MANAGEMENT ADVISORY SERVICES

REVIEWER

1.)
Which of the following statements is not correct concerning the price to earnings (PE) ratio?
A. PEs tend to be larger in industries experiencing high growth.
B. PEs tend to vary a great deal; however, they tend to be similar within industries.
C. Assume that a firm gives stock options to its managers and net income and the PE
ratio remain relatively steady. The result of the stock option issuance would be an
increase in stock price.
D. The PE ratio is a measure of investor confidence in the management of a firm. A high
ratio implies greater confidence.
EXPLANATION:
The PE ratio is defined as the market price of the stock divided by fully diluted earnings per
share (EPS). If a firm issues stock options, fully diluted EPS should decrease. If the firm's PE
ratio is fairly constant, then the firm's stock price must fall.

2.)
Mayson Company reported net income of $350,000 for last year. The company had 100,000
shares of $10 par value common stock outstanding and 5,000 shares of common stock in treasury
during the year. Mayson declared and paid $1 per share dividends on common stock. The market
price per common share at the end of last year was $30. The company's dividend yield for the
year was:
A. 30.03%.
B. 28.57%.
C. 11.11%
D. 3.33%.
EXPLANATION:
The dividend yield on common stock is calculated as:
Dividend yield on common stock = (annual dividend per common share) / (market price of
common stock)
Therefore, the dividend yield = $1 / $30 = 0.0333, or 3.33%.
3.)
ABC Corporation has earnings per share of $5, pays a dividend of $1 per share, and has a current
market price of $60 per share. What is ABC Corporation's common stock dividend yield?
A. 1.7%.
B. 8.3%.
C. 1.2%.
D. 20%.
EXPLANATION:
The dividend yield is calculated by dividing the dividends per common share by the current
market price per share. $1 dividend per share ÷ $60 current market price = 0.017, or 1.7%.

4.)
Capital structure is the:
A. mix of current and long-term assets, such as cash and fixed assets (plants and equipment).
B. terms a firm has on its equity, such as dividend payment schedules, stock repurchase
agreements, etc.
C. mix of equity, such as common stock, preferred stock, paid-in capital, and retained
earnings.
D. mix of debt and equity the firm uses to finance operations and asset purchases.

EXPLANATION:
Capital structure is the mix of long-term debt, on which interest and principal payments must be
made, and equity, in the form of common and preferred stock, which the firm uses to finance
operations.

5.)
A firm's total assets are $3,000,000 and its total equity is $2,000,000. If current assets represent
50% of total assets and current liabilities represent 30% of total liabilities, then what is the firm's
working capital?
A. $500,000.
B. $4,000,000.
C. $1,800,000.
 D. $1,200,000.
EXPLANATION:
Working capital is current assets minus current liabilities: $1,500,000 − $300,000 =
$1,200,000.

6.)
Globetrade is a retailer that buys virtually all of its merchandise from manufacturers in a country
experiencing significant inflation. Globetrade is considering changing its method of inventory
costing from first-in, first-out (FIFO) to last-in, first-out (LIFO). What effect would the change
from FIFO to LIFO have on Globetrade's current ratio and inventory turnover ratio?
A. Both the current ratio and the inventory turnover ratio would decrease.
B. The current ratio would decrease but the inventory turnover ratio would increase.
C. The current ratio would increase but the inventory turnover ratio would decrease.
D. Both the current ratio and the inventory turnover ratio would increase.

EXPLANATION:
The value of inventory as a result of changing from FIFO to LIFO would decrease when prices
are rising. The effect of the change in inventory valuation would cause the current ratio to
decrease but the inventory turnover ratio would increase.

7.)
All of the following are included when calculating the acid test ratio except:
A. six-month treasury bills.
B. 60-day certificates of deposit.
C. prepaid insurance.
D. accounts receivable.
EXPLANATION:
The acid test ratio is calculated as cash plus marketable securities plus accounts receivable
divided by total current liabilities or as current liabilities less inventories and prepayments
divided by current liabilities.
8.)
A firm's financial risk is a function of how it manages and maintains its debt. Which one of the
following sets of ratios characterizes the firm with the greatest amount of financial risk?
A. high debt-to-equity ratio, low interest coverage ratio, volatile return on equity.
B. low debt-to-equity ratio, low interest coverage ratio, volatile return on equity.
C. high debt-to-equity ratio, high interest coverage ratio, volatile return on equity.
D. low debt-to-equity ratio, high interest coverage ratio, stable return on equity.

EXPLANATION:
Financial risk is represented by the variability in expected returns, and a volatile return on equity
is risky. An increase in the debt-to-equity ratio increases risk by the increased debt load. A
decrease in the interest coverage ratio increases risk by decreasing the organization's ability to
service its debt.

9.)
Which of the following ratios is NOT considered a solvency measure?
A. Times interest earned.
B. Debt-to-equity ratio.
C. Current ratio.
D. Financial leverage index.

EXPLANATION:
The current ratio is considered a liquidity ratio and not a solvency ratio. The other ratios listed
are considered solvency ratios.

10.)
When reviewing a credit application, the credit manager should be most concerned with the
applicant's:
A. price-earnings ratio and current ratio.
B. working capital and return on equity.
C. working capital and current ratio.
D. profit margin and return on assets.

EXPLANATION:
Liquidity measures, such as net working capital and the current ratio, help determine ability to
pay expenses on a timely basis. Therefore, the credit manager should be most concerned with
these measures in comparison to the others listed in the problem. Profit margin, price-earnings
ratio, and return on equity are profitability measures.

11.)
On a manufacturing company's income statement, sales are $50 million and cost of goods
manufactured equals $25 million. If beginning and ending finished goods inventory are $3
million and $4 million, respectively, which of the following statements is true?
A. Gross profit equals $26 million.
B. Gross profit equals $25 million.
 C. Contribution margin equals $25 million.
D. Gross profit equals $24 million.

EXPLANATION:
The gross profit is sales minus the cost of goods sold. Cost of goods sold is beginning finished
goods inventory plus cost of goods manufactured minus ending finished goods inventory ($3 +
25 − 4 = $24 million). Therefore, gross profit is $50 million − $24 million = $26 million.

12.)
The acid test ratio shows the ability of a company to pay its current liabilities without having to:
A. reduce its cash balance.
B. liquidate its inventory.
C. borrow additional funds.
D. collect its receivables.

EXPLANATION:
The acid test ratio is calculated as current assets less inventories and prepayments divided by
total current liabilities. The acid test ratio shows the ability of a company to pay its current
liabilities without having to liquidate its inventory.

13.)
During the current year, Beverly Industries reports an inventory turnover of 10 times, a gross
profit margin of 30%, a net profit margin of 4%, and average inventory of $21,000. What are net
sales for the year?
A. $2,800,000.
B. $700,000.
C. $210,000.
D. $300,000.

EXPLANATION:
Since we know that average inventory is $21,000 and the inventory turnover rate is 10X, we can
find that cost of goods sold (COGS) is $210,000. Since the gross profit margin is 30%, the firm's
COGS must be 70% of net sales. Therefore, net sales must be $300,000.

14.)
Douglas Company purchased 10,000 shares of its common stock at the beginning of the year for
cash. This transaction will affect all of the following except the:
A. net profit margin.
B. earnings per share.
C. current ratio.
D. debt-to-equity ratio.

EXPLANATION:
The issuance of stock has no effect on profit margin (net income divided by sales). It would
increase equity, decreasing the debt/equity ratio. The increased number of shares outstanding
would decrease earnings per share (net income divided by shares). The cash received would
increase cash, a current asset, and the current ratio (current assets divided by current liabilities).

15.)
Firms with high degrees of financial leverage would be best characterized as having:
A. high fixed-charge coverage.
B. zero coupon bonds in their capital structures.
C. high debt-to-equity ratios.
D. low current ratios.

EXPLANATION:
Financial leverage is the use of debt (fixed cost funds) to increase returns to owners
(stockholders). A high degree of financial leverage means the benefits from tax deductibility of
interest (from additional debt) is more than offset by the increase in the payments to repay the
debt.

16)
If a company is profitable and is effectively using leverage, which one of the following ratios is
likely to be the largest?
A. return on total assets (ROA).
B. return on total shareholders' equity.
C. return on investment (ROI).
D. return on common equity (ROE).

EXPLANATION:
ROE is equal to ROA multiplied by the leverage ratio. The leverage ratio is the ratio of total
assets to common stock equity. The leverage ratio is greater than one if leverage is effective.
ROA is also called ROI. Total shareholders' equity includes preferred stock, which is part of the
financial leverage.

17.)
A bondholder would be most concerned with which one of the following ratios?
A. Inventory turnover.
B. Times interest earned.
C. Earnings per share.
D. Quick ratio.

EXPLANATION:
Times-interest-earned ratio reflects the company's ability to meet interest payments when they
are due. Since long-term creditors (bond holders) are interested in the company's long-run
solvency, the times-interest-earned ratio provides a valuable analysis.
18.)
The owner of a chain of grocery stores has bought a large supply of mangoes and paid for the
fruit with cash. This purchase will adversely impact which one of the following?
A. Current ratio.
B. Working capital.
C. Price earnings ratio.
D. Quick or acid test ratio.

EXPLANATION:
The acid test ratio is calculated as current assets less inventories and prepayments divided by
total current liabilities. Purchasing inventory and paying cash would adversely impact this ratio
by decreasing cash. The cash purchase of inventory has no effect on current assets and, therefore,
will not affect working capital (current assets – current liabilities) or the current ratio (current
assets divided by current liabilities). Purchases have no effect on the price earnings ratio (stock
price divided by EPS).

19.)
All of the following are affected when merchandise is purchased on credit except:
A. current ratio.
B. total current assets.
C. net working capital.
D. total current liabilities.

EXPLANATION:
When merchandise is purchased on credit, total current assets increase and total current liabilities
increase by the same amount . . . therefore, the net working capital (current assets − current
liabilities) remains the same when merchandise is purchased on credit. The current ratio,
however, will change.

20.)
If accounts payable is understated at the end of the year, which of the following statements is
correct?
A. The current ratio is understated.
B. The times interest earned ratio is understated.
C. The days' purchases in accounts payable is understated.
D. The long-term debt-to-equity ratio is understated.

EXPLANATION:
If accounts payable is understated at the end of the year, then current liabilities are understated.
This would cause the current ratio to be overstated. The long-term debt-to equity ratio and the
times interest earned ratio would not be affected by the problem. However, since the days'
purchases in accounts payable has average accounts payable in the numerator, this ratio would be
understated.

21.)
If a company has a current ratio of 2.1 and pays off a portion of its accounts payable with cash,
the current ratio will:
A. increase.
B. decrease.
C. move closer to the quick ratio.
D. remain unchanged.

EXPLANATION:
The current ratio is calculated as current assets divided by current liabilities. Paying off a portion
of accounts payable with cash will cause the current ratio to increase by decreasing both current
assets and current liabilities by the same amount.

22.)
Assume that a firm has a positive return on assets (ROA) that is less than 100%. What is the
effect on ROA if this firm purchases a new asset for cash and the result is an increase in net
income?
A. ROA is not calculated using net income.
B. ROA will decrease.
C. ROA will increase.
D. ROA will remain the same.
ROA is calculated by dividing net income by assets. If an asset is purchased for cash, the
transaction results in no change in assets. However, given that net income increases from this
asset, we have an increase in net income accompanied with no change in total assets. Therefore,
the ROA will increase.

23.)
The two financial statements that are most important for assessing a firm's liquidity are the:
A. balance sheet and retained earnings statement.
B. income statement and statement of cash flows.
C. income statement and balance sheet.
D. balance sheet and statement of cash flows.

EXPLANATION:
Liquidity is typically measured by cash flow from operations in the statement of cash flows, by
the current and quick ratios taken from the balance sheet, and by the operating cash flow to
current liabilities ratio which uses both statements. The current ratio equals current assets divided
by current liabilities. The quick ratio (acid test) equals the “quick” assets divided by the current
liabilities. The “quick” assets are cash, cash equivalents, short-term investments, and receivables.

24.)
The dividend yield ratio is calculated by which one of the following methods?
A. Earnings per share divided by dividends per share.
B. Dividends per share divided by market price per share.
C. Market price per share divided by dividends per share.
D. Dividends per share divided by earnings per share.

EXPLANATION:
The dividend yield ratio is calculated by taking dividends per share divided by market price per
share.

25.)
Zubin Corporation experiences a decrease in sales and the cost of goods sold, an increase in
accounts receivable, and no change in inventory. If all else is held constant, what is the total
effect of these changes on the receivables turnover and inventory ratios?
A. Inventory Turnover: Increased; Receivables Turnover: Increased.
B. Inventory Turnover: Decreased; Receivables Turnover: Increased.
C. Inventory Turnover: Increased; Receivables Turnover: Decreased.
D. Inventory Turnover: Decreased; Receivables Turnover: Decreased.

EXPLANATION:
The inventory turnover ratio is cost of goods sold (COGS) divided by average inventory. The
accounts receivables turnover is net sales on credit divided by average receivables. Since sales
and COGS decreased, accounts receivable increased, and inventory remained constant, both
ratios would decrease.

26.)
Garstka Auto Parts must increase its acid test ratio above the current 0.9 level in order to comply
with the terms of a loan agreement. Which one of the following actions is most likely to produce
the desired results?
A. Expediting collection of accounts receivable.
B. Selling auto parts on account.
C. Purchasing marketable securities for cash.
D. Making a payment to trade accounts payable.
EXPLANATION:
The acid test ratio is calculated as current assets less inventories and prepayments divided by
total current liabilities. Selling auto parts on account would increase the acid test ratio increasing
the accounts receivable without changing current liabilities.

27.)
Which one of the following factors would likely cause a firm to increase its use of debt financing
as measured by the debt-to-total-capitalization ratio?
A. an increase in the corporate income tax rate.
B. an increase in the degree of operating leverage.
C. increased economic uncertainty.
D. a decrease in times interest earned.
EXPLANATION:
The tax deductibility of the interest on debt reduces the effective cost of the debt by (1 − tax
rate). The attractiveness of debt, therefore, increases with the tax rate.

28.)
Which one of the following is the best indicator of long-term debt paying ability?
A. Working capital turnover.
B. Current ratio.
C. Debt-to-total assets ratio.
D. Asset turnover.

EXPLANATION:
The debt-to-total-assets ratio is an indicator of financial leverage. It tells you the
percentage of total assets that were financed by creditors, liabilities, and debt. This ratio is an
indicator of the long-term debt paying ability of a company. The other three measures are
liquidity measures dealing with short-term debt paying ability.

29.)
Donovan Corporation recently declared and issued a 50% stock dividend. This transaction will
reduce the company's:
A. book value per common share.
B. return on operating assets.
C. debt-to-equity ratio.
D. current ratio.

EXPLANATION:
Book value per common share (common shareholders' equity divided by number of common
shares outstanding). A stock dividend would increase the number of shares outstanding without
affecting the equity.

30.)
Which of the following statements is true?
A. Book value is usually higher than market value and is calculated by dividing net earnings
by the number of common shares outstanding.
B. Book value is usually lower than market value and is calculated by dividing net earnings
by the number of common shares outstanding.
C. Book value is usually lower than market value and is calculated by dividing the
common shareholders' equity by the number of common shares outstanding.
D. Book value is usually higher than market value and is calculated by dividing the common
shareholders' equity by the number of common shares outstanding.

EXPLANATION:
Book value is usually lower than market value because investors trade on the potential earnings
of the company, not just its current book value. Book value is calculated by dividing the common
shareholders' equity by the number of common shares outstanding.

31.)
What is the most important purpose of a balanced scorecard?
a. Develop strategy.
b. Measure performance.
c. Develop cause-and-effect linkages.
d. Set priorities.

EXPLANATION:
The requirement is to identify the purpose of a balanced scorecard. Answer (b) is correct because
the balanced scorecard uses financial and nonfinancial measures to measure performance.

32.)
Which of the following is not one of the four perspectives of the balanced scorecard?
a. Investment in resources perspective.
b. Customer perspective.
c. Learning and growth perspective.
d. Financial perspective.

EXPLANATION:
The requirement is to identify the item that is not one of the four perspectives of the balanced
scorecard. Answer (A) is correct because investment in resources is not a perspective of the
balanced scorecard. The balanced scorecard deals with performance measurement.

33.)
The balanced scorecard generally uses performance measures with four different perspectives.
Which of the following performance measures would be part of those used for the internal
business processes perspective?

a. Cycle time.
b. Employee satisfaction.
c. Hours of training per employee.
d. Customer retention.

EXPLANATION:
The requirement is to identify the measure that is related to internal business processes. Answer
(a) is correct because cycle time is the time it takes Lo manufacture a product and, therefore, is
an important part of the business processes perspective.

34.)
The balanced scorecard has been adopted by many corporations. Which of the following best
describes the balanced scorecard?
a. A strategy that meets management's' objectives.
b. A diagram illustrating cause and effect relationships.
c. A table of key actions to achieve strategic objectives.
d. A strategic performance measurement and management framework.

EXPLANATION:
The requirement is to define the balanced scorecard. Answer (d) is correct because the balanced
scorecard is a strategic performance measurement and management framework.

35.)
The balanced scorecard and value-based management are techniques that are being used by a
number of corporations. In comparison to the balanced scorecard, value-based management
focuses on
a. Nonfinancial measures.
b. Financial measures.
c. Both financial and nonfinancial measures.
d. Quality measures.

EXPLANATION:
The requirement is to identify the focus of value based management. Answer (b) is correct
because value based management focuses on financial measures to measure performance. The
balanced scorecard uses both
financial and nonfinancial measures to measure performance.

36.)
Management has identified a relationship between customer satisfaction and return on
investment. This relationship could be depicted in a
a. Strategy map.
b. Value chain.
c. Customer perspectives chart.
d. Strategic initiatives list.

EXPLANATION:
The requirement is to identify what illustrates cause-and-effect relationships. Answer (a) is
correct because a strategy map displays cause-and-effect relationships within the balanced
scorecard framework.

37.)
Which of the following is not a component of the balanced scorecard?
a. Strategic objectives.
b. Targets.
c. Strategy initiatives.
d. Assessment of human resources.

EXPLANATION:
The requirement is to identify the item that is not a component of the balanced scorecard.
Answer (d) is correct because an assessment of human resources is not a component of a
balanced scorecard.

38.)
Which of the following best describes a value chain in the balanced scorecard framework?
a. The cause-and-effect linkages.
b. The baseline level of performance,
c. The sequence of business processes in which usefulness is added to products or services.
d. The chain of financial and nonfinancial measures.

EXPLANATION:
The requirement is to identify the description of the value chain. Answer (c) is correct because
the value chain is the sequence of business processes in which usefulness is added to the product
or service.

39.)
Which of the following is not a characteristic of the balanced scorecard?
a. Both financial and nonfinancial performance measures are included.
b. Cause-and-effect linkages between strategic objectives.
c. Customer performance measures are excluded.
d. Internal process performance measures are included.

EXPLANATION:
The requirement is to identify which item is not a characteristic of the balanced scorecard.
Answer (c) is correct because customer performance is one of the four primary components of
the balanced scorecard framework; therefore, it is not excluded.

40.)
In the balanced scorecard framework, a survey of employee satisfaction is a potential measure in
which of the four perspectives?
a. Financial.
b. Customer.
c. Internal business processes.
d. Learning and growth.
EXPLANATION:
The requirement is to identify where in the balanced scorecard framework surveys of employee
satisfaction should appear. Answer (d) is correct because surveys of employee satisfaction would
appear in the learning and growth perspective which includes various employee measures
including employee turnover.

41.)
Which of the following is an example of an efficiency measure?
a. The rate of absenteeism.
b. The goal of becoming a leading manufacturer.
c. The number of insurance claims processed per day.
d. The rate of customer complaints.

EXPLANATION:
The requirement is to identify the efficiency measure. Answer (c) is correct because an
efficiency measure relates output to a measure of input.

42.)
A strategy objective in the balanced scorecard framework is:
a. A statement of what the strategy must achieve and what is critical to its success.
b. Key action programs required to achieve strategic objectives.
c. Diagrams of the cause-and-effect relationships between strategic objectives.
d. The level of performance or rate of improvement needed in the performance measure.

EXPLANATION:
The requirement is to identify the definition of a strategy objective, Answer (a) is correct because
it is the definition of a strategy objective in the balanced scorecard framework.

43.)
A target in the balanced scorecard framework is
a. A statement of what the strategy must achieve and what is critical to its success.
b. A key action program required to achieve strategic objectives.
c. A diagram of the cause-and-effect relationships between strategic objectives.
d. The level of performance or rate of improvement needed in the performance measure.

EXPLANATION:
The requirement is to identify the definition of a target. Answer (d) is correct because it is the
definition of a target in the balanced scorecard framework.
44.)
In considering cost of quality methodology, quality circles are associated with
a. Prevention.
b. Appraisal.
c. Internal failure.
d. External failure.

EXPLANATION:
The requirement is to identify the nature of quality circles. Answer (a) is correct because quality
circles are designed to develop ways to prevent defects.

45.)
In the cost of quality, which of the following is an example of an internal failure?
a. Cost of inspecting products on the production line by quality inspectors.
b. Labor cost of product designers whose task is to design components that will not break under
extreme temperature conditions.
c. Cost of reworking defective parts detected by the quality assurance group.
d. Cost of parts returned by customers.

EXPLANATION:
The requirement is to identify the item which reflects the internal failure component. An internal
failure cost is a cost incurred when substandard products are produced but discovered before
shipment to the customer. Reworking defective parts is an example of an internal failure.

46.)
In the cost of quality, which of the following is an example of a "prevention cost"?
a. Cost of inspecting products on the production line by quality inspectors.
b. Labor cost of product designers whose task is to design components that will not break
under extreme temperature conditions.
c. Cost of reworking defective parts detected by the quality assurance group.
d. Cost of parts returned by customers.

EXPLANATION:
The requirement is to identify the item which reflects the prevention cost component. A
prevention cost is a cost incurred to prevent defects. These costs include the cost to identify the
cause of the defect, take corrective action to eliminate the cause, train people, and redesign the
product or the production process. Answer (b) is correct because it is an example of a quality
activity designed to do the job right the first time.

47.)
Delta Manufacturing Co. has had a problem with its product quality. The company has had a
large amount of costs related to product recalls. In considering cost of quality methodology, if
the company wants to reduce these costs, the most likely place to incur costs would be for
a. Prevention.
b. Appraisal.
c. Internal failure.
d. External failure.

EXPLANATION:
The requirement is to identify where to incur costs to prevent product recalls. Answer (a) is
correct because spending funds to prevent defects is generally most cost effective.

48.)
In the cost of quality, costs incurred in detecting individual units of product that do not conform
to specifications are
a. Prevention costs.
b. Appraisal costs.
c. Internal failure costs.
d. External failure costs.

EXPLANATION:
The requirement is to identify how costs incurred to detect nonconforming units are classified.
Answer (b) is correct because appraisal costs are costs associated
with quality control and include testing and inspection.

49.)
In an attempt to improve operations, companies often go through analyses and redesign of the
way processes are performed. Which of the following is not considered to be an aspect of a
business process that may be focused on to achieve improvement:
a. Technology.
b. Human performance.
c. The interaction between technology and human performance.
d. Strategic goals.

EXPLANATION:
The requirement is to identify the aspect of business process improvement that is not generally a
focus. Answer (d) is correct because examination of strategic goals is part of strategic planning,
not part of business process management.

50.)
Management of organizations that engage in business process management view business
processes as
a. Requirements for good control over the organization.
b. Systems that provide information for good management.
c. Strategic assets that must be understood. Managed and improved.
d. Mechanisms that keep employees from shirking.

EXPLANATION:
The requirement is to identify how business process managers view business processes. Answer
(c) is correct because business process managers view processes as strategic assets that can
create value and competitive. advantage.