Financial Statement Analysis Questions and Answers

Financial Statement Analysis Questions and Answers A financial analyst is required to analyze the financial statements of Alliah Company. While analyzing, the analyst discovered that the company does not have adequate current assets to meet its total current liabilities. Thus, the company might face difficulties in meeting its upcoming payments toward its current liabilities. Which method did the financial analyst use to make this analysis? The financial analyst calculated various short-term liquidity ratios. 3 multiple choice options A financial analyst who was analyzing Company P's financial statements concluded that this year, the company's revenue increased by 20%, gross income by 16%, and net income by 10%. Last year, the same items increased by 12%, 6%, and 4%, respectively. Which financial statement analysis tool did the financial analyst use to conclude? Percentage change financial statements 3 multiple choice options A company evaluates the industry's economic conditions using Porter's five forces model. Using the analysis, the company wishes to identify the vertical competition in the value chain and its impact on its performance. Which one of Porter's five forces should the company refer to? Buyer power 3 multiple choice options A start-up's chief executive officer (CEO) plans to expand the business by acquisition of a mature company. The CEO is particularly interested in companies that exhibit superior sales volume and market share and is willing to accept low profit margins. Which company meets the CEO's investment criteria based on the framework for strategic analysis? A company that sells nondifferentiated products 3 multiple choice options Corollary Marketing has prepared the common-size balance sheet for the current year and has determined the following percentages: Cash and equivalents: 15% Receivables: 20% Property, plant, and equipment: 12% Accumulated depreciation: (5%) Accounts payable: 9% How does Corollary Marketing calculate these percentages? All items are a percentage of total assets. 3 multiple choice options Orange Zest Company specializes in household goods and appliances. In recent years, the market has become increasingly competitive with the emergence of new entrants. In light of this, the business decided to continue selling its nondifferentiated items while taking a smaller profit margin in exchange for increased market share and sales volume. Which strategy did the company choose to compete in its industry? Low-cost leadership strategy 3 multiple choice options A company's financial analyst identified that the cost of goods sold in a common-size income statement was 18% in the previous year. However, it changed to 21% in the current year. What does this analysis indicate? The cost of goods sold as a percentage of sales has increased. 3 multiple choice options A company's financial analyst analyzes the current year's income statement and balance sheet. The analyst has already calculated some of the profitability and risk ratios. The company wants the analyst to determine what a reasonable price for the company's common shares is. Which ratio will help the analyst in fulfilling the requirement? Price-earnings ratio 3 multiple choice options A firm's management team is examining the income statement and is concerned that while revenues are growing, gross profit is declining. Which financial activity caused the decline? An increase in cost of sales 3 multiple choice options A hardware manufacturing firm has high expenditures on property, plant, and equipment (PPE). Where in the statement of cash flows are the net additions reflected? Investing 3 multiple choice options A financial analyst analyzes a company's recently published annual report to estimate the company's future earnings. While adjusting the company's net income to estimate the company's future profitability, the company excluded the income on investment securities deemed available for sale. Why did the analyst exclude the income on investment securities deemed available for sale? Because the income is treated as transitory 3 multiple choice options A financial analyst is assessing a tech company's financial statement and has noted the following findings: The company's net income is $1,950,000 for this year. The company has reported $80,000 toward a gain on the sale of buildings. The company has reported a gain of $50,000 from the sale of old laptops used by employees. The company has been selling a batch of old laptops every year for the last four years. The company has recorded a fair value income of $120,000 on securities that are deemed available for sale. Which net income will the financial analyst consider for future earnings prediction for the company? (Ignore income tax for this problem.) $1,750,000 3 multiple choice options A financial analyst is analyzing Sparkit's financial statement. The analyst noticed that the company uses special purpose entities (SPE) to meet its short-term needs and treats this transaction as a collateralized loan. What should the analyst consider while analyzing Sparkit's liabilities? Sparkit enjoys the benefits and takes the economic risks of the receivables. 3 multiple choice options A financial analyst excluded other comprehensive items reported in the income statement while estimating the company's future earnings. Why did the analyst exclude this item from the analysis? As these are considered transitory income or loss 3 multiple choice options While analyzing the financial statements of a company, a financial analyst noticed a contingent liability of $2 million reported on its balance sheet. This contingent liability is related to a lawsuit filed by one of the customers for the damage caused by the malfunction of the company's product. Which interpretation should the financial analyst make for this item? The company expects to probably lose the lawsuit and has reasonably estimated the loss to be $2 million. 3 multiple choice options Which two factors can affect the accounting quality in the case of reporting inventory? The accounting choice and management judgment 3 multiple choice options A financial analyst has extracted the data from the current year regarding a consumer durable firm's financial statement. The analyst has computed the accrual component of current earnings for analysis as follows: Net income $4,500,000 Cash inflows from operations $2,800,000 Average total assets $5,000,000 Accrual component of current earnings 0.34 Which judgment can the analyst make about the accruals and earnings quality of the firm? The firm has reported income-increasing accruals and low earnings quality. 3 multiple choice options A financial analyst analyzing a company's financial statements has decided to include the gain on the sale of equipment to assess the current period profitability of the company. What can be a possible reason for the analyst to do so? The analyst noticed that gains and losses from the sale of equipment is a corporate strategy for the company. 3 multiple choice options How will a company's gross margin percentage index (GMI) change if its gross margin decreases in the current year compared to last year? The company's GMI will be greater than one. 3 multiple choice options In which case does a high sales growth index (SGI) indicate the possibility of management engaging in the manipulation of earnings? When a growing company is able to secure low-cost external debt 3 multiple choice options Two years ago, a brokerage services company purchased an electric vehicle with a list price of $100,000. During the purchase, the company paid money to get the title to the vehicle. The company also paid the license fee for operating the vehicle in the first year and property and liability insurance for its first year of operation. How should the electric vehicle be valued in financial statements, and how will it impact the financial results? It should be valued at the adjusted historical cost, and the financial results might be inaccurate as it relates to uncertain future amounts. 3 multiple choice options A company purchased a tract of land for a cash purchase price of $225,000 in January 20X1. The market value of the tract of land in December 20X5 is $400,000. What is the impact of the difference in the financial statement? The land is undervalued in the financial statements. 3 multiple choice options Rusty RoboTech had purchased a plant and equipment in 20X1. The market value of the plant and equipment in 20X3 is less than the value of the plant and equipment in the balance sheet. What does this valuation indicate about the company's financial performance? The assets of the company are overstated. 3 multiple choice options A financial analyst is reviewing a company's financial statements prepared using the rules laid out by the Generally Accepted Accounting Principles (GAAP). The analyst wants to determine whether its assets and liabilities are valued appropriately as per the mixed attribution model and wishes to use these results for investment purposes. What should the analyst be aware of while analyzing the company's balance sheet? The adjusted historical cost method is the valuation method used for equipment and other depreciable assets. 3 multiple choice options A supermarket chain issues cards that are pre-loaded with cash to its customers. Customers have three years to utilize these pre-loaded cards in the company's physical stores or online stores. The company records revenue on the date of loading the card with cash. What is the impact of this transaction the company's financial performance? The liabilities of the company are understated. 3 multiple choice options Endothon Company, an electronics manufacturer, follows the mixed attribute measurement model to measure its assets, liabilities, expenses, and income. Which asset's measurement closely reflects current market conditions? Inventories measured at lower of cost or fair value 3 multiple choice options How does depreciation on equipment impact the variance in tax basis and realized value on a balance sheet? As a temporary difference in reporting periods 3 multiple choice options A financial analyst is analyzing a company's statement of cash flows prepared using the indirect method. Which information can the analyst obtain from the operating section of the statement of cash flows? The changes in the working capital of the company for the year 3 multiple choice options Which information can be found in the statement of cash flows prepared using the direct method that cannot be found in the statement if prepared using the indirect method? The amount of cash the company generated through sales 3 multiple choice options A financial analyst is analyzing the financial statements of Merrilton Robotics, which is in the growth phase of the business life cycle. The analyst noticed that the company reported positive net income but negative cash flows from operating activities. The analyst also noticed that the company's cash flows from financing activities were positive. What is a possible reason for this distinction between the company's net income and net operating cash flows? The company's accounts receivable increased rapidly this year. 3 multiple choice options A company's balance sheet shows that its common stock has increased from $10 million to $11 million. Which interpretation can be made based on this information? It is a source of cash and is classified as a financing activity. 3 multiple choice options A footwear and accessories retailer drew out its statement of cash flows, and it shows that the cash flow from operations is $1,345,000. The firm reported a net income of $2,530,000. What is a possible reason for the reported net income to be significantly higher than the cash flow from operating activities? Decrease in accounts payable 3 multiple choice options A company's statement of cash flows for the year ended 20X3 is provided as follows (amounts in thousands): Operating Activities: Net income $380 Depreciation $300 Changes in Working Capital Accounts: Accounts receivables ($330) Inventory ($210) Other current assets ($10) Accounts payable $160 Other current liabilities $50 Net cash flows from operating activities $340 Investing Activities: Purchase of equipment ($650) Net cash flows from investing activities ($650) Financing Activities: Increase in long-term bond Proceeds from the sale of common stock $720 Net cash flows from financing activities $720 Net change in cash $410 Cash at the beginning of the year $140 Cash at the end of the year $550 Which conclusion can be accurately drawn from the provided cash flow statement? The company's ownership has diluted in 20X3. 3 multiple choice options Which change in the balance sheet item affects the investing activities section in the financial statements? Changes in the intangible assets 3 multiple choice options A building materials manufacturing company reported net income of $4,125,000 for 20X8. In the statement of cash flows for 20X8, the net cash flows from operations is $7,315,000. What is a possible reason for the reported net income to be significantly lower than the cash flow from operations? High amortization expenses in 20X8 3 multiple choice options A company's statement of cash flows for the year ended 20X2 is shown as follows (amounts in thousands): Operating Activities: Net income $2,300 Depreciation $350 Loss on sale of machinery $10 Changes in Working Capital Accounts: Accounts receivables ($420) Inventory ($280) Other current assets ($110) Accounts payable $290 Other current liabilities $120 Net cash flows from operating activities $2,260 Investing Activities: Sale of machinery $40 Net cash flows from investing activities $40 Financing Activities: Cash dividend paid ($400) Repayment of long-term loan ($1,000) Net cash flows from financing activities ($1,400) Net change in cash $900 Cash at the beginning of the year $780 Cash at the end of the year $1,680 Which precise interpretation can be made from the given cash flow statement? The company has used cash from operations in 20X2 to repay its debts. 3 multiple choice options In which phase of the business life cycle does a company have falling cash flows from operating and investing activities and negative cash flows from financing activities? Decline phase 3 multiple choice options How does payment recognition from clients under the direct method on the statement of cash flows influence financial stability? It increases the number of cash receipts from customers. 3 multiple choice options Which ratio measures a firm's profitability but ignores the proportion of debt versus equity financing that the firm uses? Return on assets 3 multiple choice options The portion of Endothon Company's financial statements at the beginning and end of the current year include the following. Preferred stock, $150 par value, 1,000 shares issued and outstanding on January 1, and December 31 Common stock, $50 par value, 5,000 shares issued and 5,000 shares outstanding on January 1 and 4,000 shares outstanding on December 31 Additional paid-in capital Retained earnings Treasury stock - common (2,000 shares) Total stockholders' equity Which statement regarding the company's basic earnings per share (EPS) and diluted earnings per share (EPS) is accurate? The basic EPS should be calculated to determine the profitability and diluted EPS is not required, as there are no diluters in the capital structure. 3 multiple choice options A company's cost of goods sold to sales percentage and the inventory turnover ratio have increased in the current year, when compared to the previous year. What is the possible reason behind this increase? The company has lowered the product prices to sell inventory more quickly. 3 multiple choice options The data from 20X3 financial statements of Yellow Leaf Bookstore is as follows. Cost of goods sold $58,000 Beginning inventory $28,000 Purchases $35,000 Sales $70,000 Accounts receivable $48,000 Accounts payable $22,000 What does the inventory turnover ratio of the company indicate? Assume 365 days in a year. The inventory was held for 103.84 days before selling. 3 multiple choice options Which technique helps in analyzing whether a company can strategically employ debt financing to boost common shareholders' returns on investment? Return on capital employed (ROCE) 3 multiple choice options A furniture retailer wishes to determine the ratio of current assets that could be converted into cash within 90 days and the obligations coming due during the period. The company's sales turnover is slow and the inventory quickly becomes obsolete. Which ratio should the company calculate? Acid-test ratio 3 multiple choice options A company has determined its return on capital employed (ROCE) for the first time in the current year as 24.2%. However, the company is not sure if the company's performance is good or bad. The company's management has approached a finance expert to suggest a benchmark to analyze the company's performance. Which benchmark should the finance expert suggest? Return demanded by the common shareholders 3 multiple choice options A financial analyst estimates a company's free cash flows for all debt and equity stakeholders. Which item will the analyst add to the cash flow from operations while estimating the company's free cash flows for all debt and equity stakeholders? Cash from the sale of the company's machinery 3 multiple choice options Autojor is a tech firm with the following financial projections for the next three years: Year 1 Year 2 Year 3 Net income $300,000 $320,000 $340,000 Expected increase in net working capital (NWC) $20,000 $25,000 $30,000 Expected capital expenditures $50,000 $60,000 $70,000 The required rate of return on equity (RE) is 11%. Assume there are no debt payments or preferred dividends. The present value (PV) of $1 at the end of the period for 11% is as follows: Period 1 2 3 Factor 0.901 0.812 0.731 What is the sum of the present value of free cash flows to Autojor's common shareholders for the three years, rounded to the nearest whole dollar? $573,490 3 multiple choice options Plairtrack, a leading tech firm, provided the following financial information for the current fiscal year: Free cash flows from operations for equity $150,000 Depreciation and amortization $25,000 Net capital expenditure $40,000 Interest expense (after tax) $8,000 Change in working capital $10,000 (increase) New borrowings. $50,000 Corporate tax rate 25% Pruhart Tech, another tech company, plans to purchase the company at four times Plairtrack's free cash flow for common equity stakeholders. What is Plairtrack's free cash flow for common equity stakeholders that is to be used for its valuation? $160,000 3 multiple choice options A financial analyst analyzing Freedom Rock Bicycles' valuation has derived the company's present value (PV) of free cash flows to all debt and equity stakeholders as $49,964,700. The analyst has assumed the cash flows to be at the end of the year for discounting. The analyst was able to ascertain the following additional details of the company: Book value of common equity $28,990,000 Number of common shares outstanding 1,000,000 Book value of total debt $17,000,000 Fair value of total debt $18,300,000 Return on equity (RE) 9% Weighted average cost of capital 6.5% What is the Freedom Rock Bicycles' value per share? (All options are in whole dollars.) $32.69 3 multiple choice options Paradigm Toys provided the following projected financial data for the next three years (in thousands): 20X1 20X2 20X3 Free cash flows—all debt and equity stakeholders $4,234 $3,496 $4,353 The company's weighted average cost of capital (WACC) is 6%. This free cash flow amount is the beginning of a perpetuity of continuing free cash flows that the company will generate beginning in 20X3, growing at 2.0% each year thereafter. The present value (PV) of $1 at the end of the period for 6% is as follows: Period 1 2 3 Factor 0.943 0.890 0.840 What is Paradigm Toys' PV of the continuing value of free cash flows to all debt and equity for 20X3 and beyond? $96,854,250 3 multiple choice options A financial analyst is analyzing a company's valuation based on their estimated future cash flows. The analyst has calculated the following details about the company: Present value (PV) of free cash flows for common equity shareholders from Year 1 through Year 3 $1,328,600 PV of continuing free cash flows for common equity shareholders in Year 4 and beyond $8,790,000 The analyst noticed that in Year 3 the increase in cash required for operations was $130,000 and not $80,000. What will be the valuation of the company after considering the change if the company's rate of return on equity is 9%? (Use PV factor for 9% for 3 years as 0.772.) $10,533,600 3 multiple choice options Wild Parsley Grill provided the following projected financial data from its financial records: Cash flows from operations $1,012,000 Net interest expense $100,000 Changes in cash required for liquidity (decrease) $200,000 Cash inflow from sale of old assets $80,000 Cash outflow from repayment of borrowings $240,000 Marginal corporate tax rate 25% Endothon Company plans to acquire the Wild Parsley Grill to enter the market of Golden Maple. Endothon Company has proposed to pay eight times the company's free cash flows for common equity shareholders. What is the value of Wild Parsley Grill based on Endothon Company's proposal? $8,416,000 3 multiple choice options An automobile manufacturing company uses earnings-based valuation model for its valuation. The company's information is as follows. Earnings before interest and taxes = $10 million Depreciation and amortization = $1 million Interest expense = $2 million Market capitalization = $120 million Total debt = $22 million Total cash and cash equivalents = $18 million What is the Enterprise value (EV) / Earnings before interest, taxes, depreciation, and amortization (EBITDA) multiple? 11.27 3 multiple choice options A company has the following financial details. Total earnings = $3.50 million Depreciation and amortization = $500,000 Total debt = $1 million Market price = $80 per share Number of outstanding shares = 500,000 shares What is the price-earnings (PE) ratio of the company? 11.43 3 multiple choice options A company's financial information is as follows: Sales revenue = $40 million Net income = $18 million Operating expenses = $8 million Interest expense = $5 million Depreciation and amortization expense = $7 million Income tax expense = $2 million Market price per share = $120 Number of shares outstanding = 2 million shares Total assets = $90 million (cash and cash equivalents = $15 million) Total debt = $65 million What is the Earnings before interest and taxes / Enterprise value (EBIT / EV) of t he company? 8.62% 3 multiple choice options A company has 12 million outstanding shares and the market value per share is $28.00. The company's earnings before interest and taxes (EBIT) during the year is $50.00 million. The company incurred the following expenses during the year. Depreciation and amortization expense = $8 million Selling and administration expense = $10 million Interest expense = $5 million Tax expense = $2 million What is the price-earnings (PE) ratio of the company? 7.91 3 multiple choice options A company's EV / EBITDA multiple in the most recent year is 11.50. The company is planning to buy new equipment worth $3 million to explore new opportunities. This is going to lead to an additional depreciation expense of $250,000 per year. What effect does the equipment purchase have on the Enterprise value / Earnings before interest, taxes, depreciation, and amortization (EV / EBITDA) multiple, assuming all other values remain constant? There is no impact on the EV / EBITDA multiple. 3 multiple choice options A company has a market capitalization of $400 million. The company's cash and cash equivalents are worth $35 million, and the total debt is worth $80 million. A snippet of the company's income statement is given below: Revenue $70 million Less: Cost of goods sold $20 million Gross profit $50 million Less: Depreciation expense $6 million Less: Amortization expense $7 million Operating income $37 million Less: Interest expense $5 million Profit before taxes $32 million Less: Taxes $2 million Net income $30 million What is the Enterprise value / Earnings before interest, taxes, depreciation, and amortization (EV / EBITDA) multiple of the company? 8.90 3 multiple choice options Paradigm Toys reported a net income of $180 million in the current year. The company has 50 million shares outstanding and the current market price per share is $110. The analysts of the company predict that the net income available for shareholders is going to increase by 12% in the next year. The company also predicts retaining the entire amount of net income and not paying any dividend. What is Paradigm Toys' forward price-earnings (PE) ratio, if the company estimates not to issue any shares for the next five years? 27.29 3 multiple choice options An investor is valuing Sparkit, a start-up. The investor uses the price-to-sales (P/S) multiple of Autojor, another public company, that is similar to Sparkit to value Sparkit. What is a possible reason for the investor to use the P/S multiple method to value Sparkit? Sparkit is still generating operating losses. 3 multiple choice options Firm T, a legal firm, plans to purchase Firm Q, which offers legal consultancy services. The owners of Firm Q are asking for $78 million. Firm Q generated an annual revenue of $130 million last year, and its net income margin was 50%. Firm Q has total assets worth $10 million as per its books. According to Firm T's research, firms similar to Firm Q are sold at a price-to-sales (P/S) multiple of 0.9. Should Firm T purchase Firm Q? Yes, as Firm Q's valuation of $117 million is more than the asking price of $78 million. 3 multiple choice options The owner of a privately owned manufacturing company is planning to sell the business. The major asset of the company is its plant, which has a book value of $100 million, and the land in which this plant is situated, which has a book value of $70 million. The plant still has a useful life of 20 years. As per the market value, the plant is worth $90 million, and the land is worth $100 million. The company has a total debt of $30 million. What is the market value of equity if the company is valued using the asset-based valuation method? $160,000,000 3 multiple choice options Which company finds the asset-based valuation method more appropriate for its firm value calculation? A company that does not have intangible assets 3 multiple choice options Firm A is an accounting firm whose financial statements show the following data for the last year: Revenue: $235 million Net income: $138 million Accounts receivables: $47 million Cash and cash equivalent: $20 million Fixed assets: $15 million A similar accounting firm was recently sold for a 0.90 price-to-sales (P/S) multiple. What is the value of Firm A? $211,500,000 3 multiple choice options Which company should be valued using the sales multiple valuation method for a reasonable valuation? Company M, which provides tax and accounting services 3 multiple choice options A company has decided to sell its business because it has a cash crunch. It intends to use asset-based analysis to get a rough idea of what its adjusted net asset value is. The company has listed the book value and fair market value of its assets and liabilities in the following table: Book Value Fair Market Value Cash and cash equivalents $200,000 $200,000 Accounts receivables $220,000,000 $198,000,000 Inventory $189,000,000 $122,850,000 Property and equipment $350,000,000 $262,500,000 Short-term liabilities $50,000,000 $50,000,000 Long-term liabilities $220,000,000 $220,000,000 What is the adjusted net asset value of the company? $313,550,000 3 multiple choice options