Question1. Ratio analysis involves a comparison of the relationships between

1. Ratio analysis involves a comparison of the relationships between
financial statement accounts so as to analyze the financial position
and strength of a firm.
a. True
b. False
2. The current ratio and inventory turnover ratio measure the liquidity of
a firm. The current ratio measures the relationship of a firm’s
current assets to its current liabilities and the inventory turnover
ratio measures how rapidly a firm turns its inventory back into
a “quick” asset or cash.
a. True
b. False
3. If a firm has high current and quick ratios, this is always a good
indication that a firm is managing its liquidity position well.
a. True
b. False
4. The inventory turnover ratio and days sales outstanding (DSO) are two
ratios that can be used to assess how effectively the firm is managing
its assets in consideration of current and projected operating levels.
a. True
b. False
5. A decline in the inventory turnover ratio suggests that the firm’s
liquidity position is improving.
a. True
b. False
6. The degree to which the managers of a firm attempt to magnify the
returns to owners’ capital through the use of financial leverage is
captured in debt management ratios.
a. True
b. False
7. The times-interest-earned ratio is one indication of a firm’s ability
to meet both long-term and short-term obligations.
a. True
b. False
8. Profitability ratios show the combined effects of liquidity, asset
management, and debt management on operations.
a. True
b. False
9. Since ROA measures the firm’s effective utilization of assets (without
considering how these assets are financed), two firms with the same
EBIT must have the same ROA.
a. True
b. False
10. Market value ratios provide management with a current assessment of how
investors in the market view the firm’s past performance and future
prospects.
a. True
b. False
11. Determining whether a firm’s financial position is improving or
deteriorating requires analysis of more than one set of financial
statements. Trend analysis is one method of measuring a firm’s
performance over time.
a. True
b. False
Medium:
12. If the current ratio of Firm A is greater than the current ratio of
Firm B, we cannot be sure that the quick ratio of Firm A is greater
than that of Firm B. However, if the quick ratio of Firm A exceeds
that of Firm B, we can be assured that Firm A’s current ratio also
exceeds B’s current ratio.
a. True
b. False
13. The inventory turnover and current ratios are related. The combination
of a high current ratio and a low inventory turnover ratio relative to
the industry norm might indicate that the firm is maintaining too high
an inventory level or that part of the inventory is obsolete or damaged.
a. True
b. False
14. We can use the fixed assets turnover ratio to legitimately compare
firms in different industries as long as all the firms being compared
are using the same proportion of fixed assets to total assets.
a. True
b. False
15. Suppose two firms have the same amount of assets, pay the same interest
rate on their debt, have the same basic earning power (BEP), and have
the same tax rate. However, one firm has a higher debt ratio. If BEP
is greater than the interest rate on debt, the firm with the higher
debt ratio will also have a higher rate of return on common equity.
a. True
b. False
16. If the equity multiplier is 2.0, the debt ratio must be 0.5.
a. True
b. False
17. Suppose a firm wants to maintain a specific TIE ratio. If the firm
knows the level of its debt, the interest rate it will pay on that
debt, and the applicable tax rate, the firm can then calculate the
earnings level required to maintain its target TIE ratio.
a. True
b. False
18. If sales decrease and financial leverage increases, we can say with
certainty that the profit margin on sales will decrease.
a. True
b. False
Multiple Choice: Conceptual
19. Other things held constant, which of the following will not affect the
current ratio, assuming an initial current ratio greater than 1.0?
a. Fixed assets are sold for cash.
b. Long-term debt is issued to pay off current liabilities.
c. Accounts receivable are collected.
d. Cash is used to pay off accounts payable.
e. A bank loan is obtained, and the proceeds are credited to the firm’s
checking account.
20. Other things held constant, which of the following will not affect the
quick ratio? (Assume that current assets equal current liabilities.)
a. Fixed assets are sold for cash.
b. Cash is used to purchase inventories.
c. Cash is used to pay off accounts payable.
d. Accounts receivable are collected.
e. Long-term debt is issued to pay off a short-term bank loan.
Answer: a
21. Company J and Company K each recently reported the same earnings per
share (EPS). Company J’s stock, however, trades at a higher price.
Which of the following statements is most correct?
a. Company J must have a higher P/E ratio.
b. Company J must have a higher market to book ratio.
c. Company J must be riskier.
d. Company J must have fewer growth opportunities.
e. All of the statements above are correct.
22. Stennett Corp.’s CFO has proposed that the company issue new debt and
use the proceeds to buy back common stock. Which of the following are
likely to occur if this proposal is adopted? (Assume that the proposal
would have no effect on the company’s operating earnings.)
a. Return on assets (ROA) will decline.
b. The times interest earned ratio (TIE) will increase.
c. Taxes paid will decline.
d. None of the statements above is correct.
e. Statements a and c are correct.
Medium:
23. Which of the following statements is most correct?
a. If a company increases its current liabilities by $1,000 and
b. If a company increases its current liabilities by $1,000 and
simultaneously increases its inventories by $1,000, its current
ratio must rise.
simultaneously increases its inventories by $1,000, its quick ratio
must fall.
c. A company’s quick ratio may never exceed its current ratio.
d. Answers b and c are correct.
e. None of the answers above is correct.
24. Which of the following actions can a firm take to increase its current
ratio?
a. Issue short-term debt and use the proceeds to buy back long-term
b. Reduce the company’s days sales outstanding to the industry average
c. Use cash to purchase additional inventory.
d. Statements a and b are correct.
e. None of the statements above is correct.
debt with a maturity of more than one year.
and use the resulting cash savings to purchase plant and equipment.
25. Which of the following actions will cause an increase in the quick
ratio in the short run?
a. $1,000 worth of inventory is sold, and an account receivable is
b. A small subsidiary which was acquired for $100,000 two years ago and
created. The receivable exceeds the inventory by the amount of
profit on the sale, which is added to retained earnings.
which was generating profits at the rate of 10 percent is sold for
$100,000 cash. (Average company profits are 15 percent of assets.)
c. Marketable securities are sold at cost.
d. All of the answers above.
e. Answers a and b above.
26. As a short-term creditor concerned with a company’s ability to meet its
financial obligation to you, which one of the following combinations of
ratios would you most likely prefer?
Current Debt
ratio TIE ratio
a. 0.5 0.5 0.33
b. 1.0 1.0 0.50
c. 1.5 1.5 0.50

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