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Exam 9: Financial Statement Analysis

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Question 1

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Indicate whether each of the following statements about financial statement analysis is true or false. Solvency ratios measure a company's short-term debt-paying ability and its financial structure. ______ A company with a high debt to assets ratio probably would be considered to have a high level of financial risk. ______ The debt to equity ratio and debt to assets ratio are two ways to measure the same relationship. ______ From the point of view of stockholders, a decline in the debt to equity ratio is always good news. ______ The lower the debt to equity ratio, the higher a company's financial leverage. ______

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Question 2

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The following information was provided by Joseph Company as of December 31, Year 2: $\begin{array}{llr} \text { Net income } &\$528,000\\ \text {Preferred stock, (20,000 shares at \( \$ 10 \) par, 4\%) } &\$200,000\\ \text {Common stock, \( (220,000 \) shares at \( \$ 1 \) par) } &\$220,000\\ \text { Paid-in capital in excess of par-common } &\$2,475,500\\ \text { Retained earnings} &\$3,824,500\\\end{array}$ On the most recent trading date, Joseph's common shares sold at $36 and the preferred shares sold at $14. The following information on industry averages is provided: Earnings per share $2.06 Price-earnings ratio 13.2:1 Required: Calculate and compare Joseph Company's ratios with the industry averages shown above. (Round your answer to two decimal places.) Discuss whether you would invest in this company.

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To calculate and compare Joseph Company's ratios with the industry averages, we can first calculate the earnings per share and the price-earnings ratio for Joseph Company. Earnings per share (EPS) = Net income / Number of common shares outstanding = $528,000 / 220,000 = $2.40 Price-earnings ratio = Market price per share / Earnings per share = $36 / $2.40 = 15:1 Comparing these ratios with the industry averages, we find that Joseph Company's EPS is higher than the industry average of $2.06, indicating that the company is more profitable on a per-share basis. However, the price-earnings ratio of 15:1 is higher than the industry average of 13.2:1, indicating that investors are paying a higher price for each dollar of earnings compared to the industry average. In considering whether to invest in this company, we should also take into account other factors such as the company's financial stability, growth prospects, and management team. While the higher EPS suggests that the company is profitable, the higher price-earnings ratio may indicate that the stock is overvalued compared to the industry average. Therefore, additional analysis and consideration of the company's overall financial health and future prospects would be necessary before making an investment decision.

Question 3

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The Martin Company reported net income of $15,700 on gross sales of $86,500. The company has average total assets of $121,700, of which $106,500 is property, plant and equipment. What is the company's return on investment? (Round your final answer to 1 decimal place.)

You are considering an investment in Frontier Airlines stock and wish to assess the firm's earnings performance. All of the following ratios can be used to assess profitability except:

Indicate whether each of the following statements about financial statement analysis is true or false. Both dividends and earnings performance are indicators of the value of a company's stock. ______ The most widely quoted measure of a company's earnings performance is return on equity. ______ Earnings per share is calculated for a company's common stock. ______ Investors need to understand that the value of a company's earnings per share is affected by its choices of accounting principles and assumptions. ______ The book value per share measures the market value of a corporation's stock. ______

You are considering an investment in Apple stock and wish to assess the firm's short-term debt-paying ability. All of the following ratios are used to assess liquidity except:

A vertical analysis uses percentages to compare each of the parts of an individual statement to a key statement figure. For example, on an income statement each item would be shown as a percentage of net sales.

Indicate whether each of the following statements about financial statement analysis is true or false. Meaningful comparisons between two companies generally should be made using percentage analysis or ratio analysis, not absolute amounts. ______ The materiality of accounting information refers to whether it is viewed as favorable (good news) or unfavorable (bad news). ______ Companies must account for immaterial items in compliance with generally accepted accounting principles. ______ To judge the materiality of an absolute financial statement amount, one must consider the size of the company reporting it. ______ Comparing percentages derived from financial statement analysis has the drawback of varying materiality levels. ______

Benson Company received cash of $5,000,000 by issuing 20-year bonds payable. As a result of this transaction, the company's current ratio will:

The Crestar Company reported net income of $64,600 on 14,000 average outstanding common shares. Preferred dividends total $11,400. On the most recent trading day, the preferred shares sold at $44 and the common shares sold at $74. What is this company's current price-earnings ratio? (Do not round your intermediate calculations.)

Indicate whether each of the following statements about financial statement analysis is true or false. The value of a corporation's price-earnings ratio indicates how optimistic investors are about a company's growth potential. ______ The dividend yield ratio indicates the percentage of a company's net income that it paid out in dividends. ______ Conservatism produces a positive bias in a company's financial statements and thus in the ratios calculated from the financial statements. ______ Changes in general economic conditions (such as rate of inflation) can cause the values for a company's financial statement ratios to change from one year to the next. ______ Comparing financial statement ratios of companies in different industries can give misleading results. ______

Longwood Company had a current ratio of 3:1 at the end of Year 1. The asset section of the company's balance sheet is provided below: $\begin{array}{llr} \text {Cash } &&100,000\\ \text {Accounts receivable } &\$400,000\\ \text { Less allowance for uncollectible Accounts } &\underline{50,000}&350,000\\ \text { Inventory} &&550,000\\ \text { Prepaid expenses } &&74,000\\ \text { Property, plant, \& equipment, net} &&\underline{926,000}\\ \text { Total assets} &&\underline{\$2,000,000}\\\end{array}$ Required: Compute Longwood Company's end-of-year working capital.Compute the company's quick (acid-test) ratio.The company has a debt agreement with its bank that authorizes the bank to call in its loan to the company if the company's current ratio falls below 3:1 as of the last day of any month during the term of the loan. During January Year 2, the company engaged in the three following transactions:Collected $100,000 on accountPurchased inventory on account, $50,000Paid accounts payable, $60,000 Will the company be in default after completing these transactions? Justify your answer. (Round your answers to two decimal places.)

The accounting concept or principle that is perhaps the greatest single culprit in distorting the results of financial statement analysis is the:

As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $18,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. - On January 1, Year 2, Gant issued common stock at par value for $10,000 cash. Which of the following statements is correct?

The accounting profession assumes that financial statement users have an expert knowledge of business.

Lilly Corporation has working capital of $620,000, and Harmon Corporation has working capital of $840,000. Which of the following statements is incorrect?

Many companies have to monitor closely certain ratios, such as the current ratio, due to debt covenants. Selected transactions are provided below for a company that uses a perpetual inventory system, sells its merchandise at a selling price that exceeds cost, and had a current ratio of 1.85 and a quick ratio of 1.19 before the event occurred. Required: In the above table, indicate whether each transaction would increase (+), decrease (−), or not affect (0) the company's current ratio and quick ratio.

Two ratios that provide insight on the relationship between credit sales and receivables are:

All of the following are considered to be measures of a company's short-term debt-paying ability except:

The following balance sheet information is provided for Duke Company for Year 2: $\begin{array}{lr}\text { Assets }\\\text { Cash } & \$ 5,400 \\\text { Accounts receivable } & 15,500 \\\text { Inventory } & 18,000 \\\text { Prepaid expenses } & 1,600 \\\text { Plant and equipment, net of depreciation } & 20,200 \\\text { Land } & \underline{ 19,950 }\\\text { Total assets } &\underline{ \$ 80,650}\\\text { Liabilities and Stockholders' Equity }\\\text { Accounts payable } & \$ 4,500 \\\text { Salaries payable } & 11,500 \\\text { Bonds payable (Due in ten years) } & 19,000 \\\text { Common stock, no par } & 30,000 \\\text { Retained earnings } &\underline{ 15,650} \\\text { Total liabilities and stockholders' equity }& \$ 80,650\end{array}$ What is the company's current ratio? (Round your answer to 2 decimal places.)