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Finance 2000 – Chapter 4

(T/F) The income statement of a firm shows the value of its assets and liabilities over a specified period of time.
False
(T/F) Net working capital to total assets and current ratio are both liquidity ratios.
True
Other things equal, an increase in average accounts receivable will increase a firm’s return on assets.
False
If a firm’s total debt ratio is greater than .5, then:
its current liabilities are quite high.
its debt-equity ratio exceeds 1.0.
it has too few total assets.
it has more long-term debt than equity.
its debt-equity ratio exceeds 1.0.
Which of the following actions could improve a firm’s current ratio if it is now less than 1.0?
Converting marketable securities to cash
Paying accounts payable with cash
Buying inventory on credit
Selling inventory at cost
Buying inventory on credit
A firm reports a net profit margin of 10% on sales of $3 million when ignoring the effects of financing. If taxes are $200,000, how much is EBIT?
$100,000
$300,000
$500,000
$800,000
$500,000
Last year’s return on equity was 30%. This year the ROE has decreased to 20% even though the firm’s earnings equaled last year’s earnings. The firm has no preferred stock. What caused the decrease?
Equity decreased by 10%.
Equity decreased by 50%.
Equity increased by 10%.
Equity increased by 50%.
Equity increased by 50%.
After-tax operating income for a leveraged firm is defined as:
net income + after-tax interest.
EBIT × (1 – tax rate).
net income + depreciation.
profit margin × sales.
net income + after-tax interest.
Which one of these changes indicates an improvement in a firm’s asset management efficiency?
An increase in the amount of assets per dollar of sales
An increase in the inventory turnover rate
A decrease in the receivables turnover rate
An increase in the average days in inventory
An increase in the inventory turnover rate
Which one of these statements is correct?
Market value added measures the difference between the total market value and the total book value of equity.
Net income is also called economic value added.
EVA measures the net profit of a firm after deducting the cost of the assets used in the production process.
EVA considers the cost of long-term debt financing but excludes the cost of equity financing.
Market value added measures the difference between the total market value and the total book value of equity.
market capitalization
Total market value of equity, equal to share price times number of shares outstanding.
market value added
The difference between the market value of firm’s equity and its book value.
market-to-book ratio
Ratio of market value of equity to book value of equity
economic value added (EVA)
Income that is measured after deduction of the cost of capital. Also called residual income. EVA = after-tax interest + net income – (cost of capital * total capitalization) ior EVA = after-tax income – (cost of capital * total capitalization)
total long term capital
usually called total capitalization, is the sum of long-term debt and shareholders equity
EVA vs. accounting income
EVA, or residual income, is a better measure of a company’s performance than is accounting income. Accounting income is calculated after deducting all costs except the cost of capital. By contrast, EVA recognizes that companies need to cover their opportunity costs before they add value.
Return on Capital (ROC)
After-tax operating income as a percentage of long-term capital. ROC = after-tax operating income/total capitalization
Return on Assets (ROA)
After-tax operating income as a percentage of total assets. ROA = after-tax operating income/total assets
Return on Equity (ROE)
Net income as a percentage of shareholders’ equity. ROE = net income/equity
asset turnover ratio
measures how efficiently the business is using its entire asset base
asset turnover = sales/total assets
inventory turnover
cost of goods sold/inventory at start of year
average days in inventory
inventory at start of year/ daily costs of goods sold
receivables turnover =
receivables (sales for which you have not been paid) RT = sales/receivables at start of year
average collection period
receivables at start of year/average daily sales
profit margin
net incomes/ net sales
operating profit margin
After-tax operating income as a percentage of sales. OPM = after-tax operating income/ sales
Du Pont formula
A breakdown of ROE and ROA into component ratios. ROA = asset turnover * operating profit margin
long-term debt ratio
long term debt/ (long term debt + equity)
long term debt-equity ratio
= long-term debt/equity
total debt ratio
total liabilities/total assets
times interest earned ratio
EBIT/interest payments
cash coverage ratio
(EBIT + depreciation)/interest payments
Net working Capital to Total Assets Ratio
NWC/TA..obvious
current ratio
current assets/current liabilities
quick (Acid-Test) Ratio
(cash + marketable securities + receivables) / current liabilities
cash ratio
(cash + marketable securities)/ current liabilities

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