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CH 12.
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
Reset Selection

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%

(A/2000)*(1000) – (500/2000)*(1000) – (500/2000)*(3000*0.7)

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

 

Quest 9 to 20

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 AFN 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
Reset Selection

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

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

 
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