978-0073382395 Chapter 4 Concepts Review and Critical Thinking Questions

Type

Quiz

Book Title

Fundamentals of Corporate Finance Standard Edition 9th Edition

ISBN 13

978-0073382395

April 3, 2019

CHAPTER 4

LONG-TERM FINANCIAL PLANNING

AND GROWTH

Answers to Concepts Review and Critical Thinking Questions

1. The reason is that, ultimately, sales are the driving force behind a business. A firm’s assets,

employees, and, in fact, just about every aspect of its operations and financing exist to directly or

2. Two assumptions of the sustainable growth formula are that the company does not want to sell new

equity, and that financial policy is fixed. If the company raises outside equity, or increases its debt-

3. The internal growth rate is greater than 15%, because at a 15% growth rate the negative EFN

indicates that there is excess internal financing. If the internal growth rate is greater than 15%, then

the sustainable growth rate is certainly greater than 15%, because there is additional debt financing

used in that case (assuming the firm is not 100% equity-financed). As the retention ratio is increased,

4. The sustainable growth rate is greater than 20%, because at a 20% growth rate the negative EFN

indicates that there is excess financing still available. If the firm is 100% equity financed, then the

sustainable and internal growth rates are equal and the internal growth rate would be greater than

20%. However, when the firm has some debt, the internal growth rate is always less than the

5. Presumably not, but, of course, if the product had been much less popular, then a similar fate would

have awaited due to lack of sales.

6. Since customers did not pay until shipment, receivables rose. The firm’s NWC, but not its cash,

increased. At the same time, costs were rising faster than cash revenues, so operating cash flow

B-30 SOLUTIONS

7. Apparently not! In hindsight, the firm may have underestimated costs and also underestimated the

extra demand from the lower price.

8. Financing possibly could have been arranged if the company had taken quick enough action.

9. All three were important, but the lack of cash or, more generally, financial resources ultimately

10. Demanding cash up front, increasing prices, subcontracting production, and improving financial

SolutionstoQuestionsandProblems

NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple

steps. Due to space and readability constraints, when these intermediate steps are included in this

solutions manual, rounding may appear to have occurred. However, the final answer for each problem is

found without rounding during any step in the problem.

Basic

1. It is important to remember that equity will not increase by the same percentage as the other assets.

If every other item on the income statement and balance sheet increases by 15 percent, the pro forma

income statement and balance sheet will look like this:

Pro forma income statement Pro forma balance sheet

Sales $ 26,450 Assets $ 18,170 Debt $ 5,980

Costs 19,205 Equity 12,190

Net income $ 7,245 Total $ 18,170 Total $ 18,170

In order for the balance sheet to balance, equity must be: