Fundamentals of Corporate Finance, 12e (Ross)
Chapter 4 Long-Term Financial Planning and Growth
1) Atlas Industries combines the investment proposals from each operational unit into one single
project for planning purposes. This process is referred to as:
A) conjoining.
B) aggregation.
C) conglomeration.
D) appropriation.
E) summation.
2) When developing a financial plan for a corporation you should consider which of the
following?
I. How much net working capital will be needed?
II. Will additional fixed assets be required?
III. Will dividends be paid to shareholders?
IV. How much new debt must be obtained?
A) I and IV only
B) II and III only
C) I, III, and IV only
D) II, III, and IV only
E) I, II, III, and IV
3) Financial planning:
A) focuses solely on the short-term outlook for a firm.
B) is a process that firms employ only when major changes to a firm’s operations are anticipated.
C) is a process that firms undergo once every five years.
D) considers multiple options and scenarios.
E) provides minimal benefits for firms that are highly responsive to economic changes.
4) Financial planning includes the:
I. determination of asset requirements.
II. development of contingency plans.
III. establishment of priorities.
IV. analysis of funding options.
A) I and III only
B) II and IV only
C) I, III, and IV only
D) I, II, and III only
E) I, II, III, and IV
5) When planning for the long run, the planning horizon is usually a period of:
A) 5 to 10 years.
B) 2 to 5 years.
C) 1 to 3 years.
D) 3 to 7 years.
E) 5 years or more.
6) Which of the following questions are appropriate to address during the financial planning
process?
I. Should the firm merge with a competitor?
II. Should additional shares of stock be sold?
III. Should a particular division be sold?
IV. Should a new product be introduced?
A) I only
B) II and III only
C) I and II only
D) I, II, and III only
E) I, II, III, and IV
7) Financial plans:
A) concentrate solely on income and expense items.
B) often contain alternative options based on economic developments.
C) frequently contain conflicting goals.
D) assume that firms obtain no additional external financing.
E) are based on a single set of economic assumptions.
8) Which one of the following are you most apt to estimate first as you begin the process of
preparing pro forma statements?
A) Need for additional fixed assets
B) Current fixed costs
C) Projected sales
D) Desired net income
E) Desired dividend payments
9) Pro forma statements:
A) must assume that no new equity is issued.
B) are projections, not guarantees.
C) are limited to a balance sheet and income statement.
D) must assume that no dividends will be paid.
E) exclude net working capital needs.
10) The retention ratio can be computed as:
A) 1 − Plowback ratio.
B) Change in retained earnings/Cash dividends.
C) 1 + Dividend payout ratio.
D) (Change in retained earnings + Cash dividends)/Net income.
E) 1 − (Cash dividends/Net income).
11) The financial planning method that uses the projected sales level as the basis for determining
changes in balance sheet and income statement account values is referred to as the ________
method.
A) percentage of sales
B) sales dilution
C) sales reconciliation
D) common-size
E) trend
12) The portion of net income that a firm reinvests in itself is called the:
A) retention ratio.
B) dividend yield.
C) dividend payout ratio.
D) internal growth rate.
E) cash influx ratio.
13) Which ratio identifies the amount of total assets a firm needs in order to generate $1 in sales?
A) Return on assets
B) Equity multiplier
C) Retention ratio
D) Capital intensity ratio
E) Current ratio
14) When utilizing the percentage of sales approach, managers:
A) estimate company sales based on a desired level of net income and the current profit margin.
B) consider only those assets that vary directly with sales.
C) consider the current production capacity level.
D) can project net income but not net cash flows.
E) assume all liability accounts will remain constant.
15) Which one of the following is correct in relation to pro forma statements?
A) Fixed assets must increase if sales are projected to increase.
B) Net working capital is affected only when a firm’s sales are expected to exceed the firm’s
current production capacity.
C) The addition to retained earnings is equal to net income less cash dividends.
D) Long-term debt varies directly with sales when a firm is currently operating at maximum
capacity.
E) Inventory changes are not proportional to sales changes.
16) When constructing a pro forma statement, net working capital generally:
A) remains fixed.
B) varies only if the firm is currently producing at full capacity.
C) varies only if the firm maintains a fixed debt-equity ratio.
D) varies only if the firm is producing at less than full capacity.
E) varies proportionally with sales.
17) A pro forma statement indicates that both sales and fixed assets are projected to increase by 7
percent over their current levels. Given this, you can safely assume the firm:
A) is projected to grow at the internal rate of growth.
B) is projected to grow at the sustainable rate of growth.
C) currently has excess capacity.
D) is currently operating at full capacity.
E) retains all of its net income.
18) A firm is currently operating at full capacity. Net working capital, costs, and all assets vary
directly with sales. The firm does not wish to obtain any additional equity financing. The
dividend payout ratio is constant at 40 percent. If the firm has a positive external financing need,
that need will be met by:
A) accounts payable.
B) long-term debt.
C) fixed assets.
D) retained earnings.
E) common stock.
19) When compiling a pro forma statement, which policy most directly affects the projection of
the retained earnings account balance?
A) Net working capital policy
B) Capital structure policy
C) Dividend policy
D) Capital budgeting policy
E) Capacity utilization policy
20) Next year’s pro forma statement is based on an annual increase in sales of four percent. The
firm is currently operating at 85 percent of capacity. Net working capital and all costs vary
directly with sales. The tax rate and the dividend payout ratio are fixed. Given this information,
the:
A) projected dividends must equal the current dividends.
B) depreciation expense will decrease by four percent.
C) retained earnings will increase by 85 percent of projected net income.
D) total assets will increase by less than four percent.
E) total liabilities and owners’ equity will increase by four percent.
21) A firm is operating at 90 percent of capacity. This information is primarily needed to project
which one of the following account values when compiling pro forma statements?
A) Sales
B) Cost of goods sold
C) Accounts receivable
D) Fixed assets
E) Long-term debt
22) Which capital intensity ratio indicates the smallest need for fixed assets per dollar of sales?
A) .07
B) .86
C) .39
D) 1.00
E) 1.15
23) Martin Aerospace is currently operating at full capacity based on its current level of assets.
Sales are expected to increase by 4.5 percent next year, which is the firm’s internal rate of
growth. Net working capital and operating costs are expected to increase directly with sales. The
interest expense will remain constant at its current level. The tax rate and the dividend payout
ratio will be held constant. Current and projected net income is positive. Which one of the
following statements is correct regarding the pro forma statement for next year?
A) The pro forma profit margin is equal to the current profit margin.
B) Retained earnings will increase at the same rate as sales.
C) Total assets will increase at the same rate as sales.
D) Long-term debt will increase in direct relation to sales.
E) Owners’ equity will remain constant.
24) A firm’s external financing need is met by:
A) retained earnings.
B) net working capital and retained earnings.
C) net income and retained earnings.
D) debt or equity.
E) owners’ equity, including retained earnings.
25) Wood Products is operating at 87 percent capacity and earning a substantial profit. A sales
increase is least apt to increase the firm’s:
A) accounts receivable.
B) cost of goods sold.
C) accounts payable.
D) fixed assets.
E) inventory.
26) The external financing need:
A) will limit growth if unfunded.
B) is unaffected by the dividend payout ratio.
C) must be funded by long-term debt.
D) ignores any changes in retained earnings.
E) considers only the required increase in fixed assets.
27) Worthington Industries is currently operating at full-capacity sales. Thus, sales are currently
being limited by the firm’s:
A) net working capital.
B) long-term debt.
C) inventory.
D) fixed assets.
E) debt-equity ratio.
28) The plowback ratio is:
A) equal to net income divided by the change in total equity.
B) the percentage of net income available to the firm to fund future growth.
C) equal to one minus the retention ratio.
D) the change in retained earnings divided by the dividends paid.
E) the dollar increase in net income divided by the dollar increase in sales.
29) BJ Company’s net working capital and all of its expenses vary directly with sales. The firm is
currently operating at 86 percent of capacity. The firm wants no additional external financing of
any kind. The tax rate is 21 percent and the dividend payout ratio is fixed at 25 percent. Which
statement related to next year’s pro forma statements must be correct?
A) Total equity will remain constant at this year’s ending value.
B) The maximum rate of sales increase is four percent.
C) The firm cannot exceed its internal rate of growth.
D) Accounts payable will increase at the same rate as fixed assets.
E) Inventory will remain constant at the current level.
30) The maximum rate of growth a corporation can achieve can be increased by:
A) avoiding new external equity financing.
B) increasing the corporate tax rate.
C) increasing the retention ratio.
D) increasing the dividend payout ratio.
E) increasing the sales forecast.
31) The internal growth rate of a firm is best described as the ________ growth rate achievable
________.
A) minimum; assuming a retention ratio of 100 percent
B) minimum; if the firm maintains a constant equity multiplier
C) maximum; excluding external financing of any kind
D) maximum; excluding any external equity financing while maintaining a constant debt-equity
ratio
E) maximum; with unlimited debt financing
32) The sustainable growth rate of a firm is best described as the ________ growth rate
achievable ________.
A) minimum; assuming a 100 percent retention ratio
B) minimum; if the firm maintains a constant equity multiplier
C) maximum; excluding external financing of any kind
D) maximum; excluding any external equity financing while maintaining a constant debt-equity
ratio
E) maximum; with unlimited debt financing
33) All else constant, a(n) ________ will increase the internal rate of growth.
A) decrease in the retention ratio
B) decrease in net income
C) increase in the dividend payout ratio
D) decrease in total assets
E) increase in cost of goods sold
34) If a firm equates its pro forma sales growth to the rate of sustainable growth, and has positive
net income and excess capacity, then the:
A) maximum capacity level will have to increase at the same rate as sales growth.
B) total assets will have to increase at the same rate as sales growth.
C) debt-equity ratio will increase.
D) retained earnings will increase.
E) number of common shares outstanding will increase
35) Buster’s Market earns a profit and has a dividend payout ratio of 30 percent. The firm does
not want to issue additional equity shares nor increase its long-term debt at this time. Which one
of the following defines the maximum rate at which this firm can currently grow?
A) Internal growth rate (1 − .30)
B) Sustainable growth rate (1 − .30)
C) Internal growth rate
D) Sustainable growth rate
E) Zero percent
36) Which one of the following has the least effect on a firm’s sustainable rate of growth?
A) Capital intensity ratio
B) Profit margin
C) Dividend policy
D) Debt-equity ratio
E) Quick ratio
37) Which one of these is a requirement if the sustainable growth rate is to exceed the internal
growth rate?
A) Net working capital > $0
B) Total debt > $0
C) Dividend ratio = 0
D) Retention ratio = 0
E) Sales > Total assets
38) Financial plans generally tend to ignore:
A) dividend policy.
B) manager’s goals and objectives.
C) risks associated with cash flows.
D) operating capacity levels.
E) capital structure policy.
39) The financial planning process tends to place the least emphasis on a firm’s:
A) growth limitations.
B) capacity utilization.
C) market value.
D) capital structure.
E) dividend policy.
40) The financial planning process is least apt to:
A) involve internal negotiations among divisions.
B) quantify senior manager’s goals.
C) consider the development of future technologies.
D) reconcile a company’s activities across divisions
E) consider factors that currently provide a negative rate of growth.
41) A Procrustes approach to financial planning is based on:
A) a policy of producing a financial plan once every five years.
B) developing a plan around the goals of senior managers.
C) a proactive approach to the economic outlook.
D) a flexible capital budget.
E) a flexible capital structure.
42) Urban’s, which is currently operating at full capacity, has sales of $47,000, current assets of
$5,100, current liabilities of $6,200, net fixed assets of $51,500, and a profit margin of 5 percent.
The firm has no long-term debt and does not plan on acquiring any. The firm does not pay any
dividends. Sales are expected to increase by 3 percent next year. If all assets, short-term
liabilities, and costs vary directly with sales, how much additional equity financing is required
for next year?
A) −$908.50
B) −$722.50
C) $967.30
D) $1,698.00
E) $1,512.00
43) Fresno Salads has current sales of $6,000 and a profit margin of 6.5 percent. The firm
estimates that sales will increase by 4 percent next year and that all costs will vary in direct
relationship to sales. What is the pro forma net income?
A) $303.33
B) $327.18
C) $405.60
D) $438.70
E) $441.10
44) Baked at Home Cookies expects sales of $672,500 next year. The profit margin is 4.6
percent and the firm has a dividend payout ratio of 15 percent. What is the projected increase in
retained earnings?
A) $26,294.75
B) $17,500.50
C) $4,640.25
D) $20,640.25
E) $30,935.00