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41. Of the following methods of examining the uncertainty of financial outcomes around point estimates, which answers hypothetical questions about the effect of changes in a single variable and which uses assumed probability distributions for key variables? Hypothetical question Probability distributions A. Sensitivity analysis Simulation B. Scenario analysis Simulation C. Scenario analysis Sensitivity analysis

Ans: A. Sensitivity analysis is based on hypothetical (“what if”) questions about a single variable, such as “what if sales decline by 10%?” simulation is a technique in which probability distributions for key variables are assumed and a computer is used to generate a distribution of outcomes based on repeated random selection of values for the key variables. Scenario analysis is based on one or more specific scenarios (a specific set of outcomes for key variables), which include changes in multiple variables.

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42. Bao, Inc., uses short-term bank debt to buy inventory. Assuming an initial current ratio that is greater than 1, and an initial quick (or acid test) ratio that is less than 1, what is the effect of these transactions on the current ratio and the quick ratio? A. Both ratios will decrease. B. neither ratio will decrease. C. Only one ratio will decrease.

Ans: A. As an example, start with CA=2, CL=1, and Inv =1.2. we begin with a current ratio of 2 and a quick ratio of 0.8. if the firm increases short-term bank debt (a current liability) by 1 to buy inventory (a current asset) of 1, both the numerator and denominator increase by 1, resulting in 3/2=1.5 (new current ratio) and (3-2.2)/2=0.4 (new quick ratio).

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43. From the extended (5-part) DuPont equation, which of the following components describes the equation EBT/EBIT? A. Tax burden. B. EBIT margin. C. Interest burden.

Ans: C. EBT/WBIT is the interest burden, the second component in the extended DuPont equation. It shows that more leverage does not always lead to higher ROE. As leverage rises, so does the interest burden. The positive effects of leverage can be offset by the higher interest payments that accompany higher levels of debt. A is incorrect. Net income / EBT is called the tax burden and is equal to (1-rax rate). The higher the tax rate, the lower the ROE level. B is incorrect. EBIT/ revenue is called the EBIT margin or operating margin.

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44. Which of the following is most likely presented on a common-size balance sheet or common-size income statement? A. Total asset turnover. B. Operating profit margin. C. Return on common equity.

Ans: B. Operating profit margin can be read directly from a common-size income statement. Asset turnover and return on equity mix balance sheet and income statement items.

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45. Two firms in the same industry show the following ratios for the most recent year after all proper adjustments have been made for dilutive securities and differences in financial reporting standards: EPS CFO per share Company Y $3.50 $2.00 Company Z $2.00 $3.00 Based on this information, the better financial performance of these two firms: A. is Company Y because it has the highest EPS. B. is Company Z because it generated the most CFO per share. C. Cannot be determined because per-share ratios are not comparable.

Ans: C. When stated on a per-share basis, difference companies’ financial data cannot be compared meaningfully because these depend on the number of shares outstanding, which is unrelated to the companies’ operating performance or profitability. A company with a $200 share price should have much higher valuation measures than a company with a $2 share price.

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46. A firm pays accrued wages with cash. Assuming a current ratio greater than one and a quick ratio that is less than one, what will be the impact on the current ratio and the quick ratio? A. Both ratios will remain the same. B. The current ratio will increase and the quick ratio will decrease. C. The current ratio will decrease and the quick ratio will increase.

Ans: B. Reducing the numerator and denominator by the same amount will increase a ratio that is greater than one and decrease a ratio that is less than one.

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47.  Bao Company has a cash conversion cycle of 80 days. If the company’s average receivables turnover increases from 11 to 12, the company’s cash conversion cycle: A. decreases by approximately 3 days. B. increases by approximately 3 days C. decreases by approximately 1 days

ans: A. Cash conversion cycle = Days of inventory on hand (DOH) + Days Sales Outstanding (DSO) – payables payment period DSO= ==33.18 =30.42 33.18-30.42=2.76 This means the CCC decreases by 2.76 days.

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48. The presentation format of balance sheet data that standardizes the first-year values to 1.0 and presents subsequent year’s amounts relative to 1.0 is a(n): A. indexed balance sheet. B. vertical common-size balance sheet. C. horizontal common-size balance sheet.

Ans: C. On horizontal common-size balance sheet, the divisor is the first year values so they are all standardized to 1.0 by construction. Trends in the values of these items as well as the relative growth in these items are readily apparent. A vertical common-size balance sheet expresses all balance sheet accounts as a percentage of total assets and does not standardize the initial year.

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49. Bao Corp. has a current ratio above 1 and a quick ratio less than 1. Which of the following actions will increase the current ratio and decrease the quick ratio? Bao Corp.: A. buys fixed assets on credit. B. uses cash to purchase inventory. C. pays off accounts payable from cash.

Ans: C. Paying off accounts payable from cash lowers current assets and current liabilities by the same amount. Because the current ratio started off above 1, the current ratio will increase. Because the quick ratio started off less than 1, it will decrease further. A is incorrect. Buying fixed assets on credit decreases both ratios because the denominator increases, with no change to the numerator. C is incorrect. Using cash to purchase inventory would result in no change in the current ratio but would decrease the quick ratio by decreasing the numerator.

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50. A company has a Cash conversion cycle of 70 days. If the company’s payables turnover decreases from 11 to 10 and days of sales outstanding increase by 5, the company’s Cash conversion cycle will: A. decreases by approximately 8 days. B. decreases by approximately 3 days. C. increases by approximately 2 days.

Ans: C. Cash conversion cycle (CCC) = Days of inventory on hand (DOH) + Days Sales Outstanding (DSO) – payables payment period Payables payment period ===33.18days =36.5days Since the payables payment period increases by 3.32 days and receivables days increases by 5, CCC increases by 1.68 days.