Financial Statement Analysis

PROBLEMS:
Horizontal analysis
i
. 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:
A. P 600,000 and P5,500,000 C. P1,400,000 and P3,500,000
B. P5,500,000 and P 600,000 D. P1,400,000 and P5,500,000
ii
. Assume that Axle Inc. reported a net loss of P50,000 in 2006 and net income of P250,000 in 2007. The increase in net income of P300,000:
A. can be stated as 0% C. cannot be stated as a percentage
B. can be stated as 100% increase D. can be stated as 200% increase

Liquidity ratios
iii
. The following financial data have been taken from the records of Ratio Company:
Accounts receivable P200,000
Accounts payable 80,000
Bonds payable, due in 10 years 500,000
Cash 100,000
Interest payable, due in three months 25,000
Inventory 440,000
Land 800,000
Notes payable, due in six months 250,000
What will happen to the ratios below if Ratio Company uses cash to pay 50 percent of its accounts payable?
A. B. C. D.
Current ratio Increase Decrease Increase Decrease
Acid-test ratio Increase Decrease Decrease Increase

Question Nos. 4 through 6 are based on the data taken from the balance sheet of Nomad Company at the end of the current year:
Accounts payable P145,000
Accounts receivable 110,000
Accrued liabilities 4,000
Cash 80,000
Income tax payable 10,000
Inventory 140,000
Marketable securities 250,000
Notes payable, short-term 85,000
Prepaid expenses 15,000

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 Financial Statement Analysis

iv
. The amount of working capital for the company is:
A. P351,000 C. P211,000
B. P361,000 D. P336,000
v
. The company’s current ratio as of the balance sheet date is:
A. 2.67:1 C. 2.02:1
B. 2.44:1 D. 1.95:1
vi
. The company’s acid-test ratio as of the balance sheet date is:
A. 1.80:1 C. 2.02:1
B. 2.40:1 D. 1.76:1

Activity ratios
Receivables turnover
vii
. Pine Hardware Store had net credit sales of P6,500,000 and cost of goods sold of P5,000,000 for the year. The Accounts Receivable balances at the beginning and end of the year were P600,000
and P700,000, respectively. The receivables turnover was
A. 7.7 times. C. 9.3 times.
B. 10.8 times. D. 10.0 times.
viii
. Milward Corporation’s books disclosed the following information for the year ended December 31, 2007:
Net credit sales P1,500,000
Net cash sales 240,000
Accounts receivable at beginning of year 200,000
Accounts receivable at end of year 400,000
Milward’s accounts receivable turnover is
A. 3.75 times C. 5.00 times
B. 4.35 times D. 5.80 times

Days receivable
ix
. Batik Clothing Store had a balance in the Accounts Receivable account of P390,000 at the beginning of the year and a balance of P410,000 at the end of the year. The net credit sales during the year
amounted to P4,000,000. Using 360-day year, what is the average collection period of the receivables?
A. 30 days C. 73 days
B. 65 days D. 36 days

Cash collection
x
. Deity Company had sales of P30,000, increase in accounts payable of P5,000, decrease in accounts receivable of P1,000, increase in inventories of P4,000, and depreciation expense of P4,000. What
was the cash collected from customers?

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 Financial Statement Analysis

A. P31,000 C. P34,000
B. P35,000 D. P25,000

Inventory turnover
xi
. During 2007, Tarlac Company purchased P960,000 of inventory. The cost of goods sold for 2007 was P900,000, and the ending inventory at December 31, 2007 was P180,000. What was the
inventory turnover for 2007?
A. 6.4 C. 5.3
B. 6.0 D. 5.0
xii
. Selected information from the accounting records of Petals Company is as follows:
Net sales for 2007 P900,000
Cost of goods sold for 2007 600,000
Inventory at December 31, 2006 180,000
Inventory at December 31, 2007 156,000
Petals’ inventory turnover for 2007 is
A. 5.77 times C. 3.67 times
B. 3.85 times D. 3.57 times
xiii
. The Moss Company presents the following data for 2007.
Net Sales, 2007 P3,007,124
Net Sales, 2006 P 930,247
Cost of Goods Sold, 2007 P2,000,326
Cost of Goods Sold, 2007 P1,000,120
Inventory, beginning of 2007 P  341,169
Inventory, end of 2007 P  376,526
The merchandise inventory turnover for 2007 is:
A. 5.6 C. 7.5
B. 15.6 D. 7.7
xiv
. Based on the following data for the current year, what is the inventory turnover?
Net sales on account during year P 500,000
Cost of merchandise sold during year 330,000
Accounts receivable, beginning of year 45,000
Accounts receivable, end of year 35,000
Inventory, beginning of year 90,000
Inventory, end of year 110,000
A. 3.3 C. 3.7
B. 8.3 D. 3.0

569
 Financial Statement Analysis

Days inventory
xv
. Selected information from the accounting records of Eternity Manufacturing Company follows:
Net sales P3,600,000
Cost of goods sold 2,400,000
Inventories at January 1 672,000
Inventories at December 31 576,000
What is the number of days’ sales in average inventories for the year?
A. 102.2 C. 87.6
B. 94.9 D. 68.1

Turnover ratios
Asset turnover
Asset
xvi
. Net sales are P6,000,000, beginning total assets are P2,800,000, and the asset turnover is 3.0. What is the ending total asset balance?
A. P2,000,000. C. P2,800,000.
B. P1,200,000. D. P1,600,000.

Solvency ratios
Debt ratio
xvii
. Jordan Manufacturing reports the following capital structure:
Current liabilities P100,000
Long-term debt 400,000
Deferred income taxes 10,000
Preferred stock 80,000
Common stock 100,000
Premium on common stock 180,000
Retained earnings 170,000
What is the debt ratio?
A. 0.48 C. 0.93
B. 0.49 D. 0.96

Times interest earned

xviii
. House of Fashion Company had the following financial statistics for 2006:
Long-term debt (average rate of interest is 8%) P400,000
Interest expense 35,000
Net income 48,000
Income tax 46,000

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 Financial Statement Analysis

Operating income 107,000

What is the times interest earned for 2006?
A. 11.4 times C. 3.1 times
B. 3.3 times D. 3.7 times
xix
. Brava Company reported the following on its income statement:
Income before taxes P400,000
Income tax expense 100,000
Net income P300,000
An analysis of the income statement revealed that interest expense was P100,000. Brava Company’s times interest earned (TIE) was
A. 5 times C. 3.5 times
B. 4 times D. 3 times
xx
. The balance sheet and income statement data for Candle Factory indicate the following:
Bonds payable, 10% (issued 1998 due 2022) P1,000,000
Preferred 5% stock, P100 par (no change during year) 300,000
Common stock, P50 par (no change during year) 2,000,000
Income before income tax for year 350,000
Income tax for year 80,000
Common dividends paid 50,000
Preferred dividends paid 15,000
Based on the data presented above, what is the number of times bond interest charges were earned (round to one decimal point)?
A. 3.7 C. 4.5
B. 4.4 D. 3.5
xxi
. The following data were abstracted from the records of Johnson Corporation for the year:
Sales P1,800,000
Bond interest expense 60,000
Income taxes 300,000
Net income 400,000
How many times was bond interest earned?
A. 7.67 C. 12.67
B. 11.67 D. 13.67

Net income
xxii
. The times interest earned ratio of Mikoto Company is 4.5 times. The interest expense for the year was P20,000, and the company’s tax rate is 40%. The company’s net income is:
A. P22,000 C. P54,000
B. P42,000 D. P66,000

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 Financial Statement Analysis

Profitability Ratios
Return on Common Equity
xxiii
. Selected information for Ivano Company as of December 31 is as follows:
2006 2007
Preferred stock, 8%, par P100, nonconvertible, P250,000 P250,000
noncumulative
Common stock 600,000 800,000
Retained earnings 150,000 370,000
Dividends paid on preferred stock for the year 20,000 20,000
Net income for the year 120,000 240,000
Ivano’s return on common stockholders’ equity, rounded to the nearest percentage point, for 2007 is
A. 17% C. 21%
B. 19% D. 23%

Dividend yield
xxiv
. The following information is available for Duncan Co.:
2006
Dividends per share of common stock P 1.40
Market price per share of common stock 17.50
Which of the following statements is correct?
A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market price of their stocks.
B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns on their investments.
C. The dividend yield is 12.5%, which is of interest to bondholders.
D. The dividend yield is 8.0 times the market price, which is important in solvency analysis.

Market Test Ratios

Market/Book value ratio
Price per share
xxv
. What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book value of equity of P3,000,000, and a market/book ratio of 3.5?
A. P8.57 C. P85.70
B. P30.00 D. P105.00

P/E ratio
xxvi
. Orchard Company’s capital stock at December 31 consisted of the following:
 Common stock, P2 par value; 100,000 shares authorized, issued, and outstanding.
 10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares authorized, issued, and outstanding.
Orchard’s common stock, which is listed on a major stock exchange, was quoted at P4 per share on December 31. Orchard’s net income for the year ended December 31 was P50,000. The yearly

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 Financial Statement Analysis

preferred dividend was declared. No capital stock transactions occurred. What was the price earnings ratio on Orchard’s common stock at December 31?
A. 6 to 1 C. 10 to 1
B. 8 to 1 D. 16 to 1
xxvii
. On December 31, 2006 and 2007, Renegade Corporation had 100,000 shares of common stock and 50,000 shares of noncumulative and nonconvertible preferred stock issued and outstanding.
Additional information:
Stockholders’ equity at 12/31/07 P4,500,000
Net income year ended 12/31/07 1,200,000
Dividends on preferred stock year ended 12/31/07 300,000
Market price per share of common stock at 12/31/07 144
The price-earnings ratio on common stock at December 31, 2007, was
A. 10 to 1 C. 14 to 1
B. 12 to 1 D. 16 to 1

Payout ratio
xxviii
. Selected financial data of Alexander Corporation for the year ended December 31, 2007, is presented below:
Operating income P900,000
Interest expense (100,000)
Income before income taxes 800,000
Income tax (320,000)
Net income 480,000
Preferred stock dividend (200,000)
Net income available to common stockholders 280,000
Common stock dividends were P120,000. The payout ratio is:
A. 42.9 percent C. 25.0 percent
B. 66.7 percent D. 71.4 percent

P/E ratio & Payout ratio

Use the following information for question Nos. 33 and 34:
Terry Corporation had net income of P200,000 and paid dividends to common stockholders of P40,000 in 2007. The weighted-average number of shares outstanding in 2007 was 50,000 shares. Terry
Corporation’s common stock is selling for P60 per share in the local stock exchange.
xxix
. Terry Corporation’s price-earnings ratio is
A. 3.8 times C. 18.8 times
B. 15 times D. 6 times
xxx
. Terry Corporation’s payout ratio for 2007 is
A. P4 per share C. 20.0 percent

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 Financial Statement Analysis

B. 12.5 percent D. 25.0 percent

DuPont Model
Debt ratio
xxxi
. The Board of Directors is dissatisfied with last year's ROE of 15%. If the profit margin and asset turnover remain unchanged at 8% and 1.25 respectively, by how much must the total debt ratio increase to
achieve 20% ROE?
A. Total debt ratio must increase by .5
B. Total debt ratio must increase by 5
C. Total debt ratio must increase by 5%
D. Total debt ratio must increase by 50%
xxxii
. Assume you are given the following relationships for the Orange Company:
Sales/total assets 1.5X
Return on assets (ROA) 3%
Return on equity (ROE) 5%
The Orange Company’s debt ratio is
A. 40% C. 35%
B. 60% D. 65%

Leverage Ratio
Degree of financial leverage
xxxiii
. A summarized income statement for Leveraged Inc. is presented below.
Sales P1,000,000
Cost of Sales    600,000
Gross Profit P 400,000
Operating Expenses    250,000
Operating Income P 150,000
Interest Expense     30,000
Earnings Before Tax P 120,000
Income Tax     40,000
Net Income P   80,000
The degree of financial leverage is:
A. P 150,000 ÷ P 30,000 C. P1,000,000 ÷ P400,000
B. P 150,000 ÷ P120,000 D. P 150,000 ÷ P 80,000

Other Ratios
Book value per share
xxxiv
. M Corporation’s stockholders’ equity at December 31, 2007 consists of the following:

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 Financial Statement Analysis

6% cumulative preferred stock, P100 par, liquidating value

was P110 per share; issued and outstanding 50,000 shares P5,000,000
Common stock, par, P5 per share; issued and
outstanding, 400,000 shares 2,000,000
Retained earnings 1,000,000
Total P8,000,000
Dividends on preferred stock have been paid through 2006.
At December 31, 2007, M Corporation’s book value per share was
A. P5.50 C. P6.75
B. P6.25 D. P7.50
xxxv
. The following data were gathered from the annual report of Desk Products.
Market price per share P30.00
Number of common shares 10,000
Preferred stock, 5% P100 par P10,000
Common equity P140,000
The book value per share is:
A. P30.00 C. P14.00
B. P15.00 D. P13.75

Integrated ratios
Liquidity & activity ratios
Inventory
xxxvi
. The current assets of Mayon Enterprise consists of cash, accounts receivable, and inventory. The following information is available:
Credit sales 75% of total sales
Inventory turnover 5 times
Working capital P1,120,000
Current ratio 2.00 to 1
Quick ratio 1.25 to 1
Average Collection period 42 days
Working days 360
The estimated inventory amount is:
A. 840,000 C. 720,000
B. 600,000 D. 550,000
xxxvii
. The following data were obtained from the records of Salacot Company:
Current ratio (at year end) 1.5 to 1
Inventory turnover based on sales and ending inventory 15 times

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 Financial Statement Analysis

Inventory turnover based on cost of goods sold and ending inventory 10.5 times
Gross margin for 2007 P360,000
What was Salacot Company’s December 31, 2007 balance in the Inventory account?
A. P120,000 C. P 80,000
B. P 54,000 D. P 95,000

Net sales
xxxviii
.Selected data from Mildred Company’s year-end financial statements are presented below. The difference between average and ending inventory is immaterial.
Current ratio 2.0
Quick ratio 1.5
Current liabilities P120,000
Inventory turnover (based on cost of sales) 8 times
Gross profit margin 40%
Mildred’s net sales for the year were
A. P 800,000 C. P 480,000
B. P 672,000 D. P1,200,000

Gross margin
xxxix
. Selected information from the accounting records of the Blackwood Co. is as follows:
Net A/R at December 31, 2006 P 900,000
Net A/R at December 31, 2007 P1,000,000
Accounts receivable turnover 5 to 1
Inventories at December 31, 2006 P1,100,000
Inventories at December 31, 2007 P1,200,000
Inventory turnover 4 to 1
What was the gross margin for 2007?
A. P150,000 C. P300,000
B. P200,000 D. P400,000

Market Test Ratio

Dividend yield
xl
. Recto Co. has a price earnings ratio of 10, earnings per share of P2.20, and a pay out ratio of 75%. The dividend yield is
A. 25.0% C. 7.5%
B. 22.0% D. 10.0%
xli
. The following were reflected from the records of Salvacion Company:
Earnings before interest and taxes P1,250,000
Interest expense 250,000

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 Financial Statement Analysis

Preferred dividends 200,000

Payout ratio 40 percent
Shares outstanding throughout 2006
Preferred 20,000
Common 25,000
Income tax rate 40 percent
Price earnings ratio 5 times
The dividend yield ratio is
A. 0.50 C. 0.40
B. 0.12 D. 0.08

Comprehensive
xlii
. The balance sheets of Magdangal Company at the end of each of the first two years of operations indicate the following:
2007   2006  
Total current assets P600,000 P560,000
Total investments 60,000 40,000
Total property, plant, and equipment 900,000 700,000
Total current liabilities 150,000 80,000
Total long-term liabilities 350,000 250,000
Preferred 9% stock, P100 par 100,000 100,000
Common stock, P10 par 600,000 600,000
Paid-in capital in excess of par-common stock 60,000 60,000
Retained earnings 300,000 210,000
Net income is P115,000 and interest expense is P30,000 for 2007.
What is the rate earned on total assets for 2007 (round percent to one decimal point)?
A. 9.3 percent C. 8.9 percent
B. 10.1 percent D. 7.4 percent
xliii
. What is the rate earned on stockholders' equity for 2007 (round percent to one decimal point)?
A. 10.6 percent C. 12.4 percent
B. 11.2 percent D. 15.6 percent
xliv
. What is the earnings per share on common stock for 2007, (round to two decimal places)?
A. P1.92 C. P1.77
B. P1.89 D. P1.42
xlv
. If the market price is P30, what is the price-earnings ratio on common stock for 2007 (round to one decimal point)?
A. 17.0 C. 12.4

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 Financial Statement Analysis

B. 12.1 D. 15.9

578
i
. Answer: A
2007: P2,000,000 (1 – 0.7) = P600,000
2008: P2,000,000 (1 + 1.75) = P5,500,000
Note: For 2007 & 2008, 2006 was used as a base year.
ii
. Answer: C
iii
. Answer: C
Current Assets:
Cash P100,000
Accounts receivable 200,000
Total liquid assets 300,000
Inventory 440,000
Total current assets P740,000
Current Liabilities:
Accounts payable P 80,000
Notes payable, due in 6 months 250,000
Interest payable 25,000
Total current liabilities P355,000

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

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

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

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

Working Capital P351,000

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

Average Collection Period: Average Accounts Receivable ÷ Average Daily Sales

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

Alternative Computation:
Average daily cost of goods sold: = (P2,400,000 ÷ 365) P6,575.34
Turnover in Days: P624,000 ÷ P6,575.34 94.9 days
xvi
. Answer: A
Average Accounts Receivable: (P900,000 ÷ P1,000,000) ÷ 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
xvii
. Answer: B
Current liabilities P 100,000
Long-term debt 400,000
Deferred income tax 10,000
Total Liabilities 510,000
Stockholders’ Equity
Preferred stock P 80,000
Common stock 100,000
Premium on common stock 180,000
Retained earnings 170,000 530,000
Total Assets P1,040,000
 Debt Ratio: P510,000 ÷ P1,040,000 = 0.49
xviii
. Answer: D
Times interest earned: Earnings before interest ÷ Interest
Income before tax (P48,000 + P46,000) P 94,000
Add Interest expense 35,000
Income before Interest expense P129,000

TIE: P129,000 ÷ P35,000 3.7 times

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

TIE: P500,000 ÷ P100,000 5 times

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

TIE: P760,000 ÷ P60,000 12.67 times

xxii
. Answer: B
Earnings before interest expense (P20,000 x 4.5) P90,000
Deduct interest expense 20,000
Income before income tax P70,000
Deduct income tax (P70,000 x 0.4) 28,000
Net income P42,000
xxiii
. Answer: D
Income to Common; (P240,000 – P20,000) P220,000
Average Common Equity: (P750,000 + P1,170,000) ÷ 2 P960,000
Return on Common Equity: (P220 ÷ P960) 23 percent
xxiv
. Answer: B
The dividend yield is 8 percent (P1.40 ÷ P17.50)
The dividend yield measures the return of investment in terms of dividends received. The total
expected returns consists of Dividend Yield and the Appreciation in market price and dividend
xxv
. Answer: D
Market Value of Equity (P3M x 3.5) P10,500,000
Market price per share: (P10.5M ÷ 100,000) P105
xxvi
. Answer: B
EPS: P50,000 ÷ 100,000 shares P0.50
P/E Ratio: P4.00 ÷ P0.50 8 to 1
xxvii
. Answer: D
EPS: (P1,200,000 – P300,000) ÷ 100,000 P9.00
P/E Ratio: 144 ÷ 9 16
xxviii
. Answer: A
Payout Ratio: Common Dividends ÷ Income Available to Common
P120,000 ÷ P280,000 = 42.9%
xxix
. Answer: B
Price-earnings ratio: Market price ÷ EPS
EPS: Net income ÷ /Weighted-average common shares
EPS: P200,000 ÷ 50,000 sharesP4.00
P/E Ratio: P60 ÷ P4 15.0X
xxx
. Answer: C
Payout Ratio: Dividends ÷ Income to Common
P40,000÷ P200,000 = 20.0%
xxxi
. Answer: D
ROE: (8% x 1.25) 10.00%
Last year’s Debt Ratio 1 – (10% ÷ 15%) 33.33%
Proposed Debt Ratio 1 – (10% ÷ 20%) 50.00%
Increase in debt ratio: (50.00% - 33.33%) ÷ 33.33% 50.00%
xxxii
. Answer: A
1 – (0.03 ÷ 0.05) = 40%
xxxiii
. Answer: B
Degree of Financial Leverage: Operating Income ÷ Interest Expense
xxxiv
. Answer: A
Total stockholders’ equity P8,000,000
Deduct:
Liquidation value of Preferred Stock (50,000 s P110) P5,500,000
Unpaid Preferred Dividends (P5M x 6%) 300,000 5,800,000
Common Equity P2,200,000

Book Value per Share: P2.2M ÷ 400,000 shares P5.50

xxxv
. Answer: C
Book Value per Share: Common Equity ÷ Outstanding Shares
P140,000 ÷ 10,000 shares = P14.00
xxxvi
. Answer: A
The inventory amount can be calculated as follows:
Current liabilities: Working Capital = current liabilities based on 2:1 current ratio. At 2:1 current
ratio, the amount of working capital and current liabilities are both P1,120,000.

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

P1,120,000 x (2.0 – 1.25) P840,000

A detailed computation can be made as follows:

Current assets: P1,120,000 x 2 P2,240,000
Liquid assets: P1,120,000 x 1.25 1,400,000
Inventory P 840,000
xxxvii
. Answer: C
Inventory balance: Gross profit ÷ (Difference between 2 inventory turnovers)
360,000/(15 – 10.5) = P80,000
xxxviii
. Answer: A
Inventory balance (P120,000 x (2.0 – 1.5) P 60,000
Cost of goods sold 60,000 x 8 P480,000
Sales (P480,000 ÷ 0.60) P800,000
xxxix
. Answer: A
Average Accounts Receivable: (P900,000 ÷ P1,000,000) ÷ 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
xl
. Answer: C
Dividend per share: 0.75 x P2.20 P1.65
Market price: 10 x 2.20 22.00
Dividend yield: P1.65 ÷ P22.00 = 7.5%
xli
. Answer: D
EBIT 1,250,000
Less interest expense 250,000
Earnings before tax 1,000,000
Less Income tax 40% 400,000
Net income 600,000
Less Preferred dividends 200,000
Earnings to Common Stock 400,000
Earnings per share 400,000/25,000 16.00
Dividend per share: 400,000 x 0.40 ÷ 25,000 6.40

Dividend yield 6.4 ÷ (16 x 5) 8.0%

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

EPS: (P106,000 ÷ 60,000) P1.77

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

Liquidity ratios Answer: d Diff: M

. Which of the following statements is most correct?

a. If a company increases its current liabilities by $1,000 and simultaneously increases its
inventories by $1,000, its current ratio must rise.
b. If a company increases its current liabilities by $1,000 and simultaneously increases its
inventories by $1,000, its quick ratio must fall.
c. A company’s quick ratio may never exceed its current ratio.
d. Statements b and c are correct.
e. None of the statements above is correct.
Ratio analysis Answer: c Diff: M
. As a short-term creditor concerned with a company’s ability to meet its financial obligation to
you, which one of the following combinations of ratios would you most likely prefer?

Current Debt
ratio TIE ratio
a. 0.5 0.5 0.33
b. 1.0 1.0 0.50
c. 1.5 1.5 0.50
d. 2.0 1.0 0.67
e. 2.5 0.5 0.71
Miscellaneous ratios Answer: a Diff: M R
. Which of the following statements is most correct?

a. If a firm’s ROE and ROA are the same, this implies that the firm is financed entirely with
common equity. (That is, common equity = total assets).
b. All else equal, a firm with a higher debt ratio will have a lower basic earning power ratio.
c. If Firm A has a higher market to book ratio than Firm B, then Firm A must also have a
higher price earnings ratio (P/E).
d. All of the statements above are correct.
e. Statements a and b are correct.

Statement a is correct. Use the Du Pont equation to find that the equity multiplier equals 1, so
the company is 100 percent equity financed.

Market price per share Answer: b Diff: E

. You are given the following information: Stockholders’ equity = $1,250; price/earnings ratio =
5; shares outstanding = 25; market/book ratio = 1.5. Calculate the market price of a share of the
company’s stock.

a. $ 33.33
b. $ 75.00
c. $ 10.00
d. $166.67
e. $133.32
Total market value = $1,250(1.5) = $1,875.
Market value per share = $1,875/25 = $75.

Alternative solution:
Book value per share = $1,250/25 = $50.
Market value per share = $50(1.5) = $75.

ROA Answer: d Diff: E

. A firm has a profit margin of 15 percent on sales of $20,000,000. If the firm has debt of
$7,500,000, total assets of $22,500,000, and an after-tax interest cost on total debt of 5 percent,
what is the firm’s ROA?

a. 8.4%
b. 10.9%
c. 12.0%
d. 13.3%
e. 15.1%
Net income = 0.15($20,000,000) = $3,000,000.
ROA = $3,000,000/$22,500,000 = 13.3%.

Accounts receivable Answer: a Diff: M

. Ruth Company currently has $1,000,000 in accounts receivable. Its days sales outstanding
(DSO) is 48 days. The company wants to reduce its DSO to the industry average of 32 days by
pressuring more of its customers to pay their bills on time. The company’s CFO estimates that
if this policy is adopted the company’s average sales will fall by 10 percent. Assuming that the
company adopts this change and succeeds in reducing its DSO to 32 days and does lose 10
percent of its sales, what will be the level of accounts receivable following the change?
Assume a 360-day year.

a. $600,000
b. $666,667
c. $750,000
d. $900,000
e. $966,667
First solve for current annual sales using the DSO equation as follows: 48 =
$1,000,000/(Sales/360) to find annual sales equal to $7,500,000.
If sales fall by 10%, the new sales level will be $7,500,000(0.9) = $6,750,000. Again, using the
DSO equation, solve for the new accounts receivable figure as follows: 32 =
AR/($6,750,000/360) or AR = $600,000.

ROA Answer: a Diff: M

. The Meryl Corporation’s common stock is currently selling at $100 per share, which represents
a P/E ratio of 10. If the firm has 100 shares of common stock outstanding, a return on equity of
20 percent, and a debt ratio of 60 percent, what is its return on total assets (ROA)?
 a. 8.0%
b. 10.0%
c. 12.0%
d. 16.7%
e. 20.0%
Equity multiplier = 1/(1 - D/A) = 1/(1 - 0.60) = 2.5.
ROE = ROA  Equity multiplier.
20% = (ROA)(2.5).
ROA = 8.0%.
ROA Answer: a Diff: M
. A fire has destroyed a large percentage of the financial records of the Carter Company. You
have the task of piecing together information in order to release a financial report. You have
found the return on equity to be 18 percent. If sales were $4 million, the debt ratio was 0.40,
and total liabilities were $2 million, what would be the return on assets (ROA)?

a. 10.80%
b. 0.80%
c. 1.25%
d. 12.60%
e. Insufficient information.
Equity multiplier = 1/(1 - D/A) = 1/(1 - 0.4) = 1.67.
ROE = ROA  Equity multiplier.

18% = (ROA)(1.67)
ROA = 10.8%.

ROA Answer: a Diff: M

. Q Corp. has a basic earnings power (BEP) ratio of 15 percent, a times interest earned (TIE)
ratio of 6, and total assets are $100,000. Its corporate tax rate is 40 percent. What is Q Corp.’s
return on assets (ROA)?

a. 7.5%
b. 10.0%
c. 12.2%
d. 13.1%
e. 14.5%
EBIT
BEP = = 0.15.
TA
TA = $100,000.
EBIT = 0.15($100,000) = $15,000.
EBIT
TIE = = 6.
INT
EBIT $15,000
Int = = = $2,500.
6 6

Calculate Net income:

EBIT $15,000
Int 2,500
EBT $12,500
Tax (40%) 5,000
NI $ 7,500

NI $7,500
ROA = = $100,000 = 7.5%.
TA

ROE Answer: c Diff: M

. The Amer Company has the following characteristics:

Sales $1,000
Total assets $1,000
Total debt/Total assets 35%
Basic Earning Power (BEP) ratio 20%
Tax rate 40%
Interest rate on total debt 4.57%

What is Amer’s ROE?

 a. 11.04%
b. 12.31%
c. 16.99%
d. 28.31%
e. 30.77%
Calculate debt, equity, and EBIT:
Debt = D/A  TA = 0.35($1,000) = $350.
Equity = TA - Debt = $1,000 - $350 = $650.
EBIT = TA  BEP = $1,000(0.20) = $200.

Calculate net income and ROE:

Net income = (EBIT - I)(1 - T) = [200 - 0.0457(350)](0.6) = 110.4.
ROE = 110.4/650 = 16.99%.

TIE ratio Answer: d Diff: M

. A firm has total interest charges of $10,000 per year, sales of $1 million, a tax rate of 40
percent, and a net profit margin of 6 percent. What is the firm’s times interest earned ratio?

a. 16
b. 10
c. 7
d. 11
e. 20
NI = $1,000,000(0.06) = $60,000.
EBT = $60,000/0.6 = $100,000.
EBIT = $100,000 + $10,000 = $110,000.
TIE = EBIT/I = $110,000/$10,000 = 11.