Question 1 of 20

The percentage of sales method is based on which of the following assumptions?

A. a. All balance sheet accounts are tied directly to sales.

B. b. Most balance sheet accounts are tied directly to sales.

C. c. The current level of total assets is optimal for the current sales level.

D. d. Answers a and c above.

E. e. Answers b and c above.

Question 2 of 20

The percentage of sales method produces accurate results unless which of the following conditions is (are) present?

A. a. Fixed assets are “lumpy.”

B. b. Strong economies of scale are present.

C. c. Excess capacity exists because of a temporary recession.

D. d. Answers a, b, and c all make the percentage of sales method inaccurate.

E. e. Answers a and c make the percentage of sales method inaccurate, but, as the text explains, the assumption of increasing economies of scale is built into the percentage of sales method.

Question 3 of 20

Which of the following statements is correct?

A. a. One of the key steps in the development of pro forma financial statements is to identify those assets and liabilities which increase spontaneously with net income.

B. b. The first, and most critical, step in constructing a set of pro forma financial statements is establishing the sales forecast.

C. c. Pro forma financial statements as discussed in the text are used primarily to assess a firm’s historical performance.

D. d. The capital intensity ratio reflects how rapidly a firm turns over its assets and is the reciprocal of the fixed assets turnover ratio.

E. e. The percentage of sales method produces accurate results when fixed assets are lumpy and when economies of scale are present

Question 4 of 20

Considering each action independently and holding other things constant, which of the following actions would reduce a firm’s need for additional capital?

A. a. An increase in the dividend payout ratio.

B. b. A decrease in the profit margin.

C. c. A decrease in the days sales outstanding.

D. d. An increase in expected sales growth.

E. e. A decrease in the accrual accounts (accrued wages and taxes).

Question 5 of 20

Which of the following statements is correct?

A. a. Since accounts payable and accruals must eventually be paid, as these accounts increase, AFN also increases.

B. b. Suppose a firm is operating its fixed assets below 100 percent capacity but is at 100 percent with respect to current assets. If sales grow, the firm can offset the needed increase in current assets with its idle fixed assets capacity.

C. c. If a firm retains all of its earnings, then it will not need any additional funds to support sales growth.

D. d. Additional funds needed are typically raised from some combination of notes payable, long-term bonds, and common stock. These accounts are nonspontaneous in that they require an explicit financing decision to increase them.

E. e. All of the statements above are false.

Question 6 of 20

Which of the following statements is correct?

A. a. Any forecast of financial requirements involves determining how much money the firm will need and is obtained by adding together increases in assets and spontaneous liabilities and subtracting operating income.

B. b. The percentage of sales method of forecasting financial needs requires only a forecast of the firm’s balance sheet. Although a forecasted income statement helps clarify the need, it is not essential to the percentage of sales method.

C. c. Because dividends are paid after taxes from retained earnings, dividends are not included in the percentage of sales method of forecasting.

D. d. Financing feedbacks describe the fact that interest must be paid on the debt used to help finance AFN and dividends must be paid on the shares issued to raise the equity part of the AFN. These payments would lower the net income and retained earnings shown in the projected financial statements.

E. e. All of the statements above are false.

Question 7 of 20

Which of the following statements is correct?

A. a. Inherent in the AFN formula is the assumption that each asset item must increase in direct proportion to sales increases and that spontaneous liability accounts also grow at the same rate as sales.

B. b. If a firm has positive growth in its assets, but has no increase in retained earnings, AFN for the firm must be positive.

C. c. Using the AFN formula, if a firm increases its dividend payout ratio in anticipation of higher earnings, but sales actually decrease, the firm will automatically experience an increase in additional funds needed.

D. d. Higher sales usually require higher asset levels. Some of the increase in assets can be supported by spontaneous increases in accounts payable and accruals, and by increases in certain current asset accounts and retained earnings.

E. e. Dividend policy does not affect requirements for external capital under the AFN formula method.

 

Question 8 of 20

Jill’s Wigs Inc. had the following balance sheet last year:

Cash 800 Accounts Payable 350

Accounts Receivable 450 Accrued Wages 150

Inventories 950 Notes Payable 2,000

Fixed Assets 34,000 Mortgage 26,500

Common Stock 3,200

Retained earnings 4,000

Total Assets 36,200 Total liabilites and equity 36,200

Jill has just invented a non-slip wig for men which she expects will cause sales to double from $10,000 to $20,000, increasing net income to $1,000. She feels that she can handle the increase without adding any fixed assets. (1) Will Jill need any outside capital if she pays no dividends? (2) If so, how much?

A. a. No; zero

B. b. Yes; $7,700

C. c. Yes; $1,700

D. d. Yes; $700

E. e. No; there will be a $700 surplus.

Question 9 of 20

Brown & Sons recently reported sales of $100 million, and net income equal to $5 million. The company has $70 million in total assets. Over the next year, the company is forecasting a 20 percent increase in sales. Since the company is at full capacity, its assets must increase in proportion to sales. The company also estimates that if sales increase 20 percent, spontaneous liabilities will increase by $2 million. If the company’s sales increase, its profit margin will remain at its current level. The company’s dividend payout ratio is 40 percent. Based on the formula, how much additional capital must the company raise in order to support the 20 percent increase in sales?

A. a. $ 2.0 million

B. b. $ 6.0 million

C. c. $ 8.4 million

D. d. $ 9.6 million

E. e. $14.0 million

Question 10 of 20

Splash Bottling’s December 31st balance sheet is given below:

Cash 10 Accounts payable 15

Accounts Receivable 25 Notes payable 20

Inventories 40 Accrued wages and taxes 15

Net fixed assets 75 Long-term debt 30

Common equity 70

Total assets 150 Total liabilities and equity 150

Sales during the past year were $100, and they are expected to rise by 50 percent to $150 during next year. Also, during last year fixed assets were being utilized to only 85 percent of capacity, so Splash could have supported $100 of sales with fixed assets that were only 85 percent of last year’s actual fixed assets. Assume that Splash’s profit margin will remain constant at 5 percent and that the company will continue to pay out 60 percent of its earnings as dividends. To the nearest whole dollar, what amount of nonspontaneous, additional funds (AFN) will be needed during the next year?

A. a. $57

B. b. $51

C. c. $36

D. d. $40

E. e. $48

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Question 11 of 20

Which of the following would reduce the additional funds required if all other things are held constant?

A. a. An increase in the dividend payout ratio.

B. b. A decrease in the profit margin.

C. c. An increase in the capital intensity ratio.

D. d. An increase in the expected sales growth rate.

E. e. A decrease in the firm’s tax rate.

 

Question 12 of 20

Which of the following statements is correct?

A. a. Suppose economies of scale exist in a firm’s use of assets. Under this condition, the firm should use the regression method of forecasting asset requirements rather than the percent of sales method.

B. b. If a firm must acquire assets in lumpy units, it can avoid errors in forecasts of its need for funds by using the linear regression method of forecasting asset requirements because all the points will lie on the regression line.

C. c. If economies of scale in the use of assets exist, then the AFN formula rather than the percent of sales method should be used to forecast additional funds requirements.

D. d. Notes payable to banks are included in the AFN formula, along with a projection of retained earnings.

E. e. One problem with the AFN formula is that it does not take account of the firm’s dividend policy.

Question 13 of 20

Elvis Inc. has the following balance sheet:

Current assets $5,000 Accounts payable $1,000

Notes payable 1,000

Net fixed assets 5,000 Long-term debt 4,000

Common equity 4,000

Total assets $10,000 Total liabilities and equity $10,000

Business has been slow; therefore, fixed assets are vastly underutilized. Management believes it can triple sales next year with the introduction of a new product. No new fixed assets will be required, and management expects that there will be no earnings retained next year. What is next year’s additional financing requirement?

A. a. $3,500

B. b. $4,600

C. c. $5,900

D. d. $8,000

E. e. $10,000

Question 14 of 20

The 2007 balance sheet for Laura Inc. is shown below (in millions of dollars):

Cash $ 3.0 Accounts payable $ 2.0

Accounts receivable 3.0 Notes payable 1.5

Inventory 5.0

Current Assets $11.0 Current liabilities $ 3.5

Fixed assets 3.0 Long-term debt 3.0

Common equity 7.5

Total assets $14.0 Total liabilities and equity $14.0

In 2007, sales were $60 million. In 2008, management believes that sales will increase by 30 percent to a total of $78 million. The profit margin is expected to be 6 percent, and the retention ratio is targeted at 40 percent. No excess capacity exists. What is the additional financing requirement (in millions) for 2008 using the formula method?

A. a. $1.73

B. b. $6.67

C. c. $18.2

D. d. -$6.67

E. e. -$1.73

Question 15 of 20

The 2007 balance sheet for Laura Inc. is shown below (in millions of dollars):

Cash $ 3.0 Accounts payable $ 2.0

Accounts receivable 3.0 Notes payable 1.5

Inventory 5.0

Current Assets $11.0 Current liabilities $ 3.5

Fixed assets 3.0 Long-term debt 3.0

Common equity 7.5

Total assets $14.0 Total liabilities and equity $14.0

In 2007, sales were $60 million. In 2008, management believes that sales will increase by 30 percent to a total of $78 million. The profit margin is expected to be 6 percent, and the retention ratio is targeted at 40 percent. No excess capacity exists. How much can sales grow above the 2007 level of $60 million without requiring any additional funds?

A. a. 10.34%

B. b. 13.64%

C. c. 14.83%

D. d. 15.63%

E. e. 19.17%

Question 16 of 20

Smith Machines Inc. has a net income this year of $500 on sales of $2,000 and is operating its fixed assets at full capacity. Management expects sales to increase by 50 percent next year and is forecasting a dividend payout ratio of 30 percent. The profit margin is not expected to change. If spontaneous liabilities are $500 this year and no excess funds are expected next year, what are Smith’s total assets this year?

A. a. $ 1,250

B. b. $1,550

C. c. $2,750

D. d. $3,425

E. e. $3,574

Question 17 of 20

Bill Inc.’s 2007 financial statements are shown below:

Bill Inc. Balance Sheet as of December 31, 2007

Cash $ 90,000 Accounts payable $ 180,000

Receivables 180,000 Notes payable 78,000

Inventory 360,000 Accruals 90,000

Total current assets $630,000 Total current liabilities $ 348,000

Common stock 900,000

Net fixed assets 720,000 Retained earnings 102,000

Total assets $1,350,000 Total liabilities and equity $1,350,000

Bill Inc. Income Statement for December 31, 2007

Sales $1,800,000

Operating costs 1,639,860

EBIT $ 160,140

Interest 10,140

EBT $ 150,000

Taxes (40%) 60,000

Net income $90,000

Dividends (60%) $ 54,000

Addition to retained earnings $ 36,000

Suppose that in 2008, sales increase by 20 percent over 2007 sales. Construct the pro forma financial statements using the percent of sales method. Assume the firm operated at full capacity in 2007. How much additional capital will be required?

A. e. $263,921

B. b. $95,288

C. c. $100,251

D. d. $172,313

E. e. $263,921

Question 18 of 20

Bill Inc. Balance Sheet as of December 31, 2007

Cash $ 90,000 Accounts payable $ 180,000

Receivables 180,000 Notes payable 78,000

Inventory 360,000 Accruals 90,000

Total current assets $ 630,000 Total current liabilities $ 348,000

Common stock 900,000

Net fixed assets 720,000 Retained earnings 102,000

Total assets $1,350,000 Total liabilities and equity $1,350,000

Bill Inc. Income Statement for December 31, 2007

Sales $1,800,000

Operating costs 1,639,860

EBIT $ 160,140

Interest 10,140

EBT $ 150,000

Taxes (40%) 60,000

Net income $ 90,000

Dividends (60%) $ 54,000

Addition to retained earnings $ 36,000

Suppose that in 2008, sales increase by 20 percent over 2007 sales. Assume that fixed assets are only being operated at 95 percent of capacity. Construct the proforma financial statements using the percent of sales method. How much additional capital will be required?

A. a. $73,218

B. b. $85,201

C. c. $91,873

D. d. $100,800

E. e. $129,113

Question 19 of 20

Your company’s sales were $2,000 last year, and they are forecasted to rise by 100 percent during the coming year. Here is the latest balance sheet:

Cash $ 100 Accounts payable $200

Receivables 300 Notes payable 200

Inventory 800 Accruals 20

Total current assets $1,200 Total current liabilities $420

Long-term debt 780

Common stock 400

Net Fixed Assets 800 Retained earnings 400

Total assets $2,000 Total liabilities and equity $2,000

Fixed assets were used to only 80 percent of capacity last year, and year-end inventory holdings were $100 greater than were needed to support the $2,000 of sales. The other current assets (cash and receivables) were at their proper levels. All assets would be a constant percentage of sales if excess capacity did not exist; that is, all assets would increase at the same rate as sales if no excess capacity existed. The company’s after-tax profit margin will be 3 percent, and its payout ratio will be 80 percent. If all additional funds needed (AFN) are raised as notes payable and financing feedbacks are ignored, what will the current ratio be at the end of the coming year?

A. a. 1.17

B. b. 1.93

C. c. 2.19

D. d. 2.50

E. e. 2.73 (Not sure)

Question 20 of 20

The Bouchard Company’s sales are forecasted to increase from $500 in 2007 to $ 1,000 in 2008. Here is the December 31, 2007, balance sheet:

Cash $ 50 Accounts payable $25

Receivables 100 Notes payable 75

Inventory 100 Accruals 25

Total current assets $250 Total current liabilities $125

Long-term debt 200

Common stock 50

Net Fixed Assets 250 Retained earnings 125

Total assets $500 Total liabilities and equity $500

Bouchard’s fixed assets were used to only 50 percent of capacity during 2007, but its current assets were at their proper levels. All assets except fixed assets should be a constant percentage of sales, and fixed assets would also increase at the same rate if the current excess capacity did not exist. Bouchard’s after-tax profit margin is forecasted to be 8 percent, and its payout ratio will be 40 percent. What is Bouchard’s additional funds needed (AFN) for the coming year?

A. a. $102

B. b. $152

C. c. $197

D. d. $167

E. e. $183