Financial Statement Analysis

MODULE 10 small firm.

C. Relative numbers would be most meaningful for the large firm; absolute numbers would be most
FINANCIAL STATEMENT ANALYSIS meaningful for the small firm.
D. Relative numbers would be most meaningful for both the large and small firm, especially for
THEORIES: interfirm comparisons.
6. Management is a user of financial analysis. Which of the following comments does not represent a fair statement as to the
management perspective? 4. Which of these statements is false?
A. Management is always interested in maximum profitability. A. Many companies will not clearly fit into any one industry.
B. Management is interested in the view of investors. B. A financial service uses its best judgment as to which industry the firm best fits.
C. Management is interested in the financial structure of the entity. C. The analysis of an entity's financial statements can be more meaningful if the results are compared
D. Management is interested in the asset structure of the entity. with industry averages and with results of competitors.
D. A company comparison should not be made with industry averages if the company does not clearly
Limitations fit into any one industry.
1. A limitation in calculating ratios in financial statement analysis is that
A. it requires a calculator. Common-sized financial statements
B. no one other than the management would be interested in them. 9. Which of the following generally is the most useful in analyzing companies of different sizes?
C. some account balances may reflect atypical data at year end. A. comparative statements C. price-level accounting
D. they seldom identify problem areas in a company. B. common-sized financial statements D. profitability index

2. Which of the following is not a limitation of financial statement analysis? 12. Statements in which all items are expressed only in relative terms (percentages of a base) are termed:
A. The cost basis. C. The diversification of firms. A. Vertical statements C. Funds Statements
B. The use of estimates. D. The availability of information. B. Horizontal Statements D. Common-Size Statements

5. Which of the following does not represent a problem with financial analysis? 10. The percent of property, plant and equipment to total assets is an example of:
A. Financial statement analysis is an art; it requires judgment decisions on the part of the analyst. A. vertical analysis C. profitability analysis
B. Financial analysis can be used to detect apparent liquidity problems. B. solvency analysis D. horizontal analysis
C. There are as many ratios for financial analysis as there are pairs of figures.
D. Some industry ratio formulas vary from source to source. 15. Vertical analysis is a technique that expresses each item in a financial statement
A. in pesos and centavos.
77. The use of alternative accounting methods: B. as a percent of the item in the previous year.
A. is not a problem in ratio analysis because the footnotes disclose the method used. C. as a percent of a base amount.
B. may be a problem in ratio analysis even if disclosed. D. starting with the highest value down to the lowest value.
C. is not a problem in ratio analysis since eventually all methods will lead to the same end.
D. is only a problem in ratio analysis with respect to inventory. 17. In performing a vertical analysis, the base for prepaid expenses is
A. total current assets. C. total liabilities.
Industry Analysis B. total assets. D. prepaid expenses in a previous year.
3. Suppose you are comparing two firms in the steel industry. One firm is large and the other is small. Which type of numbers
would be most meaningful for statement analysis? Horizontal analysis
A. Absolute numbers would be most meaningful for both the large and small firm. 8. The percentage analysis of increases and decreases in individual items in comparative financial
B. Absolute numbers would be most meaningful in the large firm; relative numbers would be most meaningful in the statements is called:

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A. vertical analysis C. profitability analysis A. instead of horizontal and vertical analyses.

B. solvency analysis D. horizontal analysis B. because they can provide information that may not be apparent from inspection of the individual
components of a particular ratio.
11. Horizontal analysis is also known as C. because even single ratios by themselves are quite meaningful.
A. linear analysis. C. trend analysis. D. because they are prescribed by GAAP.
B. vertical analysis. D. common size analysis.
18. In the near term, the important ratios that provide the information critical to the short-run operation of
13. In which of the following cases may a percentage change be computed? the firm are:
A. The trend of the amounts is decreasing but all amounts are positive. A. liquidity, activity, and profitability C. liquidity, activity, and equity
B. There is no amount in the base year. B. liquidity, activity, and debt D. activity, debt, and profitability
C. There is a negative amount in the base year and a negative amount in the subsequent year.
D. There is a negative amount in the base year and a positive amount in the subsequent year. 75. The ability of a business to pay its debts as they come due and to earn a reasonable amount of income
is referred to as:
14. Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time A. solvency and leverage C. solvency and liquidity
A. that has been arranged from the highest number to the lowest number. B. solvency and profitability D. solvency and equity
B. that has been arranged from the lowest number to the highest number.
C. to determine which items are in error. Liquidity ratios
D. to determine the amount and/or percentage increase or decrease that has taken place. Interested parties
19. The primary concern of short-term creditors when assessing the strength of a firm is the entitys
Trend analysis A. short-term liquidity C. market price of stock
16. Trend analysis allows a firm to compare its performance to: B. profitability D. leverage
A. other firms in the industry C. other industries
B. other time periods within the firm D. none of the above 35. Short-term creditors are usually most interested in assessing
A. solvency. C. marketability.
Risk and return B. liquidity. D. profitability.
29. The present and prospective stockholders are primarily concerned with a firm
A. profitability C. leverage 36. The two categories of ratios that should be utilized to asses a firms true liquidity are the
B. liquidity D. risk and return A. current and quick ratios C. liquidity and profitability ratios
B. liquidity and debt ratios D. liquidity and activity ratios
69. Which suppliers of funds bear the greatest risk and should therefore earn the greatest return?
A. common stockholders C. preferred shareholders 47. Which of the following is the most of interest to a firms suppliers?
B. general creditors such as banks D. bondholders A. profitability C. asset utilization
B. debt D. liquidity
Measures of Risk
54. The following groups of ratios primarily measure risk: Measures of liquidity
A. liquidity, activity, and common equity C. liquidity, activity, and debt 21. The ratios that are used to determine a companys short-term debt paying ability are
B. liquidity, activity, and profitability D. activity, debt, and profitability A. asset turnover, times interest earned, current ratio, and receivables turnover.
B. times interest earned, inventory turnover, current ratio, and receivables turnover.
Financial ratios C. times interest earned, acid-test ratio, current ratio, and inventory turnover.
7. Ratios are used as tools in financial analysis D. current ratio, acid-test ratio, receivables turnover, and inventory turnover.

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B. Current ratio
20. Which of the following is a measure of the liquidity position of a corporation? C. Degree of Financial Leverage
A. earnings per share D. Accounts Receivable Turnover in Days
B. inventory turnover
C. current ratio 41. A weakness of the current ratio is
D. number of times interest charges earned A. the difficulty of the calculation.
B. that it does not take into account the composition of the current assets.
37. Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit C. that it is rarely used by sophisticated analysts.
to a company? D. that it can be expressed as a percentage, as a rate, or as a proportion.
A. Current ratio C. Asset turnover
B. Acid-test ratio D. Receivables turnover Acid-test or quick ratio
42. A measure of a companys immediate short-term liquidity is the
51. Which of the following ratios would be least helpful in appraising the liquidity of current assets? A. current ratio.
A. Accounts Receivable turnover C. Current Ratio B. current cash debt coverage ratio.
B. Days sales in inventory D. Days sales in accounts receivable C. cash debt coverage ratio.
D. acid-test ratio.
53. Which ratio is most helpful in appraising the liquidity of current assets?
A. current ratio C. acid-test ratio 23. The acid-test or quick ratio
B. debt ratio D. accounts receivable turnover A. is used to quickly determine a companys solvency and long-term debt paying ability.
B. relates cash, short-term investments, and net receivables to current liabilities.
Not a measure of liquidity C. is calculated by taking one item from the income statement and one item from the balance sheet.
79. Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to D. is the same as the current ratio except it is rounded to the nearest whole percent.
a company?
A. accounts receivable turnover. C. acid test ratio. Not a liquidity ratio
B. asset turnover. D. current ratio. 28. Which one of the following would not be considered a liquidity ratio?
A. Current ratio. C. Quick ratio.
Current ratio B. Inventory turnover. D. Return on assets.
24. Typically, which of the following would be considered to be the most indicative of a firm's short-term debt paying ability?
A. working capital C. acid test ratio Activity ratios
B. current ratio D. days sales in receivables Days receivable & receivable turnover
Quality of receivables
22. The current ratio is 25. Which of the following does not bear on the quality of receivables?
A. calculated by dividing current liabilities by current assets. A. shortening the credit terms
B. used to evaluate a companys liquidity and short-term debt paying ability. B. lengthening the credit terms
C. used to evaluate a companys solvency and long-term debt paying ability. C. lengthening the outstanding period
D. calculated by subtracting current liabilities from current assets. D. all of the above bear on the quality of receivables

30. Which of the following ratios is rated to be a primary measure of liquidity and considered of highest significance rating of Days receivable
the liquidity ratios a bank analyst? 27. A general rule to use in assessing the average collection period is
A. Debt/Equity A. that is should not exceed 30 days.

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B. it can be any length as long as the customer continues to buy merchandise. 90. The tendency of the rate earned on stockholders' equity to vary disproportionately from the rate earned
C. that it should not greatly exceed the discount period. on total assets is sometimes referred to as:
D. that it should not greatly exceed the credit term period. A. leverage C. yield
B. solvency D. quick assets
Asset utilization ratios
Performance measures 55. Using financial leverage is a good financial strategy from the viewpoint of stockholders of companies
65. All of the following are asset utilization ratios except: having:
A. average collection period C. receivables turnover A. a high debt ratio C. a steadily declining current ratio
B. inventory turnover D. return on assets B. steady or rising profits D. cyclical highs and lows

Asset turnover 46. The ratio that indicates a companys degree of financial leverage is the
63. Asset turnover measures A. cash debt coverage ratio. C. free cash flow ratio.
A. how often a company replaces its assets. B. debt to total assets. D. times-interest earned ratio.
B. how efficiently a company uses its assets to generate sales.
C. the portion of the assets that have been financed by creditors. 73. Interest expense creates magnification of earnings through financial leverage because:
D. the overall rate of return on assets. A. while earnings available to pay interest rise, earnings to residual owners rise faster
B. interest accompanies debt financing
66. Total asset turnover measures the ability of a firm to: C. interest costs are cheaper than the required rate of return to equity owners
A. generate profits on sales S. the use of interest causes higher earnings
B. generate sales through the use of assets
C. cover long-term debt Measures of solvency
D. buy new assets 34. The set of ratios that is most useful in evaluating solvency is
A. debt ratio, current ratio, and times interest earned
76. A measure of how efficiently a company uses its assets to generate sales is the B. debt ratio, times interest earned, and return on assets
A. asset turnover ratio. C. profit margin ratio. C. debt ratio, times interest earned, and quick ratio
B. cash return on sales ratio. D. return on assets ratio. D. debt ratio, times interest earned, and cash flow to debt

Solvency ratios 49. Which of the following ratios is most relevant to evaluating solvency?
Interested parties A. Return on assets C. Days purchases in accounts payable
50. Long-term creditors are usually most interested in evaluating B. Debt ratio D. Dividend yield
A. liquidity. C. profitability.
B. marketability. D. solvency. Fixed assets to long-term liabilities
44. Which of the following ratios provides a solvency measure that shows the margin of safety of
Financial Leverage noteholders or bondholders and also gives an indication of the potential ability of the business to borrow
45. Trading on the equity (leverage) refers to the additional funds on a long-term basis?
A. amount of working capital. A. ratio of fixed assets to long-term liabilities
B. amount of capital provided by owners. B. ratio of net sales to assets
C. use of borrowed money to increase the return to owners. C. number of days' sales in receivables
D. earnings per share. D. rate earned on stockholders' equity

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Debt ratio D. fixed charge ratio will be overstated, based upon the financial statements
59. The debt ratio indicates:
A. a comparison of liabilities with total assets Profitability ratios
B. the ability of the firm to pay its current obligations Interested parties
C. the efficiency of the use of total assets 39. The return on assets ratio is affected by the
D. the magnification of earnings caused by leverage A. asset turnover ratio.
B. debt to total assets ratio.
78. The debt to total assets ratio measures C. profit margin ratio.
A. the companys profitability. D. asset turnover and profit margin ratios.
B. whether interest can be paid on debt in the current year.
C. the proportion of interest paid relative to dividends paid. 52. Stockholders are most interested in evaluating
D. the percentage of the total assets provided by creditor. A. liquidity. C. profitability.
B. solvency. D. marketability.
Debt-to-equity ratio
60. Which of the following statements best compares long-term borrowing capacity ratios? Performance measures
A. The debt/equity ratio is more conservative than the debt ratio. 48. The set of ratios that are most useful in evaluating profitability is
B. The debt to tangible net worth ratio is more conservative than the debt/equity ratio. A. ROA, ROE, and debt to equity ratio C. ROA, ROE, and acid-test ratio
C. The debt/equity ratio is more conservative than the debt to tangible net worth ratio. B. ROA, ROE, and dividend yield D. ROA, ROE, and cash flow to debt
D. The debt ratio is more conservative than the debt/equity ratio.
Earnings per share
Times interest earned 82. Which of the following ratios appears most frequently in annual reports?
74. A times interest earned ratio of 0.90 to 1 means that A. Earnings per Share C. Profit Margin
A. the firm will default on its interest payment B. Return on Equity D. Debt/Equity
B. net income is less than the interest expense
C. the cash flow is less than the net income Return on assets
D. the cash flow exceeds the net income 64. Return on assets
A. can be determined by looking at a balance sheet
Fixed charge coverage B. should be smaller than return on sales
61. A fixed charge coverage: C. can be affected by the companys choice of a depreciation method
A. is a balance sheet indication of debt carrying ability D. should be larger than return on equity
B. is an income statement indication of debt carrying ability
C. frequently includes research and development Return on investments
D. computation is standard from firm to firm 72. Return on investment measures:
A. return to all suppliers of funds C. return to all long-term suppliers of funds
Off-balance sheet liabilities B. return to all long-term creditors D. return to stockholders
62. If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in the financial statements,
then the Market test ratios
A. times interest earned ratio will be overstated, based upon the financial statements Price-earnings ratio
B. debt ratio will be understated 56. The price/earnings ratio
C. working capital will be understated A. measures the past earning ability of the firm

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B. is a gauge of future earning power as seen by investors A. Buy raw materials on credit
C. relates price to dividends B. Sell marketable securities at cost
D. relates C. Pay off accounts payable with cash
D. Pay off a portion of long-term debt with cash
58. Which of the following ratios usually reflects investors opinions of the future prospects for the firm?
A. dividend yield C. book value per share Fixed asset turnover ratio
B. price/earnings ratio D. earnings per share 68. Which of the following circumstances will cause sales to fixed assets to be abnormally high?
A. A labor-intensive industry.
Dividend yield B. The use of units-of-production depreciation.
57. Which of the following ratios represents dividends per common share in relation to market price per common share? C. A highly mechanized facility.
A. dividend payout C. price/earnings D. High direct labor costs from a new union contract.
B. dividend yield D. book value per share
Total asset turnover
Financial Statement Analysis 81. A firm with a total asset turnover lower than the industry standard and a current ratio which meets
Accounts Receivable industry standard might have excessive:
26. Which of the following reasons should not be considered in order to explain why the receivables appear to be abnormally A. Accounts receivable C. Debt
high? B. Fixed assets D. Inventory
A. Sales volume decreases materially late in the year.
B. Receivables have collectibility problems and possibly some should have been written off. Profitability analysis
C. Material amount of receivables are on the installment basis. 84. Denver Dynamics has net income of P2,000,000. Oakland Enterprises has net income of P2,500,000.
D. Sales volume expanded materially late in the year. Which of the following best compares the profitability of Denver and Oakland?
A. Oakland Enterprises is 25% more profitable than Denver Dynamics.
31. An acceleration in the collection of receivables will tend to cause the accounts receivable turnover to: B. Oakland Enterprises is more profitable than Denver Dynamics, but the comparison can't be
A. decrease C. either increase or decrease quantified.
B. remain the same D. increase C. Oakland Enterprises is only more profitable if it is smaller than Denver Dynamics.
D. Further information is needed for a reasonable comparison.
Inventories
32. Which of the following would best indicate that the firm is carrying excess inventory? Debt ratio
A. a decline in the current ratio 86. Companies A and B are in the same industry and have similar characteristics except that Company A
B. stable current ratio with declining quick ratios is more leveraged than Company B. Both companies have the same income before interest and
C. a decline in days' sales in inventory taxes and the same total assets. Based on this information we could conclude that
D. a rise in total asset turnover A. Company A has higher net income than Company B
B. Company A has a lower return on assets than company B
89. When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an average quick ratio, and a low C. Company A is more risky than Company B.
inventory turnover. What might you assume about Tri-C? D. Company A has a lower debt ratio than company B
A. Its cash balance is too low. C. Its current liabilities are too low.
B. Its cost of goods sold is too low. D. Its average inventory is too high. Sensitivity Analysis
Current ratio
Current ratio 40. A firm has a current ratio of 1:1. In order to improve its liquidity ratios, this firm should
33. Which of the following would be most detrimental to a firm's current ratio if that ratio is currently 2.0? A. improve its collection practices, thereby increasing cash and increasing its current and quick

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ratios. Return on assets

B. improve its collection practices and pay accounts payable, there decreasing current liabilities and increasing the 67. Return on assets cannot fall under which of the following circumstances?
current and quick ratios. A. B. C. D.
C. decrease current liabilities by utilizing more long-term debt, thereby increasing the current and quick ratios. Net profit margin Decline Rise Rise Decline
D. increase inventory, thereby increasing current assets and the current and quick ratios. Total asset turnover Rise Decline Rise Decline

43. Recently the M&M Company has been having problems. As a result, its financial situation has deteriorated. M&M Debt ratio
approached the First National Bank for a badly needed loan, but the loan officer insisted that the current ratio (now 0.5) be 83. Jones Company has long-term debt of P1,000,000, while Smith Company, Jones' competitor, has long-
improved to at least 0.8 before the bank would even consider granting the credit. Which of the following actions would do term debt of P200,000. Which of the following statements best represents an analysis of the long-term
the most to improve the ratio in the short run? debt position of these two firms?
A. Using some cash to pay off some current liabilities. A. Jones obviously has too much debt when compared to its competitor.
B. Collecting some of the current accounts receivable. B. Smith Company's times interest earned should be lower than Jones.
C. Paying off some long-term debt. C. Smith has five times better long-term borrowing ability than Jones.
D. Purchasing additional inventory on credit (accounts payable). D. Not enough information to determine if any of the answers are correct.
87. Tyner Company had P250,000 of current assets and P90,000 of current liabilities before borrowing P60,000 from the Times interest earned
bank with a 3-month note payable. What effect did the borrowing transaction have on Tyner Company's current ratio? 85. Which of the following will not cause times interest earned to drop? Assume no other changes than
A. The ratio remained unchanged. those listed.
B. The change in the current ratio cannot be determined. A. A rise in preferred stock dividends.
C. The ratio decreased. B. A drop in sales with no change in interest expense.
D. The ratio increased. C. An increase in interest rates.
D. An increase in bonds payable with no change in operating income.
88. Which of the following actions will increase a firm's current ratio if it is now less than 1.0?
A. Convert marketable securities to cash. DuPont Analysis
B. Pay accounts payable with cash. 71. Which of the following could cause return on assets to decline when net profit margin is increasing?
C. Buy inventory with short term credit (i.e. accounts payable). A. sale of investments at year-end C. purchase of a new building at year-end
D. Sell inventory at cost. B. increased turnover of operating assets D. a stock split
Acid-test ratio 80. A firm with a lower net profit margin can improve its return on total assets by
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 A. increasing its debt ratio C. increasing its total asset turnover
collection of accounts receivable have on the ratio? B. decreasing its fixed assets turnover D. decreasing its total asset turnover
A. B. C. D.
Short-term borrowing Increase Increase Decrease Decrease
Collection of receivable No effect Increase No effect Decrease PROBLEMS:
Horizontal analysis
i
Profit margin . Kline Corporation had net income of P2 million in 2006. Using the 2006 financial elements as the base
70. Which of the following would most likely cause a rise in net profit margin? data, net income decreased by 70 percent in 2007 and increased by 175 percent in 2008. The
A. increased sales C. decreased operating expenses respective net income reported by Kline Corporation for 2007 and 2008 are:
B. decreased preferred dividends D. increased cost of sales A. P 600,000 and P5,500,000 C. P1,400,000 and P3,500,000
B. P5,500,000 and P 600,000 D. P1,400,000 and P5,500,000

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ii vi
. 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 . The companys acid-test ratio as of the balance sheet date is:
income of P300,000: A. 1.80:1 C. 2.02:1
A. can be stated as 0% C. cannot be stated as a percentage B. 2.40:1 D. 1.76:1
B. can be stated as 100% increase D. can be stated as 200% increase
Activity ratios
Liquidity ratios Receivables turnover
iii vii
. The following financial data have been taken from the records of Ratio Company: . Pine Hardware Store had net credit sales of P6,500,000 and cost of goods sold of P5,000,000 for the
Accounts receivable P200,000 year. The Accounts Receivable balances at the beginning and end of the year were P600,000 and
Accounts payable 80,000 P700,000, respectively. The receivables turnover was
Bonds payable, due in 10 years 500,000 A. 7.7 times. C. 9.3 times.
Cash 100,000 B. 10.8 times. D. 10.0 times.
Interest payable, due in three months 25,000
viii
Inventory 440,000 . Milward Corporations books disclosed the following information for the year ended December 31, 2007:
Land 800,000 Net credit sales P1,500,000
Notes payable, due in six months 250,000 Net cash sales 240,000
What will happen to the ratios below if Ratio Company uses cash to pay 50 percent of its accounts payable? Accounts receivable at beginning of year 200,000
A. B. C. D. Accounts receivable at end of year 400,000
Current ratio Increase Decrease Increase Decrease Milwards accounts receivable turnover is
Acid-test ratio Increase Decrease Decrease Increase A. 3.75 times C. 5.00 times
B. 4.35 times D. 5.80 times
Question Nos. 4 through 6 are based on the data taken from the balance sheet of Nomad Company at the end of the current
year: Days receivable
ix
Accounts payable P145,000 . Batik Clothing Store had a balance in the Accounts Receivable account of P390,000 at the beginning of
Accounts receivable 110,000 the year and a balance of P410,000 at the end of the year. The net credit sales during the year
Accrued liabilities 4,000 amounted to P4,000,000. Using 360-day year, what is the average collection period of the receivables?
Cash 80,000 A. 30 days C. 73 days
Income tax payable 10,000 B. 65 days D. 36 days
Inventory 140,000
Marketable securities 250,000 Cash collection
x
Notes payable, short-term 85,000 . Deity Company had sales of P30,000, increase in accounts payable of P5,000, decrease in accounts
Prepaid expenses 15,000 receivable of P1,000, increase in inventories of P4,000, and depreciation expense of P4,000. What was
the cash collected from customers?
iv
. The amount of working capital for the company is: A. P31,000 C. P34,000
A. P351,000 C. P211,000 B. P35,000 D. P25,000
B. P361,000 D. P336,000
Inventory turnover
xi
v
. The companys current ratio as of the balance sheet date is: . During 2007, Tarlac Company purchased P960,000 of inventory. The cost of goods sold for 2007
A. 2.67:1 C. 2.02:1 was P900,000, and the ending inventory at December 31, 2007 was P180,000. What was the
B. 2.44:1 D. 1.95:1 inventory turnover for 2007?

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 Financial Statement Analysis

A. 6.4 C. 5.3 A. 102.2 C. 87.6

B. 6.0 D. 5.0 B. 94.9 D. 68.1
xii
. Selected information from the accounting records of Petals Company is as follows: Turnover ratios
Net sales for 2007 P900,000 Asset turnover
Cost of goods sold for 2007 600,000 Asset
xvi
Inventory at December 31, 2006 180,000 . Net sales are P6,000,000, beginning total assets are P2,800,000, and the asset turnover is 3.0. What
Inventory at December 31, 2007 156,000 is the ending total asset balance?
Petals inventory turnover for 2007 is A. P2,000,000. C. P2,800,000.
A. 5.77 times C. 3.67 times B. P1,200,000. D. P1,600,000.
B. 3.85 times D. 3.57 times
Solvency ratios
xiii
. The Moss Company presents the following data for 2007. Debt ratio
xvii
Net Sales, 2007 P3,007,124 . Jordan Manufacturing reports the following capital structure:
Net Sales, 2006 P 930,247 Current liabilities P100,000
Cost of Goods Sold, 2007 P2,000,326 Long-term debt 400,000
Cost of Goods Sold, 2007 P1,000,120 Deferred income taxes 10,000
Inventory, beginning of 2007 P 341,169 Preferred stock 80,000
Inventory, end of 2007 P 376,526 Common stock 100,000
The merchandise inventory turnover for 2007 is: Premium on common stock 180,000
A. 5.6 C. 7.5 Retained earnings 170,000
B. 15.6 D. 7.7 What is the debt ratio?
A. 0.48 C. 0.93
xiv
. Based on the following data for the current year, what is the inventory turnover? B. 0.49 D. 0.96
Net sales on account during year P 500,000
Cost of merchandise sold during year 330,000 Times interest earned
xviii
Accounts receivable, beginning of year 45,000 . House of Fashion Company had the following financial statistics for 2006:
Accounts receivable, end of year 35,000 Long-term debt (average rate of interest is 8%) P400,000
Inventory, beginning of year 90,000 Interest expense 35,000
Inventory, end of year 110,000 Net income 48,000
A. 3.3 C. 3.7 Income tax 46,000
B. 8.3 D. 3.0 Operating income 107,000
What is the times interest earned for 2006?
Days inventory A. 11.4 times C. 3.1 times
xv
. Selected information from the accounting records of Eternity Manufacturing Company follows: B. 3.3 times D. 3.7 times
Net sales P3,600,000
xix
Cost of goods sold 2,400,000 . Brava Company reported the following on its income statement:
Inventories at January 1 672,000 Income before taxes P400,000
Inventories at December 31 576,000 Income tax expense 100,000
What is the number of days sales in average inventories for the year? Net income P300,000

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An analysis of the income statement revealed that interest expense was P100,000. Brava Companys times interest Retained earnings 150,000 370,000
earned (TIE) was Dividends paid on preferred stock for the year 20,000 20,000
A. 5 times C. 3.5 times Net income for the year 120,000 240,000
B. 4 times D. 3 times Ivanos return on common stockholders equity, rounded to the nearest percentage point, for 2007 is
A. 17% C. 21%
xx
. The balance sheet and income statement data for Candle Factory indicate the following: B. 19% D. 23%
Bonds payable, 10% (issued 1998 due 2022) P1,000,000
Preferred 5% stock, P100 par (no change during year) 300,000 Dividend yield
Common stock, P50 par (no change during year) 2,000,000 xxiv
. The following information is available for Duncan Co.:
Income before income tax for year 350,000 2006
Income tax for year 80,000 Dividends per share of common stock P 1.40
Common dividends paid 50,000 Market price per share of common stock 17.50
Preferred dividends paid 15,000 Which of the following statements is correct?
Based on the data presented above, what is the number of times bond interest charges were earned (round to one decimal A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market price of
point)? their stocks.
A. 3.7 C. 4.5 B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns on their
B. 4.4 D. 3.5 investments.
C. The dividend yield is 12.5%, which is of interest to bondholders.
xxi
. The following data were abstracted from the records of Johnson Corporation for the year: D. The dividend yield is 8.0 times the market price, which is important in solvency analysis.
Sales P1,800,000
Bond interest expense 60,000 Market Test Ratios
Income taxes 300,000 Market/Book value ratio
Net income 400,000 Price per share
How many times was bond interest earned? xxv
. What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book value of
A. 7.67 C. 12.67 equity of P3,000,000, and a market/book ratio of 3.5?
B. 11.67 D. 13.67 A. P8.57 C. P85.70
B. P30.00 D. P105.00
Net income
xxii
. The times interest earned ratio of Mikoto Company is 4.5 times. The interest expense for the year was P20,000, and P/E ratio
the companys tax rate is 40%. The companys net income is: xxvi
. Orchard Companys capital stock at December 31 consisted of the following:
A. P22,000 C. P54,000 Common stock, P2 par value; 100,000 shares authorized, issued, and outstanding.
B. P42,000 D. P66,000 10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares
authorized, issued, and outstanding.
Profitability Ratios Orchards common stock, which is listed on a major stock exchange, was quoted at P4 per share on
Return on Common Equity December 31. Orchards net income for the year ended December 31 was P50,000. The yearly
xxiii
. Selected information for Ivano Company as of December 31 is as follows: preferred dividend was declared. No capital stock transactions occurred. What was the price earnings
2006 2007 ratio on Orchards common stock at December 31?
Preferred stock, 8%, par P100, nonconvertible, P250,000 P250,000 A. 6 to 1 C. 10 to 1
noncumulative B. 8 to 1 D. 16 to 1
Common stock 600,000 800,000

64
 Financial Statement Analysis

Debt ratio
xxvii xxxi
. On December 31, 2006 and 2007, Renegade Corporation had 100,000 shares of common stock and 50,000 shares of . The Board of Directors is dissatisfied with last year's ROE of 15%. If the profit margin and asset
noncumulative and nonconvertible preferred stock issued and outstanding. turnover remain unchanged at 8% and 1.25 respectively, by how much must the total debt ratio increase
Additional information: to achieve 20% ROE?
Stockholders equity at 12/31/07 P4,500,000 A. Total debt ratio must increase by .5
Net income year ended 12/31/07 1,200,000 B. Total debt ratio must increase by 5
Dividends on preferred stock year ended 12/31/07 300,000 C. Total debt ratio must increase by 5%
Market price per share of common stock at 12/31/07 144 D. Total debt ratio must increase by 50%
The price-earnings ratio on common stock at December 31, 2007, was
xxxii
A. 10 to 1 C. 14 to 1 . Assume you are given the following relationships for the Orange Company:
B. 12 to 1 D. 16 to 1 Sales/total assets 1.5X
Return on assets (ROA) 3%
Payout ratio Return on equity (ROE) 5%
xxviii
. Selected financial data of Alexander Corporation for the year ended December 31, 2007, is presented below: The Orange Companys debt ratio is
Operating income P900,000 A. 40% C. 35%
Interest expense (100,000) B. 60% D. 65%
Income before income taxes 800,000
Income tax (320,000) Leverage Ratio
Net income 480,000 Degree of financial leverage
xxxiii
Preferred stock dividend (200,000) . A summarized income statement for Leveraged Inc. is presented below.
Net income available to common stockholders 280,000 Sales P1,000,000
Common stock dividends were P120,000. The payout ratio is: Cost of Sales 600,000
A. 42.9 percent C. 25.0 percent Gross Profit P 400,000
B. 66.7 percent D. 71.4 percent Operating Expenses 250,000
Operating Income P 150,000
P/E ratio & Payout ratio Interest Expense 30,000
Use the following information for question Nos. 33 and 34: Earnings Before Tax P 120,000
Terry Corporation had net income of P200,000 and paid dividends to common stockholders of P40,000 in 2007. The Income Tax 40,000
weighted-average number of shares outstanding in 2007 was 50,000 shares. Terry Corporations common stock is selling Net Income P 80,000
for P60 per share in the local stock exchange. The degree of financial leverage is:
A. P 150,000 P 30,000 C. P1,000,000 P400,000
xxix
. Terry Corporations price-earnings ratio is B. P 150,000 P120,000 D. P 150,000 P 80,000
A. 3.8 times C. 18.8 times
B. 15 times D. 6 times Other Ratios
Book value per share
xxx xxxiv
. Terry Corporations payout ratio for 2007 is . M Corporations stockholders equity at December 31, 2007 consists of the following:
A. P4 per share C. 20.0 percent 6% cumulative preferred stock, P100 par, liquidating value
B. 12.5 percent D. 25.0 percent was P110 per share; issued and outstanding 50,000 shares P5,000,000
Common stock, par, P5 per share; issued and
DuPont Model outstanding, 400,000 shares 2,000,000

65
 Financial Statement Analysis

Retained earnings 1,000,000

Total P8,000,000 Net sales
xxxviii
Dividends on preferred stock have been paid through 2006. . Selected data from Mildred Companys year-end financial statements are presented below. The
At December 31, 2007, M Corporations book value per share was difference between average and ending inventory is immaterial.
A. P5.50 C. P6.75 Current ratio 2.0
B. P6.25 D. P7.50 Quick ratio 1.5
Current liabilities P120,000
xxxv
. The following data were gathered from the annual report of Desk Products. Inventory turnover (based on cost of sales) 8 times
Market price per share P30.00 Gross profit margin 40%
Number of common shares 10,000 Mildreds net sales for the year were
Preferred stock, 5% P100 par P10,000 A. P 800,000 C. P 480,000
Common equity P140,000 B. P 672,000 D. P1,200,000
The book value per share is:
A. P30.00 C. P14.00 Gross margin
xxxix
B. P15.00 D. P13.75 . Selected information from the accounting records of the Blackwood Co. is as follows:
Net A/R at December 31, 2006 P 900,000
Integrated ratios Net A/R at December 31, 2007 P1,000,000
Liquidity & activity ratios Accounts receivable turnover 5 to 1
Inventory Inventories at December 31, 2006 P1,100,000
xxxvi
. The current assets of Mayon Enterprise consists of cash, accounts receivable, and inventory. The following information Inventories at December 31, 2007 P1,200,000
is available: Inventory turnover 4 to 1
Credit sales 75% of total sales What was the gross margin for 2007?
Inventory turnover 5 times A. P150,000 C. P300,000
Working capital P1,120,000 B. P200,000 D. P400,000
Current ratio 2.00 to 1
Quick ratio 1.25 to 1 Market Test Ratio
Average Collection period 42 days Dividend yield
xl
Working days 360 . Recto Co. has a price earnings ratio of 10, earnings per share of P2.20, and a pay out ratio of 75%.
The estimated inventory amount is: The dividend yield is
A. 840,000 C. 720,000 A. 25.0% C. 7.5%
B. 600,000 D. 550,000 B. 22.0% D. 10.0%
xxxvii xli
. The following data were obtained from the records of Salacot Company: . The following were reflected from the records of Salvacion Company:
Current ratio (at year end) 1.5 to 1 Earnings before interest and taxes P1,250,000
Inventory turnover based on sales and ending inventory 15 times Interest expense 250,000
Inventory turnover based on cost of goods sold and ending inventory 10.5 times Preferred dividends 200,000
Gross margin for 2007 P360,000 Payout ratio 40 percent
What was Salacot Companys December 31, 2007 balance in the Inventory account? Shares outstanding throughout 2006
A. P120,000 C. P 80,000 Preferred 20,000
B. P 54,000 D. P 95,000 Common 25,000

66
 Financial Statement Analysis

Income tax rate 40 percent

Price earnings ratio 5 times
The dividend yield ratio is
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

67
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