accounting midterm

Module 4

Analyzing and Interpreting Financial Statements

Learning Objectives – coverage by question

True/
False
Multiple Choice
Exercises
Problems
Essay Questions
LO1 Compute return on equity (ROE) and disaggregate it into operating and nonoperating returns.
1-6
1-9
1-6
1-4
1-2
LO2 Disaggregate operating return (RNOA) into components of profitability and asset turnover.
1, 7-9
10-14
7-9
5-6
1-3
LO3 Explain nonoperating return and compute it from return on equity and the operating return.
1-2, 10-11
15-17
10
7-8
1-2, 4
LO4 Compute and interpret measures of liquidity and solvency.
1, 12-14
18-24
11-14
9-10
1-2, 5-6
LO5 Describe and illustrate traditional DuPont disaggregation of ROE.
1, 15
25
15
11
1-2, 7

Module 4: Analyzing and Interpreting Financial Statements

True/False

Topic: Use of ratios
LO: 1-5
1. Ratios provide one way to compare companies in the same industry regardless of their size.

Answer: True
Rationale: Ratios mitigate problems arising from different sizes of companies.

Topic: Financial leverage and RNOA
LO: 1, 3
2. Highly leveraged firms have higher RNOA than firms with lower leverage.
Answer: False
Rationale: Financial leverage does not affect the RNOA computation because it is based on operating profit. Financial leverage will increase ROE, however.

Topic: Return on equity and treasury stock
LO: 1
3. Repurchasing shares near year end will increase a firm’s return on equity (ROE).
Answer: True
Rationale: Repurchasing shares will decrease equity because treasury stock is a contra-account (it reduces total equity). If the repurchases happen at year end, there are likely no significant profit impacts and thus, the numerator in the ROE ratio will be unaffected. Thus, the ratio will increase.

Topic: Nonoperating return
LO: 1
4. All else equal, when investors consider a firm’s return on equity (ROE) they consider less risk a firm that earns