CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
1. 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, spontaneous liabilities that reduce
AFN arise from transactions brought on by sales increases.
a.
True
b.
False
True
2. Firms pay a low interest rate on spontaneous liabilities so these funds are its cheapest source of capital. Consequently,
the firm should make arrangements with its suppliers to use as much of this credit as possible.
a.
True
b.
False
False
3. A firm will use spontaneous funds to the extent possible; however, due to credit terms, contracts with workers, and tax
laws there is little flexibility in their usage.
a.
True
b.
False
True
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
4. As long as a firm does not pay out 100% of its earnings, the firm’s annual profit that is retained in the business (i.e., the
addition to retained earnings) is another source of funds for a firm’s expansion.
a.
True
b.
False
True
5. 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
True
6. A firm’s AFN must come from external sources. Typical sources include short-term bank loans, long-term bonds,
preferred stock, and common stock.
a.
True
b.
False
True
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
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
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
False
9. The capital intensity ratio is the amount of assets required per dollar of sales and it has a major impact on a firm’s
capital requirements.
a.
True
b.
False
True
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
10. One of the first steps in arriving at a firm’s forecasted financial statements is a review of industry-average operating
ratios relative to these same ratios for the firm to determine whether changes to the ratios need to be made.
a.
True
b.
False
True
11. Operating plans sketch out broad approaches for realization of the firm’s strategic vision. These plans usually are
developed for a period no longer than a 1-year time horizon because detail is “lost” by extending out the time horizon by
more than 1 year.
a.
True
b.
False
False
12. One of the necessary steps in the financial planning process is a forecast of financial statements under each alternative
version of the operating plan in order to analyze the effects of different operating procedures on projected profits and
financial ratios.
a.
True
b.
False
True
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
13. 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
True
14. 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
False
15. Companies with relatively high assets-to-sales ratios require a relatively large amount of new assets for any given
increase in sales; hence, they have a greater need for external financing. There are currently no alternatives for these types
of firms to lower their asset requirements.
a.
True
b.
False
False
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
16. Firms with high capital intensity ratios have found ways to lower this ratio permitting them to achieve a given level of
growth with fewer assets and consequently less external capital. For example, just-in-time inventory systems, multiple
shifts for labor, and outsourcing production are all feasible ways for firms to reduce their capital intensity ratios.
a.
True
b.
False
True
17. 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
True
18. 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
False
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
19. The minimum growth rate that a firm can achieve with no access to external capital is called the firm’s sustainable
growth rate. It can be calculated by using the AFN equation with AFN equal to zero and solving for g.
a.
True
b.
False
False
20. 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
False
21. 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
True
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
22. Which of the following assumptions is embodied in the AFN equation?
a.
Accounts payable and accruals are tied directly to sales.
b.
Common stock and long-term debt are tied directly to sales.
c.
Fixed assets, but not current assets, are tied directly to sales.
d.
Last year’s total assets were not optimal for last year’s sales.
e.
None of the firm’s ratios will change.
Difficulty: Easy
INTE.GENE.16.62 – LO: 9-6
United States – BUSPROG: Analytic
United States – AK – DISC: Financial statements, anal – DISC: Financial statements, analysis,
United States – OH – Default City – TBA
AFN equation
TYPE: Multiple Choice: Conceptual
23. F. Marston, Inc. 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 switch to a just-in-time inventory system and outsourcing production.
b.
The company reduces its dividend payout ratio.
c.
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.
d.
The company discovers that it has excess capacity in its fixed assets.
e.
A sharp increase in its forecasted sales.
Difficulty: Moderate
Difficulty: Moderate
INTE.GENE.16.66 – LO: 9-7
United States – BUSPROG: Reflective Thinking
United States – OH – Default City – TBA
Forecasting when ratios chg.
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
24. 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.
a
Difficulty: Moderate
INTE.GENE.16.62 – LO: 9-6
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
Additional funds needed
TYPE: Multiple Choice: Conceptual
25. 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.
Difficulty: Moderate
INTE.GENE.16.62 – LO: 9-6
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
INTE.GENE.16.62 – LO: 9-6
United States – BUSPROG: Analytic
United States – AK – DISC: Financial statements, anal – DISC: Financial statements, analysis,
forecasting, and cash flows
United States – OH – Default City – TBA
Additional funds needed
TYPE: Multiple Choice: Conceptual
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
Capital intensity ratio
TYPE: Multiple Choice: Conceptual
26. Which of the following is NOT one of the steps taken in the financial planning process?
a.
Monitor operations after implementing the plan to spot any deviations and then take corrective actions.
b.
Determine the amount of capital that will be needed to support the plan.
c.
Develop a set of forecasted financial statements under alternative versions of the operating plan in order to
analyze the effects of different operating procedures on projected profits and financial ratios.
d.
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.
e.
Forecast the funds that will be generated internally. If internal funds are insufficient to cover the required new
investment, then identify sources from which the required external capital can be raised.
Difficulty: Moderate
INTE.GENE.16.64 – LO: 9-1
United States – BUSPROG: Analytic
United States – AK – DISC: Financial statements, anal – DISC: Financial statements, analysis,
forecasting, and cash flows
United States – OH – Default City – TBA
Financial planning
TYPE: Multiple Choice: Conceptual
27. 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.
Difficulty: Moderate
INTE.GENE.16.62 – LO: 9-6
United States – BUSPROG: Analytic
United States – AK – DISC: Financial statements, anal – DISC: Financial statements, analysis,
forecasting, and cash flows
United States – OH – Default City – TBA
Spontaneous funds
TYPE: Multiple Choice: Conceptual
CHAPTER 9—CORPORATE VALUATION AND FINANCIAL PLANNING
28. 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.
Difficulty: Moderate
INTE.GENE.16.62 – LO: 9-6
United States – BUSPROG: Analytic
United States – AK – DISC: Financial statements, anal – DISC: Financial statements, analysis,
forecasting, and cash flows
United States – OH – Default City – TBA
Additional funds needed
TYPE: Multiple Choice: Conceptual
29. 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.
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.
Difficulty: Moderate
INTE.GENE.16.66 – LO: 9-7
United States – BUSPROG: Analytic
United States – AK – DISC: Financial statements, anal – DISC: Financial statements, analysis,
forecasting, and cash flows
United States – OH – Default City – TBA
Forecasting concepts
TYPE: Multiple Choice: Conceptual
30. 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.