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Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year.Trend analysis is one method of examining changes in a firm's performance over time.

A) True
B) False

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Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc.Note that the firm has no amortization charges,it does not lease any assets,none of its debt must be retired during the next 5 years,and the notes payable will be rolled over.  Assets 2018 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity  Accounts payable $18,630 Accruals 8,370 Notes payable 6,000 Total current liabilities $33,000 Long-term bonds $9,000 Total liabilities $42,000 Common stock $5,040 Retained earnings 12,960 Total common equity $18,000 Total liabilities and equity $60,000\begin{array}{lc}\text { Assets } & 2018 \\\text { Cash and securities } & \$ 3,000 \\\text { Accounts receivable } & 15,000 \\\text { Inventories } & 18,000 \\\text { Total current assets } & \$ 36,000 \\\text { Net plant and equipment } & \$ 24,000 \\\text { Total assets } & \$ 60,000\\\text { Liabilities and Equity }\\\text { Accounts payable } & \$ 18,630 \\\text { Accruals } & 8,370 \\\text { Notes payable } & 6,000 \\\text { Total current liabilities } & \$ 33,000\\\\\text { Long-term bonds } & \$ 9,000 \\\text { Total liabilities } & \$ 42,000 \\\text { Common stock } & \$ 5,040 \\\text { Retained earnings } & 12,960 \\\text { Total common equity } & \$ 18,000\\\text { Total liabilities and equity }&\$60,000\end{array}  Income Statement (Millions of $ )  2018 Net sales $84,000 Operating costs except depreciation 78,120 Depreciation 1,680 Earnings before interest and taxes (EBIT)  $4,200 Less interest 900 Earnings before taxes (EBT)  $3,300 Taxes 1,320 Net income $1,980 Other data:  Shares outstanding (millions)  500.00 Common dividends (millions of $ )  $693.00 Int rate on notes payable & L-T bonds 6% Federal plus state income tax rate 40% Year-end stock price $47.52\begin{array}{lr}\text { Income Statement (Millions of } \$ \text { ) } & {2018} \\ \text { Net sales } & \$ 84,000 \\\text { Operating costs except depreciation } & 78,120 \\\text { Depreciation } & 1,680 \\\text { Earnings before interest and taxes (EBIT) } & \$ 4,200 \\\text { Less interest } & 900\\\text { Earnings before taxes (EBT) } &{\$ 3,300} \\\text { Taxes } & 1,320 \\\text { Net income } & \$ 1,980\\\\\text { Other data: }\\\text { Shares outstanding (millions) } & 500.00 \\\text { Common dividends (millions of } \$ \text { ) } & \$ 693.00 \\\text { Int rate on notes payable \& L-T bonds } & 6 \% \\\text { Federal plus state income tax rate } & 40 \% \\\text { Year-end stock price } & \$ 47.52\end{array} -Refer to Exhibit 4.1.What is the firm's EPS? Do not round your intermediate calculations.


A) $3.72
B) $3.84
C) $3.96
D) $4.20
E) $3.80

F) All of the above
G) A) and B)

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Precision Aviation had a profit margin of 6.25%,a total assets turnover of 1.5,and an equity multiplier of 1.8.What was the firm's ROE?


A) 17.72%
B) 20.93%
C) 14.34%
D) 13.84%
E) 16.88%

F) C) and D)
G) A) and B)

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Ajax Corp's sales last year were $400,000,its operating costs were $362,500,and its interest charges were $12,500.What was the firm's times-interest-earned (TIE) ratio?


A) 3.00
B) 3.66
C) 2.46
D) 2.61
E) 3.48

F) None of the above
G) B) and E)

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The return on invested capital (ROIC)differs from the return on assets (ROA).First,ROIC is based on total invested capital rather than total assets.Second,the numerator of the ROIC is after-tax operating income rather than net income.

A) True
B) False

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Klein Cosmetics has a profit margin of 5.0%,a total assets turnover ratio of 1.5 times,no debt and therefore an equity multiplier of 1.0,and an ROE of 7.5%.The CFO recommends that the firm borrow money,use the funds to buy back stock,and raise the equity multiplier to 2.0.The size of the firm (assets)would not change.She thinks that operations would not be affected,but interest on the new debt would lower the profit margin to 4.5%.This would probably be a good move,as it would increase the ROE from 7.5% to 13.5%.

A) True
B) False

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Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc.Note that the firm has no amortization charges,it does not lease any assets,none of its debt must be retired during the next 5 years,and the notes payable will be rolled over.  Assets 2018 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity  Accounts payable $18,630 Accruals 8,370 Notes payable 6,000 Total current liabilities $33,000 Long-term bonds $9,000 Total liabilities $42,000 Common stock $5,040 Retained earnings 12,960 Total common equity $18,000 Total liabilities and equity $60,000\begin{array}{lc}\text { Assets } & 2018 \\\text { Cash and securities } & \$ 3,000 \\\text { Accounts receivable } & 15,000 \\\text { Inventories } & 18,000 \\\text { Total current assets } & \$ 36,000 \\\text { Net plant and equipment } & \$ 24,000 \\\text { Total assets } & \$ 60,000\\\text { Liabilities and Equity }\\\text { Accounts payable } & \$ 18,630 \\\text { Accruals } & 8,370 \\\text { Notes payable } & 6,000 \\\text { Total current liabilities } & \$ 33,000\\\\\text { Long-term bonds } & \$ 9,000 \\\text { Total liabilities } & \$ 42,000 \\\text { Common stock } & \$ 5,040 \\\text { Retained earnings } & 12,960 \\\text { Total common equity } & \$ 18,000\\\text { Total liabilities and equity }&\$60,000\end{array}  Income Statement (Millions of $ )  2018 Net sales $84,000 Operating costs except depreciation 78,120 Depreciation 1,680 Earnings before interest and taxes (EBIT)  $4,200 Less interest 900 Earnings before taxes (EBT)  $3,300 Taxes 1,320 Net income $1,980 Other data:  Shares outstanding (millions)  500.00 Common dividends (millions of $ )  $693.00 Int rate on notes payable & L-T bonds 6% Federal plus state income tax rate 40% Year-end stock price $47.52\begin{array}{lr}\text { Income Statement (Millions of } \$ \text { ) } & {2018} \\ \text { Net sales } & \$ 84,000 \\\text { Operating costs except depreciation } & 78,120 \\\text { Depreciation } & 1,680 \\\text { Earnings before interest and taxes (EBIT) } & \$ 4,200 \\\text { Less interest } & 900\\\text { Earnings before taxes (EBT) } &{\$ 3,300} \\\text { Taxes } & 1,320 \\\text { Net income } & \$ 1,980\\\\\text { Other data: }\\\text { Shares outstanding (millions) } & 500.00 \\\text { Common dividends (millions of } \$ \text { ) } & \$ 693.00 \\\text { Int rate on notes payable \& L-T bonds } & 6 \% \\\text { Federal plus state income tax rate } & 40 \% \\\text { Year-end stock price } & \$ 47.52\end{array} -Refer to Exhibit 4.1.What is the firm's market-to-book ratio? Do not round your intermediate calculations.


A) 1.35
B) 1.00
C) 1.65
D) 1.33
E) 1.32

F) B) and E)
G) B) and D)

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Companies HD and LD have the same sales,tax rate,interest rate on their debt,total assets,and basic earning power.Both firms finance using only debt and common equity,and total assets equal total invested capital.Both companies have positive net incomes.Company HD has a higher total debt to total capital ratio and therefore a higher interest expense.Which of the following statements is CORRECT?


A) Company HD pays less in taxes.
B) Company HD has a lower equity multiplier.
C) Company HD has a higher ROA.
D) Company HD has a higher times-interest-earned (TIE) ratio.
E) Company HD has more net income.

F) A) and B)
G) B) and D)

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Which of the following statements is CORRECT?


A) If Firms X and Y have the same P/E ratios,then their market-to-book ratios must also be equal.
B) If Firms X and Y have the same net income,number of shares outstanding,and price per share,then their P/E ratios must also be the same.
C) If Firms X and Y have the same earnings per share and market-to-book ratio,then they must have the same price/earnings ratio.
D) If Firm X's P/E ratio exceeds that of Firm Y,then Y is likely to be less risky and/or be expected to grow at a faster rate.
E) If Firms X and Y have the same net income,number of shares outstanding,and price per share,then their market-to-book ratios must also be the same.

F) A) and B)
G) B) and E)

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Faldo Corp sells on terms that allow customers 45 days to pay for merchandise.Its sales last year were $425,000,and its year-end receivables were $60,000.If its DSO is less than the 45-day credit period,then customers are paying on time.Otherwise,they are paying late.By how much are customers paying early or late? Base your answer on this equation: DSO - Credit Period = Days early or late,and use a 365-day year when calculating the DSO.A positive answer indicates late payments,while a negative answer indicates early payments.Assume all sales to be on credit.Do not round your intermediate calculations.


A) 5.16
B) 8.10
C) 6.20
D) 6.53
E) 6.73

F) A) and B)
G) A) and C)

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Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed,two firms with the same EBIT must have the same ROA.

A) True
B) False

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The times-interest-earned ratio measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs.

A) True
B) False

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Which of the following statements is CORRECT?


A) If one firm has a higher total debt to total capital ratio than another,we can be certain that the firm with the higher total debt to total capital ratio will have the lower TIE ratio,as that ratio depends entirely on the amount of debt a firm uses.
B) A firm's use of debt will have no effect on its profit margin.
C) If two firms differ only in their use of debt-i.e. ,they have identical assets,identical total invested capital,sales,operating costs,interest rates on their debt,and tax rates-but one firm has a higher total debt to total capital ratio,then the firm that uses more debt will have a lower profit margin on sales and a lower return on assets.
D) The total debt to total capital ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases,so the debt ratios of firms that lease different percentages of their assets are still comparable.
E) If two firms differ only in their use of debt-i.e. ,they have identical assets,identical total invested capital,operating costs,and tax rates-but one firm has a higher total debt to total capital ratio,then the firm that uses more debt will have a higher operating margin and return on assets.

F) A) and B)
G) B) and C)

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High current and quick ratios always indicate that the firm is managing its liquidity position well.

A) True
B) False

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Suppose all firms follow similar financing policies,face similar risks,have equal access to capital,and operate in competitive product and capital markets.However,firms face different operating conditions because,for example,the grocery store industry is different from the airline industry.Under these conditions,firms with high profit margins will tend to have high asset turnover ratios,and firms with low profit margins will tend to have low turnover ratios.

A) True
B) False

Correct Answer

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Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc.Note that the firm has no amortization charges,it does not lease any assets,none of its debt must be retired during the next 5 years,and the notes payable will be rolled over.  Assets 2018 Cash and securities $3,000 Accounts receivable 15,000 Inventories 18,000 Total current assets $36,000 Net plant and equipment $24,000 Total assets $60,000 Liabilities and Equity  Accounts payable $18,630 Accruals 8,370 Notes payable 6,000 Total current liabilities $33,000 Long-term bonds $9,000 Total liabilities $42,000 Common stock $5,040 Retained earnings 12,960 Total common equity $18,000 Total liabilities and equity $60,000\begin{array}{lc}\text { Assets } & 2018 \\\text { Cash and securities } & \$ 3,000 \\\text { Accounts receivable } & 15,000 \\\text { Inventories } & 18,000 \\\text { Total current assets } & \$ 36,000 \\\text { Net plant and equipment } & \$ 24,000 \\\text { Total assets } & \$ 60,000\\\text { Liabilities and Equity }\\\text { Accounts payable } & \$ 18,630 \\\text { Accruals } & 8,370 \\\text { Notes payable } & 6,000 \\\text { Total current liabilities } & \$ 33,000\\\\\text { Long-term bonds } & \$ 9,000 \\\text { Total liabilities } & \$ 42,000 \\\text { Common stock } & \$ 5,040 \\\text { Retained earnings } & 12,960 \\\text { Total common equity } & \$ 18,000\\\text { Total liabilities and equity }&\$60,000\end{array}  Income Statement (Millions of $ )  2018 Net sales $84,000 Operating costs except depreciation 78,120 Depreciation 1,680 Earnings before interest and taxes (EBIT)  $4,200 Less interest 900 Earnings before taxes (EBT)  $3,300 Taxes 1,320 Net income $1,980 Other data:  Shares outstanding (millions)  500.00 Common dividends (millions of $ )  $693.00 Int rate on notes payable & L-T bonds 6% Federal plus state income tax rate 40% Year-end stock price $47.52\begin{array}{lr}\text { Income Statement (Millions of } \$ \text { ) } & {2018} \\ \text { Net sales } & \$ 84,000 \\\text { Operating costs except depreciation } & 78,120 \\\text { Depreciation } & 1,680 \\\text { Earnings before interest and taxes (EBIT) } & \$ 4,200 \\\text { Less interest } & 900\\\text { Earnings before taxes (EBT) } &{\$ 3,300} \\\text { Taxes } & 1,320 \\\text { Net income } & \$ 1,980\\\\\text { Other data: }\\\text { Shares outstanding (millions) } & 500.00 \\\text { Common dividends (millions of } \$ \text { ) } & \$ 693.00 \\\text { Int rate on notes payable \& L-T bonds } & 6 \% \\\text { Federal plus state income tax rate } & 40 \% \\\text { Year-end stock price } & \$ 47.52\end{array} -Refer to Exhibit 4.1.What is the firm's equity multiplier? Do not round your intermediate calculations.


A) 3.33
B) 3.43
C) 3.50
D) 3.40
E) 2.73

F) D) and E)
G) B) and D)

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Other things held constant,the more debt a firm uses,the lower the firm's operating margin will be.

A) True
B) False

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You observe that a firm's ROE is above the industry average,but both its profit margin and equity multiplier are below the industry average.Which of the following statements is CORRECT?


A) Its total assets turnover must be above the industry average.
B) Its return on assets must equal the industry average.
C) Its TIE ratio must be below the industry average.
D) Its total assets turnover must be below the industry average.
E) Its total assets turnover must equal the industry average.

F) A) and C)
G) B) and D)

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The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year,depending on the time of year when the financial statements are constructed.

A) True
B) False

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If the CEO of a large and diversified firm were filling out a fitness report on a division manager (i.e. ,"grading" the manager) ,which of the following situations would be likely to cause the manager to receive a better grade? In all cases,assume that other things are held constant.


A) The division's basic earning power ratio is above the average of other firms in its industry.
B) The division's total assets turnover ratio is below the average for other firms in its industry.
C) The division's total debt to total capital ratio is above the average for other firms in the industry.
D) The division's inventory turnover is 6×,whereas the average for its competitors is 8×.
E) The division's DSO (days' sales outstanding) is 40 days,whereas the average for its competitors is 30 days.

F) D) and E)
G) A) and B)

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