Lecture 4 Quiz 1

Common size analysis also makes it easier to compare a company to its competitors.

Common size analysis allows to identify important components in the income statement and in the balance sheet.

Common size analysis cannot be done across time

Common size analysis expresses each item in the income statement as a percentage of net sales revenue, and each item in the balance sheet as a percentage of total asset.

Horizontal analysis helps to see if an item experiences improvement or deterioration in a year.

Horizontal analysis involves calculating the annual growth rate for each item in the financial statement.

Horizontal analysis alone can be misleading. A massive change in an item may not be important if the item accounts for only a small percentage in the revenue or total asset.

Horizontal analysis helps to identify the items that account for large proportions of revenue in the income statement and items that accounts for large proportions of total assets in the balance sheet.

ROE is the ratio of net income to equity. As such ROE would change when interest rate or tax rate changes

When ROA is higher than interest rate, a higher leverage will increase ROE

ROA is the ratio of EBIT to total assets. As such ROA does not change when interest rate or tax rate changes

When the leverage (debt/equity) ratio increases, ROA becomes more volatile, while the volatility of ROE stays the same.

Cost differentiation involves operating more efficiently than competitors so that the company can offer lower prices to attract customers

When adopting product differentiation strategy, it is not possible to adopt cost differentiation

Product differentiation involves offering products or services with unique benefits to charge high prices

To be successful, companies can use business strategies such as product differentiation and cost differentiation

Du Pont decompositions provide a complete picture on drivers of the profitability of a company. No further research on the real activities of the company is required

Tax burden and debt burden receive values between 0 and 1. High tax burden or high debt burden values will lead to high ROE.

When applied to ROA, Du Pont technique decomposes ROA into asset turnover and operating profit margin. This can be useful for the identification of the business strategies pursued by the firm.

Du Pont technique that decomposes ROE into tax burden, ROA and compound leverage factor can help to identify if leverage is hurting or helping ROE.