US CMA Part 2 · Chapter 2
Financial statement analysis: profitability, market measures and special issues MCQs with Answers
15 multiple-choice questions on Financial statement analysis: profitability, market measures and special issues for US CMA Part 2 Strategic Financial Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Mercer Apparel had net sales of $2,400,000 and cost of goods sold of $1,560,000. What is its gross profit margin?
- A) 46.2%
- B) 65.0%
- C) 53.8%
- D) 35.0%
Show answer & explanation
Answer: D) 35.0%
Gross profit = $2,400,000 - $1,560,000 = $840,000. Gross profit margin = gross profit / net sales = $840,000 / $2,400,000 = 35.0%. 65.0% is the cost of goods sold percentage, and 53.8% is a markup on cost rather than a margin on sales.
Question 2
Norland Foods earned net income of $288,000. Its average total assets for the year were $3,200,000. What is its return on assets?
- A) 11.1%
- B) 9.0%
- C) 18.0%
- D) 7.2%
Show answer & explanation
Answer: B) 9.0%
Return on assets = net income / average total assets = $288,000 / $3,200,000 = 9.0%. Return on assets measures how effectively management uses the company's total resources to generate profit.
Question 3
Using the DuPont model, what is the return on equity of a company with a net profit margin of 6%, total asset turnover of 1.5 times and an equity multiplier (average assets / average equity) of 2.2?
- A) 22.2%
- B) 9.0%
- C) 13.2%
- D) 19.8%
Show answer & explanation
Answer: D) 19.8%
DuPont ROE = net profit margin x asset turnover x equity multiplier = 6% x 1.5 x 2.2 = 19.8%. Net profit margin x asset turnover = 9.0% is return on assets; multiplying by the equity multiplier reflects the effect of financial leverage.
Question 4
Orchard Holdings has a return on equity of 15% and a return on assets of 6%, both based on the same net income and year-end balances. What is its ratio of total liabilities to total assets?
- A) 9%
- B) 60%
- C) 150%
- D) 40%
Show answer & explanation
Answer: B) 60%
Equity multiplier = ROE / ROA = 15% / 6% = 2.5, so total assets are 2.5 times equity and equity / assets = 1 / 2.5 = 40%. Total liabilities / total assets = 1 - 40% = 60%. 40% is the equity ratio, and 150% is the debt-to-equity ratio, not the debt-to-assets ratio.
Question 5
Pembroke Industries reported net income of $1,250,000 and declared preferred dividends of $150,000. The weighted average number of common shares outstanding was 440,000. What is basic earnings per share?
- A) $3.18
- B) $2.27
- C) $2.50
- D) $2.84
Show answer & explanation
Answer: C) $2.50
Basic EPS = (net income - preferred dividends) / weighted average common shares = ($1,250,000 - $150,000) / 440,000 = $1,100,000 / 440,000 = $2.50. Preferred dividends are deducted because those earnings are not available to common shareholders; ignoring them gives $2.84.
Question 6
Quinton Corp. had 300,000 common shares outstanding on January 1. It issued 60,000 new shares for cash on April 1 and repurchased 24,000 shares as treasury stock on October 1. What is the weighted average number of shares outstanding for the calendar year?
- A) 339,000
- B) 336,000
- C) 297,000
- D) 345,000
Show answer & explanation
Answer: A) 339,000
Shares are weighted by the fraction of the year they were outstanding: 300,000 x 12/12 = 300,000; new issue 60,000 x 9/12 = 45,000; repurchase -24,000 x 3/12 = -6,000. Weighted average = 300,000 + 45,000 - 6,000 = 339,000. The year-end count of 336,000 ignores timing, and reversing the fractions gives 297,000.
Question 7
Ridley Motors' common stock trades at $42.00 per share and its earnings per share are $3.50. What is its price/earnings ratio?
- A) 13.2 times
- B) 11.0 times
- C) 12.0 times
- D) 8.3 times
Show answer & explanation
Answer: C) 12.0 times
Price/earnings ratio = market price per share / earnings per share = $42.00 / $3.50 = 12.0 times. The inverse, EPS / price = 8.3%, is the earnings yield, which is a percentage rather than a multiple.
Question 8
Sutton Paper paid dividends of $1.20 per share. Its earnings per share were $3.00 and its share price is $30.00. What are its dividend yield and dividend payout ratio?
- A) Dividend yield 4.0%; payout ratio 40%
- B) Dividend yield 40%; payout ratio 4.0%
- C) Dividend yield 10.0%; payout ratio 40%
- D) Dividend yield 4.0%; payout ratio 60%
Show answer & explanation
Answer: A) Dividend yield 4.0%; payout ratio 40%
Dividend yield = dividends per share / market price = $1.20 / $30.00 = 4.0%. Payout ratio = dividends per share / EPS = $1.20 / $3.00 = 40%. 60% is the retention ratio, and 10.0% is the earnings yield.
Question 9
Thornbury Inc. has total shareholders' equity of $5,600,000, which includes preferred stock with a liquidation value of $800,000. There are 400,000 common shares outstanding and the market price is $18.00 per share. What is the market-to-book ratio of the common stock?
- A) 1.29
- B) 1.12
- C) 1.50
- D) 0.67
Show answer & explanation
Answer: C) 1.50
Book value per common share = (total equity - preferred equity) / common shares = ($5,600,000 - $800,000) / 400,000 = $12.00. Market-to-book = $18.00 / $12.00 = 1.50. Failing to remove the preferred stock gives a book value of $14.00 and a ratio of 1.29.
Question 10
Upton Devices has a return on equity of 16% and a dividend payout ratio of 35%. Assuming it maintains its capital structure and these ratios, what is its sustainable growth rate?
- A) 5.6%
- B) 10.4%
- C) 24.6%
- D) 16.0%
Show answer & explanation
Answer: B) 10.4%
Sustainable growth rate = ROE x retention ratio. Retention ratio = 1 - payout = 1 - 35% = 65%. Sustainable growth = 16% x 65% = 10.4%. Multiplying ROE by the payout ratio (5.6%) uses the share of earnings paid out rather than reinvested.
Question 11
Which of the following is the strongest indicator of LOW earnings quality?
- A) Revenue growth is matched by a similar growth in cash collections from customers
- B) The company uses conservative depreciation lives and expenses all research costs as incurred
- C) Net income has grown steadily for three years while cash flow from operating activities has declined each year
- D) Cash flow from operating activities has consistently exceeded net income
Show answer & explanation
Answer: C) Net income has grown steadily for three years while cash flow from operating activities has declined each year
High-quality earnings are sustainable and backed by cash. When reported income rises while operating cash flow falls, earnings are increasingly driven by accruals (such as growing receivables or capitalized costs), which may reverse and can signal aggressive accounting. Operating cash flow exceeding net income, conservative policies and cash-backed revenue growth all indicate higher earnings quality.
Question 12
During a period of steadily rising purchase prices and stable inventory quantities, a US company using LIFO, compared with an otherwise identical company using FIFO, will report:
- A) Higher gross profit and a lower inventory balance
- B) Lower gross profit and a lower inventory balance
- C) Higher gross profit and a higher inventory balance
- D) Lower gross profit and a higher inventory balance
Show answer & explanation
Answer: B) Lower gross profit and a lower inventory balance
Under LIFO the most recent (higher) costs flow to cost of goods sold, so cost of goods sold is higher and gross profit lower than under FIFO. The older, lower costs remain in ending inventory, so the balance sheet inventory is lower. Analysts often adjust using the LIFO reserve to compare LIFO and FIFO companies.
Question 13
A US parent consolidates a subsidiary whose functional currency is the euro, using the current rate method. During the year the euro weakens against the US dollar and the subsidiary has net assets (assets exceed liabilities). How is the translation effect reported?
- A) As a positive translation adjustment in other comprehensive income
- B) As a negative translation adjustment in other comprehensive income
- C) As a prior-period adjustment to retained earnings
- D) As a foreign exchange loss in net income
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Answer: B) As a negative translation adjustment in other comprehensive income
Under the current rate method, translation adjustments bypass net income and are accumulated in other comprehensive income. When the foreign currency weakens, a net asset position translates into fewer dollars, producing a negative (loss) adjustment. Remeasurement gains and losses go through net income only when the temporal method applies.
Question 14
During the year Vance Software improperly capitalized $400,000 of routine maintenance costs that should have been expensed. The costs were paid in cash. Ignoring depreciation and taxes, what is the effect on the current year's financial statements?
- A) Net income is overstated but cash flow from operating activities is unaffected
- B) Net income and cash flow from operating activities are both overstated
- C) Net income is overstated and cash flow from investing activities is overstated
- D) Net income is unaffected but total assets are overstated
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Answer: B) Net income and cash flow from operating activities are both overstated
Capitalizing the cost removes $400,000 of expense, so net income and total assets are overstated. Because the payment is classified as a capital expenditure, the cash outflow appears in investing activities instead of operating activities, so operating cash flow is overstated by $400,000 and investing cash flow is understated (more negative). Analysts watch for this because it flatters both earnings and operating cash flow.
Question 15
Which inventory cost flow method is permitted under US GAAP but prohibited under IFRS?
- A) Specific identification
- B) Last-in, first-out (LIFO)
- C) First-in, first-out (FIFO)
- D) Weighted average cost
Show answer & explanation
Answer: B) Last-in, first-out (LIFO)
US GAAP permits LIFO, but IFRS (IAS 2) prohibits it. FIFO, weighted average and specific identification are permitted under both frameworks. Analysts comparing a US GAAP LIFO company with an IFRS company should restate inventory and cost of goods sold to a common basis.