1: (131) Liquidity, Solvency, and Leverage Ratios

1: (15) Common-Size Financial Statements

2: (74) Liquidity
3: (25) Solvency
4: (17) Leverage

1: (15) Common-Size Financial Statements

Question: 1 An abbreviated common-size income statements for Year 1’s actual results and Year
2’s anticipated results are shown below.

Year 1 Year 2

Sales 100% 100%

Cost of goods sold 50% 50%

Selling and administrative expenses 40% ?

Operating Income 10% ?

The corporation estimates that units sold will increase by 5% in Year 2 with no price
increase to its customers and no anticipated cost increases from its vendors. Assume
selling and administrative expenses are 5% variable and 95% fixed. If all predictions
materialize, the corporation should expect selling and administrative expenses in Year
2 to be

A. Greater than 40% but no more than 42% of sales.

B. 40% of sales.

C. Less than 40% of sales.

D. Greater than 42% of sales.

Question: 2 The following financial information is given.

Year 1 Year 2

Book value of assets $18,000 $26,000

Market value of equity 18,000 60,000

12 months ended Year 1 12 months ended Year 2

Sales $ 1,000 $ 1,300

Cost of goods sold 500 700

Operating income 500 600

Depreciation expense 200 200
Interest expense 100 100

Pretax income 200 300

Income tax expense 80 120

Net income $ 120 $ 180

Using a common-size income statement, did operating income and net income
increase or decrease?
Operating income Net income

A. Decreased Increased

B. Increased Increased

C. Increased Decreased

D. Decreased Decreased

Question: 3 A financial analyst is reviewing a competitor’s income statements for the past 2 years.

Year 1 Year 2

Sales £250,000 £275,000

Cost of goods sold 155,000 160,000

Gross profit 95,000 115,000

Selling expenses 35,000 40,000

General expenses 45,000 50,000

 Operating income before income taxes 15,000 25,000

Taxes related to operations 2,500 3,500

Net income £ 12,500 £ 21,500

The financial analyst is able to conclude that the competitor’s

A. Common size income statements will show operating income before income taxes at
22% for Year 2.

B. Common size income statements will show taxes related to operations at 16% for
Year 2.

C. Common base year income statements will show that gross profit increased by 17%
in Year 2 as compared to Year 1.

D. Common base year income statements will show that selling expenses increased by
14% in Year 2 as compared to Year 1.

Question: 4 A financial analyst is reviewing a company’s most recent fiscal year financial
statements. The relevant data is shown below.

Assets ($000) Liabilities and Equity ($000)

Cash $ 150 Accounts payable $ 300

Accounts receivable 250 Notes payable 200

Inventory 400 Long-term debt 500

Plant and equipment, net 1,200 Common equity 1,000

Total $2,000 Total $2,000

The analyst would like to examine the company in relation to other firms in the industry
utilizing common-size financial statements. The appropriate comparative value for
current assets is

A. 25%

B. 40%

C. 20%
 D. 35%

Question: 5 The dollar value of a company’s ending inventory on its balance sheet was $500,000,
$600,000, and $400,000 for Years 1, 2, and 3, respectively. In preparing a horizontal
analysis with Year 1 as the base year, the percentage change shown for Year 3 would
be

A. 20%

B. 80%

C. (20%)

D. (25%)

Question: 6 Shown below are components of a company’s financial statements.

Sales revenue $ 600,000

Cost of goods sold 300,000

Total assets 2,400,000

Total equity 1,500,000

Net income 120,000

What percentage value would net income be on a common size financial statement?

A. 5%

B. 20%

C. 8%

D. 40%

Question: 7 A company has provided the following data pertaining to one of its products.

Year Unit Sales Unit Sales Price Gross Profit Margin

1 1,000 $50 45%

2 1,200 $55 48%

 Which one of the following statements is correct?

A. The dollar amount of gross profit increased by 3% during Year 2.

B. The cost per unit increased during Year 2, in line with the increase in unit sales.

C. The cost per unit sold decreased 3% during Year 2.

D. The percentage increase in the sales price exceeded the percentage increase in the
cost per unit sold during Year 2.

Question: 8 Select information from a company’s year-end balance sheet is shown below.

Balance Sheet

As of December 31, Year 1

Cash $ 50,000
Accounts receivable 120,000
Inventory 75,000
Property, plant and equipment, net 250,000
Total assets $495,000
Accounts payable $ 35,000
Long-term debt 100,000
Total liabilities 135,000
Common stock 300,000
Retained earnings 60,000
Total equity 360,000
Total liabilities and equity $495,000
Based on the above information, a common-size balance sheet for the company will
show

A. Long-term debt at 74%.

B. Property, plant and equipment, net at 69%.

C. Retained earnings at 17%.

D. Accounts receivables at 24%.

Question: 9 A company has the following balances on its financial statements:

 Revenue $32,000,000

Cost of sales 16,000,000

Net income 4,000,000

Total assets 80,000,000

Total equity 40,000,000

A common-size income statement would show net income as

A. 10.0%

B. 5.0%

C. 25.0%

D. 12.5%

Question: 10 An enterprise is in the process of comparing its current financial performance for Year
3 with the prior 2 years. The enterprise experienced exceptionally strong growth
between Years 1 and 2, with a slight decrease in sales between Years 2 and 3.

Year 1 Year 2 Year 3

Net sales $4,560,000 $30,980,400 $26,583,220

Cost of goods sold 2,378,900 24,655,340 21,444,985

Selling expenses 490,000 1,289,466 2,099,800

General and administrative expenses 290,500 500,000 600,000

Which one of the following statements is correct when using common-size analysis to
compare the results?

A. The enterprise’s proportion of gross profit was lowest in Year 3 due to high
production costs.

B. The enterprise experienced the highest proportion of selling expenses in Year 2,

which led to the high net sales.

C. The enterprise’s profitability increased each year due to more efficient production
processes.

D. The enterprise increased the percentage of general and administrative expenses each
year in order to manage the company’s growth.
Question: 11 The accounting manager of a manufacturer of farming equipment was asked by the
CFO to analyze the company’s last 5 years of operations. The accounting manager
prepared the following analysis:

Common Base Year Income Statement

Base Year = December 31, Year 1

Year 2 Year 3 Year 4 Year 5 Year 6

Sales 1.01 1.03 1.05 1.07 1.10

Cost of goods sold 1.05 1.03 1.02 1.00 0.98
Selling and
administrative expenses 1.01 1.01 1.01 1.02 1.03
Research and
development 1.00 0.98 0.99 1.00 1.01

Income from operations 1.02 1.02 1.03 1.05 1.09

Which one of the following statements is consistent with this analysis?

A. The new production process has successfully reduced manufacturing expenses.

B. The company should decrease the sales force.

C. The company should decrease research and development expenses.

D. The new marketing strategy has been unsuccessful.

Question: 12 A company’s financial statements from the past 2 years have the following values.

Previous year Current year

Sales revenue $ 6,000,000 $ 6,600,000

Net income 500,000 540,000

Total assets 10,000,000 10,500,000

Inventory 600,000 500,000

Using horizontal analysis, what account has the largest percentage change?

A. Total assets.

B. Net income.

C. Inventory.

D. Sales revenue.
 In financial statement analysis, expressing all financial statement items as a
Question: 13
percentage of base-year amounts is called

A. Trend analysis.

B. Vertical common-size analysis.

C. Ratio analysis.

D. Horizontal common-size analysis.

Question: 14 A company has had the following financial results for the last four years.

Year 1 Year 2 Year 3 Year 4

Sales $1,250,000 $1,300,000 $1,359,000 $1,400,000

Cost of goods sold 750,000 785,000 825,000 850,000

Gross profit 500,000 515,000 534,000 550,000

Inflation factor 1.00 1.03 1.07 1.10
The company has analyzed these results using vertical common-size analysis to
determine trends. The performance of the company can best be characterized by
which one of the following statements?

A. The increased trend in the common-size gross profit percentage is the result of both
the increasing trend in sales and the decreasing trend in cost of goods sold.

B. The common-size trend in sales is increasing and is resulting in an increasing trend

in the common-size gross profit margin.

C. The common-size trend in cost of goods sold is decreasing which is resulting in an

increasing trend in the common-size gross profit margin.

D. The common-size gross profit percentage has decreased as a result of an increasing

common-size trend in cost of goods sold.

Question: 15 In assessing the financial prospects for a firm, financial analysts use various
techniques. An example of vertical, common-size analysis is

A. An assessment of the relative stability of a firm’s level of vertical integration.

B. A comparison in financial ratio form between two or more firms in the same
industry.
C. Advertising expense is 2% greater compared with the previous year.

D. Advertising expense for the current year is 2% of sales.

2: (74) Liquidity

Question: 1 The acid test ratio shows the ability of a company to pay its current liabilities without
having to

A. Liquidate its inventory.

B. Reduce its cash balance.

C. Collect its receivables.

D. Borrow additional funds.

Fact Pattern:
RST Corporation Comparative Income

Statements for the Years 5 and 6

Year 6 Year 5

Sales (all are credit) $285,000 $200,000

Cost of goods sold 150,000 120,000

Gross profit $135,000 $ 80,000

Selling and administrative expenses 65,000 36,000

Income before interest and income taxes $ 70,000 $ 44,000

Interest expense 3,000 3,000

Income before income taxes $ 67,000 $ 41,000

Income tax expense 27,000 16,000

Net income $ 40,000 $ 25,000

RST Corporation

Comparative Balance Sheets

End of Years 5 and 6

Assets Year 6 Year 5

Current assets:
Cash $ 5,000 $ 4,000
Short-term marketable investments 3,000 2,000
Accounts receivable (net) 16,000 14,000
Inventory 30,000 20,000

Total current assets $ 54,000 $ 40,000

Noncurrent assets:
Long-term investments 11,000 11,000
Property, plant, and equipment 80,000 70,000
Intangibles 3,000 4,000

Total assets $148,000 $125,000

Liabilities and Stockholders’ Equity

Current liabilities:

Accounts payable $ 11,000 $ 7,000

Accrued payables 1,000 1,000

Total current liabilities $ 12,000 $ 8,000

Long-term Liabilities:

0% Bonds payable, due in Year 12 30,000 30,000

Total liabilities $ 42,000 $ 38,000

Stockholders’ equity:

Common stock, 2,400 shares, $10 par $ 24,000 $ 24,000

Retained earnings 82,000 63,000

Total stockholders’ equity $106,000 $ 87,000

Total liabilities and stockholders’ equity $148,000 $125,000

The market value of RST’s common stock at the end of Year 6 was $100.00 per share.

Question: 2 RST’s acid-test (or quick) ratio at the end of Year 6 is

A. 2.18 to 1.

B. 2.00 to 1.

C. 1.50 to 1.

D. 2.40 to 1.
Question: 3 A financial analyst has obtained the following data from financial statements:

Cash $ 200,000

Marketable securities 100,000

Accounts receivable, net 300,000

Inventories, net 480,000

Prepaid expenses 120,000

Total current assets $1,200,000

Accounts payable $250,000

Income taxes 50,000

Accrued liabilities 100,000

Current portion of

long-term debt 200,000

Total current liabilities $600,000

In order to determine ability to pay current obligations, the financial analyst would
calculate the cash ratio as

A. 0.80

B. 1.20

C. 1.00

D. 0.50

Fact Pattern: Shown below are beginning and ending balances for certain of Grimaldi, Inc.’s accounts.
January 1 December 31

Cash $ 48,000 $ 62,000

Marketable securities 42,000 35,000

Accounts receivable (net) 68,000 47,000

Inventory 125,000 138,000

Property, plant, and equipment (net) 325,000 424,000

Accounts payable 32,000 84,000

Accrued liabilities 14,000 11,000

Deferred taxes (noncurrent) 15,000 9,000

7% long-term bonds payable 95,000 77,000

Grimaldi’s net income for the year was $96,000.

Question: 4 Grimaldi’s acid-test ratio or quick ratio at the end of the year is

A. 1.52

B. 1.15

C. 1.02

D. 0.83

Fact Pattern: Excerpts from the statement of financial position for Landau Corporation as of
September 30 of the current year are presented as follows.
Cash $ 950,000

Accounts receivable (net) 1,675,000

Inventories 2,806,000

Total current assets $5,431,000

Accounts payable $1,004,000

Accrued liabilities 785,000

Total current liabilities $1,789,000

The board of directors of Landau Corporation met on October 4 of the current year and declared the
regular quarterly cash dividend amounting to $750,000 ($.60 per share). The dividend is payable on
October 25 of the current year to all shareholders of record as of October 12 of the current year. Assume
that the only transactions to affect Landau Corporation during October of the current year are the
dividend transactions and that the closing entries have been made.
Question: 5 Landau Corporation’s working capital was

A. Unchanged by the dividend declaration and decreased by the dividend payment.

B. Decreased by the dividend declaration and unchanged by the dividend payment.

C. Unchanged by either the dividend declaration or the dividend payment.

D. Decreased by the dividend declaration and increased by the dividend payment.

Question: 6 A company has current liabilities of $2,000,000 and net working capital of $300,000. If
the company has a quick ratio of 0.8, the company has inventory of

A. $1,360,000

B. $240,000

C. $1,600,000

D. $700,000

Question: 7 North Bank is analyzing Belle Corp.’s financial statements for a possible extension of
credit. Belle’s quick ratio is significantly better than the industry average. Which of the
following factors should North consider as a possible limitation of using this ratio when
evaluating Belle’s creditworthiness?

A. Belle may need to sell its available-for-sale investments to meet its current
obligations.

B. Fluctuating market prices of short-term investments may adversely affect the ratio.

C. Belle may need to liquidate its inventory to meet its long-term obligations.

D. Increasing market prices for Belle’s inventory may adversely affect the ratio.

Question: 8 A firm has the following current assets.

Cash € 250,000

Marketable securities 100,000

 Accounts receivable 800,000

Inventories 1,450,000

Total current assets € 2,600,000

If current liabilities are €1,300,000, the firm’s

A. Current ratio will decrease if a payment of €100,000 cash is used to pay €100,000 of
accounts payable.

B. Acid-test (quick) ratio will not change if a payment of €100,000 cash is used to
purchase inventory.

C. Acid-test (quick) ratio will decrease if a payment of €100,000 cash is used to

purchase inventory.

D. Current ratio will not change if a payment of €100,000 is used to pay €100,000 of
accounts payable.

Question: 9All of the following are affected when merchandise is purchased on credit except

A. Current ratio.

B. Total current assets.

C. Net working capital.

D. Total current liabilities.

Question: 10 The following transactions occurred during a company’s first year of operations:

I. Purchased a delivery van for cash

II. Borrowed money by issuance of short-term debt
III. Purchased treasury stock

Which of the items above caused a change in the amount of working capital?

A. I and II only.

B. I and III only.

 C. I only.

D. II and III only.

Fact Pattern: Excerpts from the statement of financial position for Markham Corporation as of April 30 of
the current year are presented as follows:
Cash $ 725,000

Accounts receivable (net) 1,640,000

Inventories 2,945,000

Total current assets $5,310,000

Accounts payable $1,236,000

Accrued liabilities 831,000

Total current liabilities $2,067,000

The board of directors of Markham met on May 5 of the current year and declared a quarterly cash
dividend in the amount of $800,000 ($.50 per share). The dividend was paid on May 28 of the current
year to shareholders of record as of May 15 of the current year. Assume that the only transactions that
affected Markham during May of the current year were the dividend transactions and that the closing
entries have been made.

Question: 11 Markham’s working capital would be

A. Increased by the dividend declaration and unchanged by the dividend payment.

B. Unchanged by either the dividend declaration or the dividend payment.

C. Decreased by the dividend declaration and increased by the dividend payment.

D. Decreased by the dividend declaration and unchanged by the dividend payment.

Question: 12 All else being equal, a company with a higher dividend-payout ratio will have a <List A>
debt-to-assets ratio and a <List B> current ratio.
List A List B

A. Lower Lower

B. Lower Higher

C. Higher Higher

D. Higher Lower

Question: 13 If a company has a current ratio of 2.1 and pays off a portion of its accounts payable
with cash, the current ratio will

A. Move closer to the quick ratio.

B. Decrease.

C. Increase.

D. Remain unchanged.

Question: 14 At the beginning of the year, Company C had the following items on its balance sheet:

Cash $100,000

Marketable securities 70,000

Inventory 25,000

Prepaid assets 50,000

Net accounts receivable 30,000

Current liabilities 125,000

During the course of the year, C declared and paid dividends of $1 per share on its
40,000 shares of common stock. Assuming that the dividend payment is the only
transaction in the year, what is the percentage change in the quick ratio as a result of
the dividends?

A. 15% decrease.

B. 18% increase.
 C. 26% increase.

D. 20% decrease.

Fact Pattern: Depoole Company is a manufacturer of industrial products that uses a calendar year for
financial reporting purposes. Assume that total quick assets exceeded total current liabilities both before
and after the transaction described. Further assume that Depoole has positive profits during the year and
a credit balance throughout the year in its retained earnings account.

Question: 15 Depoole’s purchase of raw materials for $85,000 on open account will

A. Increase net working capital.

B. Decrease the current ratio.

C. Decrease net working capital.

D. Increase the current ratio.

Question: 16 A condensed comparative balance sheet for a company appears below:

12/31/Year 1 12/31/Year 2

Cash $ 40,000 $ 30,000

Accounts receivable 120,000 100,000

Inventory 200,000 300,000

Property, plant, & equipment 500,000 550,000

Accumulated depreciation (280,000) (340,000)

Total assets $ 580,000 $ 640,000

Current liabilities $ 60,000 $ 100,000

Long-term liabilities 390,000 420,000

Stockholders’ equity 130,000 120,000

Total liabilities and equity $ 580,000 $ 640,000

 In looking at liquidity ratios at both balance sheet dates, what happened to the (1)
current ratio and (2) acid test (quick) ratio?
(1) (2)
Current Ratio Acid Test Ratio

A. Decreased Decreased

B. Decreased Increased

C. Increased Decreased

D. Increased Increased

Question: 17A corporation has $90 million in current assets. If the corporation has a current ratio of 1.2 and a
quick ratio of 0.9, what is net working capital?

A. $108 million.

B. $15 million.

C. $10 million.

D. $81 million.

Question: 18 In comparing the current ratios of two companies, why is it invalid to assume that the
company with the higher current ratio is the better company?

A. A high current ratio may indicate inadequate inventory on hand.

B. The two companies may define working capital in different terms.

C. The current ratio includes assets other than cash.

D. A high current ratio may indicate inefficient use of various assets and liabilities.

Fact Pattern: Tosh Enterprises reported the following account information:

Accounts receivable $400,000
Accounts payable 260,000
Bonds payable, due in 10 years 600,000
Cash 200,000
Interest payable, due in 3 months 20,000

Question: 19 What is Tosh Enterprises’ quick (acid-test) ratio?

 A. 2.31

B. 2.14

C. 0.68

D. 1.68

Question: 20 All of the following are included when calculating the acid-test ratio except

A. Prepaid insurance.

B. Six-month treasury bills.

C. Accounts receivable.

D. 60-day certificates of deposit.

Question: 21 A company’s cash ratio will decrease if the company

A. Receives cash by issuing a short-term note payable.

B. Purchases commercial paper.

C. Sells goods for cash at a selling price lower than cost.

D. Purchases materials on account.

Fact Pattern: Depoole Company is a manufacturer of industrial products that uses a calendar year for
financial reporting purposes. Assume that total quick assets exceeded total current liabilities both before
and after the transaction described. Further assume that Depoole has positive profits during the year and
a credit balance throughout the year in its retained earnings account.

Question: 22 Depoole’s early liquidation of a long-term note with cash affects the

A. Current and quick ratio to the same degree.

B. Quick ratio to a greater degree than the current ratio.

C. Current ratio but not the quick ratio.

D. Current ratio to a greater degree than the quick ratio.

Fact Pattern: The selected data pertain to Tilghman Company at December 31:
Quick assets $208,000

Acid test ratio 2.6 to 1

Current ratio 3.5 to 1

Net sales for the year $1,800,000

Cost of sales for the year $990,000

Average total assets for the year $1,200,000

Question: 23 Tilghman Company’s inventory balance at December 31 is

A. $282,857

B. $72,000

C. $231,111

D. $187,200

Fact Pattern: CPZ Enterprises had the following account information.

Accounts receivable $200,000

Accounts payable 80,000

Bonds payable, due in 10 years 300,000

Cash 100,000

Interest payable, due in 3 months 10,000

Inventory 400,000

Land 250,000

Notes payable, due in 6 months 50,000

Prepaid expenses 40,000

The company has an operating cycle of 5 months.

Question: 24 What is CPZ’s acid-test (quick) ratio?

 A. 0.68

B. 2.14

C. 2.31

D. 1.68

Fact Pattern: Jensen Corporation’s board of directors met on June 3 and declared a regular quarterly
cash dividend of $.40 per share for a total value of $200,000. The dividend is payable on June 24 to all
stockholders of record as of June 17. Excerpts from the statement of financial position for Jensen
Corporation as of May 31 are presented as follows.
Cash $ 400,000

Accounts receivable (net) 800,000

Inventories 1,200,000

Total current assets $2,400,000

Total current liabilities $1,000,000

Assume that the only transactions to affect Jensen Corporation during June are the dividend transactions.

Question: 25Jensen’s current ratio would be

A. Unchanged by either the dividend declaration or the dividend payment.

B. Decreased by the dividend declaration and increased by the dividend payment.

C. Unchanged by the dividend declaration and decreased by the dividend payment.

D. Decreased by the dividend declaration and unchanged by the dividend payment.

Fact Pattern: A company has a current ratio of 1.4, a quick, or acid-test, ratio of 1.2, and the following
partial summary balance sheet:
Cash $ 10
Accounts receivable ___
Inventory ___
Fixed assets ___
Total assets $100
Current liabilities $___
Long-term liabilities 40
Stockholders’ equity 30
Total liabilities and equity $___

Question: 26 The company has an accounts receivable balance of

A. $100

B. $26

C. $66

D. $36

Question: 27 A company has current assets of $400,000 and current liabilities of $500,000. The
company’s current ratio will be increased by

A. The purchase of $100,000 of inventory on account.

B. The payment of $100,000 of accounts payable.

C. The collection of $100,000 of accounts receivable.

D. Refinancing a $100,000 long-term loan with short-term debt.

Fact Pattern: Broomall Corporation has decided to include certain financial ratios in its year-end annual
report to shareholders. Selected information relating to its most recent fiscal year is provided below.
Cash $ 10,000

Accounts receivable:

– Beginning of year 24,000

– End of year 20,000

Prepaid expenses 8,000

Inventory:

– Beginning of year 26,000

– End of year 30,000

Available-for-sale securities:

– Historical cost 9,000

– Fair value at year end 12,000

Accounts payable 15,000

Notes payable (due in 90 days) 25,000

Bonds payable (due in 10 years) 35,000

Net credit sales for year 220,000

Cost of goods sold 140,000

Question: 28 Broomall’s quick (acid-test) ratio at year end is

A. 1.05 to 1.

B. 1.925 to 1.

C. 1.80 to 1.

D. 2.00 to 1.

Fact Pattern: A company has a current ratio of 1.4, a quick, or acid-test, ratio of 1.2, and the following
partial summary balance sheet:
Cash $ 10
Accounts receivable ___
Inventory ___
Fixed assets ___
Total assets $100
Current liabilities $___
Long-term liabilities 40
Stockholders’ equity 30
Total liabilities and equity $___

Question: 29 The company has a fixed assets balance of

A. $58
 B. $64

C. $84

D. $16

Question: 30 In analyzing the short-term liquidity of a firm, many analysts prefer to use the quick (or
acid-test) ratio rather than the current ratio. The primary reason for this preference is
that the

A. Quick ratio excludes account receivables.

B. Conversion of inventory into cash is less reliable.

C. Current ratio includes marketable securities that may be mispriced.

D. Pro-forma cash flow statements focus on cash only.

Fact Pattern: Tosh Enterprises reported the following account information:

Accounts receivable $400,000
Accounts payable 260,000
Bonds payable, due in 10 years 600,000
Cash 200,000
Interest payable, due in 3 months 20,000

Question: 31 The current ratio for Tosh Enterprises is

A. 5.00

B. 5.29

C. 1.68

D. 2.14

Question: 32 A corporation has decided to include certain financial ratios in its year-end annual
report to shareholders. Selected information relating to its most recent fiscal year is
provided below.

Cash $10,000
 Accounts receivable 20,000

Prepaid expenses 8,000

Inventory 30,000

Available-for-sale securities

At cost 9,000

Fair value at year end 12,000

Accounts payable 15,000

Notes payable (due in 90 days) 25,000

Bonds payable (due in 10 years) 35,000

The quick (acid-test) ratio at year end is

A. 2.00 to 1.

B. 1.05 to 1.

C. 1.925 to 1.

D. 1.80 to 1.

Question: 33What is the acid-test (or quick) ratio?

Cash $ 10,000

Marketable securities 18,000

Accounts receivable 120,000

Inventories 375,000

Prepaid expenses 12,000

Accounts payable 75,000

Long-term debt -- current portion 20,000

Long-term debt 400,000

Sales 1,650,000

A. 1.97

B. 2.13
 C. 1.56

D. 5.63

Fact Pattern: Tosh Enterprises reported the following account information:

Accounts receivable $400,000
Accounts payable 260,000
Bonds payable, due in 10 years 600,000
Cash 200,000
Interest payable, due in 3 months 20,000

Question: 34 Tosh Enterprises’ amount of working capital is

A. $1,120,000

B. $1,200,000

C. $600,000

D. $1,220,000

Fact Pattern: The information below pertains to Devlin Company.

Statement of Financial Position as of May 31 Income Statement for the year ended May 31
(in thousands) (in thousands)

Year 2 Year 1 Year 2 Year 1

Assets Net sales $480 $460

Current assets Costs and expenses
Cash $ 45 $ 38 Costs of goods sold 330 315
Trading securities 30 20 Selling, general, and administrative 52 51
Interest expense 8 9
Accounts receivable (net) 68 48
Income before taxes $ 90 $ 85
Inventory 90 80 Income taxes 36 34
Prepaid expenses 22 30 Net income $ 54 $ 51

Total current assets $255 $216

Investments, at equity 38 30
Property, plant, and equipment (net) 375 400
Intangible assets (net) 80 45

Total assets $748 $691

Liabilities
Current liabilities
Accounts payable $ 70 $ 42
Accrued expenses 5 4
Notes payable 35 18
Income taxes payable 15 16
Total current liabilities $125 $ 80
Long-term debt 35 35
Deferred taxes 3 2
Total liabilities $163 $117
Equity
Preferred stock, 6%, $100 par
value, cumulative $150 $150
Common stock, $10 par value 225 195
Additional paid-in capital --
common stock 114 100
Retained earnings 96 129
Total equity $585 $574
Total liabilities and equity $748 $691

Question: 35 Devlin Company’s acid-test ratio at May 31, Year 2, was

A. 0.60 to 1.

B. 0.90 to 1.

C. 1.86 to 1.

D. 1.14 to 1.

Question: 36 Given an acid-test ratio of 2.0, current assets of $5,000, and inventory of $2,000, the
value of current liabilities is

A. $3,500

B. $6,000
 C. $1,500

D. $2,500

Question: 37 Selected financial data for a corporation are shown below.

January 1 December 31

Cash $ 48,000 $ 62,000

Accounts receivable (net) 68,000 47,000

Trading securities 42,000 35,000

Inventory 125,000 138,000

Plant and equipment (net) 325,000 424,000

Accounts payable 32,000 84,000

Accrued liabilities 14,000 11,000

Deferred taxes 15,000 9,000

Long-term bonds payable 95,000 77,000

Net income for the year was $96,000. The current ratio at the end of the year is

A. 1.71

B. 2.71

C. 1.55

D. 2.97

Fact Pattern: The selected data pertain to Tilghman Company at December 31:
Quick assets $208,000

Acid test ratio 2.6 to 1

Current ratio 3.5 to 1

Net sales for the year $1,800,000

Cost of sales for the year $990,000

Average total assets for the year $1,200,000

Question: 38 Tilghman Company’s current liabilities at December 31 equal

A. $59,429

B. $134,857

C. $187,200

D. $80,000

Question: 39 A financial analyst has gathered the following select financial data on three companies.

Company A Company B Company C

Total current assets €500,000 €1,250,000 €870,000

Total current liabilities €445,000 €970,000 €620,000

On the basis of the information provided above, the financial analyst is able to
conclude that

A. Company B and Company C both have a higher liquidity than Company A.

B. Company A and Company B both have a higher liquidity than Company C.

C. Company B has the highest liquidity.

D. Company A has the highest liquidity.

Question: 40 A corporation has a current ratio of 2 to 1 and a quick ratio (acid test) of 1 to 1. A
transaction that would change the quick ratio but not the current ratio is the

A. Collection of accounts receivable.

B. Purchase of a patent for cash.

C. Sale of inventory on account at cost.

 D. Payment of accounts payable.

Question: 41 Both the current ratio and the quick ratio for Spartan Corporation have been slowly
decreasing. For the past two years, the current ratio has been 2.3-to-1 and 2.0-to-1.
During the same time period, the quick ratio has decreased from 1.2-to-1 to 1.0-to-1.
The disparity between the current and quick ratios can be explained by which one of
the following?

A. The accounts receivable balance has decreased.

B. The current portion of long-term debt has been steadily increasing.

C. The inventory balance is unusually high.

D. The cash balance is unusually low.

Question: 42 A firm has gathered financial statement data from three companies applying for credit
as new customers. The company extends credit to customers on the credit terms 2/10,
net 30. Prior to accepting the customers, a financial analyst with the firm performs a
liquidity analysis. Summary data is shown below:

Company F Company G Company H

Cash $ 20,000 $ 12,850 $ 130,000

Accounts receivable 40,000 74,500 100,000

Inventory 170,000 42,240 354,300

Current assets 230,000 129,590 584,300

Total assets 567,888 260,400 780,560

Current liabilities 175,000 63,800 142,100

Total liabilities 487,120 97,680 364,760

Total shareholders’ equity 80,768 162,720 415,800

When evaluating the liquidity of the three potential customers, which one of the
following conclusions is correct?

A. Company F has a low current ratio, so the firm should not accept Company F as a
new customer.
 B. Company F has a high long-term debt to equity ratio, so the firm should accept
Company F as a new customer.

C. Company G has a low debt to total assets ratio, so the firm should accept Company G
as a new customer.

D. Company H has the highest current ratio but the lowest acid-test ratio, so the firm
should not accept Company H as a new customer.

Question: 43 A credit manager considering whether to grant trade credit to a new customer
is most likely to place primary emphasis on

A. Growth ratios.

B. Liquidity ratios.

C. Profitability ratios.

D. Valuation ratios.

Question: 44A company located in China has reported on its first quarter balance sheet CNY 100,000 in cash,
CNY 200,000 in accounts receivables, and CNY 90,000 in current liabilities. The controller has forecasted that
during the second quarter, there will be no change in the accounts receivables, but the cash balance will increase by
5% and the current liabilities will decrease by 10%. Based on the controller’s forecast, what is the forecasted quick
ratio for the second quarter?

A. 1.30

B. 3.39

C. 3.70

D. 3.77

Fact Pattern: Depoole Company is a manufacturer of industrial products that uses a calendar year for
financial reporting purposes. Assume that total quick assets exceeded total current liabilities both before
and after the transaction described. Further assume that Depoole has positive profits during the year and
a credit balance throughout the year in its retained earnings account.

Question: 45 Depoole’s payment of a trade account payable of $64,500 will

A. Decrease both the current and quick ratios.

 B. Increase the quick ratio, but the current ratio would not be affected.

C. Increase both the current and quick ratios.

D. Increase the current ratio, but the quick ratio would not be affected.

Question: 46 The owner of a chain of grocery stores has bought a large supply of mangoes and paid
for the fruit with cash. This purchase will adversely impact which one of the following?

A. Working capital.

B. Quick or acid test ratio.

C. Current ratio.

D. Price earnings ratio.

Fact Pattern: Depoole Company is a manufacturer of industrial products that uses a calendar year for
financial reporting purposes. Assume that total quick assets exceeded total current liabilities both before
and after the transaction described. Further assume that Depoole has positive profits during the year and
a credit balance throughout the year in its retained earnings account.

Question: 47 Obsolete inventory of $125,000 was written off by Depoole during the year. This
transaction

A. Decreased the current ratio.

B. Increased net working capital.

C. Decreased the quick ratio.

D. Increased the quick ratio.

Fact Pattern: Tosh Enterprises reported the following account information:

Accounts receivable $400,000 Inventory $800,000
Accounts payable 260,000 Land 500,000
Bonds payable, due in 10 years 600,000 Short-term prepaid expense 80,000
Cash 200,000
Interest payable, due in 3 months 20,000

Question: 48 What will happen to the ratios below if Tosh Enterprises uses cash to pay 25% of the
accounts payable?
 Current Ratio Quick Ratio

A. Decrease Decrease

B. Decrease Increase

C. Increase Decrease

D. Increase Increase

Question: 49 A mobile home manufacturer has a quick ratio of 2.0. Assuming nothing else changes,
which of the following actions would decrease the firm’s quick ratio?

A. Buying inventory on credit with 30-day terms.

B. Converting short-term debt into long-term debt.

C. Collecting cash from issuing stock.

D. Writing off obsolete inventory.

Question: 50A company has $80 million in current assets, comprised of $30 million in inventory and $50 million
in cash and marketable securities. The company’s current liabilities total $50 million. If the company purchases an
additional $10 million in inventory with $10 million in cash, the effect of this transaction on the company would be
to

A. Decrease the current ratio and increase the quick ratio.

B. Decrease the current ratio and decrease the quick ratio.

C. Decrease the quick ratio while the current ratio remains unchanged.

D. Leave both the current ratio and the quick ratio unchanged.
Question: 51 An entity has total assets of $7,500,000 and a current ratio of 2.3 times before
purchasing $750,000 of merchandise on credit for resale. After this purchase, the
current ratio will

A. Be higher than 2.3 times.

B. Be lower than 2.3 times.

C. Be exactly 2.53 times.

D. Remain at 2.3 times.

Question: 52 The balance sheet of Company XYZ as of 12/31/20X3 is shown below.

Assets Liabilities and Shareholders’ Equity

Cash $ 110 Accounts payable $ 208

Accounts receivables 280 Notes payable 150

Inventories 175 Accrued expenses 50

Prepaid expenses 20 Deferred taxes 112

Property, plant, and equipment 700 Long-term debt 485

Intangible assets 100 Stockholders’ equity 380

Total assets $1,385 Total liabilities and shareholders’ equity $1,385

What was Company XYZ’s net working capital as of 12/31/20X3?

A. $157

B. $177

C. $227

D. $65
Fact Pattern: The Statement of Financial Position for King Products Corporation for the fiscal
years ended June 30, Year 2, and June 30, Year 1, is presented below. Net sales and cost of
goods sold for the year ended June 30, Year 2, were $600,000 and $440,000, respectively.
King Products Corporation
Statement of Financial Position
(in thousands)
June 30
Year 2 Year 1
Cash $ 60 $ 50
Marketable securities (at market) 40 30
Accounts receivable (net) 90 60
Inventories (at lower of cost or market) 120 100
Prepaid items 30 40
Total current assets $ 340 $280
Land (at cost) $ 200 $190
Building (net) 160 180
Equipment (net) 190 200
Patents (net) 70 34
Goodwill (net) 40 26
Total long-term assets $ 660 $630
Total assets $1,000 $910
Notes payable $ 46 $ 24
Accounts payable 94 56
Accrued interest 30 30
Total current liabilities $ 170 $110
Notes payable, 10% due 12/31/Year 7 $ 20 $ 20
Bonds payable, 12% due 6/30/Year 10 30 30
Total long-term debt $ 50 $ 50
Total liabilities $ 220 $160
Preferred stock -- 5% cumulative, $100 par, nonparticipating,
authorized, issued and outstanding, 2,000 shares $ 200 $200
Common stock -- $10 par, 40,000 shares authorized,
30,000 shares issued and outstanding 300 300
Additional paid-in capital -- common 150 150
Retained earnings 130 100
Total equity $ 780 $750
Total liabilities & equity $1,000 $910

Question: 53 King Products Corporation’s quick (acid-test) ratio at June 30, Year 2, was

A. 1.1

B. 2.0

C. 0.6
 D. 1.8

Question: 54 A firm must increase its acid test ratio above the current 0.9 level in order to comply
with the terms of a loan agreement. Which one of the following actions is most likely to
produce the desired results?

A. Making a payment to trade accounts payable.

B. Selling auto parts on account.

C. Expediting collection of accounts receivable.

D. Purchasing marketable securities for cash.

Fact Pattern: Depoole Company is a manufacturer of industrial products that uses a calendar year for
financial reporting purposes. Assume that total quick assets exceeded total current liabilities both before
and after the transaction described. Further assume that Depoole has positive profits during the year and
a credit balance throughout the year in its retained earnings account.

Question: 55 Depoole’s issuance of serial bonds in exchange for an office building, with the first
installment of the bonds due late this year,

A. Decreases net working capital.

B. Affects all of the answers as indicated.

C. Decreases the quick ratio.

D. Decreases the current ratio.

Fact Pattern: Jensen Corporation’s board of directors met on June 3 and declared a regular quarterly
cash dividend of $.40 per share for a total value of $200,000. The dividend is payable on June 24 to all
stockholders of record as of June 17. Excerpts from the statement of financial position for Jensen
Corporation as of May 31 are presented as follows.
Cash $ 400,000
 Accounts receivable (net) 800,000

Inventories 1,200,000

Total current assets $2,400,000

Total current liabilities $1,000,000

Assume that the only transactions to affect Jensen Corporation during June are the dividend transactions.

Question: 56 Jensen’s working capital would be

A. Decreased by the dividend declaration and unchanged by the dividend payment.

B. Decreased by the dividend declaration and increased by the dividend payment.

C. Unchanged by the dividend declaration and decreased by the dividend payment.

D. Unchanged by either the dividend declaration or the dividend payment.

Question: 57 During the current year, Corporation A had 100,000 shares of common stock
outstanding. On July 1, Corporation A issued a 4-for-1 stock split. Additionally, on
September 2, A declared a dividend of $0.75 per common share, and the payment is
expected to be made in January of the following year. If A had current assets of
$2,000,000 and current liabilities of $1,200,000 before the declaration of the stock
dividend, what is the percentage change in the current ratio as a result of the dividend
declaration?

A. 20% decrease.

B. 6% decrease.

C. 2% decrease.

D. 15% decrease.

Fact Pattern: Excerpts from the statement of financial position for Landau Corporation as of
September 30 of the current year are presented as follows.
Cash $ 950,000

Accounts receivable (net) 1,675,000

Inventories 2,806,000

Total current assets $5,431,000

Accounts payable $1,004,000

Accrued liabilities 785,000

Total current liabilities $1,789,000

The board of directors of Landau Corporation met on October 4 of the current year and declared the
regular quarterly cash dividend amounting to $750,000 ($.60 per share). The dividend is payable on
October 25 of the current year to all shareholders of record as of October 12 of the current year. Assume
that the only transactions to affect Landau Corporation during October of the current year are the dividend
transactions and that the closing entries have been made.

Question: 58 Landau Corporation’s current ratio was

A. Unchanged by either the dividend declaration or the dividend payment.

B. Decreased by the dividend declaration and unchanged by the dividend payment.

C. Increased by the dividend declaration and unchanged by the dividend payment.

D. Decreased by the dividend declaration and increased by the dividend payment.

Question: 59The balance sheet of a luggage manufacturer reports the following:

Cash $531,000

Accounts receivable 439,000

Inventory 300,000

Marketable securities 200,000

Current liabilities 500,000

Long-term liabilities 676,000

Based on the information provided, the luggage manufacturer’s quick ratio is

A. 2.94

B. 1.25

C. 1.94

D. 2.34
Fact Pattern: Broomall Corporation has decided to include certain financial ratios in its year-end annual
report to shareholders. Selected information relating to its most recent fiscal year is provided below.
Cash $ 10,000

Accounts receivable:

– Beginning of year 24,000

– End of year 20,000

Prepaid expenses 8,000

Inventory:

– Beginning of year 26,000

– End of year 30,000

Available-for-sale securities:

– Historical cost 9,000

– Fair value at year end 12,000

Accounts payable 15,000

Notes payable (due in 90 days) 25,000

Bonds payable (due in 10 years) 35,000

Net credit sales for year 220,000

Cost of goods sold 140,000

Question: 60 Broomall’s working capital at year end is

A. $10,000

B. $40,000

C. $37,000

D. $28,000
Question: 61 A company has the following account balances.

Cash $160,000

Equipment 50,000

Inventory 35,000

Accounts receivable 25,000

Accrued wages 10,000

Long-term debt 30,000

Accounts payable 5,000

What is the company’s net working capital?

A. $205,000

B. $220,000

C. $180,000

D. $225,000

Question: 62 The following information pertains to Ali Corp. as of and for the year ended December
31:

Liabilities $ 60,000

Equity $500,000

Shares of common stock issued and outstanding 10,000

Net income $ 30,000

During the year, Ali’s officers exercised share options for 1,000 shares of stock at an
option price of $8 per share. What was the effect of exercising the share options?

A. Earnings per share increased by $0.33.

B. Asset turnover increased to 5.4%.

C. Debt-to-equity ratio decreased to 12%.

D. No ratios were affected.

Fact Pattern: The data presented below show actual figures for selected accounts of McKeon Company
for the fiscal year ended May 31, Year 1, and selected budget figures for the Year 2 fiscal year.
McKeon’s controller is in the process of reviewing the Year 2 budget and calculating some key ratios
based on the budget. McKeon Company monitors yield or return ratios using the average financial
position of the company. (Round all calculations to three decimal places if necessary.)
5/31/Year 2 5/31/Year 1

Current assets $210,000 $180,000

Noncurrent assets 275,000 255,000

Current liabilities 78,000 85,000

Long-term debt 75,000 30,000

Common stock ($30 par value) 300,000 300,000

Retained earnings 32,000 20,000

Year 2
Operations

Sales* $350,000
Cost of goods sold 160,000
Interest expense 3,000
Income taxes (40% rate) 48,000
Dividends declared and paid in Year 2 60,000
Administrative expense 67,000

*All sales are credit sales.

Current Assets

5/31/Year 2 5/31/Year 1

Cash $ 20,000 $10,000

Accounts receivable 100,000 70,000

Inventory 70,000 80,000

Prepaid expenses 20,000 20,000

Question: 63 McKeon Company’s current ratio for Year 2 is

A. 2.118

B. 1.176
 C. 1.373

D. 2.692

Fact Pattern: CPZ Enterprises had the following account information.

Accounts receivable $200,000

Accounts payable 80,000

Bonds payable, due in 10 years 300,000

Cash 100,000

Interest payable, due in 3 months 10,000

Inventory 400,000

Land 250,000

Notes payable, due in 6 months 50,000

Prepaid expenses 40,000

The company has an operating cycle of 5 months.

Question: 64 The current ratio for CPZ Enterprises is

A. 1.68

B. 5.29

C. 5.00

D. 2.14

Fact Pattern: Shown below are beginning and ending balances for certain of Grimaldi, Inc.’s accounts.
January 1 December 31

Cash $ 48,000 $ 62,000

Marketable securities 42,000 35,000

Accounts receivable (net) 68,000 47,000

Inventory 125,000 138,000

Property, plant, and equipment (net) 325,000 424,000

Accounts payable 32,000 84,000

Accrued liabilities 14,000 11,000

Deferred taxes (noncurrent) 15,000 9,000

7% long-term bonds payable 95,000 77,000

Grimaldi’s net income for the year was $96,000.

Question: 65 Grimaldi’s current ratio at the end of the year is

A. 1.71

B. 1.55

C. 2.71

D. 2.97

Fact Pattern: Jensen Corporation’s board of directors met on June 3 and declared a regular quarterly
cash dividend of $.40 per share for a total value of $200,000. The dividend is payable on June 24 to all
stockholders of record as of June 17. Excerpts from the statement of financial position for Jensen
Corporation as of May 31 are presented as follows.
Cash $ 400,000

Accounts receivable (net) 800,000

Inventories 1,200,000

Total current assets $2,400,000

Total current liabilities $1,000,000

Assume that the only transactions to affect Jensen Corporation during June are the dividend transactions.

Question: 66 Jensen’s quick (acid test) ratio would be

A. Decreased by the dividend declaration and increased by the dividend payment.

B. Decreased by the dividend declaration and unchanged by the dividend payment.

C. Unchanged by either the dividend declaration or the dividend payment.

 D. Unchanged by the dividend declaration and decreased by the dividend payment.

Fact Pattern:
Lisa, Inc.

Statement of Financial Position

December 31, Year 2

(000s)

Assets Year 2 Year 1

Current assets:
Cash $ 30 $ 25
Trading securities 20 15
Accounts receivable (net) 45 30
Inventories (at lower of cost or market) 60 50
Prepaid items 15 20

Total current assets 170 140

Long-term investments:
Securities (at cost) 25 20
Property, plant, & equipment:
Land (at cost) 75 75
Building (net) 80 90
Equipment (net) 95 100
Intangible assets
Patents (net) 35 17
Goodwill (net) 20 13

Total long-term assets 330 315

Total assets $500 $455

Liabilities & Shareholders’ Equity
Current liabilities:
Notes payable $ 23 $ 12
Accounts payable 47 28
Accrued interest 15 15
Total current liabilities 85 55
Long-term debt:
Notes payable 10% due 12/31/Year 9 10 10
Bonds payable 12% due 12/31/Year 8 15 15
 Total long-term debt 25 25
Total liabilities $110 $ 80
Shareholders’ equity:
Preferred -- 5% cumulative, $100 par,
non-participating, 1,000 shares authorized,
issued and outstanding $100 $100
Common -- $10 par 20,000 shares authorized,
15,000 issued and outstanding shares 150 150
Additional paid-in capital -- common 75 75
Retained earnings 65 50
Total shareholders’ equity $390 $375
Total liabilities & equity $500 $455

Question: 67 Lisa, Inc.’s acid-test (quick) ratio at December 31, Year 2, was

A. 1.1:1.0

B. 2.5:1.0

C. 1.8:1.0

D. 2.0:1.0

Question: 68 A company has a 2-to-1 current ratio. This ratio would increase to more than 2 to 1 if

A. The company sold merchandise on open account that earned a normal gross margin.

B. A previously declared stock dividend were distributed.

C. The company purchased inventory on open account.

D. The company wrote off an uncollectible receivable.

Question: 69 A company has a current ratio of 2.0. Cash is 20%, accounts receivable is 40%, and
inventory is 40% of total current assets. What is the acid-test ratio for the company?

A. 1.2

B. 0.8

C. 2.0

D. 1.6
Fact Pattern: CPZ Enterprises had the following account information.
Accounts receivable $200,000

Accounts payable 80,000

Bonds payable, due in 10 years 300,000

Cash 100,000

Interest payable, due in 3 months 10,000

Inventory 400,000

Land 250,000

Notes payable, due in 6 months 50,000

Prepaid expenses 40,000

The company has an operating cycle of 5 months.

Question: 70 What will happen to the ratios below if CPZ Enterprises uses cash to pay 50% of the
accounts payable?
Current Ratio Quick Ratio

A. Decrease Decrease

B. Increase Increase

C. Decrease Increase

D. Increase Decrease

Question: 71 A company uses the allowance method to account for credit losses. An account
receivable that was previously determined uncollectible and written off was collected
during May. The effect of the collection on the company’s current ratio and total
working capital is
Current Ratio Working Capital

A. None None

B. Decrease Decrease

C. Increase Increase

D. None Increase
Fact Pattern: Excerpts from the statement of financial position for Markham Corporation as of April 30
of the current year are presented as follows:
Cash $ 725,000

Accounts receivable (net) 1,640,000

Inventories 2,945,000

Total current assets $5,310,000

Accounts payable $1,236,000

Accrued liabilities 831,000

Total current liabilities $2,067,000

The board of directors of Markham met on May 5 of the current year and declared a quarterly cash
dividend in the amount of $800,000 ($.50 per share). The dividend was paid on May 28 of the current
year to shareholders of record as of May 15 of the current year. Assume that the only transactions that
affected Markham during May of the current year were the dividend transactions and that the closing
entries have been made.

Question: 72 Markham’s current ratio would be

A. Unchanged by either the dividend declaration or the dividend payment.

B. Unchanged by the dividend declaration and decreased by the dividend payment.

C. Increased by the dividend declaration and unchanged by the dividend payment.

D. Decreased by the dividend declaration and increased by the dividend payment.

Question: 73 If allowance for credit losses is increased, this adjustment will

A. Increase working capital.

B. Reduce debt-to-asset ratio.

C. Reduce the current ratio.

D. Increase the acid test ratio.

Fact Pattern: Depoole Company is a manufacturer of industrial products that uses a calendar year for
financial reporting purposes. Assume that total quick assets exceeded total current liabilities both before
and after the transaction described. Further assume that Depoole has positive profits during the year and
a credit balance throughout the year in its retained earnings account.

Question: 74Depoole’s collection of a current accounts receivable of $29,000 will

A. Not affect the current or quick ratios.

B. Decrease the current ratio and the quick ratio.

C. Increase the quick ratio.

D. Increase the current ratio.

3: (25) Solvency

Question: 1 Which one of the following factors would likely cause a firm to increase its use of debt
financing as measured by the debt to total capital ratio?

A. An increase in the price-earnings ratio.

B. An increase in the corporate income tax rate.

C. An increase in the degree of operating leverage.

D. Increased economic uncertainty.

Fact Pattern: Assume the following information pertains to Ramer Company, Matson
Company, and for their common industry for a recent year.
Industry
Ramer Matson Average

Current ratio 3.50 2.80 3.00

Accounts receivable turnover 5.00 8.10 6.00

Inventory turnover 6.20 8.00 6.10

Times interest earned 9.00 12.30 10.40

Debt to equity ratio 0.70 0.40 0.55

Return on investment 0.15 0.12 0.15

Dividend payout ratio 0.80 0.60 0.55

Earnings per share $3.00 $2.00

Question: 2 The attitudes of both Ramer and Matson concerning risk are best explained by the

A. Debt to equity ratio and times interest earned.

B. Current ratio, accounts receivable turnover, and inventory turnover.

C. Current ratio and earnings per share.

D. Dividend payout ratio and earnings per share.

Question: 3 A company has earnings before interest and taxes of $100,000, income taxes of
$30,000, and interest expense of $10,000. The company’s interest coverage ratio is

A. 10

B. 7

C. 9

D. 6

Question: 4 The Liabilities and Shareholders’ Equity section of a Statement of Financial Position is
shown below.

January 1 December 31

Accounts payable $ 32,000 $ 84,000

Accrued liabilities 14,000 11,000

7% bonds payable 95,000 77,000

Common stock ($10 par value) 300,000 300,000

Reserve for bond retirement 12,000 28,000

Retained earnings 155,000 206,000

Total liabilities and shareholders’ equity $608,000 $706,000

The debt/equity ratio is

A. 32.2%.

B. 25.6%.

C. 25.1%.

D. 33.9%.
Question: 5 Which of the outcomes represented in the following table would result from a
company’s retirement of debt with excess cash?
Following Period’s
Total Assets Times Interest
Turnover Ratio Earned Ratio

A. Increase Decrease

B. Increase Increase

C. Decrease Increase

D. Decrease Decrease

Question: 6 Which one of the following calculations does not employ statistical techniques such as
the normal distribution?

A. Cash flow at risk.

B. Value at risk.

C. Capital adequacy.

D. Earnings distribution.

Fact Pattern: The data presented below show actual figures for selected accounts of McKeon Company
for the fiscal year ended May 31, Year 1, and selected budget figures for the Year 2 fiscal year.
McKeon’s controller is in the process of reviewing the Year 2 budget and calculating some key ratios
based on the budget. McKeon Company monitors yield or return ratios using the average financial
position of the company. (Round all calculations to three decimal places if necessary.)
5/31/Year 2 5/31/Year 1

Current assets $210,000 $180,000

Noncurrent assets 275,000 255,000

Current liabilities 78,000 85,000

Long-term debt 75,000 30,000

Common stock ($30 par value) 300,000 300,000

Retained earnings 32,000 20,000

Year 2
Operations
Sales* $350,000
Cost of goods sold 160,000
Interest expense 3,000
Income taxes (40% rate) 48,000
Dividends declared and paid in Year 2 60,000
Administrative expense 67,000

*All sales are credit sales.

Current Assets

5/31/Year 2 5/31/Year 1

Cash $ 20,000 $10,000

Accounts receivable 100,000 70,000

Inventory 70,000 80,000

Prepaid expenses 20,000 20,000

Question: 7 McKeon Company’s times interest earned ratio in Year 2 is

A. 40

B. 41

C. 25

D. 24

Question: 8 A company issued long-term bonds and used the proceeds to repurchase 40% of the
outstanding shares of its stock. This financial transaction will likely cause the

A. Current ratio to decrease.

B. Total assets turnover ratio to increase.

C. Fixed charge coverage ratio to increase.

D. Times interest earned ratio to decrease.

 Question: 9 The relationship of the total debt to the total equity of a corporation is a measure of

A. Solvency.

B. Creditor risk.

C. Profitability.

D. Liquidity.

Question: 10 A debt to equity ratio is

A. Higher than or equal to the debt to assets ratio.

B. Not correlated with the debt to assets ratio.

C. Lower than or equal to the debt to assets ratio.

D. About the same as the debt to assets ratio.

Question: 11 If the ratio of total liabilities to equity increases, a ratio that must also increase is

A. Times interest earned.

B. The current ratio.

C. Total liabilities to total assets.

D. Return on equity.

Question: 12 A bondholder would be most concerned with which one the following ratios?

A. Times interest earned.

B. Inventory turnover.

C. Quick ratio.

D. Earnings per share.

Fact Pattern:
RST Corporation Comparative Income

Statements for the Years 5 and 6

Year 6 Year 5

Sales (all are credit) $285,000 $200,000

Cost of goods sold 150,000 120,000

Gross profit $135,000 $ 80,000

Selling and administrative expenses 65,000 36,000

Income before interest and income taxes $ 70,000 $ 44,000

Interest expense 3,000 3,000

Income before income taxes $ 67,000 $ 41,000

Income tax expense 27,000 16,000

Net income $ 40,000 $ 25,000

RST Corporation

Comparative Balance Sheets

End of Years 5 and 6

Assets Year 6 Year 5

Current assets:
Cash $ 5,000 $ 4,000
Short-term marketable investments 3,000 2,000
Accounts receivable (net) 16,000 14,000
Inventory 30,000 20,000

Total current assets $ 54,000 $ 40,000

Noncurrent assets:
Long-term investments 11,000 11,000
Property, plant, and equipment 80,000 70,000
Intangibles 3,000 4,000

Total assets $148,000 $125,000

Liabilities and Stockholders’ Equity

Current liabilities:

Accounts payable $ 11,000 $ 7,000

Accrued payables 1,000 1,000

Total current liabilities $ 12,000 $ 8,000

Long-term Liabilities:

0% Bonds payable, due in Year 12 30,000 30,000

Total liabilities $ 42,000 $ 38,000

Stockholders’ equity:

Common stock, 2,400 shares, $10 par $ 24,000 $ 24,000

Retained earnings 82,000 63,000

Total stockholders’ equity $106,000 $ 87,000

Total liabilities and stockholders’ equity $148,000 $125,000

The market value of RST’s common stock at the end of Year 6 was $100.00 per share.

Question: 13 RST’s times interest earned ratio at the end of Year 6 is

A. 14.33 times.

B. 13.33 times.

C. 23.33 times.

D. 14.67 times.

Question: 14 The following information has been derived from a company’s financial statements:

Current assets $640,000

Total assets 990,000

Long-term liabilities 130,000

Current ratio 3.2

The company’s debt to equity ratio is

A. 0.50

B. 0.13
 C. 0.33

D. 0.37

Question: 15 A corporation is considering the acquisition of one of its parts suppliers and has been
reviewing the pertinent financial statements. Specific data, shown below, has been
selected from these statements for review and comparison with industry averages.

B R W Industry

Total sales (millions) $4.27 $3.91 $4.86 $4.30

Net profit margin 9.55% 9.85% 10.05% 9.65%

Current ratio 1.32 2.02 1.96 1.95

Return on assets 11.0% 12.6% 11.4% 12.4%

Debt/equity ratio 62.5% 44.6% 49.6% 48.3%

Financial leverage 1.40 1.02 1.86 1.33

The objective for this acquisition is assuring a steady source of supply from a stable
company. Based on the information above, select the strategy that would fulfill the
objective.

A. Acquire R as both the debt/equity ratio and degree of financial leverage are below
the industry average.

B. Acquire W as the company has the highest net profit margin and degree of financial
leverage.

C. The corporation should not acquire any of these firms as none of them represents a
good risk.

D. Acquire B as both the debt/equity ratio and degree of financial leverage exceed the
industry average.

Fact Pattern: The data presented below show actual figures for selected accounts of McKeon Company
for the fiscal year ended May 31, Year 1, and selected budget figures for the Year 2 fiscal year.
McKeon’s controller is in the process of reviewing the Year 2 budget and calculating some key ratios
based on the budget. McKeon Company monitors yield or return ratios using the average financial
position of the company. (Round all calculations to three decimal places if necessary.)
5/31/Year 2 5/31/Year 1

Current assets $210,000 $180,000

Noncurrent assets 275,000 255,000

Current liabilities 78,000 85,000

Long-term debt 75,000 30,000

Common stock ($30 par value) 300,000 300,000

Retained earnings 32,000 20,000

Year 2
Operations

Sales* $350,000
Cost of goods sold 160,000
Interest expense 3,000
Income taxes (40% rate) 48,000
Dividends declared and paid in Year 2 60,000
Administrative expense 67,000

*All sales are credit sales.

Current Assets

5/31/Year 2 5/31/Year 1

Cash $ 20,000 $10,000

Accounts receivable 100,000 70,000

Inventory 70,000 80,000

Prepaid expenses 20,000 20,000

Question: 16 McKeon Company’s debt ratio for Year 2 is

A. 0.264

B. 0.352

C. 0.315

D. 0.237
Question: 17 A company has interest expense of $4 million, sales revenue of $50 million, earnings
before interest and taxes of $20 million, and an income tax rate of 35%. This company
has a times-interest-earned ratio of

A. 12.5

B. 7.5

C. 5.0

D. 0.2

Fact Pattern:
Selected data from Ostrander Corporation’s financial statements for the years indicated are presented in thousands.

Year 2 Operations December 31

Net credit sales $4,175 Year 2 Year 1
Cost of goods sold 2,880 Cash $ 32 $ 28
Interest expense 50 Trading securities 169 172
Income tax 120 Accounts receivable (net) 210 204
Gain on disposal of a segment (net of tax) 210 Merchandise inventory 440 420
Administrative expense 950 Tangible fixed assets 480 440
Net income 385 Total assets 1,397 1,320
Current liabilities 370 368
Total liabilities 790 750
Common stock outstanding 226 210
Retained earnings 381 360

Question: 18 The total debt to equity ratio for Ostrander Corporation in Year 2 is

A. 3.49

B. 1.30

C. 0.77

D. 2.07

Fact Pattern: The information below pertains to Devlin Company.

Statement of Financial Position as of May 31 Income Statement for the year ended May 31
(in thousands) (in thousands)
 Year 2 Year 1 Year 2 Year 1

Assets Net sales $480 $460

Current assets Costs and expenses
Cash $ 45 $ 38 Costs of goods sold 330 315
Trading securities 30 20 Selling, general, and administrative 52 51
Interest expense 8 9
Accounts receivable (net) 68 48
Income before taxes $ 90 $ 85
Inventory 90 80 Income taxes 36 34
Prepaid expenses 22 30 Net income $ 54 $ 51

Total current assets $255 $216

Investments, at equity 38 30
Property, plant, and equipment (net) 375 400
Intangible assets (net) 80 45

Total assets $748 $691

Liabilities
Current liabilities
Accounts payable $ 70 $ 42
Accrued expenses 5 4
Notes payable 35 18
Income taxes payable 15 16
Total current liabilities $125 $ 80
Long-term debt 35 35
Deferred taxes 3 2
Total liabilities $163 $117
Equity
Preferred stock, 6%, $100 par
value, cumulative $150 $150
Common stock, $10 par value 225 195
Additional paid-in capital --
common stock 114 100
Retained earnings 96 129
Total equity $585 $574
Total liabilities and equity $748 $691

Question: 19 Devlin Company’s times interest earned ratio for the year ended May 31, Year 2, was

A. 18.75 times.

B. 12.25 times.

C. 11.25 times.

D. 6.75 times.
Question: 20A measure of long-term debt-paying ability is a company’s

A. Length of the operating cycle.

B. Times interest earned ratio.

C. Inventory turnover ratio.

D. Return on assets.

Question: 21A company’s income statement shows interest expense of $5 million, sales revenue of $50 million,
earnings before interest and taxes of $20 million, and net income of $8 million. This company has a times interest
earned (or interest coverage) ratio of

A. 4

B. 0.25

C. 10

D. 1.6

Fact Pattern:
Selected data from Ostrander Corporation’s financial statements for the years indicated are presented in
thousands.

Year 2 Operations December 31

Net credit sales $4,175 Year 2 Year 1
Cost of goods sold 2,880 Cash $ 32 $ 28
Interest expense 50 Trading securities 169 172
Income tax 120 Accounts receivable (net) 210 204
Gain on disposal of a segment (net of tax) 210 Merchandise inventory 440 420
Administrative expense 950 Tangible fixed assets 480 440
Net income 385 Total assets 1,397 1,320
Current liabilities 370 368
Total liabilities 790 750
Common stock outstanding 226 210
Retained earnings 381 360

Question: 22 The times interest earned ratio for Ostrander Corporation for Year 2 is
 A. 6.90 times.

B. 3.50 times.

C. .57 times.

D. 7.70 times.

Question: 23 The interest expense for a company is equal to its earnings before interest and taxes
(EBIT). The company’s tax rate is 40%. The company’s times interest earned ratio is
equal to

A. 0.6

B. 2.0

C. 1.0

D. 1.2

Question: 24 Which one of the following is the best indicator of long-term debt paying ability?

A. Asset turnover.

B. Debt to total assets ratio.

C. Working capital turnover.

D. Current ratio.

Question: 25 A firm earned $10,000 before interest and taxes, has a 36% tax rate, and has the
following debt outstanding:

First mortgage bond, 9.0% $ 5,000

Debenture, 10.2% 10,000

Subordinated bond, 12.0% 6,000

Total long-term debt $21,000

The annual coverage of the firm’s debt is

A. 3.57 times.

B. 11.85 times.

C. 2.92 times.

D. 4.57 times.
4: (17) Leverage

Question: 1 Financial information for 2 years of operation is shown below.

Year 1 Year 2

Sales $4,000,000 $4,400,000

Total operating costs 3,200,000 3,440,000

Earnings before interest and taxes $ 800,000 $ 960,000

Interest payments 320,000 275,000

Income taxes 245,000 354,000

Net income $ 235,000 $ 331,000

Earnings per share $ 2.35 $ 3.31

The degree of operating leverage (DOL) is

A. 0.75

B. 4.09

C. 2.00

D. 2.67

Question: 2 Since incorporating 3 years ago, a company has estimated credit losses at a rate of
3% using the income statement approach. During its fourth year in business, after
recording the uncollectible accounts expense based on its previous estimate, the
company determined that its estimate of uncollectible accounts should be increased to
4.5%. During this fourth year, the company recorded sales of $25,000,000 and had an
ending accounts receivable balance of $2,000,000. This change would decrease

A. Both operating leverage and times interest earned.

B. The current year’s income by $1,125,000 and decrease the firm’s operating leverage.

C. The current year’s income by $30,000 and decrease the firm’s financial leverage.
 D. The current year’s income by $375,000 and increase the firm’s operating leverage.

Question: 3 This year, an entity increased earnings before interest and taxes (EBIT) by 17%.
During the same period, net income after tax increased by 42%. The degree of
financial leverage that existed during the year is

A. 2.47

B. 1.70

C. 5.90

D. 4.20

Question: 4 A firm with a higher degree of operating leverage when compared to the industry
average implies that the

A. Firm is more profitable.

B. Firm is less risky.

C. Firm’s profits are more sensitive to changes in sales volume.

D. Firm has higher variable costs.

Question: 5 The degree of operating leverage (DOL) is

A. Lower if the degree of total leverage is higher, other things held constant.

B. A measure of the change in operating income resulting from a given change in sales.

C. Higher if the degree of total leverage is lower, other things held constant.

D. A measure of the change in earnings available to common stockholders associated

with a given change in operating earnings.
Question: 6 Everything else being equal, a <List A> highly leveraged firm will have <List B>
earnings per share.
List A List B

A. More Less volatile

B. More Lower

C. Less Less volatile

D. Less Higher

Question: 7 For a firm with a degree of operating leverage of 3.5, an increase in sales of 6% will

A. Decrease pre-tax profits by 3.5%.

B. Increase pre-tax profits by 21%.

C. Increase pre-tax profits by 3.5%.

D. Increase pre-tax profits by 1.71%.

Question: 8 A company has a degree of operating leverage of 2. How much should the company
change its sales to achieve a 20% increase in operating income?

A. 10% increase.

B. 10% decrease.

C. 40% decrease.

D. 40% increase.

Question: 9 An accountant has determined that last year a company had earnings before interest
and tax of $750,000, interest expense of $125,000, and an income tax rate of 40%.
What was the company’s degree of financial leverage last year?

A. 2.00

B. 1.20
 C. 1.67

D. 0.80

Question: 10 A degree of operating leverage of 3 at 5,000 units means that a

A. 1% change in sales will cause a 3% change in earnings before interest and taxes.

B. 1% change in earnings before interest and taxes will cause a 3% change in sales.

C. 3% change in sales will cause a 3% change in earnings before interest and taxes.

D. 3% change in earnings before interest and taxes will cause a 3% change in sales.

Question: 11 Which one of the following statements concerning the effects of leverage on earnings
before interest and taxes (EBIT) and earnings per share (EPS) is correct?

A. Financial leverage affects both EPS and EBIT, while operating leverage only affects
EBIT.

B. For a firm using debt financing, a decrease in EBIT will result in a proportionally
larger decrease in EPS.

C. A decrease in the financial leverage of a firm will increase the beta value of the firm.

D. If Firm A has a higher degree of operating leverage than Firm B and Firm A offsets
this by using less financial leverage, then both firms will have the same variability in
EBIT.

Fact Pattern: The data presented below show actual figures for selected accounts of McKeon Company
for the fiscal year ended May 31, Year 1, and selected budget figures for the Year 2 fiscal year.
McKeon’s controller is in the process of reviewing the Year 2 budget and calculating some key ratios
based on the budget. McKeon Company monitors yield or return ratios using the average financial
position of the company. (Round all calculations to three decimal places if necessary.)
5/31/Year 2 5/31/Year 1

Current assets $210,000 $180,000

Noncurrent assets 275,000 255,000

Current liabilities 78,000 85,000

Long-term debt 75,000 30,000

Common stock ($30 par value) 300,000 300,000

Retained earnings 32,000 20,000

 Year 2
Operations

Sales* $350,000
Cost of goods sold 160,000
Interest expense 3,000
Income taxes (40% rate) 48,000
Dividends declared and paid in Year 2 60,000
Administrative expense 67,000

*All sales are credit sales.

Current Assets

5/31/Year 2 5/31/Year 1

Cash $ 20,000 $10,000

Accounts receivable 100,000 70,000

Inventory 70,000 80,000

Prepaid expenses 20,000 20,000

Question: 12The degree of financial leverage to be employed by McKeon Company in Year 2 is

A. 1.600

B. 1.640

C. 0.600

D. 1.025

Question: 13 The use of debt in the capital structure of a firm

A. Decreases its operating leverage.

B. Increases its financial leverage.

C. Decreases its financial leverage.

D. Increases its operating leverage.

Question: 14 A small but growing product assembler has been able to profitably ride the ups and
downs of several economic cycles, largely due to its low level of long-term assets. The
firm relies more heavily on labor than its competitors and contracts for needed facilities
only on a short-term lease basis. Working capital is largely provided through short-term
loans. Although the firm’s variable costs are much higher than its competitors’ variable
costs, its income is much less volatile. All of the above factors are consistent with the
firm having a lower level of financial and operating

A. Leverage.

B. Solvency.

C. Margin.

D. Liquidity.

Question: 15 Firms with high degrees of financial leverage would be best characterized as having

A. High debt-to-equity ratios.

B. Zero coupon bonds in their capital structures.

C. High fixed-charge coverage.

D. Low current ratios

Question: 16 A financial analyst calculated the company’s degree of financial leverage as 1.5. If
income before interest increases by 5%, earnings to shareholders will increase by

A. 1.50%

B. 7.50%

C. 3.33%

D. 5.00%

Question: 17 A summary of an income statement is shown below.

Sales $15,000,000
Cost of goods sold (9,000,000)

Operating expenses (3,000,000)

Interest expense (800,000)

Taxes (880,000)
Based on the above information, the degree of financial leverage is

A. 1.61

B. 1.36

C. 2.27

D. 0.96