Chap029.pdf

Chapter 29 - Financial Planning

Chapter 29 Financial Planning Multiple Choice Questions

1. Short-term financial decisions: I) involve short lived assets II) involve short lived liabilities III) are easily reversed A. I only B. II only C. I, II, and III D. III only

2. The main difference between short-term and long-term finance is: A. The risk of long-term cash flows being more important than short-term risks B. The present value of long-term cash flows being greater than short-term cash flows C. The timing of short-term cash flow being within a year or less D. All of the above

3. Cumulative capital requirement can be met by: I) long-term financing II) short-term financing A. I only B. II only C. I and II D. None of the above

4. According to Strategy A, a firm should: A. Maintain a high ratio of current assets to sales B. Use high levels of short-term debt and low levels of long-term financing C. Use more short-term debt and less long-term financing D. Have surplus cash that can be invested in short-term securities

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5. According to Strategy B, a firm would: A. Maintain a high ratio of current assets to sales. B. Use low or no short-term debt and more long-term financing. C. Use more short-term debt and less long-term financing. D. Be a short-term lender during a part of the year and a borrower during the rest.

6. According to Strategy C, a firm would: A. Be in permanent need of short-term borrowing B. Have high current cash holdings C. Use low or no short-term debt and more long-term financing D. None of the above

7. Given the following assets; I) Long-term assets II) Inventories III) Receivables IV) Marketable securities Which is the least liquid of these assets? A. I B. II C. III D. IV

8. Given the following assets; I) Long-term assets II) Inventories III) Receivables IV) Marketable securities Arrange the above assets in the order of liquidity. (The most liquid being first) A. I, II, III and IV B. II, III, IV and I C. III, IV, II, and I D. IV, III, II and I

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9. Given the following data: Total current assets = $852; Total current liabilities = $406; Long-term debt = $442, calculate the net working capital. A. $446 B. $852 C. $410 D. None of the above

10. Net working capital is defined as: A. The current assets in a business B. The difference between current assets and current liabilities C. The present value of all short-term cash flows D. The difference between all assets and liabilities

11. The cash cycle is represented by the following sequence: A. Cash, raw materials, finished goods, and receivables, cash B. Cash, receivables, finished goods, and raw materials, cash C. Cash, raw material, receivables, finished goods, cash D. None of the above

12. The cash budget is the primary short-term financial planning tool. The key reasons a cash budget is created are: I) To estimate your investment in assets II) To estimate the size and timing of your new cash flows III) To prepare for potential financing needs A. I only B. II and III only C. II only D. III only

13. Cash budget may be prepared on a A. monthly basis B. weekly basis C. daily basis D. all of the above

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14. A company has forecast sales in the first 3 months of the year as follows (figures in millions): January, $60; February, $80; March, $100. 60% of sales are usually paid for in the month that they take place and 40% in the following month. Receivables at the end of December were $24 million. What are the forecasted collections on accounts receivable in March? A. $88 million B. $92 million C. $100 million D. $140 million

15. A company has forecast sales in the first 3 months of the year as follows (figures in millions): January, $90; February, $20; March, $30. 70% of sales are usually paid for in the month that they take place and 30% in the following month. Receivables at the end of December were $20 million. What are the forecasted collections on accounts receivable in March? A. $27 million B. $50 million C. $23 million D. $35 million

16. The following is the general formula for calculating the "Ending accounts receivable (AR):" A. Ending (AR) = beginning (AR) - sales + collections B. Ending (AR) = beginning (AR) + sales - collections C. Ending (AR) = beginning (AR) + sales + collections D. none of the above

17. A company has forecast sales in the first 3 months of the year as follows (figures in millions): January, $80; February, $60; March, $40. 70% of sales are usually paid for in the month that they take place, 20% in the following month, and the final 10% in the next month. Receivables at the end of December were $23 million. What are the forecasted collections on accounts receivable in March? A. $180 million B. $13 million C. $40 million D. $48 million

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18. A company has forecast sales in the first 3 months of the year as follows (figures in millions): January, $200; February, $140; March, $100. 50% of sales are usually paid for in the month that they take place, 30% in the following month, and the final 20% in the next month. Receivables at the end of December were $100 million. What are the forecasted collections on accounts receivable in March? A. $132 million B. $100 million C. $240 million D. $92 million

19. The first step in the preparation of cash budget is: A. preparing the sources and uses of funds statement B. sales forecast C. estimating cash inflows D. estimating cash outflows

20. Cash inflow in cash budgeting comes mainly from: A. Collection on accounts receivable B. Short-term debt C. Issue of securities D. None of the above

21. A large part of cash outflow in cash budgeting is due to: A. Capital expenditures B. Labor costs and other expenditures C. Payments on accounts payable D. Taxes, interest payments and dividend payments

22. The most important function of a short-term financial plan is: A. to develop cash budget B. to cover the forecasted requirements in the most economical way possible C. to help develop the long-term financial plan D. none of the above

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Chapter 29 - Financial Planning

23. Short-term financial plan models are offered by: I) banks II) accounting firms III) management consultants IV) specialized computer software firms A. I only B. I and II only C. I, II and III only D. I, II III and IV

24. Short-term financial plans are developed using the following methods: I) Trial and error II) Simulation programs III) Optimization models A. I only B. I and II only C. II and III only D. I, II and III

25. When firms prepare a financial plan they use the following: I) develop several financial plans using most likely outcomes and also unexpected outcomes. II) sensitivity analysis. III) scenario analysis. A. I only B. I and II only C. I, II, and III D. II and III only

26. The basic relationship for determining external capital required is: A. External capital required = operating cash flow - investment in net working capital B. External capital required = operating cash flow - investment in net working capital investment in fixed assets C. External capital required = operating cash flow - investment in net working capital investment in fixed assets - dividends D. None of the above

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Chapter 29 - Financial Planning

27. Among the models followed to develop a financial plan, the following is the simplest: A. Percentage of sales model B. Regression model C. Computer simulation model D. None of the above

28. The firm's internal growth rate is defined as: A. retained earnings/net income B. retained earnings/net assets C. retained earnings/total assets D. none of the above

29. Internal growth rate is calculated as: A. Internal growth rate = plowback ratio × profit margin B. Internal growth rate = plowback ratio × return on equity C. Internal growth rate = plowback ratio × return on equity × [equity/net assets] D. None of the above

30. Given the following data: plow back ratio = 50%; return on equity = 20%; equity to net assets ratio = 60%. Calculate the internal growth rate for the firm: A. 6% B. 10% C. 12% D. none of the above

31. A firm can achieve a higher growth rate without raising external capital by: (within limits) A. Increasing the proportion of debt in its capital structure B. Increasing its current ratio C. Decreasing its inventory turnover D. Increasing its plowback ratio

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Chapter 29 - Financial Planning

32. The sustainable growth rate is equal to: A. plowback ratio × return on equity B. return on equity/plowback ratio C. return on assets × plowback ratio D. plowback ratio × return on equity × (equity/net assets)

33. Last year Axle Inc. reported net assets of 400, equity of $200, net income of $50, dividends of $10 and earnings retained in the period of $40. What is Axle Inc.'s internal growth rate? A. 10.0% B. 57.1% C. 20.0% D. 71.4%

34. Last year Axle Inc. reported total assets of $400, equity of $200, net income of $50, dividends of $10 and earnings retained in the period of $40. What is Axle Inc.'s sustainable growth rate? A. 25.0% B. 57.1% C. 20.0% D. 71.4%

35. Last year Foley Inc. reported total assets of $500, equity of $400, net income of $100, dividends of $50 and earnings retained in the period of $50. What is Foley Inc.'s sustainable growth rate? A. 17.5% B. 30.0% C. 10.0% D. 12.5%

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Chapter 29 - Financial Planning

36. Last year Foley Inc. reported total assets of $500, equity of $200, net income of $120, dividends of $70 and earnings retained in the period of $50. What is Foley Inc.'s internal growth rate? A. 17.5% B. 30.0% C. 10.0% D. 12.5%

True / False Questions

37. Short-term financial decisions are conceptually easier to make than long-term decisions. True False

38. Strategy A implies a permanent need for short-term borrowing. True False

39. Strategy C implies a short-term cash surplus. True False

40. Strategy B implies that the firm is a short-term lender during a part of the year and a borrower during the rest. True False

41. Most firms make a permanent investment in net working capital. True False

42. A firm with excess cash can at best generate zero NPV by investing in marketable securities. True False

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Chapter 29 - Financial Planning

43. The main source of cash in a cash budget is collection on accounts receivable. True False

44. Depreciation is not included in sources of cash because it is an expense. True False

45. Two common sources of short-term financing are borrowing from a bank and stretching payables. True False

46. Syndicated loans are subsequently resold to other institutions. True False

47. Sales forecasts are the starting point for financial planning. True False

48. Financial planning models are generated using spreadsheet programs. True False

49. The percentage of sales method is the simplest of the financial planning models. True False

50. The growth rate that a company can achieve using external funds is called the internal growth rate. True False

Short Answer Questions

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Chapter 29 - Financial Planning

51. How do firms finance investments in current assets?

52. Define net working capital.

53. Briefly describe the cash cycle.

54. Discuss the reasons why a company should prepare a cash budget.

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Chapter 29 - Financial Planning

55. Discuss the process of preparing a short-term financing plan.

56. Discuss the process of preparing a financial plan?

57. What is the model that is used to prepare a pro-forma statement?

58. How do you calculate the external capital required?

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Chapter 29 - Financial Planning

59. Briefly discuss some of the problems associated with the use of the percentage of sales model.

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Chapter 29 - Financial Planning

Chapter 29: Financial Planning Answer Key

Multiple Choice Questions

1. Short-term financial decisions: I) involve short lived assets II) involve short lived liabilities III) are easily reversed A. I only B. II only C. I, II, and III D. III only

Type: Easy

2. The main difference between short-term and long-term finance is: A. The risk of long-term cash flows being more important than short-term risks B. The present value of long-term cash flows being greater than short-term cash flows C. The timing of short-term cash flow being within a year or less D. All of the above

Type: Medium

3. Cumulative capital requirement can be met by: I) long-term financing II) short-term financing A. I only B. II only C. I and II D. None of the above

Type: Easy

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Chapter 29 - Financial Planning

4. According to Strategy A, a firm should: A. Maintain a high ratio of current assets to sales B. Use high levels of short-term debt and low levels of long-term financing C. Use more short-term debt and less long-term financing D. Have surplus cash that can be invested in short-term securities

Type: Medium

5. According to Strategy B, a firm would: A. Maintain a high ratio of current assets to sales. B. Use low or no short-term debt and more long-term financing. C. Use more short-term debt and less long-term financing. D. Be a short-term lender during a part of the year and a borrower during the rest.

Type: Medium

6. According to Strategy C, a firm would: A. Be in permanent need of short-term borrowing B. Have high current cash holdings C. Use low or no short-term debt and more long-term financing D. None of the above

Type: Medium

7. Given the following assets; I) Long-term assets II) Inventories III) Receivables IV) Marketable securities Which is the least liquid of these assets? A. I B. II C. III D. IV

Type: Easy

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8. Given the following assets; I) Long-term assets II) Inventories III) Receivables IV) Marketable securities Arrange the above assets in the order of liquidity. (The most liquid being first) A. I, II, III and IV B. II, III, IV and I C. III, IV, II, and I D. IV, III, II and I

Type: Easy

9. Given the following data: Total current assets = $852; Total current liabilities = $406; Long-term debt = $442, calculate the net working capital. A. $446 B. $852 C. $410 D. None of the above Net working capital = 852 - 406 = 446

Type: Easy

10. Net working capital is defined as: A. The current assets in a business B. The difference between current assets and current liabilities C. The present value of all short-term cash flows D. The difference between all assets and liabilities

Type: Easy

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Chapter 29 - Financial Planning

11. The cash cycle is represented by the following sequence: A. Cash, raw materials, finished goods, and receivables, cash B. Cash, receivables, finished goods, and raw materials, cash C. Cash, raw material, receivables, finished goods, cash D. None of the above

Type: Medium

12. The cash budget is the primary short-term financial planning tool. The key reasons a cash budget is created are: I) To estimate your investment in assets II) To estimate the size and timing of your new cash flows III) To prepare for potential financing needs A. I only B. II and III only C. II only D. III only

Type: Medium

13. Cash budget may be prepared on a A. monthly basis B. weekly basis C. daily basis D. all of the above

Type: Medium

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Chapter 29 - Financial Planning

14. A company has forecast sales in the first 3 months of the year as follows (figures in millions): January, $60; February, $80; March, $100. 60% of sales are usually paid for in the month that they take place and 40% in the following month. Receivables at the end of December were $24 million. What are the forecasted collections on accounts receivable in March? A. $88 million B. $92 million C. $100 million D. $140 million 80(0.4) + 100(0.6) = 92

Type: Difficult

15. A company has forecast sales in the first 3 months of the year as follows (figures in millions): January, $90; February, $20; March, $30. 70% of sales are usually paid for in the month that they take place and 30% in the following month. Receivables at the end of December were $20 million. What are the forecasted collections on accounts receivable in March? A. $27 million B. $50 million C. $23 million D. $35 million 20(0.3) + 30(0.7) = 27

Type: Difficult

16. The following is the general formula for calculating the "Ending accounts receivable (AR):" A. Ending (AR) = beginning (AR) - sales + collections B. Ending (AR) = beginning (AR) + sales - collections C. Ending (AR) = beginning (AR) + sales + collections D. none of the above

Type: Medium

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Chapter 29 - Financial Planning

17. A company has forecast sales in the first 3 months of the year as follows (figures in millions): January, $80; February, $60; March, $40. 70% of sales are usually paid for in the month that they take place, 20% in the following month, and the final 10% in the next month. Receivables at the end of December were $23 million. What are the forecasted collections on accounts receivable in March? A. $180 million B. $13 million C. $40 million D. $48 million 80(0.1) + 60(0.2) + 40(0.7) = 48

Type: Difficult

18. A company has forecast sales in the first 3 months of the year as follows (figures in millions): January, $200; February, $140; March, $100. 50% of sales are usually paid for in the month that they take place, 30% in the following month, and the final 20% in the next month. Receivables at the end of December were $100 million. What are the forecasted collections on accounts receivable in March? A. $132 million B. $100 million C. $240 million D. $92 million 200(0.2) + 140(0.3) + 100(0.5) = 132

Type: Difficult

19. The first step in the preparation of cash budget is: A. preparing the sources and uses of funds statement B. sales forecast C. estimating cash inflows D. estimating cash outflows

Type: Difficult

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20. Cash inflow in cash budgeting comes mainly from: A. Collection on accounts receivable B. Short-term debt C. Issue of securities D. None of the above

Type: Medium

21. A large part of cash outflow in cash budgeting is due to: A. Capital expenditures B. Labor costs and other expenditures C. Payments on accounts payable D. Taxes, interest payments and dividend payments

Type: Difficult

22. The most important function of a short-term financial plan is: A. to develop cash budget B. to cover the forecasted requirements in the most economical way possible C. to help develop the long-term financial plan D. none of the above

Type: Medium

23. Short-term financial plan models are offered by: I) banks II) accounting firms III) management consultants IV) specialized computer software firms A. I only B. I and II only C. I, II and III only D. I, II III and IV

Type: Medium

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Chapter 29 - Financial Planning

24. Short-term financial plans are developed using the following methods: I) Trial and error II) Simulation programs III) Optimization models A. I only B. I and II only C. II and III only D. I, II and III

Type: Medium

25. When firms prepare a financial plan they use the following: I) develop several financial plans using most likely outcomes and also unexpected outcomes. II) sensitivity analysis. III) scenario analysis. A. I only B. I and II only C. I, II, and III D. II and III only

Type: Difficult

26. The basic relationship for determining external capital required is: A. External capital required = operating cash flow - investment in net working capital B. External capital required = operating cash flow - investment in net working capital investment in fixed assets C. External capital required = operating cash flow - investment in net working capital investment in fixed assets - dividends D. None of the above

Type: Medium

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Chapter 29 - Financial Planning

27. Among the models followed to develop a financial plan, the following is the simplest: A. Percentage of sales model B. Regression model C. Computer simulation model D. None of the above

Type: Medium

28. The firm's internal growth rate is defined as: A. retained earnings/net income B. retained earnings/net assets C. retained earnings/total assets D. none of the above

Type: Medium

29. Internal growth rate is calculated as: A. Internal growth rate = plowback ratio × profit margin B. Internal growth rate = plowback ratio × return on equity C. Internal growth rate = plowback ratio × return on equity × [equity/net assets] D. None of the above

Type: Medium

30. Given the following data: plow back ratio = 50%; return on equity = 20%; equity to net assets ratio = 60%. Calculate the internal growth rate for the firm: A. 6% B. 10% C. 12% D. none of the above

Type: Medium

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Chapter 29 - Financial Planning

31. A firm can achieve a higher growth rate without raising external capital by: (within limits) A. Increasing the proportion of debt in its capital structure B. Increasing its current ratio C. Decreasing its inventory turnover D. Increasing its plowback ratio

Type: Medium

32. The sustainable growth rate is equal to: A. plowback ratio × return on equity B. return on equity/plowback ratio C. return on assets × plowback ratio D. plowback ratio × return on equity × (equity/net assets)

Type: Medium

33. Last year Axle Inc. reported net assets of 400, equity of $200, net income of $50, dividends of $10 and earnings retained in the period of $40. What is Axle Inc.'s internal growth rate? A. 10.0% B. 57.1% C. 20.0% D. 71.4% Internal growth rate = 40/400 = 10%

Type: Medium

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Chapter 29 - Financial Planning

34. Last year Axle Inc. reported total assets of $400, equity of $200, net income of $50, dividends of $10 and earnings retained in the period of $40. What is Axle Inc.'s sustainable growth rate? A. 25.0% B. 57.1% C. 20.0% D. 71.4% Sustainable growth rate = (40/50) × (50/200) = 20%

Type: Medium

35. Last year Foley Inc. reported total assets of $500, equity of $400, net income of $100, dividends of $50 and earnings retained in the period of $50. What is Foley Inc.'s sustainable growth rate? A. 17.5% B. 30.0% C. 10.0% D. 12.5% Sustainable growth rate: (50/100)(100/400) = 12.5%

Type: Medium

36. Last year Foley Inc. reported total assets of $500, equity of $200, net income of $120, dividends of $70 and earnings retained in the period of $50. What is Foley Inc.'s internal growth rate? A. 17.5% B. 30.0% C. 10.0% D. 12.5% Internal growth rate: 50/500 = 10%

Type: Medium

True / False Questions

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Chapter 29 - Financial Planning

37. Short-term financial decisions are conceptually easier to make than long-term decisions. TRUE

Type: Easy

38. Strategy A implies a permanent need for short-term borrowing. FALSE

Type: Medium

39. Strategy C implies a short-term cash surplus. FALSE

Type: Medium

40. Strategy B implies that the firm is a short-term lender during a part of the year and a borrower during the rest. TRUE

Type: Medium

41. Most firms make a permanent investment in net working capital. TRUE

Type: Medium

42. A firm with excess cash can at best generate zero NPV by investing in marketable securities. TRUE

Type: Easy

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Chapter 29 - Financial Planning

43. The main source of cash in a cash budget is collection on accounts receivable. TRUE

Type: Medium

44. Depreciation is not included in sources of cash because it is an expense. FALSE

Type: Medium

45. Two common sources of short-term financing are borrowing from a bank and stretching payables. TRUE

Type: Medium

46. Syndicated loans are subsequently resold to other institutions. TRUE

Type: Medium

47. Sales forecasts are the starting point for financial planning. TRUE

Type: Medium

48. Financial planning models are generated using spreadsheet programs. TRUE

Type: Medium

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Chapter 29 - Financial Planning

49. The percentage of sales method is the simplest of the financial planning models. TRUE

Type: Medium

50. The growth rate that a company can achieve using external funds is called the internal growth rate. FALSE

Type: Medium

Short Answer Questions

51. How do firms finance investments in current assets? Firms typically finance investments in current assets through short-term loans from commercial banks. Issuing commercial paper is another method used by large firms.

Type: Medium

52. Define net working capital. Net working capital is defined as current assets minus current liabilities.

Type: Easy

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Chapter 29 - Financial Planning

53. Briefly describe the cash cycle. Cash cycle starts with cash using cash firms buy raw materials, raw materials are converted to finished goods and sold on credit thus creating receivables. When receivables are collected it is converted back to cash. This is called a cash cycle.

Type: Medium

54. Discuss the reasons why a company should prepare a cash budget. There are two very important reasons for preparing a cash budget. First, cash holds a very special place in our economy. It is the only asset that may be used to pay bills. Thus, running short of cash is a very serious problem and should be avoided. Second, a cash budget provides a benchmark against which future performance can be measured.

Type: Medium

55. Discuss the process of preparing a short-term financing plan. A short-term financial plan is generally developed through a process of trial and error. Generally, smaller companies use spreadsheet packages on PCs and larger firms may have formal models that they use. The starting point for all this is the cash budget.

Type: Medium

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Chapter 29 - Financial Planning

56. Discuss the process of preparing a financial plan? The process of preparing a financial plan involves: • Project next year's operating cash flows • Project additional investment in net working capital and fixed assets • Estimate the difference between projected operating cash flow and the projected uses • Construct pro forma balance sheet incorporating additional assets and increases in debt and equity • Performing sensitivity analysis and scenario analysis

Type: Difficult

57. What is the model that is used to prepare a pro-forma statement? A pro-forma statement is prepared using the percentage-of-sales model. This method assumes that the next financial statement period will retain the same relationship between sales and relevant balance sheet and income statement items as it did in the prior period.

Type: Medium

58. How do you calculate the external capital required? External capital required is calculated as follows: External capital required = operating cash flow - investment in net working capital investment in fixed assets - dividends

Type: Medium

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59. Briefly discuss some of the problems associated with the use of the percentage of sales model. The percentage of sales model assumes that the next financial statement period will retain the same relationship between sales and relevant balance sheet and income statement items as a percentage of sales. In reality many variables will not be proportional to sales. For example, inventory and cash generally increase at a lower rate compared to sales. Fixed assets are typically not added continually as sales increase. The firm may not be operating at full capacity. In case a firm is operating at less than full capacity; sales can be increased without adding any new capacity. Also, capacity can only be added in steps and not continually.

Type: Difficult

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