Question

20.An analyst working for a potential creditor would MOST LIKELY consider a decrease in which of the following ratios to be positive news?
a.Interest Coverage
b.Debt to total assets
c.ROA

22.Like many technology companies, Cinnamon Corp. operates in an environment of steadily declining prices. It’s reported profits will tend to be highest if it accounts for inventory using:
a.FIFO
b.LIFO
c.Weighted Average Cost
d.Specific Identification

36.You are evaluating the solvency and liquidity of XYZ Co. in light of the following information:
FY 2017   FY 2016   FY 2015
           Total Debt       $2000   $1900   $1750
           Total Equity       $4000   $4500 $5000
   Your MOST LIKELY conclusion is that:
a.The company is becoming less solvent
b.The company is becoming less liquid
c.The company is becoming more solvent
d.The company is becoming more liquid

37.Using the same information as for Question #36, what is the MOST REASONABLY PROBABLE explanation for the financial data?
a.The decrease in equity is the result of the decline in the market value of the company’s stock.
b.The decrease in equity may be the result of recurring losses, payment of dividends greater than net income or repurchase of shares.
c.The increase in total debt may mean the company has a higher credit rating in FY 2017 than in FY 2015.

Answer 1

Answers-

Q 20)

The correct answer is b. Debt to total assets ratio.
The decrease in this ratio is good as the decrease in leverage or debt will decrease the default risk.
The other Options a and c are inorrect.
Option a Interest coverage ratio = EBIT / Interest Expense is the ability to service debt. This should increase and not decrease.
The Option c is ROA = Net income / Average Assets. This ratio should increase as it is the profit or net incomee generated for the assets held by the company whih should increase.

Q 22)

Cinnamon Corp.
The correct Option is b LIFO. LIFO results in the goods which are purchased at the earliest are the last to be removed from the inventory account. During declining prices the COGS value is lower as the recent prices are lower resulting in lower reported profits.
Under FIFO the goods which are purchased at the earliest are the first one to be removed from the inventory account. This results in remaining inventory at books to be valued at the most recent price. Therefore the delining prices will result in higher higher COGS and higher profits and lower inventory prices.
The Weighted Average Cost profits will be higher than LIFO and lower than FIFO in declining prices environment.

Q 36)

The correct Option is a. The company is becoming less solvent. We can see that the compay's debt isi ncreasing and the equity is decreasing from year 2015 to year 2017. The increase in debt shows that the company will find it difficult to pay off its debt thus making it less solvent.
The Options b and d are incorrect as the liquidity is related to the current assets ie cash.
The Option c is incorrect as it states the opposite of correct chioice.

Q 37)

The correct Option is a. The  equity value declines as the market value of the company’s stock price declines as the equity = market price of stock x number of shares outstanding.
The Option b is incorrect. The payment of dividends does not decrease the value of equity but decreases retained earnings.
The Option c is incorrect. The increase in total debt may mean the company has a lower not higher credit rating in FY 2017 than in FY 2015.