Finman4e Test Bank Mod 04 050914. Module 4 Analyzing and Interpreting Financial Statements

Finman4e Test Bank Mod 04 050914. Module 4 Analyzing and Interpreting Financial Statements Learning Objectives – coverage by question True/False Multiple Choice Exercises Problems Essays LO1 – Compute return on equ ...

Finman4e Test Bank Mod 04 050914. Module 4 Analyzing and Interpreting Financial Statements Learning Objectives – coverage by question True/False Multiple Choice Exercises Problems Essays LO1 – Compute return on equity (ROE) and disaggregate it into components of operating and nonoperating returns. LO2 – Disaggregate operating return (RNOA) into components of profitability and asset turnover. LO3 – Explain nonoperating return and compute it from return on equity and the operating return. LO4 – Compute and interpret measures of liquidity and solvency. LO5 – Describe and illustrate traditional DuPont disaggregation of ROE. Module 4: Analyzing and Interpreting Financial Statements True/False Topic: Use of Ratios LO: 1-5 1. Ratios provide one way to compare companies in the same industry regardless of their size. Answer: True Rationale: Ratios mitigate problems arising from different sizes of companies. Topic: Financial Leverage and RNOA LO: 1, 3 2. Highly leveraged firms have higher RNOA than firms with lower leverage. Answer: False Rationale: Financial leverage does not affect the RNOA computation because it is based on operating profit. Financial leverage will increase ROE, however. Topic: Return on Equity and Treasury Stock LO: 1 3. Repurchasing shares near year-end will increase a firm’s return on equity (ROE). Answer: True Rationale: Repurchasing shares will decrease equity because treasury stock is a contra-account (it reduces total equity). If the repurchases happen at year-end, there are likely no significant profit impacts and thus, the numerator in the ROE ratio will be unaffected. Thus, the ratio will increase. Topic: Nonoperating Return LO: 1 4. All else equal, when investors consider a firm’s return on equity (ROE) they consider less risky a firm that earns proportionately more of that return from operating activities as opposed to nonoperating activities. Answer: True Rationale: Financial leverage will increase nonoperating return and ROE; however this adds risk to the investment. For equal returns, investors typically prefer less risk. Topic: Tax on Operating Profit LO: 1 5. To determine tax on net operating profit, we begin with total tax expense and deduct taxes related to net nonoperating expenses. Answer: False Rationale: We begin with total tax expense and add back any taxes related to net nonoperating expenses (NNE). ©Cambridge Business Publishers, 2015 4-2 Financial & Managerial Accounting for MBAs, 4th EditionTopic: NOPAT LO: 1 6. NOPAT is equivalent to income from operating activities. Answer: False Rationale: NOPAT is income from operating activities after tax which excludes nonoperating expenses such as interest expense. Income from operating activities often includes interest expense and is before tax. Topic: Asset Turnover Effect on RNOA/ROE LO: 2 7. Increasing a company’s net operating asset turnover (NOAT) increases both RNOA and ROE. Answer: True. Rationale: ROE = RNOA + FLEV × Spread. RNOA is further disaggregated into profit margin × asset turnover. Therefore an increase in asset turnover will yield an increase in RNOA, which will result in an increase in ROE if all other variables remain constant. Topic: Profitability and RNOA LO: 2 8. If Company A has a higher net operating profit margin (NOPM) than Company B, then Company A’s RNOA will be higher. Answer: False Rationale: RNOA depends on NOPM but also depends on operating asset productivity (NOAT). If Company B had a much higher operating asset productivity, its RNOA could be higher despite the lower profitability. Topic: Net Operating Asset Turnover LO: 2 9. Net operating asset turnover (NOAT) measures a company’s profitability. Answer: False Rationale Net operating asset turnover is a productivity or efficiency concept. Topic: Financial Leverage and Debt Ratings LO: 3 10. All else being equal, higher financial leverage will decrease a company’s debt rating and increase the interest rate it must pay. Answer: True Rationale: Higher levels of financial leverage increase the probability of default and of bankruptcy. This reduces credit ratings and increases costs for borrowed funds. Topic: Return on Equity (ROE) LO: 3 11. ROE can be disaggregated into operating and nonoperating returns. Nonoperating return will be positive as long as Spread is positive. Answer: False Rationale: The nonoperating return can be negative (which reduces ROE) if spread is positive and financial leverage (FLEV) is negative. ©Cambridge Business Publishers, 2015 Test Bank, Module 4 4-3Topic: Current Ratio LO: 4 12. A current ratio greater than 1.0 is generally desirable for a company. Answer: True Rationale: A company with a current ratio greater than 1.0 indicates positive working capital. In general, companies prefer greater levels of current assets than current liabilities. Topic: Solvency LO: 4 13. Solvency ratios measure a company’s ability to meet its debt obligations. Answer: True Rationale: A solvent company is one that can meet its debt obligations including principal and interest payments as they come due. Topic: ROA versus RNOA LO: 5 14. The only difference between adjusted return on assets (ROA) and return on net operating assets (RNOA) is that the denominator in RNOA is typically smaller than the denominator in ROA because the former is net of operating liabilities. Answer: False Rationale: It is true that the denominator in RNOA is typically smaller but the other difference between the ratios is that the numerators are different. ROA includes all net income whereas RNOA includes only net profits from operating activities. Topic: Basic DuPont Analysis LO: 5 15. The DuPont analysis disaggregates return on equity into profitability, efficiency and leverage components. Answer: True Rationale: The DuPont disaggregation of return on equity is: ROE = Profit margin (PM) × Asset turnover (AT) × Financial leverage (FL). These three terms measure profitability, efficiency and leverage respectively. ©Cambridge Business Publishers, 2015 4-4 Financial & Managerial Accounting for MBAs, 4th EditionMultiple Choice Topic: ROE Computation LO: 1 1. ROE is computed as: A) Net income attributable to controlling interest / Average equity attributable to controlling interest B) Net income attributable to controlling interest / Net sales C) RNOA + (FLEV × Spread) x NCI ratio D) A and B E) A and C Answer: E Rationale: ROE = Net income attributable to controlling interest / Average equity attributable to controlling interest. This is the most straightforward way to calculate ROE, so A is correct. Answer C is a disaggregation of ROE into its operating and nonoperating components. Thus, the correct answer is E: A and C. Topic: ROE Computation (Numerical calculations required) LO: 1 2. The 2013 balance sheet of E.I. du Pont de Nemours and Company shows average DuPont shareholders’ equity attributable to controlling interest of $13,219 million, net operating profit after tax of $3,145 million, net income attributable to DuPont of $4,848 million, and common shares issued of 1,014 million. Assume the company has no preferred shares issued. DuPont’s return on equity (ROE) for the year is: A) 20.9% B) 36.7% C) 23.8% D) 36.4% E) There is not enough information to calculate the ratio. Answer: B Rationale: ROE = Net income/Average shareholders’ equity = $4,848 / $13,219 = 36.7% Topic: ROE Computation (Numerical calculations required) LO: 1 3. The 2013 financial statements of The New York Times Company reveal average shareholders’ equity attributable to controlling interest of $752,618 thousand, net operating profit after tax of $97,898 thousand, net income attributable to The New York Times Company of $65,105 thousand, and average net operating assets of $ 402,427 thousand. The company’s return on equity (ROE) for the year is: A) 8.7% B) 13.0% C) 16.2% D) 24.3% E) There is not enough information to calculate the ratio. Answer: A Rationale: ROE = Net income / Average shareholders’ equity = $65,105 / $752,618 = 8.7% ©Cambridge Business Publishers, 2015 Test Bank, Module 4 4-5Topic: NOA Computation (Numerical calculations required) LO: 1 4. The 2014 balance sheet of Staples, Inc. shows total assets of $11,174,876 thousand, operating assets of $10,682,344 thousand, operating liabilities of $3,929,854 thousand, and shareholders’ equity of $6,132,263 thousand. Staples’ 2014 net operating assets are: A) $ 7,245,022 thousand B) $ 10,682,344 thousand C) $ 6,752,490 thousand D) $ 6,132,263 thousand E) None of the above Answer: C Rationale: NOA = Operating assets – Operating liabilities = $10,682,344 – $3,929,854 = $6,752,490 Topic: Average NOA Computation (Numerical calculations required) LO: 1 5. The 2013 balance sheet of Whole Foods Market reports operating assets of $4,102 million, operating liabilities of $1,596 million, and total liabilities of $1,660 million. Whole Food’s average net operating assets for the year are: A) $2,506 million B) $2,442 million C) $3,256 million D) $2,051 million E) There is not enough information to calculate the amount. Answer: E Rationale: Average net operating assets requires two years of balance sheet data. The question only provided one year’s data, thus, there is not enough information to calculate the amount. Topic: Tax Shield Computation (Numerical calculations required) LO: 1 6. Mattel Inc.’s 2013 financial statements show operating profit before tax of $1,168,103 thousand, net income of $903,944 thousand, provision for income taxes of $195,184 thousand and net nonoperating expense before tax of $68,975 thousand. Assume Mattel’s statutory tax rate for 2013 is 37%. Mattel’s 2013 tax shield is: A) $ 43,454 thousand B) $ 25,521 thousand C) $ 264,159 thousand D) $ 238,638 thousand E) None of the above Answer: B Rationale: Tax shield = Net nonoperating expense before tax × statutory tax rate = $68,975 × 37% = $25,521 thousand. ©Cambridge Business Publishers, 2015 4-6 Financial & Managerial Accounting for MBAs, 4th EditionTopic: Effective Tax Rate Computation (Numerical calculations required) LO: 1 7. Mattel Inc.’s 2013 financial statements show operating profit before tax of $1,168,103 thousand, net income of $903,944 thousand, provision for income taxes of $195,184 thousand and net nonoperating expense before tax of $68,975 thousand. Assume Mattel’s statutory tax rate for 2013 is 37%. Mattel’s 2013 effective tax rate is: A) 17.8% B) 37.0% C) 19.4% D) 16.7% E) None of the above Answer: A Rationale: Effective tax rate = Provision for income taxes / Income before tax = $195,184 / ($903,944 + $195,184) = 17.8% Topic: NOPAT Definition LO: 1 8. Net operating profit after tax (NOPAT) includes operating revenues less expenses such as: A) Cost of goods sold (COGS) B) Taxes on operating income C) Selling, general and administrative expenses (SG&A) D) After-tax earnings from investments and interest expenses E) All of the above F) A, B and C only Answer: F Rationale: NOPAT is net operating profit after tax. After-tax earnings from investments and interest expenses are not included because they are nonoperating items. Topic: RNOA Computation (Numerical calculations required) LO: 1 9. The 2013 balance sheet of The New York Times Company shows average shareholders’ equity attributable to controlling interest of $752,618 thousand, net operating profit after tax of $97,898 thousand, net income attributable to The New York Times Company of $65,105 thousand, and average net operating assets of $ 402,427 thousand. The company’s return on net operating assets (RNOA) for the year is: A) 13.0% B) 16.2% C) 24.3% D) 8.7% E) There is not enough information to calculate the ratio. Answer: C Rationale: RNOA = NOPAT / average NOA = $97,898 / $402,427 = 24.3% ©Cambridge Business Publishers, 2015 Test Bank, Module 4 4-7Topic: Nonoperating Return Computation (Numerical calculations required) LO: 2, 3 10. The fiscal 2013 financial statements of Baker Hughes Inc. shows net operating profit margin (NOPM) of 5.59%, net operating asset turnover (NOAT) of 1.06, return on equity of 6.30%, and adjusted return on assets of 4.58%. What is the company’s nonoperating return? A) 0.37% B) 0.71% C) 1.45% D) 1.01% E) There is not enough information to calculate the ratio. Answer: A Rationale: ROE = RNOA + nonoperating return = 6.30% – (5.59% × 1.06) = 0.3746% Topic: Nonoperating Return Computation (Numerical calculations required) LO: 2, 3 11. The 2013 balance sheet of The New York Times Company shows net operating profit margin (NOPM) of 6.2%, net operating asset turnover (NOAT) of 3.35, return on equity of 8.7%, and adjusted return on assets of 2.4%. What is the company’s nonoperating return? A) -12.1% B) 0.7% C) -1.8% D) 2.5% E) None of the above Answer: A Rationale: ROE = RNOA + nonoperating return = 8.7% – (6.2% × 3.35) = -12.07% = -12.1% Topic: Net Operating Profit Margin (NOPM) Computation (Numerical calculations required) LO: 2 12. The fiscal year-end 2014 financial statements for Staples, Inc. report revenues of $23,114,263 thousand, net operating profit after tax of $779,262 thousand, net operating assets of $6,752,490 thousand. The fiscal year-end 2013 balance sheet reports net operating assets of $6,920,568 thousand. Staples’ 2014 net operating profit margin is: A) 29.2% B) 11.5% C) 3.4% D) 12.7% E) There is not enough information to calculate the ratio. Answer: C Rationale: NOPM = NOPAT / Revenues = $779,262 / $23,114,263 = 3.4% ©Cambridge Business Publishers, 2015 4-8 Financial & Managerial Accounting for MBAs, 4th EditionTopic: Net Operating Asset Turnover (NOAT) Computation (Numerical calculations required) LO: 2 13. The fiscal 2013 financial statements for Walgreen, Inc., report net sales of $72,217 million, net operating profit after tax of $2,478 million, net operating assets of $21,556 million. The 2012 balance sheet reports net operating assets of $21,465 million. Walgreen’s 2013 net operating asset turnover is: A) 11.5% B) 3.24 C) 3.43% D) 3.36 E) There is not enough information to calculate the ratio. Answer: D Rationale: NOAT = Net sales / Average NOA = $72,217 / [($21,556 + $21,465) / 2] = 3.36 Topic: Net Operating Asset Turnover (NOAT) Computation (Numerical calculations required) LO: 2 14. Kroger’s 2013 financial statements show net operating profit after tax of $1,799 million, net income of $1,497 million, sales of $96,751 million, and average net operating assets of $11,529 million. Kroger’s net operating asset turnover for the year is: A) 1.9% B) 8.11 C) 8.39 D) 11.9% E) There is not enough information to calculate the ratio. Answer: C Rationale: Net operating asset turnover = Sales / Average net operating assets = $96,751 million / $11,529 million = 8.39. Topic: NNO Computation (Numerical calculations required) LO: 3 15. The 2013 balance sheet of Microsoft Corp. reports total assets of $142,431 million, operating liabilities of $47,242 million, and total shareholders’ equity of $78,944 million. Microsoft 2013 nonoperating liabilities are: A) $63,487 million B) $16,245 million C) $95,189 million D) $31,702 million E) There is not enough information to calculate the amount. Answer: B Rationale: Total assets = Operating liabilities + Nonoperating liabilities + Shareholders’ equity Nonoperating liabilities = $142,431 million – $47,242 million – $78,944 million = $16,245 million