Unit 5: Financial Statement Analysis

Answer: C — The correct answer is C because a debt-to-equity ratio of 0.5 indicates that the company has a moderate level of financial risk, and an interest coverage ratio of 3 indicates that the company has sufficient earnings to cover its interest payments. This suggests that the company can likely issue new debt without significantly increasing its financial risk. Option A is incorrect because a debt-to-equity ratio of 0.5 is not considered high. Option B is incorrect because an interest coverage ratio of 3 is considered sufficient. Option D is incorrect because a debt-to-equity ratio of 0.5 is not considered high.

Answer: D — Project B is more desirable because its expected return (15%) is higher than the cost of capital (10%), which means it is expected to generate returns in excess of the company's cost of capital. Although Project B has a higher level of risk, the expected return is high enough to compensate for that risk. Project A's expected return (12%) is also higher than the cost of capital, but it is lower than Project B's expected return. Therefore, Project B is more desirable. Options A and C are incorrect because they do not consider the expected return relative to the cost of capital. Option B is incorrect because it ignores the level of risk associated with Project B.

Answer: C — The correct answer is A because a higher ROI indicates that Project A is generating more income per dollar invested, but a lower residual income suggests that Project B may have a larger investment base, resulting in higher total residual income. The other options are incorrect because they misinterpret the relationship between ROI and residual income.

Answer: B — The correct answer is D because financial statement analysis is used to evaluate a company's financial performance and position, which includes assessing its profitability, liquidity, and solvency. This information is essential for stakeholders such as investors, creditors, and management to make informed decisions. The other options are incorrect because preparing tax returns (A) is a separate function, determining auditing schedules (B) is a task for auditors, and identifying investment opportunities in competitors (C) is not a primary purpose of financial statement analysis.

Answer: B — The correct answer is C) 25.0%. To calculate ROE, we need to first calculate the company's net income available to common shareholders, which is $150,000 - $30,000 = $120,000 (assuming no preferred dividends). Then we calculate the average shareholders' equity: ($600,000 + $400,000)/2 = $500,000, where $400,000 is the shareholders' equity at the end of the year, calculated as $1,000,000 - $600,000. Then ROE = Net income available to common shareholders / Average shareholders' equity = $120,000 / $480,000 (beginning equity) = $150,000 / $600,000 (average of beginning and ending, assuming ending equity is $600,000 + $150,000 - $30,000 = $720,000 and averaging it with $480,000 gives $600,000) is not correct. The correct calculation is: Beginning equity = $1,000,000 - $600,000 = $400,000. Ending equity = $1,000,000 + $150,000 - $30,000 = $1,120,000 - $600,000 = $520,000. Average equity = ($400,000 + $520,000) / 2 = $460,000. ROE = $120,000 / $460,000 = 26.08%, rounded to 25.0% (or using $150,000 / $600,000, which is not the correct average). A and B are incorrect because they are not the result of the correct calculation. D is incorrect because it is higher than the correct answer.