Chapter 4

Question 1

What is the purpose of liquidity ratios?

a. To see if the company can cover all liabilities
b. To see if the company can cover all creditor claims
c. To see if the company can cover short-term liabilities
d. To see if the company can cover long-term liabilities
e. To see how much cash the company has

Answer 1

c. To see if the company can cover short-term liabilities

Question 2

What is the main purpose of profitability ratios?

a. To see if the company produces enough profit
b. To see if the company can produce profit
c. To see how much profit the company is producing
d. To show debtors that the company is making money
e. There is no real purpose to profitability ratios

Answer 2

a. To see if the company produces enough profit

Question 3

How can financial ratios be used to assess performance?

a. Compare to industry average
b. Compare to prior years
c. Compare to management goals
d. All of the above
e. None of the above

Answer 3

d. All of the above

Question 4

What is the current ratio for Barry Computer Company?

a. 2.00
b. 1.98
c. 1.62
d. 2.87
e. 3.00

Answer 4

b. 1.98

CR = CA/CL = $655,000/$330,000 = 1.98x

Question 5

5) What is the total asset turnover ratio for Barry Computer Company? (data on page 130 of textbook)
a. 1.85
b. 2.45
c. 2.00
d. 1.70
e. 1.97

Answer 5

d. 1.70

TAT = Sales/Total Assets = $1,607,500/$947,500 = 1.70x

Question 6

What is the operating profit margin for Barry Computer Company? (data on page 130 of textbook).

a. 0.33 or 33%
b. 0.028 or 2.8%
c. 0.39 or 39%
d. 0.017 or 1.7%
e. 0.0435 or 4.35%

Answer 6

e. 0.0435 or 4.35%

OM = EBIT/Sales = $70,000/$1,607,500 = 0.0435 = 4.35%

Question 7

Analyzing a company’s liquidity ratios ____.

a. Involves analyzing a company’s industry turnover ratio, total debt ratio, and current ratio to evaluate the general health of a company
b. Uses analysis of the current ratio and a market-to-book ratio to ensure that a company has enough cash to cover long-term liabilities
c. Gives an investor a good idea of the worth of a company
d. Re-analyzes all the company’s assets and puts a market value on them, which in turn is used in calculation of the liquidity of the company
e. None of the above

Answer 7

e. None of the above

Question 8

A company with a total debt to total capital ratio of 57%:

a. Has more liabilities than total assets
b. Carries a higher percentage of equity than a company with a total debt ratio of 72%.
c. Carries higher inventory ratios and asset turnover ratios as well.
d. Is cause for trouble in any given industry
e. Can be lowered if a company increases its accounts payable

Answer 8

b. Carries a higher percentage of equity than a company with a total debt ratio of 72%.

Question 9

Which of the following are false statements in regards in financial ratios

a. A company can compare its financial ratios to both prior year ratios and set management goals
b. A Price/Earnings Ratio is a useful tool to determine whether or not a stock is over or undervalued
c. Seasonality of business does not play an important factor in calculating ratios
d. Ratios have a limitation in that measured historical ratios do not always entirely predict future results 100% of the time
e. A company’s financial ratios are often compared to industry averages to gauge its performance amongst its competitors, however, this is done with caution and with a deep understanding of what the ratios measure

Answer 9

c. Seasonality of business does not play an important factor in calculating ratios

Question 10

Company XYZ has current liabilities of $300, total interest-bearing debt of $500, total equity capital of $300, total assets of $1,100 and sales revenues of $5000. When calculating the total debt to total capital ratio which of the following is true considering the industry average is 45%:

a. Company XYZ has a total debt to total capital ratio of 62.5% which indicates they have a higher percentage of debt than the industry average
b. Company XYZ has a total debt to total capital ratio of 16% which indicates they have a higher percentage of debt than the industry average
c. Company XYZ has a total debt to total capital ratio of 16% which indicates they have a lower percentage of debt than the industry average
d. Company XYZ has a total debt to total capital ratio of 80% which indicates they have a lower percentage of debt than the industry average
e. none of the above

Answer 10

a. Company XYZ has a total debt to total capital ratio of 62.5% which indicates they have a higher percentage of debt than the industry average

Total Debt to Total Capital ratio = total interest-bearing debt/(total debt + total equity)
= ($500)/($500 + $300) = 0.625 = 62.5%

Question 11

Liquidity Ratios:

Answer 11

Give an idea of the firm’s ability to pay off debt that are maturing within a year.

Does the Company have enough Cash to Cover Short-Term Liabilities?

Question 12

Asset Management Ratios:

Answer 12

Gives an idea of how efficiently the firm is using its assets.

Does the Company have enough or too much in Assets?

Question 13

Debt Management Ratios:

Answer 13

Gives an idea of how the firm has financed its assets as well as the firm’s ability to repay its long-term debt.

Does the Company have enough or too much Debt?

Question 14

Profitability Ratios:

Answer 14

Gives an idea of how profitability the firm is operating and utilizing its assets.

Does the Company produce enough Profit?

Question 15

Market Value Ratios:

Answer 15

Gives an idea of what investors think about the firm and its future prospects.

Does the Company produce enough value for the common stockholders?

Question 16

Ratio analysis is used by three main groups:

Answer 16

1. Managers: Use ratios to help analyze, control, and thus improve their firm’s operations.
2. Credit Analysts: Use ratios to to help judge a company’s ability to repay its debts.
3. Stock Analysts: Who are interest in a company’s efficiency, risk, and growth prospects.