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b. Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no excess current assets. Based
on the AFN equation, its AFN will be larger than if it had been operating with excess capacity in both fixed and current
assets.
c. If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth.
d. Additional funds needed (AFN) are typically raised using a combination of notes payable, long-term debt, and
common stock. Such funds are non-spontaneous in the sense that they require explicit financing decisions to obtain them.
e. If a firm has a positive free cash flow, then it must have either a zero or a negative AFN.
27. Which of the following statements is CORRECT?
a. Any forecast of financial requirements involves determining how much money the firm will need, and this need is
determined by adding together increases in assets and spontaneous liabilities and then subtracting operating income.
b. The AFN equation for forecasting funds requirements requires only a forecast of the firm’s balance sheet.
Although a forecasted income statement may help clarify the results, income statement data are not essential because
funds needed relate only to the balance sheet.
c. Dividends are paid with cash taken from the accumulated retained earnings account, hence dividend policy does
not affect the AFN forecast.
d. A negative AFN indicates that retained earnings and spontaneous capital are far more than sufficient to finance
the additional assets needed.
e. If assets and spontaneously generated liabilities are not projected to grow at the same rate as sales, then the AFN
method will provide more accurate forecasts than the projected financial statement method.
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28. Which of the following statements is CORRECT?
a. The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external
funds. In other words, it is the growth rate at which the firm’s AFN equals zero.
b. If a firm’s assets are growing at a positive rate, but its retained earnings are not increasing, then it would be
impossible for the firm’s AFN to be negative.
c. If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually
decrease, then the firm’s actual AFN must, mathematically, exceed the previously calculated AFN.
d. Higher sales usually require higher asset levels, and this leads to what we call AFN. However, the AFN will be
zero if the firm chooses to retain all of its profits, i.e., to have a zero dividend payout ratio.
e. Dividend policy does not affect the requirement for external funds based on the AFN equation.
29. Which of the following statements is CORRECT?
a. When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0)
vary from year to year in a stable, predictable manner.
b. When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more
appropriate than if assets are relatively small and can be added in small increments as sales grow.
c. Firms whose fixed assets are “lumpy” frequently have excess capacity, and this should be accounted for in the
financial forecasting process.
d. For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.
e. Regression techniques cannot be used in situations where excess capacity or economies of scale exist.
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d. 10.33%
e. 11.11%
34. Last year Jain Technologies had $250 million of sales and $100 million of fixed assets, so its Fixed Assets/Sales ratio
was 40%. However, its fixed assets were used at only 40% of capacity. Now the company is developing its financial
forecast for the coming year. As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the
level, it would have had, had it been operating at full capacity. What target Fixed Assets/Sales ratio should the company
set?
a. 13.3%
b. 14.1%
c. 16.0%
d. 18.2%
e. 18.4%
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35. Fairchild Garden Supply expects $590 million of sales this year, and it forecasts a 15% increase for next year. The
CFO uses this equation to forecast inventory requirements at different levels of sales: Inventories = $30.2 + 0.25(Sales).
All dollars are in millions. What is the projected inventory turnover ratio for the coming year?
a. 3.84 times
b. 3.23 times
c. 3.63 times
d. 3.60 times
e. 3.40 times
36. Clayton Industries is planning its operations for next year. Ronnie Clayton, the CEO, wants you to forecast the firm’s
additional funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the
AFN for the coming year? Dollars are in millions.
Last year’s sales = S0 $350 Last yr’s accounts payable $40
Sales growth rate = g 30% Last yr’s notes payable $50
Last year’s total assets = A0* $460 Last yr’s accruals $30
Last year’s prof margin = PM 5% Target payout ratio 60%
a. $87.4
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b. $124.1
c. $120.8
d. $107.9
e. $90.6
37. Chua Chang & Wu Inc. is planning its operations for next year, and the CEO wants you to forecast the firm’s
additional funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the
AFN for the coming year?
Last year’s sales = S0 $200,000 Last year’s accounts payable $50,000
Sales growth rate = g 40% Last year’s notes payable $15,000
Last year’s total assets = A0* $160,000 Last year’s accruals $20,000
Last year’s profit margin = PM 20.0% Target payout ratio 25.0%
a. -$5,400
b. -$7,140
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c. -$6,000
d. -$6,720
e. -$6,360
38. Howton & Howton Worldwide (HHW) is planning its operations for the coming year, and the CEO wants you to
forecast the firm’s additional funds needed (AFN). Data for use in the forecast are shown below. However, the CEO is
concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 75%, which the
firm’s investment bankers have recommended. Based on the AFN equation, by how much would the AFN for the coming
year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions.
Last year’s sales = S0 $300 Last year’s accounts payable $50
Sales growth rate = g 40% Last year’s notes payable $15
Last year’s total assets = A0* $500 Last year’s accruals $20
Last year’s profit margin = PM 20% Initial payout ratio 10%
New payout ratio 75%
a. $56.2
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b. $54.6
c. $57.3
d. $67.7
e. $53.0
39. Last year Emery Industries had $450 million of sales and $225 million of fixed assets, so its Fixed Assets/Sales ratio
was 50%. However, its fixed assets were used at only 85% of capacity. If the company had been able to sell off enough of
its fixed assets at book value so that it was operating at full capacity, with sales held constant at $450 million, how much
cash (in millions) would it have generated?
a. $38.14
b. $33.75
c. $30.38
d. $36.79
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e. $27.68