Financial Statement Analysis

MODULE 10 small. Which type of numbers would be most meaningful for statement analysis?
A. Absolute numbers would be most meaningful for both the large and small firm.
FINANCIAL STATEMENT ANALYSIS B. Absolute numbers would be most meaningful in the large firm; relative numbers would be
most meaningful in the small firm.
THEORIES: C. Relative numbers would be most meaningful for the large firm; absolute numbers would
6. Management is a user of financial analysis. Which of the following comments does not be most meaningful for the small firm.
represent a fair statement as to the management perspective? D. Relative numbers would be most meaningful for both the large and small firm, especially
A. Management is always interested in maximum profitability. for interfirm comparisons.
B. Management is interested in the view of investors.
C. Management is interested in the financial structure of the entity. 4. Which of these statements is false?
D. Management is interested in the asset structure of the entity. A. Many companies will not clearly fit into any one industry.
B. A financial service uses its best judgment as to which industry the firm best fits.
Limitations C. The analysis of an entity's financial statements can be more meaningful if the results are
1. A limitation in calculating ratios in financial statement analysis is that compared with industry averages and with results of competitors.
A. it requires a calculator. D. A company comparison should not be made with industry averages if the company does
B. no one other than the management would be interested in them. not clearly fit into any one industry.
C. some account balances may reflect atypical data at year end.
D. they seldom identify problem areas in a company. Common-sized financial statements
9. Which of the following generally is the most useful in analyzing companies of different sizes?
2. Which of the following is not a limitation of financial statement analysis? A. comparative statements C. price-level accounting
A. The cost basis. C. The diversification of firms. B. common-sized financial statements D. profitability index
B. The use of estimates. D. The availability of information.
12. Statements in which all items are expressed only in relative terms (percentages of a base) are
5. Which of the following does not represent a problem with financial analysis? termed:
A. Financial statement analysis is an art; it requires judgment decisions on the part of the A. Vertical statements C. Funds Statements
analyst. B. Horizontal Statements D. Common-Size Statements
B. Financial analysis can be used to detect apparent liquidity problems.
C. There are as many ratios for financial analysis as there are pairs of figures. 10. The percent of property, plant and equipment to total assets is an example of:
D. Some industry ratio formulas vary from source to source. A. vertical analysis C. profitability analysis
B. solvency analysis D. horizontal analysis
77. The use of alternative accounting methods:
A. is not a problem in ratio analysis because the footnotes disclose the method used. 15. Vertical analysis is a technique that expresses each item in a financial statement
B. may be a problem in ratio analysis even if disclosed. A. in pesos and centavos.
C. is not a problem in ratio analysis since eventually all methods will lead to the same end. B. as a percent of the item in the previous year.
D. is only a problem in ratio analysis with respect to inventory. C. as a percent of a base amount.
D. starting with the highest value down to the lowest value.
Industry Analysis
3. Suppose you are comparing two firms in the steel industry. One firm is large and the other is 17. In performing a vertical analysis, the base for prepaid expenses is

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 Financial Statement Analysis

A. total current assets. C. total liabilities. 69. Which suppliers of funds bear the greatest risk and should therefore earn the greatest return?
B. total assets. D. prepaid expenses in a previous year. A. common stockholders C. preferred shareholders
B. general creditors such as banks D. bondholders
Horizontal analysis
8. The percentage analysis of increases and decreases in individual items in comparative Measures of Risk
financial statements is called: 54. The following groups of ratios primarily measure risk:
A. vertical analysis C. profitability analysis A. liquidity, activity, and common equity C. liquidity, activity, and debt
B. solvency analysis D. horizontal analysis B. liquidity, activity, and profitability D. activity, debt, and profitability

11. Horizontal analysis is also known as Financial ratios

A. linear analysis. C. trend analysis. 7. Ratios are used as tools in financial analysis
B. vertical analysis. D. common size analysis. A. instead of horizontal and vertical analyses.
B. because they can provide information that may not be apparent from inspection of the
13. In which of the following cases may a percentage change be computed? individual components of a particular ratio.
A. The trend of the amounts is decreasing but all amounts are positive. C. because even single ratios by themselves are quite meaningful.
B. There is no amount in the base year. D. because they are prescribed by GAAP.
C. There is a negative amount in the base year and a negative amount in the subsequent
year. 18. In the near term, the important ratios that provide the information critical to the short-run
D. There is a negative amount in the base year and a positive amount in the subsequent operation of the firm are:
year. A. liquidity, activity, and profitability C. liquidity, activity, and equity
B. liquidity, activity, and debt D. activity, debt, and profitability
14. Horizontal analysis is a technique for evaluating a series of financial statement data over a
period of time 75. The ability of a business to pay its debts as they come due and to earn a reasonable amount
A. that has been arranged from the highest number to the lowest number. of income is referred to as:
B. that has been arranged from the lowest number to the highest number. A. solvency and leverage C. solvency and liquidity
C. to determine which items are in error. B. solvency and profitability D. solvency and equity
D. to determine the amount and/or percentage increase or decrease that has taken place.
Liquidity ratios
Trend analysis Interested parties
16. Trend analysis allows a firm to compare its performance to: 19. The primary concern of short-term creditors when assessing the strength of a firm is the
A. other firms in the industry C. other industries entitys
B. other time periods within the firm D. none of the above A. short-term liquidity C. market price of stock
B. profitability D. leverage
Risk and return
29. The present and prospective stockholders are primarily concerned with a firm 35. Short-term creditors are usually most interested in assessing
A. profitability C. leverage A. solvency. C. marketability.
B. liquidity D. risk and return B. liquidity. D. profitability.

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36. The two categories of ratios that should be utilized to asses a firms true liquidity are the A. accounts receivable turnover. C. acid test ratio.
A. current and quick ratios C. liquidity and profitability ratios B. asset turnover. D. current ratio.
B. liquidity and debt ratios D. liquidity and activity ratios
Current ratio
47. Which of the following is the most of interest to a firms suppliers? 24. Typically, which of the following would be considered to be the most indicative of a firm's short-
A. profitability C. asset utilization term debt paying ability?
B. debt D. liquidity A. working capital C. acid test ratio
B. current ratio D. days sales in receivables
Measures of liquidity
21. The ratios that are used to determine a companys short-term debt paying ability are 22. The current ratio is
A. asset turnover, times interest earned, current ratio, and receivables turnover. A. calculated by dividing current liabilities by current assets.
B. times interest earned, inventory turnover, current ratio, and receivables turnover. B. used to evaluate a companys liquidity and short-term debt paying ability.
C. times interest earned, acid-test ratio, current ratio, and inventory turnover. C. used to evaluate a companys solvency and long-term debt paying ability.
D. current ratio, acid-test ratio, receivables turnover, and inventory turnover. D. calculated by subtracting current liabilities from current assets.

20. Which of the following is a measure of the liquidity position of a corporation? 30. Which of the following ratios is rated to be a primary measure of liquidity and considered of
A. earnings per share highest significance rating of the liquidity ratios a bank analyst?
B. inventory turnover A. Debt/Equity
C. current ratio B. Current ratio
D. number of times interest charges earned C. Degree of Financial Leverage
D. Accounts Receivable Turnover in Days
37. Which one of the following ratios would not likely be used by a short-term creditor in
evaluating whether to sell on credit to a company? 41. A weakness of the current ratio is
A. Current ratio C. Asset turnover A. the difficulty of the calculation.
B. Acid-test ratio D. Receivables turnover B. that it does not take into account the composition of the current assets.
C. that it is rarely used by sophisticated analysts.
51. Which of the following ratios would be least helpful in appraising the liquidity of current D. that it can be expressed as a percentage, as a rate, or as a proportion.
assets?
A. Accounts Receivable turnover C. Current Ratio Acid-test or quick ratio
B. Days sales in inventory D. Days sales in accounts receivable 42. A measure of a companys immediate short-term liquidity is the
A. current ratio.
53. Which ratio is most helpful in appraising the liquidity of current assets? B. current cash debt coverage ratio.
A. current ratio C. acid-test ratio C. cash debt coverage ratio.
B. debt ratio D. accounts receivable turnover D. acid-test ratio.

Not a measure of liquidity 23. The acid-test or quick ratio

79. Which one of the following ratios would not likely be used by a short-term creditor in evaluating A. is used to quickly determine a companys solvency and long-term debt paying ability.
whether to sell on credit to a company? B. relates cash, short-term investments, and net receivables to current liabilities.

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C. is calculated by taking one item from the income statement and one item from the balance 66. Total asset turnover measures the ability of a firm to:
sheet. A. generate profits on sales
D. is the same as the current ratio except it is rounded to the nearest whole percent. B. generate sales through the use of assets
C. cover long-term debt
Not a liquidity ratio D. buy new assets
28. Which one of the following would not be considered a liquidity ratio?
A. Current ratio. C. Quick ratio. 76. A measure of how efficiently a company uses its assets to generate sales is the
B. Inventory turnover. D. Return on assets. A. asset turnover ratio. C. profit margin ratio.
B. cash return on sales ratio. D. return on assets ratio.
Activity ratios
Days receivable & receivable turnover Solvency ratios
Quality of receivables Interested parties
25. Which of the following does not bear on the quality of receivables? 50. Long-term creditors are usually most interested in evaluating
A. shortening the credit terms A. liquidity. C. profitability.
B. lengthening the credit terms B. marketability. D. solvency.
C. lengthening the outstanding period
D. all of the above bear on the quality of receivables Financial Leverage
45. Trading on the equity (leverage) refers to the
Days receivable A. amount of working capital.
27. A general rule to use in assessing the average collection period is B. amount of capital provided by owners.
A. that is should not exceed 30 days. C. use of borrowed money to increase the return to owners.
B. it can be any length as long as the customer continues to buy merchandise. D. earnings per share.
C. that it should not greatly exceed the discount period.
D. that it should not greatly exceed the credit term period. 90. The tendency of the rate earned on stockholders' equity to vary disproportionately from the
rate earned on total assets is sometimes referred to as:
Asset utilization ratios A. leverage C. yield
Performance measures B. solvency D. quick assets
65. All of the following are asset utilization ratios except:
A. average collection period C. receivables turnover 55. Using financial leverage is a good financial strategy from the viewpoint of stockholders of
B. inventory turnover D. return on assets companies having:
A. a high debt ratio C. a steadily declining current ratio
Asset turnover B. steady or rising profits D. cyclical highs and lows
63. Asset turnover measures
A. how often a company replaces its assets. 46. The ratio that indicates a companys degree of financial leverage is the
B. how efficiently a company uses its assets to generate sales. A. cash debt coverage ratio. C. free cash flow ratio.
C. the portion of the assets that have been financed by creditors. B. debt to total assets. D. times-interest earned ratio.
D. the overall rate of return on assets.
73. Interest expense creates magnification of earnings through financial leverage because:

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 Financial Statement Analysis

A. while earnings available to pay interest rise, earnings to residual owners rise faster Debt-to-equity ratio
B. interest accompanies debt financing 60. Which of the following statements best compares long-term borrowing capacity ratios?
C. interest costs are cheaper than the required rate of return to equity owners A. The debt/equity ratio is more conservative than the debt ratio.
S. the use of interest causes higher earnings B. The debt to tangible net worth ratio is more conservative than the debt/equity ratio.
C. The debt/equity ratio is more conservative than the debt to tangible net worth ratio.
Measures of solvency D. The debt ratio is more conservative than the debt/equity ratio.
34. The set of ratios that is most useful in evaluating solvency is
A. debt ratio, current ratio, and times interest earned Times interest earned
B. debt ratio, times interest earned, and return on assets 74. A times interest earned ratio of 0.90 to 1 means that
C. debt ratio, times interest earned, and quick ratio A. the firm will default on its interest payment
D. debt ratio, times interest earned, and cash flow to debt B. net income is less than the interest expense
C. the cash flow is less than the net income
49. Which of the following ratios is most relevant to evaluating solvency? D. the cash flow exceeds the net income
A. Return on assets C. Days purchases in accounts payable
B. Debt ratio D. Dividend yield Fixed charge coverage
61. A fixed charge coverage:
Fixed assets to long-term liabilities A. is a balance sheet indication of debt carrying ability
44. Which of the following ratios provides a solvency measure that shows the margin of safety of B. is an income statement indication of debt carrying ability
noteholders or bondholders and also gives an indication of the potential ability of the business C. frequently includes research and development
to borrow additional funds on a long-term basis? D. computation is standard from firm to firm
A. ratio of fixed assets to long-term liabilities
B. ratio of net sales to assets Off-balance sheet liabilities
C. number of days' sales in receivables 62. If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in
D. rate earned on stockholders' equity the financial statements, then the
A. times interest earned ratio will be overstated, based upon the financial statements
Debt ratio B. debt ratio will be understated
59. The debt ratio indicates: C. working capital will be understated
A. a comparison of liabilities with total assets D. fixed charge ratio will be overstated, based upon the financial statements
B. the ability of the firm to pay its current obligations
C. the efficiency of the use of total assets Profitability ratios
D. the magnification of earnings caused by leverage Interested parties
39. The return on assets ratio is affected by the
78. The debt to total assets ratio measures A. asset turnover ratio.
A. the companys profitability. B. debt to total assets ratio.
B. whether interest can be paid on debt in the current year. C. profit margin ratio.
C. the proportion of interest paid relative to dividends paid. D. asset turnover and profit margin ratios.
D. the percentage of the total assets provided by creditor.
52. Stockholders are most interested in evaluating

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 Financial Statement Analysis

A. liquidity. C. profitability. Dividend yield

B. solvency. D. marketability. 57. Which of the following ratios represents dividends per common share in relation to market
price per common share?
Performance measures A. dividend payout C. price/earnings
48. The set of ratios that are most useful in evaluating profitability is B. dividend yield D. book value per share
A. ROA, ROE, and debt to equity ratio C. ROA, ROE, and acid-test ratio
B. ROA, ROE, and dividend yield D. ROA, ROE, and cash flow to debt Financial Statement Analysis
Accounts Receivable
Earnings per share 26. Which of the following reasons should not be considered in order to explain why the
82. Which of the following ratios appears most frequently in annual reports? receivables appear to be abnormally high?
A. Earnings per Share C. Profit Margin A. Sales volume decreases materially late in the year.
B. Return on Equity D. Debt/Equity B. Receivables have collectibility problems and possibly some should have been written off.
C. Material amount of receivables are on the installment basis.
Return on assets D. Sales volume expanded materially late in the year.
64. Return on assets
A. can be determined by looking at a balance sheet 31. An acceleration in the collection of receivables will tend to cause the accounts receivable
B. should be smaller than return on sales turnover to:
C. can be affected by the companys choice of a depreciation method A. decrease C. either increase or decrease
D. should be larger than return on equity B. remain the same D. increase

Return on investments Inventories

72. Return on investment measures: 32. Which of the following would best indicate that the firm is carrying excess inventory?
A. return to all suppliers of funds C. return to all long-term suppliers of funds A. a decline in the current ratio
B. return to all long-term creditors D. return to stockholders B. stable current ratio with declining quick ratios
C. a decline in days' sales in inventory
Market test ratios D. a rise in total asset turnover
Price-earnings ratio
56. The price/earnings ratio 89. When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an
A. measures the past earning ability of the firm average quick ratio, and a low inventory turnover. What might you assume about Tri-C?
B. is a gauge of future earning power as seen by investors A. Its cash balance is too low. C. Its current liabilities are too low.
C. relates price to dividends B. Its cost of goods sold is too low. D. Its average inventory is too high.
D. relates
Current ratio
58. Which of the following ratios usually reflects investors opinions of the future prospects for the 33. Which of the following would be most detrimental to a firm's current ratio if that ratio is
firm? currently 2.0?
A. dividend yield C. book value per share A. Buy raw materials on credit
B. price/earnings ratio D. earnings per share B. Sell marketable securities at cost
C. Pay off accounts payable with cash

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D. Pay off a portion of long-term debt with cash quick ratios.

B. improve its collection practices and pay accounts payable, there decreasing current
Fixed asset turnover ratio liabilities and increasing the current and quick ratios.
68. Which of the following circumstances will cause sales to fixed assets to be abnormally high? C. decrease current liabilities by utilizing more long-term debt, thereby increasing the
A. A labor-intensive industry. current and quick ratios.
B. The use of units-of-production depreciation. D. increase inventory, thereby increasing current assets and the current and quick ratios.
C. A highly mechanized facility.
D. High direct labor costs from a new union contract. 43. Recently the M&M Company has been having problems. As a result, its financial situation has
deteriorated. M&M approached the First National Bank for a badly needed loan, but the loan
Total asset turnover officer insisted that the current ratio (now 0.5) be improved to at least 0.8 before the bank
81. A firm with a total asset turnover lower than the industry standard and a current ratio which would even consider granting the credit. Which of the following actions would do the most to
meets industry standard might have excessive: improve the ratio in the short run?
A. Accounts receivable C. Debt A. Using some cash to pay off some current liabilities.
B. Fixed assets D. Inventory B. Collecting some of the current accounts receivable.
C. Paying off some long-term debt.
Profitability analysis D. Purchasing additional inventory on credit (accounts payable).
84. Denver Dynamics has net income of P2,000,000. Oakland Enterprises has net income of
P2,500,000. Which of the following best compares the profitability of Denver and Oakland? 87. Tyner Company had P250,000 of current assets and P90,000 of current liabilities before
A. Oakland Enterprises is 25% more profitable than Denver Dynamics. borrowing P60,000 from the bank with a 3-month note payable. What effect did the
B. Oakland Enterprises is more profitable than Denver Dynamics, but the comparison can't borrowing transaction have on Tyner Company's current ratio?
be quantified. A. The ratio remained unchanged.
C. Oakland Enterprises is only more profitable if it is smaller than Denver Dynamics. B. The change in the current ratio cannot be determined.
D. Further information is needed for a reasonable comparison. C. The ratio decreased.
D. The ratio increased.
Debt ratio
86. Companies A and B are in the same industry and have similar characteristics except that 88. Which of the following actions will increase a firm's current ratio if it is now less than 1.0?
Company A is more leveraged than Company B. Both companies have the same income A. Convert marketable securities to cash.
before interest and taxes and the same total assets. Based on this information we could B. Pay accounts payable with cash.
conclude that C. Buy inventory with short term credit (i.e. accounts payable).
A. Company A has higher net income than Company B D. Sell inventory at cost.
B. Company A has a lower return on assets than company B
C. Company A is more risky than Company B. Acid-test ratio
D. Company A has a lower debt ratio than company B 38. If a company has an acid-test ratio of 1.2:1, what respective effects will the
borrowing of cash by short-term debt and collection of accounts receivable
Sensitivity Analysis have on the ratio?
Current ratio A. B. C. D.
40. A firm has a current ratio of 1:1. In order to improve its liquidity ratios, this firm should
Short-term borrowing Increase Increase Decrease Decrease
A. improve its collection practices, thereby increasing cash and increasing its current and
Collection of receivable No effect Increase No effect Decrease

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Profit margin
70. Which of the following would most likely cause a rise in net profit margin? PROBLEMS:
A. increased sales C. decreased operating expenses Horizontal analysis
i
B. decreased preferred dividends D. increased cost of sales . Kline Corporation had net income of P2 million in 2006. Using the 2006 financial elements as
the base data, net income decreased by 70 percent in 2007 and increased by 175 percent in
Return on assets 2008. The respective net income reported by Kline Corporation for 2007 and 2008 are:
67. Return on assets cannot fall under which of the following circumstances? A. P 600,000 and P5,500,000 C. P1,400,000 and P3,500,000
A. B. C. D. B. P5,500,000 and P 600,000 D. P1,400,000 and P5,500,000
Net profit margin Decline Rise Rise Decline ii
Total asset turnover Rise Decline Rise Decline . Assume that Axle Inc. reported a net loss of P50,000 in 2006 and net income of P250,000 in
2007. The increase in net income of P300,000:
Debt ratio A. can be stated as 0% C. cannot be stated as a percentage
83. Jones Company has long-term debt of P1,000,000, while Smith Company, Jones' competitor, B. can be stated as 100% increase D. can be stated as 200% increase
has long-term debt of P200,000. Which of the following statements best represents an
analysis of the long-term debt position of these two firms? Liquidity ratios
iii
A. Jones obviously has too much debt when compared to its competitor. . The following financial data have been taken from the records of Ratio Company:
B. Smith Company's times interest earned should be lower than Jones. Accounts receivable P200,000
C. Smith has five times better long-term borrowing ability than Jones. Accounts payable 80,000
D. Not enough information to determine if any of the answers are correct. Bonds payable, due in 10 years 500,000
Cash 100,000
Times interest earned Interest payable, due in three months 25,000
85. Which of the following will not cause times interest earned to drop? Assume no other changes Inventory 440,000
than those listed. Land 800,000
A. A rise in preferred stock dividends. Notes payable, due in six months 250,000
B. A drop in sales with no change in interest expense. What will happen to the ratios below if Ratio Company uses cash to pay 50 percent
C. An increase in interest rates. of its accounts payable?
D. An increase in bonds payable with no change in operating income. A. B. C. D.
Current ratio Increase Decrease Increase Decrease
DuPont Analysis Acid-test ratio Increase Decrease Decrease Increase
71. Which of the following could cause return on assets to decline when net profit margin is
increasing? Question Nos. 4 through 6 are based on the data taken from the balance sheet of Nomad
A. sale of investments at year-end C. purchase of a new building at year-end Company at the end of the current year:
B. increased turnover of operating assets D. a stock split Accounts payable P145,000
Accounts receivable 110,000
80. A firm with a lower net profit margin can improve its return on total assets by Accrued liabilities 4,000
A. increasing its debt ratio C. increasing its total asset turnover Cash 80,000
B. decreasing its fixed assets turnover D. decreasing its total asset turnover Income tax payable 10,000

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 Financial Statement Analysis

Inventory 140,000 during the year amounted to P4,000,000. Using 360-day year, what is the average collection
Marketable securities 250,000 period of the receivables?
Notes payable, short-term 85,000 A. 30 days C. 73 days
Prepaid expenses 15,000 B. 65 days D. 36 days
iv
. The amount of working capital for the company is: Cash collection
x
A. P351,000 C. P211,000 . Deity Company had sales of P30,000, increase in accounts payable of P5,000, decrease in
B. P361,000 D. P336,000 accounts receivable of P1,000, increase in inventories of P4,000, and depreciation expense of
P4,000. What was the cash collected from customers?
v
. The companys current ratio as of the balance sheet date is: A. P31,000 C. P34,000
A. 2.67:1 C. 2.02:1 B. P35,000 D. P25,000
B. 2.44:1 D. 1.95:1
Inventory turnover
vi xi
. The companys acid-test ratio as of the balance sheet date is: . During 2007, Tarlac Company purchased P960,000 of inventory. The cost of goods sold for
A. 1.80:1 C. 2.02:1 2007 was P900,000, and the ending inventory at December 31, 2007 was P180,000. What
B. 2.40:1 D. 1.76:1 was the inventory turnover for 2007?
A. 6.4 C. 5.3
Activity ratios B. 6.0 D. 5.0
Receivables turnover
vii xii
. Pine Hardware Store had net credit sales of P6,500,000 and cost of goods sold of . Selected information from the accounting records of Petals Company is as follows:
P5,000,000 for the year. The Accounts Receivable balances at the beginning and end of the Net sales for 2007 P900,000
year were P600,000 and P700,000, respectively. The receivables turnover was Cost of goods sold for 2007 600,000
A. 7.7 times. C. 9.3 times. Inventory at December 31, 2006 180,000
B. 10.8 times. D. 10.0 times. Inventory at December 31, 2007 156,000
Petals inventory turnover for 2007 is
viii
. Milward Corporations books disclosed the following information for the year ended December A. 5.77 times C. 3.67 times
31, 2007: B. 3.85 times D. 3.57 times
Net credit sales P1,500,000
xiii
Net cash sales 240,000 . The Moss Company presents the following data for 2007.
Accounts receivable at beginning of year 200,000 Net Sales, 2007 P3,007,124
Accounts receivable at end of year 400,000 Net Sales, 2006 P 930,247
Milwards accounts receivable turnover is Cost of Goods Sold, 2007 P2,000,326
A. 3.75 times C. 5.00 times Cost of Goods Sold, 2007 P1,000,120
B. 4.35 times D. 5.80 times Inventory, beginning of 2007 P 341,169
Inventory, end of 2007 P 376,526
Days receivable The merchandise inventory turnover for 2007 is:
ix
. Batik Clothing Store had a balance in the Accounts Receivable account of P390,000 at the A. 5.6 C. 7.5
beginning of the year and a balance of P410,000 at the end of the year. The net credit sales B. 15.6 D. 7.7

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 Financial Statement Analysis

Retained earnings 170,000

xiv
. Based on the following data for the current year, what is the inventory turnover? What is the debt ratio?
Net sales on account during year P 500,000 A. 0.48 C. 0.93
Cost of merchandise sold during year 330,000 B. 0.49 D. 0.96
Accounts receivable, beginning of year 45,000
Accounts receivable, end of year 35,000 Times interest earned
xviii
Inventory, beginning of year 90,000 . House of Fashion Company had the following financial statistics for 2006:
Inventory, end of year 110,000 Long-term debt (average rate of interest is 8%) P400,000
A. 3.3 C. 3.7 Interest expense 35,000
B. 8.3 D. 3.0 Net income 48,000
Income tax 46,000
Days inventory Operating income 107,000
xv
. Selected information from the accounting records of Eternity Manufacturing Company follows: What is the times interest earned for 2006?
Net sales P3,600,000 A. 11.4 times C. 3.1 times
Cost of goods sold 2,400,000 B. 3.3 times D. 3.7 times
Inventories at January 1 672,000
xix
Inventories at December 31 576,000 . Brava Company reported the following on its income statement:
What is the number of days sales in average inventories for the year? Income before taxes P400,000
A. 102.2 C. 87.6 Income tax expense 100,000
B. 94.9 D. 68.1 Net income P300,000
An analysis of the income statement revealed that interest expense was P100,000. Brava
Turnover ratios Companys times interest earned (TIE) was
Asset turnover A. 5 times C. 3.5 times
Asset B. 4 times D. 3 times
xvi
. Net sales are P6,000,000, beginning total assets are P2,800,000, and the asset turnover is
xx
3.0. What is the ending total asset balance? . The balance sheet and income statement data for Candle Factory indicate the following:
A. P2,000,000. C. P2,800,000. Bonds payable, 10% (issued 1998 due 2022) P1,000,000
B. P1,200,000. D. P1,600,000. Preferred 5% stock, P100 par (no change during year) 300,000
Common stock, P50 par (no change during year) 2,000,000
Solvency ratios Income before income tax for year 350,000
Debt ratio Income tax for year 80,000
xvii
. Jordan Manufacturing reports the following capital structure: Common dividends paid 50,000
Current liabilities P100,000 Preferred dividends paid 15,000
Long-term debt 400,000 Based on the data presented above, what is the number of times bond interest charges were
Deferred income taxes 10,000 earned (round to one decimal point)?
Preferred stock 80,000 A. 3.7 C. 4.5
Common stock 100,000 B. 4.4 D. 3.5
Premium on common stock 180,000

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 Financial Statement Analysis

xxi
. The following data were abstracted from the records of Johnson Corporation for the year: B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns
Sales P1,800,000 on their investments.
Bond interest expense 60,000 C. The dividend yield is 12.5%, which is of interest to bondholders.
Income taxes 300,000 D. The dividend yield is 8.0 times the market price, which is important in solvency analysis.
Net income 400,000
How many times was bond interest earned? Market Test Ratios
A. 7.67 C. 12.67 Market/Book value ratio
B. 11.67 D. 13.67 Price per share
xxv
. What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book
Net income value of equity of P3, 000,000, and a market/book ratio of 3.5?
xxii
. The times interest earned ratio of Mikoto Company is 4.5 times. The interest expense for A. P8.57 C. P85.70
the year was P20,000, and the companys tax rate is 40%. The companys net income is: B. P30.00 D. P105.00
A. P22,000 C. P54,000
B. P42,000 D. P66,000 P/E ratio
xxvi
. Orchard Companys capital stock at December 31 consisted of the following:
Profitability Ratios Common stock, P2 par value; 100,000 shares authorized, issued, and outstanding.
Return on Common Equity 10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares
xxiii
. Selected information for Ivano Company as of December 31 is as follows: authorized, issued, and outstanding.
2006 2007 Orchards common stock, which is listed on a major stock exchange, was quoted at P4 per
Preferred stock, 8%, par P100, nonconvertible, P250,000 P250,000 share on December 31. Orchards net income for the year ended December 31 was P50,000.
noncumulative The yearly preferred dividend was declared. No capital stock transactions occurred. What
Common stock 600,000 800,000 was the price earnings ratio on Orchards common stock at December 31?
Retained earnings 150,000 370,000 A. 6 to 1 C. 10 to 1
Dividends paid on preferred stock for the year 20,000 20,000 B. 8 to 1 D. 16 to 1
Net income for the year 120,000 240,000
xxvii
Ivanos return on common stockholders equity, rounded to the nearest percentage point, for . On December 31, 2006 and 2007, Renegade Corporation had 100,000 shares of common
2007 is stock and 50,000 shares of noncumulative and nonconvertible preferred stock issued and
A. 17% C. 21% outstanding.
B. 19% D. 23% Additional information:
Stockholders equity at 12/31/07 P4,500,000
Dividend yield Net income year ended 12/31/07 1,200,000
xxiv
. The following information is available for Duncan Co.: Dividends on preferred stock year ended 12/31/07 300,000
2006 Market price per share of common stock at 12/31/07 144
Dividends per share of common stock P 1.40 The price-earnings ratio on common stock at December 31, 2007, was
Market price per share of common stock 17.50 A. 10 to 1 C. 14 to 1
Which of the following statements is correct? B. 12 to 1 D. 16 to 1
A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market
price of their stocks. Payout ratio

65
 Financial Statement Analysis

xxviii xxxii
. Selected financial data of Alexander Corporation for the year ended December 31, 2007, is . Assume you are given the following relationships for the Orange Company:
presented below: Sales/total assets 1.5X
Operating income P900,000 Return on assets (ROA) 3%
Interest expense (100,000) Return on equity (ROE) 5%
Income before income taxes 800,000 The Orange Companys debt ratio is
Income tax (320,000) A. 40% C. 35%
Net income 480,000 B. 60% D. 65%
Preferred stock dividend (200,000)
Net income available to common stockholders 280,000 Leverage Ratio
Common stock dividends were P120,000. The payout ratio is: Degree of financial leverage
xxxiii
A. 42.9 percent C. 25.0 percent . A summarized income statement for Leveraged Inc. is presented below.
B. 66.7 percent D. 71.4 percent Sales P1,000,000
Cost of Sales 600,000
P/E ratio & Payout ratio Gross Profit P 400,000
Use the following information for question Nos. 33 and 34: Operating Expenses 250,000
Terry Corporation had net income of P200,000 and paid dividends to common stockholders of Operating Income P 150,000
P40,000 in 2007. The weighted-average number of shares outstanding in 2007 was 50,000 Interest Expense 30,000
shares. Terry Corporations common stock is selling for P60 per share in the local stock Earnings Before Tax P 120,000
exchange. Income Tax 40,000
Net Income P 80,000
xxix
. Terry Corporations price-earnings ratio is The degree of financial leverage is:
A. 3.8 times C. 18.8 times A. P 150,000 P 30,000 C. P1,000,000 P400,000
B. 15 times D. 6 times B. P 150,000 P120,000 D. P 150,000 P 80,000
xxx
. Terry Corporations payout ratio for 2007 is Other Ratios
A. P4 per share C. 20.0 percent Book value per share
xxxiv
B. 12.5 percent D. 25.0 percent . M Corporations stockholders equity at December 31, 2007 consists of the following:
6% cumulative preferred stock, P100 par, liquidating value
DuPont Model was P110 per share; issued and outstanding 50,000 shares P5,000,000
Debt ratio Common stock, par, P5 per share; issued and
xxxi
. The Board of Directors is dissatisfied with last year's ROE of 15%. If the profit margin and outstanding, 400,000 shares 2,000,000
asset turnover remain unchanged at 8% and 1.25 respectively, by how much must the total Retained earnings 1,000,000
debt ratio increase to achieve 20% ROE? Total P8,000,000
A. Total debt ratio must increase by .5 Dividends on preferred stock have been paid through 2006.
B. Total debt ratio must increase by 5 At December 31, 2007, M Corporations book value per share was
C. Total debt ratio must increase by 5% A. P5.50 C. P6.75
D. Total debt ratio must increase by 50% B. P6.25 D. P7.50

66
 Financial Statement Analysis

xxxv
. The following data were gathered from the annual report of Desk Products. Quick ratio 1.5
Market price per share P30.00 Current liabilities P120,000
Number of common shares 10,000 Inventory turnover (based on cost of sales) 8 times
Preferred stock, 5% P100 par P10,000 Gross profit margin 40%
Common equity P140,000 Mildreds net sales for the year were
The book value per share is: A. P 800,000 C. P 480,000
A. P30.00 C. P14.00 B. P 672,000 D. P1,200,000
B. P15.00 D. P13.75
Gross margin
xxxix
Integrated ratios . Selected information from the accounting records of the Blackwood Co. is as follows:
Liquidity & activity ratios Net A/R at December 31, 2006 P 900,000
Inventory Net A/R at December 31, 2007 P1,000,000
xxxvi
. The current assets of Mayon Enterprise consists of cash, accounts receivable, and Accounts receivable turnover 5 to 1
inventory. The following information is available: Inventories at December 31, 2006 P1,100,000
Credit sales 75% of total sales Inventories at December 31, 2007 P1,200,000
Inventory turnover 5 times Inventory turnover 4 to 1
Working capital P1,120,000 What was the gross margin for 2007?
Current ratio 2.00 to 1 A. P150,000 C. P300,000
Quick ratio 1.25 to 1 B. P200,000 D. P400,000
Average Collection period 42 days
Working days 360 Market Test Ratio
The estimated inventory amount is: Dividend yield
xl
A. 840,000 C. 720,000 . Recto Co. has a price earnings ratio of 10, earnings per share of P2.20, and a pay out ratio
B. 600,000 D. 550,000 of 75%. The dividend yield is
A. 25.0% C. 7.5%
xxxvii
. The following data were obtained from the records of Salacot Company: B. 22.0% D. 10.0%
Current ratio (at year end) 1.5 to 1
xli
Inventory turnover based on sales and ending inventory 15 times . The following were reflected from the records of Salvacion Company:
Inventory turnover based on cost of goods sold and ending inventory 10.5 times Earnings before interest and taxes P1,250,000
Gross margin for 2007 P360,000 Interest expense 250,000
What was Salacot Companys December 31, 2007 balance in the Inventory account? Preferred dividends 200,000
A. P120,000 C. P 80,000 Payout ratio 40 percent
B. P 54,000 D. P 95,000 Shares outstanding throughout 2006
Preferred 20,000
Net sales Common 25,000
xxxviii
.Selected data from Mildred Companys year-end financial statements are presented below. Income tax rate 40 percent
The difference between average and ending inventory is immaterial. Price earnings ratio 5 times
Current ratio 2.0 The dividend yield ratio is

67
 Financial Statement Analysis

A. 0.50 C. 0.40
B. 0.12 D. 0.08

Comprehensive
xlii
. The balance sheets of Magdangal Company at the end of each of the first two
years of operations indicate the following:
2007 2006
Total current assets P600,000 P560,000
Total investments 60,000 40,000
Total property, plant, and equipment 900,000 700,000
Total current liabilities 150,000 80,000
Total long-term liabilities 350,000 250,000
Preferred 9% stock, P100 par 100,000 100,000
Common stock, P10 par 600,000 600,000
Paid-in capital in excess of par-common stock 60,000 60,000
Retained earnings 300,000 210,000
Net income is P115,000 and interest expense is P30,000 for 2007.
What is the rate earned on total assets for 2007 (round percent to one decimal point)?
A. 9.3 percent C. 8.9 percent
B. 10.1 percent D. 7.4 percent
xliii
. What is the rate earned on stockholders' equity for 2007 (round percent to one decimal point)?
A. 10.6 percent C. 12.4 percent
B. 11.2 percent D. 15.6 percent
xliv
. What is the earnings per share on common stock for 2007, (round to two decimal places)?
A. P1.92 C. P1.77
B. P1.89 D. P1.42
xlv
. If the market price is P30, what is the price-earnings ratio on common stock for 2007 (round to
one decimal point)?
A. 17.0 C. 12.4
B. 12.1 D. 15.9

68
i
. Answer: A
2007: P2,000,000 (1 0.7) = P600,000
2008: P2,000,000 (1 + 1.75) = P5,500,000
Note: For 2007 & 2008, 2006 was used as a base year.
ii
. Answer: C
iii
. Answer: C
Current Assets:
Cash P100,000
Accounts receivable 200,000
Total liquid assets 300,000
Inventory 440,000
Total current assets P740,000
Current Liabilities:
Accounts payable P 80,000
Notes payable, due in 6 months 250,000
Interest payable 25,000
Total current liabilities P355,000

Current Ratio (740,000 355,000) 2.08:1.00

Acid-test Ratio (300,000 355,000) 0.85:1.00

Before any payment, the current ratio is above 1:1 and acid test ratio is below 1:1. Therefore, the current ratio shall
rise but acid test ratio shall go down. If any of these two ratios is below 1:1, the equal change in current assets and
current liabilities brings direct effect on the ratio, that is, equal increase in current assets and current liabilities causes
the ratio to rise.
iv
. Answer: A
Working capital equals the difference between the total current assets and total current liabilities.
Current Assets:
Cash P 80,000
Marketable securities 250,000
Accounts receivable 110,000
Total liquid assets 440,000
Inventory 140,000
Prepaid expense 15,000
Total Current Assets P595,000

Current Liabilities:
Accounts payable P145,000
Income tax payable 10,000
Notes payable, short-term 85,000
Accrued liabilities 4,000 244,000

Working Capital P351,000

v
. Answer: B
Current Ratio: Current Assets Current Liabilities
(P595,000 P244,000) = 2.44:1.00
vi
. Answer: A
Acid-Test Ratio: Liquid Assets Current Liabilities
(P440,000 P244,000) = 1.80:1.00
vii
. Answer: D
AR Turnover: Credit sales Average AR
6,500,000/650,000 = 10.0 times
viii
. Answer: C
Accounts Receivable Turnover: Net Credit Sales Average Accounts Receivable
P1,500,000 [(P200,000 + P400,000) 2] = 5.0 times
ix
. Answer: D
Average Daily Sales: Annual credit sales Days Year
P4 million 360 days = P11,111

Average Collection Period: Average Accounts Receivable Average Daily Sales

[(P390,000 + P410,000) 2] P11,111 = 36 days
x
. Answer: A
Sales P30,000
Add decrease in Accounts Receivable 1,000
Cash collected from sales P31,000
xi
. Answer: B
Inventory Turnover: Cost of Goods Sold Average Inventory
Cost of goods sold P 900,000
Add Ending inventory 180,000
Total cost available for sales 1,080,000
Deduct cost of purchases 960,000
Beginning inventory P 120,000
Average Inventory: (P120,000 + P180,000) 2 P150,000
Inventory Turnover: (P900,000 P150,000) 6 times
An alternative computation of the inventory turnover is to use Net Sales instead of Cost of Goods Sold.
xii
. Answer: D
Average inventory: (P180,000 + P156,000) 2 P168,000
Inventory Turnover: (P600,000 P168,000) 3.57 times
xiii
. Answer: A
Average Inventory: (P341,169 + P376,526) 2 P358,847.50
Inventory Turnover: (P2,000,326 P358,847.50) 5.6 times
xiv
. Answer: A
Average Inventory: (P90,000 + P110,000) 2 P100,000
Inventory Turnover: (P330,000 P100,000) 3.3 times
xv
. Answer: B
Average Inventory: (P672,000 + P576,000) 2 P624,000
Inventory Turnover: (P2,400,000 P624,000) 3.846 times
Inventory Turnover in Days: 365 days 3.846 94.9 days

Alternative Computation:
Average daily cost of goods sold: = (P2,400,000 365) P6,575.34
Turnover in Days: P624,000 P6,575.34 94.9 days
xvi
. Answer: A
Average Accounts Receivable: (P900,000 P1,000,000) 2 P 950,000
Average inventory; (P1.1M + P1.2M) 2 P1,150,000

Net sales: (P950,000 x 5) P4,750,000

Cost of goods sold (P1,150,000 x 4) 4,600,000
Gross margin P 150,000
xvii
. Answer: B
Current liabilities P 100,000
Long-term debt 400,000
Deferred income tax 10,000
Total Liabilities 510,000
Stockholders Equity
Preferred stock P 80,000
Common stock 100,000
Premium on common stock 180,000
Retained earnings 170,000 530,000
Total Assets P1,040,000

Debt Ratio: P510,000 P1,040,000 = 0.49

xviii
. Answer: D
Times interest earned: Earnings before interest Interest
Income before tax (P48,000 + P46,000) P 94,000
Add Interest expense 35,000
Income before Interest expense P129,000

TIE: P129,000 P35,000 3.7 times

xix
. Answer: A
 TIE: Income before interest expense Interest expense
Income before income tax P400,000
Add back Interest expense 100,000
Income before interest expense P500,000

TIE: P500,000 P100,000 5 times

xx
. Answer: C
Interest Expense: P1M x 0.1 P100,000
Income before interest expense: P350,000 + P100,000 P450,000
Times interest earned: (P450,000 P100,000) 4.5 times
xxi
. Answer: C
Net income P400,000
Add: Income taxes P300,000
Interest 60,000 360,000
Income before interest P760,000

TIE: P760,000 P60,000 12.67 times

xxii
. Answer: B
Earnings before interest expense (P20,000 x 4.5) P90,000
Deduct interest expense 20,000
Income before income tax P70,000
Deduct income tax (P70,000 x 0.4) 28,000
Net income P42,000
xxiii
. Answer: D
Income to Common; (P240,000 P20,000) P220,000
Average Common Equity: (P750,000 + P1,170,000) 2 P960,000
Return on Common Equity: (P220 P960) 23 percent
xxiv
. Answer: B
The dividend yield is 8 percent (P1.40 P17.50)
The dividend yield measures the return of investment in terms of dividends received. The total expected returns
consists of Dividend Yield and the Appreciation in market price and dividend
xxv
. Answer: D
Market Value of Equity (P3M x 3.5) P10,500,000
Market price per share: (P10.5M 100,000) P105
xxvi
. Answer: B
EPS: P50,000 100,000 shares P0.50
P/E Ratio: P4.00 P0.50 8 to 1
xxvii
. Answer: D
EPS: (P1,200,000 P300,000) 100,000 P9.00
P/E Ratio: 144 9 16
xxviii
. Answer: A
Payout Ratio: Common Dividends Income Available to Common
P120,000 P280,000 = 42.9%
xxix
. Answer: B
Price-earnings ratio: Market price EPS
EPS: Net income /Weighted-average common shares
EPS: P200,000 50,000 shares P4.00
P/E Ratio: P60 P4 15.0X
xxx
. Answer: C
Payout Ratio: Dividends Income to Common
P40,000 P200,000 = 20.0%
xxxi
. Answer: D
ROE: (8% x 1.25) 10.00%
Last years Debt Ratio 1 (10% 15%) 33.33%
Proposed Debt Ratio 1 (10% 20%) 50.00%
Increase in debt ratio: (50.00% - 33.33%) 33.33% 50.00%
xxxii
. Answer: A
1 (0.03 0.05) = 40%
xxxiii
. Answer: B
Degree of Financial Leverage: Operating Income Interest Expense
xxxiv
. Answer: A
Total stockholders equity P8,000,000
Deduct:
Liquidation value of Preferred Stock (50,000 s P110) P5,500,000
Unpaid Preferred Dividends (P5M x 6%) 300,000 5,800,000
Common Equity P2,200,000

Book Value per Share: P2.2M 400,000 shares P5.50

xxxv
. Answer: C
Book Value per Share: Common Equity Outstanding Shares
P140,000 10,000 shares = P14.00
xxxvi
. Answer: A
The inventory amount can be calculated as follows:
Current liabilities: Working Capital = current liabilities based on 2:1 current ratio. At 2:1 current ratio, the amount of
working capital and current liabilities are both P1,120,000.

Inventory: Current liabilities x (Current ratio Acid test ratio)

P1,120,000 x (2.0 1.25) P840,000

A detailed computation can be made as follows:

Current assets: P1,120,000 x 2 P2,240,000
Liquid assets: P1,120,000 x 1.25 1,400,000
Inventory P 840,000
xxxvii
. Answer: C
Inventory balance: Gross profit (Difference between 2 inventory turnovers)
360,000/(15 10.5) = P80,000
xxxviii
. Answer: A
Inventory balance (P120,000 x (2.0 1.5) P 60,000
Cost of goods sold 60,000 x 8 P480,000
Sales (P480,000 0.60) P800,000
xxxix
. Answer: A
Average Accounts Receivable: (P900,000 P1,000,000) 2 P 950,000
Average inventory; (P1.1M + P1.2M) 2 P1,150,000

Net sales: (P950,000 x 5) P4,750,000

Cost of goods sold (P1,150,000 x 4) 4,600,000
Gross margin P 150,000
xl
. Answer: C
Dividend per share: 0.75 x P2.20 P1.65
Market price: 10 x 2.20 22.00
Dividend yield: P1.65 P22.00 = 7.5%
xli
. Answer: D
EBIT 1,250,000
Less interest expense 250,000
Earnings before tax 1,000,000
Less Income tax 40% 400,000
Net income 600,000
Less Preferred dividends 200,000
Earnings to Common Stock 400,000
Earnings per share 400,000/25,000 16.00
Dividend per share: 400,000 x 0.40 25,000 6.40

Dividend yield 6.4 (16 x 5) 8.0%

xlii
. Answer: B
ROA: Operating income Average Total Assets
 P145,000 P1,430,000 = 10.1%
xliii
. Answer: B
Return on stockholders equity: Net income Average stockholders equity
P115,000 P1,027,500 = 11.2%
xliv
. Answer: C
Net income P115,000
Deduct Preferred Dividends 9,000
Income available to common shares P106,000

EPS: (P106,000 60,000) P1.77

xlv
. Answer: A
P/E Ratio: P30 1.766 = 17.0 times