Question

1) Identify the internal factor that influences the stock price of a firm.

a. Capital structure

b. Conditions in the stock market

c. Tax laws

d. Legal constraints

e. General level of economic activity

A low inventory turnover ratio might indicate that:

a. the firm is using the last-in first-out (LIFO) method of inventory valuation during inflationary periods.

b. the cost of inventory of the firm is lower than that of the similar firms.

c. the inventory of the firm is sold and restocked very often.

d. the firm purchases all its inventory on credit.

e. the firm is holding excess stocks of inventory.

Answer 1

1) Answer: a) Capital Structure

Reason: Let us use the method of deduction.

In option b) Conditions in the stock market is not an internal factor. Stock market is nothing but aggregation of buyers and sellers of stocks. Any conditions in the stock market is out of control of the firm. So it is not an internal factor.

In option c) Tax Laws. These laws are made by the statutory body of the respective countries. So changes in Tax Laws are not an internal factor that influences the stock price of a firm.

In option d) Legal constraints: These are nothing but restrictions that are enforced by the law or Acts. So a firm has no control over the legal constraints. Therefore these are also not an internal factor.

In option e) General level of economic activity: Activities that involve production, distribution and consumption of goods and services at all levels within a society is called economic activity. These involve GDP, Bank rates, inflation etc. So clearly these are also not internal factor that influences the stock price.

Therefore, Option a) Capital Structure is the correct answer. Capital structure is decided by the CFO of that firm. So it is an internal factor which influence the share price of a firm.

2)Answer: e) the firm is holding excess stocks of inventory.

We know the formula for calculating inventory turnover ratio:

i.e Cost of Goods Sold ÷ Average Inventory

What can we learn from the formula? We can see that as the average inventory gets bigger the turnover ratio will be lower. We can also say that when sales are low then also the inventory turnover ratio will be lower, but as far as the options in the MCQ is concerned we only have the option "e)" which fits the description.

From the above explanation it must be clear to why option "b)" is not the answer.

In option c): the firm has to restock very often, that means it maintains a low inventory.

Option d) will not affect the inventory turnover ratio.

Option a) needs a detailed explanation:

During inflationary periods, LIFO when compared to FIFO will cause lower inventory costs on the balance sheet and a higher cost of goods sold on the income statement. The inventory turnover ratio will be higher when LIFO is used during inflationary period. The reason is that the cost of goods sold will be higher and the inventory costs will be lower under LIFO than under FIFO.

So option e) is the correct answer.