Statement Analysis Tools and Accounting Ratios Test

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Statement Analysis Tools and Accounting Ratios Test - 43

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Weekly Quiz Competition

Question 1
1 / -0

Relationship between change in sales and the operating profit is known as ____________.

A
Financial leverage

B
Operating leverage

C
Net profit ratio

D
Gross profit ratio

Solution

Operating leverage is a measure of how the revenue growth translate in to growth in operating income. It relates to the result of different combination of fixed cost and variable cost.
Operating leverage is calculated by dividing the contribution by companies net income. It show the relationship in change in sales and the operating profit.
Question 2
1 / -0

Financial Break-even level of EBIT is one at which EPS is equal to _________.

A
One

B
Zero

C
Infinite

D
Negative

Solution

Financial break even of EBIT is that level when the EPS is zero. Financial break even is that level when the company has recovered its fixed financial charges i.e. interest on debt and preference dividend.

Financial break even is further defined as the minimum level of EBIT required to pay off the fixed financial cost i.e. interest on debt and preference dividend.
Question 3
1 / -0

For a constant EBIT, if the debt level is further increased then ____________.

A
EPS will always increase

B
EPS may increase

C
EPS will never increase

D
None of the above

Solution

For a constant EBIT, if the debt level is further increased then EPS may increase but only if the the rate of interest of debenture decreases simultaneously.

Formula for calculation of EPS = [(X-I) (1-T)- PD] /N ,
Where,
X= EBIT
I1= Fixed Interest
T= Tax rate
PD= Preference dividend if any
N1 = Number of shares

Alternative 1 : EBIT is $$Rs. 200000$$ , amount of debenture is $$Rs.500000$$, interest on the same is @ $$ 12$$ % and the number of equity share is $$ 10000$$ and the tax rate is $$50$$%

Alternative 2 : EBIT is $$Rs. 200000$$ , amount of debenture is $$Rs.600000$$, interest on the same is @ $$ 8$$ % and the number of equity share is $$ 10000$$ and the tax rate is $$50$$%
So now,
Alternative 1 EPS = [($$200000-60000$$) ($$1$$-$$0.5$$) -$$0$$]/ $$10000$$ = $$Rs.7$$
Alternative 2 EPS = [($$200000-48000$$) ($$1$$-$$0.5$$) -$$0$$]/ $$10000$$ = $$Rs.7.6$$
Question 4
1 / -0

Securitization is related to conversion of _____________.

A
Receivables

B
Stock

C
Investments

D
Creditors

Solution

Accounts receivables represents the amount due from the customers to whom organization has done sales. Recovery of money from receivables can take a larger time which depends on the credit policy.

Organization can convert the receivable in cash by doing the securitization. In such case, receivables are converted in to securities and sold to an investor who will provide immediate cash to the organization.
Securitization allows company to get immediate cash rather than waiting for payment from the customers. By this organization can pass the risk of non payment to investors.
Question 5
1 / -0

At indifference level of EBIT, different capital have .

A
Same EBIT

B
Same EPS

C
Same PAT

D
Same PBT

Solution

At indifference level of EBIT, different capital have same EPS. Let us take a look at an example:
The formula for calculating the point of indifference is as follows
[(X-I1) (1-T)- PD] /N1 = [(X-I2) (1-T)- PD] /N2 ,
Where,
X= EBIT Indifference level
I1= Fixed Interest under alternative 1
I2= Fixed Interest under alternative 2
T= Tax rate
PD= Preference dividend if any
N1 = Number of shares in option 1
N2 = Number of shares in option 2

The investment required in the project is $$Rs.1500000$$. Interest on debenture capital is $$12$$% and the tax rate is $$50$$%. Face value of share is $$Rs.100$$ , the debt equity ratio is $$1:2$$ and EBIT indifference level is $$Rs. 180000$$
Alternative 1: Raising the whole amount by equity share. So, shares to be issued would be $$Rs. 1500000$$ / $$100$$ = $$15000$$ shares.
Alternative 2: Raising $$500000$$ by shares and $$1000000$$ by equity. So interest payable would be $$500000$$ x $$12$$ % = $$60000$$ and number of equity shares would be $$1000000$$ / $$100$$ = $$10000$$ shares. So now,
Alternative 1 EPS = [($$180000 - 0 $$) ($$1-0.5$$)- $$0$$] / $$15000$$
= $$Rs.6$$
Alternative 2 EPS = [($$180000 - 60000 $$) ($$1-0.5$$)- $$0$$] / $$10000$$
= $$Rs. 6$$
Question 6
1 / -0

Which of the following appearing in the balance sheet, generates tax advantage and hence affects the capital structure decision?

A
Reserves and Surplus.

B
Long-term Debt.

C
Preference Share Capital.

D
Equity Share Capital.

Solution

In case of Long-term debt the cost to the company is in the form of interest payments to the debenture holders. The interest paid is an eligible expense while calculating income tax and so tax benefit can be availed on the same. A proper mixture of Debt and Equity can help in increasing the EPS of the company. This is the reason why most of the companies conduct in-depth analysis while taking the capital structure decision keeping in mind the leverage achievable.
Question 7
1 / -0

Every company should follow     .

A
High Dividend Payment

B
Low Dividend Payment

C
Stable Dividend Payment

D
Fixed Dividend Payment

Solution

Every company should follow stable dividend policy, this is because the fluctuations in dividend payment would affect the market price of the share.
We can clearly understand this by using Walters Formula for Market price of share:
Walter's formula :
P = D/k + [r/k(E-D)] /k or,
P = [D + r/k(E-D)]/k
where,
P= market price per share
D=dividend per share
E= earnings per share
r= internal rate of return (IRR) of the firm
k= cost of capital of the firm.
Scenario 1:  Let D= $$Rs.10$$, k= $$10$$% , r= $$12$$% and E= $$Rs.15$$
P= [$$10 + 0.12/0.1(15-10)]/0.1$$
= $$Rs.160$$
Scenario 2:  Let D= $$Rs.12$$, k= $$10$$% , r= $$12$$% and E= $$Rs.15$$
P= [$$12 + 0.12/0.1(15-12)]/0.1$$
= $$Rs. 156$$
Scenario 3:  Let D= $$Rs.5$$, k= $$10$$% , r= $$12$$% and E= $$Rs.15$$
P= [$$5 + 0.12/0.1(15-5)]/0.1$$
= $$Rs. 170$$.
Question 8
1 / -0

Given below are two statements, identify the correctness of the following:
I. Activity ratios show where the company is going.
II. Balance sheet ratios show how the company stands.

A
I is correct, but II is wrong

B
Both I and II are correct

C
I is wrong, but II is correct

D
Both I and II are wrong

Solution

Activity ratios are used to assess the efficiency with which the firm manages and utilises its assets. These ratios usually compare the revenue growth with respect to the asset deployed giving an idea of where the company is headed, towards growth or decline.
Balance sheet ratios are those in which the variables used are those which are present in the balance sheet. A balance sheet is a statement which shows a picture of how the company stands as on a particular date and so the balance sheet ratios carry out the same task.
Question 9
1 / -0

Which of the following is correct?
i.Liquidity ratios measure long term solvency of a concern.
ii.Inventory is a part of current assets.
iii.Rule of thumb for acid test ratio is 1 : 1.
iv.The amount of gross assets is equal to net capital employed.

A
(i), (ii) and (iv)

B
(ii), (iii) and (iv)

C
(i), (ii), (iii) and (iv)

D
None of the above
Solution
1. The liquidity ratios measure the ability of a concern to pay off its short term obligations.
2. Inventory is a part of current assets and not liquid assets.
3. Rule of thumb for acid test ratio is $$1:1$$
4. The amount of gross assets minus the current liabilities is equal to net capital employed.
Question 10
1 / -0

If debt is Rs 220, and equity is Rs 300 , then the gearing ratio is ______.

A
$$20$$%

B
$$73.33$$%

C
$$50$$%

D
$$30$$%

Solution

Capital gearing ratio = Fixed Interest bearing Capital/ Equity funds or Networth
= $$220/300$$
= $$73.33$$ %

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Re-Attempt Weekly Quiz Competition

Statement Analysis Tools and Accounting Ratios Test - 43

Result

Statement Analysis Tools and Accounting Ratios Test - 43

Score

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Rank

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SHARING IS CARING

Question 1

Financial leverage

Operating leverage

Net profit ratio

Gross profit ratio

Solution

Question 2

One

Zero

Infinite

Negative

Solution

Question 3

EPS will always increase

EPS may increase

EPS will never increase

None of the above

Solution

Question 4

Receivables

Stock

Investments

Creditors

Solution

Question 5

Same EBIT

Same EPS

Same PAT

Same PBT

Solution

Question 6

Reserves and Surplus.

Long-term Debt.

Preference Share Capital.

Equity Share Capital.

Solution

Question 7

High Dividend Payment

Low Dividend Payment

Stable Dividend Payment

Fixed Dividend Payment

Solution

Question 8

I is correct, but II is wrong

Both I and II are correct

I is wrong, but II is correct

Both I and II are wrong

Solution

Question 9

(i), (ii) and (iv)

(ii), (iii) and (iv)

(i), (ii), (iii) and (iv)

None of the above

Solution

Question 10

$$20$$%

$$73.33$$%

$$50$$%

$$30$$%

Solution

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