978-0134083285 Chapter 14 Part 1

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Foundations of Finance, 9e (Keown/Martin/Petty)

Chapter 14 Short-Term Financial Planning

Learning Objective 14.1

1) The key ingredient in a firm‘s financial planning is an accurate sales forecast.

Keywords: Financial Planning, Sales Forecast

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

2) Financial forecasting is the process of attempting to estimate a firm’s future financing requirements.

Keywords: Financial Forecasting, Financing Needs

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

3) The percent of sales method does not provide a reasonable prediction of asset levels for instances when

there are economies of scale in the use of the asset being forecast and when asset purchases are lumpy.

Keywords: Percent of Sales Method, Economies of Scale, Lumpy Assets

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

4) The percent of sales method assumes that all assets and all liabilities increase proportionally with sales,

but retained earnings does not.

Keywords: Percent of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

5) A corporation that increases it net profit margin will need less discretionary financing, other things

being equal.

Keywords: Net Profit Margin, Discretionary Financing Needed

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

6) Discretionary financing needed is equal to the predicted change in total assets minus the change in

retained earnings.

Keywords: Discretionary Financing Needed

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

7) For a typical firm expecting higher sales, external financing needed will be greater than discretionary

financing needed.

Keywords: External Financing Needed, Discretionary Financing Needed

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

8) Issuing new short-term bonds to finance an expansion is an example of spontaneous financing.

Keywords: Spontaneous Financing

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

9) If the sales growth rate is greater than zero, then the discretionary financing needed will also be greater

than zero.

Keywords: Discretionary Financing Needed, Sales Growth Rate

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

10) Discretionary financing needed must be obtained through additional borrowing because additional

equity measured by the increase in retained earnings has already been deducted.

Keywords: Discretionary Financing Needed, Debt, Retained Earnings

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

11) The first step in a corporation’s financial forecasting process is the determination of the firm’s

financing needs.

Keywords: Financial Forecasting, Financing Needs

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

12) In the percent of sales method, a company’s asset requirements are based on the company‘s projected

sales level.

Keywords: Percent of Sales Method, Asset Requirement

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

13) Notes payable and bonds payable are spontaneous liabilities.

Keywords: Spontaneous Liabilities

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

14) In order to reduce discretionary financing needed, a profitable company could decrease its dividend

payout ratio.

Keywords: Discretionary Financing Needed, Dividend Payout Ratio

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

15) The forecasted retained earnings balance is equal to (current retained earnings/current sales) times

projected sales for next year.

Keywords: Retained Earnings, Percent of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

16) Discretionary financing needed is equal to projected total assets minus projected total liabilities.

Keywords: Discretionary Financing Needed

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

17) Discretionary financing needed will be zero when the company’s sales growth rate is zero.

Keywords: Discretionary Financing Needed, Sales Growth Rate

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

18) When fixed costs are part of a firm‘s cost structure, the percent of sales method will understate net

income and overstate discretionary financing needed, if sales are increasing.

Keywords: Fixed Costs, Percent of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

19) Traditional financial forecasting takes the sales forecast as given and forecasts the corresponding

expenses, assets, and liabilities of the firm.

Keywords: Financial Forecasting, Sales Forecast

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

20) Accounts payable and accrued expenses are known as discretionary sources of financing.

Keywords: Spontaneous Liabilities, Accounts Payable, Accrued Expenses

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

21) One of the virtues of the percent-of-sales method is the precision of the estimate of future financing

needs.

Keywords: Percent of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

22) Pro forma financial statements depict the end result of the planning period’s operations.

Keywords: Pro Forma Financial Statements

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

23) Accrued expenses represent a spontaneous form of financing.

Keywords: Accrued Expenses, Spontaneous Liabilities

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

24) Discretionary sources of financing are those sources that vary automatically with a firm’s level of

sales.

Keywords: Discretionary Sources of Financing

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

25) A set of estimates which corresponds to the worst and best case outcomes is often desired in

preparing a financial forecast.

Keywords: Sensitivity Analysis, Forecasting

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

26) Forecasts of revenues and their related expenses are the basis on which firms forecast their future

financing needs.

Keywords: Financial Forecasting

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

27) It is often the case that the planning process has its greatest value when the resulting forecasts have

the most error, because the planning process offers its greatest value when the future is the most

uncertain.

Keywords: Planning Process

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

28) Purchasing supplies on credit and paying for them 45 days later is an example of discretionary

financing.

Keywords: Discretionary Financing

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

29) Spontaneous financing is financing obtained at the last minute due to poor financial planning.

Keywords: Spontaneous Financing

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

30) When preparing pro forma financial statement, the income statement must be prepared first because

the projected retained earnings balance on the balance sheet is based on the expected net income.

Keywords: Pro Forma Financial Statements, Retained Earnings

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

31) Discretionary financing needed (DFN) is equal to projected total assets minus projected total liabilities

minus projected owners’ equity.

Keywords: Discretionary Financing Needed

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

32) Other things equal, higher net profit margins mean higher discretionary financing needed.

Keywords: Net Profit Margin, Discretionary Financing Needed

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

33) Other things equal, if a firm increases its dividend payout ratio, its discretionary financing needed

will also increase.

Keywords: Dividend Payout Ratio, Discretionary Financing Needed

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

34) Discretionary financing needed can be positive or zero, but not negative.

Keywords: Discretionary Financing Needed

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

35) For a growing firm, external financing needed will most likely be greater than discretionary financing

needed due to increases in accounts payable and accruals.

Keywords: External Financing Needed, Discretionary Financing Needed

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

36) Using the percent of sales method, projected common stock on the 2010 pro forma balance sheet is

equal to (Common Stock 2009/Sales 2009) times Projected Sales 2010.

Keywords: Percent of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

37) If external financing needed cannot be obtained due to poor market conditions, a firm could reduce

the amount needed by increasing its retention ratio.

Keywords: External Financing Needed, Retention Ratio

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

38) The percent of sales forecasting method works well because it accounts for economies of scale in

assets such as inventory.

Keywords: Percent of Sales Method, Economies of Scale

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

39) Pro forma statements are important since they formally report the performance of the firm during the

previous reporting period.

Keywords: Pro Forma Statements

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

40) The percent of sales method can be used to forecast

A) expenses.

B) assets.

C) liabilities.

D) all of the above

Keywords: Percent of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

41) A company calculates its discretionary financing needed and determines this amount of capital

cannot be raised at a reasonable cost. Which of the following would reduce the amount of discretionary

financing needed?

A) reduce the company‘s net profit margin

B) reduce the company‘s sales growth rate

C) increase the company‘s dividend payout ratio

D) increase the proportion of the company‘s sales that are made on credit

Keywords: Discretionary Financing Needed, Sales Growth Rate

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

42) Ribbon Industries reported sales of $3 million and net income of $400,000 for 2010. The retained

earnings balance at the end of 2012 is $7 million. Ribbon Industries has a dividend payout ratio of 30%. If

sales are expected to increase by 25% next year, what will be the projected balance in retained earnings

using the percent of sales method?

A) $7,280,000

B) $6,720,000

C) $7,350,000

D) $8,750,000

Keywords: Retained Earnings, Percent of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

43) Discretionary financing accounts include all of the following EXCEPT

A) long-term debt.

B) notes payable.

C) accrued liabilities.

D) common stock.

Keywords: Discretionary Financing, Accounts Payable

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

44) Using the percent of sales method and assuming that no excess capacity exists, a 20% increase in sales

will result in

A) a 20% increase in total assets.

B) a 20% increase in total liabilities.

C) a 20% increase in retained earnings.

D) a 20% increase in the company‘s profit margin.

Keywords: Percent of Sales Method, Full Capacity

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

45) The CFO of Twine Enterprises expects sales to increase from $8,000,000 in 2010 to $12,000,000 in 2011.

Current assets in 2010 are equal to $5,000,000. Using the percent of sales method, projected current assets

for 2011 are equal to

A) $5,500,000.

B) $7,083,333.

C) $9,000,000.

D) $7,500,000.

Keywords: Percent of Sales Method, Current Assets

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

46) All of the following will increase the discretionary financing needed EXCEPT

A) decrease the net profit margin.

B) decrease the dividend payout ratio.

C) decrease the sales growth rate.

D) decrease the spontaneous financing.

Keywords: Discretionary Financing Needed, Dividend Payout Ratio

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

47) DAS, Inc. is preparing its financial forecast for next year and its discretionary financing needed is

negative. This means that

A) sales growth must be negative.

B) the predicted change in total assets must be negative.

C) the predicted change in spontaneous liabilities and retained earnings must be greater than the

predicted change in total assets.

D) the dividend payout ratio must be greater than the predicted growth rate in sales.

Keywords: Discretionary Financing Needed, Spontaneous Liabilities, Retained Earnings

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

48) Potential sources of financing to support an increase in sales include all of the following EXCEPT

A) increase in the dividend payout ratio.

B) increase in spontaneous liabilities.

C) increase in accounts payable.

D) issuance of bonds and/or common stock.

Keywords: Sources of Financing, Spontaneous Liabilities, Retained Earnings, External Financing

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

49) When forecasting fixed asset requirements, the projected fixed asset balance will

A) not increase proportionally with sales if the existing level of fixed assets is sufficient to support current

sales.

B) not increase proportionally if excess capacity exists.

C) remain the same since the balance is fixed.

D) always increase proportionally with sales.

Keywords: Fixed Assets, Excess Capacity, Percentage of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

50) Using the percentage of sales method of forecasting,

A) all asset and liability accounts increase or decrease proportionally with sales.

B) only asset accounts increase or decrease proportionally with sales.

C) accounts payable and accrued expenses are the only liabilities that increase or decrease proportionally

with sales.

D) all balance sheet accounts increase or decrease proportionally with sales.

Keywords: Percentage of Sales Method, Spontaneous Liabilities

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

51) Which of the following will most likely result in an increase in discretionary funding needed?

A) The company‘s profit margin increases.

B) The company‘s dividend payout ratio increases.

C) The company’s assets are only operating at 50% of capacity.

D) The company pays its accounts payable in 50 days, up from 45 days.

Keywords: Discretionary Funding Needed, Spontaneous Liabilities

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking

52) Fixed assets are often estimated incorrectly by the percent of sales method because

A) fixed assets remain constant and the percent of sales method assumes all assets increase proportionally

with sales.

B) fixed asset are very expensive.

C) fixed assets are typically purchased in “lumps” and therefore do not increase proportionally with sales.

D) fixed assets are part of the capital budgeting process.

Keywords: Fixed Assets, Percent of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Reflective Thinking

53) Using the percentage of sales method, forecasted retained earnings balance is equal to

A) prior year retained earnings plus projected net income less projected dividends.

B) the ratio of retained earnings to sales for the current year multiplied by projected sales for next year.

C) the retained earnings balance for the current year as no changes are made to this financing account

when using the percent of sales method.

D) the ratio of retained earnings to sales for the current year multiplied by projected sales for next year,

minus dividends paid.

Keywords: Retained Earnings, Percent of Sales Method

Learning Obj.: L.O. 14.1

AACSB: Analytical Thinking