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Exam 17: Financial Planning and Forecasting

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Question 21

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Which of the following statements is CORRECT?

A) Perhaps the most important step when developing forecasted financial statements is to determine the breakdown of common equity between common stock and retained earnings.
B) The first, and perhaps the most critical, step in forecasting financial requirements is to forecast future sales.
C) 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.
D) The capital intensity ratio gives us an idea of the physical condition of the firm's fixed assets.
E) The AFN equation produces more accurate forecasts than the forecasted financial statement method, especially if fixed assets are lumpy and economies of scale exist.

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Question 22

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The term "spontaneously generated funds" generally refers to increases in the cash account that result from growth in sales, assuming the firm is operating with a positive profit margin.

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Question 23

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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.

Last year Wei Guan Inc. had $350 million of sales, and it had $270 million of fixed assets that were used at 65% of capacity. In millions, by how much could Wei Guan's sales increase before it is required to increase its fixed assets?

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 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.

Kamath-Meier Corporation's CFO uses this equation, which was developed by regressing inventories on sales over the past 5 years, to forecast inventory requirements: Inventories = $22.0 + 0.125(Sales) . The company expects sales of $400 million during the current year, and it expects sales to grow by 30% next year. What is the inventory forecast for next year? All dollars are in millions.

The term "additional funds needed (AFN) " is generally defined as follows:

When we use the AFN formula to forecast the additional funds needed (AFN), we are implicitly assuming that all financial ratios are constant. If financial ratios are not constant, regression techniques can be used to improve the financial forecast.

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.

Jefferson City Computers 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) ?