Chapter 16: Financial Planning and Forecasting
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1. The first, and most critical, step in constructing a set of forecasted financial statements is the sales forecast.
a. True
b. False
2. 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.
a. True
b. False
3. 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.
a. True
b. False
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4. 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.
a. True
b. False
5. 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.
a. True
b. False
6. A rapid build-up of inventories normally requires additional financing, unless the increase is matched by an equally
large decrease in some other asset.
a. True
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b. False
7. If a firm wants to maintain its ratios at their existing levels, then if it has a positive sales growth rate of any amount, it
will require some amount of external funding.
a. True
b. False
8. 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.
a. True
b. False
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9. When developing forecasted financial statements there are some inputs that management controls such as the growth
rate and operating costs/sales ratio, while other inputs such as the tax rate and interest rate are not under its control.
a. True
b. False
10. If a firm with a positive net worth is operating its fixed assets at full capacity, if its dividend payout ratio is 100%, and
if it wants to hold all financial ratios constant, then for any positive growth rate in sales, it will require external financing.
a. True
b. False
11. A firm’s profit margin is 5%, its debt 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, 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.
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a. True
b. False
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.
a. True
b. False
13. 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.
a. True
b. False
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b. The statement of the corporate scope.
c. The statement of cash flows.
d. The statement of corporate objectives.
e. The operating plan.
17. Which of the following assumptions is embodied in the AFN equation?
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.
e. Last year’s total assets were not optimal for last year’s sales.
18. 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 (AFN)?
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 switches its materials purchases to a supplier that sells on terms of 1/5, net 90, from a supplier
whose terms are 3/15, net 35.
e. The company discovers that it has excess capacity in its fixed assets.
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19. The term “additional funds needed (AFN)” is generally defined as follows:
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 assets required per dollar of sales.
d. 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.
e. A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held
constant.
20. The capital intensity ratio is generally defined as follows:
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 sales to current assets.
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d. The ratio of current assets to sales.
e. The amount of assets required per dollar of sales, or A0*/S0.
21. Which of the following is NOT one of the steps taken in the financial planning process?
a. Assumptions are made about future levels of sales, costs, and interest rates for use in the forecast.
b. The entire financial plan is reexamined, assumptions are reviewed, and the management team considers how
additional changes in operations might improve results.
c. Projected ratios are calculated and analyzed.
d. Develop a set of projected financial statements.
e. 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.
22. Spontaneously generated funds are generally defined as follows:
a. 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 arise out of normal business operations from its suppliers, employees, and the government, and they
include spontaneous increases in accounts payable and accruals.
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e. The amount of cash raised in a given year minus the amount of cash needed to finance the additional capital
expenditures and working capital needed to support the firm’s growth.
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 previously thought its fixed assets were being operated at full capacity, but now it learns that it
actually has excess capacity.
b. The company increases its dividend payout ratio.
c. The company begins to pay employees monthly rather than weekly.
d. The company’s profit margin increases.
e. The company decides to stop taking discounts on purchased materials.
24. Which of the following statements is CORRECT?
a. Perhaps the most important step when developing forecasted 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. Forecasted financial statements, as discussed in the text, are used primarily as a part of the managerial
compensation program, where management’s historical performance is evaluated.
d. The capital intensity ratio gives us an idea of the physical condition of the firm’s fixed assets.
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e. The AFN equation produces more accurate forecasts than the forecasted financial statement method, especially if
fixed assets are lumpy and economies of scale exist.
25. 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 for achieving a firm’s
goals.
b. A firm’s corporate purpose states the general philosophy of the business and provides managers with specific
operational objectives.
c. Operating plans provide management with detailed implementation guidance, consistent with the corporate
strategy, to help 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.
e. The corporate scope is a condensed version of the entire set of strategic plans.
26. 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.