SECOND MIDTERM EXAM

0CTOBER 13
NAME: ANDRES REDONDO
I.
True/false questions

The balance sheet contains market values of assets at a point in

time.
True
False

The income statement is also known as the P&L statement.

True
False

The income statement has three components: operating activities,

investing activities, and financing activities.
True
False

A common-size balance sheet expresses all account balances as a

percentage of net sales.
True
False

The statement of cash flows is based on accrual accounting.

True
False
High inventories are an early warning sign that a firm is having
trouble selling its products.
True
False

Reporting earning in terms of EBITDA can result in inflation of

these earnings if it includes the consolidated earnings of a
company that was acquired with goodwill.
True
False

The use of financial ratios makes financial statements less

comparable across firms of different sizes.
True
False

Off-balance-sheet activities can undermine the usefulness of

financial ratio analysis for failure prediction.
True
False

When earnings occur from financing activity, it is seen as a sign of

high quality of reported earnings.
True
False

Reductions in managed costs, such as advertising, are a sign of

low quality of earnings.
True
False
A summary of last year's annual financial report for a business is
as follows:

What is the net profit margin ratio?

5.7%

10.1
%

16.7
%

14.6
%

What is the average settlement period for receivables (in

months)?
2.97

4.39
 2.06

4.04

A summary of last year's annual financial report for a business is

as follows:

What is the acid test ratio?

2.07:1

1.67:1

2.20:1

2.44:1

What is the interest cover ratio?

7.0 times

7.8%

8.0 times

12.5%

The P/E ratio is:

the after-tax profit per share divided by the retained profit per share.

the share price divided by the dividend paid per share.

the after-tax profit per share divided by the dividend per share.

the share price divided by the after-tax profit per share.

 The gross profit margin ratio of Penguin Products Ltd is higher
this year than it was last year. Which one of the following
factors could not be true of this year relative to last year?
A decrease in sales revenue and a decrease in cost of sales.

A decrease in sales revenue and an increase in cost of sales.

An increase in sales revenue and a decrease in cost of sales.

An increase in sales revenue and an increase in cost of sales.

Solar plc is a Stock Exchange listed business. Today the business's

share price rose. What effect will this have on its price/earnings
ratio (P/E) and its dividend yield ratio (DY)?
P/E DY

A Increase Increase

B Increase Decrease

C Decrease Increase

D Decrease Decrease

II. Multiple choice

Financial statements report only items that have significant

economic value.” This statement summarizes which basic
accounting concept?

Matching.

Materiality.
 Realization.

Disclosure.

Which basic accounting concept does the following statement

summarize?

“Transactions are recorded using price paid, not current prices.”

Disclosure.

Conservatism.

Matching.

Historical cost.

Which basic accounting concept prohibits firms from frequently

changing their method of valuing inventory?
Conservatism.

Historical cost.

Disclosure.

Consistency.

Which of the following does not indicate high quality of earnings?

 Conservative accounting methods were used to calculate earnings.

The firm has no extraordinary income.

Earnings are from financing activities.

Earnings are stable.

Which of the following is least likely to be associated with low-

quality earnings?
Increase in intangible assets.

Slowdown in inventory turnover.

Decrease in borrowings.

One-time sources of income.

III.- Open question

An investment analyst has discovered a firm’s current assets are $510

million, current liabilities are $270 million, and long-term liabilities are $30
million. The firm issued 4 million shares whose current market price is $45 per
share. Based on book value, is this stock underpriced or overpriced? Why?

ANSWER: The stock is underpriced because the firm can utilize the current
assets to pay all of the liabilities ($300 million). Therefore, $210 million will
remain left to pay their shareholders $52.50 dollars per share (210 million / 4
million).

This year R&C Corporation reported net income of $190 million,

depreciation of $100 million, and a dividend payment to
stockholders of $10 million. If the firm paid off $15 million in
long-term debt, what was the net cash flow for the firm?

ANSWER: Net Cash Flow = Net Income + Depreciation – Dividend Payment –

Debt repayment.
Then, 190 million + 100 million – 10 million – 15 million = $265 Million

The Net Cash Flow for the firm was $265 Million.

Suppose Amoco Inc. changed its accounting auditors five times over
the past 5 years. Is this a good or a bad signal? Explain.

ANSWER: Changing auditors is a bad sign. The Auditors are in

charge of reviewing the company's accounts, in that sense, their
mission is to maintain the transparency of the money that enters
and leaves the company or organization. Therefore, several changes
of auditors point out that the companies accounts might have been
manipulated by the fired auditors.

Suppose you analyze the auto industry and find the following
current ratios: Ford = 1.1, Chrysler = 1.2, General Motors = 0.6, and
Honda = 0.98. Which firm seems to be best able to pay its
immediate liabilities?

ANSWER: The current ratio is a liquidity ratio that measures a

company's ability to pay short-term obligations (those due within
one year). A ratio under 1 indicates that the company’s debts due in
a year or less are greater than its assets (cash or other short-term
assets expected to be converted to cash within a year or less). The
higher the current ratio, the more capable a company is of paying its
obligations because it has a larger proportion of short-term asset
value relative to the value of its short-term liabilities. Therefore,
Chrysler is the company that is best able to pay their immediate
liabilities.

How do the following activities affect the firm’s balance sheet?

a. The firm issues $1 million in stock and uses the money to redeem $1 million
in bonds. Answer: Liabilities will be reduced $1 million and equity will
increase $1 million.
b. The firm issues $1 million in bonds and uses the money to buy a new
building. Answer: Both liabilities and equity will increase $1 million each.
c. The firm issues $1 million in bonds and keeps the money in cash. Answer:
Both liabilities and equity will increase by $1 million each.
d. The firm sells $1 million of current assets to pay $1 million of current
liabilities. Answer: Both liabilities and equity will decrease $1 million each.
e. The firm borrows an additional $1 million on a short-term basis and uses the
money to repay long-term debt. Answer: It will not affect liabilities, assets or
equity as a whole. Only the level of short-term and long-term liabilities will
be affected.
 IV. Underline the correct answer

1. Which of the following is not a current asset?

Inventory
Prepaid Insurance
Fixtures

2. Current asset MINUS current liabilities is the

Current Ratio
Net Worth
Working Capital

3. Current assets DIVIDED BY current liabilities is the

Current Ratio
Net Worth Ratio
Working Capital

4. The quick ratio EXCLUDES which of the following?

Accounts Receivable
Inventory
Cash

Use the following information to answer items 5 - 7:

At December 31 a company's records show the following information:

5. The company's working capital is

$60,000
$66,000
$196,000

6. The company's current ratio is

1.0 : 1
2.0 : 1
2.1 : 1
7. The company's quick ratio is
0.7 : 1
1.0 : 1
2.0 : 1
Use the following information to answer items 8 - 11:
For its most recent year a company had Sales (all on credit) of $830,000 and Cost of Goods
Sold of $525,000. At the beginning of the year its Accounts Receivable were $80,000 and
its Inventory was $100,000. At the end of the year its Accounts Receivable were $86,000 and its
Inventory was $110,000.

8. The inventory turnover ratio for the year was

4.8
5.0
7.9

9. The accounts receivable turnover ratio for the year was

6.3
7.5
10.0

10. On average how many days of sales were in Accounts Receivable during the year?
27
37
49

11. On average how many days of sales were in Inventory during the year?
14
46
73

Use the following information for items 12 and 13:

A company's net income after tax was $400,000 for its most recent year. The company's income
statement included Income Tax Expense of $140,000 and Interest Expense of $60,000. At the
beginning of the year the company's stockholders' equity was $1,900,000 and at the end of the
year it was $2,100,000.

12. What is the times interest earned for the company?

6.7
9.0
10.0

13. What is the after-tax return on stockholder's equity for the year?
20%
25%
30%

14.The debt to equity ratio is computed as: (Total Liabilities ÷ Total

_____Stockholder´s equity_____)

15. Which of the following are likely to have the reported amounts on the balance sheet being
close to their current value?
Current Assets

Long-term Assets

Stockholders' Equity
16. A corporation's excellent reputation will be listed among the corporation's assets on its
balance sheet.
True
False

17.The current market value of a corporation is approximately the amount reported on the
balance sheet as stockholders' equity.
True
False

18. Free cash flow is the cash provided by operating activities minus the cash used by financing
activities.
True
False

19. The quality of a company's earnings are suspect when the company's net income is more
than the cash flow from which activities?
Operating
Investing
Financing

20.A balance sheet which reports percentages of total assets instead of dollar amounts is
referred to as a common-size balance sheet

V. MULTIPLE CHOICE

Answer each multiple choice and short-answer question. For each multiple choice question
circle the letter of the correct answer on the exam (a,b,c,d,e,f,g, or h). Answer each short-answer
question in the space provided. (If the answer to a short-answer question cannot be determined
precisely indicate why.) Some questions have special directions.

1. The (cash + marketable securities + accounts receivable)/current liabilities ratio

a) always decreases when management tries to increase the current ratio by

manipulation
b) includes inventory in the numerator
c) includes projected expenditures from future operations in the denominator
d) none of the above

2. Trends observed in historical accounting information

a) can be misleading due to changes in accounting procedures

b) can provide a basis for estimating future trends
c) are likely to be more valuable in turnaround situations
d) a and b
e) a and c
f) b and c
g) all of the above
h) none of the above
3. Percent or common-size financial statements are used to

a) focus on the importance of corporate size on the firm

b) compare relative asset allocations across firms
c) compare changes in relative asset allocations for a given firm over time
d) a and b
e) a and c
f) b and c
g) all of the above
h) none of the above

4. The operating income/sales ratio is an example of a

a) turnover or efficiency ratio

b) coverage or liquidity ratio
c) leverage or debt ratio
d) none of the above