BA 324 - Introduction to Finance

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Financial Analysis - Review

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1) Ratios are used to compare different firms in the same industry.

2) Financial ratios are used to weigh and evaluate the operational performance of the firm.

3) Liquidity ratios indicate how fast a firm can generate cash to pay bills.

4) Profitability ratios allow one to measure the ability of the firm to earn an adequate return on sales, total assets, and invested capital.

5) Debt utilization ratios are used to evaluate the firm's debt position with regard to its asset base and earning power.

6) Ratio analysis can be useful for historical trend analysis within a firm, comparison of ratios within a single industry, and measuring the effects of financing.

7) In examining the liquidity ratios, the primary emphasis is the firm's ability to pay short-term obligations on time.

8) Asset utilization ratios include inventory turnover, fixed asset turnover, and average collection period.

9) A short-term creditor would be most interested in liquidity ratios.

10) Two ratios are used in the DuPont system to create return on assets. They are profit margin and asset turnover.

11) For a given level of profitability as measured by profit margin, the firm's return on equity will increase as its debt-to assets ratio increases.

12) Asset utilization ratios A. relate balance sheet assets to income statement sales.

13) A decreasing average collection period could be associated with increasing sales and decreasing account receivable.

14) If accounts receivable stays the same, and credit sales go up, the average collection period will go down.

15) Total asset turnover indicates the firm's ability to use its assets to generate sales.

16) A quick ratio that is much smaller than the current ratio reflects a large portion of current assets is in inventory.

17) Investors and financial analysts wanting to evaluate the operating efficiency of a firm's managers would probably look primarily at the firm's asset utilization ratios.

18) An increasing average collection period indicates the company is becoming less efficient in its collection policy.

19) In addition to comparison with industry ratios, it is also helpful to analyze ratios using trend analysis, and historical comparisons.

20) If a firm has both interest expense and lease payments, times interest earned will be greater than fixed charge coverage.

21) The higher a firm's debt utilization ratios, excluding debt-to-total assets, the A. less risky the firm's financial position.

22) If lease payments are reduced, fixed charges coverage goes up

23) Industries most sensitive to inflation-induced profits are those with cyclical products.

24) Replacement cost accounting (current cost method) will usually increase assets, decrease net income before taxes, and lower the return on equity.

25) During inflation, replacement cost accounting will, increase the value of assets, lower the debt to asset ratio., and reduce incomes.

26) The DuPont system of analysis emphasizes that profit generated by assets can be derived by various combinations of profit margins and asset turnover.

27) Heavy use of long-term debt can be of benefit to a firm.

28) Return on equity will be higher than return on assets if there is debt in the capital structure.

29) Higher debt utilization ratios will always increase a firm's return on equity given a positive return on assets.

30) Asset utilization ratios relate balance sheet assets to income statement sales.

31) Asset utilization ratios can be used to measure the effectiveness of a firm's managers.

32) Fiercely competitive industries such as the computer industry have had lower profit margins and return on equity in recent years even though they are under extreme pressure to maintain high profitability.

33) Profitability ratios are distorted by inflation because profits are stated in current dollars and assets and equity are stated in historical dollars.

34) As long as prices continue to rise faster than costs in an inflationary environment, reported profits will generally continue to rise.

35) Under generally acceptable accounting principles, two companies with identical operating results may not report identical net incomes.

36) During disinflation, stock prices tend to go up because the investor's required rate of return goes down.

37) Analysts agree that extraordinary gains/losses should be excluded from ratio analysis because they are one time events, and do not measure annual operating performance.

38) LIFO inventory pricing does a better job than FIFO in equating current costs with current revenue.

39) A company can improve their ROE by changing their capital structure.

40) Income can be distorted by factors other than inflation. The most important causes of distortion for inter-industry comparisons are timing of revenue receipts and nonrecurring gains or losses, and tax write-off policy and use of different inventory methods.

41) Disinflation may cause a reduced required return demanded by investors on financial assets.

42) Disinflation as compared to inflation would normally be good for investments in bonds.

43) A company experiencing rapid price increases for its products would take the most conservative approach by using LIFO accounting.

44) The LIFO method of inventory costing is least likely to lead to inflation-induced profits.

45) A large extraordinary loss has no effect on cost of goods sold.

46) Potential problems of utilizing ratio analysis include trends and industry averages are historical in nature, financial data may be distorted due to price-level changes, and firms within an industry may not use similar accounting methods.

47) The most rigorous test of a firm's ability to pay its short-term obligations is its quick ratio.

48) If the company's accounts receivable turnover is increasing, the average collection period is going down.

49) Historical cost based depreciation tends to increase profits when there is inflation.

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