Level 1 — RecognitionFinancial Ratios

Financial Ratios

⏱ 20 minutes30 marksprintable — key stays hidden on paper

Chapter: 2.5 Financial Ratios Level: 1 — Recognition (MCQ + Matching + True/False with justification) Time Limit: 20 minutes Total Marks: 30

Section A — Multiple Choice (1 mark each, 10 marks)

Choose the single best answer.

Q1. Earnings Per Share (EPS) is calculated as:

(a) Net Income ÷ Total Assets
(b) Net Income ÷ Number of Outstanding Shares
(c) Market Price ÷ Book Value
(d) Dividends ÷ Net Income

Q2. A high P/E ratio, all else equal, most commonly signals that:

(a) The stock is undervalued
(b) Investors expect higher future earnings growth
(c) The company pays no dividends
(d) The company has high debt

Q3. Which ratio is best suited to value a company that currently has negative earnings but strong sales?

(a) P/E ratio
(b) P/S ratio
(c) PEG ratio
(d) Interest coverage ratio

Q4. The Quick Ratio differs from the Current Ratio because it:

(a) Adds goodwill to current assets
(b) Excludes inventory from current assets
(c) Uses total liabilities instead of current liabilities
(d) Excludes cash

Q5. In the DuPont three-step decomposition, ROE equals:

(a) Net Margin × Asset Turnover × Equity Multiplier
(b) Gross Margin × Current Ratio × D/E
(c) ROA × Interest Coverage
(d) P/E × EPS × Payout

Q6. EV/EBITDA is often preferred to P/E because Enterprise Value:

(a) Ignores debt entirely
(b) Captures both debt and cash, making cross-company comparison fairer
(c) Is always smaller than market cap
(d) Uses net income rather than operating profit

Q7. The dividend payout ratio is defined as:

(a) Dividends per Share ÷ Market Price
(b) Dividends ÷ Net Income
(c) Net Income ÷ Dividends
(d) Retained Earnings ÷ Net Income

Q8. A PEG ratio below 1.0 generally suggests:

(a) The stock is overvalued relative to growth
(b) The stock may be undervalued relative to its earnings growth
(c) The company has no earnings
(d) The dividend yield is high

Q9. Return on Capital Employed (ROCE) primarily uses which numerator?

(a) Net Income
(b) EBIT (Operating Profit)
(c) Gross Profit
(d) Free Cash Flow

Q10. Free Cash Flow (FCF) is most commonly computed as:

(a) Net Income − Dividends
(b) Operating Cash Flow − Capital Expenditures
(c) Revenue − Cost of Goods Sold
(d) EBITDA − Taxes

Section B — Matching (1 mark each, 8 marks)

Q11–Q18. Match each ratio in Column X to its correct formula/description in Column Y. Write the letter.

Column X		Column Y
Q11. Gross Margin		A. Current Assets ÷ Current Liabilities
Q12. ROA		B. EBIT ÷ Interest Expense
Q13. Current Ratio		C. (Revenue − COGS) ÷ Revenue
Q14. Interest Coverage		D. Net Income ÷ Total Assets
Q15. Dividend Yield		E. COGS ÷ Average Inventory
Q16. Debt-to-Equity		F. Dividend per Share ÷ Price per Share
Q17. Inventory Turnover		G. Total Debt ÷ Total Equity
Q18. FCF Yield		H. Free Cash Flow ÷ Market Cap

Section C — True/False WITH Justification (2 marks each: 1 for T/F, 1 for reason, 12 marks)

State True or False and give a one-line justification.

Q19. "A company with net margin 10%, asset turnover 2.0, and equity multiplier 1.5 has an ROE of 30%." (2)

Q20. "The P/B ratio compares a company's market value to its book (net asset) value, and a P/B below 1 means the market values the firm below its accounting net worth." (2)

Q21. "Operating margin includes interest and tax expense in its calculation." (2)

Q22. "Receivables turnover measures how many times a company collects its average accounts receivable during a period; a higher value indicates faster collection." (2)

Q23. "ROE can be increased purely by taking on more debt, without any improvement in operating performance." (2)

Q24. "A current ratio of exactly 1.0 means a company has zero current liabilities." (2)

Answer keyMark scheme & solutions

Section A (1 mark each)

Q1 — (b). EPS = Net Income ÷ Shares Outstanding; it apportions profit per share.

Q2 — (b). A high P/E means investors pay more per unit of current earnings, typically because they expect earnings growth.

Q3 — (b). P/S uses sales, which stays positive even when earnings are negative; P/E and PEG break down with negative earnings.

Q4 — (b). Quick ratio removes inventory (least liquid current asset): (CA − Inventory) ÷ CL.

Q5 — (a). DuPont: ROE = Net Margin × Asset Turnover × Equity Multiplier.

Q6 — (b). EV = Market Cap + Debt − Cash, so EV/EBITDA neutralises capital-structure differences.

Q7 — (b). Payout ratio = Dividends ÷ Net Income (fraction of profit paid out).

Q8 — (b). PEG < 1 implies price is low relative to growth → potentially undervalued.

Q9 — (b). ROCE = EBIT ÷ Capital Employed; it uses operating profit before financing.

Q10 — (b). FCF = Operating Cash Flow − CapEx.

Section B (1 mark each)

Q	Answer
Q11 Gross Margin	C
Q12 ROA	D
Q13 Current Ratio	A
Q14 Interest Coverage	B
Q15 Dividend Yield	F
Q16 Debt-to-Equity	G
Q17 Inventory Turnover	E
Q18 FCF Yield	H

Section C (2 marks each: 1 T/F + 1 justification)

Q19 — TRUE. ROE = $0.10 \times 2.0 \times 1.5 = 0.30 = 30\%$ . DuPont multiplies the three factors. (1 for True, 1 for calculation.)

Q20 — TRUE. P/B = Market Cap ÷ Book Value of Equity; P/B < 1 means market price is below accounting net worth. (1 True, 1 reason.)

Q21 — FALSE. Operating margin = Operating Income (EBIT) ÷ Revenue; it is computed before interest and tax. Net margin includes them. (1 False, 1 reason.)

Q22 — TRUE. Receivables turnover = Net Credit Sales ÷ Average Receivables; higher = customers pay faster / shorter collection period. (1 True, 1 reason.)

Q23 — TRUE. Via the equity multiplier (Assets/Equity) in DuPont, higher leverage raises ROE even with unchanged margins/turnover — but adds financial risk. (1 True, 1 reason.)

Q24 — FALSE. Current ratio 1.0 means Current Assets equal Current Liabilities (ratio = 1), not that liabilities are zero. (1 False, 1 reason.)

[
  {"claim":"DuPont ROE = 0.10*2.0*1.5 = 0.30 (Q19)","code":"roe = Rational(1,10)*2*Rational(3,2); result = (roe == Rational(3,10))"},
  {"claim":"EPS = NetIncome/Shares: 500 net income, 250 shares -> 2 (Q1 form)","code":"eps = Rational(500,250); result = (eps == 2)"},
  {"claim":"Quick ratio removes inventory: CA=300, Inv=100, CL=100 -> quick=2 (Q4)","code":"quick = Rational(300-100,100); result = (quick == 2)"},
  {"claim":"Payout ratio: dividends 40, net income 100 -> 0.4 (Q7)","code":"payout = Rational(40,100); result = (payout == Rational(2,5))"},
  {"claim":"Current ratio equals 1 means CA==CL (Q24): CA=150,CL=150 -> ratio 1","code":"cr = Rational(150,150); result = (cr == 1)"}
]