1.

In financial analysis, ratios are used to help us learn about the firm’s:
a. profitability
b. growth and potential for growth
c. resource needs
d. All of the above answers are correct.

2. A ratio that is used to evaluate a firm’s operating margin percentage is classified as:
a. a specialty ratio
b. an investment ratio
c. a credit ratio
d. an operating ratio

3. A ratio that measures income taxes to revenues is:

a. relatively meaningless since it tells us little about the income tax rate or the profitability of
the firm
b. an excellent metric since it compares the effective rate of income tax to the profitability of
the firm
c. classified as a common investment ratio
d. complimentary to the return on common equity ratio

4. The only operating ratio that uses the cost of sales in its numerator is the:
a. market-to-book ratio
b. quick ratio
c. inventory turnover ratio
d. days payables outstanding ratio

5. An operating ratio, such as the inventory turnover ratio, varies greatly by industry. An example of
a business with a high inventory turnover ratio is a:
a. watch repair shop
b. grocery store
c. jewelry retailer
d. CPA firm

6. To help determine whether a business should extend credit to various other businesses, an analyst
will look at credit ratios. The ratio that measures the speed with which the firm can pay its
obligations with cash, cash equivalents, and short-term investments is known as the:
a. days payables outstanding ratio
b. debt to capital ratio
c. current ratio
d. quick ratio

7. The denominator in the debt to capital ratio consists of:

a. debt, minority interest, and equity
b. the total obligations of the firm
c. the total equity of the firm
d. net income, common and preferred stock, and retained earnings

8. Investors and managers use the price-to-earnings and market-to-book ratios to:
a. primarily measure business performance
b. primarily screen potential investments
c. measure business performance and screen potential investments
d. track the efficiency of leverage in capital spending in both foreign and domestic markets

9. The __________ ratio uses net income in its numerator while the __________ ratio uses diluted
earnings per share in its denominator.
a. return on common equity; market-to-book
b. return on common equity; price-to earnings
c. return on capital; market-to-book
d. return on capital; price-to-earnings

10. A ratio has little meaning until it is compared to a benchmark. Financial analysts use several
common benchmarks to help them better understand and interpret financial ratios. The benchmark
in which ratios from several different companies or an industry segment are analyzed is known as
a:
a. cross-sectional analysis
b. trend analysis
c. cause-of-change analysis
d. cause-of-action analysis
11. A thorough financial analysis includes any adjustments to the financial statements that are
necessary to develop useful forecasts. Such forecasts are used in the analyst’s valuation work. An
example of an adjustment made to understand a business more completely for purposes of valuation
is to:
a. change financial statement items even though such adjustment may not be per GAAP
b. change financial statement items that may incorporate accounting policies different than
that of the firm
c. exclude a financial statement item such as joint venture income
d. All of the answers above are correct.

12. An analyst can restate each item on an income statement as a percentage of revenues. This will
afford the analyst an opportunity to factor out size differences among statements of various firms.
What is this restatement known as and with which method can it be used?
a. change of accounting principle restatement; cross-sectional analysis only
b. change of accounting principle restatement; trend or cross-sectional analysis
c. common-size income statement; trend or cross-sectional analysis
d. common-size income statement; trend analysis only

13. Identify the ratio that cannot be computed given the following information for a firm: Current assets
are $475,806; current liabilities are $257,814; cash is $89,774; earnings before interest and taxes is
$72,005; short-term investments, $145,850; equity, $192,615; minority interest, $0; interest
expense, $47,899.
a. current
b. quick
c. debt to capital
d. interest coverage

14. Identify the ratio that can be computed given the following information for a firm: Current assets
are $475,806; current liabilities are $257,814; cash is $89,774; earnings before taxes is $72,005;
short-term investments, $145,850; equity at end of period, $192,615; minority interest, $0; income
taxes, $11,211; interest expense, $47,899.
a. return on capital
b. effective income tax rate
c. gross margin percentage
d. inventory turnover

15. Identify the ratio that cannot be computed given the following information for a firm: Diluted
earnings per share, $3.57; market price of the firm’s stock, $47.75; average common equity,
$879,550; net income, $99,772; average total capital, $625,740; aftertax interest expense, $14,885.
a. price-earnings
b. market-to-book
c. return on common equity
d. return on capital

16. A firm has the following growth rates for the last four years: 2000, 39.8%; 2001, 34.2%; 2002,
28.4%; 2003, 29.1%. From a standpoint of trend analysis, what conclusion might an analyst reach
regarding the firm’s revenue growth?
a. The trend analysis indicates the firm has had flat revenue growth over time.
b. The trend analysis indicates the firm has had diminished revenue growth over time.
c. The trend analysis indicates the firm has had moderately increasing revenue growth over
time.
d. The trend analysis indicates the firm has had significant, but slowing, revenue growth over
time.

17. A firm has the following operating income rates for the last four years: 2000, 9.0%; 2001, 8.9%;
2002, 9.1%; 2003, 8.8%. From a standpoint of trend analysis, what conclusion might an analyst
reach regarding the firm’s revenue growth?
a. The trend analysis indicates the firm’s operating income has been flat over time.
b. The trend analysis indicates the firm’s operating income has materially declined over time
and is cause for investor concern.
c. The trend analysis indicates the firm’s operating income has been increasing at a fiscally
healthy rate over time.
d. The conclusion is indeterminable from the information given.
18. There are two key ratios that measure operating profitability. The numerator for the __________
ratio uses income while the __________ ratio uses revenues less cost of goods sold in its
computation.
a. gross margin percentage; operating margin percentage
b. operating margin percentage; gross margin percentage
c. quick; operating margin percentage
d. current; gross margin percentage

19. The analyst must exercise caution when using ratios as part of the analysis of a firm. The fact that
ratios often vary across industries is an example of what is called:
a. an accounting method discrepancy
b. an industry and business difference
c. a business environment change
d. an ambiguous ratio definition

20. Select the answer that best fits this statement, “Analysts define ratios differently.”
a. What some analysts call trend analysis others call cross-sectional analysis.
b. What some analysts call the current ratio is called the quick ratio by others.
c. The numerator used in the return on capital ratio may vary.
d. The income statement is restated in non-GAAP terms.

21. Ratios often aid analysts to project the future. Such projections require the adjustment of certain
items found on the financial statements. One such item that should be adjusted in such a projection
is:
a. removing an extraordinary item from the income statement
b. removing revenue from the income statement
c. the earnings-per-share calculation when there are no dilutive or anti-dilutive items
d. the reconciliation of cash on the balance sheet

22. In the multiples approach, the analyst assumes the ratio of value to some firm-specific variable is
the same across firms. The most common multiple is the:
a. earnings per share ratio
b. price/sales ratio
c. price/earnings ratio
d. market/book ratio

23. The multiples approach is based on the idea that similar assets sell at similar prices. Analysts expect
that two firms in the same industry would be comparable for this purpose. The term “comparable,”
when used in this sense, means that two firms would differ only in their:
a. growth prospects
b. size
c. operating margins
d. cash flow needs

24. The multiples approach is used to value one firm based on the observed multiple of another. The
firm being valued is called the:
a. multiple driver
b. value driver
c. comparable firm
d. target

25. For the multiples formula to work both mathematically and logically, there must be consistency
between the multiple and its value driver. The element necessary for consistency is:
a. the multiple and value driver must be for the same period or as of the same date
b. the value driver and numerator of the multiple must be based on exactly the same definition
c. the value driver and denominator of the multiple must be based on exactly the same
definition
d. Answers a and c are both correct.

26. To use the multiples approach, the analyst must observe certain variables. The variable the analyst
will observe is the value:
a. of the comparable firm
b. driver of the target firm
c. driver of the comparable firm
d. All of the answers above are correct.
27. When an analyst is looking at several firms whose multiples are not identical, the analyst can use
the averaging approach to determine the appropriate multiple. When averaging is used, the analyst
must be aware that:
a. the target firm is most similar to the average of comparable firms
b. it is better to use the averaging approach when firms’ multiples are very different from each
other
c. firms are comparable even when their multiples are very different from each other
d. All of the above answers are correct.

28. Which statement below is incorrect regarding the multiples approach to the valuation of a firm?
a. The multiples approach makes one explicit assumption that the companies’ multiples are equal.
b. The analyst avoids all discounted cash flow assumptions in a multiples valuation.
c. The multiples approach permits the analyst to make discounted cash flow assumptions
implicitly.
d. Not all discounted cash flow assumptions are avoided in a multiples valuation.

29. Which statement below is an argument supporting the use of the multiples approach?
a. The multiples approach is determined by future cash flows.
b. It is incorrect to use accounting earnings instead of cash flow in a valuation.
c. Due to the popularity of the multiples approach, the value of many firms in the marketplace
may actually be based on multiples.
d. Using a single year’s results to estimate value effectively ignores all expected results beyond
the first year.

30. One problem with using a single year of earnings in the multiples approach is:
a. some firms may have unusual or extraordinary items included in their earnings in a
particular year
b. two economically identical firms could report very different earnings amounts if they made
different accounting choices
c. value is not related to earnings per se but to cash flow
d. cash flow, not earnings, drives the model

31. Which statement below is not a reason why firms trade at different PE ratios?
a. Actual PE ratios are related to earnings growth in the same way a discounted cash flow
analysis would predict.
b. Investors consider very few factors in selecting the appropriate PE ratio for valuing a firm.
c. A discounted cash flow analysis would also produce different PEs under different
accounting methods.
d. Using a discounted cash flow model, the PE for a firm would change as earnings growth
changed.

32. The reality is that people use the multiples approach in practice; however they:
a. do not apply it in a simple, mechanistic way
b. apply it in a simple, analytical way
c. apply the same multiple to different firms
d. apply the model in a way that demonstrates how investors should value firms, not how they
actually value firms

33. Comparable firms need not be similar when:

a. examining the cash flow needs of each firm
b. looking at the growth prospects of each firm
c. a variable exists that does not affect a given multiple
d. analyzing the type of business in which each firm is engaged

34. To find comparable firms for a multiples analysis, the analyst would look at all of the following
factors except:
a. the firm’s potential for growth
b. the size of the market segment
c. future expected cash flow streams
d. to match firms on industry

35. One way in which an analyst can identify comparable firms is to:
a. find firms all of the same size
b. look at the target firm’s list of peer companies in its proxy statement
c. find firms whose present value of discounted expected future cash flows is similar
d. find firms who have many of the same members on each firm’s board of directors
36. The first step an analyst should take when using the multiples approach is to:
a. analyze the price/earnings ratio of the target firm
b. analyze the market/book ratios of comparable firms
c. analyze the price/sales ratio of the target firm
d. identify comparable companies

37. An analyst should not assume that because firms are in the same industry they are comparable in a
multiples approach. Regarding the earnings of potentially comparable firms, the analyst should
carefully evaluate to ensure:
a. there are no unusual or extraordinary items
b. the firms are of the same size
c. that the PE ratios of the potential firms create a vast range of values for averaging purposes
d. None of the above answers are correct.

38. An analyst wants to ensure that the earnings of comparable firms do not include any special
adjustments or one-time items. To verify this, the analyst will:
a. look at the economics of the underlying business for the comparable firms
b. examine the projected earnings rates for the comparable firms
c. analyze the capital structures for the comparable firms
d. perform an accounting analysis of the quarterly and annual financial statements of the
comparable firms

39. It is difficult, if not impossible, to find a perfectly comparable firm. Although analysts can find
firms in a similar industry with similar products, there are still likely to be differences in growth
potential, capital structures, or accounting methods. One strategy for dealing with a situation where
the multiple should be less sensitive to differences in important variables is to:
a. adjust the multiple
b. refine the multiple
c. adjust the value driver
d. None of the answers above are correct.

40. In evaluating comparable firms, it is still likely that there will be differences in accounting methods.
One strategy an analyst might implement to deal with differences in accounting methods is to:
a. switch from using the price/earnings ratio to the market/book ratio
b. switch from using the price/earnings ratio to the price/sales ratio
c. adjust the value driver
d. None of the above answers are correct.

41. If a certain variable affects the PE ratio, the analyst will most likely:
a. not use the PE ratio in a multiples valuation
b. match on it with comparable firms in a multiples valuation
c. adjust for its effect in a multiples valuation
d. Answers b and c are both correct.

42. The analyst can compare multiples of firms with different capital structures, eliminating the need
to match on this variable, because:
a. the unlevered pretax PE ratio is insensitive to leverage
b. the equity PE ratio varies with leverage
c. the unlevered pretax PE ratio is sensitive to leverage, which can be corrected through
adjustment
d. None of the above answers are correct.

43. Mathematically the value of PE equity is the:

a. firm’s equity minus earnings before interest and taxes
b. pretax debt PE multiplied by interest
c. pretax equity PE ratio multiplied by earnings after interest but before taxes
d. pretax equity PE ratio multiplied by earnings after interest and taxes

44. Regarding PE analysis, mathematically the value of debt is the:

a. pretax debt PE multiplied by earnings before interest and taxes
b. pretax debt PE multiplied by interest
c. pretax debt PE multiplied by earnings after interest but before taxes
d. None of the above answers are correct.
45. Regarding adjustments for capital structure differences in a PE valuation, to get the value of the
target firm’s equity, the analyst will:
a. estimate the unlevered value of the target firm, subtract the value of its debt, and then add
the value created by its leverage
b. estimate the unlevered value of the target firm, add the value created by its leverage, and
then subtract the value of its debt
c. multiply the comparable firm’s unlevered pretax PE by the target firm’s EBIT
d. estimate the total value of the target firm’s debt and equity, less the value it creates by
leverage

46. Which of the financial reporting differences below will produce different PE ratios?
a. using straight-line rather than accelerated depreciation
b. the amounts of allowances for uncollectible accounts
c. specific criteria for recognizing revenue
d. All of the above reporting differences will produce different PE ratios.

47. Earnings quality is especially important in multiples valuation because:

a. there are three definitions of earnings quality, which may make a multiples valuation for
comparable firms impossible
b. earnings subject to manipulation are more likely to be understated than overstated, resulting in
lower multiples
c. the firm’s earnings directly drives the valuation
d. None of the above answers are correct.

48. An analyst determines that a difference in depreciation methods can be adjusted to reduce the error
in a multiples valuation. Although the analyst will probably not have all the necessary accounting
information at hand, the analyst can:
a. still recompute depreciation expense under a different method and “plug” the amount into an
earnings adjustment for valuation purposes
b. eliminate depreciation expense altogether for both comparable and target firms
c. estimate the amount of depreciation computed under a different method by relating deprecation
expense to the firm’s gross fixed assets
d. None of the above answers are correct.

49. The price/sales (PS) ratio may be used in a multiples valuation because this approach will eliminate:
a. leverage differences across firms
b. most reporting differences caused by the timing of expense recognition
c. differences in operating margins across firms
d. differences in capital structures across firms

50. The most logical way to eliminate differences and make multiples more comparable is to:
a. use the price/sales (PS) ratio rather than the PE ratio in the multiples valuation
b. use cash flow instead of earnings as the value driver in the valuation
c. not consider accounting differences in the valuation process
d. None of the answers above are correct.

51. Which statement below is incorrect regarding PE ratios and firms with near-zero earnings or losses?
a. For firms with losses or near-zero earnings, the PE ratio is virtually meaningless, however the
PEG ratio can be modified to provide useful information for the valuation.
b. A common multiples-based valuation approach for a company with near-zero earnings or losses
is to use some other factor as the value driver.
c. Sometimes start-up companies are incurring losses while experiencing incredibly high growth
in revenues.
d. The PE ratio can be redefined using a forecasting earnings number from a period two or three
years in the future, assuming earnings are expected to reach a normal level by then.

52. A common multiples-based valuation approach for a company with near-zero earnings or losses is
to use some other factor as the value driver. The factor used in determining the ratio of value to
some other value driver is the:
a. number must in some way be earnings related
b. value of the cash flow stream per unit of the value driver
c. expected growth in the number of units of the value driver
d. Answers b and c are both correct.
53. A common multiples-based valuation approach for a company with near-zero earnings or losses is
to use some other factor as the value driver. An example of the factor used in determining the ratio
of value to some other value driver would be:
a. the firm’s historical earnings from the past
b. the number of “hits” on the firm’s Internet site
c. the firm’s sales during its first year of operations
d. None of the answers above are correct.

54. Which of the statements below is incorrect regarding PE decomposition?

a. PEG ratios cannot be used in conjunction with PE decomposition when a firm has several
diverse lines of business.
b. Although the divisions of a firm may be listed in one broad industry classification, if the
divisions are in sufficiently different markets, their multiples are likely to differ, and PE
decomposition can be used.
c. Under PE decomposition, using unlevered, pretax PE ratios can eliminate potential leverage
differences.
d. PE decomposition can be used to value firms with marketable securities by adding the value of
the securities in the same way we subtract the value of debt.

55. When the target firm has discontinued operations:

a. PE decomposition cannot be used in a multiples valuation
b. the analyst will separate the valuation into two pieces, the value of continuing operations and
the value of discontinued operations
c. the separation of discontinued operations from continuing operations applies only to the period
in which the disposal of the discontinued operation occurs
d. the analyst must estimate the value the discontinued operations based on its sales price, net of
taxes and transaction costs

56. What is the relationship among the market/book (MB), price/earnings (PE), and return on equity
(ROE) ratios?
a. There is no common relationship among these three ratios.
b. ROE is not mathematically related to either the MB or PE ratios.
c. ROE is not mathematically related to either the MB or PE ratios, and therefore the majority of
factors that influence ROE do not affect the MB or PE ratios.
d. The MB ratio is the product of the PE ratio and the ROE.

Use the comparative balance sheets and income statements below for the Cool Hand Luke Company in
answering the questions:

Cool Hand Luke Company

Comparative Balance Sheets
December 31, 2021 and 2022

2022 2021
Assets
Cash $ 61,100 $ 27,200
Accounts Receivable (net) 72,500 142,700
Inventory 122,600 107,800
Property, Plant, and Equipment (net) 577,700 507,500
Total Assets $833,900 $785,200

Liabilities and Stockholders' Equity

Accounts Payable $104,700 $ 72,300

Notes Payable within one year 50,000 50,000
Bonds Payable 200,000 210,000
Common Stock -- $10 par value 300,000 300,000
Retained Earnings 179,200 152,900
Total Liabilities and Stockholders' Equity $833,900 $785,200
 Cool Hand Luke Company
Comparative Income Statements
For the Years Ended 12/31/21 and 12/31/22

2022 2021

Sales $ 800,400 $ 900,000

Cost of Goods Sold 454,100 396,200
Gross Profit $ 346,300 $ 503,800
Operating Expenses
Selling Expenses $ 130,100 $ 104,600
Administrative Expenses 40,300 115,500
Interest Expense 25,000 20,000
Income Tax Expense 14,000 35,000
Total Operating Expenses $ 209,400 $ 275,100
Net Income $ 136,900 $ 71,300

57. The Cool Hand Luke Company's current ratio for 2022 was

58. Cool Hand Luke Company's total debt to equity ratio has (compare 2021 to 2022)

59. Cool Hand Luke Company's gross profit rate for 2021 was

60. In 2022, Cool Hand Luke Company's return on sales was