Chapter 16: Forecasting True/False Page 587
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Note that there is some overlap between the T/F and the multiple choice questions, as some T/F
statements are used in the MC questions. See the preface for information on the AACSB letter
indicators (F, M, etc.) on the subject lines.
Multiple Choice: True/False
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
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
CHAPTER 16
FINANCIAL PLANNING AND FORECASTING
Page 588 True/False Chapter 16: Forecasting
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
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
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/assets 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.
a. True
b. False
Chapter 16: Forecasting True/False Page 589
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 (A0*/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
14
. The fact that long-term debt and common stock are raised infrequently
and in large amounts lessens the need for the firm to forecast those
accounts on a continual basis.
a. True
b. False
15
. When we use the AFN equation to forecast the additional funds needed
(AFN), we are implicitly assuming that all financial ratios are
constant. If financial ratios are not constant, regression techniques
can be used to improve the financial forecast.
a. True
b. False
Multiple Choice: Conceptual
16
. Which of the following is NOT a key element in strategic planning as it
is described in the text?
a. The mission statement.
b. The statement of the corporation’s scope.
c. The statement of cash flows.
d. The statement of corporate objectives.
e. The operating plan.
Page 590 Conceptual M/C Chapter 16: Forecasting
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.
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.
d. The ratio of current assets to sales.
e. The amount of assets required per dollar of sales, or A0*/S0.
Chapter 16: Forecasting Conceptual M/C Page 591
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.
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.
Page 592 Conceptual M/C Chapter 16: Forecasting
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.
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.
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.
Chapter 16: Forecasting Conceptual M/C Page 593
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.
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.
Page 594 M/C Problems Chapter 16: Forecasting
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.
Multiple Choice: Problems
30
. Last year Godinho Corp. had $250 million of sales, and it had $75
million of fixed assets that were being operated at 80% of capacity.
In millions, how large could sales have been if the company had
operated at full capacity?
a. $312.5
b. $328.1
c. $344.5
d. $361.8
e. $379.8
31
. Kamath-Meier Corporation’s CFO uses this equation, which was developed
by regressing inventories on sales over the past 5 years, to forecast
inventory requirements: Inventories = $22.0 + 0.125(Sales). The
company expects sales of $400 million during the current year, and it
expects sales to grow by 30% next year. What is the inventory forecast
for next year? All dollars are in millions.
a. $74.6
b. $78.5
c. $82.7
d. $87.0
e. $91.4
32
. Last year Wei Guan Inc. had $350 million of sales, and it had $270
million of fixed assets that were used at 65% of capacity. In
millions, by how much could Wei Guan’s sales increase before it is
required to increase its fixed assets?
a. $170.09
b. $179.04
c. $188.46
Chapter 16: Forecasting M/C Problems Page 595
d. $197.88
e. $207.78
33
. Last year Handorf-Zhu Inc. had $850 million of sales, and it had $425
million of fixed assets that were used at only 60% of capacity. What
is the maximum sales growth rate the company could achieve before it
had to increase its fixed assets?
a. 54.30%
b. 57.16%
c. 60.17%
d. 63.33%
e. 66.67%
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 75% 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. 28.5%
b. 30.0%
c. 31.5%
d. 33.1%
e. 34.7%
35
. Fairchild Garden Supply expects $600 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. 3.40
b. 3.57
c. 3.75
d. 3.94
e. 4.14
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 year’s accounts payable $40
Sales growth rate = g 30% Last year’s notes payable $50
Last year’s total assets = A0* $500 Last year’s accruals $30
Last year’s profit margin = PM 5% Target payout ratio 60%
Page 596 M/C Problems Chapter 16: Forecasting
a. $102.8
b. $108.2
c. $113.9
d. $119.9
e. $125.9
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* $135,000 Last year’s accruals $20,000
Last year’s profit margin = PM 20.0% Target payout ratio 25.0%
a. -$14,440
b. -$15,200
c. -$16,000
d. -$16,800
e. -$17,640
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 50%, 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 $300.0 Last year’s accounts payable $50.0
Sales growth rate = g 40% Last year’s notes payable $15.0
Last year’s total assets = A0* $500.0 Last year’s accruals $20.0
Last year’s profit margin = PM 20.0% Initial payout ratio 10.0%
a. $31.9
b. $33.6
c. $35.3
d. $37.0
e. $38.9
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 65% 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. $74.81
b. $78.75
c. $82.69
Chapter 16: Forecasting M/C Problems Page 597
d. $86.82
e. $91.16
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ANSWERS AND SOLUTIONS
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