Class Notes for Corporate Finance, 2nd Edition

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Class Notes for Corporate Finance, 2nd Edition summarizes important topics for quick revision.

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Instructor’s Resource Guide for
Dr. Michael Casey
University of Central Arkansas

ii
Introduction
This Instructors’ Resource Manual is meant to be a tool for instructors, to make their teaching
less stressful and more effective. The tools and activities contained here are comprehensive in
type and scope, and we hope you find them useful as you progress through Corporate Finance
Online during your semester.
This Instructors’ Manual has several tools, each geared toward mastery of the learning
objectives in their respective sections:
Pre-Test These Pre-Tests come at the beginning of every chapter; they are 10 questions
long, all multiple choice, focusing on terms and background for the topic covered in that
chapter. They will help instructors to ascertain students’ incoming level of knowledge, so
teaching may be focused on areas where students need more instruction.
Overview Short paragraphs at the beginning of each chapter review learning objectives
and main concepts and explain the context of the topics covered in the finance world.
Teaching Tools There are many tools in CFO: videos, Excel templates, Explain it! and
Solution Tools. The Teaching Tools section identifies each tool in the chapter, with a brief
explanation of its content and purpose.
Assessment Tools CFO also contains many built-in assessments. Assessment Tools
identifies the Self-Tests, Practice, Homework, and Quiz assignments by section, so
instructors may use and evaluate them as needed.
Class Application Activities These applied classroom activities help instructors vary and
guide class time. They include Q&A, teaching notes, and a quick summary of the major
concept discussed.
Post-Test The Post-Test at the end of each chapter reviews the main concepts and
equations from each chapter. It is similar in structure to the Pre-Test, being multiple-
choice, but the questions are more detailed and aimed at assessing student mastery.
You will find the tools listed in this order in each chapter of the Instructors’ Manual; hyperlinks
in the Table of Contents make them easy to reach.

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CONTENTS
CHAPTER 1: INTRODUCTION TO FINANCE .................................................................................................... 1
I. PRE-TEST ................................................................................................................................................ 1
II. Chapter 1: OVERVIEW ........................................................................................................................... 2
III. TEACHING TOOLS ................................................................................................................................. 3
IV. ASSESSMENT TOOLS ............................................................................................................................ 4
V. CLASS APPLICATION ACTIVITIES ............................................................................................................ 5
CLASS APPLICATION ACTIVITIES 1.1 ...................................................................................................... 5
CLASS APPLICATION ACTIVITIES 1.2 ...................................................................................................... 6
CLASS APPLICATION ACTIVITIES 1.3 ...................................................................................................... 6
CLASS APPLICATION ACTIVITIES 1.4 ...................................................................................................... 7
VI. POST-TEST ............................................................................................................................................ 8
CHAPTER 2: FINANCIAL STATEMENT AND RATIO ANALYSIS ....................................................................... 10
I. PRE-TEST .............................................................................................................................................. 10
II. CHAPTER 2: OVERVIEW ....................................................................................................................... 11
III. TEACHING TOOLS ............................................................................................................................... 12
IV. ASSESSMENT TOOLS .......................................................................................................................... 14
V. CLASS APPLICATION ACTIVITIES .......................................................................................................... 15
CLASS APPLICATION ACTIVITIES 2.1 .................................................................................................... 15
CLASS APPLICATION ACTIVITIES 2.2 .................................................................................................... 16
CLASS APPLICATION ACTIVITIES 2.3 .................................................................................................... 17
CLASS APPLICATION ACTIVITIES 2.4 .................................................................................................... 18
VI. POST-TEST .......................................................................................................................................... 18
CHAPTER 3: INTRODUCTION TO TIME VALUE OF MONEY .......................................................................... 22
I. PRE-TEST .............................................................................................................................................. 22
II. CHAPTER 3: OVERVIEW ....................................................................................................................... 23
III. TEACHING TOOLS ............................................................................................................................... 24

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IV. ASSESSMENT TOOLS .......................................................................................................................... 26
V. CLASS APPLICATION ACTIVITIES .......................................................................................................... 27
CLASS APPLICATION ACTIVITIES 3.1 .................................................................................................... 27
CLASS APPLICATION ACTIVITIES 3.2 .................................................................................................... 28
CLASS APPLICATION ACTIVITIES 3.3 .................................................................................................... 29
CLASS APPLICATION ACTIVITIES 3.4 .................................................................................................... 29
VI. POST-TEST .......................................................................................................................................... 30
CHAPTER 4: ANNUITIES AND LOANS ........................................................................................................... 33
I. PRE-TEST .............................................................................................................................................. 33
II. CHAPTER 4: OVERVIEW ....................................................................................................................... 34
III. TEACHING TOOLS ............................................................................................................................... 35
IV. ASSESSMENT TOOLS .......................................................................................................................... 38
V. CLASS APPLICATION ACTIVITIES .......................................................................................................... 39
CLASS APPLICATION ACTIVITIES 4.1 .................................................................................................... 39
CLASS APPLICATION ACTIVITIES 4.2 .................................................................................................... 40
CLASS APPLICATION ACTIVITIES 4.3 .................................................................................................... 40
CLASS APPLICATION ACTIVITIES 4.4 .................................................................................................... 41
VI. POST-TEST .......................................................................................................................................... 42
CHAPTER 5: INTRODUCTION TO RISK AND RETURN ................................................................................... 45
I. PRE-TEST .............................................................................................................................................. 45
II. CHAPTER 5: OVERVIEW ....................................................................................................................... 46
III. TEACHING TOOLS ............................................................................................................................... 47
IV. ASSESSMENT TOOLS .......................................................................................................................... 48
V. CLASS APPLICATION ACTIVITIES .......................................................................................................... 49
CLASS APPLICATION ACTIVITIES 5.1 .................................................................................................... 49
CLASS APPLICATION ACTIVITIES 5.2 .................................................................................................... 50
CLASS APPLICATION ACTIVITIES 5.3 .................................................................................................... 50

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CLASS APPLICATION ACTIVITIES 5.4 .................................................................................................... 51
CLASS APPLICATION ACTIVITIES 5.5 .................................................................................................... 52
VI. POST-TEST .......................................................................................................................................... 53
CHAPTER 6: PORTFOLIO THEORY ................................................................................................................ 56
I. PRE-TEST .............................................................................................................................................. 56
II. CHAPTER 6: OVERVIEW ....................................................................................................................... 57
III. TEACHING TOOLS ............................................................................................................................... 58
IV. ASSESSMENT TOOLS .......................................................................................................................... 60
V. CLASS APPLICATION ACTIVITIES .......................................................................................................... 62
CLASS APPLICATION ACTIVITIES 6.1 .................................................................................................... 62
CLASS APPLICATION ACTIVITIES 6.2 .................................................................................................... 62
CLASS APPLICATION ACTIVITIES 6.3 .................................................................................................... 63
CLASS APPLICATION ACTIVITIES 6.4 .................................................................................................... 64
VI. POST-TEST .......................................................................................................................................... 65
CHAPTER 7: INTEREST RATES AND BONDS ................................................................................................. 68
I. PRE-TEST .............................................................................................................................................. 68
II. CHAPTER 7: OVERVIEW ....................................................................................................................... 69
III. TEACHING TOOLS ............................................................................................................................... 70
IV. ASSESSMENT TOOLS .......................................................................................................................... 73
V. CLASS APPLICATION ACTIVITIES .......................................................................................................... 74
CLASS APPLICATION ACTIVITIES 7.1 .................................................................................................... 74
CLASS APPLICATION ACTIVITIES 7.2 .................................................................................................... 75
CLASS APPLICATION ACTIVITIES 7.3 .................................................................................................... 76
CLASS APPLICATION ACTIVITIES 7.4 .................................................................................................... 77
CLASS APPLICATION ACTIVITIES 7.5 .................................................................................................... 77
VI. POST-TEST .......................................................................................................................................... 78
CHAPTER 8: STOCK VALUATION AND MARKET EFFICIENCY........................................................................ 81

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I. PRE-TEST .............................................................................................................................................. 81
II. CHAPTER 8: OVERVIEW ....................................................................................................................... 82
III. TEACHING TOOLS ............................................................................................................................... 83
IV. ASSESSMENT TOOLS .......................................................................................................................... 86
V. CLASS APPLICATION ACTIVITIES .......................................................................................................... 87
CLASS APPLICATION ACTIVITIES 8.1 .................................................................................................... 87
CLASS APPLICATION ACTIVITIES 8.2 .................................................................................................... 87
CLASS APPLICATION ACTIVITIES 8.3 .................................................................................................... 88
CLASS APPLICATION ACTIVITIES 8.4 .................................................................................................... 89
VI. POST-TEST .......................................................................................................................................... 90
CHAPTER 9: CAPITAL BUDGETING: INTRODUCTION AND TECHNIQUES ..................................................... 92
I. PRE-TEST .............................................................................................................................................. 92
II. CHAPTER 9: OVERVIEW ....................................................................................................................... 93
III. TEACHING TOOLS ............................................................................................................................... 94
IV. ASSESSMENT TOOLS .......................................................................................................................... 96
V. CLASS APPLICATION ACTIVITIES .......................................................................................................... 97
CLASS APPLICATION ACTIVITIES 9.1 .................................................................................................... 97
CLASS APPLICATION ACTIVITIES 9.2 .................................................................................................... 97
CLASS APPLICATION ACTIVITIES 9.3 .................................................................................................... 98
CLASS APPLICATION ACTIVITIES 9.4 .................................................................................................... 99
VI. POST-TEST ........................................................................................................................................ 100
CHAPTER 10: CAPITAL BUDGETING: ESTIMATING CASH FLOWS .............................................................. 103
I. PRE-TEST ............................................................................................................................................ 103
II. CHAPTER 10: OVERVIEW ................................................................................................................... 104
III. TEACHING TOOLS ............................................................................................................................. 105
IV. ASSESSMENT TOOLS ........................................................................................................................ 107
V. CLASS APPLICATION ACTIVITIES ........................................................................................................ 108

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CLASS APPLICATION ACTIVITIES 10.1 ................................................................................................ 108
CLASS APPLICATION ACTIVITIES 10.2 ................................................................................................ 109
CLASS APPLICATION ACTIVITIES 10.3 ................................................................................................ 110
CLASS APPLICATION ACTIVITIES 10.4 ................................................................................................ 110
VI. POST-TEST ........................................................................................................................................ 111
CHAPTER 11: COST OF CAPITAL ................................................................................................................ 114
I. PRE-TEST ............................................................................................................................................ 114
II. CHAPTER 11: OVERVIEW ................................................................................................................... 115
III. TEACHING TOOLS ............................................................................................................................. 116
IV. ASSESSMENT TOOLS ........................................................................................................................ 117
V. CLASS APPLICATION ACTIVITIES ........................................................................................................ 118
CLASS APPLICATION ACTIVITIES 11.1 ................................................................................................ 118
CLASS APPLICATION ACTIVITIES 11.2 ................................................................................................ 119
CLASS APPLICATION ACTIVITIES 11.3 ................................................................................................ 120
CLASS APPLICATION ACTIVITIES 11.4 ................................................................................................ 121
VI. POST-TEST: ....................................................................................................................................... 121
CHAPTER 12: CAPITAL STRUCTURE ........................................................................................................... 124
I. PRE-TEST ............................................................................................................................................ 124
II. CHAPTER 12: OVERVIEW ................................................................................................................... 125
III. TEACHING TOOLS ............................................................................................................................. 126
IV. ASSESSMENT TOOLS ........................................................................................................................ 128
V. CLASS APPLICATION ACTIVITIES ........................................................................................................ 129
CLASS APPLICATION ACTIVITIES 12.1 ................................................................................................ 129
CLASS APPLICATION ACTIVITIES 12.2 ................................................................................................ 129
CLASS APPLICATION ACTIVITIES 12.3 ................................................................................................ 130
CLASS APPLICATION ACTIVITIES 12.4 ................................................................................................ 131
VI. POST-TEST: ....................................................................................................................................... 132

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CHAPTER 13: DIVIDENDS, REPURCHASES, AND SPLITS ............................................................................. 134
I. PRE-TEST ............................................................................................................................................ 134
II. CHAPTER 13: OVERVIEW ................................................................................................................... 136
III. TEACHING TOOLS ............................................................................................................................. 136
IV. ASSESSMENT TOOLS ........................................................................................................................ 138
V. CLASS APPLICATION ACTIVITIES ........................................................................................................ 139
CLASS APPLICATION ACTIVITIES 13.1 ................................................................................................ 139
CLASS APPLICATION ACTIVITIES 13.2 ................................................................................................ 139
CLASS APPLICATION ACTIVITIES 13.3 ................................................................................................ 140
CLASS APPLICATION ACTIVITIES 13.4 ................................................................................................ 141
VI. POST-TEST ........................................................................................................................................ 141
CHAPTER 14: FINANCIAL PLANNING AND FORECASTING ......................................................................... 144
I. PRE-TEST ............................................................................................................................................ 144
II. CHAPTER 14: OVERVIEW ................................................................................................................... 145
III. TEACHING TOOLS ............................................................................................................................. 145
IV. ASSESSMENT TOOLS ........................................................................................................................ 147
V. CLASS APPLICATION ACTIVITIES ........................................................................................................ 148
CLASS APPLICATION ACTIVITIES 14.1 ................................................................................................ 148
CLASS APPLICATION ACTIVITIES 14.2 ................................................................................................ 148
CLASS APPLICATION ACTIVITIES 14.3 ................................................................................................ 149
CLASS APPLICATION ACTIVITIES 14.4 ................................................................................................ 150
VI. POST-TEST: ....................................................................................................................................... 150
CHAPTER 15: THE MANAGEMENT OF WORKING CAPITAL ....................................................................... 153
I. PRE-TEST ............................................................................................................................................ 153
II. CHAPTER 15: OVERVIEW ................................................................................................................... 154
III. TEACHING TOOLS: ............................................................................................................................ 155
IV. ASSESSMENT TOOLS ........................................................................................................................ 155

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V. CLASS APPLICATION ACTIVITIES ........................................................................................................ 156
CLASS APPLICATION ACTIVITIES 15.1 ................................................................................................ 156
CLASS APPLICATION ACTIVITIES 15.2 ................................................................................................ 157
CLASS APPLICATION ACTIVITIES 15.3 ................................................................................................ 158
CLASS APPLICATION ACTIVITIES 15.4 ................................................................................................ 159
CLASS APPLICATION ACTIVITIES 15.5 ................................................................................................ 160
VI. POST-TEST ........................................................................................................................................ 160
CHAPTER 16: INTERNATIONAL FINANCE ................................................................................................... 163
I. PRE-TEST ............................................................................................................................................ 163
II. CHAPTER 16: OVERVIEW ................................................................................................................... 164
III. TEACHING TOOLS ............................................................................................................................. 165
IV. ASSESSMENT TOOLS ........................................................................................................................ 165
V. CLASS APPLICATION ACTIVITIES ........................................................................................................ 166
CLASS APPLICATION ACTIVITIES 16.1 ................................................................................................ 166
CLASS APPLICATION ACTIVITIES 16.2 ................................................................................................ 167
CLASS APPLICATION ACTIVITIES 16.3 ................................................................................................ 168
CLASS APPLICATION ACTIVITIES 16.4 ................................................................................................ 169
VI. POST-TEST ........................................................................................................................................ 169
CHAPTER 17: CORPORATE VALUATION .................................................................................................... 172
I. PRE-TEST ............................................................................................................................................ 172
II. CHAPTER 17: OVERVIEW ................................................................................................................... 173
III. TEACHING TOOLS ............................................................................................................................. 173
IV. ASSESSMENT TOOLS ........................................................................................................................ 175
V. CLASS APPLICATION ACTIVITIES ........................................................................................................ 176
CLASS APPLICATION ACTIVITIES 17.1 ................................................................................................ 176
CLASS APPLICATION ACTIVITIES 17.2 ................................................................................................ 177
CLASS APPLICATION ACTIVITIES 17.3 ................................................................................................ 178

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CLASS APPLICATION ACTIVITIES 17.4 ................................................................................................ 178
VI. POST-TEST ........................................................................................................................................ 179
CHAPTER 18: FUTURES AND OPTIONS ...................................................................................................... 181
I. PRE-TEST ............................................................................................................................................ 181
II. CHAPTER 18: OVERVIEW ................................................................................................................... 182
III. TEACHING TOOLS ............................................................................................................................. 183
IV. ASSESSMENT TOOLS ........................................................................................................................ 184
V. CLASS APPLICATION ACTIVITIES ........................................................................................................ 185
CLASS APPLICATION ACTIVITIES 18.1 ................................................................................................ 185
CLASS APPLICATION ACTIVITIES 18.2 ................................................................................................ 186
CLASS APPLICATION ACTIVITIES 18.3 ................................................................................................ 186
CLASS APPLICATION ACTIVITIES 18.4 ................................................................................................ 187
VI. POST-TEST ........................................................................................................................................ 188

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CHAPTER 1: INTRODUCTION TO FINANCE
I. PRE-TEST
These 10 questions can be used to determine the students’ understanding of the skills and
information covered in the chapter. Use the results of the class pre-test to focus your chapter
lecture on the concepts that students have not yet grasped.
LO1 – Understand the Features of CFO
1. In the context of this text, CFO is an acronym for
a. Certified Financial Obligations.
b. Chief Financial Officer.
c. Corporate Finance Online.
d. Credited Fiscal Offering.
LO2 – Understand the Four Facets of Finance: the role of the financial manager, careers in
finance, personal finance, and academic finance
2. The field of finance covers all of the following areas except
a. corporate finance.
b. financial markets.
c. investing.
d. corporate finance, financial markets, and investing are all topics covered in finance.
LO3 – Understand the Function of the Financial System
3. The primary function of the financial system is to
a. transfer money from suppliers to users.
b. help the government borrow money.
c. identify areas of economic strength.
d. ensure Social Security remains solvent.
LO4 – Distinguish between Money and Capital Markets
4. Capital market securities include
a. T-bills.
b. banker’s acceptances.
c. common stocks.
d. commercial paper.
LO5 – Learn the Difference between Primary and Secondary Markets
5. When a firm issues stock to the public for the very first time it is known as
a. seasoned equity issue.
b. initial public offering.
c. underwriter’s issue.
d. over-the-counter offering.

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LO6 – Learn about the Structure and Governance of Corporations
6. The most common form of business organization in the United States is the
a. corporation.
b. sole proprietorship.
c. partnership.
d. limited liability company.
7. Most of the revenue generated in the United States by businesses comes from
a. corporations.
b. sole proprietorships.
c. partnerships.
d. corporations, sole proprietorships, and partnerships all generate approximately equal
shares of revenue annually.
LO7 – Learn Six Important Ideas in Finance
8. One of the key concepts in finance is that
a. the SEC enforces the law of one price.
b. the time value of money.
c. people act irrationally.
d. markets are inefficient.
9. In order to earn higher returns, you must
a. invest in emerging markets
b. buy AAA rated bonds
c. invest only cash
d. assume a higher level of risk
10. If the price of an asset currently reflects the asset’s true value, the market is said to be
a. efficient
b. transactional
c. arbitraged
d. riskless
II. Chapter 1: OVERVIEW
This chapter introduces the features of CFO so that students can take full advantage of all the
resources available in this text. Spend some time making sure that students understand how to
use each feature. In addition, this chapter observes that the field of finance has a number of
applications in academics, business, and your personal life, and all of those areas present several
career paths where students can find great jobs. The chapter also introduces the financial
system, corporate governance issues, the concept of risk and return, the time value of money,
and other key financial topics with every day applications. Students will learn the difference
between money and capital markets and also between primary and secondary markets.
LO1 – Understand the Features of CFO
LO2 – Understand the Four Facets of Finance: the role of the financial manager, careers in
finance, personal finance, and academic finance

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LO3 – Understand the Function of the Financial System
LO4 – Distinguish between Money and Capital Markets
LO5 – Learn the Difference between Primary and Secondary Markets
LO6 – Learn about the Structure and Governance of Corporations
LO7 – Learn Six Important Ideas in Finance
III. TEACHING TOOLS
The following list summarizes the concepts covered in the chapter videos and solution tools.
1.1.1 Explain It – Features of CFO - LO1: This video explains the features of CFO using Explain It
videos, Interactive graphs, and Solution Tools that will be utilized throughout the text to provide
greater detail on certain concepts and problems.
1.2.1 Explain It – Four Facets of Finance - LO2: This video shows the student the four different
perspectives through which you can view the field of finance: academic finance, business
finance, careers in finance, and personal finance.
1.5.1 Explain It – Initial Public Offerings – LO5: This text file provides some specifics on a recent
IPO and also some information on IPO investing.
1.5.2 Explain it – Dealer Markets Part 1 – LO5: This video shows how a dealer buys and sells
shares of stock and makes a profit on the spread (the difference in the bid and ask prices).
1.5.2 Explain it – Dealer Markets Part 2 – LO5: This video shows how buying and selling shares
of stock (demand and supply) impacts price determination in the market.
1.6.2 Explain it – Management’s Fiduciary Duty – LO6: This text file provides two examples
where managers placed the interest of one stakeholder group over shareholders and the stock
prices responded negatively.
1.6.2 Explain it – Principal-Agent Problem: Contractual Remedies – LO6: This video illustrates
the classic principal agent problem using Tyco’s CEO Dennis Kozlowski’s exorbitant corporate
spending practices.
1.6.2 Explain it – Principal-Agent Problem: Government Regulation – LO6: This text box directs
students to conduct an Internet search for information on Tyco, Enron, or WorldCom, since each
case represents a clear example of an agency problem.
1.7.2 Explain it – Bernie Madoff and the Risk/Return Tradeoff – LO7: This text box provides
some historical information on Bernie Madoff and his Ponzi scheme and how it relates to risk
and return.
1.7.3 Explain it – Efficiency, Arbitrage, and Law of One Price – LO7: This video provides a
humorous introduction to the concept of market efficiency.

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IV. ASSESSMENT TOOLS
Here is a listing (by page number) and description of all the assessments provided in this
chapter.
Page Number Description
1.2.1 Self-Test Question 1
1.2.1 Self-Test Question 2
1.3.1 Self-Test Question 3
1.3.1 Self-Test Question 4
1.4.1 Self-Test Question 5
1.4.1 Self-Test Question 6
1.4.2 Self-Test Question 7
1.5.1 Self-Test Question 8
1.5.2 Self-Test Question 9
1.5.2 Self-Test Question 10
1.6.1 Self-Test Question 11
1.6.2 Self-Test Question 12
1.7.6 Self-Test Question 13
1.7.6 Self-Test Question 14
Practice Section 1.2
Practice Section 1.3
Practice Section 1.4
Practice Section 1.5
Chapter 1 Homework
Chapter 1 Quiz

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V. CLASS APPLICATION ACTIVITIES
These activities, complete with solutions, provide opportunities to reinforce (either in class or in
small groups) students’ ability to apply chapter concepts in business contexts.
CLASS APPLICATION ACTIVITIES 1.1
Title: Occupational Outlook Handbook and Finance Careers
LO2 – Understand the Four Facets of Finance: the role of the financial manager, careers in
finance, personal finance, and academic finance
Numerous career options are available to finance graduates. Students can begin careers in
government, the non-profit sector, corporate finance, banking, investments and wealth
management, education and other fields. However, it is useful to know the expected salaries
and the projected job demand for a particular skill set prior to spending years acquiring the
expertise to work in that field. One of the ways you can learn more about a particular career is
to research that career in the Occupational Outlook Handbook published by the Bureau of Labor
Statistics. Go to the following website:
http://www.bls.gov/ooh/
Now look under the heading “Occupation Groups” and click on the link “Business and Financial.”
Scroll down through the list of job titles and select one that interests you and read all the
information posted about that job.
Questions to pose:
1. What is the education required for an entry-level position? Does the job require any
licensure requirements?
Answer: It varies according to the job selected.
2. What is the expected starting salary for this position?
Answer: It varies according to the job selected.
3. What is the projected job growth in this field for the next several years?
Answer: It varies according to the job selected.
Time on task: This exercise can take between 15 and 30 minutes, depending on how long it
takes to find and summarize the findings.
Teaching Notes: This activity pushes students to begin thinking in terms of the market demand
for a particular skill set. You can extend this activity by requiring groups to make presentations
on two or three jobs or have individuals draft a one-page report about a specific job.

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CLASS APPLICATION ACTIVITIES 1.2
Title: Nasdaq IPOs
LO5 – Learn the Difference between Primary and Secondary Markets
An initial public offering (IPO) occurs when corporations sell equity capital to the public for the
first time and become listed and publicly traded on an organized stock exchange. Sizes of the
IPOs typically fall into the $50 million to $500 million range and are relatively unknown
companies. Nasdaq tracks IPOs and maintains an extensive database on IPOs in the pipeline and
recent IPOs. Go to the following website and then answer a few questions.
http://www.nasdaq.com/markets/ipos/
Questions to pose:
1. Look at the “Latest IPOs” and click on the link “View All Latest IPOs.” How many IPOs came
out during that period? What was the size (offer amount) of the largest IPO? What was the
size (offer amount) of the smallest? What was the smallest offer price? What was the largest
offer price?
Answer: Varies.
2. Scroll down the page to the “IPO Performance” graph that shows the best and worst
performers over the past six months. What company generated the best returns for
investors? What company generated the worst returns for investor? Provide some
background information on each firm and information on the returns generated.
Answer: Varies.
Time on task: This exercise can take between 15 and 30 minutes, depending on how long it
takes to find and summarize the findings.
Teaching Notes: This activity allows students to learn about the IPO market at the time they are
taking the class. You can ask dozens of questions about the material on this site and IPOs in
general.
Table of Contents
CLASS APPLICATION ACTIVITIES 1.3
Title: Charles Ponzi
LO6 – Learn about the Structure and Governance of Corporations
We’ve all heard of Ponzi schemes but how much do you know about Charles Ponzi? A particular
type of financial fraud, Ponzi schemes were named after an Italian immigrant named Charles
Ponzi who became famous for his fraudulent activities in the early 1900s. Go to your favorite
Internet search engine and search for “Charles Ponzi” and then answer a few questions about
Ponzi schemes and Charles Ponzi.

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Questions to pose:
1. What is a Ponzi scheme?
Answer: A Ponzi scheme promises investors high returns and then delivers those returns by
paying existing investors with money flowing in from new investors. Ponzi schemes require a
continuous inflow of new money to keep going.
2. Look up some of the other famous financial con artists such as Bernie Madoff, Dona Branca
and others. What do most of these schemes have in common?
Answer: They all promise high returns and prey on human greed. A good rule of thumb is
illustrated in the old saying, “If it sounds too good to be true, it probably is.”
Time on task: This exercise can take between 15 and 30 minutes depending on how long it takes
to find and summarize the findings. You can extend this to a full class period or more if you have
students do presentations on various con artists and their fraud.
Teaching Notes: This activity is a great example to use to teach students about risk and return
and financial ethics. There are always people willing to separate you from your money. This is a
great classroom debate and you can assign students various individuals to report on so that
everyone reports on a different con artist.
CLASS APPLICATION ACTIVITIES 1.4
Title: Refund anticipation loans and the time value of money
LO7 – Learn Six Important Ideas in Finance
Refund anticipation loans (RALs) are available from a number of tax preparers and touted as a
way to access your tax refund sooner. The tax preparer loans you an amount equal to your
anticipated refund, minus interest charges and fees, and then has your refund directed to their
account. In the following article, it states that in 2009 approximately 7 million taxpayers took
advantage of RALs and paid more than $650 million in interest and fees to receive their refund a
few weeks early. Read the following article and then answer a few questions.
http://www.aarp.org/money/taxes/info-03-2011/ask-sid-tax-refund-loans.html
Questions to pose:
1. How do RALs relate to the time value of money?
Answer: Individuals are obviously willing to accept a smaller sum today in lieu of a larger sum
at some point in the future. This example illustrates the concept of the time value of money,
or a dollar today is worth more than a dollar in the future.
2. What makes this practice unethical according to some critics?
Answer: The fees and interest charges can range from 50% to 500% per year if annualized.
Charges this high are considered predatory lending practices and prey primarily on the poor.

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Time on task: This exercise can take between 5 and 15 minutes depending on how long it takes
to find and summarize the findings and have a class discussion.
Teaching Notes: This activity is a great example of the time value of money and also allows you
to introduce some ethical issues in finance. You can have a lengthy discussion about the
morality of this practice.
VI. POST-TEST
These 10 questions can be used to determine the students’ understanding of the skills and
information covered in this chapter, and in customizing your chapter lecture or exam review to
the concepts that students had difficulty mastering
LO1 – Understand the Features of CFO
1. In Corporate Finance Online, you can find additional explanations and details on a particular
topic by clicking on
a. Explore it icons.
b. Explain it icons.
c. Solution Tools icons.
d. Explore it!, Explain it!, and Solution Tools all provide additional information about a
topic.
LO2 – Understand the Four Facets of Finance: the role of the financial manager, careers in
finance, personal finance, and academic finance
2. Which of the following is not considered one of the broad perspectives through which you
can view the field of finance?
a. automotive finance
b. academic finance
c. careers in finance
d. personal finance
LO3 – Understand the Function of the Financial System
3. One of the primary functions of the secondary market is
a. to provide firms with a place to sell initial equity.
b. to provide investors with liquidity.
c. to monitor illegal activity.
d. to function as a legal gambling mechanism.
LO4 – Distinguish between Money and Capital Markets
4. All of the following are money market securities except
a. common stocks.
b. commercial paper.
c. Fed funds.
d. Negotiable Certificates of Deposit.

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LO5 – Learn the Difference between Primary and Secondary Markets
5. When an investor buys stock on the New York Stock Exchange it is a
a. primary market transaction.
b. secondary market transaction.
c. money market transaction.
d. derivative security transaction.
LO6 – Learn about the Structure and Governance of Corporations
6. All except which of the following are advantages of incorporating?
a. Ownership is easy to transfer.
b. Corporations have an unlimited life.
c. Incorporating makes it easier to raise money.
d. Corporate profits are only taxed at the investor level.
7. Which of the following pieces of legislation attempts to resolve the principal-agent problem
that exists between shareholders and managers?
a. Congressional Accountability Act
b. Gramm-Rudman-Hollings Act
c. Sarbanes-Oxley Act
d. Securities Exchange Commission Act
LO7 – Learn Six Important Ideas in Finance
8. According to the law of one price, if a stock listed on an international stock exchange is
trading for $45.50 a share,
a. it will sell for the same price the next day.
b. arbitrage will ensure it trades at the same price in other markets.
c. it will always be available for sale at $45.50 a share.
d. None of these options illustrate the law of one price.
9. If an investor buys gold contracts in London for $1,595 an ounce and simultaneously sells it
in New York for $1,610 an ounce then the price of gold in London will
a. move lower.
b. move higher.
c. remain stable.
d. always be $1,595 an ounce.
10. Information asymmetry states that
a. everyone has access to the same information.
b. the Internet has leveled the playing field with regard to access to information.
c. all companies operate under the same economic assumptions.
d. information is not distributed evenly.
Return to the Table of Contents

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CHAPTER 2: FINANCIAL STATEMENT AND RATIO ANALYSIS
I. PRE-TEST
These 10 questions can be used to determine the students’ extant understanding of the skills
and information covered in the chapter. Use the results of the class pre-test to focus your
chapter lecture on the concepts that students have not yet grasped.
LO1 – Describe the Three Financial Statements Needed for Financial Analysis
1. All of the following are financial statements except
a. income statement.
b. asset statement.
c. balance sheet.
d. statement of cash flows.
2. The basic accounting identity presented in the balance sheet is
a. debt = assets + liabilities.
b. assets = owner’s equity + stock.
c. assets = liabilities + owner’s equity.
d. liabilities = assets.
3. The income statement is a financial statement that
a. shows a firm’s performance over time.
b. is a snapshot of a firm’s performance on one date.
c. is irrelevant to managerial decision making.
d. is only used by accountants.
LO2 – Explain the Goals of Financial Statement Analysis
4. Financial analysis is
a. a powerful tool to help managers make decisions.
b. is considered inside information and therefore illegal for decision-making.
c. is almost impossible to conduct.
d. only used for inventory management.
5. Ratio analysis can be used for all of the following except
a. identifying company strengths.
b. focusing attention on problem areas.
c. to identify stocks to buy and sell.
d. identifying specific customers .
LO3 – Perform Financial Statement Analysis
6. All of the following are a category of financial ratios except
a. profitability ratios.
b. bankruptcy ratios.
c. activity ratios.
d. market value ratios.

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7. Liquidity ratios provide lenders with information about
a. a firm’s ability to meet its financial obligations.
b. a firm’s ability to manage its assets.
c. a firm’s overall profitability.
d. a firm’s stock price.
LO4 – Prepare Common Sized Financial Statements
8. To construct a common-sized balance sheet, you divide every balance sheet item by what so
that you can make comparisons with other firms?
a. 100
b. total assets
c. sales
d. 72
LO5 – Evaluate Company Performance Using the DuPont Ratio
9. The Du Pont ratio analysis was developed by
a. consultants.
b. the Du Pont Corporation.
c. Henry Du Pont.
d. none of these.
LO6 – Integrate Ratios Together to Perform Company Analysis
10. Ratio interaction makes it useful for a financial analyst or manager to evaluate a firm
a. using only liquidity ratios.
b. using several ratios at the same time.
c. by pairing certain ratios that go together.
d. None of these is correct.
II. CHAPTER 2: OVERVIEW
Financial statements provide financial managers with the information they need to make
decisions that contribute to shareholder wealth maximization. This chapter provides the tools
necessary to perform analysis using that information. Students will learn how to calculate and
interpret ratios that help us make decisions about asset utilization, efficiency, liquidity,
financing, and market valuation. Students will also learn how to prepare common sized financial
statements and evaluate a firm using the DuPont ratio. By the end of this chapter, students
should:
LO1 – Describe the Three Financial Statements Needed for Financial Analysis
LO2 – Explain the Goals of Financial Statement Analysis
LO3 – Perform Financial Statement Analysis
LO4 – Prepare Common Sized Financial Statements
LO5 – Evaluate Company Performance Using the DuPont Ratio
LO6 – Integrate Ratios Together to Perform Company Analysis

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III. TEACHING TOOLS
The following list summarizes the concepts covered in the chapter videos and solution tools.
2.1.1 Explain it – The Balance Sheet- LO1 – This video shows a sample balance sheet and then
provides a concise explanation of the balance sheet; it also shows how a financial manager can
glean a tremendous amount of useful information from the raw data.
2.1.2 Explain it – The Income Statement - LO1 – This video shows a sample income statement
and provides an explanation of the various components, such as sales, profits, etc. The author
also points out a primary difference between the income statement and the balance sheet. The
income statement provides the financial manager with information about operations over one
operating cycle, whereas the balance sheet is a snapshot of the firm’s assets and liabilities at a
point in time.
2.1.3 Explain it – Statement of Cash Flows- LO1 – This video provides a brief explanation of the
three components of the statement of cash flows. The first section shows whether the firm is
generating cash from operations. The other two components of the statement of cash flows
show cash flows from investing activities and cash flows from financing activities.
2.3.1 Explain it – SIC Codes and Industry Classification – LO3 – This text explains Standard
Industrial Classification (SIC) codes and how you can use that information to find peer data to
use for comparison with your firm.
TABLE 2.4 – 2.3.2 - Profitability Ratios
2.3.2 Explain it – Return on Equity (ROE) (equation 2.1) – LO3 – This video explains how to
calculate ROE, shows you where to find the ratio inputs, and then provides information on how
to interpret this ratio.
2.3.2 Explain it – Return on Assets (ROA) (equation 2.2) – LO3 – This video explains how to
calculate the ROA, shows you where to find the ratio inputs, and then provides information on
how to interpret this ratio.
2.3.2 Explain it – Gross Profit Margin (equation 2.3) – LO3 – This video explains how to
calculate the Gross Profit Margin, shows you where to find the ratio inputs, and then provides
information on how to interpret this ratio.
2.3.2 Explain it – Operating Profit Margin (equation 2.4) – LO3 – This video explains how to
calculate the Operating Profit Margin, shows you where to find the ratio inputs, and then
provides information on how to interpret this ratio.
2.3.2 Explain it – Net Profit Margin (equation 2.5) – LO3 – This video explains how to calculate
the Net Profit Margin, shows you where to find the ratio inputs, and then provides information
on how to interpret this ratio.
2.3.2 Explain it – Summary of Profitability Ratios – LO3: This video provides a detailed
explanation about how profitability ratios are used in practice. The video focuses on how each
different profitability ratio gives us slightly different useful information that we can use to
improve operations, evaluate performance or both.

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TABLE 2.5 – 2.3.3 - Liquidity Ratios
2.3.1 Explain it – Liquidity Ratios – LO3 – This text explains how lenders use liquidity ratios to
evaluate whether a firm has sufficient liquidity to warrant making a loan.
2.3.1 Explain it – Current Ratio (equation 2.6) – LO3 – This video explains how to calculate the
Current Ratio, shows you where to find the ratio inputs, and also provides information on how
to interpret this ratio.
2.3.1 Explain it – Quick Ratio (equation 2.7) – LO3 – This video explains how to calculate the
Quick Ratio, shows you where to find the ratio inputs, and also provides information on how to
interpret this ratio.
2.3.1 Explain it – Liquidity Summary – LO3 – This video uses some sample liquidity ratios from
industry and explains how these ratios can be interpreted in different ways.
TABLE 2.6 – 2.3.4 - Activity Ratios
2.3.4 Explain it – Inventory Turnover (equation 2.8) – LO3 – This video explains how to calculate
the Inventory Turnover ratio, shows you where to find the ratio inputs, and also provides
information on how to interpret this ratio.
2.3.4 Explain it – Accounts Receivables Turnover (equation 2.9) – LO3 – This video explains how
to calculate the Accounts Receivables Turnover ratio, shows you where to find the ratio inputs,
and also provides information on how to interpret this ratio.
2.3.4 Explain it – Total Asset Turnover (equation 2.10) – LO3 – This video explains how to
calculate the Total Asset Turnover ratio, shows you where to find the ratio inputs, and also
provides information on how to interpret this ratio.
2.3.4 Explain it – Average Collection Period (equation 2.11) – LO3 – This video explains how to
calculate the Average Collection Period, shows you where to find the ratio inputs, and also
provides information on how to interpret this ratio.
TABLE 2.7 – 2.3.5 – Financing Ratios
2.3.5 Explain it – Debt Ratio (equation 2.12) – LO3 – This video explains how to calculate the
Debt Ratio, shows you where to find the ratio inputs, and also provides information on how to
interpret this ratio.
2.3.5 Explain it – Debt Equity Ratio (equation 2.13) – LO3 – This video explains how to calculate
the Debt to Equity Ratio, shows you where to find the ratio inputs, and also provides
information on how to interpret this ratio.
2.3.5 Explain it – Times Interest Earned Ratio (equation 2.14) – LO3 – This video explains how
to calculate the Times Interest Earned, shows you where to find the ratio inputs, and also
provides information on how to interpret this ratio.
TABLE 2.8 – 2.3.6 – Market Ratios

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2.3.6 Explain it – Earnings Per Share (equation 2.15) – LO3 – This video explains how to
calculate Earnings Per Share, shows you where to find the ratio inputs, and also provides
information on how to interpret this ratio.
2.3.6 Explain it – Price Earnings (PE) (equation 2.16) – LO3 – This video explains how to
calculate the Price Earnings ratio, shows you where to find the ratio inputs, and also provides
information on how to interpret this ratio.
2.3.6 Explain it – Market to Book (equation 2.17) – LO3 – This video explains how to calculate
the Market to Book ratio, shows you where to find the ratio inputs, and also provides
information on how to interpret this ratio.
2.4.1 Explain it – Common-Sized Financial Statements – LO4 – This video explains how to create
common-sized balance sheets using spreadsheet software and then how to use this information
for trend analysis. The video then shows how to create common-sized income statements and
how to interpret the information contained in this statement.
2.5.1 Explain it – DuPont Analysis – LO5 – This video explains how to perform analysis using the
DuPont analysis method.
IV. ASSESSMENT TOOLS
Here is a listing (by page number) and description of all the assessments provided in this
chapter.
Page Number
(Chapter: Learning Objective: Page) Description
2.1.3 Self-Test Question 1
2.1.3 Self-Test Question 2
2.1.3 Self-Test Question 3
2.2.1 Self-Test Question 4
2.3.1 Self-Test Question 5
2.3.1 Self-Test Question 6
2.3.2 Self-Test Question 7
2.3.3 Self-Test Question 8
2.3.3 Self-Test Question 9
2.3.4 Self-Test Question 10
2.3.5 Self-Test Question 11
2.3.6 Self-Test Question 12
2.4.1 Self-Test Question 13
2.4.1 Self-Test Question 14
2.5.1 Self-Test Question 15

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Page Number
(Chapter: Learning Objective: Page) Description
2.5.1 Self-Test Question 16
2.6.1 Self-Test Question 17
2.6.1 Self-Test Question 18
Practice Section 2.1
Practice Section 2.2
Practice Section 2.3
Practice Section 2.4
Practice Section 2.5
Practice Section 2.6
Chapter 2 Homework
Chapter 2 Quiz
V. CLASS APPLICATION ACTIVITIES
These activities, complete with solutions, provide opportunities to reinforce (either in class or in
small groups) students’ ability to apply chapter concepts in business contexts.
CLASS APPLICATION ACTIVITIES 2.1
Wal-Mart’s Income Statement
LO1 – Describe the Three Financial Statements Needed for Financial Analysis
Wal-Mart Stores Inc. (WMT) is one of the largest companies in the world and has more than two
million employees. The company operates retail outlets in various formats in all 50 U.S. states
and 26 countries other than the United States. Wal-Mart also has online retail operations.
Go to your favorite financial site and type in the ticker symbol for Wal-Mart Stores Inc. (WMT).
Find a button labeled as “Financial Statements” or “Financials” and then navigate to the income
statement and look at the last three years.
Questions to pose:
1. What was WMT’s revenue trend for the past three years?
Answer: Varies depending on the period.
2. Has WMT’s net income been increasing or decreasing?
Answer: Varies depending on the period.
3. Briefly summarize the information you can rapidly glean from WMT’s income statement.
Does anything surprise you?

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Answer: Varies.
Time on task: This exercise can take between 10 and 20 minutes depending on how long it takes
to find and summarize the findings.
Teaching Notes: This activity is a current example of the types of information you can glean
from an income statement. In addition, it provides an opportunity to discuss how some firms
continue to perform well even during poor economic conditions.
CLASS APPLICATION ACTIVITIES 2.2
Benchmarking and Peer Comparison
LO2 – Explain the Goals of Financial Statement Analysis
Benchmarking is the process of comparing some aspect of firm performance with industry peers
that are performing at a high level. A financial ratio may not provide much information in
isolation but when compared with other firms in the same industry, it allows a financial manager
to see whether they are performing at an average, below average, or above average level. This
comparison can then be used to focus attention only on areas in need of improvement. So
where do you find peer data? RMA’s annual statement studies are one source of peer
information.
Go to the following website:
http://www.rmahq.org/tools-publications/publications/annual-statement-studies/annual-
statement-studies
Now open the PDF file entitled “Sample Financial Ratio Benchmarks” and look over this sample
data. Next open the PDF file entitled “Financial Ratio Benchmarks: Definition of Ratios.” Use the
information in these two files to answer the following questions.
Questions to pose:
1. Which liquidity ratios are available for comparison?
Answer: Both the current ratio and the quick ratio are reported.
2. Why does RMA report three different current ratios for each size firm?
Answer: The top ratio is the cutoff for the upper quartile of firms where 25% of the firms have
ratios higher than that reported number. The middle ratio is the median current ratio, which
means 50% of the firms have current ratios higher than this number and 50% have current
ratios lower than this number. The bottom number is the cutoff for the lower quartile where
25% of the firms have ratios lower than this reported number.
Time on task: This exercise can take between 15 and 30 minutes depending on how long it takes
to find and summarize the findings.
Teaching Notes: This activity is a current example how ratios can be used for peer group
comparison and benchmarking. You can spend more time on this exercise and look at more

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financial data and also have a discussion about the importance of selecting the appropriate
peers for your firm.
CLASS APPLICATION ACTIVITIES 2.3
Altman’s Z-Score
LO3 – Perform Financial Statement Analysis
Edward Altman published the following seminal paper in finance on predicting firm bankruptcy:
"Financial Ratios, Discriminant Analysis, and the Prediction of Corporate Bankruptcy." Journal of
Finance: 189–209 (September 1968).
In the paper, Altman used a statistical method known as discriminant analysis to calculate a
single score, known as a Z-score, that was useful in predicting whether a firm was in danger of
filing bankruptcy. Altman used publicly available information and calculated several ratios from
the financial data that were good predictors of bankruptcy. Spend some time looking up
information on Altman’s paper, or find a copy of Altman’s paper, and then answer the following
questions.
Questions to pose:
1. What specific ratios did Altman include in his bankruptcy prediction model? Why do you
think these ratios provide information about bankruptcy?
Answer: Ratio 1 = Working Capital / Total Assets. This ratio is a good measure of liquidity,
which tells us whether a firm has enough liquid assets to pay its debt.
Ratio 2 = Retained Earnings / Total Assets. This ratio is a measure of profitability over time
relative to a firm’s size.
Ratio 3 = Earnings Before Interest and Taxes / Total Assets. This ratio tells us whether the firm is
generating profits from current operations.
Ratio 4 = Market Value of Equity / Book Value of Total Liabilities. This ratio gives some indication
of investor awareness of high debt levels. Investors concerned that a firm’s debt is too high will
sell shares and push the stock price down.
Ratio 5 = Sales/ Total Assets. (Total asset turnover). This asset utilization ratio tells us how well
the firm is doing generating sales with the current level of assets.
These ratios all provide indications of profitability, cash flows, leverage, and a firm’s ability to
service debt. Because firms file bankruptcy when cash flows are not sufficient to meet current
obligations, these ratios are a good indicator of financial problems over time.
Time on task: This exercise can take between 25 and 40 minutes depending on how long it takes
to find and summarize the findings.
Teaching Notes: This activity is a good example of how ratio analysis can provide external users
with important information about the overall health of a firm. Note that most of these ratios are
not the ones covered in the text. This illustrates how financial ratios can be created that focus

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on specific components of a firm where either an internal user or external user may be
interested in learning more information.
CLASS APPLICATION ACTIVITIES 2.4
Ratio Analysis in Practice
LO3 – Perform Financial Statement Analysis
Ratio analysis can provide both internal and external users with a tremendous amount of
information about firm performance. Select a publicly traded firm in the manufacturing sector
and have the students conduct a ratio analysis of this firm and report their findings.
Questions to pose:
1. Does the firm have any problem areas that you would investigate further if you were a
manager?
Answer: Varies depending on the firm selected.
2. Are there any other specific pieces of information that you would request from your
management team with regards to this firm? If so, why?
Answer: Varies depending on the firm selected.
3. Would you invest money in this firm based on your analysis?
Answer: Varies depending on the firm selected.
Time on task: This exercise can take between 45 and 60 minutes depending on how long it takes
to find and summarize the findings. Often the interpretation can take more time.
Teaching Notes: This activity gives the students the ability to practice ratio analysis. This activity
is also a very good team project. Team members can split the analysis into ratio groups and each
member do a ratio group (liquidity ratios, profitability ratios, etc.) and then have a discussion of
their findings. Short group presentations can then be given that enable other students to
provide input on interpretation. This gives the instructor opportunity to show why a ratio can
often be interpreted as “good” or “bad” and often we need additional information to make a
more informed decision.
VI. POST-TEST
These 10 questions can be used to determine the students’ understanding of the skills and
information covered in this chapter, and in customizing your chapter lecture or exam review to
the concepts that students had difficulty mastering.
LO1 – Know the Three Financial Statements Needed for Financial Analysis
1. Assets are used by the firm to
a. generate income.
Answer: Correct. A firm uses assets to generate income.
b. provide financing.
Answer: Incorrect. A firm uses assets to generate income.

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c. increase costs.
Answer: Incorrect. A firm uses assets to generate income.
d. reduce efficiency.
Answer: Incorrect. A firm uses assets to generate income.
2. The statement of cash flows is split into three sections that include all of the following
except
a. cash flows from operations.
Answer: Incorrect: This is one of the sections of the statement of cash flows.
b. cash flows from financing.
Answer: Incorrect: This is one of the sections of the statement of cash flows.
c. cash flows from salaries.
Answer: the sections of the statement of cash flows include cash flows from operations, cash
flows from financing, and cash flows from investments.
d. cash flows from investments.
Answer: Incorrect: This is one of the sections of the statement of cash flows.
3. All of the following are assets except
a. new building.
Answer: Incorrect: a building is an asset.
b. a metal lathe.
Answer: Incorrect: a metal lathe is a piece of equipment that is an asset.
c. a short-term bank loan.
Answer: Correct: A short-term bank loan is a liability.
d. a fleet of company trucks.
Answer: Incorrect: trucks are assets.
LO2 – Explain the Goals of Financial Statement Analysis
4. Financial managers can use ratio analysis to
a. improve performance.
Answer: Incorrect because all of the answers are possible uses of ratio analysis.
b. identify areas of weakness.
Answer: Incorrect because all of the answers are possible uses of ratio analysis.
c. create greater efficiencies in operations.
Answer: Incorrect because all of the answers are possible uses of ratio analysis.
d. improve performance, identify areas of weakness and create greater efficiencies in
operations.
Answer: Correct because all of the answers are possible uses of ratio analysis.
LO3 – Perform Financial Statement Analysis
5. The current ratio for a firm with current assets of 2,000, inventories of 300 and current
liabilities of 800 is
a. 0.400.
Answer: Incorrect: Because current ratio = CA/CL so is 2,000/800 = 2.5.
b. 2.125.
Answer: Incorrect: Because current ratio = CA/CL so is 2,000/800 = 2.5.
c. 2.875.

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Answer: Incorrect: Because current ratio = CA/CL so is 2,000/800 = 2.5.
d. 2.500.
Answer: Current ratio = CA/CL, so is 2,000/800 = 2.5.
6. A firm with an inventory turnover of 6 times, an average inventory of 1,200, and current
liabilities of 1,000 should have a cost of goods sold equal to
a. 7,200.
Answer: Correct: 6 x average inventory = COGS, so COGS = 6 x 1,200 = 7,200.
b. 2,200 .
Answer: Incorrect: 6 x average inventory = COGS so COGS = 6 x 1,200 = 7,200.
c. 6,000.
Answer: Incorrect: 6 x average inventory = COGS so COGS = 6 x 1,200 = 7,200.
d. 1,200,000.
Answer: Incorrect: 6 x average inventory = COGS so COGS = 6 x 1,200 = 7,200.
LO4 – Prepare Common Sized Financial Statements
7. To construct a common-sized income statement, you need to divide each line item by
a. total assets.
Answer: Incorrect. To construct a common-sized balance sheet you need to divide each line
item by total assets.
b. sales.
Answer: Correct: Dividing each line item by sales converts the item to a percentage of sales
and makes it easy to compare with other firms or look at changes over time.
c. total debt.
Answer: Incorrect: This information would be nonsensical.
d. None of these responses is correct.
Answer: Incorrect: Income statement items are divided by sales and balance sheet items are
divided by total assets.
LO5 – Evaluate Company Performance Using the DuPont Ratio
8. The DuPont Ratio decomposed ROE into turnover, profit margins, and
a. leverage.
Answer: Correct: The DuPont ratio helps a manager understand the source of ROE and
potentially helps identify ways to improve ROE.
b. sales.
Answer: Incorrect: The DuPont ratio is ROE = net profit margin x total asset turnover x equity
multiplier.
c. liquid assets.
Answer: Incorrect: The DuPont ratio is ROE = net profit margin x total asset turnover x equity
multiplier.
d. operating expenses.
Answer: Incorrect: The DuPont ratio is ROE = net profit margin x total asset turnover x equity
multiplier.

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