Lecture 3 Practice Questions: Financial Statements Analysis

Part 1: Multiple Choice Questions

1. If a firm has a debt-equity ratio of 3.0, then its debt to asset ratio must be which one of the
following?
a. 0.75
b. 2.00
c. 3.00
d. 3.75
3
= =
1
3 3
= = = = 0.75
3+1 4

2. If a firm produces a fifteen percent return on assets and also an eighteen percent return on
equity, then the firm has an equity multiplier of?
a. 0.03
b. 0.33
c. 0.83
d. 1.20

18%
= = = 1.2
15%

3. Pioneer Limited has a profit margin of 10 percent, a return on assets of 15 percent, and an
equity multiplier of 2. What is the return on equity?
a. 1.50%
b. 5.00%
c. 20.00%
d. 30.00%

=

= = 15% 2 = 30%

4. Omega Limited has cash of $10,000, accounts receivable of $14,000, accounts payable of
$12,000, and inventory of $16,000. What is the value of the quick ratio?
a. 0.71
b. 0.83
c. 2.00
d. 3.33

+ 10,000 + 14,000
= = = 2.00
12,000

1
5. A firm has total debt of $12,000 and a debt-equity ratio of 0.60. What is the value of the
total assets?
a. $16,500
b. $16,800
c. $19,200
d. $32,000

=

12,000
= = = 20,000
0.60
= + = 12,000 + 20,000 = 32,000

6. Venus Limited has net working capital of $5,000, net fixed assets of $40,000, sales of
$50,000, and current liabilities of $8,000. Calculate total asset turnover ratio.
a. 0.94 times
b. 1.11 times
c. 1.25 times
d. 1.35 times
TA = + + = 40,000 + 5,000 + 8,000 = 53,000
50,000
Total asset turnover = = = 0.94
53,000

7. Mars Limited has net income of $30,000, a price-earnings ratio of 15, and earnings per
share of $0.6. How many shares of stock are outstanding?
a. 1,200
b. 2,000
c. 18,000
d. 50,000

EPS =
Shares outstanding
30,000
Shares outstanding = = = 50,000
0.6

8. Sigma Ltd has sales of $600,000, costs of goods sold of $400,000, inventory of $100,000,
and accounts receivable of $60,000. How many days, on average, does it take the firm to
sell its inventory assuming that all sales are on credit?
a. 36.50 days
b. 54.75 days
c. 60.83 days
d. 91.25 days
400,000
= = =4
100,000
365
= = 91.25
4
2
9. Pioneer Ltd has sales of $1,000,000, total assets of $1,200,000, and a profit margin of 10
percent. The firm has a total equity ratio of 40 percent. What is the return on equity?
a. 8.33%
b. 20.83%
c. 40.00%
d. 83.33%

=

= = 1,000,000 10% = 100,000

=

= = 1,200,000 40% = 480,000
100,000
= = = 20.83%
480,000

10. Financial ratios that measures the ability of a firm to meet its short-term commitments are
known as ratios.
a. Activity ratios
b. Liquidity ratios
c. Profitability ratios
d. Solvency ratios

11. 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

12. Long term solvency of a firm can be measured by

a. Current ratio
b. Debt equity ratio
c. Gross profit ratio
d. Net profit ratio

13. The formula which breaks down the return on equity into three component parts is referred
to as which one of the following?
a. Altman Z Score
b. Balance of payment
c. Balance sheet
d. Du Pont Analysis

3
14. Financial ratios that measures the ability of a firm to meet its long-term commitments are
known as ratios.
a. Activity ratios
b. Liquidity ratios
c. Profitability ratios
d. Solvency ratios

15. An increase in which one of the following will increase a firm's quick ratio without
affecting its cash ratio?
a. Accounts payable
b. Accounts receivable
c. Cash
d. Inventory

16. Relationships determined from a firm's financial information and used for comparison
purposes are known as
a. Dimensional analysis
b. Financial ratios
c. Scenario analysis
d. Sensitivity analysis

17. Pioneer Limited has sales of $100 million, $40 million and $120 million for the years 2007,
2008 and 2009 respectively. It also has net income of $10 million, $1 million and $15
million for the years 2007, 2008 and 2009 respectively. Assuming 2007 is a base year, the
horizontal analysis of net income of 2009 is
a. -50.00%
b. 12.50%
c. 50.00%
d. 200.00%
2007 2008 2009
Sales 100 40 120
NI 10 5 15
(15 10)
() = = 50%
10

4
18. Pioneer Limited has sales of $100 million, $40 million and $120 million for the years 2007,
2008 and 2009 respectively. It also has net income of $10 million, $1 million and $15
million for the years 2007, 2008 and 2009 respectively. Assuming 2007 is a base year, the
year to year percentage change of net income of 2009 is
a. -50.00%
b. 12.50%
c. 50.00%
d. 200.00%
2007 2008 2009
Sales 100 40 120
NI 10 5 15
(15 5)
%() = = 200%
5

19. Pioneer Limited has sales of $100 million, $40 million and $120 million for the years 2007,
2008 and 2009 respectively. It also has net income of $10 million, $1 million and $15
million for the years 2007, 2008 and 2009 respectively. Assuming 2007 is a base year, the
vertical analysis of net income of 2009 is
a. -50.00%
b. 12.50%
c. 50.00%
d. 200.00%
2007 2008 2009
Sales 100 40 120
NI 10 5 15
15
() = = 12.50%
120

20. The ratios that show the capacity of the firm to meet its short-term obligation out of its
short-term resources is known as
a. Activity ratio
b. Liquidity ratio
c. Profitability ratio
d. Solvency ratio

5
Part 2: Case Studies

Use the following balance sheets and income statements for the years 2014 and 2015 to
calculate the following questions. Perform all the calculations for the year 2015.

Balance Sheet as of June 30 (in millions)

2014 2015 2014 2015

Current Assets Current Liabilities
Cash 30 35 Accounts Payable 20 50
Accounts Receivable 30 60 Notes Payable 10 5
Inventories 40 20 Current Portion of LTD 20 20
Total Current Assets 100 115 Total Current Liabilities 50 75

Long Term Liabilities

Long Term Assets Long Term Loan 250 300
PPE (Gross) 500 620 Bonds Payable 50 40
Accumulated Depreciation 200 220 Total Long Term Liabilities 300 340
PPE (Net) 300 400
Goodwill 100 100 Total Liabilities 350 415
Total Long Term Assets 400 500
Shareholders' Equity
Contributed Capital 100 130
Retained Earnings 50 70
Total Shareholders' Equity 150 200

Total Assets 500 615 Total Liabilities and Equity 500 615

6
 Income Statement for the year ended June 30 (in millions)

2014 2015

Sales 200 240

Cost of Goods Sold (COGS) 115 140

Gross Profit 85 100

S,G & A 10 5

Depreciation & Amortization 15 20

Earnings Before Interest and Tax (EBIT) 60 75

Interest expense 25 30

Earnings Before Tax (EBT) 35 45

Tax expense @ 30% 10.5 13.5

Net income (NI) 24.5 31.5

Dividends 9.5 11.5

Retained Earnings 15 20

Shares Outstanding (in millions) 50 50

Market Value per Share ($/Share) 4 5

7
Question 1

Apply horizontal analysis for balance sheet for the year 2015 (assume the base year is 2014).
Balance Sheet as of June 30 (in millions) Horizontal Analysis
2014 2015 2015
Current Assets
Cash 30 35 16.7%
Accounts Receivable 30 60 100.0%
Inventories 40 20 -50.0%
Total Current Assets 100 115 15.0%

Long Term Assets

PPE (Gross) 500 620 24.0%
Accumulated Depreciation 200 220 10.0%
PPE (Net) 300 400 33.3%
Goodwill 100 100 0.0%
Total Long Term Assets 400 500 25.0%

Total Assets 500 615 23.0%

Current Liabilities
Accounts Payable 20 50 150.0%
Notes Payable 10 5 -50.0%
Current Portion of LTD 20 20 0.0%
Total Current Liabilities 50 75 50.0%

Long Term Liabilities

Long Term Loan 250 300 20.0%
Bonds Payable 50 40 -20.0%
Total Long Term Liabilities 300 340 13.3%

Total Liabilities 350 415 18.6%

Shareholders' Equity
Contributed Capital 100 130 30.0%
Retained Earnings 50 70 40.0%
Total Shareholders' Equity 150 200 33.3%

Total Liabilities and Equity 500 615 23.0%

8
Question 2
Apply vertical analysis for balance sheets for the year 2015.
Balance Sheet as of June 30 (in millions) Vertical Analysis
2014 2015 2015
Current Assets
Cash 30 35 5.7%
Accounts Receivable 30 60 9.8%
Inventories 40 20 3.3%
Total Current Assets 100 115 18.7%

Long Term Assets

PPE (Gross) 500 620 100.8%
Accumulated Depreciation 200 220 35.8%
PPE (Net) 300 400 65.0%
Goodwill 100 100 16.3%
Total Long Term Assets 400 500 81.3%

Total Assets 500 615 100.0%

Current Liabilities
Accounts Payable 20 50 8.1%
Notes Payable 10 5 0.8%
Current Portion of LTD 20 20 3.3%
Total Current Liabilities 50 75 12.2%

Long Term Liabilities

Long Term Loan 250 300 48.8%
Bonds Payable 50 40 6.5%
Total Long Term Liabilities 300 340 55.3%

Total Liabilities 350 415 67.5%

Shareholders' Equity
Contributed Capital 100 130 21.1%
Retained Earnings 50 70 11.4%
Total Shareholders' Equity 150 200 32.5%

Total Liabilities and Equity 500 615 100.0%

9
Question 3
Apply horizontal analysis for income statement for the year 2015 (assume the base year is
2014).

Income Statement for the year ended June 30 (in millions) Horizontal
Analysis

2014 2015 2015

Sales 200 240 20.0%

Cost of Goods Sold (COGS) 115 140 21.7%

Gross Profit 85 100 17.6%

Cash Operating Expense 10 5 -50.0%

Depreciation & Amortization 15 20 33.3%

Earnings Before Interest and Tax (EBIT) 60 75 25.0%

Interest expense 25 30 20.0%

Earnings Before Tax (EBT) 35 45 28.6%

Tax expense @ 30% 10.5 13.5 28.6%

Net income (NI) 24.5 31.5 28.6%

Dividends 9.5 11.5

Retained Earnings 15 20

10
Question 4
Apply vertical analysis for income statement for the year 2015.

Income Statement for the year ended June 30 (in millions) Vertical
Analysis

2014 2015 2015

Sales 200 240 100.0%

Cost of Goods Sold (COGS) 115 140 58.3%

Gross Profit 85 100 41.7%

Cash Operating Expense 10 5 2.1%

Depreciation & Amortization 15 20 8.3%

Earnings Before Interest and Tax (EBIT) 60 75 31.3%

Interest expense 25 30 12.5%

Earnings Before Tax (EBT) 35 45 18.8%

Tax expense @ 30% 10.5 13.5 5.6%

Net income (NI) 24.5 31.5 13.1%

Dividends 9.5 11.5

Retained Earnings 15 20

11
Question 5
Calculate enterprise value for the year 2015.

Market Value of Equity (MVE) = Shares Outstanding * Market Price/ Share

MVE = 50m * 5 = $250 million

Enterprise Value (EV) = MVE + Debt Cash

Enterprise Value (EV) = MVE + (BVD - A/P) Cash

EV = 250m + (415m 50m) 35m = $580 million

12
Question 6
Calculate various profitability ratios.
[1] Calculate Gross Profit Margin.

=

100
= = 41.67%
240

[2] Calculate Operating Profit Margin.

=

75
= = 31.25%
240

[3] Calculate Profit Margin.

=

31.5
= = 13.13%
240

[4] Calculate Return on Asset.

=

31.5
= = 5.12%
615

[5] Calculate Return on Equity.

=

31.5
= = 15.75%
200
[6] Calculate Return on Capital Employed.

=

75
= = 13.89%
615 75

13
Question 7

Calculate various liquidity ratios.

[1] Calculate Current Ratio.

115
= = = 1.53
75

[2] Calculate Quick Ratio.

=

115 20
= = 1.27
75

[3] Calculate Cash Ratio.

=

35
= = 0.47
75

[4] Calculate Net Working Capital.

=
= 115 75 = $40

[5] Calculate NWC to Total Assets.

=

40
= = 6.5%
615

[6] Calculate Interval Measure.

=


=
( + )/365
115
= = 289.48
(140 + 5)/365

14
Question 8
Calculate various solvency ratios.

[1] Calculate Debt Ratio.

=

415
= = 67.48%
615

[2] Calculate Equity Ratio.

=

200
= = 32.52%
615

[3] Calculate Debt-to-Equity Ratio.

415
= = 2.08
200

[4] Calculate Equity Multiplier.

615
= = 3.08
200

[5] Calculate Fixed to Equity.

400
= = 2
200

15
[6] Calculate Long-Term Debt Ratio.

=
+

340
= = 62.96%
(340 + 200)

[7] Calculate Times Interest Earned.

75
= = 2.5
30

[8] Calculate Cash Coverage.

+
=

75 + 20
= = 3.17
30

[9] Calculate Debt Service Coverage Ratio.

=
+

75
= = 1.5
(30 + 20)

16
Question 9
Calculate various activity ratios.
[1] Calculate Inventory Turnover.

140
= = = 7
20

[2] Calculate Days' Sales in Inventory.

365 365
= = = 52.14
7

[3] Calculate Receivables Turnover.

240
= = = 4
60

[4] Calculate Days Sales in Receivables.

365 365
= = = 91.25
4

[5] Calculate Payables Turnover.

140
= = = 2.8
50

[6] Calculate Days Sales in Payables.

365 365
= = = 130.36
2.8

[7] Calculate Cash Conversion Cycle.

()
= +

() = 52.14 + 91.25 130.36 = 13.04

17
[8] Calculate Total Asset Turnover.

=

240
= = 0.39
615

[9] Calculate Capital Intensity.

615
= = 2.56
240

[10] Calculate Fixed Asset Turnover.

240
= = 0.6
400

[11] Calculate NWC Turnover.

240
= = 6
(115 75)

18
Question 10

Calculate various market value measure.

[1] Calculate Earnings Per Share (EPS).

=

31.5
= = $0.63/
50

[2] Calculate Dividends Per Share (DPS).

=

11.5
= = $0.23/
50

[3] Calculate Price Earnings (PE) Ratio.

5
= = 7.94
0.63

[4] Calculate Dividend Payout Ratio (DPO).

() =

11.5
() = = 36.51%
31.5

[5] Calculate Retention Ratio (RR).

() =

20
() = = 63.49%
31.5

19
[6] Calculate Dividend Yield.

11.5/50
= = 4.6%
5

[7] Calculate Market-to-Book Ratio.

5 50
= = 1.25
200

[8] Calculate Sustainable Growth Rate.

() =

() = 15.75% 63.49% = 10%

20
Question 11

Apply DuPont Analysis.

[1] Compute Three-factor DuPont Analysis.

Equity
= ( )( )( )
Multiplier

=

31.5 240 615

=
240 615 200

= 13.13% 0.39 3.08

= 15.75%

[2] Compute Two-factor DuPont Analysis.

Equity
= ( )( )
Multiplier

=

31.5 615
=
615 200

= 5.12% 3.08

= 15.75%

21