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CHAPTER 3

Working with Financial Statements


1.
a.
b.
c.
d.
e.

Activities of the firm that generate cash are known as:


sources of cash.
uses of cash.
cash payments.
cash receipts.
cash on hand.

2.
a.
b.
c.
d.
e.

Activities of the firm in which cash is spent are known as:


sources of cash.
uses of cash.
cash payments.
cash receipts.
cash on hand.

3.

The financial statement that summarizes the sources and uses of cash over a specified period of
time is the:
income statement.
balance sheet.
tax reconciliation statement.
statement of cash flows.
statement of operating position.

a.
b.
c.
d.
e.
4.
a.
b.
c.
d.
e.
5.
a.
b.
c.
d.
e.
6.
a.
b.
c.
d.
e.
7.
a.
b.

A _____ standardizes items on the income statement and balance sheet as a percentage of total
sales and total assets, respectively.
tax reconciliation statement
statement of standardization
statement of cash flows
common-base year statement
common-size statement
A _____ standardizes items on the income statement and balance sheet relative to their values
as of a common point in time.
statement of standardization
statement of cash flows
common-base year statement
common-size statement
tax reconciliation statement
Relationships determined from a firms financial information and used for comparison purposes
are known as:
financial ratios.
comparison statements.
dimensional analysis.
scenario analysis.
solvency analysis.
Financial ratios that measure a firms ability to pay its bills over the short run without undue
stress are known as _____ ratios.
asset management
long-term solvency

c.
d.
e.

short-term solvency
profitability
market value

8.
a.
b.
c.
d.
e.

The current ratio is measured as:


current assets minus current liabilities.
current assets divided by current liabilities.
current liabilities minus inventory, divided by current assets.
cash on hand divided by current liabilities.
current liabilities divided by current assets.

9.
a.
b.
c.
d.
e.

The quick ratio is measured as:


current assets divided by current liabilities.
cash on hand plus current liabilities, divided by current assets.
current liabilities divided by current assets, plus inventory.
current assets minus inventory, divided by current liabilities.
current assets minus inventory minus current liabilities.

10.
a.
b.
c.
d.
e.

The cash ratio is measured as:


current assets divided by current liabilities.
current assets minus cash on hand, divided by current liabilities.
current liabilities plus current assets, divided by cash on hand.
cash on hand plus inventory, divided by current liabilities.
cash on hand divided by current liabilities.

11.
a.
b.
c.
d.
e.

The financial ratio measured as current assets divided by average daily operating costs is the:
cash ratio.
net working capital to total assets ratio.
acid-test ratio.
interval measure.
operating measure.

12.
a.
b.
c.
d.
e.

Ratios that measure a firms financial leverage are known as _____ ratios.
asset management
long-term solvency
short-term solvency
profitability
market value

13.
a.
b.
c.
d.
e.

The financial ratio measured as total assets minus total equity, divided by total assets, is the:
total debt ratio.
equity multiplier.
debt-equity ratio.
current ratio.
times interest earned ratio.

14.
a.
b.
c.
d.
e.

The debt-equity ratio is measured as total:


equity minus total debt.
equity divided by total debt.
debt divided by total equity.
debt plus total equity.
debt minus total assets, divided by total equity.

15. The equity multiplier ratio is measured as total:

a.
b.
c.
d.
e.

equity divided by total assets.


equity plus total debt.
assets minus total equity, divided by total assets.
assets plus total equity, divided by total debt.
assets divided by total equity.

16.
a.
b.
c.
d.
e.

The total long-term debt and equity of the firm is frequently called:
total assets.
total capitalization.
total financing.
debt-equity consolidation.
debt-equity reconciliation.

17. The financial ratio measured as the firms long-term debt divided by its total capitalization is
the:
a. interval measure.
b. equity multiplier.
c. total debt ratio.
d. long-term debt ratio.
e. debt-equity ratio.
18. The financial ratio measured as earnings before interest and taxes, divided by interest expense
is the:
a. cash coverage ratio.
b. debt-equity ratio.
c. times interest earned ratio.
d. gross margin.
e. total debt ratio.
19. The financial ratio measured as earnings before interest and taxes, plus depreciation, divided by
interest expense, is the:
a. cash coverage ratio.
b. debt-equity ratio.
c. times interest earned ratio.
d. gross margin.
e. total debt ratio.
20. Ratios that measure how efficiently a firm uses its assets to generate sales are known as _____
ratios.
a. asset management
b. long-term solvency
c. short-term solvency
d. profitability
e. market value
21.
a.
b.
c.
d.
e.

The inventory turnover ratio is measured as:


total sales minus inventory.
inventory times total sales.
cost of goods sold divided by inventory.
inventory times cost of goods sold.
inventory plus cost of goods sold.

22. The financial ratio days sales in inventory is measured as:


a. inventory turnover plus 365 days.

b.
c.
d.
e.

inventory times 365 days.


inventory plus cost of goods sold, divided by 365 days.
365 days divided by the inventory.
365 days divided by the inventory turnover.

23.
a.
b.
c.
d.
e.

The receivables turnover ratio is measured as:


sales plus accounts receivable.
sales divided by accounts receivable.
sales minus accounts receivable, divided by sales.
accounts receivable times sales.
accounts receivable divided by sales.

24.
a.
b.
c.
d.
e.

The financial ratio days sales in receivables is measured as:


receivables turnover plus 365 days.
accounts receivable times 365 days.
accounts receivable plus sales, divided by 365 days.
365 days divided by the receivables turnover.
365 days divided by the accounts receivable.

25.
a.
b.
c.
d.
e.

The net working capital turnover ratio is measured as:


sales divided by net working capital.
sales minus net working capital.
sales times net working capital.
net working capital divided by sales.
net working capital plus sales.

26.
a.
b.
c.
d.
e.

The fixed asset turnover ratio is measured as:


sales minus net fixed assets.
sales times net fixed assets.
sales divided by net fixed assets.
net fixed assets divided by sales.
net fixed assets plus sales.

27.
a.
b.
c.
d.
e.

The total asset turnover ratio is measured as:


sales minus total assets.
sales divided by total assets.
sales times total assets.
total assets divided by sales.
total assets plus sales.

28. Ratios that measure how efficiently a firms management uses its assets and equity to generate
bottom line net income are known as _____ ratios.
a. asset management
b. long-term solvency
c. short-term solvency
d. profitability
e. market value
29.
a.
b.
c.
d.
e.

The financial ratio measured as net income divided by sales is known as the firms:
profit margin.
return on assets.
return on equity.
asset turnover.
earnings before interest and taxes.

30.
a.
b.
c.
d.
e.

The financial ratio measured as net income divided by total assets is known as the firms:
profit margin.
return on assets.
return on equity.
asset turnover.
earnings before interest and taxes.

31.
a.
b.
c.
d.
e.

The financial ratio measured as net income divided by total equity is known as the firms:
profit margin.
return on assets.
return on equity.
asset turnover.
earnings before interest and taxes.

32. The financial ratio measured as the price per share of stock divided by earnings per share is
known as the:
a. return on assets.
b. return on equity.
c. debt-equity ratio.
d. price-earnings ratio.
e. Du Pont identity.
33.
a.
b.
c.
d.
e.

The market-to-book ratio is measured as:


total equity divided by total assets.
net income times market price per share of stock.
net income divided by market price per share of stock.
market price per share of stock divided by earnings per share.
market value of equity per share divided by book value of equity per share.

34.
a.
b.
c.
d.
e.

The _____ breaks down return on equity into three component parts.
Du Pont identity
return on assets
statement of cash flows
asset turnover ratio
equity multiplier

35. The U.S. government coding system that classifies firms by their specific type of business
operations is known as the:
a. NASDAQ 100.
b. Standard & Poors 500.
c. Standard Industrial Classification system.
d. governmental ID system.
e. Government Engineering Enterprise system.
36.
a.
b.
c.
d.
e.

An increase in which one of the following is a source of cash?


accounts payable
cash
inventory
fixed assets
accounts receivable

37. Which of the following is (are) sources of cash?


I. an increase in accounts receivable

II.
III.
IV.
a.
b.
c.
d.
e.

a decrease in common stock


an increase in long-term debt
a decrease in accounts payable
I only
III only
II and IV only
I and III only
I, II, and IV only

38.
a.
b.
c.
d.
e.

Which one of the following is a use of cash?


payment received from a customer on their account
sale of inventory
decrease in the cash balance
sale of common stock
payment to a supplier

39.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Which of the following is (are) uses of cash?


payment of a note payable
repurchase of common stock
granting of credit to a customer
sale of a fixed asset
I only
IV only
II and III only
I and III only
I, II, and III only

40. Which one of the following is found in the financing activity section of a statement of cash
flows?
a. fixed asset acquisition
b. depreciation
c. increase in accounts receivable
d. dividends paid
e. net income
41. According to the statement of cash flows, an increase in accounts receivable will _____ the
cash flow from _____ activities.
a. decrease; operating
b. decrease; financing
c. increase; operating
d. decrease; financing
e. decrease; investment
42.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Which of the following are types of activities shown on a statement of cash flows?
investment
liquidating
operating
financing
I and III only
II and IV only
II, III, and IV only
I, III, and IV only
I, II, and III only

43.
a.
b.
c.
d.
e.

On a common-size balance sheet, all _____accounts are shown as a percentage of:


income; total assets.
liability; net income.
asset; sales.
liability; total assets.
equity; sales.

44.
a.
b.
c.
d.
e.

On a common-base year financial statement, all accounts are expressed relative to the base:
year amount.
amount of sales.
amount of total assets.
net income.
net cash flow.

45.
a.
b.
c.
d.
e.

Which one of the following statements is correct concerning ratio analysis?


A single ratio is often computed differently by different individuals.
Ratios do NOT address the problem of size differences among firms.
There is only a very limited number of ratios which can be used for analytical purposes.
Each ratio has a specific formula that is used consistently by all analysts.
Ratios can NOT be used for comparison purposes over periods of time.

46.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Which of the following are liquidity ratios?


interval measure
current ratio
quick ratio
net working capital to total assets
II and III only
I and II only
II, III, and IV only
I, III, and IV only
I, II, III, and IV

47. An increase in which one of the following accounts increases a firms current ratio without
affecting its quick ratio?
a. accounts payable
b. cash
c. inventory
d. accounts receivable
e. fixed assets
48. A supplier, who requires payment within ten days, is most concerned with which
one of the following ratios when granting credit?
a. current
b. cash
c. debt-equity
d. quick
e. total debt
49.
a.
b.
c.
d.
e.

A firm has an interval measure of 83. This means that the firm must:
pay its creditors within the next 83 days or go bankrupt.
get additional financing within the next 83 days or possibly face closing the firm.
sell all of its common stock in the next 83 days or become privately owned.
pay a dividend to its shareholders every 83 days.
pay interest on its debt every 83 days.

50.
a.
b.
c.
d.
e.

A firm has a total debt ratio of .47. This means that that firm has 47 cents in debt for every:
$1 in equity.
$1 in total sales.
$1 in current assets.
$.53 in equity.
$.53 in total assets.

51.
a.
b.
c.
d.
e.

The long-term debt ratio is probably of most interest to a firms:


credit customers.
employees.
suppliers.
mortgage holder.
shareholders.

52. A banker considering loaning a firm money for ten years would most likely prefer the firm
have a debt ratio of _____ and a times interest earned ratio of_____:
a. .75; .75.
b. .50; 1.00.
c. .45; 1.75.
d. .40; 2.50.
e. .35; 3.00.
53. From a cash flow position, which one of the following ratios best measures a firms
ability to pay the interest on its debts?
a. times interest earned ratio
b. cash coverage ratio
c. cash ratio
d. quick ratio
e. interval measure
54.
a.
b.
c.
d.
e.

The higher the inventory turnover measure, the:


faster a firm sells its inventory.
faster a firm collects payment on its sales.
longer it takes a firm to sell its inventory.
greater the amount of inventory held by a firm.
lesser the amount of inventory held by a firm.

55. Which one of the following statements is correct if a firm has a receivables turnover measure of
10?
a. It takes a firm 10 days to collect payment from its customers.
b. It takes a firm 36.5 days to sell its inventory and collect the payment from the sale.
c. It takes a firm 36.5 days to pay its creditors.
d. The firm has an average collection period of 36.5 days.
e. The firm has ten times more in accounts receivable than it does in cash.
56.
a.
b.
c.
d.
e.

A total asset turnover measure of 1.03 means that a firm has $1.03 in:
total assets for every $1 in cash.
total assets for every $1 in total debt.
total assets for every $1 in equity.
sales for every $1 in total assets.
long-term assets for every $1 in short-term assets.

57. If a firm wishes to increase its net working capital turnover rate, it should _____, all else
constant.
a. increase its current assets
b. increase its total assets
c. decrease its current liabilities
d. decrease its total liabilities
e. increase its sales
58. Bobs Toys has a fixed asset turnover rate of 1.2 and a total asset turnover rate
of .84. Gerolds Toys has a fixed asset turnover rate of 1.1 and a total asset
turnover rate of .96. Both companies have similar operations. Bobs Toys:
a. is using its fixed assets more efficiently than Gerolds Toys.
b. is using its total assets more efficiently than Gerolds Toys.
c. is generating $1 in sales for every $1.20 in net fixed assets.
d. is generating $1.20 in net income for every $1 in net fixed assets.
e. has $.84 in total assets for every $.96 Gerolds has in total assets.
59. Puffys Pastries generates five cents of net income for every $1 in sales. Thus,
Puffys has a _____ of 5 percent.
a. return on assets
b. return on equity
c. profit margin
d. Du Pont measure
e. total asset turnover
60. If a firm produces a 10 percent return on assets and also a 10 percent return on
equity, then the firm:
a. has no debt of any kind.
b. is using its assets as efficiently as possible.
c. has no net working capital.
d. also has a current ratio of 10.
e. has an equity multiplier of 2.
61. If shareholders want to know how much profit a firm is making on their entire
investment in the firm, the shareholders should look at the:
a. profit margin.
b. return on assets.
c. return on equity.
d. equity multiplier.
e. earnings per share.
62. BGL Enterprises increases its operating efficiency such that costs decrease while sales remain
constant. As a result, given all else constant, the:
a. return on equity will increase.
b. return on assets will decrease.
c. profit margin will decline.
d. equity multiplier will decrease.
e. price-earnings ratio will increase.
63. The only difference between Joes and Moes is that Joes has old, fully depreciated equipment.
Moes just purchased all new equipment which will be depreciated over eight years. Assuming
all else equal:
a. Joes will have a lower profit margin.
b. Joes will have a lower return on equity.

c.
d.
e.

Moes will have a higher net income.


Moes will have a lower profit margin.
Moes will have a higher return on assets.

64. Last year, Alfreds Automotive had a price-earnings ratio of 15. This year, the price
earnings ratio is 18. Based on this information, it can be stated with certainty that:
a. the price per share increased.
b. the earnings per share decreased.
c. investors are paying a higher price for each share of stock purchased.
d. investors are receiving a higher rate of return this year.
e. either the price per share, the earnings per share, or both changed.
65. Turners Inc. has a price-earnings ratio of 16. Alfreds Co. has a price-earnings ratio of 19.
Thus, you can state with certainty that one share of stock in Alfreds:
a. has a higher market price than one share of stock in Turners.
b. has a higher market price per dollar of earnings than does one share of Turners.
c. sells at a lower price per share than one share of Turners.
d. represents a larger percentage of firm ownership than does one share of Turners stock.
e. earns a greater profit per share than does one share of Turners stock.
66.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Which two of the following are most apt to cause a firm to have a higher price-earnings ratio?
slow industry outlook
high prospect of firm growth
very low current earnings
investors with a low opinion of the firm
I and II only
II and III only
II and IV only
I and III only
III and IV only

67. Vinnies Motors has a market-to-book ratio of 3. The book value per share is $4.00.
This means that a $1 increase in the book value per share will:
a. cause the accountants to increase the equity of the firm by an additional $2.
b. increase the market price per share by $1.
c. increase the market price per share by $12.
d. tend to cause the market price per share to rise.
e. only affect book values but not market values.
68.
a.
b.
c.
d.
e.

Which one of the following sets of ratios applies most directly to shareholders?
return on assets and profit margin
quick ratio and times interest earned
price-earnings ratio and debt-equity ratio
market-to-book ratio and price-earnings ratio
cash coverage ratio and times equity multiplier

69.
I.
II.
III.
IV.
a.

The three parts of the Du Pont identity can be generally described as:
operating efficiency, asset use efficiency and firm profitability.
financial leverage, operating efficiency and asset use efficiency.
the equity multiplier, the profit margin and the total asset turnover.
the debt-equity ratio, the capital intensity ratio and the profit margin.
I and II only

b.
c.
d.
e.

II and III only


I and IV only
I and III only
III and IV only

70.
a.
b.
c.
d.
e.

If a firm decreases their operating costs, all else constant, then:


the profit margin increases while the equity multiplier decreases.
the return on assets increases while the return on equity decreases.
the total asset turnover rate decreases while the profit margin increases.
both the profit margin and the equity multiplier increase.
both the return on assets and the return on equity increase.

71.
a.
b.
c.
d.
e.

Which one of the following statements is correct?


Book values should always be given precedence over market values.
Financial statements are frequently the basis used for performance evaluations.
Historical information has no value when predicting the future.
Potential lenders place little value on financial statement information.
Reviewing financial information over time has very limited value.

72.
a.
b.
c.
d.
e.

It is easier to evaluate a firm using their financial statements when the firm:
is a conglomerate.
is global in nature.
uses the same accounting procedures as other firms in their industry.
has a different fiscal year than other firms in their industry.
tends to have one-time events such as asset sales and property acquisitions.

73. Which two of the following represent the most effective methods of
directly evaluating the financial performance of a firm?
I.
comparing the current financial ratios to those of the same firm from prior time
periods
II. comparing a firms financial ratios to those of other firms in the firms peer
group who have similar operations
III. comparing the financial statements of the firm to the financial statements of similar firms
operating in other countries
IV. comparing the financial ratios of the firm to the average ratios of all firms located in the same
geographic area
a. I and II only
b. II and III only
c. III and IV only
d. I and IV only
e. I and III only
74. Which of the following represent problems encountered when comparing the financial
statements of one firm with those of another firm?
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 for inventory purposes.

IV.
a.
b.
c.
d.
e.

The two firms may be seasonal in nature and have different fiscal year ends.
I and II only
II and III only
I, III, and IV only
I, II, and III only
I, II, III, and IV

75. Last year Tys Grocery had inventory of $237,500 and fixed assets of $51,400. This
year, Tys has inventory of $231,900 and fixed assets of $48,700. Depreciation for this
year is $6,300. Which one of the following statements is true given this information?
a. Both inventory and fixed assets are uses of cash in the amounts of $5,600 and $3,600,
respectively.
b. Both inventory and fixed assets are uses of cash in the amounts of $5,600 and $2,700,
respectively.
c. Inventory is a source of cash in the amount of $5,600 and fixed assets is a use of cash
in the amount of $2,700.
d. Inventory is a source of cash in the amount of $5,600 and fixed assets is a use of cash
in the amount of $3,600.
e. Both inventory and fixed assets are sources of cash in the amounts of $5,600 and
$3,600 respectively.
76. During the year, Dougs Bakery decreased their accounts receivable by $50, increased
their inventory by $100, and decreased their accounts payable by $50. For these three
accounts, the firm has a net:
a. $200 use of cash.
b. $100 use of cash.
c. $0 use of cash.
d. $100 source of cash.
e. $200 source of cash.

CHAPTER 4

Long-Term Financial Planning and Growth


1.
a.
b.
c.
d.
e.
2.

The long-range time period, usually the next two to five years, over which the financial
planning process focuses is known as the:
planning horizon.
planning strategy.
planning agenda.
short-run.
current financing period.

a.
b.
c.
d.
e.

The process by which smaller investment proposals of each of a firms operational units are
added up and treated as one big project is known as:
separation.
aggregation.
conglomeration.
appropriation.
striation.

3.
a.
b.

Pro forma financial statements are:


statements recapping the performance of a firm for the past five years.
accounting statements filed with the Securities and Exchange Commission.

c.
d.
e.

accounting statements filed with the Internal Revenue Service.


projected accounting statements based on a sales forecast.
the most-recently compiled accounting statements of a firm.

4.

The designated source of external financing required to make a pro forma balance sheet balance
is called the:
retained earnings account.
common stock account.
debt-equity ratio.
cash flow variable.
plug variable.

a.
b.
c.
d.
e.
5.
a.
b.
c.
d.
e.

The financial planning method in which accounts vary depending on a firms predicted sales
level is called the _____ approach.
percentage of sales
sales dilution
sales reconciliation
common-size
time-trend

6.
a.
b.
c.
d.
e.

The dividend payout ratio is calculated as:


net income minus additions to retained earnings.
cash dividends divided by the change in retained earnings.
cash dividends divided by net income.
net income minus cash dividends.
one plus the retention ratio.

7.
a.
b.
c.
d.
e.

The retention ratio is calculated as:


one plus the dividend payout ratio.
the additions to retained earnings divided by net income.
the additions to retained earnings divided by dividends paid.
net income minus additions to retained earnings.
net income minus cash dividends.

8.
a.
b.
c.
d.
e.

The capital intensity ratio is calculated as:


long-term debt multiplied by total assets.
net fixed assets divided by net income.
net fixed assets multiplied by total sales.
total assets divided by total sales.
total sales divided by total assets.

9.
a.
b.
c.
d.
e.

The internal growth rate of a firm is best described as the:


minimum growth rate achievable if the firm does not pay out any cash dividends.
minimum growth rate achievable if the firm maintains a constant equity multiplier.
maximum growth rate achievable without external financing of any kind.
maximum growth rate achievable without using any external equity financing, and while
maintaining a constant debt-equity ratio.
maximum growth rate achievable without any limits on the level of debt financing.

10.
a.
b.
c.

The sustainable growth rate of a firm is best described as the:


minimum growth rate achievable if the firm does not pay out any cash dividends.
minimum growth rate achievable if the firm maintains a constant equity multiplier.
maximum growth rate achievable without external financing of any kind.

d.
e.

maximum growth rate achievable without using any external equity financing, and while
maintaining a constant debt-equity ratio.
maximum growth rate achievable without any limits on the level of debt financing.

11.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Which of the following are basic elements of financial planning for a corporation?
dividend policy
net working capital decision
capital budgeting decision
capital structure policy
I and IV only
II and III only
I, III, and IV only
II, III,and IV only
I, II, III, and IV

12.
a.
b.
c.
d.
e.

Financial planning:
is limited to projecting activities of a firm for the next twelve months.
formulates the way in which financial goals are to be achieved.
is formulated based primarily on a net income assumption.
for capital acquisitions is done on a purely segregated basis.
focuses solely on the assumptions that are most likely to occur.

13.
a.
b.
c.
d.
e.

Financial planning:
encourages managers to separate their goals from their plans.
is generally based solely on the best-case scenario.
generally has been found ineffective.
helps managers establish priorities.
prevents firms from encountering surprise events.

14. Managers of the Automotive Warehouse are currently in the process of updating their
financial plans and preparing revised pro forma statements. During this process, the
managers should focus primarily on which of the following future time periods?
a. 6 to 12 months
b. 1 to 3 years
c. 1 to 6 years
d. 2 to 5 years
e. 2 to 10 years
15.
a.
b.
c.
d.
e.

One of the primary benefits of aggregation is gaining an understanding of the:


interactions of the net working capital.
total investment needs of the firm.
trade-offs between debt and equity.
trade-offs between the dividend policy and the plowback ratio.
total asset turnover ratio.

16.
I.
II.
III.
IV.
a.
b.
c.
d

When utilizing the percentage of sales approach, managers:


determine the level of sales required based on the desired profit margin percentage.
need to identify which expenses are variable and which are fixed.
need to determine the capital intensity ratio.
can ignore any projected dividends.
I and II only
II and III only
III and IV only
I, II, and IV only

e.

I, III, and IV only

17.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Sales forecasts are:


frequently based on macroeconomic projections.
often affected by industry forecasts.
generally the output from most pro forma statements.
generally the basis for projecting future asset requirements.
I and II only
III and IV only
II and III only
I, II, and III only
I, II, and IV only

18.
a.
b.
c.
d.
e.

When constructing a pro forma statement, net working capital generally varies:
directly with sales.
with the level of capacity utilization.
directly with the growth rate of fixed assets.
based upon the financial leverage employed.
as necessary to get the balance sheet to balance.

19. When fixed assets on a pro forma statement are projected to increase at a rate
equivalent to the projected rate of sales growth, it can be assumed that the firm is:
a. projected to grow at the internal rate of growth.
b. projected to grow at the sustainable rate of growth.
c. creating excess capacity.
d. currently operating at full capacity.
e. retaining all of its projected net income.
20. A firm is currently operating at full capacity. Net working capital, costs, and all assets
vary directly with sales. The firm does not wish to obtain any additional equity
financing. The dividend payout ratio is constant at 40 percent. When the firm compiles
a pro forma statement, the plug variable is most likely going to be:
a. accounts payable.
b. long-term debt.
c. fixed assets.
d. retained earnings.
e. common stock.
21. The composition of the liability and equity sections of a pro forma statement depend
most heavily on a firms:
a. net working capital policies.
b. financing and dividend policies.
c. desired level of liquidity.
d. capital budgeting and working capital policies.
e. level of capacity utilization and net working capital policy.
22. You are comparing a current income statement and a pro forma income statement for a
firm. The pro forma statement reflects a 7 percent rate of growth. Both income
statements include a common-size statement. The firm is currently operating at 80
percent of their capacity. On the pro forma statement, all costs increase at the same
rate as sales. Given this,
a. the net income shown on both statements is identical.
b. the tax rate is assumed to increase at the same rate as the sales.
c. both common size income statements are identical.

d.
e.

the projected increase in retained earnings is equal to the current increase in retained
earnings.
total assets are required to also increase at a rate equal to the rate of sales growth.

23. Which of the following statements concerning pro forma financials are correct?
I.
A pro forma income statement should consider both macroeconomic and industry
forecasts.
II. Pro forma statements should consider the dividend policy of the firm.
III. A pro forma balance sheet must always maintain the current debt-equity ratio of a firm.
IV. A pro forma balance sheet should include consideration of the capacity level of the
firm.
a. I and II only
b. III and IV only
c. I, III, and IV only
d. I, II, and IV only
e. I, II, III, and IV
24. By compiling pro forma statements, firms can:
a. ensure that their anticipated rate of growth will in fact occur.
b. avoid increasing their level of financial leverage while still increasing the growth rate
of the firm.
c. see the projected effects of their planned activities.
d. determine how to grow at a rate that exceeds their sustainable rate of growth without
increasing their equity financing.
e. reduce the daily level of management involvement in the operations of the firm.
25. To ascertain the amount of total assets required to support a projected level of sales,
you primarily need to know the:
a. projected level of capacity utilization.
b. capital intensity ratio.
c. financial structure policy of the firm.
d. rate of internal growth.
e. fixed-asset utilization rate.
26.
a.
b.
c.
d.
e.

The plowback ratio:


is equal to net income divided by the change in total equity.
shows the percentage of net income available to the firm for future growth.
plus the retention ratio must equal 100 percent.
is equal to the change in retained earnings divided by the dividends paid.
represents the earnings returned to the shareholders.

27. Big Macs and Small Dogs are two firms that are equal in every way except for their
retention ratios. Big Macs has a 50 percent retention ratio. Small Dogs has a 60
percent retention ratio. Given this difference,
a. Small Dogs profit margin next year will exceed the profit margin of Big Macs.
b. Small Dogs dividend payout ratio will exceed that of Big Macs.
c. Big Macs plowback ratio will exceed that of Small Dogs.
d. Big Macs has a higher internal rate of growth than does Small Dogs.
e. Small Dogs has a higher sustainable rate of growth than does Big Macs.
28.
a.
b.
c.

Which one of the following statements concerning the capital intensity ratio is correct?
The capital intensity ratio is equal to sales divided by net fixed assets.
The lower the capital intensity ratio, the greater the capital intensity level of the firm.
The capital intensity ratio is equal to one minus the total asset turnover ratio.

d.

The capital intensity ratio is based on the degree of financial leverage employed by a
firm.
e. The capital intensity ratio tells the amount of total assets needed to generate each
dollar of sales.
29. You are comparing the financial statements of General Motors (an automaker) and
Sears (a department store). Which of the following items should you consider if you
are attempting to compare the future growth prospects of both firms?
I.
profit margin
II. capital intensity
III. dividend policy
IV. capital structure policy
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
30.
a.
b.
c.
d.
e.

Any external financing need is generally covered by:


the net income retained by the firm.
adjusting accounts payable.
adjusting the projected cash balance.
adjusting the level of debt or equity.
the projected operating cash flow.

31.
a.
b.
c.
d.
e.

Sales can often increase without increasing which one of the following?
accounts receivable
cost of goods sold
manufacturing labor
fixed assets
inventory

32. If a firm is at full-capacity sales, it means the firm is at the maximum level of
production possible without increasing:
a. net working capital.
b. cost of goods sold.
c. inventory.
d. fixed assets.
e. the debt ratio.
33.
a.
b.
c.
d.
e.

The internal growth rate increases when the:


retention ratio decreases.
dividend payout ratio increases.
net income decreases.
total assets decrease.
plowback ratio decreases.

34. Which of the following are generally expected to increase as the projected growth rate
of a firm increases?
I.
addition to retained earnings
II. external financing need
III. fixed assets
IV. current assets
a. II and IV only

b.
c.
d.
e.

I, II, and IV only


I, III, and IV only
I, II, and III only
I, II, III, and IV

35.
a.
b.
c.
d.
e.

The sustainable growth rate will be equivalent to the internal growth rate when:
a firm has no debt.
the growth rate is positive.
the plowback ratio is positive but less than 1.
a firm has a debt-equity ratio exactly equal to 1.
net income is greater than zero.

36.
a.
b.
c.
d.
e.

The sustainable growth rate:


assumes there is no external financing of any kind.
is normally higher than the internal growth rate.
assumes the debt-equity ratio is variable.
is based on receiving additional external debt and equity financing.
assumes that 100 percent of all income is retained by the firm.

37. If a firm bases its growth projection on the rate of sustainable growth, and shows
positive net income, then the:
a. fixed assets will have to increase at the same rate, regardless of the current capacity
level.
b. number of common shares outstanding will increase at the same rate of growth.
c. debt-equity ratio will have to increase.
d. debt-equity ratio will remain constant while retained earnings increase.
e. fixed assets, debt-equity ratio, and number of common shares outstanding will all
increase.
38. Marcies Mercantile wants to maintain their current dividend policy, which is a payout
ratio of 40 percent. The firm does not want to increase their equity financing but are
willing to maintain their current debt-equity ratio. Given these requirements, the
maximum rate at which Marcies can grow is equal to:
a. 40 percent of the internal rate of growth.
b. 60 percent of the internal rate of growth.
c. the internal rate of growth.
d. the sustainable rate of growth.
e. 60 percent of the sustainable rate of growth.
39.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Which of the following statements concerning the sustainable growth rate are correct?
A decrease in the profit margin will decrease the sustainable rate of growth.
Decreasing capital intensity increases the sustainable rate of growth.
Decreasing the debt-equity ratio also decreases the sustainable rate of growth.
Decreasing the dividend payout ratio also decreases the sustainable rate of growth.
I and II only
III and IV only
I, II, and III only
I, III, and IV only
I, II, III, and IV

40.
a.
b.
c.

One of the primary advantages of financial planning is that it:


concentrates solely on short-term profits.
reconciles planned activities with company priorities.
establishes the highest possible growth rate at any cost.

d.
e.

limits expansion to the maximum achievable internal rate of growth.


eliminates future surprises and unplanned activities.

41.
a.
b.
c.
d.
e.

One of the primary weaknesses of many financial planning models is that they:
rely too much on financial relationships and too little on accounting relationships.
are iterative in nature.
ignore the goals and objectives of senior management.
are based solely on best case assumptions.
ignore the size, risk, and timing of cash flows.

42.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Financial planning:
is an on-going process.
must consider the constraints that exist both internally and externally.
helps a firm establish priorities.
reconciles the activities of the various departments within a firm.
III and IV only
II and III only
I, II, and IV only
II, III, and IV only
I, II, III, and IV

43.
a.
b.
c.
d.
e.

Financial planning, when properly executed,


ignores the normal restraints encountered by a firm.
ensures that the primary goals of senior management are fully achieved.
reduces the necessity of daily management oversight of the business operations.
helps ensure that proper financing is in place to support the desired level of growth.
eliminates the need to plan more than one year in advance.

CHAPTER 2

Financial Statements, Taxes, and Cash Flow


1.
a.
b.
c.
d.
e.

The financial statement showing a firms accounting value on a particular date is the:
income statement.
balance sheet.
statement of cash flows.
tax reconciliation statement.
shareholders equity sheet.

2.
a.
b.
c.
d.
e.

A current asset is:


an item currently owned by the firm.
an item that the firm expects to own within the next year.
an item currently owned by the firm that will convert to cash within the next 12 months.
the amount of cash on hand the firm currently shows on its balance sheet.
the market value of all items currently owned by the firm.

3.
a.
b.
c.
d.

The long-term debts of a firm are liabilities:


that come due within the next 12 months.
that do not come due for at least 12 months.
owed to the firms suppliers.
owed to the firms shareholders.

e.

the firm expects to incur within the next 12 months.

4.
a.
b.
c.
d.
e.

Net working capital is defined as:


total liabilities minus shareholders equity.
current liabilities minus shareholders equity.
fixed assets minus long-term liabilities.
total assets minus total liabilities.
current assets minus current liabilities.

5.
a.
b.
c.
d.
e.

A(n) ____ asset is one which can be quickly converted into cash without significant loss in
value.
current
fixed
intangible
liquid
long-term

6.
a.
b.
c.
d.
e.

Financial leverage refers to the:


amount of debt used in a firms capital structure.
ratio of retained earnings to shareholders equity.
ratio of paid-in surplus to shareholders equity.
ratio of cost-of-goods-sold to total sales.
amount of receivables present in the firms asset structure.

7.
a.
b.
c.
d.
e.

The common set of standards and procedures by which audited financial statements are
prepared is known as the:
matching principle.
cash flow identity.
Generally Accepted Accounting Principles (GAAP).
Freedom of Information Act (FOIA).
1993 Omnibus Budget Reconciliation Act.

8.
a.
b.
c.
d.
e.

The financial statement summarizing a firms performance over a period of time is the:
income statement.
balance sheet.
statement of cash flows.
tax reconciliation statement.
shareholders equity sheet.

9.
a.
b.
c.
d.
e.

Noncash items refer to:


the credit sales of a firm.
the accounts payable of a firm.
the costs incurred for the purchase of intangible fixed assets.
expenses charged against revenues that do not directly affect cash flow.
all accounts on the balance sheet other than cash on hand.

10.
a.
b.
c.
d.
e.

Your _____ tax rate is the amount of tax payable on the next taxable dollar you earn.
deductible
residual
total
average
marginal

11. Your _____ tax rate measures the total taxes you pay divided by your taxable income.

a.
b.
c.
d.
e.

deductible
residual
total
average
marginal

12.
a.
b.
c.
d.
e.

_____ refers to the cash flow that results from the firms ongoing, normal business activities.
Operating cash flow
Capital spending
Net working capital
Cash flow from assets
Cash flow to creditors

13.
a.
b.
c.
d.
e.

_____ refers to the net expenditures by the firm on fixed asset purchases.
Operating cash flow
Capital spending
Net working capital
Cash flow from assets
Cash flow to creditors

14.
a.
b.
c.
d.
e.

_____ refers to the difference between a firms current assets and its current liabilities.
Operating cash flow
Capital spending
Net working capital
Cash flow from assets
Cash flow to creditors

15. _____ refers to the net total cash flow of the firm available for distribution to its creditors and
stockholders.
a. Operating cash flow
b. Capital spending
c. Net working capital
d. Cash flow from assets
e. Cash flow to creditors
16.
a.
b.
c.
d.
e.

_____ refers to the firms interest payments less any net new borrowing.
Operating cash flow
Capital spending
Net working capital
Cash flow from assets
Cash flow to creditors

17.
a.
b.
c.
d.
e.

_____ refers to the firms dividend payments less any net new equity raised.
Operating cash flow
Capital spending
Net working capital
Cash flow from assets
Cash flow to stockholders

18.
a.
b.
c.
d.

Cash flow from assets is also known as the firms:


capital structure.
equity structure.
hidden cash flow.
free cash flow.

e.

historical cash flow.

19.
a.
b.
c.
d.
e.

Earnings per share is equal to:


net income divided by the total number of shares outstanding.
net income divided by the par value of the common stock.
gross income multiplied by the par value of the common stock.
operating income divided by the par value of the common stock.
net income divided by total shareholders equity.

20.
a.
b.
c.
d.
e.

Dividends per share is equal to dividends paid:


divided by the par value of common stock.
divided by the total number of shares outstanding.
divided by total shareholders equity.
multiplied by the par value of the common stock.
multiplied by the total number of shares outstanding.

21.
a.
b.
c.
d.
e.

A computer used in a business office by the office manager is classified as:


a current asset.
an intangible asset.
net working capital.
a tangible asset.
an inventory item.

22.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Which of the following are included in current assets?


equipment
inventory
accounts payable
cash
II and IV only
I and III only
I, II, and IV only
III and IV only
II, III, and IV only

23.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Which of the following are included in current liabilities?


note payable to a supplier in eighteen months
debt payable to a mortgage company in nine months
accounts payable to suppliers
loan payable to the bank in fourteen months
I and III only
II and III only
III and IV only
II, III, and IV only
I, II, and III only

24.
a.
b.
c.
d.

Which one of the following statements concerning net working capital is correct?
Net working capital is negative when current assets exceed current liabilities.
Net working capital includes cash, accounts receivables, fixed assets, and accounts payable.
Inventory is a part of net working capital.
The change in net working capital is equal to the beginning net working capital minus the
ending net working capital.
Net working capital includes accounts from the income statement.

e.

25. Which one of the following statements concerning net working capital is correct?

a.
b.
c.
d.
e.

The greater the net working capital, the greater the ability of a firm to meet its short-term
obligations.
The change in net working capital is equal to current assets minus current liabilities.
Depreciation must be added back to current assets when computing the change in net working
capital.
Net working capital is equal to long-term assets minus long-term liabilities.
Net working capital is a part of the operating cash flow.

26.
a.
b.
c.
d.
e.

An increase in total assets:


means that net working capital is also increasing.
requires an investment in fixed assets.
means that shareholders equity must also increase.
must be offset by an equal increase in liabilities and shareholders equity.
can only occur when a firm has positive net income.

27.
a.
b.
c.
d.
e.

Which one of the following accounts is the most liquid?


inventory
building
accounts receivable
equipment
patent

28. Which of the following accounts generally increase in value when a firm sells shares
of its common stock at a price in excess of par value?
I. retained earnings
II. paid-in surplus
III. common stock
IV. preferred stock
a. I and II only
b. II and III only
c. III and IV only
d. I, II, and III only
e. II, III, and IV only
29.
a.
b.
c.
d.
e.

Which one of the following statements concerning liquidity is correct?


If you can sell an asset today, it is a liquid asset.
If you can sell an asset next year at a price equal to its actual value, the asset is highly liquid.
Trademarks and patents are highly liquid.
The less liquidity a firm has, the lower the probability the firm will encounter financial
difficulties.
Balance sheet accounts are listed in order of decreasing liquidity.

30.
a.
b.
c.
d.
e.

Liquidity is:
a measure of the use of debt in a firms capital structure.
equal to current assets minus current liabilities.
equal to the market value of a firms total assets minus its current liabilities.
valuable to a firm even though liquid assets tend to be less profitable to own.
generally associated with intangible assets.

31.
I.
II.
III.
IV.

Which of the following accounts are included in shareholders equity?


interest paid
retained earnings
paid in surplus
long-term debt

a.
b.
c.
d.
e.

I and II only
II and IV only
I and IV only
II and III only
I and III only

32.
a.
b.
c.
d.
e.

Shareholders equity:
includes common stock, paid in surplus, retained earnings, and long-term debt.
on a balance sheet is equivalent to the market value of the outstanding shares of stock.
includes all of a firms earnings retained by the firm to date.
increases, all else equal, when the dividends paid are greater than the net income for a year.
includes the book value of any bonds issued by the firm.

33.
a.
b.
c.
d.
e.

The higher the degree of financial leverage employed by a firm, the:


lower the probability that the firm will encounter financial distress.
greater the amount of debt incurred.
greater the number of shares of common stock issued.
greater the cash flow to creditors each year.
lower the potential gains to shareholders.

34.
a.
b.
c.
d.
e.

Book value:
is equivalent to market value for firms with fixed assets.
is based on historical cost.
generally tends to exceed market value when fixed assets are included.
is more of a financial than an accounting valuation.
is adjusted to market value whenever the market value exceeds the stated book value.

35.
a.
b.
c.
d.
e.

When making financial decisions related to assets, you should:


always consider market values.
place more emphasis on book values than on market values.
rely primarily on the value of assets as shown on the balance sheet.
place primary emphasis on historical costs.
only consider market values if they are less than book values.

36. As seen on an income statement:


a. interest is deducted from income and increases the total taxes incurred.
b. the tax rate is applied to the earnings before interest and taxes when the firm has both
depreciation and interest expenses.
c. depreciation is shown as an expense but does not affect the taxes payable.
d. depreciation reduces both the taxable income and the net income.
e. interest expense is added to earnings before interest and taxes to get taxable income.
37.
a.
b.
c.
d.
e.

The earnings per share will:


increase as net income increases.
increase as the number of shares outstanding increase.
decrease as the total revenue of the firm increases.
increase as the tax rate increases.
decrease as the costs decrease.

38. Dividends per share:


a. increase as the net income increases as long as the number of shares outstanding remains
constant.
b. decrease as the number of shares outstanding decrease, all else constant.
c. are inversely related to the earnings per share.

d.
e.

are based upon the dividend requirements established by Generally Accepted Accounting
Procedures.
are equal to the amount of net income distributed to shareholders divided by the number
of shares outstanding.

39.
a.
b.
c.
d.
e.

According to Generally Accepted Accounting Principles,


income is recorded based on the matching principle.
income is recorded based on the realization principle.
costs are recorded based on the liquidity principle.
net income is recorded based on the realization principle.
depreciation is recorded as it affects the cash flows of a firm.

40.
a.
b.
c.
d.
e.

According to Generally Accepted Accounting Principles, costs are:


recorded as incurred.
recorded when paid.
matched with revenues.
matched with production levels.
expensed as management desires.

41.
a.
b.
c.
d.
e.

Depreciation:
is a noncash expense that is recorded on the income statement.
increases the net fixed assets as shown on the balance sheet.
reduces both the net fixed assets and the costs of a firm.
is a non-cash expense which increases the net operating income.
decreases net fixed assets, net income, and operating cash flows.

42.
I.
II.
III.
IV.
a.
b.
c.
d.
e.

Fixed costs in the short-run generally include which of the following?


manufacturing wages
cost of materials used in production
property insurance
contractually determined management salaries
I and II only
II and III only
III and IV only
I and IV only
II and IV only

43.
a.
b.
c.
d.
e.

When you are making a financial decision, the most relevant tax rate is the _____ rate.
average
fixed
marginal
total
variable

44.
a.
b.
c.
d.

The cash flow from assets is equal to:


operating cash flow minus the change in net working capital plus net capital spending.
cash flow to creditors minus the cash flow to shareholders.
earnings before interest and taxes plus depreciation plus taxes.
earnings before interest and taxes plus depreciation plus taxes minus net capital spending minus
the change in net working capital.
earnings before interest and taxes plus depreciation minus taxes minus net capital
spending minus the change in net working capital.

e.

45. An increase in which one of the following will cause the cash flow from assets to increase?

a.
b.
c.
d.
e.

depreciation
change in net working capital
net working capital
taxes
costs

46.
a.
b.
c.
d.
e.

Cash flow from assets must be negative when:


the firm has a taxable loss for the year.
the cash flow from creditors and the cash flow from stockholders are both negative.
the cash flow from creditors is negative and the cash flow from stockholders is positive.
the change in net working capital exceeds the net capital spending.
operating cash flow is less than the change in net working capital.

47.
a.
b.
c.
d.
e.

Assume a firm has depreciation, taxes, and interest expense. In this case, operating cash flow:
is the same as net income.
is the same as net income plus depreciation.
must be positive because depreciation is added to the taxable income.
can be positive, negative, or equal to zero.
is equal to the cash flow to creditors.

48. A firm starts its year with a positive net working capital. During the year, the firm acquires
more short-term debt than it does short-term assets. This means that:
a. the ending net working capital will be negative.
b. both accounts receivable and inventory decreased during the year.
c. the beginning current assets were less than the beginning current liabilities.
d. accounts payable increased and inventory decreased during the year.
e. the ending net working capital can be positive, negative, or equal to zero.
49. Net capital spending:
a. is negative if the sale of fixed assets is greater than the acquisition of current assets.
b. is equal to zero if the decrease in the fixed assets account is equal to the depreciation
expense for the period.
c. reflects the net changes in total assets over a stated period of time.
d. is equivalent to the cash flow from assets.
e. is equal to the ending net fixed assets minus the beginning net fixed assets.
50.
a.
b.
c.
d.
e.

The cash flow to creditors includes the cash:


received by the firm when payments are paid to suppliers.
outflow of the firm when new debt is acquired.
outflow when interest is paid on outstanding debt.
inflow when accounts payable decreases.
received when long-term debt is paid off.

51.
a.
b.
c.
d.
e.

Cash flow to stockholders must be positive when:


the dividends paid exceed the net new equity raised.
the net sale of common stock exceeds the amount of dividends paid.
no income is distributed but new shares of stock are sold.
both the cash flow to assets and the cash flow to creditors are negative.
both the cash flow to assets and the cash flow to creditors are positive.