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CFIN4
Chapter 17 – Financial Planning and Control
1. 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
2. As a firm's sales grow its current asset accounts tend to increase. For instance, as sales increase the firm's
purchases increase and its level of accounts payable will increase. Thus, spontaneously generated funds will arise
from transaction accounts that increase as sales increase.
a. True
b. False
3. 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
4. To determine the amount of additional funds needed, you may subtract the expected increase in liabilities (a source
of funds) from the sum of the expected increases in retained earnings and assets (both uses of funds).
a. True
b. False
5. Two key objectives of financial planning and control are to avoid cash squeezes and to improve profitability.
a. True
b. False
6. One limitation of operating breakeven analysis is that variable cost must be assumed constant throughout the analysis
in order to completely analyze changes in fixed investment.
a. True
b. False
7. Breakeven analysis can be used to determine how large sales of a new product must be for the firm to achieve
profitability, but it is not useful in studying the effects of a general expansion in the firm's operations.
a. True
b. False
8. Operating costs include variable costs, depreciation, and interest charges.
a. True
b. False
9. The DOL is an index number that measures the effect of a change in sales price on the operating breakeven point.
a. True
b. False
10. Other things held constant, if a firm is operating at a profit and then sales increase, the degree of operating leverage
will decline.
a. True
b. False
11. Today, computer simulation models can calculate multiple breakeven charts providing management with an idea of
how the firm's breakeven point would change under different assumptions for key variables.
a. True
b. False
12. Two firms which have the same operating leverage must also have the same ROA, since operating leverage and
ROA both measure the effective utilization of assets by the firm.
a. True
b. False
13. The higher the percentage of a firm's total costs that are fixed, the higher the degree of operating leverage and the
lower the operating breakeven point.
a. True
b. False
14. Alternative methods for producing a given product often have different degrees of operating leverage and hence
have different breakeven points and degrees of risk.
a. True
b. False
15. The closer a firm is to its operating breakeven point, the greater is the absolute value of the degree of operating
leverage.
a. True
b. False
16. The purpose of financial breakeven analysis is to determine the level of sales a firm needs in order to cover the fixed
and variable costs associated with producing and selling inventory items.
a. True
b. False
17. If a firm has no preferred stock, its financial breakeven point is the sales level that results in net income equal to
zero.
a. True
b. False
18. The degree of financial leverage gives an indication of how a change in EBIT will affect EPS.
a. True
b. False
19. Everything else equal, the higher the DFL is for a firm, the closer its operations are to its financial breakeven point.
a. True
b. False
20. Everything else equal, the higher the DFL is for a firm, the closer its operations are to its operating breakeven point.
a. True
b. False
21. Two firms that have the same financial leverage must also have the same ROE, because both financial leverage and
ROE measure the risk associated with equity financing.
a. True
b. False
22. Other things held constant, a high degree of total leverage will mean that a relatively small change in sales will result
in a large change in EPS.
a. True
b. False
23. Financial planning involves the projection of sales, income, and assets as well as the determination of the resources
needed to achieve these projections.
a. True
b. False
24. Financial control involves the projection of sales, income, and assets as well as the determination of the resources
needed to achieve these projections.
a. True
b. False
25. Financial planning involves implementing the financial plans, or forecasts, and dealing with the feedback and
adjustment process that is necessary to ensure the goals of the firm are pursued appropriately.
a. True
b. False
26. In general, excess capacity means more external financing is required to support increases in operations than would
be needed if the firm previously operated at full capacity.
a. True
b. False
27. A firm that only utilizes 40% of its fixed assets capacity to generate $1,000,000 in sales will be able to increase sales
to $4,000,000 before full capacity is reached and plant and equipment would have to be increased.
a. True
b. False
28. Lumpy assets are assets that cannot be acquired in small increments; they must be obtained in large discrete
amounts.
a. True
b. False
29. Breakeven analysis is important in the planning and control process because the cost-volume-profit relationship can
be influenced greatly by the proportion of the firm's assets that are fixed.
a. True
b. False
30. A firm whose degree of operating leverage (DOL) is equal to three means that a given percentage change in sales
will change earnings per share by three times as much.
a. True
b. False
CFIN4
Chapter 17 – Financial Planning and Control
31. The degree of total leverage shows how a change in sales will affect operating income.
a. True
b. False
32. The fact that long-term debt and equity funds are raised infrequently and in large amounts lessens the need for the
firm to forecast them on a continual basis.
a. True
b. False
33. The projected balance sheet method assumes that the key ratios are constant, which means, for example, that if you
plotted a graph of inventories versus sales, the regression line would be linear and would have a positive Y-intercept.
a. True
b. False
34. The projected balance sheet forecasting method would be appropriate if, in a regression of sales on each asset and
spontaneous liability, the regression line was linear and passed through the origin.
a. True
b. False
35. If any firm with a positive net worth is operating its fixed assets at full capacity, if its dividend payout ratio is 100
percent, and if it wants to hold all financial ratios constant, then for any positive growth rate in sales, the firm will
require external financing.
a. True
b. False
CFIN4
Chapter 17 – Financial Planning and Control
36. Breakeven analysis can involve determining the magnitude of the firm's profit or losses at output levels on and
around the point where revenues equal costs.
a. True
b. False
37. The operating breakeven volume in units can be found by dividing the firm's total fixed cost in dollars by its profit
margin per unit (i.e., price less variable cost).
a. True
b. False
38. One potential benefit of high operating leverage is that it can reduce the average cost per unit at high levels of
output, thus generating a competitive cost advantage.
a. True
b. False
39. The firm's cost-volume-profit relationship is most influenced by variable cost and, thus, the level of fixed or operating
costs plays a relatively minor role.
a. True
b. False
40. Other things held constant, a high degree of operating leverage will mean that a relatively small change in sales will
result in a large change in operating income.
a. True
b. False
CFIN4
Chapter 17 – Financial Planning and Control
41. If firm A uses more operating leverage than firm B, firm A will probably have a greater percentage profit margin per
unit than firm B, if both firms are otherwise identical and operating above their respective operating breakeven
levels.
a. True
b. False
42. Suppose a firm uses a high degree of operating leverage and operates in an industry whose sales are greatly
affected by changes in the overall level of economic activity. The riskiness of that firm's earnings stream will likely
be greater than the earnings of a firm in the same industry which has a lower degree of operating leverage.
a. True
b. False
43. The higher the DOL, the greater the firm's use of debt and the more earnings will change following a change in
sales.
a. True
b. False
44. A high degree of operating leverage, other things held constant, means that a relatively small change in unit sales will
result in a large change in operating income.
a. True
b. False
45. It is more difficult to estimate fixed and variable cost per unit for a project during planning than once the project is
underway. This is because, once a project is operational, the firm has access to clearly reported and separated actual
costs that the project incurs.
a. True
b. False
46. An advantage of breakeven analysis is that it can be applied with equal precision whether a firm's cost curve is
linear or nonlinear.
a. True
b. False
47. If a small change in sales results in a large change in EPS, then it must be caused by the financial leverage
associated with the firm.
a. True
b. False
48. Other things held constant, the greater the firm's use of debt, the greater the change in EPS that will result from a
change in sales volume.
a. True
b. False
49. Management need not consider economies of scale in operations when constructing pro forma financial statements
since economies of scale do not impact the financial statements.
a. True
b. False
50. The projected balance sheet method of forecasting is based on which of the following assumptions?
a. All balance sheet accounts are tied directly to sales.
b. Most balance sheet accounts are tied directly to sales.
c. The current level of total assets are optimal for the current sales level.
d. Answers a and c above.
e. Answers b and c above.
51. The projected balance sheet forecasting method produces accurate results unless which of the following condition(s)
is (are) present?
a. Fixes assets are "lumpy."
b. Strong economies of scale are present.
c. Excess capacity exists because of a temporary recession.
d. Answers a, b, and c all make the projected balance sheet method inaccurate.
e. Answers a and c make the projected balance sheet method inaccurate, but as the text explains, the
assumption of increasing economies of scale is built into the projected balance sheet method.
52. Which of the following statements is correct?
a. One of the key steps in the development of pro forma financial statements is to identify those assets and
liabilities which increase spontaneously with net income.
b. The first, and most critical, step in constructing a set of pro forma financial statements is establishing the sales
forecast.
c. Pro forma financial statements as discussed in the text are used primarily to assess a firm's historical
performance.
d. All else equal, if a firm operates at full capacity, the greater its payout ratio, the less additional funds that will
be needed for a particular growth in sales.
e. The projected balance sheet forecasting method produces accurate results when fixed assets are lumpy and
when economies of scale are present.
53. Assume a portion of a firm's long-term funds includes either debt or preferred stock. Which of the following
statements is correct?
a. The firm must possess operating leverage, which means that a change in net income will result in a greater
percentage change in earnings before interest and taxes (EBIT).
b. The firm has financial leverage, which means that a change in sales will result in a greater percentage change
in EBIT.
c. The firm has financial leverage, which means that a change in EBIT will result in a greater percentage
change in earnings per share (EPS).
d. The firm doesn't have leverage, because leverage is created through the use of common equity financing only.
e. None of the above is a correct answer.
54. The degree of financial leverage for ABC Inc. is 2.5, and the degree of financial leverage for XYZ Corporation is
1.5. According to this information, which firm is considered to have greater financial risk?
a. ABC Inc.
b. XYZ Corporation.
c. The degree of financial leverage is not a measure of financial risk, so it is not possible to tell which firm has
the greater financial risk given the above information.
d. To determine which firm has the greater financial risk, we need to know the operating income (NOI or EBIT)
of each firm. XYZ Corporation would have less financial risk if its operating income is at least twice that of
ABC Inc.
e. None of the above is a correct answer.
55. Which of the following is a key determinant of financial leverage?
a. Level of debt.
b. Technology.
c. Labor costs.
d. Amount of fixed assets used by the firm.
e. Variable cost of goods sold.
56. Once the "base case" forecasted financial statements have been prepared, top managers want to know
a. how realistic the results are.
b. how to attain the results.
c. what impact changes in operations would have on the forecasts.
d. All of the above.
e. None of the above.
57. When constructing pro forma financial statements, which of the following steps should be completed first?
a. Forecast next period's balance sheet.
b. Determine the additional funds needed, AFN, to support expected growth.
c. Forecast next period's income statement.
d. Consider the impact of external financing on the additional funds needed (AFN) to determine how much
additional interest or dividends must be paid to support expected growth that is, consider financing
feedbacks.
e. Determine whether the firm is operating above or below its operating breakeven point.
58. Which of the following liabilities is most likely to increase spontaneously with an increase in sales?
a. Notes payable
b. Long-term bonds
c. Preferred stock
d. Accounts payable
e. Common stock
59. Which of the following accounts will not rise spontaneously with an increase in sales?
a. Accounts payable
b. Accrued wages
c. Accrued taxes
d. Accounts receivable
e. Notes payable
60. The decision of how to raise additional funds needed to support sales growth is based on several factors including
a. firm's ability to handle additional debt.
b. conditions in the equity markets.
c. firm's current capital structure.
d. existing debt covenants.
e. All of the above.
61. Which of the following factors might cause "spontaneous" assets and liabilities to change at a different rate than
sales?
a. Lumpy assets
b. Economies of scale
c. Excess capacity
d. All of the above
e. Answers b and c above
62. By definition, a firm's operating breakeven point represents the level of production and sales at which
a. additional funds needed equals zero.
b. variable costs equals operating revenue.
c. fixed variable costs equals operating revenue.
d. net operating income equals zero.
e. the cost of equity equals the cost of debt.
63. By definition, a firm's financial breakeven point is the level of operating income (NOI) where its
a. stock value is maximized.
b. earnings before interest and taxes (EBIT) equal zero.
c. earnings per share equal zero.
d. taxes equal zero.
e. interest expense equal zero.
64. All else equal, which of the following activities should increase the financial risk of a firm?
a. decrease common stock dividends
b. issue new bonds
c. issue new common stock
d. repurchase (pay off) outstanding debt
e. an increase in the fixed operating costs
65. Expert Analysts Resources (EAR) has provided you with the following information about three companies you are
currently evaluating:
Degree of Operating
Degree of Financial
Company
Leverage (DOL)
Leverage (DFL)
Acme
1.5×
6.0×
Apex
3.0×
4.0×
Alps
5.0×
2.0×
According to this information, which firm would be considered riskiest?
a. Acme, because its DFL equals 6.0, which is the highest leverage associated with any of the three firms.
b. Acme, because its degree of total leverage (DTL) is almost equal to 10×.
c. Apex, because it has the highest degree of total (DTL).
d. Alps, because it has the highest DOL.
e. Acme, because is has the lowest DOL.
66. Considering each action independently and holding other things constant, which of the following actions would
reduce the firm's need for additional capital?
a. An increase in the dividend payout ratio.
b. A decrease in the profit margin.
c. A decrease in the days sales outstanding.
d. An increase in expected sales growth.
e. A decrease in the accrual accounts (accrued wages and taxes).
67. Which of the following statements is correct?
a. Any forecast of financial requirements involves determining how much money the firm will need and is
obtained by adding together increases in assets and spontaneous liabilities and subtracting operating income.
b. The projected balance sheet method of forecasting financial needs requires only a forecast of the firm's
balance sheet. Although a forecasted income statement helps clarify the financing needs, it is not essential to
the balance sheet method.
c. Because dividends are paid after taxes from retained earnings, dividends are not included in the projected
balance sheet method of forecasting.
d. The projected balance sheet method forces recognition of the fact that new financing creates additional
financial obligations. For instance, new financing can increase expenses which can actually decrease taxes
but increase the projected financial need.
e. Financing feedback describes the effect on the firm's stock price of the announcement that the firm will sell
new equity or debt to raise needed capital.
68. The degree of operating leverage has which of the following characteristics?
a. The closer the firm is operating to breakeven quantity, the smaller the DOL.
b. A change in quantity demanded will produce the same percentage change in EBIT as an identical change in
price per unit of output, other things held constant.
c. The DOL is not a fixed number for a given firm, but will depend upon the time zero values of the economic
variables Q (Quantity), P (Price), and V (Volume).
d. The DOL relates the change in net income to the change in net operating income.
e. If the firm has no debt, the DOL will equal 1.
