Deck 5: Financial Planning and Forecasting Financial Statements

Question 1

Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are not large, sales forecast accuracy is not critical to the firm.

Answer 1

False

Question 2

If a firm's capital intensity ratio (A*/S0) DECREASES as sales increase, use of the AFN formula is likely to UNDERSTATE the amount of additional funds required, other things held constant.

Answer 2

False

Question 3

As a firm's sales grow, its current assets also tend to increase. For instance, as sales increase, the firm's inventories generally increase, and purchases of inventories result in more accounts payable. Thus, spontaneously generated funds arise from transactions brought on by sales increases.

Answer 3

True

Question 4

The first, and most critical, step in constructing a set of pro forma financial statements is the sales forecast.

Question 5

By developing a financial plan, a firm benefits by being forced to think about and forecast the future, set goals and establish priorities, and make sure that goals are internally consistent.

Question 6

Which of the following is NOT a key element in strategic planning as it is described in the text?

A) the mission statement
B) the statement of the corporation's scope
C) the statement of cash flows
D) the statement of corporate objectives

Question 7

The AFN formula would be appropriate if, in a regression of each asset and spontaneous liability on sales, the regression line was linear and passed through the origin.

Question 8

One of the key steps in the development of pro forma financial statements is to identify those assets and liabilities that increase spontaneously with sales.

Question 9

Suppose that a firm's profit margin is 5%, its debt/assets ratio is 56%, and its dividend payout ratio is
40%. If the firm is operating at less than full capacity, then sales could increase to some extent without the need for external funds; however, but if it is operating at full capacity with respect to all assets, including fixed assets, then any positive growth in sales will require some external financing.

Question 10

The term "spontaneously generated funds" generally refers to increases in the cash account that result from growth in sales, assuming the firm is operating with a positive profit margin.

Question 11

Pro forma financial statements are used primarily to assess a firm's historical performance.

Question 12

Two firms with identical capital intensity ratios are generating the same amount of sales. However, Firm A is operating at full capacity, while Firm B is operating below capacity. If the two firms expect the same growth in sales during the next period, then Firm A is likely to need more additional funds than Firm B, other things held constant.

Question 13

A rapid build-up of inventories normally requires additional financing, unless the increase is matched by an equally large decrease in some other asset.

Question 14

When we use the AFN formula to forecast the additional funds needed, we are implicitly assuming that all financial ratios are constant. This means, for example, that if you plotted a graph of inventories versus sales, the regression line would be linear and would have a positive (non zero) Y-intercept.

Question 15

A typical sales forecast, though concerned with future events, will usually be based on recent historical trends and events as well as on forecasts of economic prospects.

Question 16

Which of the following assumptions is embodied in the AFN formula forecasting method?

A) All balance sheet accounts are tied directly to sales.
B) Accounts payable and accruals are tied directly to sales.
C) Common stock and long-term debt are tied directly to sales.
D) Fixed assets, but not current assets, are tied directly to sales.

Question 17

To determine the amount of additional funds needed (AFN), you may subtract the expected increase in liabilities, which represents a source of funds, from the sum of the expected increases in retained earnings and assets, both of which are uses of funds.

Question 18

Suppose a firm with a positive net worth is operating its fixed assets at full capacity, its dividend payout ratio is 100%, and it wants to hold all financial ratios constant. Then, for any positive growth rate in sales, it will require external financing.

Question 19

The fact that long-term debt and common stock are raised infrequently and in large amounts lessens the need for the firm to forecast those accounts on a continual basis.

Question 20

When a firm wants to maintain its ratios at their existing levels, if it has a positive sales growth rate of any amount, it will require some amount of external funding.

Question 21

Last year Wei Guan Inc. had $350 million of sales, and it had $270 million of fixed assets that were used at 65% of capacity. In millions, by how much could Wei Guan's sales increase before it is required to increase its fixed assets?

A) $170.1
B) $179.0
C) $188.5
D) $197.9

Question 22

Suppose that Kamath-Meier Corporation's CFO uses this equation, which was developed by regressing inventories on sales over the past 5 years, to forecast inventory requirements: Inventories = $22.0 + 0.125(Sales). The company expects sales of $400 million during the current year, and it expects sales to grow by 30% next year. All dollars are in millions. What is the inventory forecast for next year?

A) $74.6
B) $78.5
C) $82.7
D) $87.0

Question 23

A company expects sales to increase during the coming year, and it is using the AFN equation to forecast the additional capital that it must raise. Which of the following conditions would cause the AFN to INCREASE?

A) The company increases its dividend payout ratio.
B) The company begins to pay employees monthly rather than weekly.
C) The company's profit margin increases.
D) The company decides to stop taking discounts on purchased materials.

Question 24

Last year Godinho Corp. had $250 million of sales, and it had $75 million of fixed assets that were being operated at 80% of capacity. In millions, how large could sales have been if the company had operated at full capacity?

A) $312.5
B) $328.1
C) $344.5
D) $361.8

Question 25

Other things being equal, firms pursuing which type of working capital strategy will need what type of long-term external financing?

A) aggressive, less
B) conservation, less
C) moderate, less
D) aggressive, more

Question 26

Which of the following statements is correct?

A) When we use the AFN formula, we assume that the ratios of assets and liabilities to sales (A*/S0 and L*/S0) vary from year to year in a stable, predictable manner.
B) Firms whose fixed assets are "lumpy" frequently have excess capacity, and this should be accounted for in the financial forecasting process.
C) For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.
D) When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow

Question 27

Last year Handorf-Zhu Inc. had $850 million of sales, and it had $425 million of fixed assets that were used at only 60% of capacity. What is the maximum sales growth rate the company could achieve before it had to increase its fixed assets?

A) 57.16%
B) 60.17%
C) 63.33%
D) 66.67%

Question 28

Which of the following statements is correct?

A) Because the process of planning involves long periods of time, only long-term considerations are involved.
B) Financial planning is built upon the assumption of the target capital structure being made.
C) If total assets increase by the same percentage as sales increase, then assets and sales will increase by same dollar amounts.
D) Financial planning models always include the three basic elements of firm value: cash flow size, risk, and timing.

Question 29

Which of the following is not an issue in the process of the FFS method?

A) analyzing the interaction of all decisions of the firm
B) projecting the consequences of decisions to avoid surprises
C) establishing capital budgeting procedures
D) measuring performance against the plan

Question 30

Last year Jain Technologies had $250 million of sales and $100 million of fixed assets, so its FA/Sales ratio was 40%. However, its fixed assets were used at only 75% of capacity. Now the company is developing its financial forecast for the coming year. As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full capacity. What target FA/Sales ratio should the company set?

A) 28.5%
B) 30.0%
C) 31.5%
D) 33.1%

Question 31

Which of the following relationships describes a situation of very large increases in sales requiring very little additional inventory?

A) lumpiness
B) curvilinear
C) declining ratio
D) constant ratio

Question 32

Which of the following statements is correct?

A) Since accounts payable and accrued liabilities must eventually be paid off, as these accounts increase, AFN as calculated by the AFN equation must also increase.
B) Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no excess current assets. Based on the AFN equation, its AFN will be larger than if it had been operating with excess capacity in both fixed and current assets.
C) If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth.
D) Additional funds needed (AFN) are typically raised using a combination of notes payable, long-term debt, and common stock. Such funds are nonspontaneous in the sense that they require explicit financing decisions to obtain them.

Question 33

Which of the following defines spontaneously generated funds?

A) the amount of assets required per dollar of sales
B) a forecasting approach in which the forecasted percentage of sales for each item is held constant
C) funds that a firm must raise externally through borrowing or by selling new common or preferred stock
D) funds that are obtained automatically from normal operations, and they include spontaneous increases in accounts payable and accruals, plus additions to retained earnings

Question 34

Which of the following statements is correct?

A) Once a firm has defined its purpose, scope, and objectives, it must develop a strategy or strategies for achieving its goals. The statement of corporate strategies sets forth detailed plans rather than broad approaches.
B) A firm's corporate purpose states the general philosophy of the business and provides managers with specific operational objectives.
C) Operating plans provide detailed guidance, consistent with the corporate strategy, to help operating managers meet the corporate objectives. These operating plans can be developed for any time horizon, but many companies use a 5-year horizon.
D) A firm's mission statement defines its lines of business and geographic area of operations.

Question 35

Which of the following is NOT one of the steps taken in the financial planning process?

A) Forecast financial statements and use these projections to analyze the likely effects of the operating plan on profits and various financial ratios.
B) Forecast the funds that will be needed to support the 5-year plan.
C) Develop a cash budget for use in determining when funds will be needed or when surplus funds will be available for investment.
D) Consult with key competitors about the optimal set of prices to charge, i.e., the prices that will maximize profits for our firm and its competitors.

Question 36

Fairchild Garden Supply expects $600 million of sales this year, and it forecasts a 15% increase for next year. The CFO uses this equation to forecast inventory requirements at different levels of sales: Inventories = $30.2 + 0.25(Sales). All dollars are in millions. What is the projected inventory turnover ratio for the coming year?

A) 3.40
B) 3.57
C) 3.75
D) 3.94

Question 37

Which of the following defines the capital intensity ratio?

A) sales divided by total assets, i.e., the total assets turnover ratio.
B) the percentage of liabilities that increase spontaneously as a percentage of sales.
C) the ratio of current assets to sales.
D) the amount of assets required per dollar of sales, or A*/S0.

Question 38

Which of the following statements is correct?

A) The most important step when developing pro forma financial statements is to determine the breakdown of common equity between common stock and retained earnings.
B) The first, and perhaps the most critical, step in forecasting financial requirements is to forecast future sales.
C) In a financial plan, the way that liabilities and owner's equity are projected to change depends on the firm's sales forecast.
D) The capital intensity ratio gives us an idea of the physical condition of the firm's fixed assets.

Question 39

Which of the following defines the term "additional funds needed (AFN)"?

A) funds that are obtained automatically from routine business transactions.
B) funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock, to support operations.
C) the amount of internally generated cash in a given year minus the amount of cash needed to acquire the new assets needed to support growth.
D) a forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant.

Question 40

Jefferson City Computers has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an INCREASE of the additional funds needed?

A) a sharp increase in its forecasted sales
B) a sharp reduction in its forecasted sales
C) the company reduces its dividend payout ratio
D) the company discovers that it has excess capacity in its fixed assets

Question 41

ABC Co. is planning its operations for next year, and Ronnie Clayton, the CEO, wants you to forecast the firm's additional funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year? Dollars are in millions.

A) $102.8
B) $108.2
C) $113.9
D) $119.9

Question 42

Chua Chang & Wu Inc. is planning its operations for next year, and the CEO wants you to forecast the firm's additional funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year?

A) -$14,440
B) -$15,200
C) -$16,000
D) -$17,640

Question 43

Suppose a firm has net income of $8 on sales of $40, fixed assets of $75, and total assets of $90. The firm retains 50% of its earnings. If the firm is operating at 80% capacity, what are the full capacity sales?

A) $40
B) $48
C) $50
D) $72

Question 44

Last year Emery Industries had $450 million of sales and $225 million of fixed assets, so its FA/Sales ratio was 50%. However, its fixed assets were used at only 65% of capacity. If the company had been able to sell off enough of its fixed assets at book value so that it was operating at full capacity, with sales held constant at $450 million, how much cash (in millions) would it have generated?

A) $74.81
B) $78.75
C) $82.69
D) $86.82