Question

13. Determine the following changes as source of cash or use of cash: (1p each, total 4p) Change Source of cash Use of cash Increase in Inventory Decrease in Accounts Payable Decrease in Plant & Equipment Increase in Common Stock 14. When testing a company's ability to meet short term liabilities, which ratio should you regard, if; (5p) a. the company has out of fashion inventories difficult to liquidate in a short time with a reasonable loss and b. the company has receivables from credible customers expected to turn cash within next 3 months. A. Debt ratio B. Equity ratio C. Current ratio D. Acid-test ratio E. Cash ratio (3) 15. Although you know that, to reach a conclusion merely by looking to ratios is not possible, the Price Price nigher ratios such as p Earnings o rta-indicates in general; Book Value A. A relatively higher assets turnover B. A relatively higher profitability C. A relatively higher share price D. A relatively higher efficiency E. A relatively higher liquidity

Answer 1

13. Increase in inventory is a use of cash, as cash is being spent to acquire more inventory.

Decrease in accounts payables is a use of cash as outstanding liabilities have been paid off.

Decrease in plant and equipment is a source of cash , as it is sold off and cash is created.

Increase in common stock is a use of cash, as cash is being paid to acquire inventory.

14. The liquidity ratios helps determine the ability of the company to pay off the short term liabilities. In this problem, the company is having out of fashion inventories, so we need to determine the ability of the company to meet the short term liabilities but without taking into account the inventories.

Current ratio = CA/ CL, Where current assets = cash + accounts receivables + inventory.

Quick ratio = quick assets/ current liabilities, where this ratio does not take inventories while calculating the ratio, but includes accounts receivables in the calculations.

So, the correct option is Acid test ratio/ quick ratio which is option D.

15. Higher P/B and a higher P/E ratio, indicates a higher share price.

P/B = MARKET PRICE OF SHARE/ BOOK VALUE OF SHARE

P/E = MARKET PRICE OF SHARE/ EARNINGS PER SHARE

So, the correct option is option C.