Student Evaluation
Multiple Choice Questions
General on the IEM in general and trading on the IEM
1. What kinds of assets are traded on the IEM?
a. Fixed income
b. Equity
c. Derivative
d. All three
e. None of the above
2. The contracts you trade on the IEM for this class are based on:
a. the returns for entertainment industry stocks.
b. the returns for computer industry stocks.
c. the outcomes of elections.
d. the level of prices in the economy.
3. Ratios can help in IEM trading because they:
a. can help explain past returns for stocks.
b. can help predict future returns for stocks.
c. determine completely the current price of a stock.
d. are based on past accounting numbers.
4. Contracts are created on the IEM through the following procedure:
a. Each trader gets contracts when he or she opens an account.
b. Contracts are created each time you make a purchase.
c. Contracts are created when traders buy bundles.
d. The number of contracts in the market is fixed and, therefore, no contracts are ever created.
5. If you think that AAPL is in the best financial shape and will have the highest return over the next month among AAPL, IBM, MSFT and the S&P500, you should:
a. Try to buy AAPLm by placing an ask.
b. Try to buy AAPLm by placing a bid.
c. Try to sell AAPLm by placing an ask.
d. Try to sell AAPLm by placing a bid.
Questions on computing common financial ratios
Answer the questions 6-14 based on the following simplified financial statement from IBM (source: MSN Investor 10/30/00):
6.
The ROE (measured on an end-of-year basis) for IBM in 1999 was:
a. 8.81%
b. 37.60%
c. 38.62%
d. 57.32%
7. The ROA (measured on an end-of year basis) for IBM in 1999 was:
a. 8.81%
b. 8.89%
c. 8.96%
d. 37.60%
8. The current ratio for IBM in 1999 was:
a. 0.917
b. 1.000
c. 1.090
d. 1.306
9. The quick ratio for IBM in 1999 was:
a. 0.123
b. 0.967
c. 1.034
d. 1.618
10. The total debt ratio for IBM in 1999 was:
a. 0.306
b. 0.324
c. 0.766
d. 3.266
11. The net profit margin for IBM in 1999 was:
a. 8.81%
b. 13.43%
c. 14.25%
d. 42.99%
12. If the EPS was $4.10 and the dividend was $0.52, the retention ratio for IBM in 1999 was:
a. 0.123
b. 0.873
c. 1.000
d. 1.145
13. The total asset turnover ratio (based on end-of-year numbers) for IBM in 1999 was:
a. 0.506
b. 0.991
c. 0.999
d. 11.345
14. The inventory turnover ratio (based on sales and end-of-year numbers) for IBM in 1999 was:
a. 0.056
b. 1.060
c. 17.984
d. 20.295
Questions on the performance objectives measured by the ratios
15. Liquidity ratios measure the firm’s:
a. ability to cover current obligations.
b. ability to cover long-term debt obligations.
c. activity level relative to amount of resources used.
d. profits relative to amount of resources used.
e. market price relative to assets or earnings.
16. Leverage ratios measure the firm’s:
a. ability to cover current obligations.
b. ability to cover long-term debt obligations.
c. activity level relative to amount of resources used.
d. profits relative to amount of resources used.
e. market price relative to assets or earnings.
17. Turnover ratios measure the firm’s:
a. ability to cover current obligations.
b. ability to cover long-term debt obligations.
c. activity level relative to amount of resources used.
d. profits relative to amount of resources used.
e. market price relative to assets or earnings.
18. Profitability ratios measure the firm’s:
a. ability to cover current obligations.
b. ability to cover long-term debt obligations.
c. activity level relative to amount of resources used.
d. profits relative to amount of resources used.
e. market price relative to assets or earnings.
19. Valuation ratios measure the firm’s:
a. ability to cover current obligations.
b. ability to cover long-term debt obligations.
c. activity level relative to amount of resources used.
d. profits relative to amount of resources used.
e. market price relative to assets or earnings.
Questions on the interpretation of financial ratios and evaluation the company’s performance
20. Which of the following would cause Net Worth to increase?
a. One of the firm’s customers pays an outstanding bill with cash.
b. The firm uses cash to pay off a bank note.
c. The firm pays a cash dividend to its stockholders.
d. The firm sells inventory for a profit.
21. If IBM’s quick ratio exceeds 1, then:
a. IBM can pay off all its current obligations if it liquidates its inventory.
b. IBM can pay off all its current obligations even if sales cease.
c. IBM has more current liabilities than current assets.
d. IBM has more current liabilities than current assets if you subtract inventories.
22. If you find that a company’s ratio for a particular item (for example, the company’s debt ratio) is higher than the industry average, this is:
a. good for the company.
b. bad for the company.
c. can be either of the above.
d. none of the above.
23. The fraction of a firm owned by equity holders is given by:
a. 1/(debt ratio)
b. 1-(debt ratio)
c. (equity ratio)/(debt ratio)
d. cannot be determined by the debt ratio.
24. All else constant, a surprise announcement that shows a higher ROE for a firm that is expected to remain after it is announced should:
a. result in a higher than expected return for the company’s stock.
b. result in a lower than expected return for the company’s stock.
c. not affect the company’s stock.
d. lead to the invalidation of the DuPont method.
25. A higher retention ratio should lead to:
a. lower current dividends.
b. higher sustainable growth.
c. higher future dividends.
d. all of the above.
26. A higher profit margin results from:
a. lower assets.
b. lower expenses.
c. lower taxes
d. lower interest.
27. All else constant, a higher asset turnover ratio should lead to:
a. less efficient operations.
b. lower profits.
c. more assets required.
d. all of the above.
e. none of the above.
Questions on DuPont analysis
28. DuPont analysis shows:
a. how profit margin, asset turnover ratio, and equity multiplier determine ROE
b. how expense control, efficient use of assets in production and capital structure affect return on equity.
c. production and financing aspects of firm are tied together
d. all of the above.
e. none of the above.
29. According to DuPont analysis, an increase in the profit margin (all else constant) should:
a. increase both ROE and ROA.
b. increase ROE but not ROA.
c. increase ROA but not ROE.
d. increase neither ROA nor ROE.
30. According to DuPont analysis, an increase in asset turnover (all else constant) should:
a. increase both ROE and ROA.
b. increase ROE but not ROA.
c. increase ROA but not ROE.
d. increase neither ROA nor ROE.
31. According to DuPont analysis, an increase in the equity multiplier (all else constant) should:
a. increase both ROE and ROA.
b. increase ROE but not ROA.
c. increase ROA but not ROE.
d. increase neither ROA nor ROE.
- In 1999, IBM’s equity multiplier was 4.266, its asset turnover was 0.999 and its net profit margin was 0.088. According to the DuPont method, the ROE should be:
a. 8.791%.
b. 37.503%.
c. 37.541%.
d. 426.173%.
33. In 1999, IBM’s equity multiplier was 4.266, its asset turnover was 0.999 and its net profit margin was 0.088. According to the DuPont method, the ROA should be:
a. 8.791%.
- 37.503%.
- 37.541%.
- 426.173%.
Short Answer Questions
- If you purchase one IBMm contract in the Computer Industry Returns Market for $0.595 and hold until liquidation, what will be your return if the contract liquidates at $1.00? If it liquidates at $0?
- Explain how historical information such as financial ratios can be used to help predict returns.
- Describe your IEM investment objective and trading strategy.
- Suppose that firm X has a 5% profit margin while firm Z has a 15% profit margin. Both firms are in the same industry. Which firm is doing a better job of controlling expenses? Carefully explain what the profit margin measures and how you reached your conclusion.
- As a financial troubleshooter, you have been given the following information on two firms.
Return on Assets Return on Equity
Firm A 10% 25%
Firm B 10% 15%
Using the Dupont system, tell why the firms have different Returns on Equity when their Returns on Assets are identical. Which firm uses more debt? Carefully explain how you reached this conclusion.
- Why is it useful to use ratios? Why not use the values taken directly from the financial statements? In your answer be sure to explain what ratios are used for.
Questions 7-14 are based on the following information for Doric Corporation:
THE DORIC CORP.'S BALANCE SHEETS FOR 1998 AND 1999
Thousands of Dollars
1999 1998
Cash $ 150 $ 180
Receivables 310 200
Inventories 740 620
Total current assets $1,200 $1000
Net fixed assets $1,450 $1,450
Total assets $2,650 $2,450
Accounts payable $ 370 $ 330
Notes payable 150 110
Accruals 180 160
Total current liabilities $ 700 $ 600
Long-term debt 250 400
Common stock (200,000 shrs) 550 550
Retained earnings 1,150 900
Total long-term capital $1,950 $1,850
Total liabilities and equity $2,650 $2,450
THE DORIC CORP.'S 1999 INCOME STATEMENT
Thousands of Dollars
Sales $5,000
Cost of goods sold 2,400
General expenses 1,700
EBIT $ 900
Interest 50
EBT $ 850
Taxes 200
Net income $ 650
Compute the following.
- Net Worth ______
- P/E if stock trades at $81.25 per share ______
- Market/Book if stock trades at $39.75 per share ______
- Return on Assets ______
You are in charge of evaluating the performance of Doric Inc. by comparing it to the industry leader, Trion Corp. You have obtained the following information for Trion.
Trion Doric
Profit Margin 10% _____
Asset Turnover 2.5 _____
Debt/Assets 60% _____
- Compared to Trion, how is Doric doing in terms of expense control? Explain how you know.
- Compared to Trion, how is Doric doing in efficient use of assets? Explain how you know.
- Based on what you see here, which stock is likely to be more risky? Explain how you know.
- Based on what you see here, which stock has the higher return on equity? Explain how you know.
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