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Chapter 09: Corporate Valuation and Financial Planning
b.
The company reduces its dividend payout ratio.
c.
The company switches its materials purchases to a supplier that offers a longer credit period (with all other
terms held equal).
d.
The company discovers that it has excess capacity in its fixed assets.
e.
A sharp increase in its forecasted sales.
ANSWER:
e
29. The term "additional funds needed (AFN)" is generally defined as follows:
a.
Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new
stock to support operations.
b.
The amount of assets required per dollar of sales.
c.
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.
d.
A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held
constant.
e.
Funds that are obtained automatically from routine business transactions.
ANSWER:
a
30. The capital intensity ratio is generally defined as follows:
a.
The percentage of liabilities that increase spontaneously as a percentage of sales.
b.
The ratio of sales to current assets.
c.
The ratio of current assets to sales.
d.
The amount of assets required per dollar of sales, or A0*/S0.
e.
Sales divided by total assets, i.e., the total assets turnover ratio.
ANSWER:
d
31. Spontaneous funds are generally defined as follows:
a.
A forecasting approach in which the forecasted percentage of sales for each item is held constant.
b.
Funds that a firm must raise externally through short-term or long-term borrowing and/or by selling new
common or preferred stock.
c.
Funds that arise out of normal business operations from its suppliers, employees, and the government, and
they include immediate increases in accounts payable, accrued wages, and accrued taxes.
d.
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.
e.
Assets required per dollar of sales.
ANSWER:
c
32. 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 increases its dividend payout ratio.
b.
The company begins to pay employees monthly rather than weekly.
c.
The company's profit margin increases.
d.
The company decides to stop taking discounts on purchased materials.
e.
The company previously thought its fixed assets were being operated at full capacity, but now it learns that it
actually has excess capacity.
ANSWER:
a
33. Which of the following statements is CORRECT?
a.
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.
b.
If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth.
c.
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.
d.
If a firm has a positive free cash flow, then it must have either a zero or a negative AFN.
e.
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.
ANSWER:
c
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34. Which of the following statements is CORRECT?
a.
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.
b.
Dividends are paid with cash taken from the accumulated retained earnings account, hence dividend policy
does not affect the AFN forecast.
c.
A negative AFN indicates that retained earnings and spontaneous liabilities are far more than sufficient to
finance the additional assets needed.
d.
If the ratios of assets to sales and spontaneous liabilities to sales do not remain constant, then the AFN
equation will provide more accurate forecasts than the forecasted financial statements method.
e.
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.
ANSWER:
c
35. Which of the following statements is CORRECT?
Chapter 09: Corporate Valuation and Financial Planning
a.
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.
b.
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.
c.
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.
d.
Dividend policy does not affect the requirement for external funds based on the AFN equation.
e.
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.
ANSWER:
e
36. Daniel Sawyer, the CEO of the Sawyer Group, is initiating planning for the company's operations next year, and he
wants you to forecast the firm's additional funds needed (AFN). The firm is operating at full capacity. 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%
a.
$102.8
b.
$108.2
c.
$113.9
d.
$119.9
e.
$125.9
ANSWER:
d
37. In your internship with Lewis, Lee, & Taylor Inc. you have been asked to forecast the firm's additional funds needed
(AFN) for next year. The firm is operating at full capacity. 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
ANSWER:
c
38. You have been asked to forecast the additional funds needed (AFN) for Houston, Hargrove, & Worthington (HHW),
which is planning its operation for the coming year. The firm is operating at full capacity. 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
ANSWER:
b
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39. The AFN equation assumes that the ratios of assets and liabilities to sales remain constant over time. However, this
assumption can be relaxed when we use the forecasted financial statement method. Three conditions where constant ratios
cannot be assumed are economies of scale, lumpy assets, and excess capacity.
a.
True
b.
False
ANSWER:
True
40. Which of the following statements is CORRECT?
a.
The first, and perhaps the most critical, step in forecasting financial requirements is to forecast future sales.
b.
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.
c.
The capital intensity ratio gives us an idea of the physical condition of the firm's fixed assets.
Chapter 09: Corporate Valuation and Financial Planning
d.
The AFN equation produces more accurate forecasts than the forecasted financial statement method, especially
if fixed assets are lumpy, economies of scale exist, or if excess capacity exists.
e.
Perhaps the most important step when developing forecasted financial statements is to determine the
breakdown of common equity between common stock and retained earnings.
ANSWER:
a
41. Which of the following statements is CORRECT?
a.
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.
b.
Firms whose fixed assets are "lumpy" frequently have excess capacity, and this should be accounted for in the
financial forecasting process.
c.
For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed
assets.
d.
There are economies of scale in the use of many kinds of assets. When economies occur the ratios are likely to
remain constant over time as the size of the firm increases. The Economic Ordering Quantity model for
establishing inventory levels demonstrates this relationship.
e.
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.
ANSWER:
b
42. The Besnier Company had $250 million of sales last year, 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
ANSWER:
a
43. Last year Baron Enterprises had $350 million of sales, and it had $270 million of fixed assets that were used at 65% of
capacity last year. In millions, by how much could Baron's sales increase before it is required to increase its fixed assets?
a.
$170.09
b.
$179.04
c.
$188.46
d.
$197.88
e.
$207.78
ANSWER:
c
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44. North Construction had $850 million of sales last year, and it had $425 million of fixed assets that were used at only
60% of capacity. What is the maximum sales growth rate North 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%
ANSWER:
e
45. Last year National Aeronautics had a FA/Sales ratio of 40%, comprised of $250 million of sales and $100 million of
fixed assets. 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 FA/Sales ratio should the company set?
Chapter 09: Corporate Valuation and Financial Planning
a.
28.5%
b.
30.0%
c.
31.5%
d.
33.1%
e.
34.7%
ANSWER:
b
46. Weber Interstate Paving Co. had $450 million of sales and $225 million of fixed assets last year, so its FA/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
d.
$86.82
e.
$91.16
ANSWER:
b
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