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Chapter 03 - Working with Financial Statements

Chapter 03
Working with Financial Statements
Multiple Choice Questions

1. Common-size financial statements present all balance sheet account values as a percentage
of:
A. the forecasted budget.
B. sales.
C. total equity.
D. total assets.
E. last year's account value.

2. The ratios that are based on financial statement values and used for comparison purposes
are called:
A. financial ratios.
B. industrial statistics.
C. equity standards.
D. accounting returns.
E. analytical standards.

3. The Du Pont identity can be totally defined by which one of the following?
A. Return on equity, total asset turnover, and equity multiplier
B. Equity multiplier and return on assets
C. Profit margin and return on equity
D. Total asset turnover, profit margin, and debt-equity ratio
E. Equity multiplier, return on assets, and profit margin

4. Which one of the following is the maximum growth rate that a firm can achieve without
any additional external financing?
A. Du Pont rate
B. External growth rate
C. Sustainable growth rate
D. Internal growth rate
E. Cash flow rate

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Chapter 03 - Working with Financial Statements

5. The sustainable growth rate is defined as the maximum rate at which a firm can grow given
which of the following conditions?
A. No new external financing of any kind
B. No new debt but additional external equity equal to the increase in retained earnings
C. New debt and external equity in equal proportions
D. New debt and external equity, provided the debt-equity ratio remains constant
E. No new equity and a constant debt-equity ratio

6. Which one of the following is the abbreviation for the U.S. government coding system that
classifies a firm by its specific type of business operations?
A. BEC
B. SED
C. BID
D. SIC
E. SBC

7. Builder's Outlet just hired a new chief financial officer. To get a feel for the company, she
wants to compare the firm's sales and costs over the past 3 years determine if any trends are
present and also determine where the firm might need to make changes. Which one of the
following statements will best suit her purposes?
A. Income statement
B. Balance sheet
C. Common-size income statement
D. Common-size balance sheet
E. Statement of cash flows

8. A common-size balance sheet helps financial managers determine:


A. which customers are paying on a timely basis.
B. if costs are increasing faster or slower than sales.
C. if changes are occurring in a firm's mix of assets.
D. if a firm is generating more or less sales per dollar of assets than in prior years.
E. the rate at which the firm's dividends are changing.

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Chapter 03 - Working with Financial Statements

9. High Tower Pharmacy pays a fixed percentage of its net income out to its shareholders in
the form of annual dividends. Given this, the percent shown on a common-size income
statement for the dividend account will:
A. remain constant over time.
B. be equal to the dividend amount divided by the net income.
C. vary in direct relation to the net profit percentage.
D. vary in direct relation to changes in the sales level.
E. vary but not in direct relation to any other variable.

10. Which one of the following transactions will increase the liquidity of a firm?
A. Cash purchase of new production equipment
B. Payment of an account payable
C. Cash purchase of inventory
D. Credit sale of inventory at cost
E. Cash payment of employee wages

11. Which one of the following actions will increase the current ratio, all else constant?
Assume the current ratio is greater than 1.0.
A. Cash purchase of inventory
B. Cash payment of an account receivable
C. Cash payment of an account payable
D. Credit sale of inventory at cost
E. Cash sale of inventory at a loss

12. A firm has a current ratio of 1.4 and a quick ratio of 0.9. Given this, you know for certain
that the firm:
A. pays cash for its inventory.
B. has more than half its current assets invested in inventory.
C. has more cash than inventory.
D. has more current liabilities than it does current assets.
E. has positive net working capital.

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13. Fred is the owner of a local feed store. Which one of the following ratios should he
compute if he wants to know how long the store can pay its bills given the amount of cash the
store currently has?
A. Current ratio
B. Debt ratio
C. Cash coverage ratio
D. Quick ratio
E. Cash ratio

14. Which one of the following is a measure of long-term solvency?


A. Price-earnings ratio
B. Profit margin
C. Equity multiplier
D. Receivables turnover
E. Quick ratio

15. The cash coverage ratio is used to evaluate the:


A. liquidity of a firm.
B. speed at which a firm generates cash.
C. length of time that a firm can pay its bills if no additional cash becomes available.
D. ability of a firm to pay the interest on its debt.
E. relationship between the firm's cash balance and its current liabilities.

16. The equity multiplier is equal to:


A. one plus the debt-equity ratio.
B. one plus the total asset turnover.
C. total debt divided by total equity.
D. total equity divided by total assets.
E. one divided by the total asset turnover.

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17. Blooming Gardens has an inventory turnover of 16. This means the firm:
A. sells its entire inventory every 16 days.
B. only stocks its inventory every 16 days.
C. buys 16 days of inventory with each order.
D. sells its inventory by granting customers 16 days credit.
E. sells its inventory an average of 16 times each year.

18. Which one of the following best indicates a firm is utilizing its assets more efficiently than
it has in the past?
A. Decrease in the total asset turnover
B. Decrease in the capital intensity ratio
C. Increase in days' sales in receivables
D. Decrease in the profit margin
E. Decrease in the inventory turnover rate

19. Kelso's Pharmacy generates $2 in sales for every $1 the firm has invested in total assets.
Which one of the following ratios would reflect this relationship?
A. Receivables turnover
B. Equity multiplier
C. Profit margin
D. Return on assets
E. Total asset turnover

20. Which one of the following will increase the profit margin of a firm, all else constant?
A. Increase in interest paid
B. Increase in fixed costs
C. Increase in depreciation expense
D. Decrease in the tax rate
E. Decrease in sales

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Chapter 03 - Working with Financial Statements

21. You would like to borrow money three years from now to build a new building. In
preparation for applying for that loan, you are in the process of developing target ratios for
your firm. Which set of ratios represents the best target mix considering that you want to
obtain outside financing in the relatively near future?
A. Times interest earned = 1.7; debt-equity ratio = 1.6
B. Times interest earned = 1.5; debt-equity ratio = 1.2
C. Cash coverage ratio = 0.8; debt-equity ratio = 0.8
D. Cash coverage ratio = 2.6; debt-equity ratio = 0.3
E. Cash coverage ratio = 0.5; total debt ratio = 0.2

22. All else constant, which one of the following will decrease if a firm increases its net
income?
A. Return on assets
B. Profit margin
C. Return on equity
D. Price-sales ratio
E. Price-earnings ratio

23. Which one of the following statements is true concerning the price-earnings (PE) ratio?
A. A high PE ratio may indicate that a firm is expected to grow significantly.
B. A PE ratio of 16 indicates that investors are willing to pay $1 for every $16 of current
earnings.
C. PE ratios are unaffected by the accounting methods employed by a firm.
D. The PE ratio is classified as a profitability ratio.
E. The PE ratio is a constant value for each firm.

24. New Century Products is a company that was founded last year. While the outlook for the
company is positive, it currently has negative earnings. If you wanted to measure the progress
of this firm, which one of the following ratios would probably be best to monitor given the
firm's current situation?
A. Price-sales ratio
B. Market-to-book ratio
C. Profit margin
D. ROE
E. ROA

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Chapter 03 - Working with Financial Statements

25. The Du Pont identity can be used to help a financial manager determine the:
I. degree of financial leverage used by a firm.
II. operating efficiency of a firm.
III. utilization rate of a firm's assets.
IV. rate of return on a firm's assets.
A. II and III only
B. I and III only
C. II, III, and IV only
D. I, II, and III only
E. I, II, III, and IV

26. The T-shirt Hut successfully managed to reduce its general and administrative costs this
year. This cost improvement will increase which of the following ratios?
I. Profit margin
II. Return on assets
III. Total asset turnover
IV. Return on equity
A. I and II only
B. I and III only
C. II, III, and IV only
D. I, II, and IV only
E. I, II, III, and IV

27. Martha's Sweet Shop reduced its fixed assets this year without affecting the shop's
operations, sales, or equity. This reduction will increase which of the following ratios?
I. Capital intensity ratio
II. Return on assets
III. Total asset turnover
IV. Return on equity
A. I and II only
B. II and III only
C. II, III, and IV only
D. I, II, and IV only
E. I, II, III, and IV

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28. Donovan Brothers, Inc. would like to increase its internal rate of growth. Decreasing
which one of the following will help the firm achieve its goal?
A. Return on assets
B. Net income
C. Retention ratio
D. Dividend payout ratio
E. Return on equity

29. If a firm has a 100 percent dividend payout ratio, then the internal growth rate of the firm
is:
A. zero percent.
B. 100 percent.
C. equal to the ROA.
D. negative.
E. infinite.

30. Which of the following are determinants of a firm's sustainable rate of growth?
I. Amount of sales generated from each dollar invested in assets
II. Amount of debt per dollar of equity
III. Amount of current assets per dollar of current liabilities
IV. Percent of net income distributed as dividends
A. I and III only
B. II and IV only
C. I, II, and IV only
D. II, III, and IV only
E. I, II, III, and IV

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Chapter 03 - Working with Financial Statements

31. Which of the following will increase the sustainable rate of growth for a firm?
I. Decreasing the profit margin
II. Increasing the dividend payout ratio
III. Decreasing the capital intensity ratio
IV. Increasing the target debt-equity ratio
A. I and II only
B. III and IV only
C. II and IV only
D. I, III, and IV only
E. I, II, III, and IV

32. Financial statement analysis:


A. is primarily used to identify account values that meet the normal standards.
B. is limited to internal use by a firm's managers.
C. provides useful information that can serve as a basis for forecasting future performance.
D. provides useful information to shareholders but not to debt holders.
E. is enhanced by comparing results to those of a firm's peers but not by comparing results to
prior periods.

33. Which one of the following statements is correct?


A. Peer group analysis is easier when a firm is a conglomerate versus when it only has a
single
B. line of business.
C. Peer group analysis is easier when seasonal firms have different fiscal years.
D. Peer group analysis is simplified when firms use varying methods of depreciation.
E. Comparing results across geographic locations is easier since all countries now use a
common
F. set of accounting standards.
G. Adjustments have to be made when comparing the income statements of firms which use
different methods of accounting for inventory.

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Chapter 03 - Working with Financial Statements

34. Russell's Hardware has inventory of $218,000, equity of $421,800, total assets of
$647,700, and sales of $587,200. What is the common-size percentage for the inventory
account?
A. 26.81 percent
B. 33.66 percent
C. 37.12 percent
D. 49.09 percent
E. 51.68 percent

35. A firm has inventory of $11,400, accounts payable of $9,800, cash of $850, net fixed
assets of $12,150, long-term debt of $9,500, accounts receivable of $6,600, and total equity of
$11,700. What is the common-size percentage for the net fixed assets?
A. 19.60 percent
B. 26.67 percent
C. 39.19 percent
D. 42.08 percent
E. 48.75 percent

36. Foreign Travel Services has net income of $48,400, total assets of $219,000, total equity
of $154,800, and total sales of $311,700. What is the common-size percentage for the net
income?
A. 9.00 percent
B. 13.90 percent
C. 15.53 percent
D. 22.10 percent
E. 31.27 percent

37. Delmont Movers has a profit margin of 6.2 percent and net income of $48,900. What is
the common-size percentage for the cost of goods sold if that expense amounted to $379,000
for the year?
A. 12.90 percent
B. 23.50 percent
C. 33.25 percent
D. 41.06 percent
E. 48.05 percent

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Chapter 03 - Working with Financial Statements

38. A firm has sales of $428,000 for the year. The profit margin is 3.4 percent and the
retention ratio is 60 percent. What is the common-size percentage for the dividends paid?
A. 0.99 percent
B. 1.18 percent
C. 1.21 percent
D. 1.36 percent
E. 1.42 percent

39. Peter's Motor Works has total assets of $689,400, long-term debt of $299,500, total equity
of $275,000, net fixed assets of $497,800, and sales of $721,500. The profit margin is 4.6
percent. What is the current ratio?
A. 0.60
B. 0.91
C. 1.01
D. 1.67
E. 2.16

40. Healthy Foods has total assets of $129,800, net fixed assets of $71,500, long-term debt of
$52,000, and total debt of $78,700. If inventory is $31,800, what is the current ratio?
A. 0.33
B. 0.46
C. 0.84
D. 1.18
E. 2.18

41. A firm has net working capital of $3,800 and current assets of $11,700. What is the current
ratio?
A. 0.34
B. 0.60
C. 1.48
D. 1.65
E. 2.92

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Chapter 03 - Working with Financial Statements

42. Slightly Used Goods has cash of $2,150, inventory of $28,470, fixed assets of $9,860,
accounts payable of $11,900, and accounts receivable of $4,660. What is the cash ratio?
A. 0.08
B. 0.18
C. 0.32
D. 0.46
E. 0.51

43. You are analyzing a company that has cash of $11,200, accounts receivable of $27,800,
fixed assets of $124,600, accounts payable of $31,300, and inventory of $56,900. What is the
quick ratio?
A. 0.30
B. 0.67
C. 0.80
D. 1.25
E. 1.37

44. Tasty Dee-Lite has current liabilities of $6,630, net working capital of $2,180, inventory
of $2,750, and sales of $36,800. What is the quick ratio?
A. 0.76
B. 0.84
C. 0.91
D. 1.09
E. 1.19

45. Tressler Dry Cleaners has inventory of $1,700, accounts payable of $4,200, cash of
$1,950, and accounts receivable of $3,680. What is the cash ratio?
A. 0.24
B. 0.46
C. 0.53
D. 0.98
E. 1.34

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Chapter 03 - Working with Financial Statements

46. Your firm has cash of $3,800, accounts receivable of $9,600, inventory of $33,100, and
net working capital of $1,100. What is the cash ratio?
A. 0.04
B. 0.08
C. 0.87
D. 1.21
E. 3.45

47. Wilson's Realty has total assets of $46,800, net fixed assets of $37,400, current liabilities
of $6,100, and long-term liabilities of $24,600. What is the total debt ratio?
A. 0.41
B. 0.60
C. 0.66
D. 0.78
E. 0.86

48. Denton, Inc. has total equity of $389,600, long-term debt of $116,400, net working capital
of $1,600, and total assets of $527,600. What is the total debt ratio?
A. 0.22
B. 0.26
C. 0.67
D. 1.49
E. 3.85

49. A firm has total assets of $523,100, current assets of $186,500, current liabilities of
$141,000, and total debt of $215,000. What is the debt-equity ratio?
A. 0.48
B. 0.70
C. 1.10
D. 1.43
E. 2.13

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50. The Jelly Jar has total assets of $79,600 and an equity multiplier of 1.35. What is the debtequity ratio?
A. 0.28
B. 0.35
C. 0.47
D. 0.58
E. 0.67

51. Underwood Homes Sales has total assets of $589,900 and total debt of $318,000. What is
the equity multiplier?
A. 0.46
B. 0.54
C. 1.21
D. 1.85
E. 2.17

52. A firm has an equity multiplier of 1.5. This means that the firm has a:
A. debt-equity ratio of 0.67.
B. debt-equity ratio of 0.33.
C. total debt ratio of 0.50.
D. total debt ratio of 0.67.
E. total debt ratio of 0.33.

53. Preston's Market has sales of $213,600, total assets of $198,700, a debt-equity ratio of 1.6,
and a profit margin of 2.4 percent. What is the equity multiplier?
A. 0.60
B. 0.63
C. 1.83
D. 2.60
E. 2.84

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Chapter 03 - Working with Financial Statements

54. Friendly's Shoe Store has earnings before interest and taxes of $21,680 and net income of
$12,542. The tax rate is 34 percent. What is the times interest earned ratio?
A. 0.88
B. 1.67
C. 3.09
D. 5.59
E. 8.10

55. The Berry Patch has sales of $438,000, cost of goods sold of $369,000, depreciation of
$37,400, and interest expense of $13,800. The tax rate is 35 percent. What is the times interest
earned ratio?
A. 2.29
B. 3.46
C. 3.87
D. 4.38
E. 4.79

56. A firm has net income of $5,890 and interest expense of $2,130. The tax rate is 34 percent.
What is the firm's times interest earned ratio?
A. 4.82
B. 5.19
C. 5.38
D. 5.67
E. 6.33

57. A firm has net income of $31,300, depreciation of $5,100, taxes of $14,600, and interest
paid of $3,100. What is the cash coverage ratio?
A. 8.78
B. 10.10
C. 14.14
D. 16.32
E. 17.45

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58. Blue Water Cafe has $28,700 in total assets, depreciation of $3,100, and interest of
$1,400. The total asset turnover rate is 1.2. Earnings before interest and taxes are equal to 28
percent of sales. What is the cash coverage ratio?
A. 6.33
B. 7.51
C. 9.10
D. 10.23
E. 10.98

59. The Global Network has sales of $418,700, cost of goods sold of $264,900, and inventory
of $61,900. What is the inventory turnover rate?
A. 1.33
B. 4.28
C. 6.76
D. 7.14
E. 8.47

60. The Tourist Stop takes an average of 63 days to sell its inventory and an average of 1.5
days to collect payment on its sales. What is the inventory turnover rate?
A. 5.79
B. 7.29
C. 8.68
D. 10.18
E. 11.42

61. Galaxy Sales has sales of $746,700, cost of goods sold of $603,200, and inventory of
$94,300. How long on average does it take the firm to sell its inventory?
A. 6.40 days
B. 7.23 days
C. 48.68 days
D. 57.06 days
E. 61.10 days

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Chapter 03 - Working with Financial Statements

62. Handy Hardware sells its inventory in 85 days, on average. Costs of goods sold for the
year are $631,800. What is the average value of the firm's inventory?
A. $114,706
B. $123,506
C. $147,132
D. $161,096
E. $182,513

63. Kessler, Inc. has accounts receivable of $31,600, total assets of $311,500, cost of goods
sold of $208,400, and a capital intensity ratio of 1.08. What is the accounts receivables
turnover rate?
A. 8.99
B. 9.13
C. 9.42
D. 9.61
E. 9.72

64. It takes The Corner Store an average of 51 days to sell its inventory and 32 days to collect
its accounts receivable. The firm has sales of $568,700 and costs of goods sold of $398,800.
What is the accounts receivable turnover rate?
A. 11.23
B. 11.41
C. 11.78
D. 12.23
E. 12.55

65. Textile Mills has sales of $923,000, cost of goods sold of $748,000, and accounts
receivable of $106,700. How long on average does it take the firm's customers to pay for their
purchases?
A. 8.65 days
B. 11.28 days
C. 25.01 days
D. 42.19 days
E. 45.33 days

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Chapter 03 - Working with Financial Statements

66. A firm has $42,900 in receivables and $211,800 in total assets. The total asset turnover
rate is 1.45 and the profit margin is 4.2 percent. How long on average does it take the firm to
collect its receivables?
A. 7.16 days
B. 9.45 days
C. 11.68 days
D. 31.25 days
E. 50.99 days

67. Aardvaark & Co. has sales of $291,200, cost of goods sold of $163,300, net profit of
$11,360, net fixed assets of $154,500, and current assets of $89,500. What is the total asset
turnover rate?
A. 1.08
B. 1.11
C. 1.19
D. 1.24
E. 1.28

68. Holiday House has sales of $648,000, a profit margin of 6.1 percent, and a capital
intensity ratio of 0.84. What is the total asset turnover rate?
A. 1.04
B. 1.08
C. 1.13
D. 1.19
E. 1.26

69. Martha's Fabric House has sales of $137,200, total equity of $74,400, and a debt-equity
ratio of 0.45. What is the capital intensity ratio?
A. 0.79
B. 0.83
C. 1.06
D. 1.20
E. 1.27

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Chapter 03 - Working with Financial Statements

70. Circle Stores has net income of $41,000, a profit margin of 6.7 percent, and a return on
assets of 9 percent. What is the capital intensity ratio?
A. 0.74
B. 0.86
C. 1.16
D. 1.34
E. 1.38

71. Tally Ho Inn has annual sales of $737,000. Earnings before interest and taxes is equal to
21 percent of sales. For the period, the firm paid $7,900 in interest. What is the profit margin
if the tax rate is 35 percent?
A. 12.46 percent
B. 12.95 percent
C. 13.33 percent
D. 15.29 percent
E. 16.11 percent

72. The Medicine Cabinet has a return on equity of 18.2 percent, a profit margin of 11.6
percent, and total equity of $738,000. What is the net income?
A. $85,608
B. $113,875
C. $134,316
D. $142,311
E. $149,897

73. The Next Life has sales of $428,300, total assets of $389,100, and a profit margin of 6.2
percent. What is the return on assets?
A. 6.29 percent
B. 6.54 percent
C. 6.83 percent
D. 7.01 percent
E. 7.27 percent

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Chapter 03 - Working with Financial Statements

74. Goshen Industrial Sales has sales of $828,900, total equity of $539,200, a profit margin of
4.6 percent and a debt-equity ratio of 0.55. What is the return on assets?
A. 3.89 percent
B. 4.56 percent
C. 6.67 percent
D. 12.86 percent
E. 13.33 percent

75. Cross Hairs Gun Shop has sales of $189,000, a profit margin of 4.8 percent, and a capital
intensity ratio of 0.79. What is the return on assets?
A. 5.67 percent
B. 6.08 percent
C. 6.39 percent
D. 6.42 percent
E. 6.67 percent

76. Freedom Health Centers has total equity of $861,300, sales of $1.48 million, and a profit
margin of 5.2 percent. What is the return on equity?
A. 5.82 percent
B. 6.49 percent
C. 7.18 percent
D. 8.68 percent
E. 8.94 percent

77. The Closet Shoppe has total sales of $713,200 and a profit margin of 5.8 percent.
Currently, the firm has 12,500 shares outstanding. What are the earnings per share?
A. $2.98
B. $3.31
C. $3.56
D. $3.89
E. $4.02

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Chapter 03 - Working with Financial Statements

78. Baxter & Baxter has total assets of $710,000. There are 45,000 shares of stock outstanding
with a market value of $28 a share. The firm has a profit margin of 7.1 percent and a total
asset turnover of 1.29. What is the price-earnings ratio?
A. 16.38
B. 17.99
C. 19.38
D. 20.12
E. 22.41

79. Ratzell's Place has a market-to-book ratio of 2.7, net income of $68,400, a book value per
share of $37, and 45,000 shares of stock outstanding. What is the price-earnings ratio?
A. 24.34
B. 28.16
C. 55.10
D. 59.09
E. 65.72

80. The Green House has a profit margin of 5.6 percent on sales of $311,200. The firm
currently has 15,000 shares of stock outstanding at a market price of $11.60 per share. What is
the price-earnings ratio?
A. 9.98
B. 10.02
C. 11.50
D. 11.93
E. 12.84

81. A firm has sales of $311,000 and net income of $21,600. Currently, there are 18,000
shares outstanding at a market price of $36 per share. What is the price-sales ratio?
A. 2.08
B. 3.11
C. 4.26
D. 5.15
E. 6.95

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Chapter 03 - Working with Financial Statements

82. The common stock of The Burger Hut is selling for $16.25 a share. The company has
earnings per share of $0.42 and a book value per share of $9.28. What is the market-to-book
ratio?
A. 1.58
B. 1.69
C. 1.75
D. 1.87
E. 1.92

83. Swanton Foods has a book value per share of $12.68, earnings per share of $1.21, and a
price-earnings ratio of 17.6. What is the market-to-book ratio?
A. 1.32
B. 1.68
C. 1.99
D. 2.47
E. 2.61

84. The Inside Door has total debt of $78,600, total equity of $214,000, and a return on equity
of 14.5 percent. What is the return on assets?
A. 9.14 percent
B. 10.61 percent
C. 21.45 percent
D. 34.61 percent
E. 39.48 percent

85. The Noodle Place has total assets of $123,800, a debt-equity ratio of 0.65, and net income
of $7,100. What is the return on equity?
A. 3.48 percent
B. 3.73 percent
C. 8.01 percent
D. 9.46 percent
E. 13.61 percent

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Chapter 03 - Working with Financial Statements

86. Computer Geeks has sales of $521,000, a profit margin of 14.8 percent, a total asset
turnover rate of 2.16, and an equity multiplier of 1.30. What is the return on equity?
A. 8.91 percent
B. 12.67 percent
C. 18.28 percent
D. 32.11 percent
E. 41.56 percent

87. Morrison Motors has total equity of $289,100 and net income of $64,500. The debt-equity
ratio is 0.45 and the total asset turnover is 1.6. What is the profit margin?
A. 3.10 percent
B. 5.23 percent
C. 5.67 percent
D. 8.21 percent
E. 9.62 percent

88. A firm has net income of $114,000, a return on assets of 12.6 percent, and a debt-equity
ratio of 0.60. What is the return on equity?
A. 17.11 percent
B. 18.98 percent
C. 20.16 percent
D. 22.20 percent
E. 24.60 percent

89. The Blue Lantern has a return on equity of 17.8 percent, an equity multiplier of 1.9, and a
total asset turnover of 1.45. What is the profit margin?
A. 2.76 percent
B. 3.57 percent
C. 4.90 percent
D. 5.28 percent
E. 6.46 percent

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Chapter 03 - Working with Financial Statements

90. The Saw Mill has a return on assets of 6.1 percent, a total asset turnover rate of 1.8, and a
debt-equity ratio of 1.6. What is the return on equity?
A. 4.26 percent
B. 9.76 percent
C. 12.28 percent
D. 15.86 percent
E. 19.03 percent

91. Webster & Jones has net income of $49,200, sales of $936,800, a capital intensity ratio of
0.74, and an equity multiplier of 1.5. What is the return on equity?
A. 6.67 percent
B. 8.98 percent
C. 10.65 percent
D. 12.21 percent
E. 14.09 percent

92. New Steel Products has total assets of $991,000, a total asset turnover rate of 1.1, a debtequity ratio of 0.6, and a return on equity of 8.7 percent. What is the firm's net income?
A. $53,885.63
B. $58,303.33
C. $64,624.14
D. $70,548.09
E. $77,236.67

93. Eastern Hardwood Sales has total equity of $89,000, a profit margin of 4.8 percent, an
equity multiplier of 1.5, and a total asset turnover of 1.3. What is the amount of the firm's
sales?
A. $168,200
B. $173,550
C. $181,430
D. $185,620
E. $187,500

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Chapter 03 - Working with Financial Statements

94. Tessler Farms has a return on equity of 12.71 percent, a debt-equity ratio of 0.75, and a
total asset turnover of 0.9. What is the return on assets?
A. 7.26 percent
B. 8.06 percent
C. 13.67 percent
D. 15.24 percent
E. 17.41 percent

95. A firm earns $0.17 in profit for every $1 of equity in the firm. The company borrows
$0.60 for every $1 of equity. What is the firm's return on assets?
A. 10.63 percent
B. 13.53 percent
C. 25.15 percent
D. 26.07 percent
E. 28.33 percent

96. The Veggie Hut has net income of $26,400, total equity of $102,700, and total assets of
$189,500. The dividend payout ratio is 0.30. What is the internal growth rate?
A. 7.99 percent
B. 8.57 percent
C. 10.81 percent
D. 16.87 percent
E. 21.94 percent

97. Quick Foods has sales of $238,900, total assets of $217,000, total equity of $121,300, net
income of $18,700, and dividends paid of $6,000. What is the internal growth rate?
A. 5.48 percent
B. 6.22 percent
C. 6.67 percent
D. 7.34 percent
E. 7.92 percent

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Chapter 03 - Working with Financial Statements

98. A firm has adopted a policy whereby it will not seek any additional external financing.
Given this, what is the maximum growth rate for the firm if it has net income of $12,100, total
equity of $94,000, total assets of $156,000, and a 40 percent dividend payout ratio?
A. 4.88 percent
B. 5.11 percent
C. 6.62 percent
D. 7.67 percent
E. 8.37 percent

99. Underwood Enterprises earns $0.07 in profit on every $1 of sales and has $0.67 in assets
for every $1 of sales. The firm pays out 20 percent of its profits to its shareholders. What is
the internal growth rate?
A. 6.37 percent
B. 7.76 percent
C. 8.80 percent
D. 9.12 percent
E. 9.65 percent

100. Joshua's Antiques has a total asset turnover rate of 1.2, an equity multiplier of 1.4, a
profit margin of 5 percent, a retention ratio of 0.8, and total assets of $120,000. What is the
sustainable growth rate?
A. 6.98 percent
B. 7.20 percent
C. 7.33 percent
D. 7.54 percent
E. 7.91 percent

101. A firm has a return on equity of 16 percent, a return on assets of 11 percent, and a 40
percent dividend payout ratio. What is the sustainable growth rate?
A. 5.72 percent
B. 6.84 percent
C. 7.12 percent
D. 9.58 percent
E. 10.62 percent

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Chapter 03 - Working with Financial Statements

102. Valentino's maintains a constant debt-equity ratio of 0.45. The firm had net income of
$11,800 for the year and paid $6,500 in dividends. The firm has total assets of $92,000. What
is the sustainable growth rate?
A. 7.38 percent
B. 8.27 percent
C. 9.11 percent
D. 9.62 percent
E. 10.38 percent

103. The Donut Hut has sales of $68,000, current assets of $11,300, net income of $5,100, net
fixed assets of $54,900, total debt of $23,800, and dividends of $800. What is the sustainable
growth rate?
A. 10.48 percent
B. 11.29 percent
C. 11.79 percent
D. 12.08 percent
E. 12.39 percent

104. Last year, a firm earned $31,200 in net income on sales of $217,600. The company paid
$7,500 in dividends. What is the dividend payout ratio?
A. 3.45 percent
B. 4.71 percent
C. 14.34 percent
D. 22.85 percent
E. 24.04 percent

105. Last year, Blakely's Fashions earned net income of $68,400 and had 12,000 shares of
stock outstanding. The dividends per share were $2.20. What is the dividend payout ratio?
A. 32.98 percent
B. 34.00 percent
C. 38.60 percent
D. 40.21 percent
E. 44.14 percent

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Chapter 03 - Working with Financial Statements

106. Gabriel Furniture has a profit margin of 8.2 percent and a dividend payout ratio of 30
percent. What is the plowback ratio?
A. 10.66 percent
B. 27.33 percent
C. 54.60 percent
D. 70.00 percent
E. 78.20 percent

107. Town Centre Market has sales of $311,800, a profit margin of 2.9 percent, and dividends
of $4,500. What is the plowback ratio?
A. 46.32 percent
B. 49.78 percent
C. 50.23 percent
D. 51.15 percent
E. 53.68 percent

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Chapter 03 - Working with Financial Statements

108. Use the following financial information to answer this question.

What are the values of the three components of the DuPont identity? Use ending balance sheet
values.
A. 0.15; 1.02; 0.35
B. 0.15; 2.02; 0.35
C. 0.15; 0.98; 2.86
D. 0.16; 0.98; 0.35
E. 0.16; 1.02; 2.86

3-29

Chapter 03 - Working with Financial Statements

109. Global Ventures has a return on equity of 9.8 percent, a retention ratio of 60 percent, and
a profit margin of 4.5 percent. The company paid $378 in dividends and has net working
capital of $100. Net fixed assets are $18,550 and current liabilities are $520. What is the total
equity of the firm?
A. $6,457
B. $6,890
C. $7,360
D. $9,643
E. $11,480

Essay Questions

110. Assume this is your first day on the job as the new chief financial officer of a mid-size
company. Identify the three key ratios that you would compute first as you begin to try to
understand the financial status of the firm. Explain why you selected the three ratios that you
did.

111. You are trying to compare the financial performance of your firm to that of similar firms.
What are some of the key problems you might encounter in doing this comparison?

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Chapter 03 - Working with Financial Statements

112. Explain why the DuPont identity is so useful to a financial manager.

113. Since there are no perfect or ideal standard ratios for a firm, why is ratio analysis still
considered a valuable management tool?

Multiple Choice Questions

114. Peterboro Supply has a current accounts receivable balance of $391,648. Credit sales for
the year just ended were $5,338,411. How long did it take on average for credit customers to
pay off their accounts during the past year?
A. 24.78 days
B. 26.78 days
C. 29.09 days
D. 31.15 days
E. 33.33 days

115. Sunshine Rentals has a debt-equity ratio of 0.84. Return on assets is 7.9 percent, and total
equity is $438,000. What is the net income?
A. $41,147.09
B. $54,311.29
C. $63,667.68
D. $48,887.02
E. $50,458.95

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Chapter 03 - Working with Financial Statements

116. Turner's Store had a profit margin of 6.8 percent, sales of $898,200, and total assets of
$798,000. If management set a goal of increasing the total asset turnover to 1.40 times, what
would the new sales figure need to be, assuming no increase in total assets?
A. $860,333
B. $984,320
C. $1,088,500
D. $1,117,200
E. $1,257,480

117. True Blue Transport has a current stock price of $27. For the past year, the company had
net income of $2,187,400, total equity of $13,892,300, sales of $26,511,000, and 2.5 million
shares outstanding. What is the market-to-book ratio?
A. 3.54
B. 3.81
C. 3.99
D. 4.27
E. 4.86

118. Taylor, Inc. has sales of $11,898, total assets of $9,315, and a debt-equity ratio of 0.55. If
its return on equity is 14 percent, what is its net income?
A. $841.35
B. $887.16
C. $904.10
D. $911.16
E. $927.46

119. Mercier United has net income of $128,470. There are currently 32.67 days' sales in
receivables. Total assets are $1,419,415, total receivables are $122,306, and the debt-equity
ratio is 0.40. What is the return on equity?
A. 11.42 percent
B. 12.67 percent
C. 13.09 percent
D. 13.48 percent
E. 15.03 percent

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Chapter 03 - Working with Financial Statements

120. For the most recent year, Wilson Enterprises had sales of $689,000, cost of goods sold of
$470,300, depreciation expense of $61,200, and additions to retained earnings of $48,560.
The firm currently has 12,000 shares of common stock outstanding, and the previous year's
dividends per share were $1.18. Assuming a 35 percent tax rate, what was the times interest
earned ratio?
A. 1.47
B. 2.09
C. 2.58
D. 3.15
E. 3.67

121. A fire has destroyed a large percentage of the financial records of the Strongwell Co. You
have the task of piecing together information in order to release a financial report. You have
found the return on equity to be 13.8 percent. Sales were $979,000, the total debt ratio was
0.42, and total debt was $548,000. What is the return on assets?
A. 6.92 percent
B. 8.00 percent
C. 8.45 percent
D. 9.03 percent
E. 9.29 percent

122. Donegal's Industrial Products wishes to maintain a growth rate of 6 percent a year, a
debt-equity ratio of 0.45, and a dividend payout ratio of 30 percent. The ratio of total assets to
sales is constant at 1.25. What profit margin must the firm achieve?
A. 4.68 percent
B. 5.29 percent
C. 6.33 percent
D. 6.97 percent
E. 8.19 percent

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Chapter 03 - Working with Financial Statements

123. A firm wishes to maintain an internal growth rate of 4.5 percent and a dividend payout
ratio of 60 percent. The current profit margin is 7.5 percent and the firm uses no external
financing sources. What must the total asset turnover be?
A. 0.98
B. 1.06
C. 1.21
D. 1.44
E. 1.59

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Chapter 03 - Working with Financial Statements

Chapter 03 Working with Financial Statements Answer Key

Multiple Choice Questions

1. Common-size financial statements present all balance sheet account values as a percentage
of:
A. the forecasted budget.
B. sales.
C. total equity.
D. total assets.
E. last year's account value.
Refer to section 3.1.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-01 Standardize financial statements for comparison purposes.
Section: 3.1
Topic: Common-size statement

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Chapter 03 - Working with Financial Statements

2. The ratios that are based on financial statement values and used for comparison purposes
are called:
A. financial ratios.
B. industrial statistics.
C. equity standards.
D. accounting returns.
E. analytical standards.
Refer to section 3.2.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Financial ratios

3. The Du Pont identity can be totally defined by which one of the following?
A. Return on equity, total asset turnover, and equity multiplier
B. Equity multiplier and return on assets
C. Profit margin and return on equity
D. Total asset turnover, profit margin, and debt-equity ratio
E. Equity multiplier, return on assets, and profit margin
Refer to section 3.3.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.3
Topic: DuPont identity

3-36

Chapter 03 - Working with Financial Statements

4. Which one of the following is the maximum growth rate that a firm can achieve without
any additional external financing?
A. Du Pont rate
B. External growth rate
C. Sustainable growth rate
D. Internal growth rate
E. Cash flow rate
Refer to section 3.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.4
Topic: Internal growth rate

5. The sustainable growth rate is defined as the maximum rate at which a firm can grow given
which of the following conditions?
A. No new external financing of any kind
B. No new debt but additional external equity equal to the increase in retained earnings
C. New debt and external equity in equal proportions
D. New debt and external equity, provided the debt-equity ratio remains constant
E. No new equity and a constant debt-equity ratio
Refer to section 3.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.4
Topic: Sustainable growth rate

3-37

Chapter 03 - Working with Financial Statements

6. Which one of the following is the abbreviation for the U.S. government coding system that
classifies a firm by its specific type of business operations?
A. BEC
B. SED
C. BID
D. SIC
E. SBC
Refer to section 3.5.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-04 Identify and explain some of the problems and pitfalls in financial statement analysis.
Section: 3.5
Topic: SIC code

7. Builder's Outlet just hired a new chief financial officer. To get a feel for the company, she
wants to compare the firm's sales and costs over the past 3 years determine if any trends are
present and also determine where the firm might need to make changes. Which one of the
following statements will best suit her purposes?
A. Income statement
B. Balance sheet
C. Common-size income statement
D. Common-size balance sheet
E. Statement of cash flows
Refer to section 3.1.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 03-01 Standardize financial statements for comparison purposes.
Section: 3.1
Topic: Common-size statement

3-38

Chapter 03 - Working with Financial Statements

8. A common-size balance sheet helps financial managers determine:


A. which customers are paying on a timely basis.
B. if costs are increasing faster or slower than sales.
C. if changes are occurring in a firm's mix of assets.
D. if a firm is generating more or less sales per dollar of assets than in prior years.
E. the rate at which the firm's dividends are changing.
Refer to section 3.1.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 03-01 Standardize financial statements for comparison purposes.
Section: 3.1
Topic: Common-size statement

9. High Tower Pharmacy pays a fixed percentage of its net income out to its shareholders in
the form of annual dividends. Given this, the percent shown on a common-size income
statement for the dividend account will:
A. remain constant over time.
B. be equal to the dividend amount divided by the net income.
C. vary in direct relation to the net profit percentage.
D. vary in direct relation to changes in the sales level.
E. vary but not in direct relation to any other variable.
Refer to section 3.1.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-01 Standardize financial statements for comparison purposes.
Section: 3.1
Topic: Common-size percentage

3-39

Chapter 03 - Working with Financial Statements

10. Which one of the following transactions will increase the liquidity of a firm?
A. Cash purchase of new production equipment
B. Payment of an account payable
C. Cash purchase of inventory
D. Credit sale of inventory at cost
E. Cash payment of employee wages
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Liquidity

11. Which one of the following actions will increase the current ratio, all else constant?
Assume the current ratio is greater than 1.0.
A. Cash purchase of inventory
B. Cash payment of an account receivable
C. Cash payment of an account payable
D. Credit sale of inventory at cost
E. Cash sale of inventory at a loss
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Current ratio

3-40

Chapter 03 - Working with Financial Statements

12. A firm has a current ratio of 1.4 and a quick ratio of 0.9. Given this, you know for certain
that the firm:
A. pays cash for its inventory.
B. has more than half its current assets invested in inventory.
C. has more cash than inventory.
D. has more current liabilities than it does current assets.
E. has positive net working capital.
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Quick ratio

13. Fred is the owner of a local feed store. Which one of the following ratios should he
compute if he wants to know how long the store can pay its bills given the amount of cash the
store currently has?
A. Current ratio
B. Debt ratio
C. Cash coverage ratio
D. Quick ratio
E. Cash ratio
Refer to section 3.2.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Cash ratio

3-41

Chapter 03 - Working with Financial Statements

14. Which one of the following is a measure of long-term solvency?


A. Price-earnings ratio
B. Profit margin
C. Equity multiplier
D. Receivables turnover
E. Quick ratio
Refer to section 3.2.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Equity multiplier

15. The cash coverage ratio is used to evaluate the:


A. liquidity of a firm.
B. speed at which a firm generates cash.
C. length of time that a firm can pay its bills if no additional cash becomes available.
D. ability of a firm to pay the interest on its debt.
E. relationship between the firm's cash balance and its current liabilities.
Refer to section 3.2.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Cash coverage ratio

3-42

Chapter 03 - Working with Financial Statements

16. The equity multiplier is equal to:


A. one plus the debt-equity ratio.
B. one plus the total asset turnover.
C. total debt divided by total equity.
D. total equity divided by total assets.
E. one divided by the total asset turnover.
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Equity multiplier

17. Blooming Gardens has an inventory turnover of 16. This means the firm:
A. sells its entire inventory every 16 days.
B. only stocks its inventory every 16 days.
C. buys 16 days of inventory with each order.
D. sells its inventory by granting customers 16 days credit.
E. sells its inventory an average of 16 times each year.
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Inventory turnover

3-43

Chapter 03 - Working with Financial Statements

18. Which one of the following best indicates a firm is utilizing its assets more efficiently than
it has in the past?
A. Decrease in the total asset turnover
B. Decrease in the capital intensity ratio
C. Increase in days' sales in receivables
D. Decrease in the profit margin
E. Decrease in the inventory turnover rate
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Capital intensity ratio

19. Kelso's Pharmacy generates $2 in sales for every $1 the firm has invested in total assets.
Which one of the following ratios would reflect this relationship?
A. Receivables turnover
B. Equity multiplier
C. Profit margin
D. Return on assets
E. Total asset turnover
Refer to section 3.2.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Total asset turnover

3-44

Chapter 03 - Working with Financial Statements

20. Which one of the following will increase the profit margin of a firm, all else constant?
A. Increase in interest paid
B. Increase in fixed costs
C. Increase in depreciation expense
D. Decrease in the tax rate
E. Decrease in sales
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Profit margin

21. You would like to borrow money three years from now to build a new building. In
preparation for applying for that loan, you are in the process of developing target ratios for
your firm. Which set of ratios represents the best target mix considering that you want to
obtain outside financing in the relatively near future?
A. Times interest earned = 1.7; debt-equity ratio = 1.6
B. Times interest earned = 1.5; debt-equity ratio = 1.2
C. Cash coverage ratio = 0.8; debt-equity ratio = 0.8
D. Cash coverage ratio = 2.6; debt-equity ratio = 0.3
E. Cash coverage ratio = 0.5; total debt ratio = 0.2
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Long term solvency

3-45

Chapter 03 - Working with Financial Statements

22. All else constant, which one of the following will decrease if a firm increases its net
income?
A. Return on assets
B. Profit margin
C. Return on equity
D. Price-sales ratio
E. Price-earnings ratio
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Price-earnings ratio

23. Which one of the following statements is true concerning the price-earnings (PE) ratio?
A. A high PE ratio may indicate that a firm is expected to grow significantly.
B. A PE ratio of 16 indicates that investors are willing to pay $1 for every $16 of current
earnings.
C. PE ratios are unaffected by the accounting methods employed by a firm.
D. The PE ratio is classified as a profitability ratio.
E. The PE ratio is a constant value for each firm.
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Price-earnings ratio

3-46

Chapter 03 - Working with Financial Statements

24. New Century Products is a company that was founded last year. While the outlook for the
company is positive, it currently has negative earnings. If you wanted to measure the progress
of this firm, which one of the following ratios would probably be best to monitor given the
firm's current situation?
A. Price-sales ratio
B. Market-to-book ratio
C. Profit margin
D. ROE
E. ROA
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Price-sales ratio

25. The Du Pont identity can be used to help a financial manager determine the:
I. degree of financial leverage used by a firm.
II. operating efficiency of a firm.
III. utilization rate of a firm's assets.
IV. rate of return on a firm's assets.
A. II and III only
B. I and III only
C. II, III, and IV only
D. I, II, and III only
E. I, II, III, and IV
Refer to section 3.3.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-47

Chapter 03 - Working with Financial Statements

26. The T-shirt Hut successfully managed to reduce its general and administrative costs this
year. This cost improvement will increase which of the following ratios?
I. Profit margin
II. Return on assets
III. Total asset turnover
IV. Return on equity
A. I and II only
B. I and III only
C. II, III, and IV only
D. I, II, and IV only
E. I, II, III, and IV
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Profitability ratios

27. Martha's Sweet Shop reduced its fixed assets this year without affecting the shop's
operations, sales, or equity. This reduction will increase which of the following ratios?
I. Capital intensity ratio
II. Return on assets
III. Total asset turnover
IV. Return on equity
A. I and II only
B. II and III only
C. II, III, and IV only
D. I, II, and IV only
E. I, II, III, and IV
Refer to section 3.2.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Total asset turnover and return on assets

3-48

Chapter 03 - Working with Financial Statements

28. Donovan Brothers, Inc. would like to increase its internal rate of growth. Decreasing
which one of the following will help the firm achieve its goal?
A. Return on assets
B. Net income
C. Retention ratio
D. Dividend payout ratio
E. Return on equity
Refer to section 3.4.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Internal growth rate

29. If a firm has a 100 percent dividend payout ratio, then the internal growth rate of the firm
is:
A. zero percent.
B. 100 percent.
C. equal to the ROA.
D. negative.
E. infinite.
Refer to section 3.4.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Internal growth rate

3-49

Chapter 03 - Working with Financial Statements

30. Which of the following are determinants of a firm's sustainable rate of growth?
I. Amount of sales generated from each dollar invested in assets
II. Amount of debt per dollar of equity
III. Amount of current assets per dollar of current liabilities
IV. Percent of net income distributed as dividends
A. I and III only
B. II and IV only
C. I, II, and IV only
D. II, III, and IV only
E. I, II, III, and IV
Refer to section 3.4.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Sustainable growth rate

31. Which of the following will increase the sustainable rate of growth for a firm?
I. Decreasing the profit margin
II. Increasing the dividend payout ratio
III. Decreasing the capital intensity ratio
IV. Increasing the target debt-equity ratio
A. I and II only
B. III and IV only
C. II and IV only
D. I, III, and IV only
E. I, II, III, and IV
Refer to section 3.4.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Sustainable growth rate

3-50

Chapter 03 - Working with Financial Statements

32. Financial statement analysis:


A. is primarily used to identify account values that meet the normal standards.
B. is limited to internal use by a firm's managers.
C. provides useful information that can serve as a basis for forecasting future performance.
D. provides useful information to shareholders but not to debt holders.
E. is enhanced by comparing results to those of a firm's peers but not by comparing results to
prior periods.
Refer to section 3.5.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-04 Identify and explain some of the problems and pitfalls in financial statement analysis.
Section: 3.5
Topic: Financial statement analysis

33. Which one of the following statements is correct?


A. Peer group analysis is easier when a firm is a conglomerate versus when it only has a
single
B. line of business.
C. Peer group analysis is easier when seasonal firms have different fiscal years.
D. Peer group analysis is simplified when firms use varying methods of depreciation.
E. Comparing results across geographic locations is easier since all countries now use a
common
F. set of accounting standards.
G. Adjustments have to be made when comparing the income statements of firms which use
different methods of accounting for inventory.
Refer to section 3.5.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 03-04 Identify and explain some of the problems and pitfalls in financial statement analysis.
Section: 3.5
Topic: Financial statement analysis

3-51

Chapter 03 - Working with Financial Statements

34. Russell's Hardware has inventory of $218,000, equity of $421,800, total assets of
$647,700, and sales of $587,200. What is the common-size percentage for the inventory
account?
A. 26.81 percent
B. 33.66 percent
C. 37.12 percent
D. 49.09 percent
E. 51.68 percent
Inventory common-size percent = $218,000/$647,700 = 33.66 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-01 Standardize financial statements for comparison purposes.
Section: 3.1
Topic: Common-size percentage

35. A firm has inventory of $11,400, accounts payable of $9,800, cash of $850, net fixed
assets of $12,150, long-term debt of $9,500, accounts receivable of $6,600, and total equity of
$11,700. What is the common-size percentage for the net fixed assets?
A. 19.60 percent
B. 26.67 percent
C. 39.19 percent
D. 42.08 percent
E. 48.75 percent
NFA common-size percent = $12,150/($850 + $6,600 + $11,400 + $12,150) = 39.19 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-01 Standardize financial statements for comparison purposes.
Section: 3.1
Topic: Common-size ratio

3-52

Chapter 03 - Working with Financial Statements

36. Foreign Travel Services has net income of $48,400, total assets of $219,000, total equity
of $154,800, and total sales of $311,700. What is the common-size percentage for the net
income?
A. 9.00 percent
B. 13.90 percent
C. 15.53 percent
D. 22.10 percent
E. 31.27 percent
Net income common-size percent = $48,400/$311,700 = 15.53 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-01 Standardize financial statements for comparison purposes.
Section: 3.1
Topic: Common-size percent

37. Delmont Movers has a profit margin of 6.2 percent and net income of $48,900. What is
the common-size percentage for the cost of goods sold if that expense amounted to $379,000
for the year?
A. 12.90 percent
B. 23.50 percent
C. 33.25 percent
D. 41.06 percent
E. 48.05 percent
COGS common-size percent = $379,000/($48,900/0.062) = 48.05 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-01 Standardize financial statements for comparison purposes.
Section: 3.1
Topic: Common-size percent

3-53

Chapter 03 - Working with Financial Statements

38. A firm has sales of $428,000 for the year. The profit margin is 3.4 percent and the
retention ratio is 60 percent. What is the common-size percentage for the dividends paid?
A. 0.99 percent
B. 1.18 percent
C. 1.21 percent
D. 1.36 percent
E. 1.42 percent
Dividends paid common-size percent = [$428,000 0.034 (1 - 0.60)]/$428,000 = 1.36
percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-01 Standardize financial statements for comparison purposes.
Section: 3.1
Topic: Common-size percent

39. Peter's Motor Works has total assets of $689,400, long-term debt of $299,500, total equity
of $275,000, net fixed assets of $497,800, and sales of $721,500. The profit margin is 4.6
percent. What is the current ratio?
A. 0.60
B. 0.91
C. 1.01
D. 1.67
E. 2.16
Current ratio = ($689,400 - $497,800)/($689,400 - $299,500 - $275,000) = 1.67

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Current ratio

3-54

Chapter 03 - Working with Financial Statements

40. Healthy Foods has total assets of $129,800, net fixed assets of $71,500, long-term debt of
$52,000, and total debt of $78,700. If inventory is $31,800, what is the current ratio?
A. 0.33
B. 0.46
C. 0.84
D. 1.18
E. 2.18
Current ratio = ($129,800 - $71,500)/($78,700 - $52,000) = 2.18

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Current ratio

41. A firm has net working capital of $3,800 and current assets of $11,700. What is the current
ratio?
A. 0.34
B. 0.60
C. 1.48
D. 1.65
E. 2.92
Current ratio = $11,700/($11,700 - $3,800) = 1.48

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Current ratio

3-55

Chapter 03 - Working with Financial Statements

42. Slightly Used Goods has cash of $2,150, inventory of $28,470, fixed assets of $9,860,
accounts payable of $11,900, and accounts receivable of $4,660. What is the cash ratio?
A. 0.08
B. 0.18
C. 0.32
D. 0.46
E. 0.51
Cash ratio = $2,150/$11,900 = 0.18

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Cash ratio

43. You are analyzing a company that has cash of $11,200, accounts receivable of $27,800,
fixed assets of $124,600, accounts payable of $31,300, and inventory of $56,900. What is the
quick ratio?
A. 0.30
B. 0.67
C. 0.80
D. 1.25
E. 1.37
Quick ratio = ($11,200 + $27,800)/$31,300 = 1.25

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Quick ratio

3-56

Chapter 03 - Working with Financial Statements

44. Tasty Dee-Lite has current liabilities of $6,630, net working capital of $2,180, inventory
of $2,750, and sales of $36,800. What is the quick ratio?
A. 0.76
B. 0.84
C. 0.91
D. 1.09
E. 1.19
Quick ratio = ($6,630 + $2,180 - $2,750)/$6,630 = 0.91

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Quick ratio

45. Tressler Dry Cleaners has inventory of $1,700, accounts payable of $4,200, cash of
$1,950, and accounts receivable of $3,680. What is the cash ratio?
A. 0.24
B. 0.46
C. 0.53
D. 0.98
E. 1.34
Cash ratio = $1,950/$4,200 = 0.46

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Cash ratio

3-57

Chapter 03 - Working with Financial Statements

46. Your firm has cash of $3,800, accounts receivable of $9,600, inventory of $33,100, and
net working capital of $1,100. What is the cash ratio?
A. 0.04
B. 0.08
C. 0.87
D. 1.21
E. 3.45
Cash ratio = $3,800/($3,800 + $9,600 + $33,100 - $1,100) = 0.08

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Cash ratio

47. Wilson's Realty has total assets of $46,800, net fixed assets of $37,400, current liabilities
of $6,100, and long-term liabilities of $24,600. What is the total debt ratio?
A. 0.41
B. 0.60
C. 0.66
D. 0.78
E. 0.86
Total debt ratio = ($6,100 + $24,600)/$46,800 = 0.66

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Total debt ratio

3-58

Chapter 03 - Working with Financial Statements

48. Denton, Inc. has total equity of $389,600, long-term debt of $116,400, net working capital
of $1,600, and total assets of $527,600. What is the total debt ratio?
A. 0.22
B. 0.26
C. 0.67
D. 1.49
E. 3.85
Total debt ratio = ($527,600 - $389,600)/$527,600 = 0.26

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Total debt ratio

49. A firm has total assets of $523,100, current assets of $186,500, current liabilities of
$141,000, and total debt of $215,000. What is the debt-equity ratio?
A. 0.48
B. 0.70
C. 1.10
D. 1.43
E. 2.13
Debt-equity ratio = $215,000/($523,100 - $215,000) = 0.70

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Debt-equity ratio

3-59

Chapter 03 - Working with Financial Statements

50. The Jelly Jar has total assets of $79,600 and an equity multiplier of 1.35. What is the debtequity ratio?
A. 0.28
B. 0.35
C. 0.47
D. 0.58
E. 0.67
Debt-equity ratio = 1.35 - 1 = 0.35

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Debt-equity ratio

51. Underwood Homes Sales has total assets of $589,900 and total debt of $318,000. What is
the equity multiplier?
A. 0.46
B. 0.54
C. 1.21
D. 1.85
E. 2.17
Equity multiplier = $589,900/($589,900 - $318,000) = 2.17

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Equity multiplier

3-60

Chapter 03 - Working with Financial Statements

52. A firm has an equity multiplier of 1.5. This means that the firm has a:
A. debt-equity ratio of 0.67.
B. debt-equity ratio of 0.33.
C. total debt ratio of 0.50.
D. total debt ratio of 0.67.
E. total debt ratio of 0.33.
Refer to section 3.2.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Equity multiplier

53. Preston's Market has sales of $213,600, total assets of $198,700, a debt-equity ratio of 1.6,
and a profit margin of 2.4 percent. What is the equity multiplier?
A. 0.60
B. 0.63
C. 1.83
D. 2.60
E. 2.84
Equity multiplier = 1 + 1.6 = 2.6

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Equity multiplier

3-61

Chapter 03 - Working with Financial Statements

54. Friendly's Shoe Store has earnings before interest and taxes of $21,680 and net income of
$12,542. The tax rate is 34 percent. What is the times interest earned ratio?
A. 0.88
B. 1.67
C. 3.09
D. 5.59
E. 8.10
Times interest earned ratio = $21,680/{$21,680 - [$12,542/(1 - 0.34)]} = 8.10

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Times interest earned

55. The Berry Patch has sales of $438,000, cost of goods sold of $369,000, depreciation of
$37,400, and interest expense of $13,800. The tax rate is 35 percent. What is the times interest
earned ratio?
A. 2.29
B. 3.46
C. 3.87
D. 4.38
E. 4.79
Times interest earned ratio = ($438,000 - $369,000 - $37,400)/$13,800 = 2.29

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Times interest earned

3-62

Chapter 03 - Working with Financial Statements

56. A firm has net income of $5,890 and interest expense of $2,130. The tax rate is 34 percent.
What is the firm's times interest earned ratio?
A. 4.82
B. 5.19
C. 5.38
D. 5.67
E. 6.33
Times interest earned ratio = {[$5,890/(1 - 0.34)] + $2,130}/$2,130 = 5.19

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Times interest earned

57. A firm has net income of $31,300, depreciation of $5,100, taxes of $14,600, and interest
paid of $3,100. What is the cash coverage ratio?
A. 8.78
B. 10.10
C. 14.14
D. 16.32
E. 17.45
Cash coverage ratio = ($31,300 + $14,600 + $3,100 + $5,100)/$3,100 = 17.45

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Cash coverage ratio

3-63

Chapter 03 - Working with Financial Statements

58. Blue Water Cafe has $28,700 in total assets, depreciation of $3,100, and interest of
$1,400. The total asset turnover rate is 1.2. Earnings before interest and taxes are equal to 28
percent of sales. What is the cash coverage ratio?
A. 6.33
B. 7.51
C. 9.10
D. 10.23
E. 10.98
Cash coverage ratio = {[0.28 (1.2 $28,700)] + $3,100}/$1,400 = 9.10

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Cash coverage ratio

59. The Global Network has sales of $418,700, cost of goods sold of $264,900, and inventory
of $61,900. What is the inventory turnover rate?
A. 1.33
B. 4.28
C. 6.76
D. 7.14
E. 8.47
Inventory turnover = $264,900/$61,900 = 4.28

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Inventory turnover

3-64

Chapter 03 - Working with Financial Statements

60. The Tourist Stop takes an average of 63 days to sell its inventory and an average of 1.5
days to collect payment on its sales. What is the inventory turnover rate?
A. 5.79
B. 7.29
C. 8.68
D. 10.18
E. 11.42
Inventory turnover = 365/63 = 5.79

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Inventory turnover

61. Galaxy Sales has sales of $746,700, cost of goods sold of $603,200, and inventory of
$94,300. How long on average does it take the firm to sell its inventory?
A. 6.40 days
B. 7.23 days
C. 48.68 days
D. 57.06 days
E. 61.10 days
Inventory turnover = $603,200/$94,300 = 6.39661
Days sales in inventory = 365/6.39661 = 57.06 days

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Days sales in inventory

3-65

Chapter 03 - Working with Financial Statements

62. Handy Hardware sells its inventory in 85 days, on average. Costs of goods sold for the
year are $631,800. What is the average value of the firm's inventory?
A. $114,706
B. $123,506
C. $147,132
D. $161,096
E. $182,513
Inventory turnover = 365/85 = 4.29412
Inventory = $631,800/4.29412 = $147,132

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Inventory

63. Kessler, Inc. has accounts receivable of $31,600, total assets of $311,500, cost of goods
sold of $208,400, and a capital intensity ratio of 1.08. What is the accounts receivables
turnover rate?
A. 8.99
B. 9.13
C. 9.42
D. 9.61
E. 9.72
Accounts receivable turnover = ($311,500/1.08)/$31,600 = 9.13

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Accounts receivable turnover

3-66

Chapter 03 - Working with Financial Statements

64. It takes The Corner Store an average of 51 days to sell its inventory and 32 days to collect
its accounts receivable. The firm has sales of $568,700 and costs of goods sold of $398,800.
What is the accounts receivable turnover rate?
A. 11.23
B. 11.41
C. 11.78
D. 12.23
E. 12.55
Receivables turnover = 365/32 = 11.41

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Accounts receivable turnover

65. Textile Mills has sales of $923,000, cost of goods sold of $748,000, and accounts
receivable of $106,700. How long on average does it take the firm's customers to pay for their
purchases?
A. 8.65 days
B. 11.28 days
C. 25.01 days
D. 42.19 days
E. 45.33 days
Accounts receivable turnover = $923,000/$106,700 = 8.65042
Days sales in receivables = 365/8.65042 = 42.19 days

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Days sales in receivables

3-67

Chapter 03 - Working with Financial Statements

66. A firm has $42,900 in receivables and $211,800 in total assets. The total asset turnover
rate is 1.45 and the profit margin is 4.2 percent. How long on average does it take the firm to
collect its receivables?
A. 7.16 days
B. 9.45 days
C. 11.68 days
D. 31.25 days
E. 50.99 days
Receivables turnover = ($211,800 1.45)/$42,900 = 7.15874
Days sales in receivables = 365/7.15874 = 50.99 days

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Days sales in receivables

67. Aardvaark & Co. has sales of $291,200, cost of goods sold of $163,300, net profit of
$11,360, net fixed assets of $154,500, and current assets of $89,500. What is the total asset
turnover rate?
A. 1.08
B. 1.11
C. 1.19
D. 1.24
E. 1.28
Total asset turnover = $291,200/($154,500 + $89,500) = 1.19

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Total asset turnover

3-68

Chapter 03 - Working with Financial Statements

68. Holiday House has sales of $648,000, a profit margin of 6.1 percent, and a capital
intensity ratio of 0.84. What is the total asset turnover rate?
A. 1.04
B. 1.08
C. 1.13
D. 1.19
E. 1.26
Total asset turnover = 1/0.84 = 1.19

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Total asset turnover

69. Martha's Fabric House has sales of $137,200, total equity of $74,400, and a debt-equity
ratio of 0.45. What is the capital intensity ratio?
A. 0.79
B. 0.83
C. 1.06
D. 1.20
E. 1.27
Total assets = (0.45 $74,400) + $74,400 = $107,880
Capital intensity ratio = $107,880/$137,200 = 0.79

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Capital intensity ratio

3-69

Chapter 03 - Working with Financial Statements

70. Circle Stores has net income of $41,000, a profit margin of 6.7 percent, and a return on
assets of 9 percent. What is the capital intensity ratio?
A. 0.74
B. 0.86
C. 1.16
D. 1.34
E. 1.38
Capital intensity ratio = ($41,000/0.09)/($41,000/0.067) = 0.74

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Capital intensity ratio

71. Tally Ho Inn has annual sales of $737,000. Earnings before interest and taxes is equal to
21 percent of sales. For the period, the firm paid $7,900 in interest. What is the profit margin
if the tax rate is 35 percent?
A. 12.46 percent
B. 12.95 percent
C. 13.33 percent
D. 15.29 percent
E. 16.11 percent
Profit margin = {[(0.21 $737,000) - $7,900] (1 - 0.35)}/$737,000 = 12.95 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Profit margin

3-70

Chapter 03 - Working with Financial Statements

72. The Medicine Cabinet has a return on equity of 18.2 percent, a profit margin of 11.6
percent, and total equity of $738,000. What is the net income?
A. $85,608
B. $113,875
C. $134,316
D. $142,311
E. $149,897
Net income = 0.182 $738,000 = $134,316

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Return on equity

73. The Next Life has sales of $428,300, total assets of $389,100, and a profit margin of 6.2
percent. What is the return on assets?
A. 6.29 percent
B. 6.54 percent
C. 6.83 percent
D. 7.01 percent
E. 7.27 percent
Return on assets = (0.062 $428,300)/$389,100 = 6.83 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Return on assets

3-71

Chapter 03 - Working with Financial Statements

74. Goshen Industrial Sales has sales of $828,900, total equity of $539,200, a profit margin of
4.6 percent and a debt-equity ratio of 0.55. What is the return on assets?
A. 3.89 percent
B. 4.56 percent
C. 6.67 percent
D. 12.86 percent
E. 13.33 percent
Return on assets = (0.046 $828,900)/[(1 + 0.55) $539,200)] = 4.56 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Return on assets

75. Cross Hairs Gun Shop has sales of $189,000, a profit margin of 4.8 percent, and a capital
intensity ratio of 0.79. What is the return on assets?
A. 5.67 percent
B. 6.08 percent
C. 6.39 percent
D. 6.42 percent
E. 6.67 percent
Return on assets = (0.048 $189,000)/(0.79 $189,000) = 6.08 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Return on assets

3-72

Chapter 03 - Working with Financial Statements

76. Freedom Health Centers has total equity of $861,300, sales of $1.48 million, and a profit
margin of 5.2 percent. What is the return on equity?
A. 5.82 percent
B. 6.49 percent
C. 7.18 percent
D. 8.68 percent
E. 8.94 percent
Return on equity = (0.052 $1,480,000)/$861,300 = 8.94 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Return on equity

77. The Closet Shoppe has total sales of $713,200 and a profit margin of 5.8 percent.
Currently, the firm has 12,500 shares outstanding. What are the earnings per share?
A. $2.98
B. $3.31
C. $3.56
D. $3.89
E. $4.02
Earnings per share = (0.058 $713,200)/12,500 = $3.31

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Earnings per share

3-73

Chapter 03 - Working with Financial Statements

78. Baxter & Baxter has total assets of $710,000. There are 45,000 shares of stock outstanding
with a market value of $28 a share. The firm has a profit margin of 7.1 percent and a total
asset turnover of 1.29. What is the price-earnings ratio?
A. 16.38
B. 17.99
C. 19.38
D. 20.12
E. 22.41
Price-earnings ratio = $28/{[0.071 ($710,000 1.29)]/45,000} = 19.38

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Price-earnings ratio

79. Ratzell's Place has a market-to-book ratio of 2.7, net income of $68,400, a book value per
share of $37, and 45,000 shares of stock outstanding. What is the price-earnings ratio?
A. 24.34
B. 28.16
C. 55.10
D. 59.09
E. 65.72
Price-earnings ratio = (2.7 $37)/($68,400/45,000) = 65.72

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Price-earnings ratio

3-74

Chapter 03 - Working with Financial Statements

80. The Green House has a profit margin of 5.6 percent on sales of $311,200. The firm
currently has 15,000 shares of stock outstanding at a market price of $11.60 per share. What is
the price-earnings ratio?
A. 9.98
B. 10.02
C. 11.50
D. 11.93
E. 12.84
Price-earnings ratio = $11.60/[(0.056 $311,200)/15,000] = 9.98

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Price-earnings ratio

81. A firm has sales of $311,000 and net income of $21,600. Currently, there are 18,000
shares outstanding at a market price of $36 per share. What is the price-sales ratio?
A. 2.08
B. 3.11
C. 4.26
D. 5.15
E. 6.95
Price - sales ratio = $36/($311,000/18,000) = 2.08

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Price-sales ratio

3-75

Chapter 03 - Working with Financial Statements

82. The common stock of The Burger Hut is selling for $16.25 a share. The company has
earnings per share of $0.42 and a book value per share of $9.28. What is the market-to-book
ratio?
A. 1.58
B. 1.69
C. 1.75
D. 1.87
E. 1.92
Market-to-book ratio = $16.25/$9.28 = 1.75

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Market-to-book ratio

83. Swanton Foods has a book value per share of $12.68, earnings per share of $1.21, and a
price-earnings ratio of 17.6. What is the market-to-book ratio?
A. 1.32
B. 1.68
C. 1.99
D. 2.47
E. 2.61
Market-to-book ratio = ($1.21 17.6)/$12.68 = 1.68

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Market-to-book ratio

3-76

Chapter 03 - Working with Financial Statements

84. The Inside Door has total debt of $78,600, total equity of $214,000, and a return on equity
of 14.5 percent. What is the return on assets?
A. 9.14 percent
B. 10.61 percent
C. 21.45 percent
D. 34.61 percent
E. 39.48 percent
Return on assets = 0.145/[($78,600 + $214,000)/$214,000] = 10.61 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

85. The Noodle Place has total assets of $123,800, a debt-equity ratio of 0.65, and net income
of $7,100. What is the return on equity?
A. 3.48 percent
B. 3.73 percent
C. 8.01 percent
D. 9.46 percent
E. 13.61 percent
Return on equity = ($7,100/$123,800) (1 + 0.65) = 9.46 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-77

Chapter 03 - Working with Financial Statements

86. Computer Geeks has sales of $521,000, a profit margin of 14.8 percent, a total asset
turnover rate of 2.16, and an equity multiplier of 1.30. What is the return on equity?
A. 8.91 percent
B. 12.67 percent
C. 18.28 percent
D. 32.11 percent
E. 41.56 percent
Return on equity = 0.148 2.16 1.30 = 41.56 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

87. Morrison Motors has total equity of $289,100 and net income of $64,500. The debt-equity
ratio is 0.45 and the total asset turnover is 1.6. What is the profit margin?
A. 3.10 percent
B. 5.23 percent
C. 5.67 percent
D. 8.21 percent
E. 9.62 percent
Profit margin = ($64,500/$289,100)/[(1 + 0.45) 1.6] = 9.62 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-78

Chapter 03 - Working with Financial Statements

88. A firm has net income of $114,000, a return on assets of 12.6 percent, and a debt-equity
ratio of 0.60. What is the return on equity?
A. 17.11 percent
B. 18.98 percent
C. 20.16 percent
D. 22.20 percent
E. 24.60 percent
Return on equity = 0.126 (1 + 0.60) = 20.16 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

89. The Blue Lantern has a return on equity of 17.8 percent, an equity multiplier of 1.9, and a
total asset turnover of 1.45. What is the profit margin?
A. 2.76 percent
B. 3.57 percent
C. 4.90 percent
D. 5.28 percent
E. 6.46 percent
Profit margin = 0.178/(1.45 1.9) = 6.46 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-79

Chapter 03 - Working with Financial Statements

90. The Saw Mill has a return on assets of 6.1 percent, a total asset turnover rate of 1.8, and a
debt-equity ratio of 1.6. What is the return on equity?
A. 4.26 percent
B. 9.76 percent
C. 12.28 percent
D. 15.86 percent
E. 19.03 percent
Return on equity = 0.061 (1 + 1.6) = 15.86 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

91. Webster & Jones has net income of $49,200, sales of $936,800, a capital intensity ratio of
0.74, and an equity multiplier of 1.5. What is the return on equity?
A. 6.67 percent
B. 8.98 percent
C. 10.65 percent
D. 12.21 percent
E. 14.09 percent
Return on equity = ($49,200/$936,800) (1/0.74) 1.5 = 10.65 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-80

Chapter 03 - Working with Financial Statements

92. New Steel Products has total assets of $991,000, a total asset turnover rate of 1.1, a debtequity ratio of 0.6, and a return on equity of 8.7 percent. What is the firm's net income?
A. $53,885.63
B. $58,303.33
C. $64,624.14
D. $70,548.09
E. $77,236.67
Return on equity = 0.087 = [Net income/($991,000 1.1)] 1.1 (1 + 0.6); Net
income = $53,885.63

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

93. Eastern Hardwood Sales has total equity of $89,000, a profit margin of 4.8 percent, an
equity multiplier of 1.5, and a total asset turnover of 1.3. What is the amount of the firm's
sales?
A. $168,200
B. $173,550
C. $181,430
D. $185,620
E. $187,500
Sales = $89,000 1.5 1.3 = $173,550

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-81

Chapter 03 - Working with Financial Statements

94. Tessler Farms has a return on equity of 12.71 percent, a debt-equity ratio of 0.75, and a
total asset turnover of 0.9. What is the return on assets?
A. 7.26 percent
B. 8.06 percent
C. 13.67 percent
D. 15.24 percent
E. 17.41 percent
Return on assets = 0.1271/(1 + 0.75) = 7.26 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

95. A firm earns $0.17 in profit for every $1 of equity in the firm. The company borrows
$0.60 for every $1 of equity. What is the firm's return on assets?
A. 10.63 percent
B. 13.53 percent
C. 25.15 percent
D. 26.07 percent
E. 28.33 percent
Return on assets = ($0.17/$1)/($1.60/$1) = 10.63 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-82

Chapter 03 - Working with Financial Statements

96. The Veggie Hut has net income of $26,400, total equity of $102,700, and total assets of
$189,500. The dividend payout ratio is 0.30. What is the internal growth rate?
A. 7.99 percent
B. 8.57 percent
C. 10.81 percent
D. 16.87 percent
E. 21.94 percent
Internal growth rate = [($26,400/$189,500) (1 - 0.30)]/{1 - [($26,400/$189,500) (1 0.30)]} = 10.81 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Internal growth rate

97. Quick Foods has sales of $238,900, total assets of $217,000, total equity of $121,300, net
income of $18,700, and dividends paid of $6,000. What is the internal growth rate?
A. 5.48 percent
B. 6.22 percent
C. 6.67 percent
D. 7.34 percent
E. 7.92 percent
Internal growth rate = {($18,700/$217,000) [($18,700 - $6,000)/$18,700]}/ {1 {($18,700/$217,000) [($18,700 - $6,000)/$18,700]}}/ = 6.22 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Internal growth rate

3-83

Chapter 03 - Working with Financial Statements

98. A firm has adopted a policy whereby it will not seek any additional external financing.
Given this, what is the maximum growth rate for the firm if it has net income of $12,100, total
equity of $94,000, total assets of $156,000, and a 40 percent dividend payout ratio?
A. 4.88 percent
B. 5.11 percent
C. 6.62 percent
D. 7.67 percent
E. 8.37 percent
Internal growth rate = [($12,100/$156,000) (1 - 0.40)]/{1 - [($12,100/$156,000) (1 0.40)]} = 4.88 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Internal growth rate

99. Underwood Enterprises earns $0.07 in profit on every $1 of sales and has $0.67 in assets
for every $1 of sales. The firm pays out 20 percent of its profits to its shareholders. What is
the internal growth rate?
A. 6.37 percent
B. 7.76 percent
C. 8.80 percent
D. 9.12 percent
E. 9.65 percent
Internal growth rate = [($0.07/$0.67) (1 - 0.20)]/{1 - [($0.07/$0.67) (1 - 0.20)]} = 9.12
percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Internal growth rate

3-84

Chapter 03 - Working with Financial Statements

100. Joshua's Antiques has a total asset turnover rate of 1.2, an equity multiplier of 1.4, a
profit margin of 5 percent, a retention ratio of 0.8, and total assets of $120,000. What is the
sustainable growth rate?
A. 6.98 percent
B. 7.20 percent
C. 7.33 percent
D. 7.54 percent
E. 7.91 percent
Sustainable growth rate = [(0.05 1.2 1.4) 0.8]/{1 - [(0.05 1.2 1.4) 0.8]} = 7.20
percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Sustainable growth rate

101. A firm has a return on equity of 16 percent, a return on assets of 11 percent, and a 40
percent dividend payout ratio. What is the sustainable growth rate?
A. 5.72 percent
B. 6.84 percent
C. 7.12 percent
D. 9.58 percent
E. 10.62 percent
Sustainable growth rate = [0.16 (1 - 0.40)]/{1 - [0.16 (1 - 0.40)]} = 10.62 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Sustainable growth rate

3-85

Chapter 03 - Working with Financial Statements

102. Valentino's maintains a constant debt-equity ratio of 0.45. The firm had net income of
$11,800 for the year and paid $6,500 in dividends. The firm has total assets of $92,000. What
is the sustainable growth rate?
A. 7.38 percent
B. 8.27 percent
C. 9.11 percent
D. 9.62 percent
E. 10.38 percent
Sustainable growth rate = {$11,800/[$92,000/(1 + 0.45)]} [($11,800 - $6,500) /$11,800]/{1
- {$11,800/[$92,000/(1 + 0.45)]} [($11,800 - $6,500)/$11,800]} = 9.11 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Sustainable growth rate

103. The Donut Hut has sales of $68,000, current assets of $11,300, net income of $5,100, net
fixed assets of $54,900, total debt of $23,800, and dividends of $800. What is the sustainable
growth rate?
A. 10.48 percent
B. 11.29 percent
C. 11.79 percent
D. 12.08 percent
E. 12.39 percent
Sustainable growth rate = {[$5,100/($11,300 + $54,900 - $23,800)] [($5,100 - $800)/
$5,100]}/{1 - {[$5,100/($11,300 + $54,900 - $23,800)] [($5,100 - $800) /$5,100]}} = 11.29
percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Sustainable growth rate

3-86

Chapter 03 - Working with Financial Statements

104. Last year, a firm earned $31,200 in net income on sales of $217,600. The company paid
$7,500 in dividends. What is the dividend payout ratio?
A. 3.45 percent
B. 4.71 percent
C. 14.34 percent
D. 22.85 percent
E. 24.04 percent
Dividend payout ratio = $7,500/$31,200 = 24.04 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Dividend payout ratio

105. Last year, Blakely's Fashions earned net income of $68,400 and had 12,000 shares of
stock outstanding. The dividends per share were $2.20. What is the dividend payout ratio?
A. 32.98 percent
B. 34.00 percent
C. 38.60 percent
D. 40.21 percent
E. 44.14 percent
Dividend payout ratio = $2.20/($68,400/12,000) = 38.60 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Dividend payout ratio

3-87

Chapter 03 - Working with Financial Statements

106. Gabriel Furniture has a profit margin of 8.2 percent and a dividend payout ratio of 30
percent. What is the plowback ratio?
A. 10.66 percent
B. 27.33 percent
C. 54.60 percent
D. 70.00 percent
E. 78.20 percent
Plowback ratio = 1 - 0.30 = 0.70

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Plowback ratio

107. Town Centre Market has sales of $311,800, a profit margin of 2.9 percent, and dividends
of $4,500. What is the plowback ratio?
A. 46.32 percent
B. 49.78 percent
C. 50.23 percent
D. 51.15 percent
E. 53.68 percent
Plowback ratio = 1 - [$4,500/(0.029 $311,800)] = 50.23 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Plowback ratio

3-88

Chapter 03 - Working with Financial Statements

108. Use the following financial information to answer this question.

What are the values of the three components of the DuPont identity? Use ending balance sheet
values.
A. 0.15; 1.02; 0.35
B. 0.15; 2.02; 0.35
C. 0.15; 0.98; 2.86
D. 0.16; 0.98; 0.35
E. 0.16; 1.02; 2.86
Profit margin = $1,220/$8,200 = 0.15
Total asset turnover = $8,200/$8,340 = 0.98
Equity multiplier = $8,340/($1,500 + $1,420) = 2.86

3-89

Chapter 03 - Working with Financial Statements


AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

109. Global Ventures has a return on equity of 9.8 percent, a retention ratio of 60 percent, and
a profit margin of 4.5 percent. The company paid $378 in dividends and has net working
capital of $100. Net fixed assets are $18,550 and current liabilities are $520. What is the total
equity of the firm?
A. $6,457
B. $6,890
C. $7,360
D. $9,643
E. $11,480
Net income = $378/(1 - 0.60) = $945
Sales = $945/0.045 = $21,000
ROE = PM (Sales/Total equity) = 0.098 = 0.045 ($21,000/TE); TE = $9,643

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-90

Chapter 03 - Working with Financial Statements


Essay Questions

110. Assume this is your first day on the job as the new chief financial officer of a mid-size
company. Identify the three key ratios that you would compute first as you begin to try to
understand the financial status of the firm. Explain why you selected the three ratios that you
did.
Student answers will vary but should include a measure of liquidity as the inability of a firm
to pay its bills would be a top priority for a CFO. A key for grading is the strength and the
logic of the student explanations for their ratio selections.

AACSB: Reflective thinking


Bloom's: Evaluation
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.3
Topic: Ratio analysis

111. You are trying to compare the financial performance of your firm to that of similar firms.
What are some of the key problems you might encounter in doing this comparison?
The first problem is identifying an appropriate peer group. This is a particular problem for
conglomerates and firms with international operations. Conglomerates have operations in
multiple industrial sectors. International firms encounter various accounting and regulatory
standards and currency conversion problems. Even national firms operating in a single
industrial sector still encounter problems when comparing firms because of different fiscal
years, seasonal factors, various accounting methods, and modes of operation.

AACSB: Reflective thinking


Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-04 Identify and explain some of the problems and pitfalls in financial statement analysis.
Section: 3.5
Topic: Financial analysis problems

3-91

Chapter 03 - Working with Financial Statements

112. Explain why the DuPont identity is so useful to a financial manager.


Student answers will vary but a good answer will explain that the DuPont identity helps
identify how various aspects of a firm affect the firm's return to its shareholders. The profit
margin relates to the efficiency of a firm's operations and the ability to generate a profit on
sales. The total asset turnover shows the amount of sales that can be generated per each dollar
of assets and helps managers determine if the firm has acquired the right assets. The equity
multiplier is the amount of assets that a firm has at its disposal per dollar of equity and reveals
how much leverage a firm utilizes.

AACSB: Reflective thinking


Bloom's: Evaluation
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

113. Since there are no perfect or ideal standard ratios for a firm, why is ratio analysis still
considered a valuable management tool?
Ratios allow managers to compare the financial performance of a firm over time to view
trends which helps managers identify areas of improvement as well as areas of performance
deterioration. Ratios also allow managers to compare the performance of their firms to that of
their peers. This comparison helps identify common industrial trends and areas of
discrepancies. Ratios do not provide managers with answers but they do provide key
information that aid in the management process.

AACSB: Reflective thinking


Bloom's: Evaluation
Difficulty: Intermediate
Learning Objective: 03-04 Identify and explain some of the problems and pitfalls in financial statement analysis.
Section: 3.5
Topic: Financial analysis

3-92

Chapter 03 - Working with Financial Statements


Multiple Choice Questions

114. Peterboro Supply has a current accounts receivable balance of $391,648. Credit sales for
the year just ended were $5,338,411. How long did it take on average for credit customers to
pay off their accounts during the past year?
A. 24.78 days
B. 26.78 days
C. 29.09 days
D. 31.15 days
E. 33.33 days
Accounts receivable turnover = $5,338,411/$391,648 = 13.63064
Days sales in receivables = 365/13.63064 = 26.78 days
EOC #: 3.3

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Accounts receivable period

115. Sunshine Rentals has a debt-equity ratio of 0.84. Return on assets is 7.9 percent, and total
equity is $438,000. What is the net income?
A. $41,147.09
B. $54,311.29
C. $63,667.68
D. $48,887.02
E. $50,458.95
Return on equity = 0.079 (1 + 0.84) = 0.14536
Net income = 0.14536 $438,000 = $63,667.68
EOC #: 3.10

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-93

Chapter 03 - Working with Financial Statements

116. Turner's Store had a profit margin of 6.8 percent, sales of $898,200, and total assets of
$798,000. If management set a goal of increasing the total asset turnover to 1.40 times, what
would the new sales figure need to be, assuming no increase in total assets?
A. $860,333
B. $984,320
C. $1,088,500
D. $1,117,200
E. $1,257,480
Total asset turnover = 1.40 $798,000 = $1,117,200
EOC #: 3.22

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Total asset turnover

117. True Blue Transport has a current stock price of $27. For the past year, the company had
net income of $2,187,400, total equity of $13,892,300, sales of $26,511,000, and 2.5 million
shares outstanding. What is the market-to-book ratio?
A. 3.54
B. 3.81
C. 3.99
D. 4.27
E. 4.86
Book value per share = $13,892,300/2,500,000 = $5.55692
Market-to-book = $27/$5.55692 = 4.86
EOC #: 3.24

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Market-to-book ratio

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Chapter 03 - Working with Financial Statements

118. Taylor, Inc. has sales of $11,898, total assets of $9,315, and a debt-equity ratio of 0.55. If
its return on equity is 14 percent, what is its net income?
A. $841.35
B. $887.16
C. $904.10
D. $911.16
E. $927.46
Return on equity = 0.14 = (Net income/$9,315) (1 + 0.55); Net income = $841.35
EOC #: 3.26

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

119. Mercier United has net income of $128,470. There are currently 32.67 days' sales in
receivables. Total assets are $1,419,415, total receivables are $122,306, and the debt-equity
ratio is 0.40. What is the return on equity?
A. 11.42 percent
B. 12.67 percent
C. 13.09 percent
D. 13.48 percent
E. 15.03 percent
Return on equity = ($128,470/$1,419,415) (1 + 0.40)] = 12.67 percent
EOC #: 3.29

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.3
Topic: DuPont identity

3-95

Chapter 03 - Working with Financial Statements

120. For the most recent year, Wilson Enterprises had sales of $689,000, cost of goods sold of
$470,300, depreciation expense of $61,200, and additions to retained earnings of $48,560.
The firm currently has 12,000 shares of common stock outstanding, and the previous year's
dividends per share were $1.18. Assuming a 35 percent tax rate, what was the times interest
earned ratio?
A. 1.47
B. 2.09
C. 2.58
D. 3.15
E. 3.67
Net income = $48,560 + ($1.18 12,000) = $62,720
Earnings before taxes = [$62,720/(1 - 0.35)] = $96,492.31
Earnings before interest and taxes = $689,000 - $470,300 - $61,200 = $157,500
Interest = $157,500 - $96,492.31 = $61,007.69
Times interest earned = $157,500/$61,007.69 = 2.58
EOC #: 3.31

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Times interest earned

3-96

Chapter 03 - Working with Financial Statements

121. A fire has destroyed a large percentage of the financial records of the Strongwell Co. You
have the task of piecing together information in order to release a financial report. You have
found the return on equity to be 13.8 percent. Sales were $979,000, the total debt ratio was
0.42, and total debt was $548,000. What is the return on assets?
A. 6.92 percent
B. 8.00 percent
C. 8.45 percent
D. 9.03 percent
E. 9.29 percent
Debt-equity ratio = 0.42/(1 - 0.42) = 0.72414
Return on assets = 0.138/(1 + 0.72414) = 8.00 percent
EOC #: 3.32

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-02 Compute and; more importantly; interpret some common ratios.
Section: 3.2
Topic: Return on assets

122. Donegal's Industrial Products wishes to maintain a growth rate of 6 percent a year, a
debt-equity ratio of 0.45, and a dividend payout ratio of 30 percent. The ratio of total assets to
sales is constant at 1.25. What profit margin must the firm achieve?
A. 4.68 percent
B. 5.29 percent
C. 6.33 percent
D. 6.97 percent
E. 8.19 percent
Sustainable growth = 0.06 = {[(PM (1/1.25) (1 + 0.45)] (1 - 0.30)}/{1 - {[(PM
(1/1.25) (1 + 0.45)] (1 - 0.30)}} = 6.97 percent
EOC #: 3.38

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Sustainable growth rate

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Chapter 03 - Working with Financial Statements

123. A firm wishes to maintain an internal growth rate of 4.5 percent and a dividend payout
ratio of 60 percent. The current profit margin is 7.5 percent and the firm uses no external
financing sources. What must the total asset turnover be?
A. 0.98
B. 1.06
C. 1.21
D. 1.44
E. 1.59
Internal growth rate = 0.045 = [0.075 TAT (1 - 0.60)]/{1 - [0.075 TAT (1 - 0.60)]};
TAT = 1.44
EOC #: 3.40

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 03-03 Assess the determinants of a firm's profitability and growth
Section: 3.4
Topic: Internal growth rate

3-98