Financial Statement Analysis

MODULE 10 77.The use of alternative accounting methods:

A. is not a problem in ratio analysis because the footnotes disclose
FINANCIAL STATEMENT ANALYSIS the method used.
B. may be a problem in ratio analysis even if disclosed.
THEORIES: C. is not a problem in ratio analysis since eventually all methods
6. Management is a user of financial analysis. Which of the following will lead to the same end.
comments does not represent a fair statement as to the D. is only a problem in ratio analysis with respect to inventory.
management perspective?
A. Management is always interested in maximum profitability. Industry Analysis
B. Management is interested in the view of investors. 3. Suppose you are comparing two firms in the steel industry. One firm
C. Management is interested in the financial structure of the entity. is large and the other is small. Which type of numbers would be
D. Management is interested in the asset structure of the entity. most meaningful for statement analysis?
A. Absolute numbers would be most meaningful for both the large
Limitations and small firm.
1. A limitation in calculating ratios in financial statement analysis is B. Absolute numbers would be most meaningful in the large firm;
that relative numbers would be most meaningful in the small firm.
A. it requires a calculator. C. Relative numbers would be most meaningful for the large firm;
B. no one other than the management would be interested in absolute numbers would be most meaningful for the small firm.
them. D. Relative numbers would be most meaningful for both the large
C. some account balances may reflect atypical data at year end. and small firm, especially for interfirm comparisons.
D. they seldom identify problem areas in a company.
4. Which of these statements is false?
2. Which of the following is not a limitation of financial statement A. Many companies will not clearly fit into any one industry.
analysis? B. A financial service uses its best judgment as to which industry
A. The cost basis. C. The diversification of firms. the firm best fits.
B. The use of estimates. D. The availability of C. The analysis of an entity's financial statements can be more
information. meaningful if the results are compared with industry averages
and with results of competitors.
5. Which of the following does not represent a problem with financial D. A company comparison should not be made with industry
analysis? averages if the company does not clearly fit into any one
A. Financial statement analysis is an art; it requires judgment industry.
decisions on the part of the analyst.
B. Financial analysis can be used to detect apparent liquidity Common-sized financial statements
problems. 9. Which of the following generally is the most useful in analyzing
C. There are as many ratios for financial analysis as there are pairs companies of different sizes?
of figures. A. comparative statements C. price-level accounting
D. Some industry ratio formulas vary from source to source. B. common-sized financial statements D. profitability index

55
 Financial Statement Analysis

12.Statements in which all items are expressed only in relative terms amount in the subsequent year.
(percentages of a base) are termed: D. There is a negative amount in the base year and a positive
A. Vertical statements C. Funds Statements amount in the subsequent year.
B. Horizontal Statements D. Common-Size Statements
14.Horizontal analysis is a technique for evaluating a series of financial
10.The percent of property, plant and equipment to total assets is an statement data over a period of time
example of: A. that has been arranged from the highest number to the lowest
A. vertical analysis C. profitability analysis number.
B. solvency analysis D. horizontal analysis B. that has been arranged from the lowest number to the highest
number.
15.Vertical analysis is a technique that expresses each item in a C. to determine which items are in error.
financial statement D. to determine the amount and/or percentage increase or
A. in pesos and centavos. decrease that has taken place.
B. as a percent of the item in the previous year.
C. as a percent of a base amount. Trend analysis
D. starting with the highest value down to the lowest value. 16.Trend analysis allows a firm to compare its performance to:
A. other firms in the industry C. other industries
17.In performing a vertical analysis, the base for prepaid expenses is B. other time periods within the firm D. none of the above
A. total current assets. C. total liabilities.
B. total assets. D. prepaid expenses in a Risk and return
previous year. 29.The present and prospective stockholders are primarily concerned
with a firm
Horizontal analysis A. profitability C. leverage
8. The percentage analysis of increases and decreases in individual B. liquidity D. risk and return
items in comparative financial statements is called:
A. vertical analysis C. profitability analysis 69.Which suppliers of funds bear the greatest risk and should therefore
B. solvency analysis D. horizontal analysis earn the greatest return?
A. common stockholders C. preferred shareholders
11.Horizontal analysis is also known as B. general creditors such as banks D. bondholders
A. linear analysis. C. trend analysis.
B. vertical analysis. D. common size analysis. Measures of Risk
54.The following groups of ratios primarily measure risk:
13.In which of the following cases may a percentage change be A. liquidity, activity, and common equity C. liquidity, activity,
computed? and debt
A. The trend of the amounts is decreasing but all amounts are B. liquidity, activity, and profitability D. activity, debt, and
positive. profitability
B. There is no amount in the base year.
C. There is a negative amount in the base year and a negative Financial ratios

56
 Financial Statement Analysis

7. Ratios are used as tools in financial analysis

A. instead of horizontal and vertical analyses. Measures of liquidity
B. because they can provide information that may not be apparent 21.The ratios that are used to determine a companys short-term debt
from inspection of the individual components of a particular paying ability are
ratio. A. asset turnover, times interest earned, current ratio, and
C. because even single ratios by themselves are quite meaningful. receivables turnover.
D. because they are prescribed by GAAP. B. times interest earned, inventory turnover, current ratio, and
receivables turnover.
18.In the near term, the important ratios that provide the information C. times interest earned, acid-test ratio, current ratio, and
critical to the short-run operation of the firm are: inventory turnover.
A. liquidity, activity, and profitability C. liquidity, activity, D. current ratio, acid-test ratio, receivables turnover, and inventory
and equity turnover.
B. liquidity, activity, and debt D. activity, debt, and profitability
20.Which of the following is a measure of the liquidity position of a
75.The ability of a business to pay its debts as they come due and to corporation?
earn a reasonable amount of income is referred to as: A. earnings per share
A. solvency and leverage C. solvency and liquidity B. inventory turnover
B. solvency and profitability D. solvency and equity C. current ratio
D. number of times interest charges earned
Liquidity ratios
Interested parties 37.Which one of the following ratios would not likely be used by a
19.The primary concern of short-term creditors when assessing the short-term creditor in evaluating whether to sell on credit to a
strength of a firm is the entitys company?
A. short-term liquidity C. market price of stock A. Current ratio C. Asset turnover
B. profitability D. leverage B. Acid-test ratio D. Receivables turnover

35.Short-term creditors are usually most interested in assessing 51.Which of the following ratios would be least helpful in appraising
A. solvency. C. marketability. the liquidity of current assets?
B. liquidity. D. profitability. A. Accounts Receivable turnover C. Current Ratio
B. Days sales in inventory D. Days sales in accounts
36.The two categories of ratios that should be utilized to asses a firms receivable
true liquidity are the
A. current and quick ratios C. liquidity and profitability ratios 53.Which ratio is most helpful in appraising the liquidity of current
B. liquidity and debt ratios D. liquidity and activity ratios assets?
A. current ratio C. acid-test ratio
47.Which of the following is the most of interest to a firms suppliers? B. debt ratio D. accounts receivable turnover
A. profitability C. asset utilization
B. debt D. liquidity Not a measure of liquidity

57
 Financial Statement Analysis

79.Which one of the following ratios would not likely be used by a A. current ratio.
short-term creditor in evaluating whether to sell on credit to a B. current cash debt coverage ratio.
company? C. cash debt coverage ratio.
A. accounts receivable turnover. C. acid test ratio. D. acid-test ratio.
B. asset turnover. D. current ratio.
23.The acid-test or quick ratio
Current ratio A. is used to quickly determine a companys solvency and long-
24.Typically, which of the following would be considered to be the most term debt paying ability.
indicative of a firm's short-term debt paying ability? B. relates cash, short-term investments, and net receivables to
A. working capital C. acid test ratio current liabilities.
B. current ratio D. days sales in receivables C. is calculated by taking one item from the income statement and
one item from the balance sheet.
22.The current ratio is D. is the same as the current ratio except it is rounded to the
A. calculated by dividing current liabilities by current assets. nearest whole percent.
B. used to evaluate a companys liquidity and short-term debt
paying ability. Not a liquidity ratio
C. used to evaluate a companys solvency and long-term debt 28.Which one of the following would not be considered a liquidity ratio?
paying ability. A. Current ratio. C. Quick ratio.
D. calculated by subtracting current liabilities from current assets. B. Inventory turnover. D. Return on assets.

30.Which of the following ratios is rated to be a primary measure of Activity ratios

liquidity and considered of highest significance rating of the Days receivable & receivable turnover
liquidity ratios a bank analyst? Quality of receivables
A. Debt/Equity 25.Which of the following does not bear on the quality of receivables?
B. Current ratio A. shortening the credit terms
C. Degree of Financial Leverage B. lengthening the credit terms
D. Accounts Receivable Turnover in Days C. lengthening the outstanding period
D. all of the above bear on the quality of receivables
41.A weakness of the current ratio is
A. the difficulty of the calculation. Days receivable
B. that it does not take into account the composition of the 27.A general rule to use in assessing the average collection period is
current assets. A. that is should not exceed 30 days.
C. that it is rarely used by sophisticated analysts. B. it can be any length as long as the customer continues to buy
D. that it can be expressed as a percentage, as a rate, or as a merchandise.
proportion. C. that it should not greatly exceed the discount period.
D. that it should not greatly exceed the credit term period.
Acid-test or quick ratio
42.A measure of a companys immediate short-term liquidity is the Asset utilization ratios

58
 Financial Statement Analysis

Performance measures sometimes referred to as:

65.All of the following are asset utilization ratios except: A. leverage C. yield
A. average collection period C. receivables turnover B. solvency D. quick assets
B. inventory turnover D. return on assets
55.Using financial leverage is a good financial strategy from the
Asset turnover viewpoint of stockholders of companies having:
63.Asset turnover measures A. a high debt ratio C. a steadily declining current
A. how often a company replaces its assets. ratio
B. how efficiently a company uses its assets to generate sales. B. steady or rising profits D. cyclical highs and lows
C. the portion of the assets that have been financed by creditors.
D. the overall rate of return on assets. 46.The ratio that indicates a companys degree of financial leverage
is the
66.Total asset turnover measures the ability of a firm to: A. cash debt coverage ratio. C. free cash flow ratio.
A. generate profits on sales B. debt to total assets. D. times-interest earned ratio.
B. generate sales through the use of assets
C. cover long-term debt 73.Interest expense creates magnification of earnings through financial
D. buy new assets leverage because:
A. while earnings available to pay interest rise, earnings to residual
76.A measure of how efficiently a company uses its assets to generate owners rise faster
sales is the B. interest accompanies debt financing
A. asset turnover ratio. C. profit margin ratio. C. interest costs are cheaper than the required rate of return to
B. cash return on sales ratio. D. return on assets ratio. equity owners
S. the use of interest causes higher earnings
Solvency ratios
Interested parties Measures of solvency
50.Long-term creditors are usually most interested in evaluating 34.The set of ratios that is most useful in evaluating solvency is
A. liquidity. C. profitability. A. debt ratio, current ratio, and times interest earned
B. marketability. D. solvency. B. debt ratio, times interest earned, and return on assets
C. debt ratio, times interest earned, and quick ratio
Financial Leverage D. debt ratio, times interest earned, and cash flow to debt
45.Trading on the equity (leverage) refers to the
A. amount of working capital. 49.Which of the following ratios is most relevant to evaluating
B. amount of capital provided by owners. solvency?
C. use of borrowed money to increase the return to owners. A. Return on assets C. Days purchases in accounts
D. earnings per share. payable
B. Debt ratio D. Dividend yield
90.The tendency of the rate earned on stockholders' equity to vary
disproportionately from the rate earned on total assets is Fixed assets to long-term liabilities

59
 Financial Statement Analysis

44.Which of the following ratios provides a solvency measure that

shows the margin of safety of noteholders or bondholders and also Fixed charge coverage
gives an indication of the potential ability of the business to borrow 61.A fixed charge coverage:
additional funds on a long-term basis? A. is a balance sheet indication of debt carrying ability
A. ratio of fixed assets to long-term liabilities B. is an income statement indication of debt carrying ability
B. ratio of net sales to assets C. frequently includes research and development
C. number of days' sales in receivables D. computation is standard from firm to firm
D. rate earned on stockholders' equity
Off-balance sheet liabilities
Debt ratio 62.If a firm has substantial capital or financing leases disclosed in the
59.The debt ratio indicates: notes but not capitalized in the financial statements, then the
A. a comparison of liabilities with total assets A. times interest earned ratio will be overstated, based upon the
B. the ability of the firm to pay its current obligations financial statements
C. the efficiency of the use of total assets B. debt ratio will be understated
D. the magnification of earnings caused by leverage C. working capital will be understated
D. fixed charge ratio will be overstated, based upon the financial
78.The debt to total assets ratio measures statements
A. the companys profitability.
B. whether interest can be paid on debt in the current year. Profitability ratios
C. the proportion of interest paid relative to dividends paid. Interested parties
D. the percentage of the total assets provided by creditor. 39.The return on assets ratio is affected by the
A. asset turnover ratio.
Debt-to-equity ratio B. debt to total assets ratio.
60.Which of the following statements best compares long-term C. profit margin ratio.
borrowing capacity ratios? D. asset turnover and profit margin ratios.
A. The debt/equity ratio is more conservative than the debt ratio.
B. The debt to tangible net worth ratio is more conservative than 52.Stockholders are most interested in evaluating
the debt/equity ratio. A. liquidity. C. profitability.
C. The debt/equity ratio is more conservative than the debt to B. solvency. D. marketability.
tangible net worth ratio.
D. The debt ratio is more conservative than the debt/equity ratio. Performance measures
48.The set of ratios that are most useful in evaluating profitability is
Times interest earned A. ROA, ROE, and debt to equity ratio C. ROA, ROE, and
74.A times interest earned ratio of 0.90 to 1 means that acid-test ratio
A. the firm will default on its interest payment B. ROA, ROE, and dividend yield D. ROA, ROE, and cash flow to
B. net income is less than the interest expense debt
C. the cash flow is less than the net income
D. the cash flow exceeds the net income Earnings per share

60
 Financial Statement Analysis

82.Which of the following ratios appears most frequently in annual Financial Statement Analysis
reports? Accounts Receivable
A. Earnings per Share C. Profit Margin 26.Which of the following reasons should not be considered in order to
B. Return on Equity D. Debt/Equity explain why the receivables appear to be abnormally high?
A. Sales volume decreases materially late in the year.
Return on assets B. Receivables have collectibility problems and possibly some
64.Return on assets should have been written off.
A. can be determined by looking at a balance sheet C. Material amount of receivables are on the installment basis.
B. should be smaller than return on sales D. Sales volume expanded materially late in the year.
C. can be affected by the companys choice of a depreciation
method 31.An acceleration in the collection of receivables will tend to cause
D. should be larger than return on equity the accounts receivable turnover to:
A. decrease C. either increase or decrease
Return on investments B. remain the same D. increase
72.Return on investment measures:
A. return to all suppliers of funds C. return to all long-term Inventories
suppliers of funds 32.Which of the following would best indicate that the firm is carrying
B. return to all long-term creditors D. return to stockholders excess inventory?
A. a decline in the current ratio
Market test ratios B. stable current ratio with declining quick ratios
Price-earnings ratio C. a decline in days' sales in inventory
56.The price/earnings ratio D. a rise in total asset turnover
A. measures the past earning ability of the firm
B. is a gauge of future earning power as seen by investors 89.When Tri-C Corp. compares its ratios to industry averages, it has a
C. relates price to dividends higher current ratio, an average quick ratio, and a low inventory
D. relates turnover. What might you assume about Tri-C?
A. Its cash balance is too low. C. Its current liabilities are too
58.Which of the following ratios usually reflects investors opinions of low.
the future prospects for the firm? B. Its cost of goods sold is too low. D. Its average inventory is
A. dividend yield C. book value per share too high.
B. price/earnings ratio D. earnings per share
Current ratio
Dividend yield 33.Which of the following would be most detrimental to a firm's current
57.Which of the following ratios represents dividends per common ratio if that ratio is currently 2.0?
share in relation to market price per common share? A. Buy raw materials on credit
A. dividend payout C. price/earnings B. Sell marketable securities at cost
B. dividend yield D. book value per share C. Pay off accounts payable with cash
D. Pay off a portion of long-term debt with cash

61

Fixed asset turnover ratio
68.Which of the following circumstances will cause sales to fixed assets
to be abnormally high?
A. A labor-intensive industry.
B. The use of units-of-production depreciation.
C. A highly mechanized facility.
D. High direct labor costs from a new union contract.
Total asset turnover
81.A firm with a total asset turnover lower than the industry standard
and a current ratio which meets industry standard might have
excessive:
A. Accounts receivable C. Debt
B. Fixed assets D. Inventory
Profitability analysis
84.Denver Dynamics has net income of P2,000,000. Oakland
Enterprises has net income of P2,500,000. Which of the following
best compares the profitability of Denver and Oakland?
A. Oakland Enterprises is 25% more profitable than Denver
Dynamics.
B. Oakland Enterprises is more profitable than Denver Dynamics,
but the comparison can't be quantified.
C. Oakland Enterprises is only more profitable if it is smaller than
Denver Dynamics.
D. Further information is needed for a reasonable comparison.
Debt ratio
86.Companies A and B are in the same industry and have similar
characteristics except that Company A is more leveraged than
Company B. Both companies have the same income before
interest and taxes and the same total assets. Based on this
information we could conclude that
A. Company A has higher net income than Company B
B. Company A has a lower return on assets than company B
C. Company A is more risky than Company B.
D. Company A has a lower debt ratio than company B
62
Financial Statement Analysis
Sensitivity Analysis
Current ratio
40.A firm has a current ratio of 1:1. In order to improve its liquidity
ratios, this firm should
A. improve its collection practices, thereby increasing cash and
increasing its current and quick ratios.
B. improve its collection practices and pay accounts payable,
there decreasing current liabilities and increasing the current
and quick ratios.
C. decrease current liabilities by utilizing more long-term debt,
thereby increasing the current and quick ratios.
D. increase inventory, thereby increasing current assets and the
current and quick ratios.
43.Recently the M&M Company has been having problems. As a result,
its financial situation has deteriorated. M&M approached the First
National Bank for a badly needed loan, but the loan officer insisted
that the current ratio (now 0.5) be improved to at least 0.8 before
the bank would even consider granting the credit. Which of the
following actions would do the most to improve the ratio in the
short run?
A. Using some cash to pay off some current liabilities.
B. Collecting some of the current accounts receivable.
C. Paying off some long-term debt.
D. Purchasing additional inventory on credit (accounts payable).
87.Tyner Company had P250,000 of current assets and P90,000 of
current liabilities before borrowing P60,000 from the bank with a 3-
month note payable. What effect did the borrowing transaction
have on Tyner Company's current ratio?
A. The ratio remained unchanged.
B. The change in the current ratio cannot be determined.
C. The ratio decreased.
D. The ratio increased.
88.Which of the following actions will increase a firm's current ratio if it
is now less than 1.0?
 Financial Statement Analysis

A. Convert marketable securities to cash. B. Smith Company's times interest earned should be lower than
B. Pay accounts payable with cash. Jones.
C. Buy inventory with short term credit (i.e. accounts payable). C. Smith has five times better long-term borrowing ability than
D. Sell inventory at cost. Jones.
D. Not enough information to determine if any of the answers are
Acid-test ratio correct.
38.If a company has an acid-test ratio of 1.2:1, what respective
effects will the borrowing of cash by short-term debt and collection Times interest earned
of accounts receivable have on the ratio? 85.Which of the following will not cause times interest earned to drop?
A. B. C. D. Assume no other changes than those listed.
Short-term Increase Increase Decrease Decrease A. A rise in preferred stock dividends.
borrowing B. A drop in sales with no change in interest expense.
Collection of No effect Increase No effect Decrease C. An increase in interest rates.
receivable D. An increase in bonds payable with no change in operating
income.
Profit margin
70.Which of the following would most likely cause a rise in net profit DuPont Analysis
margin? 71.Which of the following could cause return on assets to decline when
A. increased sales C. decreased operating expenses net profit margin is increasing?
B. decreased preferred dividends D. increased cost of sales A. sale of investments at year-end C. purchase of a new
building at year-end
Return on assets B. increased turnover of operating assets D. a stock split
67.Return on assets cannot fall under which of the following
circumstances? 80.A firm with a lower net profit margin can improve its return on total
A. B. C. D. assets by
A. increasing its debt ratio C. increasing its total asset
Net profit Decline Rise Rise Decline
turnover
margin
B. decreasing its fixed assets turnover D. decreasing its total
Total asset Rise Decline Rise Decline
asset turnover
turnover

Debt ratio PROBLEMS:

83.Jones Company has long-term debt of P1,000,000, while Smith
Company, Jones' competitor, has long-term debt of P200,000.
Which of the following statements best represents an analysis of
the long-term debt position of these two firms?
A. Jones obviously has too much debt when compared to its
competitor.
Horizontal analysis
1
. Kline Corporation had net income of P2 million in 2006. Using the
2006 financial elements as the base data, net income decreased by
70 percent in 2007 and increased by 175 percent in 2008. The
respective net income reported by Kline Corporation for 2007 and
2008 are:

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 Financial Statement Analysis

A. P 600,000 and P5,500,000 C. P1,400,000 and P3,500,000 Inventory 140,000

B. P5,500,000 and P 600,000 D. P1,400,000 and P5,500,000 Marketable securities 250,000
Notes payable, short-term 85,000
2
. Assume that Axle Inc. reported a net loss of P50,000 in 2006 and Prepaid expenses 15,000
net income of P250,000 in 2007. The increase in net income of
4
P300,000: . The amount of working capital for the company is:
A. can be stated as 0% C. cannot be stated as a A. P351,000 C. P211,000
percentage B. P361,000 D. P336,000
B. can be stated as 100% increase D. can be stated as 200%
5
increase . The companys current ratio as of the balance sheet date is:
A. 2.67:1 C. 2.02:1
Liquidity ratios B. 2.44:1 D. 1.95:1
3
. The following financial data have been taken from the records of
6
Ratio Company: . The companys acid-test ratio as of the balance sheet date is:
Accounts receivable P200,000 A. 1.80:1 C. 2.02:1
Accounts payable 80,000 B. 2.40:1 D. 1.76:1
Bonds payable, due in 10 years 500,000
Cash 100,000 Activity ratios
Interest payable, due in three months 25,000 Receivables turnover
7
Inventory 440,000 . Pine Hardware Store had net credit sales of P6,500,000 and cost of
Land 800,000 goods sold of P5,000,000 for the year. The Accounts Receivable
Notes payable, due in six months 250,000 balances at the beginning and end of the year were P600,000 and
What will happen to the ratios below if Ratio Company uses cash P700,000, respectively. The receivables turnover was
to pay 50 percent of its accounts payable? A. 7.7 times. C. 9.3 times.
A. B. C. D. B. 10.8 times. D. 10.0 times.
Current Increase Decrease Increase Decrease
8
ratio . Milward Corporations books disclosed the following information for
Acid-test Increase Decrease Decrease Increase the year ended December 31, 2007:
ratio Net credit sales P1,500,000
Net cash sales 240,000
Question Nos. 4 through 6 are based on the data taken from the Accounts receivable at beginning of year 200,000
balance sheet of Nomad Company at the end of the current year: Accounts receivable at end of year 400,000
Accounts payable P145,000 Milwards accounts receivable turnover is
Accounts receivable 110,000 A. 3.75 times C. 5.00 times
Accrued liabilities 4,000 B. 4.35 times D. 5.80 times
Cash 80,000
Income tax payable 10,000 Days receivable
9
. Batik Clothing Store had a balance in the Accounts Receivable

64
 Financial Statement Analysis

account of P390,000 at the beginning of the year and a balance of Inventory, beginning of 2007 P 341,169
P410,000 at the end of the year. The net credit sales during the Inventory, end of 2007 P 376,526
year amounted to P4,000,000. Using 360-day year, what is the The merchandise inventory turnover for 2007 is:
average collection period of the receivables? A. 5.6 C. 7.5
A. 30 days C. 73 days B. 15.6 D. 7.7
B. 65 days D. 36 days
14
. Based on the following data for the current year, what is the
Cash collection inventory turnover?
10
. Deity Company had sales of P30,000, increase in accounts payable Net sales on account during year P 500,000
of P5,000, decrease in accounts receivable of P1,000, increase in Cost of merchandise sold during year 330,000
inventories of P4,000, and depreciation expense of P4,000. What Accounts receivable, beginning of year 45,000
was the cash collected from customers? Accounts receivable, end of year 35,000
A. P31,000 C. P34,000 Inventory, beginning of year 90,000
B. P35,000 D. P25,000 Inventory, end of year 110,000
A. 3.3 C. 3.7
Inventory turnover B. 8.3 D. 3.0
11
. During 2007, Tarlac Company purchased P960,000 of inventory.
The cost of goods sold for 2007 was P900,000, and the ending Days inventory
15
inventory at December 31, 2007 was P180,000. What was the . Selected information from the accounting records of Eternity
inventory turnover for 2007? Manufacturing Company follows:
A. 6.4 C. 5.3 Net sales P3,600,000
B. 6.0 D. 5.0 Cost of goods sold 2,400,000
Inventories at January 1 672,000
12
. Selected information from the accounting records of Petals Inventories at December 31 576,000
Company is as follows: What is the number of days sales in average inventories for the
Net sales for 2007 P900,000 year?
Cost of goods sold for 2007 600,000 A. 102.2 C. 87.6
Inventory at December 31, 2006 180,000 B. 94.9 D. 68.1
Inventory at December 31, 2007 156,000
Petals inventory turnover for 2007 is Turnover ratios
A. 5.77 times C. 3.67 times Asset turnover
B. 3.85 times D. 3.57 times Asset
16
. Net sales are P6,000,000, beginning total assets are P2,800,000,
13
. The Moss Company presents the following data for 2007. and the asset turnover is 3.0. What is the ending total asset
Net Sales, 2007 P3,007,124 balance?
Net Sales, 2006 P 930,247 A. P2,000,000. C. P2,800,000.
Cost of Goods Sold, 2007 P2,000,326 B. P1,200,000. D. P1,600,000.
Cost of Goods Sold, 2007 P1,000,120

65
 Financial Statement Analysis

Solvency ratios Preferred 5% stock, P100 par (no change during year)300,000
Debt ratio Common stock, P50 par (no change during year) 2,000,000
17
. Jordan Manufacturing reports the following capital structure: Income before income tax for year 350,000
Current liabilities P100,000 Income tax for year 80,000
Long-term debt 400,000 Common dividends paid 50,000
Deferred income taxes 10,000 Preferred dividends paid 15,000
Preferred stock 80,000 Based on the data presented above, what is the number of times
Common stock 100,000 bond interest charges were earned (round to one decimal point)?
Premium on common stock 180,000 A. 3.7 C. 4.5
Retained earnings 170,000 B. 4.4 D. 3.5
What is the debt ratio?
21
A. 0.48 C. 0.93 . The following data were abstracted from the records of Johnson
B. 0.49 D. 0.96 Corporation for the year:
Sales P1,800,000
Times interest earned Bond interest expense 60,000
18
. House of Fashion Company had the following financial statistics for Income taxes 300,000
2006: Net income 400,000
Long-term debt (average rate of interest is 8%) P400,000 How many times was bond interest earned?
Interest expense 35,000 A. 7.67 C. 12.67
Net income 48,000 B. 11.67 D. 13.67
Income tax 46,000
Operating income 107,000 Net income
22
What is the times interest earned for 2006? . The times interest earned ratio of Mikoto Company is 4.5 times.
A. 11.4 times C. 3.1 times The interest expense for the year was P20,000, and the companys
B. 3.3 times D. 3.7 times tax rate is 40%. The companys net income is:
A. P22,000 C. P54,000
19
. Brava Company reported the following on its income statement: B. P42,000 D. P66,000
Income before taxes P400,000
Income tax expense 100,000 Profitability Ratios
Net income P300,000 Return on Common Equity
23
An analysis of the income statement revealed that interest expense . Selected information for Ivano Company as of December 31 is as
was P100,000. Brava Companys times interest earned (TIE) was follows:
A. 5 times C. 3.5 times 2006 2007
B. 4 times D. 3 times Preferred stock, 8%, par P100, P250,000 P250,000
nonconvertible, noncumulative
20
. The balance sheet and income statement data for Candle Factory Common stock 600,000 800,000
indicate the following: Retained earnings 150,000 370,000
Bonds payable, 10% (issued 1998 due 2022) P1,000,000

66
 Financial Statement Analysis

Dividends paid on preferred stock for 20,000 20,000 par value; 1,000 shares authorized, issued, and outstanding.
the year Orchards common stock, which is listed on a major stock exchange,
Net income for the year 120,000 240,000 was quoted at P4 per share on December 31. Orchards net income
Ivanos return on common stockholders equity, rounded to the for the year ended December 31 was P50,000. The yearly preferred
nearest percentage point, for 2007 is dividend was declared. No capital stock transactions occurred.
A. 17% C. 21% What was the price earnings ratio on Orchards common stock at
B. 19% D. 23% December 31?
A. 6 to 1 C. 10 to 1
Dividend yield B. 8 to 1 D. 16 to 1
24
. The following information is available for Duncan Co.:
27
2006 . On December 31, 2006 and 2007, Renegade Corporation had
Dividends per share of common stock P 1.40 100,000 shares of common stock and 50,000 shares of
Market price per share of common stock 17.50 noncumulative and nonconvertible preferred stock issued and
Which of the following statements is correct? outstanding.
A. The dividend yield is 8.0%, which is of interest to investors Additional information:
seeking an increase in market price of their stocks. Stockholders equity at 12/31/07 P4,500,000
B. The dividend yield is 8.0%, which is of special interest to Net income year ended 12/31/07 1,200,000
investors seeking current returns on their investments. Dividends on preferred stock year ended 12/31/07 300,000
C. The dividend yield is 12.5%, which is of interest to bondholders. Market price per share of common stock at 12/31/07 144
D. The dividend yield is 8.0 times the market price, which is The price-earnings ratio on common stock at December 31, 2007,
important in solvency analysis. was
A. 10 to 1 C. 14 to 1
Market Test Ratios B. 12 to 1 D. 16 to 1
Market/Book value ratio
Price per share Payout ratio
28
25
. What is the market price of a share of stock for a firm with 100,000 . Selected financial data of Alexander Corporation for the year ended
shares outstanding, a book value of equity of P3,000,000, and a December 31, 2007, is presented below:
market/book ratio of 3.5? Operating income P900,000
A. P8.57 C. P85.70 Interest expense (100,000)
B. P30.00 D. P105.00 Income before income taxes 800,000
Income tax (320,000)
P/E ratio Net income 480,000
26
. Orchard Companys capital stock at December 31 consisted of the Preferred stock dividend (200,000)
following: Net income available to common stockholders 280,000
Common stock, P2 par value; 100,000 shares authorized, Common stock dividends were P120,000. The payout ratio is:
issued, and outstanding. A. 42.9 percent C. 25.0 percent
10% noncumulative, nonconvertible preferred stock, P100 B. 66.7 percent D. 71.4 percent

67
 Financial Statement Analysis

33
P/E ratio & Payout ratio . A summarized income statement for Leveraged Inc. is presented
Use the following information for question Nos. 33 and 34: below.
Terry Corporation had net income of P200,000 and paid dividends to Sales P1,000,000
common stockholders of P40,000 in 2007. The weighted-average Cost of Sales 600,000
number of shares outstanding in 2007 was 50,000 shares. Terry Gross Profit P 400,000
Corporations common stock is selling for P60 per share in the local Operating Expenses 250,000
stock exchange. Operating Income P 150,000
Interest Expense 30,000
29
. Terry Corporations price-earnings ratio is Earnings Before Tax P 120,000
A. 3.8 times C. 18.8 times Income Tax 40,000
B. 15 times D. 6 times Net Income P 80,000
The degree of financial leverage is:
30
. Terry Corporations payout ratio for 2007 is A. P 150,000 P 30,000 C. P1,000,000 P400,000
A. P4 per share C. 20.0 percent B. P 150,000 P120,000 D. P 150,000 P 80,000
B. 12.5 percent D. 25.0 percent
Other Ratios
DuPont Model Book value per share
34
Debt ratio . M Corporations stockholders equity at December 31, 2007
31
. The Board of Directors is dissatisfied with last year's ROE of 15%. If consists of the following:
the profit margin and asset turnover remain unchanged at 8% and 6% cumulative preferred stock, P100 par, liquidating value
1.25 respectively, by how much must the total debt ratio increase was P110 per share; issued and outstanding 50,000 shares
to achieve 20% ROE? P5,000,000
A. Total debt ratio must increase by .5 Common stock, par, P5 per share; issued and
B. Total debt ratio must increase by 5 outstanding, 400,000 shares 2,000,000
C. Total debt ratio must increase by 5% Retained earnings 1,000,000
D. Total debt ratio must increase by 50% Total P8,000,000
Dividends on preferred stock have been paid through 2006.
32
. Assume you are given the following relationships for the Orange At December 31, 2007, M Corporations book value per share was
Company: A. P5.50 C. P6.75
Sales/total assets 1.5X B. P6.25 D. P7.50
Return on assets (ROA) 3%
35
Return on equity (ROE) 5% . The following data were gathered from the annual report of Desk
The Orange Companys debt ratio is Products.
A. 40% C. 35% Market price per share P30.00
B. 60% D. 65% Number of common shares 10,000
Preferred stock, 5% P100 par P10,000
Leverage Ratio Common equity P140,000
Degree of financial leverage The book value per share is:

68
 Financial Statement Analysis

A. P30.00 C. P14.00 Current liabilities P120,000

B. P15.00 D. P13.75 Inventory turnover (based on cost of sales) 8 times
Gross profit margin 40%
Integrated ratios Mildreds net sales for the year were
Liquidity & activity ratios A. P 800,000 C. P 480,000
Inventory B. P 672,000 D. P1,200,000
36
. The current assets of Mayon Enterprise consists of cash, accounts
receivable, and inventory. The following information is available: Gross margin
39
Credit sales 75% of total sales . Selected information from the accounting records of the Blackwood
Inventory turnover 5 times Co. is as follows:
Working capital P1,120,000 Net A/R at December 31, 2006 P 900,000
Current ratio 2.00 to 1 Net A/R at December 31, 2007 P1,000,000
Quick ratio 1.25 to 1 Accounts receivable turnover 5 to 1
Average Collection period 42 days Inventories at December 31, 2006 P1,100,000
Working days 360 Inventories at December 31, 2007 P1,200,000
The estimated inventory amount is: Inventory turnover 4 to 1
A. 840,000 C. 720,000 What was the gross margin for 2007?
B. 600,000 D. 550,000 A. P150,000 C. P300,000
B. P200,000 D. P400,000
37
. The following data were obtained from the records of Salacot
Company: Market Test Ratio
Current ratio (at year end) 1.5 to 1 Dividend yield
40
Inventory turnover based on sales and ending inventory 15 . Recto Co. has a price earnings ratio of 10, earnings per share of
times P2.20, and a pay out ratio of 75%. The dividend yield is
Inventory turnover based on cost of goods sold and ending A. 25.0% C. 7.5%
inventory 10.5 times B. 22.0% D. 10.0%
Gross margin for 2007 P360,000
41
What was Salacot Companys December 31, 2007 balance in the . The following were reflected from the records of Salvacion
Inventory account? Company:
A. P120,000 C. P 80,000 Earnings before interest and taxes P1,250,000
B. P 54,000 D. P 95,000 Interest expense 250,000
Preferred dividends 200,000
Net sales Payout ratio 40 percent
38
. Selected data from Mildred Companys year-end financial Shares outstanding throughout 2006
statements are presented below. The difference between average Preferred 20,000
and ending inventory is immaterial. Common 25,000
Current ratio 2.0 Income tax rate 40 percent
Quick ratio 1.5 Price earnings ratio 5 times

69
 Financial Statement Analysis

The dividend yield ratio is A. 17.0 C. 12.4

A. 0.50 C. 0.40 B. 12.1 D. 15.9
B. 0.12 D. 0.08

Comprehensive
42
. The balance sheets of Magdangal Company at the end of each of
the first two years of operations indicate the following:
2007 2006
Total current assets P600,00 P560,00
0 0
Total investments 60,000 40,000
Total property, plant, and equipment 900,000 700,000
Total current liabilities 150,000 80,000
Total long-term liabilities 350,000 250,000
Preferred 9% stock, P100 par 100,000 100,000
Common stock, P10 par 600,000 600,000
Paid-in capital in excess of par- 60,000 60,000
common stock
Retained earnings 300,000 210,000
Net income is P115,000 and interest expense is P30,000 for 2007.
What is the rate earned on total assets for 2007 (round percent to
one decimal point)?
A. 9.3 percent C. 8.9 percent
B. 10.1 percent D. 7.4 percent
43
. What is the rate earned on stockholders' equity for 2007 (round
percent to one decimal point)?
A. 10.6 percent C. 12.4 percent
B. 11.2 percent D. 15.6 percent
44
. What is the earnings per share on common stock for 2007, (round to
two decimal places)?
A. P1.92 C. P1.77
B. P1.89 D. P1.42
45
. If the market price is P30, what is the price-earnings ratio on
common stock for 2007 (round to one decimal point)?

70
1
. Answer: A
2007: P2,000,000 (1 0.7) = P600,000
2008: P2,000,000 (1 + 1.75) = P5,500,000
Note: For 2007 & 2008, 2006 was used as a base year.
2
. Answer: C
3
. Answer: C
Current Assets:
Cash P100,000
Accounts receivable 200,000
Total liquid assets 300,000
Inventory 440,000
Total current assets P740,000
Current Liabilities:
Accounts payable P 80,000
Notes payable, due in 6 months 250,000
Interest payable 25,000
Total current liabilities P355,000

Current Ratio (740,000 355,000) 2.08:1.00

Acid-test Ratio (300,000 355,000) 0.85:1.00

Before any payment, the current ratio is above 1:1 and acid test ratio is below
1:1. Therefore, the current ratio shall rise but acid test ratio shall go down. If any
of these two ratios is below 1:1, the equal change in current assets and current
liabilities brings direct effect on the ratio, that is, equal increase in current assets
and current liabilities causes the ratio to rise.
4
. Answer: A
Working capital equals the difference between the total current assets and total
current liabilities.
Current Assets:
Cash P 80,000
Marketable securities 250,000
Accounts receivable 110,000
Total liquid assets 440,000
Inventory 140,000
Prepaid expense 15,000
Total Current Assets P595,000

Current Liabilities:
Accounts payable P145,000
Income tax payable 10,000
Notes payable, short-term 85,000
Accrued liabilities 4,000 244,000

Working Capital P351,000

5
. Answer: B
Current Ratio: Current Assets Current Liabilities
(P595,000 P244,000) = 2.44:1.00
6
. Answer: A
Acid-Test Ratio: Liquid Assets Current Liabilities
(P440,000 P244,000) = 1.80:1.00
7
. Answer: D
AR Turnover: Credit sales Average AR
6,500,000/650,000 = 10.0 times
8
. Answer: C
Accounts Receivable Turnover: Net Credit Sales Average Accounts Receivable
P1,500,000 [(P200,000 + P400,000) 2] = 5.0 times
9
. Answer: D
Average Daily Sales: Annual credit sales Days Year
P4 million 360 days = P11,111

Average Collection Period: Average Accounts Receivable Average Daily Sales

[(P390,000 + P410,000) 2] P11,111 = 36 days
10
. Answer: A
Sales P30,000
Add decrease in Accounts Receivable 1,000
Cash collected from sales P31,000
11
. Answer: B
Inventory Turnover: Cost of Goods Sold Average Inventory
Cost of goods sold P 900,000
Add Ending inventory 180,000
Total cost available for sales 1,080,000
Deduct cost of purchases 960,000
Beginning inventory P 120,000
Average Inventory: (P120,000 + P180,000) 2 P150,000
Inventory Turnover: (P900,000 P150,000) 6 times
An alternative computation of the inventory turnover is to use Net Sales instead of
Cost of Goods Sold.
12
. Answer: D
Average inventory: (P180,000 + P156,000) 2 P168,000
Inventory Turnover: (P600,000 P168,000) 3.57 times
13
. Answer: A
Average Inventory: (P341,169 + P376,526) 2 P358,847.50
Inventory Turnover: (P2,000,326 P358,847.50) 5.6 times
14
. Answer: A
Average Inventory: (P90,000 + P110,000) 2 P100,000
Inventory Turnover: (P330,000 P100,000) 3.3 times
15
. Answer: B
Average Inventory: (P672,000 + P576,000) 2 P624,000
Inventory Turnover: (P2,400,000 P624,000) 3.846 times
Inventory Turnover in Days: 365 days 3.846 94.9 days

Alternative Computation:
Average daily cost of goods sold: = (P2,400,000 365)P6,575.34
Turnover in Days: P624,000 P6,575.34 94.9 days
16
. Answer: A
Average Accounts Receivable: (P900,000 P1,000,000) 2P 950,000
 Average inventory; (P1.1M + P1.2M) 2 P1,150,000

Net sales: (P950,000 x 5) P4,750,000

Cost of goods sold (P1,150,000 x 4) 4,600,000
Gross margin P 150,000
17
. Answer: B
Current liabilities P 100,000
Long-term debt 400,000
Deferred income tax 10,000
Total Liabilities 510,000
Stockholders Equity
Preferred stock P 80,000
Common stock 100,000
Premium on common stock 180,000
Retained earnings 170,000 530,000
Total Assets P1,040,000

Debt Ratio: P510,000 P1,040,000 = 0.49

18
. Answer: D
Times interest earned: Earnings before interest Interest
Income before tax (P48,000 + P46,000) P 94,000
Add Interest expense 35,000
Income before Interest expense P129,000

TIE: P129,000 P35,000 3.7 times

19
. Answer: A
TIE: Income before interest expense Interest expense
Income before income tax P400,000
Add back Interest expense 100,000
Income before interest expense P500,000

TIE: P500,000 P100,000 5 times

20
. Answer: C
Interest Expense: P1M x 0.1 P100,000
Income before interest expense: P350,000 + P100,000 P450,000
Times interest earned: (P450,000 P100,000) 4.5 times
21
. Answer: C
Net income P400,000
Add: Income taxes P300,000
Interest 60,000 360,000
Income before interest P760,000

TIE: P760,000 P60,000 12.67 times

22
. Answer: B
Earnings before interest expense (P20,000 x 4.5) P90,000
Deduct interest expense 20,000
Income before income tax P70,000
Deduct income tax (P70,000 x 0.4) 28,000
Net income P42,000
23
. Answer: D
Income to Common; (P240,000 P20,000) P220,000
Average Common Equity: (P750,000 + P1,170,000) 2P960,000
Return on Common Equity: (P220 P960) 23 percent
24
. Answer: B
The dividend yield is 8 percent (P1.40 P17.50)
The dividend yield measures the return of investment in terms of dividends
received. The total expected returns consists of Dividend Yield and the
Appreciation in market price and dividend
25
. Answer: D
Market Value of Equity (P3M x 3.5) P10,500,000
Market price per share: (P10.5M 100,000) P105
26
. Answer: B
EPS: P50,000 100,000 shares P0.50
P/E Ratio: P4.00 P0.50 8 to 1
27
. Answer: D
EPS: (P1,200,000 P300,000) 100,000 P9.00
P/E Ratio: 144 9 16
28
. Answer: A
Payout Ratio: Common Dividends Income Available to Common
P120,000 P280,000 = 42.9%
29
. Answer: B
Price-earnings ratio: Market price EPS
EPS: Net income /Weighted-average common shares
EPS: P200,000 50,000 sharesP4.00
P/E Ratio: P60 P4 15.0X
30
. Answer: C
Payout Ratio: Dividends Income to Common
P40,000 P200,000 = 20.0%
31
. Answer: D
ROE: (8% x 1.25) 10.00%
Last years Debt Ratio 1 (10% 15%) 33.33%
Proposed Debt Ratio 1 (10% 20%) 50.00%
Increase in debt ratio: (50.00% - 33.33%) 33.33% 50.00%
32
. Answer: A
1 (0.03 0.05) = 40%
33
. Answer: B
Degree of Financial Leverage: Operating Income Interest Expense
34
. Answer: A
Total stockholders equity P8,000,000
Deduct:
Liquidation value of Preferred Stock (50,000 s P110) P5,500,000
Unpaid Preferred Dividends (P5M x 6%) 300,000 5,800,000
Common Equity P2,200,000
 Book Value per Share: P2.2M 400,000 shares P5.50
35
. Answer: C
Book Value per Share: Common Equity Outstanding Shares
P140,000 10,000 shares = P14.00
36
. Answer: A
The inventory amount can be calculated as follows:
Current liabilities: Working Capital = current liabilities based on 2:1 current ratio.
At 2:1 current ratio, the amount of working capital and current liabilities are both
P1,120,000.

Inventory: Current liabilities x (Current ratio Acid test ratio)

P1,120,000 x (2.0 1.25) P840,000

A detailed computation can be made as follows:

Current assets: P1,120,000 x 2 P2,240,000
Liquid assets: P1,120,000 x 1.25 1,400,000
Inventory P 840,000
37
. Answer: C
Inventory balance: Gross profit (Difference between 2 inventory turnovers)
360,000/(15 10.5) = P80,000
38
. Answer: A
Inventory balance (P120,000 x (2.0 1.5) P 60,000
Cost of goods sold 60,000 x 8 P480,000
Sales (P480,000 0.60) P800,000
39
. Answer: A
Average Accounts Receivable: (P900,000 P1,000,000) 2P 950,000
Average inventory; (P1.1M + P1.2M) 2 P1,150,000

Net sales: (P950,000 x 5) P4,750,000

Cost of goods sold (P1,150,000 x 4) 4,600,000
Gross margin P 150,000
40
. Answer: C
Dividend per share: 0.75 x P2.20 P1.65
Market price: 10 x 2.20 22.00
Dividend yield: P1.65 P22.00 = 7.5%
41
. Answer: D
EBIT 1,250,000
Less interest expense 250,000
Earnings before tax 1,000,000
Less Income tax 40% 400,000
Net income 600,000
Less Preferred dividends 200,000
Earnings to Common Stock 400,000
Earnings per share 400,000/25,000 16.00
Dividend per share: 400,000 x 0.40 25,000 6.40

Dividend yield 6.4 (16 x 5) 8.0%

42
. Answer: B
 ROA: Operating income Average Total Assets
P145,000 P1,430,000 = 10.1%
43
. Answer: B
Return on stockholders equity: Net income Average stockholders equity
P115,000 P1,027,500 = 11.2%
44
. Answer: C
Net income P115,000
Deduct Preferred Dividends 9,000
Income available to common shares P106,000

EPS: (P106,000 60,000) P1.77

45
. Answer: A
P/E Ratio: P30 1.766 = 17.0 times