TB Chapter17

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(Difficulty: E = Easy, M = Medium, and T = Toug Tough) h)

Multiple Choice: Conceptual  Easy: Percent of sales method 1

.

The percent assumptions?

of

Answer: e sales

method

is

based

on

which

of

the

Diff: E following

a. All balance balance sheet sheet accounts accounts are are tied directly directly to to sales. sales. b. Most balance balance sheet sheet account accounts s are tied direct directly ly to sales. sales. c. The The curr curren ent t leve level l of tota total l asse assets ts is opti optima mal l for for the the curr curren ent t sale sales s level. d. Statements Statements a and c above above are correct. correct. e. Statements Statements b and c above above are correct. correct.

 Additi  Additiona onal l fund funds s need needed ed 2

.

Answer Answer: : b

Diff: Diff: E

A comp compan any y is for forec ecas asti ting ng an an incr increa ease se in in sale sales s and and is usi using ng the the AF AF mod model el to forecast the additional capital that they need to raise. !hich of the follow following ing factor factors s are li"ely li"ely to increa increase se the additi additiona onal l funds funds needed needed #AF$? a. The compan company y has a lot of e%cess e%cess capacity. capacity. b. The company company has has a high high dividend dividend payout payout ratio. ratio. c. The company company has a lot of spontaneo spontaneous us liabilitie liabilities s that increase increase as sales sales increase. d. The compan company y has a high profit profit margin. margin. e. All of of the statem statements ents above above are are correct. correct.

 Additi  Additiona onal l fund funds s need needed ed &

.

Answer Answer: : e

Diff: Diff: E

'eff 'effer erso son n (ity (ity (ompu (ompute ters rs has has devel develop oped ed a fore foreca cast stin ing g model model to det deter ermi mine ne the additional funds it needs needs in the upcoming year. All else being being e)ual* which of the following factors is li"ely to increase its additional funds needed #AF$? a. A sharp increase increase in its forecas forecasted ted sales sales and the company+s company+s fi%ed fi%ed assets assets are at full capacity. b. A reductio reduction n in its its dividend dividend payout payout ratio. ratio. c. The company company reduces reduces its reliance reliance on trade credit credit that sharply sharply reduces reduces its accounts payable. d. Statem Statement ents s a and b are are correc correct. t. e. Statem Statement ents s a and c are are correc correct. t.

Chapter 17 - Page 1

 Additi  Additiona onal l fund funds s need needed ed ,

.

Answer Answer: : c

Diff: Diff: E

!hic !hich h of the the foll follow owin ing g is li"e li"ely ly to to incr increa ease se the the add addit itio iona nal l fund funds s need needed ed #AF$ in a given year? a. The company company reduce reduces s its dividen dividend d payout payout ratio. ratio. b. The compan company+s y+s profit profit margin margin increase increases. s. c. The company company decide decides s to reduce reduce its relian reliance ce on accoun accounts ts payable payable as a form of financing. d. The company company is operati operating ng well below below full full capacity. capacity. e. All of of the statem statements ents above above are are correct. correct.

 Additi  Additiona onal l fund funds s need needed ed -

.

An increas increase e in its its dividend dividend payout payout ratio. ratio. The compan company y has a lot of e%cess e%cess capacity. capacity. Accounts Accounts payable payable increa increase se faster faster than than sales. sales. All of of the statem statements ents above above are are correct. correct. one of the statements statements above is correct. correct.

 Additi  Additiona onal l fund funds s need needed ed .

Diff: Diff: E

All else e)ual* which of the following is li"ely to increase a company+s additional funds needed #AF$? a. b. c. d. e.



Answer Answer: : a

Answer Answer: : b

Diff: Diff: E

N

Add Additio itiona nal l fun fund ds nee neede ded d ar are be best defin efined ed as/ a. Funds that are obtained automatically from routine business transactions. b. Funds that that a firm must raise raise e%ternally e%ternally through through borrowi borrowing ng or by selling selling new common or preferred stoc". c. The amount amount of assets assets re)uired re)uired per dollar dollar of of sales. sales. d. The amount amount of cash generat generated ed in a given year year minus the amount amount of cash cash needed needed to financ finance e the additi additiona onal l capita capital l e%pend e%penditu itures res and wor"in wor"ing g capital needed to support the firm+s growth. e. A forecasting forecasting approac approach h in which the forecaste forecasted d percentage percentage of sales for for each item is held constant.

 Additi  Additiona onal l fund funds s need needed ed 0

.

Answer Answer: : e

Diff: Diff: E

N

!hic !hich h of the the foll follow owin ing g is li"e li"ely ly to to decr decrea ease se the the add addit itio iona nal l fund funds s need needed ed #AF$ in a given year? a. b. c. d. e.

The company company increa increases ses its retention retention ratio. ratio. The compan company+s y+s profit profit margin margin increase increases. s. The compan company+s y+s sales sales growth growth is reduced. reduced. oth statements statements b and c are correct. correct. All of of the statem statements ents above above is is correct. correct.

Chapter 17 - Page 2

 Additi  Additiona onal l fund funds s need needed ed ,

.

Answer Answer: : c

Diff: Diff: E

!hic !hich h of the the foll follow owin ing g is li"e li"ely ly to to incr increa ease se the the add addit itio iona nal l fund funds s need needed ed #AF$ in a given year? a. The company company reduce reduces s its dividen dividend d payout payout ratio. ratio. b. The compan company+s y+s profit profit margin margin increase increases. s. c. The company company decide decides s to reduce reduce its relian reliance ce on accoun accounts ts payable payable as a form of financing. d. The company company is operati operating ng well below below full full capacity. capacity. e. All of of the statem statements ents above above are are correct. correct.

 Additi  Additiona onal l fund funds s need needed ed -

.

An increas increase e in its its dividend dividend payout payout ratio. ratio. The compan company y has a lot of e%cess e%cess capacity. capacity. Accounts Accounts payable payable increa increase se faster faster than than sales. sales. All of of the statem statements ents above above are are correct. correct. one of the statements statements above is correct. correct.

 Additi  Additiona onal l fund funds s need needed ed .

Diff: Diff: E

All else e)ual* which of the following is li"ely to increase a company+s additional funds needed #AF$? a. b. c. d. e.



Answer Answer: : a

Answer Answer: : b

Diff: Diff: E

N

Add Additio itiona nal l fun fund ds nee neede ded d ar are be best defin efined ed as/ a. Funds that are obtained automatically from routine business transactions. b. Funds that that a firm must raise raise e%ternally e%ternally through through borrowi borrowing ng or by selling selling new common or preferred stoc". c. The amount amount of assets assets re)uired re)uired per dollar dollar of of sales. sales. d. The amount amount of cash generat generated ed in a given year year minus the amount amount of cash cash needed needed to financ finance e the additi additiona onal l capita capital l e%pend e%penditu itures res and wor"in wor"ing g capital needed to support the firm+s growth. e. A forecasting forecasting approac approach h in which the forecaste forecasted d percentage percentage of sales for for each item is held constant.

 Additi  Additiona onal l fund funds s need needed ed 0

.

Answer Answer: : e

Diff: Diff: E

N

!hic !hich h of the the foll follow owin ing g is li"e li"ely ly to to decr decrea ease se the the add addit itio iona nal l fund funds s need needed ed #AF$ in a given year? a. b. c. d. e.

The company company increa increases ses its retention retention ratio. ratio. The compan company+s y+s profit profit margin margin increase increases. s. The compan company+s y+s sales sales growth growth is reduced. reduced. oth statements statements b and c are correct. correct. All of of the statem statements ents above above is is correct. correct.

Chapter 17 - Page 2

Forecasting concepts 

.

Answer: b

Diff: E

!hic !hich h of of the the foll follow owin ing g stat statem emen ents ts is most most corr correc ect? t? a. 3ne 3ne of the the "ey "ey steps teps in the the dev develop elopme ment nt of pro pro for forma finan inanci cial al statements is to identify those assets and liabilities that increase spontaneously with net income. b. The first* first* and most critica critical* l* step in construc constructing ting a set of pro forma forma financial statements is establishing the sales forecast. c. 4ro 4ro form forma a fina financ ncia ial l stat statem emen ents ts as disc discus usse sed d in the the te%t te%t are are used used primarily to assess a firm+s historical performance. d. The capital capital intensity intensity ratio ratio reflects reflects how rapidly rapidly a firm firm turns over over its assets and is the reciprocal of the fi%ed assets turnover ratio. e. The percent percent of sales method method produces produces accurate accurate results results when fi%ed fi%ed assets assets are lumpy and when economies of scale are present.

Strategic plans and corporate scope 5

.

Answer: e

Diff: E

N

!hic !hich h of of the the foll follow owin ing g stat statem emen ents ts is most most corr correc ect? t? a. A mission mission statement statement is a condensed condensed version version of a firm+s firm+s strategic strategic plans. plans. b. oth oth miss missio ion n stat statem emen ents ts and and stra strate tegi gic c plan plans s usua usuall lly y begi begin n with with a statement of the overall corporate purpose. c. A firm firm+s +s corp corpor orat ate e scop scope e defi define nes s a firm firm+s +s line lines s of busi busine ness ss and and geographic area of operations. d. oth statements statements b and c are correct. correct. e. All of of the statem statements ents above above are are correct. correct.

Operating plans and corporate strategies 16

.

Answer: c

Diff: E

N

!hic !hich h of of the the foll follow owin ing g sta state teme ment nts s is is mos most t cor corre rect ct? ? a. 3nce 3nce a firm firm has defined defined its purpose purpose* * scope* scope* and ob7ecti ob7ectives ves* * it must develop a strategy for for achieving achieving its goals. (orporate strategies are detailed plans rather than broad approaches. b. A firm firm+s +s corp corpor orat ate e purp purpos ose e stat states es the the gene genera ral l phil philos osop ophy hy of the the business and provides managers with operational ob7ectives. c. 3perating 3perating plans provide provide detailed detailed implementat implementation ion guidance* guidance* based on the corporate strategy* strategy* to help meet the corporate corporate ob7ectives. ob7ectives. These plans plans can be developed for any time hori8on* but most companies use a -9year hori8on. d. All of of the statem statements ents above above are are correct. correct. e. one of the statements statements above is correct. correct.

Spontaneously generated funds 11

.

Answer: d

Di Diff: E

N

Spon Sponta tane neou ousl sly y gen gener erat ated ed fund funds s are are best best defi define ned d as/ as/ a. The amount amount of assets assets re)uired re)uired per dollar dollar of of sales. sales. b. A forecasting forecasting approac approach h in which the forecaste forecasted d percentage percentage of sales for for each item is held constant. c. Funds that that a firm must raise raise e%ternally e%ternally through through borrowi borrowing ng or by selling selling new common or preferred stoc". d. Funds that are obtained automatically from routine business transactions.

Chapter 17 - Page 3

e. The amount of cash generated in a given year minus the amount of cash needed to finance the additional capital e%penditures and wor"ing capital needed to support the firm+s growth.

Capital intensity ratio 12

.

Answer: d

Diff: E

N

The capital intensity ratio is/ a. The inverse of the total assets turnover ratio. b. The percentage of liabilities that increase spontaneously percentage of sales. c. The amount of assets re)uired per dollar of sales. d. oth statements a and c are correct. e. one of the statements above is correct.

as

a

 Medium: Forecasting financial reuirements 1&

.

Answer: c

Diff: !  

!hich of the following statements is most correct? a. The AF formula method assumes that the balance sheet ratios of assets and liabilities to sales #A:;S6  and 9a%is$. f Thode decides to increase the percentage of earnings paid out as dividends* which of the following changes would occur in the graph? a. b. c. d. e.

The The The The The

line would shift to the line would pass through line would shift to the slope coefficient would slope coefficient would

right. the origin. left. fall. increase.

 Additional funds needed 1-

.

Diff: !

Answer: c

Diff: ! 

(onsidering each action independently and holding other things constant* which of the following actions would reduce a firm+s need for additional capital? a. An increase in the dividend payout ratio.

Chapter 17 - Page 4

b. c. d. e.

A decrease in the profit margin. A decrease in the days sales outstanding. An increase in e%pected sales growth. A decrease in the accrual accounts #accrued wages and ta%es$.

Chapter 17 - Page 5

 Additional funds needed 1

.

Answer: d

Diff: ! 

!hich of the following statements is most correct? a. Since accounts payable and accrued liabilities must eventually be paid* as these accounts increase* AF also increases. b. Suppose a firm is operating its fi%ed assets below 166 percent capacity but is at 166 percent with respect to current assets. f sales grow* the firm can offset the needed increase in current assets with its idle fi%ed assets capacity. c. f a firm retains all of its earnings* then it will not need any additional funds to support sales growth. d. Additional funds needed are typically raised from some combination of notes payable* long9term bonds* and common stoc". These accounts are nonspontaneous in that they re)uire an e%plicit financing decision to increase them. e. one of the statements above is correct.

Percent of sales method 10

.

Answer: d

Diff: !  

!hich of the following statements is most correct? a. Any forecast of financial re)uirements involves determining how much money the firm will need and is obtained by adding together increases in assets and spontaneous liabilities and subtracting operating income. b. The percent of sales method of forecasting financial needs re)uires only a forecast of the firm+s balance sheet. Although a forecasted income statement helps clarify the need* it is not essential to the percent of sales method. c. ecause dividends are paid after ta%es from retained earnings* dividends are not included in the percent of sales method of forecasting. d. Financing feedbac"s describe the fact that interest must be paid on the debt used to help finance AF and dividends must be paid on the shares issued to raise the e)uity part of the AF. These payments would lower the net income and retained earnings shown in the pro7ected financial statements. e. one of the statements above is correct.

Chapter 17 - Page 6

 AFN formula method 1

.

Answer: a

Diff: ! 

!hich of the following statements is most correct? a. nherent in the AF formula is the assumption that each asset item must increase in direct proportion to sales increases and that spontaneous liability accounts also grow at the same rate as sales. b. f a firm has positive growth in its assets* but has no increase in retained earnings* AF for the firm must be positive. c. @sing the AF formula* if a firm increases its dividend payout ratio in anticipation of higher earnings* but sales actually decrease* the firm will automatically e%perience an increase in additional funds needed. d. igher sales usually re)uire higher asset levels. Some of the increase in assets can be supported by spontaneous increases in accounts payable and accrued liabilities* and by increases in certain current asset accounts and retained earnings. e. Bividend policy does not affect re)uirements for e%ternal capital under the AF formula method.

Financial plan 15

.

Answer: e

Diff: !

N

!hich of the following is not one of the steps ta"en in the financial planning process? a. 4ro7ect financial statements and use these pro7ections to analy8e the effects of the operating plan on pro7ected profits and various financial ratios. b. Betermine the funds needed to support the -9year plan. c. Cstablish and maintain a system of controls to govern the allocation and use of funds within the firm. d. Cstablish a performance9based management compensation system. e. one of the above* i.e.* all the statements above are steps included in the financial planning process.

Chapter 17 - Page 7

Multiple Choice: P*o+lems  Easy:  Additional funds needed 26

.

Answer: d

Diff: E

'ill+s !igs nc. had the following balance sheet last year/ (ash Accounts receivable nventories et fi%ed assets

D

66 ,-6 5-6 &,*666

Total assets

D&*266

Accounts payable Accrued wages otes payable Mortgage (ommon stoc" Eetained earnings Total liabilities and e)uity

D

&-6 1-6 2*666 2*-66 &*266 ,*666

D&*266

'ill has 7ust invented a non9slip wig for men that she e%pects will cause sales to double from D16*666 to D26*666* increasing net income to D1*666. She feels that she can handle the increase without adding any fi%ed assets. #1$ !ill 'ill need any outside capital if she pays no dividends? #2$ f so* how much? a. b. c. d. e.

o 8ero =es D0*066 =es D1*066 =es D066 o D066 surplus

Forecasting addition to retained earnings 21

.

Answer: b

Diff: E

Genney (orporation recently reported the following income statement for 2662 #numbers are in millions of dollars$/ Sales 3perating costs CT nterest Carnings before ta%es #CT$ Ta%es #,6H$ et income available to common shareholders

D0*666 &*666 D,*666 266 D&*66 1*-26 D2*26

The company forecasts that its sales will increase by 16 percent in 266& and its operating costs will increase in proportion to sales. The company+s interest e%pense is e%pected to remain at D266 million* and the ta% rate will remain at ,6 percent. The company plans to pay out -6 percent of its net income as dividends* the other -6 percent will be additions to retained earnings. !hat is the forecasted addition to retained earnings for 266&? a. D1*1,6 b. D1*26 c. D1*,,6

Chapter 17 - Page 8

d. D1*056 e. D1*16

"inear regression and ratios 22

.

Answer: e

Diff: E

N

Flannery Furnishings has D1-6*666 in sales. The company e%pects that its sales will increase &6 percent this year. Flannery+s (F3 uses a simple linear regression to forecast the company+s inventory level for a given level of pro7ected sales. 3n the basis of recent history* the estimated relationship between inventories and sales #in thousands of dollars$ is nventories I D0.-6 J 6.10-#Sales$. Kiven the estimated sales forecast and the estimated relationship between inventories and sales* what is your forecast of the company+s year9end inventory turnover ratio? a. b. c. d. e.

2.22.5 &.&&. ,.,&

 Medium:  Additional funds needed 2&

.

Answer: c

Diff: ! 

rown L Sons recently reported sales of D166 million* and net income e)ual to D- million. The company has D06 million in total assets. 3ver the ne%t year* the company is forecasting a 26 percent increase in sales. Since the company is at full capacity* its assets must increase in proportion to sales. The company also estimates that if sales increase 26 percent* spontaneous liabilities will increase by D2 million. f the company+s sales increase* its profit margin will remain at its current level. The company+s dividend payout ratio is ,6 percent. ased on the AF formula* how much additional capital must the company raise in order to support the 26 percent increase in sales? a. b. c. d. e.

D 2*666*666 D *666*666 D *,66*666 D 5*66*666 D1,*666*666

Chapter 17 - Page 9

 AFN with e#cess capacity 2,

.

Answer: b

Diff: ! 

A firm has the following balance sheet/ (ash Accounts receivable nventories Fi%ed assets

D 26 26 26 16

Total assets

D2,6

Accounts payable otes payable