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Chapter 16: Financial Planning and Forecasting
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
Chapter 16: Financial Planning and Forecasting
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
b.
False
Chapter 16: Financial Planning and Forecasting
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
Chapter 16: Financial Planning and Forecasting
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.
a.
True
b.
False
Chapter 16: Financial Planning and Forecasting
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
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
Chapter 16: Financial Planning and Forecasting
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
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 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.
Chapter 16: Financial Planning and Forecasting
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.
Chapter 16: Financial Planning and Forecasting
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.
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.
Chapter 16: Financial Planning and Forecasting
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.
Chapter 16: Financial Planning and 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.
Chapter 16: Financial Planning and Forecasting
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.
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.
