Reading 55: LOS c ～ Q24-29 selected, several, class, provided

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24.Harold Adams, a financial analyst, is reviewing the financial data for Butler, Inc., for the years 2001 and 2000 and projected for 2002. Information for several selected ratios are provided in Table 1 below:

Table 1 Selected Data on Butler, Inc.
Ratios	2002 (Projected)	2001	2000
EBIT Interest Coverage Ratio	19.5	17.2	13.7
EBITDA Interest Coverage	10.0	9.0	8.0
Funds from Operations:TD	48.0	48.0	55.0
Free Operating Cash Flow:TD	NA	NA	NA
Pretax Return on Capital	26.0	24.1	18.5
Operating Income:Sales	36.0	36.5	37.8
LTD:Capitalization	29.0	28.9	31.8
TD:Capitalization	45.0	58.0	60.2

Adams also obtained Standard and Poor's information in Table 2 below which includes median ratios for various credit ratings.

Table 2 Standard & Poor's Select Median Rating Criteria
Ratios	AAA	AA	A	BBB	BB	B
EBIT Interest Coverage Ratio	12.9	9.2	7.2	4.1	2.5	1.2
EBITDA Interest coverage	18.7	14.0	10.0	6.3	3.9	2.3
Funds from Operations:TD	89.7	67.0	49.5	32.3	20.1	10.5
Free Operating Cash Flow:TD	40.5	21.6	17.4	6.3	1.0	(4.0)
Pretax Return on Capital	30.6	25.1	19.6	15.4	12.6	9.2
Operating Income:Sales	30.9	25.2	17.9	15.8	14.4	11.2
LTD:Capitalization	21.4	29.3	33.3	40.8	55.3	68.8
TD:Capitalization	31.8	37.0	39.2	46.4	58.5	71.4

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As shown, Butler ’s projected debt to capitalization ratios indicate that its total long-term debt (LTD) and total debt (TD) are expected to decline. What is the most likely implication of this trend?

A)   The firm's repayment ability is expected to increase.

B)   Butler's ability to repay will decline.

C)   These ratios have no impact on a firm's credit rating.

D)   Bondholders can anticipate an earlier default.

25.Which of the following accounting practices is least likely to have a significant impact on the balance sheet ratios of a firm?

A)   Inventory cost flow decisions.

B)   Acquisition accounting.

C)   Diluted versus basic EPS.

D)   Leasing accounting.

26.Which of the following statements regarding the use of traditional ratio analysis is TRUE?

A)   Highly cyclical companies have different ratio analysis standards than stable companies.

B)   Analysts tend to rely exclusively on traditional ratio analysis to determine the financial condition of the company.

C)   Traditional ratio analysis considers factors that may impact future cash flows of the firm.

D)   Traditional ratios are useful in forecasting the earnings growth of the firm.

27．Which of the following statements regarding the use of traditional ratios to analyze a firm’s financial condition is FALSE?

A)   Financial ratios are based on the historical accounting data of the firm.

B)   Financial ratios do not reveal any information regarding the future capital requirements of the firm.

C)   Many of the financial ratios can be used to assess the future financial position of the company.

D)   It is possible that the same financial ratio calculated at two different points in time during any given month may be materially different from one another.

28．Traditional financial ratios are useful in providing information regarding the firm’s:

A)   future earning prospects.

B)   competitive position.

C)   future capital requirements.

D)   financial position at a given point in time.

29．The office furniture industry is highly cyclical. Which of the following is NOT a limitation of ratio analysis for the office furniture industry?

A)   Cyclical companies do not have accurate industry comparisons due to the more volatile changes in ratios.

B)   Ratio analysis relies on historical information.

C)   A recession could significantly change the financial condition of the company.

D)   Ratio analysis does not fully reflect information regarding concerns about future competition and growth.

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As shown, Butler ’s projected debt to capitalization ratios indicate that its total long-term debt (LTD) and total debt (TD) are expected to decline. What is the most likely implication of this trend?

A)   The firm's repayment ability is expected to increase.

B)   Butler's ability to repay will decline.

C)   These ratios have no impact on a firm's credit rating.

D)   Bondholders can anticipate an earlier default.

The correct answer was  A)

A declining long-term-debt and total debt to capitalization ratio is most likely an indicator that the firm's ability to repay its debt will increase. It will have less debt relative to total capital.

25.Which of the following accounting practices is least likely to have a significant impact on the balance sheet ratios of a firm?

A)   Inventory cost flow decisions.

B)   Acquisition accounting.

C)   Diluted versus basic EPS.

D)   Leasing accounting.

The correct answer was  C)

LIFO/FIFO, purchase versus pooling, and operating leasing v. capital leasing can all have a major impact on the balance sheet ratios of the firm.

26.Which of the following statements regarding the use of traditional ratio analysis is TRUE?

A)   Highly cyclical companies have different ratio analysis standards than stable companies.

B)   Analysts tend to rely exclusively on traditional ratio analysis to determine the financial condition of the company.

C)   Traditional ratio analysis considers factors that may impact future cash flows of the firm.

D)   Traditional ratios are useful in forecasting the earnings growth of the firm.

The correct answer was  A)

Analysts use traditional ratio analysis to help assess the current financial condition of the firm. However, since these ratios are not forward looking, the analyst must use other means of analysis to forecast the future financial condition of the firm. Furthermore, analysts will apply different ratio analysis standards to different types of companies. For example, highly cyclical companies will likely have different standards than stable companies.

27．Which of the following statements regarding the use of traditional ratios to analyze a firm’s financial condition is FALSE?

A)   Financial ratios are based on the historical accounting data of the firm.

B)   Financial ratios do not reveal any information regarding the future capital requirements of the firm.

C)   Many of the financial ratios can be used to assess the future financial position of the company.

D)   It is possible that the same financial ratio calculated at two different points in time during any given month may be materially different from one another.

The correct answer was  C)

Traditional financial ratios have limited use in that they are not forward looking.

28．Traditional financial ratios are useful in providing information regarding the firm’s:

A)   future earning prospects.

B)   competitive position.

C)   future capital requirements.

D)   financial position at a given point in time.

The correct answer was  D)

Traditional financial ratios provide a snapshot of the firm’s financial condition at a particular point in time. They are not forward looking.

29．The office furniture industry is highly cyclical. Which of the following is NOT a limitation of ratio analysis for the office furniture industry?

A)   Cyclical companies do not have accurate industry comparisons due to the more volatile changes in ratios.

B)   Ratio analysis relies on historical information.

C)   A recession could significantly change the financial condition of the company.

D)   Ratio analysis does not fully reflect information regarding concerns about future competition and growth.

The correct answer was  A)

Different standards apply to cyclical companies versus stable companies, but accurate industry comparisons are still possible. The major limitation of ratio analysis is that it is not forward looking because it does not consider factors that can impact future cash flows.