Strategic Management and Business Policy - Chapter 12

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1

According to Schilit, forensic accounting is a search for hidden weaknesses in a company's performance.

TRUE

2

According to Schilit, unusually high goodwill gains related to recent acquisitions is a red flag, suggesting an underlying problem.

TRUE

3

According to Schilit, a change of more than 2% in gross margins from year to year is worth a closer look.

TRUE

4

The case method provides the opportunity to move from a broader, less precise analysis of the overall corporation to a narrow, specialized view that emphasizes functional techniques.

FALSE

5

Cases present actual business situations and enable you to examine ONLY successful corporations.

FALSE

6

When preparing a case analysis, you should always undertake outside research and go beyond the decision date of the case.

FALSE

7

A company's annual report from the year of the case can be helpful, but the 10-K form is not beneficial for those conducting a case analysis.

FALSE

8

According to Yankelovich Partners survey firm, eight out of 10 portfolio managers and 75 percent of security analysts use annual reports when making decisions.

TRUE

9

10-K forms include detailed information not usually available in an annual report.

TRUE

10

Ratio analysis is a valuable part of SWOT analysis, helping to assess the company's overall situation and pinpoint some problem areas.

TRUE

11

Ratios are only useful for large firms where their ratios may be compared with industry averages.

FALSE

12

One of the most important categories of financial ratios are the liquidity ratios.

TRUE

13

An important liquidity ratio is Earnings per Share (EPS).

FALSE

14

Key liquidity ratios include the current ratio, quick ratio, and cash ratio.

TRUE

15

The debt to asset ratio measures the extent to which borrowed funds have been used to finance the company's assets.

TRUE

16

In case analysis, it is best to make an exhibit that includes all the financial ratios.

FALSE

17

When conducting a financial analysis, select and discuss those financial ratios that have an impact on the company's problems.

TRUE

18

A typical financial analysis would compare the firm under study with industry standards.

TRUE

19

A typical financial analysis of a firm would include a study of the operating statements for five or so years.

TRUE

20

Common-size statements are income statements and balance sheets in which the dollar figures have been converted into percentages.

TRUE

21

If a firm's trends in common-size statements are generally in line with those of the rest of the industry, problems are less likely than if the firm's trends are worse than the industry average.

TRUE

22

If the corporation being studied appears to be in poor financial condition, use Altman's Bankruptcy Formula to calculate its Z-value.

TRUE

23

The Z-value formula combines five ratios by weighting them according to their importance to a corporation's financial strength.

TRUE

24

A Z-value below 10 indicates significant credit problems.

FALSE

25

The index of sustainable growth indicates how much of the growth rate of sales can be sustained by internally generated funds.

TRUE

26

One way to adjust for inflation for global operations outside the United States is to use the U.S. Consumer Price Index (CPI).

FALSE

27

Constant dollars are dollars adjusted for inflation to make them comparable over various years.

TRUE

28

The public interest rate is the rate of interest banks charge on their lowest risk loans.

FALSE

29

The gross domestic product (GDP) is used ONLY in the United States to measure the total output of goods and services within the country's borders.

FALSE

30

The amount of change from one year to the next in GDP indicates how much that country's economy is growing.

TRUE

31

In case analysis, how the company actually dealt with the case problem is the most important part of the solution.

FALSE

32

According to Schilit, the search for hidden weaknesses in a company's performance is known as

A) a strategic audit.

B) a SWOT analysis.

C) forensic accounting.

D) activity based accounting.

E) competitive analysis.

Answer: C

33

Which of the following is a red flag according to Schilit?

A) cash flow from operations drops below net income

B) accounts receivable growing faster than sales

C) fluctuating gross margins over time

D) nepotism on the board of directors

E) all of the above

Answer: E

34

What has been the most popular method of teaching strategy and policy for years?

A) lecture

B) case analysis

C) team teaching

D) group presentations

E) student teaching

Answer: B

35

What is the main purpose of conducting outside research into the environmental setting of the case?

A) It allows students to identify how the company addressed the problem.

B) It provides a learning experience on library usage which is helpful in all courses.

C) It gives a realistic background of the industry during a specified period.

D) It gives you clues as to what the organization should be doing in the future.

E) It furnishes large amounts of data — both pertinent and extraneous.

Answer: C

36

According to the text, what information can be obtained by accessing the SEC website?

A) corporate annual reports and 10-k forms

B) press releases

C) product specifications

D) research and development trends

E) information about graduate school

Answer: A

37

Among the most useful and important documents that can be used to understand why actions were taken are

A) news releases.

B) product specification reports.

C) its corporate history.

D) annual reports.

E) 10-Q forms.

Answer: D

38

All of the following are true of annual reports EXCEPT

A) 80% of portfolio managers use annual reports when making decisions.

B) annual reports contain income statements and balance sheets.

C) annual reports contain cash flow statements.

D) annual reports contain all the information found in the 10-K form.

E) annual reports contain notes to the financial statements indicating why certain actions were taken.

Answer: D

39

According to the text, what percentage of portfolio managers use annual reports when making decisions?

A) 20%

B) 35%

C) 50%

D) 60%

E) 80%

Answer: E

40

According to the text, what percentage of security analysts use annual reports when making decisions?

A) 20%

B) 35%

C) 50%

D) 75%

E) 100%

Answer: D

41

The calculation of ratios from financial data is referred to as

A) SWOT analysis.

B) ratio analysis.

C) receivables analysis.

D) integration analysis.

E) diversification analysis.

Answer: B

42

Which of the following is NOT one of the categories of important financial ratios that is mentioned in the text to help assess an organization's overall financial situation?

A) leverage ratios

B) liquidity ratios

C) asset management ratios

D) activity ratios

E) profitability ratios

Answer: C

43

What financial ratio serves as a short-term indicator of the company's ability to pay its short-term liabilities from its short-term assets?

A) quick ratio

B) current ratio

C) cash ratio

D) strategic ratio

E) inventory ratio

Answer: B

44

Which financial ratio measures the company's ability to pay off its short-term obligations from current assets, excluding inventories?

A) quick ratio

B) current ratio

C) cash ratio

D) strategic ratio

E) inventory ratio

Answer: A

45

Which financial ratio measures the extent to which the company's capital is in cash or cash equivalents?

A) quick ratio

B) current ratio

C) cash ratio

D) strategic ratio

E) inventory ratio

Answer: C

46

All of the following represent liquidity ratios EXCEPT

A) cash ratio.

B) inventory to net working capital.

C) quick ratio.

D) gross profit margin.

E) current ratio.

Answer: D

47

Which financial ratio indicates how much after-tax profit is generated by each dollar of sales?

  1. A) return on investment
  2. B) return on equity
  3. C) gross profit margin
  4. D) net profit margin
  5. E) inventory to net working capital

Answer: D

48

Which financial ratio measures the rate of return on the book value of shareholders' total investment in the company?

A) return on investment

B) return on equity

C) gross profit margin

D) net profit margin

E) earnings per share

Answer: B

49

Which financial ratio shows the after-tax earnings generated for each share of common stock?

A) return on investment

B) return on equity

C) gross profit margin

D) earnings per share

E) net profit margin

Answer: D

50

Which financial ratio shows the return on all of the assets under its control regardless of source of financing?

A) return on investment

B) return on equity

C) earnings per share

D) gross profit margin

E) net profit margin

Answer: A

51

Which financial ratio measures the number of times that average inventory of finished goods was turned over or sold during a period of time?

A) days of inventory

B) asset turnover

C) average collection period

D) fixed asset turnover

E) inventory turnover

Answer: E

52

Which of the following financial ratios is NOT a profitability ratio?

A) net profit margin

B) gross profit margin

C) asset turnover

D) ROE

E) ROI

Answer: C

53

Which financial indicator measures the number of one day's worth of inventory that a company has on hand at any given time?

A) days of cash

B) days of inventory

C) average collection period

D) fixed asset turnover

E) inventory turnover

Answer: B

54

"Inventory to net working capital" is an example of a(n)

A) leverage ratio.

B) liquidity ratio.

C) activity ratio.

D) asset management ratio.

E) profitability ratio.

Answer: B

55

"Earnings per share" is an example of a(n)

A) leverage ratio.

B) liquidity ratio

C) activity ratio.

D) asset management ratio.

E) profitability ratio.

Answer: E

56

"Days of inventory" is an example of a(n)

A) leverage ratio.

B) liquidity ratio

C) activity ratio.

D) asset management ratio.

E) profitability ratio.

Answer: C

57

Net profit margin is what type of financial ratio?

A) liquidity ratio

B) profitability ratio

C) activity ratio

D) leverage ratio

E) revenue ratio

Answer: B

58

Return on equity

A) is the ratio of net profit after taxes to shareholders' equity.

B) is a profitability ratio.

C) is referred to by the acronym ROE.

D) measures the rate of return on the book value of shareholders' total investment in the company.

E) all of the above

Answer: E

59

The quick ratio is also known as the

A) key profitability ratio.

B) EPS.

C) acid test.

D) asset turnover.

E) key activity ratio.

Answer: C

60

All of the following ratios represent activity ratios EXCEPT

A) accounts payable period.

B) days of inventory.

C) net working capital turnover.

D) earnings per share.

E) days of cash.

Answer: D

61

Which financial ratio measures the utilization of all of the company's assets?

A) days of inventory

B) asset turnover

C) inventory turnover

D) fixed asset turnover

E) average collection period

Answer: B

62

Which financial ratio indicates the number of days of cash on hand, at present sales levels?

A) days of inventory

B) fixed asset turnover

C) days of cash

D) average collection period

E) inventory turnover

Answer: C

63

Which financial ratio measures the utilization of plant and equipment?

A) days of inventory

B) asset turnover

C) average collection period

D) fixed asset turnover

E) inventory turnover

Answer: D

64

Which financial indicator measures the ratio of sales to fixed assets?

A) days of inventory

B) asset turnover

C) average collection period

D) fixed asset turnover

E) inventory turnover

Answer: D

65

Which financial indicator is calculated as the ratio of annual credit sales to accounts receivable?

A) days of cash

B) average collection period

C) accounts receivable turnover

D) inventory turnover

E) net working capital turnover

Answer: C

66

"Times interest earned" is an example of a(n)

A) leverage ratio.

B) liquidity ratio.

C) activity ratio.

D) asset management ratio.

E) profitability ratio.

Answer: A

67

Which financial ratio measures the extent to which borrowed funds have been used to finance the company's assets?

  1. A) debt to asset ratio
  2. B) debt to equity ratio
  3. C) long-term debt to capital structure
  4. D) times interest earned
  5. E) current liabilities to equity

Answer: A

68

Which financial ratio indicates the ability of the company to meet its annual interest costs?

A) debt to asset ratio

B) debt to equity ratio

C) times interest earned

D) long-term debt to capital structure

E) coverage of fixed charges

Answer: C

69

Which financial ratio is a measure of the ability of the company to meet all of its fixed-charge obligations?

A) debt to asset ratio

B) debt to equity ratio

C) times interest earned

D) long-term debt to capital structure

E) coverage of fixed charges

Answer: E

70

All of the following ratios reflect leverage ratios EXCEPT

A) debt to asset ratio.

B) times interest earned.

C) coverage of fixed charges.

D) price/earnings ratio.

E) debt to equity ratio.

Answer: D

71

Which financial indicator shows the current market's evaluation of a stock, based on its earnings?

A) debt to asset ratio

B) price/earnings ratio

C) coverage of fixed charges

D) debt to equity ratio

E) times interest earned

Answer: B

72

Inventory turnover and asset turnover are both examples of which type of financial ratio?

  1. A) liquidity ratio
  2. B) profitability ratio
  3. C) activity ratio
  4. D) leverage ratio
  5. E) revenue ratio

Answer: C

73

Fixed asset turnover is what type of financial ratio?

A) liquidity ratio

B) profitability ratio

C) leverage ratio

D) activity ratio

E) revenue ratio

Answer: D

74

Which two basic statements provide most of the financial data needed for analysis?

A) statement of retained earnings and income statement

B) sources and uses of working capital and the balance sheet

C) non-operating gains and losses and statement of financial position

D) historical income statement and balance sheet

E) statement of financial position and statement of owner's equity

Answer: D

75

Which financial indicator is calculated by the ratio of market price per share to earnings per share?

A) return on investment

B) price/earnings ratio

C) return on equity

D) dividend yield on common stock

E) dividend payout ratio

Answer: B

76

Which financial indicator is calculated by the ratio of annual dividends per share to annual earnings per share?

A) dividend payout ratio

B) dividend yield on common stock

C) price/earnings ratio

D) return on investment

E) return on equity

Answer: A

77

Which financial ratio indicates the percentage of profit that is paid out as dividends?

  1. A) return on equity
  2. B) dividend payout ratio
  3. C) dividend yield on common stock
  4. D) price/earnings ratio
  5. E) debt to asset ratio

Answer: B

78

Which financial indicator is calculated by the ratio of annual dividends per share to current market price per share?

A) return on equity

B) dividend payout ratio

C) dividend yield on common stock

D) price/earnings ratio

E) debt to equity ratio

Answer: C

79

Which financial ratio indicates the dividend rate of return to common shareholders at the current market price?

A) return on equity

B) dividend yield on common stock

C) price/earnings ratio

D) dividend payout ratio

E) earnings per share

Answer: B

80

Between 1997 and 1999, what percent of the mergers used the pooling approach to account for the value of the companies' stocks?

A) 95%

B) 80%

C) 55%

D) 40%

E) 20%

Answer: D

81

Converting categories on financial statements from dollar terms to percentages results in

A) inflation-adjusted statements.

B) diverse rates of returns.

C) common-size statements.

D) constant dollar denominations.

E) equivalency comparison.

Answer: C

82

To get a proper picture of the position of the organization, common-size statements and ratios should be compared to

A) the organization's future historical performance.

B) the leading competitor in the industry.

C) the financial performance of the overall U.S. gross domestic production (GDP).

D) the direct competitor least like the organization.

E) industry-wide average trends.

Answer: E

83

The formula which predicts the likelihood of a corporation going bankrupt is called

A) the return on investment.

B) the CAPM.

C) the index of sustainable growth.

D) operating cash flow.

E) the Z-value.

Answer: E

84

The Z-value uses ________ ratios and weights them according to their importance to a corporation's financial strength.

A) 2

B) 3

C) 4

D) 5

E) 6

Answer: D

85

All of the following ratios are used in the calculation of a company's Z-value EXCEPT

A) working capital/total assets.

B) retained earnings/total assets.

C) current assets/current liabilities.

D) market value of equity/total liabilities.

E) sales/total assets.

Answer: C

86

At what Z-value level is a firm considered healthy?

A) below 1.81

B) above 3.0

C) above 5.0

D) between 6.0 and 10.0

E) above 100

Answer: B

87

At what Z-value level is a firm considered in serious trouble?

A) below 1.81

B) above 1.81

C) greater than 5.0

D) between 2.2 and 3.1

E) between 3.2 and 4.1

Answer: A

88

The formula which indicates if a company embarking on a growth strategy will need to take on debt to fund this growth is called

A) the return on investment.

B) the CAPM.

C) the index of sustainable growth.

D) operating cash flow.

E) the Z-value.

Answer: C

89

What benefit does converting sales and profits to constant dollars in times of inflation offer when analyzing a case?

A) It is helpful in predicting the future potential of the organization.

B) It contributes to determining the risk factors when computing the Z-value.

C) It shows the true performance of the corporation adjusted for inflation to make them comparable over years.

D) It is easier for the financial analyst to judge the effectiveness of management's decision making.

E) It provides a method which is familiar and easy to understand.

Answer: C

90

To adjust for general inflation in the United States, what index does the text suggest?

A) Dow-Jones Industrial Average

B) New York Stock Exchange Index

C) Wilshire 500 Equity Index

D) Consumer Price Index

E) NASDAQ Series

Answer: D

91

Dollars adjusted for inflation to make them comparable over various years are known as

A) consumer dollars.

B) constant dollars.

C) consumer inflation.

D) constant inflation.

E) earning dollars.

Answer: B

92

________ is used worldwide and measures the total output of goods and services within a country's borders.

A) CPI

B) Prime interest rate

C) GDP

D) Z-Value

E) The Index of sustainable growth

Answer: C

93

Which of the following is NOT true of case analysis?

A) Case discussion focuses on critical analysis.

B) A solution is satisfactory if it resolves important problems and if it is likely to be implemented successfully.

C) Case analysis helps build analytic and decision-making skills.

D) A solution is satisfactory if it reflects what the company actually did.

E) Case discussion focuses on logical development of thought.

Answer: D

94

List Schilit's short checklist of items to examine for red flags.

Answer: Schilit proposes a checklist of items to examine for red flags:

Cash flow from operations should exceed net income.

Accounts receivable should not grow faster than sales.

Gross margins should not fluctuate over time.

Examine carefully information about top management and the board.

Read the footnotes.

95

What ratios are recommended for financial ratio analysis?

Answer: Some of the most important financial ratios recommended are liquidity ratios, profitability ratios, activity ratios, and leverage ratios. A review of key financial ratios can help to assess a company's overall situation and pinpoint some problem areas. It is important to compare a company's ratios with industry averages and to calculate only those ratios that are appropriate for the company.

96

In performing a basic financial analysis, what five steps should be taken?

Answer: At a minimum, in performing a basic financial analysis, the following five steps should be taken. Scrutinize historical income statements and balance sheets. Compare historical statements over time. Calculate changes that occur in individual categories from year to year. Determine the change as a percentage (as well as an absolute amount). And adjust for inflation.

97

What are common-size statements?

Answer: Common-size statements are income statements and balance sheets in which the dollar figures have been converted into percentages. These statements are used to identify trends in each of the categories. To get a proper picture, however, you need to make comparisons with industry data, if available, to see whether fluctuations are merely reflecting industry-wide trends. Common size statements are especially helpful in developing scenarios and pro forma statements because they provide a series of historical relationships from which you can estimate the future with your scenario assumptions for each year.

98

What is the Z-value?

Answer: If the corporation being studied appears to be in poor financial condition, Altman's Bankruptcy formula should be used to calculate its likelihood of going bankrupt. The z-value formula combines five ratios by weighting them according to their importance to a corporation's financial strength. Scores below 1.81 indicate significant credit problems, whereas a score above 3.0 indicates a healthy firm. Scores between 1.81 and 3.0 indicate question marks.

99

What are constant dollars and why are they important?

Answer: Constant dollars are dollars adjusted for inflation to make them comparable over various years. One way to adjust for inflation in the United States is to use the Consumer Price Index. Adjusting for inflation is especially important for companies operating in the emerging economies, like China and Russia.