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Things Held Constant Quiz

Determining whether a firm's financial position is improving or deteriorating requires analysis of more than one set of financial statements. Trend analysis is one method of measuring a firm's performance over time.

If the current ratio of Firm A is greater than the current ratio of Firm B, we cannot be sure that the quick ratio of Firm A is greater than that of Firm B. However, if the quick ratio of Firm A exceeds that of Firm B, we can be assured that Firm A's current ratio also exceeds B's current ratio.

The inventory turnover and current ratios are related. The combination of a high current ratio and a low inventory turnover ratio relative to the industry norm might indicate that the firm is maintaining too high an inventory level or that part of the inventory is obsolete or damaged.

We can use the fixed assets turnover ratio to legitimately compare firms in different industries as long as all the firms being compared are using the same proportion of fixed assets to total assets.

Suppose two firms have the same amount of assets, pay the same interest rate on their debt, have the same basic earning power (BEP), and have the same tax rate. However, one firm has a higher debt ratio. If BEP is greater than the interest rate on debt, the firm with the higher debt ratio will also have a higher rate of return on common equity.

If sales decrease and financial leverage increases, we can say with certainty that the profit margin on sales will decrease.

Other things held constant, which of the following will not affect the current ratio, assuming an initial current ratio greater than 1.0?

Fixed assets are sold for cash.

Long-term debt is issued to pay off current liabilities.

Accounts receivable are collected.

Cash is used to pay off accounts payable.

Other things held constant, which of the following will not affect the quick ratio? (Assume that current assets equal current liabilities.)

Fixed assets are sold for cash.

Cash is used to purchase inventories.

Cash is used to pay off accounts payable.

Accounts receivable are collected.

Which of the following statements is most correct?

If a company increases its current liabilities by $1,000 and simultaneously increases its inventories by $1,000, its current ratio must rise.

If a company increases its current liabilities by $1,000 and simultaneously increases its inventories by $1,000, its quick ratio must fall.

Answers b and c are correct.

A company’s quick ratio may never exceed its current ratio.

Which of the following actions can a firm take to increase its current ratio?

Issue short-term debt and use the proceeds to buy back long-term debt with a maturity of more than one year.

Reduce the company’s days sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.

Use cash to purchase additional inventory.

None of the statements above is correct.

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This quiz is tagged as: things held constant, things held constant, current ratio, things held constant, things held constant, current ratio, ratio

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