LM11: Financial Analysis Techniques

1. Comparison of a company’s financial results to other peer companies for the same time period
is called:
A. time-series analysis.
B. common-size analysis.
C. cross-sectional analysis.
2. An analyst observes a decrease in a company’s inventory turnover. Which of the following
would most likely explain this trend?
A. The company installed a new inventory management system, allowing more efficient
inventory management.
B. Due to problems with obsolescent inventory last year, the company wrote off a large
amount of its inventory at the beginning of the period.
C. The company installed a new inventory management system but experienced some
operational difficulties resulting in duplicate orders being placed with suppliers.
3. Which of the following would best explain an increase in receivables turnover?
A. The company adopted new credit policies last year and began offering credit to
customers with weak credit histories.
B. Due to problems with an error in its old credit scoring system, the company had
accumulated a substantial amount of uncollectible accounts and wrote off a large amount
of its receivables.
C. To match the terms offered by its closest competitor, the company adopted new
payment terms now requiring net payment within 30 days rather than 15 days, which had
been its previous requirement.
4. Brown Corporation had average days of sales outstanding of 19 days in the most recent fiscal
year. Brown wants to improve its credit policies and collection practices and decrease its
collection period in the next fiscal year to match the industry average of 15 days. Credit sales in
the most recent fiscal year were $300 million, and Brown expects credit sales to increase to $390
million in the next fiscal year. To achieve Brown’s goal of decreasing the collection period, the
change in the average accounts receivable balance that must occur is closest to:
A. +USD0.41 million.
B. –USD0.41 million.
C. –USD1.22 million.
5. An analyst is interested in assessing both the efficiency and liquidity of Spherion PLC. The
analyst has collected the data in Exhibit 1 for Spherion:

Based on the data in Exhibit 1, what is the analyst least likely to conclude?
A. Inventory management has contributed to improved liquidity.
B. Management of payables has contributed to improved liquidity.
C. Management of receivables has contributed to improved liquidity.
6. To assess a company’s ability to fulfill its long-term obligations, an analyst would most likely
examine:
A. activity ratios.
B. liquidity ratios.
C. solvency ratios.
7. An analyst is evaluating the solvency and liquidity of Apex Manufacturing and has collected
the data in Exhibit 1:

Which of the following would be the analyst’s most likely conclusion?

A. The company is becoming less liquid, as evidenced by the increase in its debt-to-
equity ratio from 0.35 to 0.50 from FY3 to FY5.
B. The company is becoming increasingly more liquid, as evidenced by the increase in its
debt-to-equity ratio from 0.35 to 0.50 from FY3 to FY5.
 C. The company is becoming increasingly less solvent, as evidenced by the increase in its
debt-to-equity ratio from 0.35 to 0.50 from FY3 to FY5.
8. Using information in question 7, With regard to the data in Problem 5, what would be the most
reasonable explanation of the financial data?
A. The decline in the company’s equity results from a decline in the market value of this
company’s common shares.
B. The EUR250 increase in the company’s debt from FY3 to FY5 indicates that lenders
are viewing the company as increasingly creditworthy.
C. The decline in the company’s equity indicates that the company may be incurring
losses, paying dividends greater than income, or repurchasing shares.
9. An analyst observes the data in Exhibit 1 for two companies:

Which of the following choices best describes reasonable conclusions that the analyst might
make about the two companies’ ability to pay their current and long-term obligations?
A. Company A’s current ratio of 4.0 indicates it is more liquid than Company B, whose
current ratio is only 1.2, but Company B is more solvent, as indicated by its lower debt-
to-equity ratio.
B. Company A’s current ratio of 0.25 indicates it is less liquid than Company B, whose
current ratio is 0.83, and Company A is also less solvent, as indicated by a debt-to-equity
ratio of 200 percent compared with Company B’s debt-to-equity ratio of only 30 percent.
C. Company A’s current ratio of 4.0 indicates it is more liquid than Company B, whose
current ratio is only 1.2, and Company A is also more solvent, as indicated by a debt-to-
equity ratio of 200 percent compared with Company B’s debt-to-equity ratio of only 30
percent.
10. The following data appear in the five-year summary of a major international company. A
business combination with another major manufacturer took place in FY13.

The company’s total assets at year-end FY9 were GBP3,500 million. Which of the following
choices best describes reasonable conclusions an analyst might make about the company’s
efficiency?
A. Comparing FY14 with FY10, the company’s efficiency deteriorated, as indicated by
its current ratio.
B. Comparing FY14 with FY10, the company’s efficiency deteriorated due to asset
growth faster than turnover revenue growth.
C. Comparing FY14 with FY10, the company’s efficiency improved, as indicated by a
total asset turnover ratio of 0.86 compared with 0.64.
11. Using information in question 10, Which of the following choices best describes reasonable
conclusions an analyst might make about the company’s solvency?

A. Comparing FY14 with FY10, the company’s solvency improved, as indicated by the
growth in its profits to GBP 645 million.
B. Comparing FY14 with FY10, the company’s solvency deteriorated, as indicated by a
decrease in interest coverage from 10.6 to 8.4.
C. Comparing FY14 with FY10, the company’s solvency improved, as indicated by an
increase in its debt-to-assets ratio from 0.14 to 0.27.
12. Using information in question 10, Which of the following choices best describes reasonable
conclusions an analyst might make about the company’s liquidity?
A. Comparing FY14 with FY10, the company’s liquidity improved, as indicated by an
increase in its current ratio from 0.71 to 0.75.
B. Comparing FY14 with FY10, the company’s liquidity deteriorated, as indicated by a
decrease in interest coverage from 10.6 to 8.4.
C. Comparing FY14 with FY10, the company’s liquidity improved, as indicated by an
increase in its debt-to-assets ratio from 0.14 to 0.27.
13. Using information in question 10, Which of the following choices best describes reasonable
conclusions an analyst might make about the company’s profitability?
A. Comparing FY14 with FY10, the company’s profitability improved, as indicated by an
increase in its debt-to-assets ratio from 0.14 to 0.27.
B. Comparing FY14 with FY10, the company’s profitability improved, as indicated by
the growth in its shareholders’ equity to GBP6,165 million.
C. Comparing FY14 with FY10, the company’s profitability deteriorated, as indicated by
a decrease in its net profit margin from 11.0 percent to 5.7 percent.
14. An analyst compiles the data in Exhibit 1 for a company:
Based only on the information above, the most appropriate conclusion is that, over the period
FY13 to FY15, the company’s:

A. net profit margin and financial leverage have decreased.

B. net profit margin and financial leverage have increased.
C. net profit margin has decreased but its financial leverage has increased.
15. A decomposition of ROE for Integra SA is as follows:

Which of the following choices best describes reasonable conclusions an analyst might make
based on this ROE decomposition?
A. Profitability and the liquidity position both improved in FY12.
B. The higher average tax rate in FY12 offset the improvement in profitability, leaving
ROE unchanged.
C. The higher average tax rate in FY12 offset the improvement in efficiency, leaving
ROE unchanged.
16. A decomposition of ROE for Company A and Company B is as follow
An analyst is most likely to conclude that:
A. Company A’s ROE is higher than Company B’s in FY15, and one explanation
consistent with the data is that Company A may have purchased new, more efficient
equipment.
B. the difference between the two companies’ ROE in FY15 is very small and Company
A’s ROE remains similar to Company B’s ROE mainly due to Company A increasing its
financial leverage.
C. Company A’s ROE is higher than Company B’s in FY15, and one explanation
consistent with the data is that Company A has made a strategic shift to a product mix
with higher profit margins.
17. When developing forecasts, analysts should most likely:
A. develop possibilities relying exclusively on the results of financial analysis.
B. aim to develop extremely precise forecasts using the results of financial analysis.
C. use the results of financial analysis, analysis of other information, and judgment.
18. Selected information for a company and its industry’s average return on equity (ROE) is
provided:
Which of the following is most likely a contributor to the company’s inferior ROE compared
with that of the industry? The company’s lower:
A. tax burden ratio.
B. financial leverage.
C. interest burden ratio.
19. By themselves, financial ratios are least likely to be sufficient in determining a company’s:
A. past performance.
B. creditworthiness.
C. current financial condition.
20. The following selected financial information is available:

The company’s cash conversion cycle (in days) is closest to:

A. 76.4.
 B. 45.2.
C. 38.2.
21. Based on each company's interest coverage ratio, which company is the most solvent?

A. Company B
B. Company C
C. Company A
22. An analysis used to forecast earnings that shows a range of possible outcomes as specific
assumptions change best describes which of the following techniques?
A. Scenario analysis
B. Simulation
C. Sensitivity analysis
23. Consider the following information available for a company for last year:

The average shareholder’s equity is closest to:

A. $164,557.
B. $123,418.
C. $219,409.
24. Other factors held constant, the reduction of a company’s average accounts payable because
of suppliers offering less trade credit will most likely:
A. not affect the operating cycle.
B. reduce the operating cycle.
 C. increase the operating cycle.
25. A company’s most recent balance sheet shows the following values (NZ$ thousands):

The company’s debt-to-capital ratio is closest to:

A. 0.65.
B. 0.77.
C. 1.86.
26. A portion of a company’s balance sheet appears in the following table (euros in millions):

The company’s quick ratio is closest to:

A. 1.40.
B. 0.06.
C. 0.73.
27. An analyst has calculated the following ratios for a company:
The company’s return on equity (ROE) is closest to:
A. 22.7%.
B. 4.8%.
C. 15.2%.
29. Which of the following ratios is most likely to be used as a measure of operating
performance?
A. Cash ratio
B. Working capital turnover ratio
C. Defensive interval ratio
30. An analyst is completing her analysis of three companies in the same industry. Which of
these companies is the most solvent?

A. Company C
B. Company B
C. Company A
LM12: Introduction to Financial Statement
Modeling
1. Nigel French, an analyst at Taurus Investment Management, is analyzing Archway
Technologies, a manufacturer of luxury electronic auto equipment, at the request of his
supervisor, Lukas Wright. French is asked to evaluate Archway’s profitability over the past five
years relative to its two main competitors, which are located in different countries with
significantly different tax structures.
French begins by assessing Archway’s competitive position within the luxury electronic auto
equipment industry using Porter’s five forces framework. A summary of French’s industry
analysis is presented in Exhibit 1.

French notes that for the year just ended (2019), Archway’s COGS was 30 percent of
sales. To forecast Archway’s income statement for 2020, French assumes that all
companies in the industry will experience an inflation rate of 8 percent on the COGS.
Exhibit 2 shows French’s forecasts relating to Archway’s price and volume changes.

After putting together income statement projections for Archway, French forecasts Archway’s
balance sheet items. He uses Archway’s historical efficiency ratios to forecast the company’s
working capital accounts.
Based on his financial forecast for Archway, French estimates a terminal value using a valuation
multiple based on the company’s average price-to-earnings multiple (P/E) over the past five
years. Wright discusses with French how the terminal value estimate is sensitive to key
assumptions about the company’s future prospects. Wright asks French:
“What change in the calculation of the terminal value would you make if a technological
development that would adversely affect Archway was forecast to occur sometime beyond your
financial forecast horizon?”
Which profitability metric should French use to assess Archway’s five-year historic performance
relative to its competitors?
A. Current ratio
B. Operating margin
C. Return on invested capital
2. Using information in question 1, Based on the current competitive landscape presented in
Exhibit 1, French should conclude that Archway’s ability to:
A. pass along price increases is high.
B. demand lower input prices from suppliers is low.
C. generate above-average returns on invested capital is low.
3. Using information in question 1, Based on the current competitive landscape presented in
Exhibit 1, Archway’s operating profit margins over the forecast horizon are least likely to:
A. decrease.
B. remain constant.
C. increase.
4. Using information in question 1, Based on Exhibit 2, Archway’s forecasted gross profit margin
for 2020 is closest to:
A. 62.7 percent.
B. 67.0 percent.
C. 69.1 percent.
5. Using information in question 1, If the luxury electronic auto equipment industry is subject to
rapid technological changes and market share shifts, how should French best adapt his approach
to modeling?
A. Examine base rates
B. Forecast multiple scenarios
 C. Speak to analysts who hold diverse opinions on the stock
6. Gertrude Fromm is a transportation sector analyst at Tucana Investments. She is conducting an
analysis of Omikroon, N.V., a hypothetical European engineering company that manufactures
and sells scooters and commercial trucks.

Omikroon’s petrol scooter division is the market leader in its sector and has two competitors.
Omikroon’s petrol scooters have a strong brand name and a well-established distribution
network. Given the strong branding established by the market leaders, the cost of entering the
industry is high. But Fromm anticipates that small, inexpensive, imported petrol-fueled
motorcycles could become substitutes for Omikroon’s petrol scooters.

Fromm uses ROIC as the metric to assess Omikroon’s performance.

Omikroon has just introduced the first electric scooter to the market at year-end 2019. The
company’s expectations are as follows:

 Competing electric scooters will reach the market in 2021.

 Electric scooters will not be a substitute for petrol scooters.
 The important research costs in 2020 and 2021 will lead to more efficient electric
scooters.
Fromm decides to use a five-year forecast horizon for Omikroon after considering the following
three factors:

Omikroon will initially outsource its electric scooter parts. But manufacturing these parts in-
house beginning in 2021 will imply changes to an existing factory. This factory cost EUR7
million three years ago and had an estimated useful life of 10 years. Fromm is evaluating two
scenarios:

Using Porter’s five forces analysis, which of the following competitive factors is most likely to
have the greatest impact on Omikroon’s petrol scooter pricing power?
A. Rivalry
B. Threat of substitutes
C. Threat of new entrants
7. Using information in question 6, The metric used by Fromm to assess Omikroon’s
performance incorporates:
A. the degree of financial leverage.
B. operating liabilities relative to operating assets.
C. the firm’s competitiveness relative to companies in other tax regimes.
8. Using information in question 6, Based on Omikroon’s expectations, the gross profit margin of
Omikroon’s electric scooter division in 2021 is most likely to be affected by:
A. competition.
B. research costs.
C. cannibalization by petrol scooters.
9. Using information in question 6, Fromm’s sensitivity analysis will result in a decrease in the
2020 base case gross profit margin closest to:
A. 0.55 percent.
B. 0.80 percent.
C. 3.32 percent.

10. Using information in question 6, To validate the forecast for rapid growth in the electronic
scooter market over the next 10 years, Fromm speaks to the management of Omikroon and
investor relations of ZeroWheel, a competitor. Which behavioral bias is Fromm most likely
subject to?
A. Confirmation
 B. Conservatism
C. Overconfidence

11. Angela Green, an investment manager at Horizon Investments, intends to hire a new
investment analyst. After conducting initial interviews, Green has narrowed the pool to three
candidates. She plans to conduct second interviews to further assess the candidates’ knowledge
of industry and company analysis.
Prior to the second interviews, Green asks the candidates to analyze Chrome Network Systems, a
company that manufactures internet networking products. Each candidate is provided Chrome’s
financial information presented in Exhibit 1.

Green asks each candidate to forecast the 2020 income statement for Chrome and to outline the
key assumptions used in their analysis. The job candidates are told to include Horizon’s
economic outlook for 2020 in their analysis, which assumes nominal GDP growth of 3.6 percent,
based on expectations of real GDP growth of 1.6 percent and inflation of 2.0 percent.
Green receives the models from each of the candidates and schedules second interviews. To
prepare for the interviews, Green compiles a summary of the candidates’ key assumptions in
Exhibit 2.
Based on Exhibit 1, which of the following provides the strongest evidence that Chrome displays
economies of scale?
A. Increasing net sales
B. Profit margins that are increasing with net sales
C. Gross profit margins that are increasing with net sales
12. Using information in question 11, Based on Exhibits 1 and 2, Candidate C’s forecast for cost
of sales in 2020 is closest to:
A. USD18.3 million.
B. USD18.9 million.
C. USD19.3 million.
13. Using information in question 11, Based on Exhibits 1 and 2, Candidate A’s forecast for
SG&A expenses in 2020 is closest to:
A. USD23.8 million.
B. USD25.5 million.
C. USD27.4 million.
14. Using information in question 11, Based on Exhibit 2, forecasted interest expense will reflect
changes in Chrome’s debt level under the forecast assumptions used by:
A. Candidate A.
B. Candidate B.
C. Candidate C.
15. Using information in question 11, Candidate B asks Green if she had additional information
on Horizon’s industry peers and competitors, to put the profitability estimates in a richer context.
By asking for this additional information for their analysis, Candidate B is most likely seeking to
mitigate which behavioral bias?
A. Conservatism
B. Base rate neglect
C. illusion of control