Answers To Exercises Fs Analysis

True / False Questions
1. In determining whether a company's financial condition is improving or deteriorating over

time, vertical analysis of financial statement data would be more useful than horizontal analysis.
FALSE
2. Trend percentages state several years' financial data in terms of a base year. For example, sales
for every year would be stated as a percentage of the sales in the base year.
TRUE
3. The gross margin percentage is computed taking the difference between sales and cost of
goods and then dividing the result by sales.
TRUE
4. The gross margin percentage is computed by dividing net income before interest and taxes by
sales.
FALSE
5. The acid-test ratio is a test of the quality of accounts receivable--in other words, whether they
are likely to be collected.
FALSE

6. Net operating income will always increase when a company increases its accounts receivable
turnover.
FALSE
7. The inventory turnover ratio is equal to the average inventory balance divided by the cost of
goods sold.
FALSE
8. Working capital equals current assets, plus noncurrent liabilities and stockholders' equity, less
total assets.
TRUE
2. Bracken Company's net income last year was $85,000 and its interest expense was $10,000.
Total assets at the beginning of the year were $660,000 and total assets at the end of the year
were $600,000. The company's income tax rate was 30%. The company's return on total assets
for the year was closest to:
Return on total assets = {Net income + [Interest expense  (1 - Tax rate)]}  Average total assets
= ($85,000 + $7,000*)  $630,000** = $92,000  $630,000** = 14.6%
*$10,000  (1 - 0.30) = $7,000
**$1,260,000 ($660,000 + $600,000)  2 = $630,000

3. The total assets of the Philbin Company on January 1 were $2.3 million and on December 31
were $2.5 million. Net income was $188,000. Dividends totaled $75,000, interest expense totaled
$70,000, and the tax rate was 30%. The return on total assets was closest to:
Return on total assets = {Net income + [Interest expense  (1 - Tax rate)]}  Average total assets
= ($188,000 + $49,000*)  $2,400,000** = $237,000  $2,400,000** = 9.9%
*$70,000  (1 - 0.30) = $49,000
**($2,300,000 + $2,500,000)  2 = $4,800,000  2 =$2,400,000

4. Excerpts from Melby Corporation's most recent balance sheet appear below:

Net income for Year 2 was $94,000. Dividends on common stock were $33,000 in total and
dividends on preferred stock were $11,000 in total. The return on common stockholders' equity
for Year 2 is closest to:
Return on common stockholders' equity = (Net income - Preferred dividends)  (Average total
stockholders' equity - Average preferred stock) = ($94,000 - $11,000)  ($1,265,000* -
$200,000**) = $83,000  $1,065,000 = 7.8%
*(1,240,000 + $1,290,000)  2 = $2,530,000  2 = $1,265,000
**($200,000 + $200,000)  2 = $400,000  2 = $200,000
5. Draper Company's working capital is $12,000 and its current liabilities are $71,000. The
company's current ratio is closest to:
Working capital = Current assets - Current liabilities

$12,000 = Current assets - $71,000
Current assets = $83,000
Current ratio = Current assets  Current liabilities = $83,000  $71,000 = 1.17
6. Harwichport Company has a current ratio of 3.5 and an acid-test ratio of 2.8. Current assets
equal $175,000 of which $5,000 consists of prepaid expenses. The remainder of current assets
consists of cash, accounts receivable, marketable securities, and inventory. Harwichport
Company's inventory must be:
Current ratio = Current assets  Current liabilities
3.5 = $175,000  Current liabilities
Current liabilities = $50,000
Acid-test ratio = (Cash + Marketable securities + Accounts receivable + Short-term notes
receivable)  Current liabilities
2.8 = (Cash + Marketable securities + Accounts receivable + Short-term notes receivable) 
$50,000
(Cash + Marketable securities + Accounts receivable + Short-term notes receivable) = $140,000
The $35,000 ($175,000 - $140,000) difference between current assets and the acid-test ratio
numerator is attributable to inventory and prepaid expenses; the inventory must be $30,000
($35,000 - $5,000) given that prepaid expenses are $5,000.

7. Marcy Corporation's current ratio is currently 1.75. The firm's current ratio cannot fall below
1.5 without violating agreements with its bondholders. If current liabilities are presently $250
million, the maximum new short-term debt that can be issued to finance an equivalent amount of
inventory expansion is:
Current ratio = Current assets  Current liabilities

1.75 = Current assets  $250 million
Current assets = $437.5 million
Current ratio = (Current assets + new short-term debt)  (Current liabilities + new short-term
debt)
1.5 = ($437.5 + new short-term debt)  ($250 + new short-term debt)
New short-term debt = $125 million
8. Eradicate Company has $16,000 in cash, $8,000 in marketable securities, $29,000 in account
receivable, $30,000 in inventories, and $34,000 in current liabilities. The company's current
assets consist of cash, marketable securities, accounts receivable, and inventory. The company's
acid-test ratio is closest to:

receivable)  Current liabilities = ($16,000 + $8,000 + $29,000)  $34,000 = $53,000  $34,000
= 1.56

9. Frawner Company had $140,000 in sales on account last year. The beginning accounts
receivable balance was $12,000 and the ending accounts receivable balance was $10,000. The
company's accounts receivable turnover was closest to:
Accounts receivable turnover = Sales on account  Average accounts receivable balance =

$140,000  $11,000* = 12.73
*($12,000 + $10,000)  2 = $22,000  2 = $11,000

10. Grast Company had $170,000 in sales on account last year. The beginning accounts
receivable balance was $14,000 and the ending accounts receivable balance was $16,000. The
company's average collection period was closest to:

$170,000  $15,000* = 11.33
*($14,000 + $16,000)  2 = $30,000  2 = $15,000
Average collection period = 365 days  Accounts receivable turnover = 365 days  11.33 =
32.21 days

PROBLEMS
1. Harrison Company, a retailer, had cost of goods sold of $180,000 last year. The beginning
inventory balance was $26,000 and the ending inventory balance was $24,000. The company's
inventory turnover was closest to:
Inventory turnover = Cost of goods sold  Average inventory balance = $180,000  $25,000* =
7.2
*($26,000 + $24,000)  2 = $50,000  2 = $25,000

2. Irawan Company, a retailer, had cost of goods sold of $200,000 last year. The beginning
inventory balance was $24,000 and the ending inventory balance was $22,000. The company's
average sale period was closest to:
Inventory turnover = Cost of goods sold  Average inventory balance = $200,000  $23,000* =
8.7
*($24,000 + $22,000)  2 = $46,000  2 = $23,000
Average sale period = 365 days  Inventory turnover = 365 days  8.7 = 41.96 days

3. Naser Corporation's total current assets are $390,000, its noncurrent assets are $500,000, its
total current liabilities are $330,000, its long-term liabilities are $370,000, and its stockholders'
equity is $190,000. Working capital is:
Working Capital = Current assets - Current liabilities = $390,000 - $330,000 = $60,000
4. Cintron Corporation's total current assets are $370,000, its noncurrent assets are $740,000, its
total current liabilities are $300,000, its long-term liabilities are $430,000, and its stockholders'
equity is $380,000. The current ratio is closest to:
Current ratio = Current assets  Current liabilities = $370,000  $300,000 = 1.23

5. Data from Sawin Corporation's most recent balance sheet appear below:

The company's acid-test ratio is closest to:

receivable)  Current liabilities = ($12,000 + $27,000 + $31,000)  $100,000 = $70,000 
$100,000 = 0.70

6. Dondero Corporation has provided the following data:

The accounts receivable turnover for this year is closest to:

$821,000  $122,500* = 6.70
*($124,000 + $121,000)  2 = $245,000  2 = $122,500

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True / False Questions

1. In determining whether a company's financial condition is improving or deteriorating over

Working capital = Current assets - Current liabilities

Current ratio = Current assets  Current liabilities

Acid-test ratio = (Cash + Marketable securities + Accounts receivable + Short-term notes

Accounts receivable turnover = Sales on account  Average accounts receivable balance =

Accounts receivable turnover = Sales on account  Average accounts receivable balance =

Working Capital = Current assets - Current liabilities = $390,000 - $330,000 = $60,000

Current ratio = Current assets  Current liabilities = $370,000  $300,000 = 1.23

Acid-test ratio = (Cash + Marketable securities + Accounts receivable + Short-term notes

Accounts receivable turnover = Sales on account  Average accounts receivable balance =

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