25) Assume all else remains the same. Which of the following statements is true?
A) The lower a firm’s profit margin, the more discretionary financing a firm will require.
B) The higher a firm‘s profit margin, the more discretionary financing a firm will require.
C) The lower a firm’s profit margin, the more cash a firm will have to reinvest.
D) A relationship between a firm’s profit margin and its requirement for external financing does
not exist.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary financing needs (DFN)
Principles: Principle 3: Cash Flows Are the Source of Value
26) Which of the following accounts would normally increase with an increase in sales and
approximately in proportion to the sales increase?
A) Common stock
B) Inventory
C) Notes payable
D) Dividends
E) Accounts receivable
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
27) Holding other things constant, a firm’s “discretionary financing needed” (the additional funds
required in order to finance the firm) would be reduced if the firm experienced an increase in
which of the following?
A) The dividend pay-out ratio
B) The profit margin
C) The accounts receivable average collection period
D) The expected growth rate in sales
E) The income tax rate
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary financing needs (DFN)
Principles: Principle 3: Cash Flows Are the Source of Value
11
28) Which of the following is a source of external capital?
A) Retained earnings
B) Inventory
C) Long-term debt
D) Operating income (earnings before interest and taxes)
E) None of the above
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary financing needs (DFN)
Principles: Principle 3: Cash Flows Are the Source of Value
29) Considering each action independently and holding other things constant, which of the
following actions would increase a firm’s discretionary financing needed (the need for additional
capital)?
A) A decrease in the firm’s accounts receivable average collection period
B) An increase in the firm’s profit margin
C) A decrease in the firm’s inventory turnover
D) A decrease in the expected growth rate in sales
E) A decrease in the firm’s tax rate
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary financing needs (DFN)
Principles: Principle 3: Cash Flows Are the Source of Value
30) Which of the following will decrease discretionary funds needed?
A) An increase in projected accounts receivable
B) An increase in projected accounts payable
C) An increase in projected dividends
D) Both A and C
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary financing needs (DFN)
Principles: Principle 3: Cash Flows Are the Source of Value
31) Which of the following is a spontaneous source of financing?
A) Accrued expenses
B) Notes payable
C) Common stock
D) Paid-in capital
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary sources of financing
Principles: Principle 3: Cash Flows Are the Source of Value
12
32) Swings in discretionary financing needed can be caused by:
A) firm profitability.
B) economic activity.
C) industry influence.
D) all of the above.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary financing needs (DFN)
Principles: Principle 3: Cash Flows Are the Source of Value
33) Which of the following will reduce the firm’s financing requirements?
A) The firm operates at full capacity
B) The firm has excess capacity
C) The firm expects rapid growth in sales
D) The firm increases its dividend payout ratio
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary financing needs (DFN)
Principles: Principle 3: Cash Flows Are the Source of Value
Use the following information and the percent-of-sales method to answer the following
question(s).
Below is the 2004 year-end balance sheet for Banner, Inc. Sales for 2004 were $1,600,000 and
are expected to be $2,000,000 during 2005. In addition, we know that Banner plans to pay
$90,000 in 2005 dividends and expects projected net income of 4% of sales. (For consistency
with the Answer selections provided, round your forecast percentages to two decimals.)
Banner, Inc. Balance Sheet
December 31, 2004
Assets
Current assets $890,000
Net fixed assets 1,000,000
Total $1,890,000
Liabilities and Owners’ Equity
Accounts payable $160,000
Accrued expenses 100,000
Notes payable 700,000
Long-term debt 300,000
Total liabilities 1,260,000
Common stock (plus paid-in capital) 360,000
Retained earnings 270,000
Common equity 630,000
Total 1,890,000
13
34) Banner’s projected current assets for 2005 are:
A) $1,000,000.
B) $1,120,000.
C) $1,500,000.
D) $1,260,000.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
35) Banner’s projected fixed assets for 2005 are:
A) $1,120,000.
B) $1,260,000.
C) $1,000,000.
D) $2,380,000.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
36) Banner’s projected accounts payable balance for 2005 is:
A) $160,000.
B) $120,000.
C) $200,000.
D) $300,000.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
37) Banner’s projected accrued expenses for 2005 are:
A) $120,000.
B) $160,000.
C) $100,000.
D) $200,000.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
14
38) Banner’s projected long-term debt for 2005 is:
A) $700,000.
B) $880,000.
C) $380,000.
D) $300,000.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
39) Banner’s projected retained earnings for 2005 are:
A) $260,000.
B) $280,000.
C) $340,000.
D) $350,000.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
40) Banner’s projected discretionary financing needed for 2005 is:
A) $420,000.
B) $440,000.
C) $360,000.
D) $370,000.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary financing needs (DFN)
Principles: Principle 3: Cash Flows Are the Source of Value
41) The projected change in retained earnings equals projected net income less any dividends to
be paid.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
42) The initiation of a major advertising campaign would be an example of an event that would
affect past trends in sales when projecting statements.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
15
43) The percentages used in the percent-of-sales method comes from pro forma financial
statements.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
44) The percent-of-sales method is a commonly used method for estimating a firm’s financing
needs.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
45) Long-term financial plans must include capital expenditures.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: long-term financial plans
Principles: Principle 3: Cash Flows Are the Source of Value
46) One of the virtues of the percent-of-sales method is the precision of the estimate it provides
for future financing needs.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
47) Holding all other variables constant, as the dividend payout ratio decreases, the sustainable
growth rate increases.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
48) Pro forma statements provide single point estimates of each budgeted item.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
16
49) Pro forma statements are important since they formally report the performance of the firm
during a previous reporting period.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
50) When forecasting statements, assets always increase proportionately to sales regardless of
capacity.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
51) The most commonly used method for making financial forecasts is the percent-of-sales
method.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: percent of sales method
Principles: Principle 3: Cash Flows Are the Source of Value
52) It is common practice to develop optimistic and pessimistic scenarios when projecting
financial statements.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
53) Discretionary sources of financing are those sources that vary automatically with a firm’s
level of sales.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary sources of financing
Principles: Principle 3: Cash Flows Are the Source of Value
54) When fixed expenses increase relative to sales, it indicates that there is not enough
productive capacity to absorb an increase in sales.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
17
55) If the firm’s current fixed assets are sufficient to support the projected level of new sales,
then these assets would be projected to remain unchanged for the forecast period.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
56) Because accounts payable and accrued expenses increase with sales, they represent sources
of spontaneous financing.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: spontaneous financing sources
Principles: Principle 3: Cash Flows Are the Source of Value
57) What is meant by spontaneous financing?
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: spontaneous financing sources
Principles: Principle 3: Cash Flows Are the Source of Value
58) What is meant by discretionary financing?
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: discretionary sources of financing
Principles: Principle 3: Cash Flows Are the Source of Value
18
59) The balance sheet of the Jackson Company is presented below:
Jackson Company Balance Sheet
March 31, 2004
(Millions of Dollars)
Current assets $12 Accounts payable $6
Fixed assets 18 Long-term debt 12
Total $30 Common equity 12
Total $30
For the year ending March 31, 2004, Jackson had sales of $35 million. The common
stockholders received all net earnings of the firm in the form of cash dividends, leaving no funds
from earnings available to the firm for expansion (assume that depreciation expense is just equal
to the cost of replacing worn-out assets).
Construct a pro forma balance sheet for March 31, 2005 for an expected level of sales of $45
million. Assume current assets and accounts payable vary as a percent of sales, and fixed assets
remain at the present level. Use notes payable as a source of discretionary financing.
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
19
60) Frog Hollow Bakery is a new firm specializing in all-natural-ingredient pastry products. In
attempting to determine what the financial position of the firm should be, the financial manager
obtained the following average ratios for the baking industry for 2004:
Common equity to total assets = 60%
Total asset turnover = 3 times
Long-term debt to total capitalization = 25%
Current ratio = 1.2
Quick ratio = .75
Average collection period (360-day year) = 10 days
Complete the accompanying pro forma balance sheet for Frog Hollow Bakery assuming 2005
sales (all credit) are $450,000.
Frog Hollow Bakery
Pro Forma Balance Sheet
December 31, 2005
Cash $ Current debt $
Accounts receivable Long-term debt
Inventory
Total current assets Common equity
Fixed assets Total liabilities and equity $
Total assets
Topic: 17.2 Developing a Long-Term Financial Plan
Keywords: pro forma financial statements
Principles: Principle 3: Cash Flows Are the Source of Value
20