory
B. 2008 total assets
C. 2009 total assets
D. 2008 inventory expressed as a percent of 2008 total assets
E. 2009 inventory expressed as a percent of 2009 total assets

Refer to section 3.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-1
Section: 3.2
Topic: Common-base year statement

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Chapter 03 - Working with Financial Statements

19. Which of the following ratios are measures of a firm's liquidity?

I. cash coverage ratio
II. interval measure
III. debt-equity ratio
IV. quick ratio
A. I and III only
B. II and IV only
C. I, III, and IV only
D. I, II, and III only
E. I, II, III, and IV

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Liquidity ratios

20. An increase in current liabilities will have which one of the following effects, all else held
constant? Assume all ratios have positive values.
A. increase in the cash ratio
B. increase in the net working capital to total assets ratio
C. decrease in the quick ratio
D. decrease in the cash coverage ratio
E. increase in the current ratio

Refer to section 3.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Ratio analysis

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Chapter 03 - Working with Financial Statements

21. An increase in which one of the following will increase a firm's quick ratio without
affecting its cash ratio?
A. accounts payable
B. cash
C. inventory
D. accounts receivable
E. fixed assets

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Liquidity ratios

22. A supplier, who requires payment within ten days, should be most concerned with which
one of the following ratios when granting credit?
A. current
B. cash
C. debt-equity
D. quick
E. total debt

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Liquidity ratios

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Chapter 03 - Working with Financial Statements

23. A firm has an interval measure of 48. This means that the firm has sufficient liquid assets
to do which one of the following?
A. pay all of its debts that are due within the next 48 hours
B. pay all of its debts that are due within the next 48 days
C. cover its operating costs for the next 48 hours
D. cover its operating costs for the next 48 days
E. meet the demands of its customers for the next 48 hours

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Interval measure

24. Over the past year, the quick ratio for a firm increased while the current ratio remained
constant. Given this information, which one of the following must have occurred? Assume all
ratios have positive values.
A. current assets increased
B. current assets decreased
C. inventory increased
D. inventory decreased
E. accounts payable increased

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Quick ratio

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Chapter 03 - Working with Financial Statements

25. Ratios that measure a firm's financial leverage are known as _____ ratios.
A. asset management
B. long-term solvency
C. short-term solvency
D. profitability
E. book value

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Long-term solvency ratios

26. Which one of the following statements is correct?

A. If the total debt ratio is greater than .50, then the debt-equity ratio must be less than 1.0.
B. Long-term creditors would prefer the times interest earned ratio be 1.4 rather than 1.5.
C. The debt-equity ratio can be computed as 1 plus the equity multiplier.
D. An equity multiplier of 1.2 means a firm has $1.20 in sales for every $1 in equity.
E. An increase in the depreciation expense will not affect the cash coverage ratio.

Refer to section 3.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Financial leverage ratios

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Chapter 03 - Working with Financial Statements

27. If a firm has a debt-equity ratio of 1.0, then its total debt ratio must be which one of the
following?
A. 0.0
B. 0.5
C. 1.0
D. 1.5
E. 2.0

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Long-term solvency ratios

28. The cash coverage ratio directly measures the ability of a firm's revenues to meet which
one of its following obligations?
A. payment to supplier
B. payment to employee
C. payment of interest to a lender
D. payment of principle to a lender
E. payment of a dividend to a shareholder

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Long-term solvency ratios

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Chapter 03 - Working with Financial Statements

29. Jasper United had sales of $21,000 in 2008 and $24,000 in 2009. The firm's current
accounts remained constant. Given this information, which one of the following statements
must be true?
A. The total asset turnover rate increased.
B. The days' sales in receivables increased.
C. The net working capital turnover rate increased.
D. The fixed asset turnover decreased.
E. The receivables turnover rate decreased.

Refer to section 3.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Turnover ratios

30. The Corner Hardware has succeeded in increasing the amount of goods it sells while
holding the amount of inventory on hand at a constant level. Assume that both the cost per
unit and the selling price per unit also remained constant. This accomplishment will be
reflected in the firm's financial ratios in which one of the following ways?
A. decrease in the inventory turnover rate
B. decrease in the net working capital turnover rate
C. no change in the fixed asset turnover rate
D. decrease in the day's sales in inventory
E. no change in the total asset turnover rate

Refer to section 3.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Turnover ratios

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Chapter 03 - Working with Financial Statements

31. Dee's has a fixed asset turnover rate of 1.12 and a total asset turnover rate of 0.91. Sam's
has a fixed asset turnover rate of 1.15 and a total asset turnover rate of 0.88. Both companies
have similar operations. Based on this information, Dee's must be doing which one of the
following?
A. utilizing its fixed assets more efficiently than Sam's
B. utilizing its total assets more efficiently than Sam's
C. generating $1 in sales for every $1.12 in net fixed assets
D. generating $1.12 in net income for every $1 in net fixed assets
E. maintaining the same level of current assets as Sam's

Refer to section 3.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Asset utilization ratios

32. Ratios that measure how efficiently a firm manages its assets and operations to generate
net income are referred to as _____ ratios.
A. asset management
B. long-term solvency
C. short-term solvency
D. profitability
E. turnover

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Profitability ratios

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Chapter 03 - Working with Financial Statements

33. If a firm produces a twelve percent return on assets and also a twelve percent return on
equity, then the firm:
A. may have short-term, but not long-term debt.
B. is using its assets as efficiently as possible.
C. has no net working capital.
D. has a debt-equity ratio of 1.0.
E. has an equity multiplier of 1.0.

Refer to section 3.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Profitability ratios

34. Which one of the following will decrease if a firm can decrease its operating costs, all else
constant?
A. return on equity
B. return on assets
C. profit margin
D. equity multiplier
E. price-earnings ratio

Refer to section 3.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Profitability ratios

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Chapter 03 - Working with Financial Statements

35. Al's has a price-earnings ratio of 18.5. Ben's also has a price-earnings ratio of 18.5. Which
one of the following statements must be true if Al's has a higher PEG ratio than Ben's?
A. Al's has more net income than Ben's.
B. Ben's is increasing its earnings at a faster rate than the Al's.
C. Al's has a higher market value per share than does Ben's.
D. Ben's has a lower market-to-book ratio than Al's.
E. Al's has a higher net income than Ben's.

Refer to section 3.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

36. Tobin's Q relates the market value of a firm's assets to which one of the following?
A. initial cost of creating the firm
B. current book value of the firm
C. average asset value of similar firms
D. average market value of similar firms
E. today's cost to duplicate those assets

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

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Chapter 03 - Working with Financial Statements

37. The price-sales ratio is especially useful when analyzing firms that have which one of the
following?
A. volatile market prices
B. negative earnings
C. positive PEG ratios
D. a negative Tobin's Q
E. increasing sales

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

38. Shareholders probably have the most interest in which one of the following sets of ratios?
A. return on assets and profit margin
B. long-term debt and times interest earned
C. price-earnings and debt-equity
D. market-to-book and times interest earned
E. return on equity and price-earnings

Refer to section 3.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

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Chapter 03 - Working with Financial Statements

39. Which one of the following accurately describes the three parts of the Du Pont identity?
A. operating efficiency, equity multiplier, and profitability ratio
B. financial leverage, operating efficiency, and profitability ratio
C. equity multiplier, profit margin, and total asset turnover
D. debt-equity ratio, capital intensity ratio, and profit margin
E. return on assets, profit margin, and equity multiplier

Refer to section 3.4

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

40. An increase in which of the following will increase the return on equity, all else constant?
I. sales
II. net income
III. depreciation
IV. total equity
A. I only
B. I and II only
C. II and IV only
D. II and III only
E. I, II, and III only

Refer to section 3.4

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

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Chapter 03 - Working with Financial Statements

41. Which of the following can be used to compute the return on equity?
I. Profit margin  Return on assets
II. Return on assets  Equity multiplier
III. Net income/Total equity
IV. Return on assets  Total asset turnover
A. I and III only
B. II and III only
C. II and IV only
D. I, II, and III only
E. I, II, III, and IV

Refer to section 3.4

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

42. The Du Pont identity can be used to help managers answer which of the following
questions related to a firm's operations?
I. How many sales dollars has the firm generated per each dollar of assets?
II. How many dollars of assets has a firm acquired per each dollar in shareholders' equity?
III. How much net profit is a firm generating per dollar of sales?
IV. Does the firm have the ability to meet its debt obligations in a timely manner?
A. I and III only
B. II and IV only
C. I, II, and III only
D. II, III and IV only
E. I, II, III, and IV

Refer to section 3.4

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

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Chapter 03 - Working with Financial Statements

43. A firm currently has $600 in debt for every $1,000 in equity. Assume the firm uses some
of its cash to decrease its debt while maintaining its current equity and net income. Which one
of the following will decrease as a result of this action?
A. equity multiplier
B. total asset turnover
C. profit margin
D. return on assets
E. return on equity

Refer to section 3.4

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

44. Which one of the following statements is correct?

A. Book values should always be given precedence over market values.
B. Financial statements are frequently used as the basis for performance evaluations.
C. Historical information provides no value to someone who is predicting future performance.
D. Potential lenders place little value on financial statement information.
E. Reviewing financial information over time has very limited value.

Refer to section 3.5

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-4
Section: 3.5
Topic: Evaluating financial statements

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Chapter 03 - Working with Financial Statements

45. It is easier to evaluate a firm using financial statements when the firm:
A. is a conglomerate.
B. has recently merged with its largest competitor.
C. uses the same accounting procedures as other firms in the industry.
D. has a different fiscal year than other firms in the industry.
E. tends to have many one-time events such as asset sales and property acquisitions.

Refer to section 3.5

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-4
Section: 3.5
Topic: Evaluating financial statements

46. The most acceptable method of evaluating the financial statements of a firm is to compare
the firm's current:
A. financial ratios to the firm's historical ratios.
B. financial statements to the financial statements of similar firms operating in other
C. countries.
D. financial ratios to the average ratios of all firms located within the same geographic area.
E. financial statements to those of larger firms in unrelated industries.
F. financial statements to the projections that were created based on Tobin's Q.

Refer to section 3.5

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 3-4
Section: 3.5
Topic: Evaluating financial statements

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Chapter 03 - Working with Financial Statements

47. Which of the following represent problems encountered when comparing the financial
statements of two separate entities?
I. Either one, or both, of the firms may be conglomerates and thus have unrelated lines of
business.
II. The operations of the two firms may vary geographically.
III. The firms may use differing accounting methods.
IV. The two firms may be seasonal in nature and have different fiscal year ends.
A. I and II only
B. II and III only
C. I, III, and IV only
D. I, II, and III only
E. I, II, III, and IV

Refer to section 3.5

AACSB: N/A
Difficulty: Basic
Learning Objective: 3-4
Section: 3.5
Topic: Evaluating financial statements

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Chapter 03 - Working with Financial Statements

48. Wise's Corner Grocer had the following current account values. What effect did the
change in net working capital have on the firm's cash flows for 2009?

A. net use of cash of $37

B. net use of cash of $83
C. net source of cash of $83
D. net source of cash of $111
E. net source of cash of $135

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Sources and uses of cash

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Chapter 03 - Working with Financial Statements

49. During the year, Kitchen Supply increased its accounts receivable by $130, decreased its
inventory by $75, and decreased its accounts payable by $40. How did these three accounts
affect the firm's cash flows for the year?
A. $245 use of cash
B. $165 use of cash
C. $95 use of cash
D. $95 source of cash
E. $165 source of cash

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Sources and uses of cash

50. A firm generated net income of $878. The depreciation expense was $47 and dividends
were paid in the amount of $25. Accounts payables decreased by $13, accounts receivables
increased by $22, inventory decreased by $14, and net fixed assets decreased by $8. There
was no interest expense. What was the net cash flow from operating activity?
A. $876
B. $902
C. $904
D. $922
E. $930

Net cash from operating activities = $878 + $47 - $13 - $22 + $14 = $904

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Operating cash flows

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Chapter 03 - Working with Financial Statements

51. A firm has sales of $2,190, net income of $174, net fixed assets of $1,600, and current
assets of $720. The firm has $310 in inventory. What is the common-size statement value of
inventory?
A. 13.36 percent
B. 14.16 percent
C. 19.38 percent
D. 30.42 percent
E. 43.06 percent

Common-size inventory = $310/($1,600 + $720) = 13.36 percent

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.2
Topic: Common-size statements

52. A firm has sales of $3,400, net income of $390, total assets of $4,500, and total equity of
$2,750. Interest expense is $40. What is the common-size statement value of the interest
expense?
A. 0.89 percent
B. 1.18 percent
C. 3.69 percent
D. 10.26 percent
E. 14.55 percent

Common-size interest = $40/$3,400 = 1.18 percent

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.2
Topic: Common-size statements

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53. Last year, which is used as the base year, a firm had cash of $52, accounts receivable of
$218, inventory of $509, and net fixed assets of $1,107. This year, the firm has cash of $61,
accounts receivable of $198, inventory of $527, and net fixed assets of $1,216. What is the
common-base year value of accounts receivable?
A. 0.08
B. 0.10
C. 0.88
D. 0.91
E. 1.18

Common-base year accounts receivable = $198/$218 = 0.91

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.2
Topic: Common-base year statements

54. Russell's Deli has cash of $136, accounts receivable of $87, accounts payable of $215, and
inventory of $409. What is the value of the quick ratio?
A. 0.31
B. 0.53
C. 0.71
D. 1.04
E. 1.07

Quick ratio = ($136 + $87)/$215 = 1.04

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Liquidity ratios

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55. Uptown Men's Wear has accounts payable of $2,214, inventory of $7,950, cash of $1,263,
fixed assets of $8,400, accounts receivable of $3,907, and long-term debt of $4,200. What is
the value of the net working capital to total assets ratio?
A. 0.31
B. 0.42
C. 0.47
D. 0.51
E. 0.56

Net working capital to total assets = ($1,263 + $3,907 + $7,950 - $2,214)/($1,263 + $3,907 +
$7,950 + $8,400) = 0.51

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Liquidity ratios

56. A firm has total assets of $311,770 and net fixed assets of $167,532. The average daily
operating costs are $2,980. What is the value of the interval measure?
A. 31.47 days
B. 48.40 days
C. 56.22 days
D. 68.05 days
E. 104.62 days

Interval measure = ($311,770 - $167,532)/$2,980 = 48.40 days

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Liquidity ratios

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57. A firm has a debt-equity ratio of 0.42. What is the total debt ratio?
A. 0.30
B. 0.36
C. 0.44
D. 1.58
E. 2.38

The debt-equity ratio is 0.42. If total debt is $42 and total equity is $100, then total assets are
$142. Total debt ratio = $42/$142 = 0.30.

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Long-term solvency ratios

58. A firm has total debt of $4,620 and a debt-equity ratio of 0.57. What is the value of the
total assets?
A. $6,128.05
B. $7,253.40
C. $9,571.95
D. $11,034.00
E. $12,725.26

Total equity = $4,620/0.57 = $8,105.26

Total assets = $4,620 + $8,105.26 = $12,725.26

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Long-term solvency ratios

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59. A firm has sales of $68,400, costs of $42,900, interest paid of $2,100, and depreciation of
$6,500. The tax rate is 34 percent. What is the value of the cash coverage ratio?
A. 12.14
B. 15.24
C. 17.27
D. 23.41
E. 24.56

Cash coverage ratio = ($68,400 - $42,900)/$2,100 = 12.14

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Long-term solvency ratios

60. The Bike Shop paid $2,310 in interest and $1,850 in dividends last year. The times interest
earned ratio is 2.2 and the depreciation expense is $460. What is the value of the cash
coverage ratio?
A. 1.67
B. 1.80
C. 2.21
D. 2.40
E. 2.52

EBIT = 2.2  $2,310 = $5,082; Cash coverage ratio = ($5,082 + $460)/$2,310 = 2.40

AACSB: Analytic
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Long-term solvency ratios

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61. Al's Sport Store has sales of $897,400, costs of goods sold of $628,300, inventory of
$208,400, and accounts receivable of $74,100. How many days, on average, does it take the
firm to sell its inventory assuming that all sales are on credit?
A. 74.19 days
B. 84.76 days
C. 121.07 days
D. 138.46 days
E. 151.21 days

Inventory turnover = $628,300/$208,400 = 3.014875

Days in inventory = 365/3.014875 = 121.07 days

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Asset utilization ratios

62. The Flower Shoppe has accounts receivable of $3,709, inventory of $4,407, sales of
$218,640, and cost of goods sold of $167,306. How many days does it take the firm to both
sell its inventory and collect the payment on the sale assuming that all sales are on credit?
A. 14.67 days
B. 15.81 days
C. 16.23 days
D. 17.18 days
E. 17.47 days

Days in inventory = 365/($167,306/$4,407) = 9.614 days

Days' sales in receivables = 365/($218,640/$3,709) = 6.192 days
Total days in inventory and receivables = 9.614 + 6.192 = 15.81 days

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Asset utilization ratios

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63. A firm has net working capital of $2,715, net fixed assets of $22,407, sales of $31,350,
and current liabilities of $3,908. How many dollars worth of sales are generated from every
$1 in total assets?
A. $1.08
B. $1.14
C. $1.19
D. $1.26
E. $1.30

Total asset turnover = $31,350/($2,715 + $22,407 + $3,908) = 1.08

Every $1 in total assets generates $1.08 in sales.

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Asset utilization ratios

64. The Purple Martin has annual sales of $687,400, total debt of $210,000, total equity of
$365,000, and a profit margin of 5.20 percent. What is the return on assets?
A. 6.22 percent
B. 6.48 percent
C. 7.02 percent
D. 7.78 percent
E. 9.79 percent

Return on assets = (.0520  $687,400)/($210,000 + $365,000) = 6.22 percent

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Profitability ratios

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65. Reliable Cars has sales of $807,200, total assets of $1,105,100, and a profit margin of 9.68
percent. The firm has a total debt ratio of 78 percent. What is the return on equity?
A. 13.09 percent
B. 16.67 percent
C. 17.68 percent
D. 28.56 percent
E. 32.14 percent

Return on equity = (.0968  $807,200)/[$1,105,100  (1 - .78)] = 32.14 percent

AACSB: Analytic
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Profitability ratios

66. The Meat Market has $747,000 in sales. The profit margin is 4.1 percent and the firm has
7,500 shares of stock outstanding. The market price per share is $27. What is the price-
earnings ratio?
A. 6.61
B. 8.98
C. 11.42
D. 13.15
E. 14.27

Earnings per share = (.041  $747,000)/7,500 = 4.0836

Price-earnings ratio = $27/4.0836 = 6.61

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

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67. Big Guy Subs has net income of $150,980, a price-earnings ratio of 12.8, and earnings per
share of $0.87. How many shares of stock are outstanding?
A. 13,558
B. 14,407
C. 165,523
D. 171,000
E. 173,540

Number of shares = $150,980/$0.87 = 173,540

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

68. A firm has 160,000 shares of stock outstanding, sales of $1.94 million, net income of
$126,400, a price-earnings ratio of 18.7, and a book value per share of $9.12. What is the
market-to-book ratio?
A. 1.62
B. 1.84
C. 2.23
D. 2.45
E. 2.57

Earnings per share = $126,400/160,000 = $0.79

Price per share = $0.79  18.7 = $14.773
Market-to-book ratio = $14.773/$9.12 = 1.62

AACSB: Analytic
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

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69. Oscar's Dog House has a profit margin of 5.6 percent, a return on assets of 12.5 percent,
and an equity multiplier of 1.49. What is the return on equity?
A. 17.14 percent
B. 18.63 percent
C. 19.67 percent
D. 21.69 percent
E. 22.30 percent

Return on equity = 12.5 percent  1.49 = 18.63 percent, using the Du Pont Identity

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

70. Taylor's Men's Wear has a debt-equity ratio of 42 percent, sales of $749,000, net income
of $41,300, and total debt of $198,400. What is the return on equity?
A. 7.79 percent
B. 8.41 percent
C. 8.74 percent
D. 9.09 percent
E. 9.16 percent

Return on equity = $41,300/($198,400/0.42) = 8.74 percent

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

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71. A firm has a debt-equity ratio of 57 percent, a total asset turnover of 1.12, and a profit
margin of 4.9 percent. The total equity is $511,640. What is the amount of the net income?
A. $28,079
B. $35,143
C. $44,084
D. $47,601
E. $52,418

Return on equity = .049  1.12  (1 + 0.57) = .0861616

Net income = $511,640  .0861616 = $44,084

AACSB: Analytic
Difficulty: Intermediate
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

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72. What is the quick ratio for 2009?

A. 0.56
B. 0.60
C. 1.32
D. 1.67
E. 1.79

Quick ratio for 2009 = ($268,100 - $186,700)/$134,700 = 0.60

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Liquidity ratios

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73. How many days of sales are in receivables? (Use 2009 values)
A. 17.08 days
B. 23.33 days
C. 26.49 days
D. 29.41 days
E. 32.97 days

Accounts receivable turnover for 2009 = $627,800/$56,700 = 11.07

Days' sales in receivables for 2009 = 365/11.07 = 32.97

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Asset utilization ratios

74. What is the price-sales ratio for 2009 if the market price is $18.49 per share?
A. 2.43
B. 3.29
C. 3.67
D. 4.12
E. 4.38

Price-sales ratio = $18.49/[$627,800/($140,000/$1)] = 4.12

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Asset utilization ratios

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75. What is debt-equity ratio? (Use 2009 values)

A. 0.52
B. 0.87
C. 0.94
D. 1.01
E. 1.06

Debt-equity ratio = ($134,700 + $141,000)/($140,000 + $131,800) = 1.01

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Financial leverage ratios

76. What is the cash coverage ratio for 2009?

A. 9.43
B. 10.53
C. 11.64
D. 11.82
E. 12.31

Cash coverage ratio = ($95,200 + $11,200)/$10,100 = 10.53

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Financial leverage ratios

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77. What is the return on equity? (Use 2009 values)

A. 10.26 percent
B. 16.38 percent
C. 20.68 percent
D. 29.96 percent
E. 40.14 percent

Return on equity = $56,200/($140,000 + $131,800) = 20.68 percent

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Profitability ratios

78. What is the amount of the dividends paid for 2009?

A. $11,100
B. $15,000
C. $32,600
D. $41,200
E. $45,100

Dividends paid = $56,200 - ($131,800 - $120,700) = $45,100

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

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79. What is the amount of the cash flow from investment activity for 2009?
A. $18,100
B. $24,800
C. $29,300
D. $32,000
E. $39,400

Cash flow from investment activity = $279,400 - $261,300 + $11,200 = $29,300

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

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80. What is the net working capital to total assets ratio for 2009?
A. 24.18 percent
B. 36.82 percent
C. 45.49 percent
D. 51.47 percent
E. 65.83 percent

Net working capital to total assets for 2009 = ($27,129 - $8,384)/$41,209 = 45.49 percent

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Liquidity ratios

81. How many days on average does it take Precision Tool to sell its inventory? (Use 2009
values)
A. 164.30 days
B. 187.77 days
C. 219.63 days
D. 247.46 days
E. 283.31 days

Days' sales in inventory = 365/($28,225/$21,908) = 283.31 days

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Asset utilization ratios

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82. How many dollars of sales are being generated from every dollar of net fixed assets? (Use
2009 values.)
A. $0.88
B. $1.87
C. $2.33
D. $2.59
E. $3.09

Fixed asset turnover for 2009 = $36,408/$14,080 = 2.59

For every $1 in net fixed assets, the firm generates $2.59 in sales.

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Asset utilization ratios

83. What is the equity multiplier for 2009?

A. 1.67
B. 1.72
C. 1.88
D. 1.93
E. 2.03

Equity multiplier for 2009 = $41,209/($17,500 + $3,825) = 1.93

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Financial leverage ratios

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84. What is the times interest earned ratio for 2009?

A. 9.63
B. 10.12
C. 12.59
D. 14.97
E. 16.05

Times interest earned for 2009 = $6,423/$510 = 12.59

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Financial leverage ratios

85. What is the return on equity for 2009? (Use 2009 values)
A. 15.29 percent
B. 16.46 percent
C. 17.38 percent
D. 18.02 percent
E. 18.12 percent

Return on equity for 2009 = $3,843/($17,500 + $3,825) = 18.02 percent

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Profitability ratios

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86. What is the net cash flow from investment activity for 2009?
A. -$1,840
B. -$1,680
C. -$80
D. $80
E. $1,840

Net cash flow from investment activity for 2009 = -$1,680

Addition to net fixed assets = $14,080 - $14,160 + $1,760 = $1,680

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

87. How does accounts receivable affect the statement of cash flows for 2009?
A. a use of $4,218 of cash as an investment activity
B. a source of $807 of cash as an operating activity
C. a use of $4,218 of cash as a financing activity
D. a source of $807 of cash as an investment activity
E. a use of $807 of cash as an operating activity

Change in accounts receivable for 2009 = $4,218 - $3,411 = $807

An increase in accounts receivable is a use of cash as an operating activity.

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

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88. BL Lumber has earnings per share of $1.21. The firm's earnings have been increasing at
an average rate of 3.1 percent annually and are expected to continue doing so. The firm has
21,500 shares of stock outstanding at a price per share of $18.70. What is the firm's PEG
ratio?
A. 0.48
B. 1.24
C. 2.85
D. 3.97
E. 4.99

PEG ratio = ($18.70/$1.21)/(.031  100) = 4.99

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

89. Townsend Enterprises has a PEG ratio of 5.3, net income of $49,200, a price-earnings
ratio of 17.6, and a profit margin of 7.1 percent. What is the earnings growth rate?
A. 0.33 percent
B. 1.06 percent
C. 3.32 percent
D. 5.30 percent
E. 10.60 percent

5.3 = 17.6/(Earnings growth rate  100); Earnings growth rate = 3.32 percent

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

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90. A firm has total assets with a current book value of $68,700, a current market value of
$74,300, and a current replacement cost of $75,600. What is the value of Tobin's Q?
A. .85
B. .87
C. .92
D. .95
E. .98

Tobin's Q = $74,300/$75,600 = .98

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

91. Dixie Supply has total assets with a current book value of $368,900 and a current
replacement cost of $486,200. The market value of these assets is $464,800. What is the value
of Tobin's Q?
A. .86
B. .92
C. .96
D. 1.01
E. 1.06

Tobin's Q = $464,800/$486,200 = .96

AACSB: Analytic
Difficulty: Basic
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

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92. Dandelion Fields has a Tobin's Q of .96. The replacement cost of the firm's assets is
$225,000 and the market value of the firm's debt is $109,000. The firm has 20,000 shares of
stock outstanding and a book value per share of $2.09. What is the market to book ratio?
A. 2.56 times
B. 3.18 times
C. 3.54 times
D. 4.01 times
E. 4.20 times

Market value of assets = .96  $225,000 = $216,000

Market value of equity = $216,000 - $109,000 = $107,000
Market value per share $107,000/20,000 = $5.35
Market-to-book ratio = $5.35/$2.09 = 2.56 times

AACSB: Analytic
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

93. A firm has annual sales of $320,000, a price-earnings ratio of 24, and a profit margin of
4.2 percent. There are 14,000 shares of stock outstanding. What is the price-sales ratio?
A. 0.97
B. 1.01
C. 1.08
D. 1.15
E. 1.22

Earnings per share = ($320,000  .042)/14,000 = $0.96

Price-sales ratio = (24  $0.96)/($320,000/14,000) = 1.01

AACSB: Analytic
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

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94. Lassiter Industries has annual sales of $220,000 with 10,000 shares of stock outstanding.
The firm has a profit margin of 7.5 percent and a price-sales ratio of 1.20. What is the firm's
price-earnings ratio?
A. 14
B. 16
C. 18
D. 20
E. 22

Price per share = 1.20  ($220,000/10,000) = $26.40

Earnings per share = ($220,000  .075)/10,000 = $1.65
Price-earnings ratio = $26.40/$1.65 = 16

AACSB: Analytic
Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Market value ratios

Essay Questions

95. Assume a firm has a positive cash balance which is increasing annually. Why then is it
important to analyze a statement of cash flows?

It is possible that the increase in the cash balance is a result of issuing more equity or
assuming more debt and not the result of generating cash from operations. If a firm cannot
generate positive cash flows internally, the firm will eventually encounter difficulties in
raising external funds and could possibly face bankruptcy.

Feedback: Refer to section 3.1

AACSB: Reflective thinking

Difficulty: Basic
Learning Objective: 3-1
Section: 3.1
Topic: Statement of cash flows

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96. You need to analyze a firm's performance in relation to its peers. You can do this either by
comparing the firms' balance sheets and income statements or by comparing the firms' ratios.
If you only had time to use one means of comparison which method would you use and why?

Firms generally are sized differently making it difficult to do comparisons on a dollar basis.
By using ratios, the relationships between variables can be seen without being influenced by
firm size. In addition, ratios allow you to analyze performance and see relationships that are
difficult to see when looking only at dollar amounts. Thus, the logical choice would be to
compare the firms using ratio analysis.

Feedback: Refer to section 3.5

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 3-4
Section: 3.5
Topic: Ratio analysis

97. In general, what does a high Tobin's Q value indicate and how reliable does that value
tend to be?

A high Tobin's Q indicates that the current market value of a firm's assets represents a high
percentage of the firm's replacement cost. Higher Q values tend to indicate that a firm has a
significant competitive advantage and/or has attractive investment opportunities. The problem
with Tobin's Q is that the information used in the computation of the Q value is often
questionable.

Feedback: Refer to section 3.3

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Tobin's Q

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98. What value does the PEG ratio provide to financial analysts?

The PEG ratio divides the PE ratio by the expected future earnings growth rate (The growth
rate is multiplied by 100). A high PEG value tends to indicate that the firm's PE ratio, and thus
the stock price, is too high relative to the expected growth rate of the firm's earnings. This is
particularly true when a firm's PEG and PE ratios are noticeably greater than those of its
peers.

Feedback: Refer to section 3.3

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: PEG and PE ratios

99. What value can the price-sales ratio provide to financial managers that the price-earnings
ratio cannot?

The price-earnings ratio loses its value when a firm has either zero or negative earnings. This
problem is avoided by using the price-sales ratio as sales should always be a positive value. In
addition, the price-sales ratio is not affected by a firm's expenses or taxes whereas the price-
earnings ratio is. If earnings are positive, both ratios can be used to ascertain if there is any
major change in the relationship between a firm's costs and its sales from one time period to
another.

Feedback: Refer to section 3.3

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 3-2
Section: 3.3
Topic: Price-sales ratio

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100. It is commonly recommended that the managers of a firm compare the performance of
their firm to that of its peers. Increasingly, this is becoming a more difficult task. Explain
some of the reasons why comparisons of this type can frequently be either difficult to perform
or produce misleading results.

Many firms are involved in multiple areas of business over diverse geographical locations
thereby making it difficult, if not impossible to identify a peer that has truly similar
operations. Firms operating in different areas may be subjected to various regulations which
might affect also their operations. In addition, many firms are cyclical in nature and have
varying fiscal years which complicates the comparison of financial statements. The financial
results for a firm are also affected by various accounting practices and one-time events, such
as a merger, acquisition, or divestiture. If each of these differences between firms is not
handled properly, any resulting comparisons or conclusions can be faulty. So, while it is
recommended that peer analysis be conducted, doing so in a meaningful manner can present
quite a challenge.

Feedback: Refer to section 3.5

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 3-4
Section: 3.5
Topic: Peer analysis

Multiple Choice Questions

101. The Burger Hut has sales of $29 million, total assets of $43 million, and total debt of $13
million. The profit margin is 11 percent. What is the return on equity?
A. 7.42 percent
B. 10.63 percent
C. 11.08 percent
D. 13.31 percent
E. 14.28 percent

Return on equity = (.11  $29m)/($43m - $13m) = 10.63 percent

AACSB: Analytic
Difficulty: Basic
EOC #: 3-2
Learning Objective: 3-2
Section: 3.3
Topic: Return on equity

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102. The Home Supply Co. has a current accounts receivable balance of $300,000. Credit
sales for the year just ended were $1,830,000. How many days on average did it take for
credit customers to pay off their accounts during this past year?
A. 54.29 days
B. 56.01 days
C. 57.50 days
D. 59.84 days
E. 61.00 days

Receivables turnover = $1,830,000/$300,000 = 6.1 times

Days' sales in receivables = 365/6.1 = 59.84 days

AACSB: Analytic
Difficulty: Basic
EOC #: 3-3
Learning Objective: 3-2
Section: 3.3
Topic: Average collection period

103. BL Industries has ending inventory of $300,000, and cost of goods sold for the year just
ended was $1,410,000. On average, how long does a unit of inventory sit on the shelf before it
is sold?
A. 17.16 days
B. 21.43 days
C. 77.66 days
D. 78.29 days
E. 83.13 days

Inventory turnover = $1,410,000/$300,000 = 4.7 times

Day's sales in inventory = 365/4.7 = 77.66 days

AACSB: Analytic
Difficulty: Basic
EOC #: 3-4
Learning Objective: 3-2
Section: 3.3
Topic: Inventory turnover

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104. Coulter Supply has a total debt ratio of 0.47. What is the equity multiplier?
A. 0.89
B. 1.13
C. 1.47
D. 1.89
E. 2.13

Debt-equity ratio = .47/(1 - 0.47) = 0.89

Equity multiplier = 1 + 0.89 = 1.89

AACSB: Analytic
Difficulty: Basic
EOC #: 3-5
Learning Objective: 3-2
Section: 3.3
Topic: Equity multiplier

105. High Mountain Foods has an equity multiplier of 1.55, a total asset turnover of 1.3, and a
profit margin of 7.5 percent. What is the return on equity?
A. 8.94 percent
B. 10.87 percent
C. 12.69 percent
D. 14.38 percent
E. 15.11 percent

Return on equity = .075  1.3  1.55 = 15.11 percent

AACSB: Analytic
Difficulty: Basic
EOC #: 3-7
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

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106. Lancaster Toys has a profit margin of 9.6 percent, a total asset turnover of 1.71, and a
return on equity of 21.01 percent. What is the debt-equity ratio?
A. 0.22
B. 0.28
C. 0.46
D. 0.72
E. 0.78

Equity multiplier = .2101/(.096  1.71) = 1.28

Debt-equity ratio = 1.28 - 1 = 0.28

AACSB: Analytic
Difficulty: Basic
EOC #: 3-8
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

107. Charlie's Chicken has a debt-equity ratio of 2.05. Return on assets is 9.2 percent, and
total equity is $560,000. What is the net income?
A. $105,616
B. $148,309
C. $157,136
D. $161,008
E. $164,909

Equity multiplier = 1 + 2.05 = 3.05

Return on equity = .092  3.05 = .2806
Net income = .2806  $560,000 = $157,136

AACSB: Analytic
Difficulty: Basic
EOC #: 3-12
Learning Objective: 3-2
Section: 3.3
Topic: Equity multiplier and return on equity

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108. Canine Supply has sales of $2,200, total assets of $1,400, and a debt-equity ratio of 0.3.
Its return on equity is 15 percent. What is the net income?
A. $138.16
B. $141.41
C. $152.09
D. $156.67
E. $161.54

Return on equity = .15 = (Net income/$2,200)  ($2,200/$1,400)  (1 + 0.30)

Net income = $161.54

AACSB: Analytic
Difficulty: Intermediate
EOC #: 3-18
Learning Objective: 3-3
Section: 3.4
Topic: Du Pont identity

109. Billings, Inc. has net income of $161,000, a profit margin of 7.6 percent, and an accounts
receivable balance of $127,100. Assume that 66 percent of sales are on credit. What is the
days' sales in receivables?
A. 21.90 days
B. 27.56 days
C. 33.18 days
D. 35.04 days
E. 36.19 days

Sales = $161,000/.076 = $2,118,421

Credit sales = $2,118,421  .66 = $1,398,158
Accounts receivable turnover = $1,398,158/$127,100 = 11 times
Days' sales in receivables = 365/11 = 33.18 days

AACSB: Analytic
Difficulty: Intermediate
EOC #: 3-19
Learning Objective: 3-2
Section: 3.3
Topic: Days' sales in receivables

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110. Gladstone Pavers has a long-term debt ratio of 0.6 and a current ratio of 1.3. Current
liabilities are $700, sales are $4,440, the profit margin is 9.5 percent, and the return on equity
is 19.5 percent. How much does the firm have in net fixed assets?
A. $4,880.18
B. $5,197.69
C. $5,666.67
D. $5,848.15
E. $6,107.70

Current assets = 1.3  $700 = $910

Net income = .095  $4,440 = $421.80
Total equity = $421.80/.195 = $2,163.0769
0.6 = Long term debt/(Long-term debt + $2,163.0769); Long-term debt = $3,244.6153
Total debt = $700 + $3,244.6153 = $3,944.6153
Total assets = $3,944.6153 + $2,163.0769 = $6,107.6922
Net fixed assets = $6,107.6922 - $910 = $5,197.69

AACSB: Analytic
Difficulty: Intermediate
EOC #: 3-20
Learning Objective: 3-2
Section: 3.3
Topic: Ratios and fixed assets

111. A firm has a debt-total asset ratio of 74 percent and a return on total assets of 13 percent.
What is the return on equity?
A. 26 percent
B. 50 percent
C. 65 percent
D. 84 percent
E. 135 percent

(Total assets - Total equity)/Total assets = .74; Total equity = .26 Total assets
Net income = .13 Total assets
Return on equity = .13 Total assets/.26 Total assets = 50 percent

AACSB: Analytic
Difficulty: Intermediate
EOC #: 3-22
Learning Objective: 3-2
Section: 3.3
Topic: Return on equity

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112. The Dockside Inn has net income for the most recent year of $8,450. The tax rate was 38
percent. The firm paid $1,300 in total interest expense and deducted $1,900 in depreciation
expense. What was the cash coverage ratio for the year?
A. 10.48 times
B. 11.48 times
C. 12.39 times
D. 12.95 times
E. 13.07 times

Earnings before taxes = $8,450/(1 - .38) = $13,629.03

Earnings before interest, taxes, and depreciation = $13,629.03 + $1,300 + $1,900 =
$16,829.03
Cash coverage ratio = $16,829.03/$1,300 = 12.95 times

AACSB: Analytic
Difficulty: Intermediate
EOC #: 3-23
Learning Objective: 3-2
Section: 3.3
Topic: Cash coverage ratio

113. Beach Wear has current liabilities of $350,000, a quick ratio of 1.65, inventory turnover
of 3.2, and a current ratio of 2.9. What is the cost of goods sold?
A. $980,000
B. $1,060,000
C. $1,200,000
D. $1,400,000
E. $1,560,000

Current assets = 2.9  $350,000 = $1,015,000

($1,015,000 - Inventory)/$350,000 = 1.65; Inventory = $437,500
Costs of goods sold = 3.2  $437,500 = $1,400,000

AACSB: Analytic
Difficulty: Intermediate
EOC #: 3-24
Learning Objective: 3-2
Section: 3.3
Topic: Cost of goods sold

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Chapter 03 - Working with Financial Statements

1. Which one of the following terms is defined as the management of a firm's long-term
investments?
A. working capital management
B. financial allocation
C. agency cost analysis
D. capital budgeting
E. capital structure

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Capital budgeting

2. Which one of the following terms is defined as the mixture of a firm's debt and equity
financing?
A. working capital management
B. cash management
C. cost analysis
D. capital budgeting
E. capital structure

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Capital structure

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3. Which one of the following is defined as a firm's short-term assets and its short-term
liabilities?
A. working capital
B. debt
C. investment capital
D. net capital
E. capital structure

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Working capital

4. A business owned by a solitary individual who has unlimited liability for its debt is called
a:
A. corporation.
B. sole proprietorship.
C. general partnership.
D. limited partnership.
E. limited liability company.

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Sole proprietorship

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5. A business formed by two or more individuals who each have unlimited liability for all of
the firm's business debts is called a:
A. corporation.
B. sole proprietorship.
C. general partnership.
D. limited partnership.
E. limited liability company.

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: General partnership

6. A business partner whose potential financial loss in the partnership will not exceed his or
her investment in that partnership is called a:
A. generally partner.
B. sole proprietor.
C. limited partner.
D. corporate shareholder.
E. zero partner.

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Limited partner

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7. A business created as a distinct legal entity and treated as a legal "person" is called a:
A. corporation.
B. sole proprietorship.
C. general partnership.
D. limited partnership.
E. unlimited liability company.

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Corporation

8. Which one of the following terms is defined as a conflict of interest between the corporate
shareholders and the corporate managers?
A. articles of incorporation
B. corporate breakdown
C. agency problem
D. bylaws
E. legal liability

Refer to section 1.4

AACSB: Ethics
Difficulty: Basic
Learning Objective: 1-4
Section: 1.4
Topic: Agency problem

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9. A stakeholder is:
A. a person who owns shares of stock.
B. any person who has voting rights based on stock ownership of a corporation.
C. a person who initially founded a firm and currently has management control over that firm.
D. a creditor to whom a firm currently owes money.
E. any person or entity other than a stockholder or creditor who potentially has a claim on the
cash flows of a firm.

Refer to section 1.4

AACSB: Ethics
Difficulty: Basic
Learning Objective: 1-4
Section: 1.4
Topic: Stakeholder

10. Which of the following questions are addressed by financial managers?

I. How should a product be marketed?
II. Should customers be given 30 or 45 days to pay for their credit purchases?
III. Should the firm borrow more money?
IV. Should the firm acquire new equipment?
A. I and IV only
B. II and III only
C. I, II, and III only
D. II, III, and IV only
E. I, II, III, and IV

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Financial management

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Chapter 03 - Working with Financial Statements

11. Which one of the following functions should be the responsibility of the controller rather
than the treasurer?
A. daily cash deposit
B. income tax returns
C. equipment purchase analysis
D. customer credit approval
E. payment to a vendor

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Financial management

12. The controller of a corporation generally reports directly to the:

A. board of directors.
B. chairman of the board.
C. chief executive officer.
D. president.
E. vice president of finance.

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Corporate structure

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13. Which one of the following correctly defines the upward chain of command in a typical
corporate organizational structure?
A. The vice president of finance reports to the chairman of the board.
B. The chief executive officer reports to president.
C. The controller reports to the president.
D. The treasurer reports to the vice president of finance.
E. The chief operations officer reports to the vice president of production.

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Corporate structure

14. Which one of the following is a capital budgeting decision?

A. determining how many shares of stock to issue
B. deciding whether or not to purchase a new machine for the production line
C. deciding how to refinance a debt issue that is maturing
D. determining how much inventory to keep on hand
E. determining how much money should be kept in the checking account

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Capital budgeting

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15. Which of the following should a financial manager consider when analyzing a capital
budgeting project?
I. project start up costs
II. timing of all projected cash flows
III. dependability of future cash flows
IV. dollar amount of each projected cash flow
A. I and IV only
B. I, II, and IV only
C. I, II, and III only
D. II, III, and IV only
E. I, II, III, and IV

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Capital budgeting

16. Which one of the following is a capital structure decision?

A. determining which one of two projects to accept
B. determining how to allocate investment funds to multiple projects
C. determining the amount of funds needed to finance customer purchases of a new product
D. determining how much debt should be assumed to fund a project
E. determining how much inventory will be needed to support a project

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Capital structure

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17. The decision to issue additional shares of stock is an example of which one of the
following?
A. working capital management
B. net working capital decision
C. capital budgeting
D. controller's duties
E. capital structure decision

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Capital structure

18. Which of the following accounts are included in working capital management?
I. accounts payable
II. accounts receivable
III. fixed assets
IV. inventory
A. I and II only
B. I and III only
C. II and IV only
D. I, II, and IV only
E. II, III, and IV only

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Working capital management

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19. Which one of the following is a working capital management decision?

A. determining the amount of equipment needed to complete a job
B. determining whether to pay cash for a purchase or use the credit offered by the supplier
C. determining the amount of long-term debt required to complete a project
D. determining the number of shares of stock to issue to fund an acquisition
E. determining whether or not a project should be accepted

Refer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
Topic: Working capital management

20. Which one of the following statements concerning a sole proprietorship is correct?
A. A sole proprietorship is designed to protect the personal assets of the owner.
B. The profits of a sole proprietorship are subject to double taxation.
C. The owner of a sole proprietorship is personally responsible for all of the company's debts.
D. There are very few sole proprietorships remaining in the U.S. today.
E. A sole proprietorship is structured the same as a limited liability company.

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Sole proprietorship

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21. Which one of the following statements concerning a sole proprietorship is correct?
A. The life of a sole proprietorship is potentially unlimited.
B. A sole proprietor can generally raise large sums of capital quite easily.
C. Transferring ownership of a sole proprietorship is easier than transferring ownership of a
corporation.
D. A sole proprietorship is taxed the same as a C corporation.
E. It is easy to create a sole proprietorship.

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Sole proprietorship

22. Which of the following individuals have unlimited liability based on their ownership
interest?
I. general partner
II. sole proprietor
III. stockholder
IV. limited partner
A. II only
B. I and II only
C. II and IV only
D. I, II, and III only
E. I, II, and IV only

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Unlimited liability

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23. Which one of the following best describes the primary advantage of being a limited
partner instead of a general partner?
A. tax-free income
B. active participation in the firm's activities
C. no potential financial loss
D. greater control over the business affairs of the partnership
E. maximum loss limited to the capital invested

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Limited partner

24. A general partner:

A. is solely responsible for all the partnership debts.
B. has no say over a firm's daily operations.
C. faces double taxation whereas a limited partner does not.
D. has a maximum loss equal to his or her equity investment.
E. receives a salary in lieu of a portion of the profits.

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: General partner

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25. A limited partnership:

A. has an unlimited life.
B. can opt to be taxed as a corporation.
C. terminates at the death of any limited partner.
D. has a greater ability to raise capital than a sole proprietorship.
E. consists solely of limited partners.

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Partnership

26. Which of the following apply to a partnership that consists solely of general partners?
I. double taxation of partnership profits
II. limited partnership life
III. active involvement in the firm by all the partners
IV. unlimited personal liability for all partnership debts
A. II only
B. I and II only
C. II and III only
D. I, II, and IV only
E. II, III, and IV only

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Partnership

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27. Which of the following are advantages of the corporate form of business ownership?
I. limited liability for firm debt
II. double taxation
III. ability to raise capital
IV. unlimited firm life
A. I and II only
B. III and IV only
C. I, III, and IV only
D. II, III, and IV only
E. I, II, III, and IV

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Corporation

28. Which one of the following statements is correct?

A. The majority of firms in the U.S. are structured as corporations.
B. Corporate profits are taxable income to the shareholders when earned.
C. Corporations can raise large amounts of capital generally easier than partnerships can.
D. Stockholders face no potential losses related to their corporate investment.
E. Corporate shareholders elect the corporate president.

Refer to section 1.2

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Corporation

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29. Which one of the following statements is correct?

A. A general partnership is legally the same as a corporation.
B. Both sole proprietorship and partnership income is taxed as individual income.
C. Partnerships are the most complicated type of business to form.
D. All business organizations have bylaws.
E. Only firms organized as sole proprietorships have limited lives.

Refer to section 1.2

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Business entity

30. The articles of incorporation:

I. describe the purpose of the firm.
II. are amended periodically.
III. set forth the number of shares of stock that can be issued.
IV. detail the method that will be used to elect corporate directors.
A. I and III only
B. I and IV only
C. II and III only
D. II and IV only
E. I, III, and IV only

Refer to section 1.2

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Articles of incorporation

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31. Corporate bylaws:

A. must be amended should a firm decide to increase the number of shares authorized.
B. cannot be amended once adopted.
C. define the name by which the firm will operate.
D. describe the intended life and purpose of the organization.
E. determine how a corporation regulates itself.

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Corporate bylaws

32. Which one of the following characteristics applies to a limited liability company?
A. available only to firms having a single owner
B. limited liability for limited partners only
C. taxed similar to a partnership
D. taxed similar to a C corporation
E. all income generated is totally tax-free

Refer to section 1.2

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Limited liability company

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33. Which one of the following business types is best suited to raising large amounts of
capital?
A. sole proprietorship
B. limited liability company
C. corporation
D. general partnership
E. limited partnership

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Corporation

34. Which type of business organization has all the respective rights and privileges of a legal
person?
A. sole proprietorship
B. general partnership
C. limited partnership
D. corporation
E. limited liability company

Refer to section 1.2

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.2
Topic: Corporation

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35. Sam, Alfredo, and Juan want to start a small U.S. business. Juan will fund the venture but
wants to limit his liability to his initial investment and has no interest in the daily operations.
Sam will contribute his full efforts on a daily basis but has limited funds to invest in the
business. Alfredo will be involved as an active consultant and manager and will also
contribute funds. Sam and Alfredo are willing to accept liability for the firm's debts as they
feel they have nothing to lose by doing so. All three individuals will share in the firm's profits
and wish to keep the initial organizational costs of the business to a minimum. Which form of
business entity should these individuals adopt?
A. sole proprietorship
B. joint stock company
C. limited partnership
D. general partnership
E. corporation

Refer to section 1.2

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Limited partnership

36. Sally and Alicia currently are general partners in a business located in Atlanta, Georgia.
They are content with their current tax situation but are both very uncomfortable with the
unlimited liability to which they are each subjected. Which form of business entity should
they consider to replace their general partnership assuming they wish to remain the only two
owners of their business? Whichever organization they select, they wish to be treated equally.
A. sole proprietorship
B. joint stock company
C. limited partnership
D. limited liability company
E. corporation

Refer to section 1.2

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Limited liability company

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37. Which one of the following best states the primary goal of financial management?
A. maximize current dividends per share
B. maximize the current value per share
C. increase cash flow and avoid financial distress
D. minimize operational costs while maximizing firm efficiency
E. maintain steady growth while increasing current profits

Refer to section 1.3

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-2
Section: 1.3
Topic: Goal of financial management

38. Which one of the following best illustrates that the management of a firm is adhering to
the goal of financial management?
A. increase in the amount of the quarterly dividend
B. decrease in the per unit production costs
C. increase in the number of shares outstanding
D. decrease in the net working capital
E. increase in the market value per share

Refer to section 1.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-2
Section: 1.3
Topic: Goal of financial management

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39. Why should financial managers strive to maximize the current value per share of the
existing stock?
A. doing so guarantees the company will grow in size at the maximum possible rate
B. doing so increases employee salaries
C. because they have been hired to represent the interests of the current shareholders
D. because this will increase the current dividends per share
E. because managers often receive shares of stock as part of their compensation

Refer to section 1.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-2
Section: 1.3
Topic: Goal of financial management

40. Decisions made by financial managers should primarily focus on increasing which one of
the following?
A. size of the firm
B. growth rate of the firm
C. gross profit per unit produced
D. market value per share of outstanding stock
E. total sales

Refer to section 1.3

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-2
Section: 1.3
Topic: Goal of financial management

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41. The Sarbanes-Oxley Act of 2002 is a governmental response to:

A. decreasing corporate profits.
B. the terrorists attacks on 9/11/2001.
C. a weakening economy.
D. deregulation of the stock exchanges.
E. management greed and abuses.

Refer to section 1.3

AACSB: Ethics
Difficulty: Basic
Learning Objective: 1-4
Section: 1.3
Topic: Sarbox

42. Which one of the following is an unintended result of the Sarbanes-Oxley Act?
A. more detailed and accurate financial reporting
B. increased management awareness of internal controls
C. corporations delisting from major exchanges
D. increased responsibility for corporate officers
E. identification of internal control weaknesses

Refer to section 1.3

AACSB: Ethics
Difficulty: Basic
Learning Objective: 1-4
Section: 1.3
Topic: Sarbox

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43. A firm which opts to "go dark" in response to the Sarbanes-Oxley Act:
A. must continue to provide audited financial statements to the public.
B. must continue to provide a detailed list of internal control deficiencies on an annual basis.
C. can provide less information to its shareholders than it did prior to "going dark".
D. can continue publicly trading its stock but only on the exchange on which it was previously
listed.
E. ceases to exist.

Refer to section 1.3

AACSB: Ethics
Difficulty: Intermediate
Learning Objective: 1-4
Section: 1.3
Topic: Sarbox

44. Which of the following are results related to the enactment of the Sarbanes-Oxley Act of
2002?
I. increased foreign stock exchange listings of U.S. stocks
II. decreased compliance costs
III. increased privatization of public corporations
IV. increased public disclosure by all corporations
A. I and III only
B. II and IV only
C. I, II, and III only
D. II, III, and IV only
E. I, III, and IV only

Refer to section 1.3

AACSB: Ethics
Difficulty: Intermediate
Learning Objective: 1-4
Section: 1.3
Topic: Sarbox

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45. Which one of the following actions by a financial manager is most apt to create an agency
problem?
A. refusing to borrow money when doing so will create losses for the firm
B. refusing to lower selling prices if doing so will reduce the net profits
C. refusing to expand the company if doing so will lower the value of the equity
D. agreeing to pay bonuses based on the market value of the company stock rather than on the
firm's level of sales
E. increasing current profits when doing so lowers the value of the firm's equity

Refer to section 1.4

AACSB: Ethics
Difficulty: Intermediate
Learning Objective: 1-4
Section: 1.4
Topic: Agency problem

46. Which of the following help convince managers to work in the best interest of the
stockholders? Assume there are no golden parachutes.
I. compensation based on the value of the stock
II. stock option plans
III. threat of a company takeover
IV. threat of a proxy fight
A. I and II only
B. III and IV only
C. I, II, and III only
D. I, III, and IV only
E. I, II, III, and IV

Refer to section 1.4

AACSB: Ethics
Difficulty: Basic
Learning Objective: 1-4
Section: 1.4
Topic: Agency problem

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47. Which form of business structure is most associated with agency problems?
A. sole proprietorship
B. general partnership
C. limited partnership
D. corporation
E. limited liability company

Refer to section 1.4

AACSB: Ethics
Difficulty: Basic
Learning Objective: 1-4
Section: 1.4
Topic: Agency problem

48. Which one of the following is an agency cost?

A. accepting an investment opportunity that will add value to the firm
B. increasing the quarterly dividend
C. investing in a new project that creates firm value
D. hiring outside accountants to audit the company's financial statements
E. closing a division of the firm that is operating at a loss

Refer to section 1.4

AACSB: Ethics
Difficulty: Basic
Learning Objective: 1-4
Section: 1.4
Topic: Agency cost

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49. Which one of the following is least likely to be an agency problem?

A. increasing the size of a firm
B. concentrating on maximizing current profits
C. closing a division with net losses
D. increasing the market value of the firm's shares
E. obtaining a patent for a new product

Refer to section 1.4

AACSB: Ethics
Difficulty: Intermediate
Learning Objective: 1-4
Section: 1.4
Topic: Agency cost

50. Which one of the following is a means by which shareholders can replace company
management?
A. stock options
B. promotion
C. Sarbanes-Oxley Act
D. agency play
E. proxy fight

Refer to section 1.4

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-4
Section: 1.4
Topic: Proxy fight

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51. Which one of the following grants an individual the right to vote on behalf of a
shareholder?
A. proxy
B. by-laws
C. indenture agreement
D. stock option
E. stock audit

Refer to section 1.4

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-4
Section: 1.4
Topic: Proxy

52. Which one of the following parties has ultimate control of a corporation?
A. chairman of the Board
B. board of directors
C. chief executive officer
D. chief operating office
E. shareholders

Refer to section 1.4

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-4
Section: 1.4
Topic: Corporate responsibility

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53. Which of the following parties are considered stakeholders of a firm?

I. employee
II. long-term creditor
III. government
IV. common stockholder
A. I only
B. IV only
C. I and III only
D. II and IV only
E. II, III, and IV only

Refer to section 1.4

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-4
Section: 1.4
Topic: Stakeholder

54. Which of the following represent cash outflows from a corporation?

I. issuance of securities
II. payment of dividends
III. new loan proceeds
IV. payment of government taxes
A. I and III only
B. II and IV only
C. I and IV only
D. I, II, and IV only
E. II, III, and IV only

Refer to section 1.5

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.5
Topic: Cash outflows

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55. Which of the following are cash flows from a corporation into the financial markets?
I. repayment of long-term debt
II. payment of government taxes
III. payment of loan interest
IV. payment of quarterly dividend
A. I and II only
B. I and III only
C. II and IV only
D. I, III, and IV only
E. I, II, and III only

Refer to section 1.5

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.5
Topic: Cash flows

56. Which one of the following is a primary market transaction?

A. sale of currently outstanding stock by a dealer to an individual investor
B. sale of a new share of stock to an individual investor
C. stock ownership transfer from one shareholder to another shareholder
D. gift of stock from one shareholder to another shareholder
E. gift of stock by a shareholder to a family member

Refer to section 1.5

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.5
Topic: Primary market

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57. Shareholder A sold 500 shares of ABC stock on the New York Stock Exchange. This
transaction:
A. took place in the primary market.
B. occurred in a dealer market.
C. was facilitated in the secondary market.
D. involved a proxy.
E. was a private placement.

Refer to section 1.5

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.5
Topic: Secondary market

58. Public offerings of debt and equity must be registered with which one of the following?
A. New York Board of Governors
B. Federal Reserve
C. NYSE Registration Office
D. Securities and Exchange Commission
E. Market Dealers Exchange

Refer to section 1.5

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.5
Topic: SEC

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59. Which one of the following statements is generally correct?

A. Private placements must be registered with the SEC.
B. All secondary markets are auction markets.
C. Dealer markets have a physical trading floor.
D. Auction markets match buy and sell orders.
E. Dealers arrange trades but never own the securities traded.

Refer to section 1.5

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.5
Topic: Auction and dealer markets

60. Which one of the following statements concerning stock exchanges is correct?
A. NASDAQ is a broker market.
B. The NYSE is a dealer market.
C. The exchange with the strictest listing requirements is NASDAQ.
D. Some large companies are listed on NASDAQ.
E. Most debt securities are traded on the NYSE.

Refer to section 1.5

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.5
Topic: NYSE and NASDAQ

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61. Shareholder A sold shares of Maplewood Cabinets stock to Shareholder B. The stock is
listed on the NYSE. This trade occurred in which one of the following?
A. primary, dealer market
B. secondary, dealer market
C. primary, auction market
D. secondary, auction market
E. secondary, OTC market

Refer to section 1.5

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.5
Topic: Secondary auction market

62. Which one of the following statements is correct concerning the NYSE?
A. The publicly traded shares of a NYSE-listed firm must be worth at least $250 million.
B. The NYSE is the largest dealer market for listed securities in the United States.
C. The listing requirements for the NYSE are more stringent than those of NASDAQ.
D. Any corporation desiring to be listed on the NYSE can do so for a fee.
E. The NYSE is an OTC market functioning as both a primary and a secondary market.

Refer to section 1.5

AACSB: N/A
Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.5
Topic: NYSE

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63. Which one of the following statements concerning NASDAQ is FALSE?

A. It is easier to be listed on NASDAQ than on the NYSE.
B. NASDAQ is an electronic market.
C. NASDAQ is a dealer market.
D. NASDAQ is an OTC market.
E. NASDAQ is an auction market.

Refer to section 1.5

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-3
Section: 1.5
Topic: NASDAQ

Essay Questions

64. List and briefly describe the three general areas of responsibility for a financial manager.

The three basic areas are:

1. capital budgeting: the identification of investment opportunities that have a positive net
value
2. capital structure: the mix of long-term debt and equity used to finance a firm's operations
3. working capital management: the daily control of a firm's short-term assets and short-term
liabilities

Feedback: Refer to section 1.1

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 1-1
Section: 1.1
Topic: Financial manager

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Chapter 03 - Working with Financial Statements

65. Describe the key advantages associated with the corporate form of organization.

The advantages of the corporate form of organization are the ease of transferring ownership,
the owners' limited liability for business debts, the ability to raise large amounts of capital,
and the potential for an unlimited life for the organization.

Feedback: Refer to section 1.2

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Corporation

66. Why are so many businesses structured as sole proprietorships when the corporate form of
business offers more advantages?

A significant advantage of the sole proprietorship is that it is inexpensive and easy to form. If
the sole proprietor has limited capital to start with, it may not be desirable to spend part of that
capital forming a corporation. Also, limited liability for business debts may not be a
significant advantage if the proprietor has most of his or her personal assets tied up in the
business already. Finally, for a typical small firm, having an unlimited life for the business has
no real advantage since the heart and soul of the business is the person who founded it,
thereby effectively limiting the life of the business to that of its founder.

Feedback: Refer to section 1.2

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Sole proprietorship

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67. What concerns might a loan officer have when loaning funds to a sole proprietorship that
he or she might not have when loaning funds to a corporation?

The existence and viability of a sole proprietor is dependent upon one individual. Should that
individual die, the entity would cease to exist. Likewise, should the owner lose interest in the
business or become ill, the business might also cease to exist. With a corporation, the
company ownership could be sold in any one of those situations such that the business entity
would continue to exist.

Feedback: Refer to section 1.2

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Organizational structure

68. From a liability point of view, what is the difference between investing in a sole
proprietorship and a general partnership?

Both a sole proprietor and a general partner have unlimited liability for the firm's debts.
However, as a sole proprietor you should be totally aware of all the business dealings of the
firm. In a general partnership, you may or may not handle the financial transactions and thus
are accepting the responsibility for actions taken not only by yourself, but those of your
partners.

Feedback: Refer to section 1.2

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.2
Topic: Personal liability

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69. Give some examples of ways in which manager's goals can differ from those of
shareholders.

The primary goal of a financial manager should be to maximize the current value of the
outstanding stock. This goal focuses on enhancing the returns to stockholders who are the
owners of the firm. However, managers frequently are more concerned with their personal
benefits from employment, the prestige of their position, and the perks to which they feel
entitled. There are numerous examples, some of which are excessive compensation packages,
large corporate offices, excessive staffing, and first-class travel and conference locations, to
name a few.

Feedback: Refer to section 1.4

AACSB: Ethics
Difficulty: Intermediate
Learning Objective: 1-4
Section: 1.4
Topic: Agency conflict

70. How do the actual effects of the Sarbanes-Oxley Act of 2002 compare to the initial intent
of that Act?

Some of the key requirements of Sarbanes-Oxley are: the prohibition of personal loans from
the company to its officers, an annual report by management of the internal control and
financial reporting within the firm along with an independent auditor's assessment of that
report, a review and sign off by the corporate officers of the annual financial statements, and
the responsibility for the accuracy of the financial reports placed directly on senior
management of the firm. While firms that have opted to remain publicly-owned are
complying with these requirements, they are paying a cost to do so. This cost has caused other
firms to "go dark" or to opt for listing on a foreign exchange rather than a U.S. exchange.
While some of the results do match the intent of the Act, the costs, "going dark", and foreign
listings were most likely not intended by the supporters of the Act.

Feedback: Refer to section 1.3

AACSB: Ethics
Difficulty: Intermediate
Learning Objective: 1-4
Section: 1.3
Topic: Sarbox

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71. How might agency problems arise in partnerships?

Agency conflicts typically arise when there is a separation between the ownership and the
management of a business. In a general partnership, especially if the partnership is small,
there is less of a chance of an agency conflict if all the partners are involved with the business
on a regular basis. However, in a limited partnership, the opportunity exists for an agency
problem to arise between the general and the limited partners.

Feedback: Refer to section 1.4

AACSB: Ethics
Difficulty: Intermediate
Learning Objective: 1-4
Section: 1.4
Topic: Agency conflict

72. Compare and contrast the NYSE with NSADAQ.

The NYSE is an auction market where sell orders are matched with buy orders. The NYSE
has a physical trading floor located on Wall Street in New York City. NASDAQ is a dealer
market which is solely electronic and therefore has no physical trading floor. Dealers buy and
sell for their own inventory. The listing requirements of the NYSE are more stringent than
those of NASDAQ and thus the NYSE tends to list larger firms with smaller firms being
listed on NASDAQ. Note however, that larger firms can, and do, opt to remain on NASDAQ
even though they qualify for NYSE listing.

Feedback: Refer to section 1.5

AACSB: Reflective thinking

Difficulty: Intermediate
Learning Objective: 1-3
Section: 1.5
Topic: Exchanges

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