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Chapter 4

Financial Forecasting, Planning, and Budgeting

True/False

1. The key ingredient in a firm’s financial planning is the sales forecast.

Difficulty: Easy

Keywords: sales forecast

1. The projected change in retained earnings equals projected net income less any dividends to be paid.

Difficulty: Easy

Keywords: change in retained earnings

1. The cash budget can be used as an accurate standard for control purposes by adjusting the cost figures for planned sales in proportion to total assets.

Difficulty: Moderate

Keywords: cash budget

1. The initiation of a major advertising campaign would be an example of an event that would affect past trends in sales when projecting statements.

Difficulty: Easy

Keywords: sales forecast

1. Depreciation expense can be obtained from the cash budget.

Difficulty: Easy

Keywords: depreciation expense

1. The percentages used in the percent-of-sales method comes from pro forma financial statements.

Difficulty: Moderate

Keywords: percent-of-sales method

1. Pro forma statements provide single point estimates of each budgeted item.

Difficulty: Easy

Keywords: pro forma statements

1. Pro forma statements are important since they formally report the performance of the firm during a previous reporting period.

Difficulty: Moderate

Keywords: pro forma statements

1. The percent-of-sales method is more detailed than the cash budget method.

Difficulty: Easy

Keywords: percent-of-sales method

1. Depreciation expense is always included in the cash budget as it reflects the impact of fixed asset purchases.

Difficulty: Easy

Keywords: depreciation expense, cash budget

1. A budget is a forecast of future events.

Difficulty: Easy

Keywords: budget

1. The cash budget can be used to provide an estimate of the firm’s future financing needs.

Difficulty: Easy

Keywords: cash budget and financing needs

1. The cash budget ignores discretionary financing.

Difficulty: Easy

Keywords: discretionary financing, cash budget

1. The percent-of-sales method is a commonly used method for estimating a firm’s financing needs.

Difficulty: Easy

Keywords: percent-of-sales method

1. Most firms prepare longer-range budgets called capital expenditure budgets.

Difficulty: Easy

Keywords: capital expenditure budgets

1. One of the virtues of the percent-of-sales method is the precision of the estimate it provides for future financing needs.

Difficulty: Moderate

Keywords: percent-of-sales method and precision

1. Holding all other variables constant, as the plowback ratio increases, the sustainable growth rate increases.

Difficulty: Easy

Keywords: plowback ratio, sustainable growth rate

1. Pro forma financial statements depict the end result of the planning period’s operations.

Difficulty: Easy

Keywords: pro forma statements

1. When forecasting statements, assets always increase proportionately to sales regardless of capacity.

Difficulty: Moderate

Keywords: capacity of assets

1. Discretionary sources of financing are those sources that vary automatically with a firm’s level of sales.

Difficulty: Easy

Keywords: discretionary financing

1. When fixed expenses increase relative to sales, it indicates that there is not enough productive capacity to absorb an increase in sales.

Difficulty: Moderate

Keywords: fixed assets and capacity

1. Economies of scale are realized from investing in assets such as finished good inventories.

Difficulty: Moderate

Keywords: economies of scale

1. A set of estimates which corresponds to the worst and the best case outcomes is often useful in preparing a financial forecast.

Difficulty: Moderate

Keywords: budgeting scenarios

1. It is common practice to develop optimistic and pessimistic scenarios when projecting financial statements.

Difficulty: Easy

Keywords: budgeting scenarios

1. The key ingredient in the firm’s planning process is the sales forecast.

Difficulty: Easy

Keywords: sales forecast

1. The most commonly used method for making financial forecasts is the percent-of-sales method.

Difficulty: Easy

Keywords: percent-of-sales method

1. The cash budget is the primary tool of financial forecasting and planning.

Difficulty: Easy

Keywords: cash budget

1. The percent-of-sales method of forecasting future financing needs is as precise and detailed as the cash budget method.

Difficulty: Moderate

Keywords: percent-of-sales method, cash budget

1. If the firm’s current fixed assets are sufficient to support the projected level of new sales, then these assets would be projected to remain unchanged for the forecast period.

Difficulty: Moderate

Keywords: fixed asset capacity

1. Because accounts payable and accrued expenses increase with sales, they represent sources of spontaneous financing.

Difficulty: Moderate

Keywords: spontaneous financing

1. Notes payable represent a source of spontaneous financing when sales increase.

Difficulty: Moderate

Keywords: spontaneous financing

1. A firm’s sustainable rate of growth represents the growth in sales that the firm can sustain if it changes its capital structure.

Difficulty: Easy

Keywords: sustainable growth rate

1. All else constant, a firm can achieve a higher level of sustainable growth the lower its dividend payout ratio is.

Difficulty: Moderate

Keywords: dividend payout, sustainable growth rate

1. All else constant, a firm can achieve a higher level of sustainable growth the lower its net profit margin is.

Difficulty: Moderate

Keywords: net profit margin, sustainable growth rate

1. When economies of scale exist for a firm, the percent-of-sales forecasting method accurately describes the relation between an asset category and sales.

Difficulty: Moderate

Keywords: economies of scale

1. When assets must be purchased in discrete quantities, the percent-of-sales forecasting method fails to describe the relation between an asset category and sales.

Difficulty: Moderate

Keywords: fixed asset purchases

1. Budgets provide management a tool for attempting to deal with agency problems because the budget is a tool that can be used to evaluate employee performance.

Difficulty: Moderate

Keywords: budgets as a management tool

Multiple Choice

1. What is the most important ingredient in developing a firm’s financial plan?

a. A forecast of sales revenues

b. Determining the amount of dividends to pay shareholders

c. Projecting the rate of interest on proposed new debt

d. Deciding upon which method of depreciation a firm should utilize

Difficulty: Moderate

Keywords: sales forecast

1. The percent-of-sales method can be used to forecast:

a. expenses.

b. assets.

c. liabilities.

d. all of the above.

Difficulty: Easy

Keywords: percent-of-sales forecast

1. Which of the following statements about the percent-of-sales method of financial forecasting is true?

a. It is the least commonly used method of financial forecasting.

b. It is a much more precise method of financial forecasting than a cash budget would be.

c. It involves estimating the level of an expense, asset, or liability for a future period as a percent of the forecast for sales revenues.

d. It projects all liabilities as a fixed percentage of sales.

Difficulty: Moderate

Keywords: percent-of-sales forecast

1. Which of the following is NOT a basic function of a budget?

a. Budgets indicate the need for future financing.

b. Budgets provide the basis for corrective action when actual figures differ from the budgeted figures.

c. Budgets compare historical costs of the firm with its current cost performance.

d. Budgets allow for performance evaluation.

Difficulty: Moderate

Keywords: budget functions

1. Which of the following will increase cumulative borrowing in the cash budget?

a. Decreasing the average collection period

b. Increasing purchases

c. Decreasing depreciation expense

1. Both a and c
2. All of the above

Difficulty: Moderate

Keywords: cash budget impacts

1. All of the following are found in the cash budget except:

a. a net change in cash for the period.

b. inventory.

c. cash disbursements.

d. new financing needed.

Difficulty: Easy

Keywords: cash budget

1. Purchases of plant and equipment can be determined from the:

a. current cash budget.

b. previous period’s balance sheet.

c. pro forma income statement.

d. use of ratio analysis.

Difficulty: Easy

Keywords: fixed asset purchases

1. The primary purpose of a cash budget is to:

a. determine the level of investment in current and fixed assets.

b. determine accounts payable.

c. provide a detailed plan of future cash flows.

d. determine the estimated income tax for the year.

Difficulty: Easy

Keywords: cash budget

1. Which of the following is always a non-cash expense?

a. Income taxes

b. Salaries

c. Depreciation

d. None of the above

Difficulty: Easy

Keywords: non-cash expense, depreciation

1. A company collects 60% of its sales during the month of the sale, 30% one month after the sale, and 10% two months after the sale. The company expects sales of $10,000 in August, $20,000 in September, $30,000 in October, and $40,000 in November. How much money is expected to be collected in October?

a. $25,000

b. $15,000

c. $35,000

d. None of the above

Difficulty: Moderate

Keywords: sales collection

Table 1

Dorian Industries’ projected sales for the first six months of 2004 are given below:

Jan. $200,000 April $400,000

Feb. $240,000 May $320,000

March $280,000 June $320,000

25% of sales is collected in cash at the time of the sale, 50% is collected in the month following the sale, and the remaining 25% is collected in the second month following the sale. Cost of goods sold is 75% of sales. Purchases are made in the month prior to the sale, and payments for purchases are made in the month of the sale. Total other cash expenses are $60,000/month. The company’s cash balance as of February 28, 2004 will be $40,000. Excess cash will be used to retire short-term borrowing (if any). Dorian has no short-term borrowing as of February 28, 2004. Assume that the interest rate on short-term borrowing is 1% per month. The company must have a minimum cash balance of $25,000 at the beginning of each month. Round all Answers to the nearest $100.

1. Based on the information in Table 1, what are Dorian Industries’ total cash receipts (collections) for April 2004?

a. $400,000

b. $300,000

c. $100,000

d. ($60,000)

Difficulty: Moderate

Keywords: cash receipts

1. Based on the information in Table 1, what is Dorian Industries’ total disbursement in May (not including interest on short-term borrowing)?

a. $300,000

b. $240,000

c. $25,900

d. ($60,000)

Difficulty: Moderate

Keywords: cash disbursements

1. Based on the information in Table 1, what is Dorian Industries’ ending cash balance (before borrowing) in March?

a. $10,000

b. $25,000

c. $20,000

d. ($30,000)

Difficulty: Hard

Keywords: ending cash balance

1. Based on the information in Table 1, what is Dorian’s projected cumulative short-term borrowing as of April 30, 2004?

a. $15,000

b. $60,000

c. $35,150

d. None of the above

Difficulty: Moderate

Keywords: cash budget, short-term borrowing

1. Based on the information in Table 1, what is Dorian’s projected EBIT for March 2004?

a. ($10,000)

b. ($30,000)

c. $70,000

d. None of the above

Difficulty: Hard

Keywords: projected EBIT

Table 2

Fielding Wilderness Outfitters had projected its sales for the first six months of 2004 to be as follows:

Jan. $ 50,000 April $180,000

Feb. $ 60,000 May $240,000

March $100,000 June $240,000

Cost of goods sold is 60% of sales. Purchases are made and paid for two months prior to the sale. 40% of sales are collected in the month of the sale, 40% are collected in the month following the sale, and the remaining 20% in the second month following the sale. Total other cash expenses are $40,000/month. The company’s cash balance as of March 1, 2004 is projected to be $40,000, and the company wants to maintain a minimum cash balance of $15,000. Excess cash will be used to retire short-term borrowing (if any exists). Fielding has no short-term borrowing as of March 1, 2004. Assume that the interest rate on short-term borrowing is 1% per month.

1. Based on the information contained in Table 2, what are Fielding’s projected total receipts (collections) for April?

a. $124,000

b. $180,000

c. ($4,000)

d. $36,000

Difficulty: Moderate

Keywords: cash receipts

1. Based on the information in Table 2, what was Fielding’s projected loss for March?

a. $184,000

b. $110,000

c. $84,000

d. None of the above

Difficulty: Hard

Keywords: projected loss

1. Based on the information in Table 2, how much short-term financing is needed by March 30, 2004?

a. $110,000

b. $15,000

c. $70,000

d. $85,000

Difficulty: Hard

Keywords: short-term financing

Table 3

Thompson Manufacturing Supplies’ projected sales for the first six months of 2004 are given below.

Jan. $250,000 April $400,000

Feb. $300,000 May $450,000

March $400,000 June $400,000

40% of sales is collected in the month of the sale, 50% is collected in the month following the sale, and 10% is written off as uncollectible. Cost of goods sold is 70% of sales. Purchases are made the month prior to the sale and are paid during the month the purchases are made (i.e. goods sold in March are bought and paid for in February). Total other cash expenses are $50,000/month. The company’s cash balance as of February 1, 2004 will be $40,000. Excess cash will be used to retire short-term borrowing (if any). Thompson has no short-term borrowing as of February 28, 2004. Assume that the interest rate on short-term borrowing is 1% per month. The company must have a minimum cash balance of $25,000 at the beginning of each month. Round all Answers to the nearest $100.

1. Based on the information in Table 3, what are Thompson’s projected total disbursements for April?

a. $365,000

b. $315,000

c. $5,000

d. $96,607

Difficulty: Moderate

Keywords: cash disbursements

1. Based on the information in Table 3, what is Thompson’s projected gross profit for April?

a. ($5,000)

b. $85,000

c. $120,000

d. None of the above

Difficulty: Moderate

Keywords: projected gross profit

1. Based on the information in Table 3, what are Thompson’s projected total receipts (collections) for March?

a. $400,000

b. $310,000

c. ($20,000)

d. None of the above

Difficulty: Moderate

Keywords: cash receipts

1. Based on the information in Table 3, what is Thompson’s projected cumulative borrowing as of March 1, 2004?

a. $85,000

b. $45,000

c. $70,000

d. - 0 -

Difficulty: Hard

Keywords: cumulative borrowing

1. Based on the information in Table 3, what is Thompson’s projected cash balance as of April 1, 2004?

a. $32,000

b. $4,300

c. $25,000

d. None of the above

Difficulty: Hard

Keywords: projected cash balance

1. The first step involved in predicting financing needs is:

a. projecting the firm’s sales revenues and expenses over the planning period.

b. estimating the levels of investment in current and fixed assets that are necessary to support the projected sales.

c. determining the firm’s financing needs throughout the planning period.

d. none of the above.

Difficulty: Moderate

Keywords: steps to forecasting

1. A sales forecast for the coming year would reflect:

a. any past trend which is expected to continue.

b. the influence of any events that might materially affect the past trend.

c. both a and b.

d. neither a nor b.

Difficulty: Moderate

Keywords: sales forecast

1. The "percentage" used in the percent-of-sales calculation can be obtained from:

a. the most recent financial statement item as a percent of current sales.

b. an average computed over several years.

c. an analyst’s judgment.

d. all of the above.

Difficulty: Easy

Keywords: percent of sales

1. Which of the following are considered to be spontaneous sources of financing (i.e., they arise naturally during the course of doing business)?

a. Notes payable and common stock

b. Accounts receivable and bonds

c. Fixed assets and inventory

d. Accounts payable and accrued expenses

Difficulty: Moderate

Keywords: spontaneous financing

1. Spontaneous sources of financing include:

a. accounts payable and accrued expenses.

b. notes payable and mortgages payable.

c. long-term debt and capital leases.

d. common stock and paid-in capital.

Difficulty: Moderate

Keywords: spontaneous financing

1. Which of the following is the correct method of determining discretionary financing needed (DFN)?

a. Projected change in assets, divided by projected change in liabilities, plus projected change in owner’s equity

b. Projected change in assets, times projected change in owner’s equity, minus projected change in liabilities

c. Projected change in owner’s equity, minus projected change in liabilities, plus projected change in assets

d. Projected change in assets, minus projected change in liabilities, minus projected change in owner’s equity

Difficulty: Moderate

Keywords: discretionary financing needed

1. A discretionary form of financing would be:

a. notes payable.

b. accounts payable.

c. accrued expenses.

d. none of the above.

Difficulty: Easy

Keywords: discretionary forms of financing

1. Which of the following would not be found in a cash budget?

a. Interest expense

b. Taxes

c. Depreciation

d. All of the above would be found in a cash budget.

Difficulty: Easy

Keywords: cash budget components

1. An increase in projected _________ will increase discretionary funds needed.

a. cash dividends

b. sales

c. retained earnings

d. both a and b

Difficulty: Moderate

Keywords: discretionary funds needed

1. Which of the following will decrease discretionary funds needed?

a. An increase in projected accounts receivable

b. An increase in projected accounts payable

c. An increase in projected dividends

d. Both a and c

Difficulty: Moderate

Keywords: discretionary funds needed

1. Firms in high-growth industries versus low-growth industries will have lower:

a. dividend payout ratios.

b. plowback ratios.

c. sales.

d. both a and b.

Difficulty: Moderate

Keywords: growth industries, dividend payout ratios

1. Which of the following is a spontaneous source of financing?

a. Accrued expenses

b. Notes payable

c. Common stock

d. Paid-in capital

Difficulty: Easy

Keywords: spontaneous financing

1. Swings in discretionary financing needed can be caused by:

a. firm profitability.

b. economic activity.

c. industry influence.

d. all of the above.

Difficulty: Easy

Keywords: discretionary funds needed

1. The cash budget consists of all the following factors except:

a. cash receipts.

b. cash disbursements.

c. new financing needed.

d. net income.

Difficulty: Easy

Keywords: cash budget components

1. Assets that must be purchased in large, nondivisible components are referred to as _______ assets.
2. capacity
3. lumpy
4. bulky
5. current

Difficulty: Easy

Keywords: lumpy assets

Use the following information and the percent-of-sales method to Answer questions. Below is the 2004 year-end balance sheet for Banner, Inc. Sales for 2004 were $1,600,000 and are expected to be $2,000,000 during 2005. In addition, we know that Banner plans to pay $90,000 in 2005 dividends and expects projected net income of 4% of sales. (For consistency with the Answer selections provided, round your forecast percentages to two decimals.)

Banner, Inc. Balance Sheet

December 31, 2004

Assets

Current assets $890,000

Net fixed assets 1,000,000

Total $1,890,000

Liabilities and Owners’ Equity

Accounts payable $160,000

Accrued expenses 100,000

Notes payable 700,000

Long-term debt 300,000

Total liabilities 1,260,000

Common stock (plus paid-in capital) 360,000

Retained earnings 270,000

Common equity 630,000

Total $1,890,000

1. Banner’s projected current assets for 2005 are:

a. $1,000,000.

b. $1,120,000.

c. $1,500,000.

d. $1,260,000.

Difficulty: Moderate

Keywords: projected current assets

1. Banner’s projected fixed assets for 2005 are:

a. $1,120,000.

b. $1,260,000.

c. $1,000,000.

d. $2,380,000.

Difficulty: Moderate

Keywords: projected fixed assets

1. Banner’s projected accounts payable balance for 2005 is:

a. $160,000.

b. $120,000.

c. $200,000.

d. $300,000.

Difficulty: Moderate

Keywords: projected accounts payable

1. Banner’s projected accrued expenses for 2005 are:

a. $120,000.

b. $160,000.

c. $100,000.

d. $200,000.

Difficulty: Moderate

Keywords: projected accrued expenses

1. Banner’s projected long-term debt for 2005 is:

a. $700,000.

b. $880,000.

c. $380,000.

d. $300,000.

Difficulty: Moderate

Keywords: projected long-term debt

1. Banner’s projected retained earnings for 2005 are:

a. $260,000.

b. $280,000.

c. $340,000.

d. $350,000.

Difficulty: Moderate

Keywords: projected retained earnings

1. Banner’s projected discretionary financing needed for 2005 is:

a. $420,000.

b. $440,000.

c. $360,000.

d. $370,000.

Difficulty: Moderate

Keywords: discretionary financing needed

1. The sustainable growth rate represents the rate at which a firm’s sales can grow to:

a. maintain present financial ratios.

b. not have to borrow.

c. have new shares of equity.

d. both a and b.

e. all of the above.

Difficulty: Moderate

Keywords: sustainable growth rate

1. An increase in ___________ will increase the sustainable growth rate.

a. net income

b. return on equity

c. plowback ratio

d. both a and b

e. all of the above

Difficulty: Moderate

Keywords: sustainable growth rate

1. A decrease in the sustainable growth rate is caused by a decrease in:

a. plowback ratio.

b. dividend payout ratio.

c. common equity.

d. both a and c.

Difficulty: Easy

Keywords: sustainable growth rate

1. The function of a budget includes to:

a. indicate the amount and time of future financing needs.

b. provide a basis for corrective action.

c. provide information for performance evaluations.

d. all of the above.

Difficulty: Easy

Keywords: budget functions

1. A firm has a total asset turnover of 2, a net profit margin of 5%, and a debt ratio of 50%. If the firm has a dividend payout ratio of 20%, calculate its sustainable growth rate.

a. 14%

b. 16%

c. 18%

d. 20%

Difficulty: Moderate

Keywords: sustainable growth rate

1. Your firm is trying to determine its cash disbursements for the next two months (June and July). In any month, the firm makes purchases of 60% of that month’s sales, which are paid the following month. In addition, the firm incurs the following costs every month and pays for them in the month the expenses are incurred: wages/salaries of $10,000, rent of $4,000, and miscellaneous cash expenses of $1,000. Depreciation amortized on a monthly basis is $2,000. June’s sales are expected to be $100,000, and July’s sales are expected to be $150,000. Cash disbursements for the month of July are expected to be:

a. $105,000.

b. $107,000.

c. $77,000.

d. $75,000.

Difficulty: Moderate

Keywords: cash disbursements

Use the following information to Answer the questions. As of December 31, Budget, Inc. had a cash balance of $50,000. December sales were $150,000 and are expected to be $100,000 in January. 20% of sales in any month are cash sales, and 80% of sales are collected during the following month. In January, Budget is expected to have total cash disbursements of $120,000, and Budget requires a minimum cash balance of $50,000.

1. Budget’s expected cash receipts for January are:

a. $80,000.

b. $100,000.

c. $110,000.

d. $140,000.

Difficulty: Moderate

Keywords: cash receipts

1. Which of the following is not an element of the cash budget?

a. Cash receipts

b. Cash disbursements

c. Depreciation expense

d. New financing needed

Difficulty: Easy

Keywords: cash budget, depreciation expense

1. A firm has an equity ratio of 40%, a net profit margin of 4%, and total asset turnover of 3. If the firm estimates a plowback ratio of 40%, calculate its sustainable growth rate.

a. 10%

b. 15%

c. 20%

d. 25%

Difficulty: Hard

Keywords: sustainable growth rate

1. A firm’s sustainable growth rate is determined by its:

a. return on equity.

b. dividend payout ratio.

c. average collection period.

d. both a and b.

e. all of the above.

Difficulty: Moderate

Keywords: sustainable growth rate

1. The sustainable growth rate assumes which of the following varies with sales?

a. Assets

b. Spontaneous financing

c. Discretionary financing

d. Both a and b

e. All of the above

Difficulty: Moderate

Keywords: sustainable growth rate

1. Assume all else remains the same. Which of the following statements is true?

a. The lower the dividend payout, the less a firm will have to reinvest.

b. The higher the dividend payout, the more discretionary financing a firm will require.

c. The lower the dividend payout, the more discretionary financing a firm will require.

d. The higher the dividend payout, the higher the retention percentage.

Difficulty: Moderate

Keywords: dividend payout

1. Assume all else remains the same. Which of the following statements is true?

a. The lower a firm’s profit margin, the more discretionary financing a firm will require.

b. The higher a firm’s profit margin, the more discretionary financing a firm will require.

c. The lower a firm’s profit margin, the more cash a firm will have to reinvest.

d. A relationship between a firm’s profit margin and its requirement for external financing does not exist.

Difficulty: Hard

Keywords: new financing needed

1. Which of the following accounts would normally increase with an increase in sales and approximately in proportion to the sales increase?

a. Common stock

b. Inventory

c. Notes payable

d. Dividends

e. Accounts receivable

Difficulty: Easy

Keywords: spontaneous accounts

1. Holding other things constant, a firm’s "discretionary financing needed" (the additional funds required in order to finance the firm) would be reduced if the firm experienced an increase in which of the following?

a. The dividend pay-out ratio

b. The profit margin

c. The accounts receivable average collection period

d. The expected growth rate in sales

e. The income tax rate

Difficulty: Moderate

Keywords: impacts on discretionary financing needed

1. Which of the following is a source of external capital?

a. Retained earnings

b. Inventory

c. Long-term debt

d. Operating income (earnings before interest and taxes)

e. None of the above

Difficulty: Easy

Keywords: external financing

1. Considering each action independently and holding other things constant, which of the following actions would increase a firm’s discretionary financing needed (the need for additional capital)?

a. A decrease in the firm’s accounts receivable average collection period

b. An increase in the firm’s profit margin

c. A decrease in the firm’s inventory turnover

d. A decrease in the expected growth rate in sales

e. A decrease in the firm’s tax rate

Difficulty: Hard

Keywords: discretionary financing needed

1. Miller Metalworks had sales in November of $60,000, in December of $40,000, and in January of $80,000. Miller collects 40% of sales in the month of the sale and 60% one month after the sale. Calculate Miller’s cash receipts for January.

a. $44,000

b. $56,000

c. $64,000

d. $72,000

Difficulty: Moderate

Keywords: cash receipts

1. Under which of the following conditions would the percent-of-sales method of financial forecasting be most accurate?

a. If assets must be purchased in discrete quantities

b. When asset requirements can be accurately forecasted as a constant percent of sales

c. If economic circumstances beyond a firm’s control drastically change from one year to the next

d. When economies of scale can be realized from investing in specific assets

Difficulty: Moderate

Keywords: limitations of percent-of-sales method

1. The preparation of pro forma financial statements accomplishes which of the following objectives?

a. It allows management to pinpoint a firm’s optimal stock price.

b. It is essential if the firm is to accurately estimate its weighted average cost of capital.

c. It assists management in making decisions with respect to raising the capital that is needed for growth.

d. All of the above.

e. None of the above.

Difficulty: Moderate

Keywords: pro forma statements

1. Which of the following best represents a firm’s sustainable growth rate?

a. The maximum rate of growth in profits that a firm can achieve while maintaining its present stock price

b. The maximum rate of growth in earnings per share that a firm can achieve while maintaining its optimal return on equity

c. The maximum rate of growth in stock price that a firm can achieve while maintaining its optimal debt structure

d. The maximum rate of growth in sales that a firm can achieve while maintaining its present capital structure

e. None of the above

Difficulty: Moderate

Keywords: sustainable growth rate

1. The percent-of-sales method of forecasting makes which of the following assumptions?

a. The inventory turnover will remain the same during the forecast period.

b. The profit margin will remain constant during the forecast period.

c. Cash, as a percent of sales, will remain constant throughout the forecast period.

d. All of the above.

e. None of the above.

Difficulty: Moderate

Keywords: percent-of–sales assumptions

1. The percent-of-sales method of forecasting makes which of the following assumptions?

a. That some assets do not increase in direct proportion to an increase in sales.

b. The accounts receivable average collection period will remain constant throughout the forecast period.

c. The firm may acquire some "lumpy" assets.

d. All of the above.

e. None of the above.

Difficulty: Moderate

Keywords: percent-of–sales assumptions

1. Marjen Manufacturing has purchases equal to 40% of sales. They purchase one month prior to sales and pay one month after sales. Given the following sales forecast, calculate Marjen’s payments for March.

Projected Sales

January $80,000

February $100,000

March $120,000

a. $40,000

b. $60,000

c. $80,000

d. $100,000

Difficulty: Easy

Keywords: cash budget payments

1. Delta.com has achieved an average return on equity of 36.5% for the last five years. If Delta generates a 17.2% net profit margin on sales of $3 billion and pays no dividends, what is Delta.com’s sustainable rate of growth?

a. 4.0%

b. 12.8%

c. 17.2%

d. 36.5%

Difficulty: Moderate

Keywords: sustainable growth rate

1. Amalgamated Steel, Inc. has averaged a net profit margin of 6.6% and a plowback ratio of 64% for the last 10 years. The firm’s sales-to-asset ratio has averaged 1.0, and its asset-to-equity ratio has averaged 1.8 for the same period. What is Amalgamated’s sustainable rate of growth?

a. 7.60%

b. 18.00%

c. 11.88%

d. 6.40%

Difficulty: Moderate

Keywords: sustainable growth rate

1. Home to House Distributors is preparing a cash budget. The initial conclusion is that the firm will need to borrow more money than its bank is willing to lend. Which of the following actions could Home to House Distributors perform to reduce its need for bank financing this year?

a. Pay cash for purchasing inventory instead of having to rely on trade credit

b. Prepay next year’s quarterly income tax payments

c. Collect the firm’s accounts receivable faster

d. Purchase larger quantities of inventory to take advantage of trade discounts

Difficulty: Moderate

Keywords: cash budget

1. Which of the following expenses should be included as a cash outlay in the preparation of a cash budget?

a. The payment of accounts payable

b. The payment of depreciation expense

c. The payment of accrued income taxes

d. All of the above

e. None of the above

Difficulty: Easy

Keywords: cash budget outlays

1. The preparation of a cash budget serves which of the following purposes?

a. To estimate the amount and timing of cash flows that are needed in order to optimize the price of the firm’s common stock

b. To calculate the amount of future cash flows that would be needed in order to achieve the optimal level of financing during the forecast period

c. To determine the amount and timing of short-term financing that would be required for the operation of a business during the forecast period

d. To estimate the amount of sales volume that would be required in order to achieve the break-even point

Difficulty: Moderate

Keywords: purpose of cash budget

1. Assume that Dynamo Corp. has sales of $15 million and accounts receivable of $2 million. The corporation utilizes the percent-of-sales method of financial forecasting. If Dynamo is expected to generate sales of $20 million next year, what will the firm’s investment in accounts receivable be?

a. $2.0 million

b. $2.7 million

c. $1.5 million

d. None of the above

Difficulty: Moderate

Keywords: projected accounts receivable

1. Apple Two Enterprises expects to generate sales of $5,950,000 for fiscal 2002; sales were $3,450,000 in fiscal 2001. Assume the following figures for the fiscal year ending 2001: cash $70,000; accounts receivable $250,000; inventory $400,000; net fixed assets $520,000; accounts payable $235,000; and accruals $155,000. Use the percent-of-sales method to forecast inventory for the fiscal year ending 2002.

a. $595,500

b. $689,855

c. $236,012

d. $400,000

Difficulty: Moderate

Keywords: projected inventory

1. Apple Two Enterprises expects to generate sales of $5,950,000 for fiscal 2002; sales were $3,450,000 in fiscal 2001. Assume the following figures for the fiscal year ending 2001: cash $70,000; accounts receivable $250,000; inventory $400,000; net fixed assets $520,000; accounts payable $235,000; and accruals $155,000. Use the percent-of-sales method to forecast accruals for the fiscal year ending 2002.

a. $890,001

b. $412,316

c. $267,319

d. $350,814

Difficulty: Moderate

Keywords: projected accruals

1. Apple Two Enterprises expects to generate sales of $5,950,000 for fiscal 2002; sales were $3,450,000 in fiscal 2001. Assume the following figures for the fiscal year ending 2001: cash $70,000; accounts receivable $250,000; inventory $400,000; net fixed assets $520,000; accounts payable $235,000; and accruals $155,000. Use the percent-of-sales method to forecast cash for the fiscal year ending 2002.

a. $120,725

b. $ 75,003

c. $216,418

d. $319,604

Difficulty: Moderate

Keywords: projected cash

1. Which of the following will decrease cumulative borrowing on the cash budget?

a. A decrease in interest expense

b. A decrease in collections

c. An increase in equipment purchases

d. Both a and b

Difficulty: Moderate

Keywords: cumulative borrowing impacts

1. Apple Two Enterprises expects to generate sales of $5,950,000 for fiscal 2002; sales were $3,450,000 in fiscal 2001. Assume the following figures for the fiscal year ending 2001: cash $70,000; accounts receivable $250,000; inventory $400,000; net fixed assets $520,000; accounts payable $235,000; and accruals $155,000. Use the percent-of-sales method to forecast accounts payable for the fiscal year ending 2002.

a. $212,036

b. $405,290

c. $619,619

d. $155,000

Difficulty: Moderate

Keywords: percent-of-sales method

1. Assume that Zybo, Inc. has sales of $10 million and inventory of $2 million. The corporation utilizes the percent-of-sales method of financial forecasting. If Zybo is expected to generate sales of $14 million next year, what will the firm’s investment in inventory be?

a. $1.4 million

b. $2.0 million

c. $2.8 million

d. None of the above

Difficulty: Moderate

Keywords: percent-of-sales method

1. Assume that Calamar Corp. has sales of $7.5 million and accounts payable of $450,000. The corporation utilizes the percent-of-sales method of financial forecasting. If Calamar is expected to generate sales of $9 million next year, what will the firm’s accounts payable be?

a. $540,000

b. $450,000

c. $405,000

d. None of the above

Difficulty: Moderate

Keywords: percent of sales method

1. Assume that Hercules Manufacturing has sales of $25 million and current assets of $5 million. The corporation utilizes the percent-of-sales method of financial forecasting. If Hercules is expected to generate sales of $31 million next year, what will the firm’s investment in current assets be?

a. $8.3 million

b. $4.0 million

c. $6.2 million

d. $5.0 million

e. None of the above

Difficulty: Moderate

Keywords: projected current assets

1. Assume that Helaron, Inc. has sales of $83 million and fixed assets of $22.4 million. The corporation utilizes the percent-of-sales method of financial forecasting. If Helaron is expected to generate sales of $94 million next year, what will the firm’s investment in fixed assets be?

a. $19.8 million

b. $28.8 million

c. $16.2 million

d. $25.4 million

e. None of the above

Difficulty: Moderate

Keywords: projected fixed assets

Short Answer

1. Discuss the limitations of the percent-of-sales forecast method.

Difficulty: Moderate

Keywords: limitations of percent-of-sales

1. Discuss the basic functions that budgets perform for a firm.

Difficulty: Easy

Keywords: budget functions

1. What is the difference between spontaneous financing and discretionary financing?

Difficulty: Easy

Keywords: spontaneous versus discretionary financing

1. The balance sheet of the Jackson Company is presented below:

Jackson Company Balance Sheet

March 31, 2004

(Millions of Dollars)

Current assets $12 Accounts payable $6

Fixed assets 18 Long-term debt 12

Total $30 Common equity 12

Total $30

For the year ending March 31, 2004, Jackson had sales of $35 million. The common stockholders received all net earnings of the firm in the form of cash dividends, leaving no funds from earnings available to the firm for expansion (assume that depreciation expense is just equal to the cost of replacing worn-out assets).

Construct a pro forma balance sheet for March 31, 2005 for an expected level of sales of $45 million. Assume current assets and accounts payable vary as a percent of sales, and fixed assets remain at the present level. Use notes payable as a source of discretionary financing.

Jackson Company

Pro Forma Balance Sheet

March 31, 2005

Current assets $15.0 Accounts payable $7.5

Fixed assets 18.0 Notes payable 1.5

Total $33.0 Long-term debt 12.0

Common equity 12.0

Total $33.0

Difficulty: Moderate

Keywords: pro forma balance sheet

1. Frog Hollow Bakery is a new firm specializing in all-natural-ingredient pastry products. In attempting to determine what the financial position of the firm should be, the financial manager obtained the following average ratios for the baking industry for 2004:

Common equity to total assets = 60%

Total asset turnover = 3 times

Long-term debt to total capitalization = 25%

Current ratio = 1.2

Quick ratio = .75

Average collection period (360-day year) = 10 days

Complete the accompanying pro forma balance sheet for Frog Hollow Bakery assuming 2005 sales (all credit) are $450,000.

Frog Hollow Bakery

Pro Forma Balance Sheet

December 31, 2005

Cash $ Current debt $

Accounts receivable Long-term debt

Inventory

Total current assets Common equity

Fixed assets Total liabilities and equity $

Total assets

Frog Hollow Bakery

Pro Forma Balance Sheet

December 31, 2005

Cash $10,000 Current debt $ 30,000

Accounts receivable 12,500 Long-term debt 30,000

Inventory 13,500

Total current assets $36,000 Common equity 90,000

Fixed assets 114,000 Total liabilities

Total assets $150,000 and equity $150,000

Difficulty: Moderate

Keywords: percent of sales, pro forma statements

1. Broad Cloth, Inc. sells its cloth to retail stores on credit terms of 3/15, net 45 (a 3% discount is given for payment within 15 days and the net amount is due in 45 days). The firm’s average collection period is 30 days.

a. The vice-president of marketing has projected credit sales of $2.0

million for the coming year. Based on this estimate, project Broad

Cloth’s accounts receivable level for the year.

b. The firm is considering changing its discount terms to 2/5, net 45,

which it believes will cause the average collection period to

increase to 40 days. Project the accounts receivable balance for

the coming year on the new credit terms and sales of $2.0 million.

a. Average collection period

= (A-R)/(Credit Sales/360)

A-R = ($2,000,000/360) × 30

A-R = $166,667

b. A-R = ($2,000,000/360) × 40

A-R = $222,222

Difficulty: Moderate

Keywords: forecasting accounts receivable

1. The cash budget for Parker Process Meats, Inc. for the fourth quarter of 2004 is given below:

Parker Process Meats, Inc.

Cash Budget for the Three Months Ending December 31, 2004

Cash receipts Oct. Nov. Dec.

Total collections $31,050 $ 4,050 $49,950

Cash disbursements:

Purchases 44,550 48,600 52,650

Wages and salaries 7,425 7,425 7,425

Other expenses 2,025 1,350 675

Taxes 17,415

Total disbursements $54,000 $57,375 $78,165

The expected sales for the period are as follows:

Oct.: $86,400 Nov.: $91,800 Dec.: $83,700

The total depreciation expense for the period will be $8,775. An interest payment on outstanding debt of $15,000 will be made in December. Using the information given, construct a pro forma income statement for the final quarter of 2004 for Parker.

Parker Processed Meats, Inc.

Pro Forma Income Statement

For the Quarter Ended December 31, 2004

Sales $261,900

Less: cost of goods sold 145,800

Gross profits $116,100

Less:

Depreciation expense $8,775

Wages and salaries 22,275

Other expenses 4,050

Net operating income $81,000

Less: interest expense 15,000

Earnings before taxes $66,000

Less: income taxes 17,415

Net income $48,585

Difficulty: Moderate

Keywords: pro forma income statement

1. Discuss the underlying assumptions of the sustainable growth rate.

Difficulty: Moderate

Keywords: sustainable growth rate assumptions

1. The treasurer for Brookdale Clothing must decide how much money the company needs to borrow in July. The balance sheet for June 30, 2004 is presented below:

Brookdale Clothing Balance Sheet

June 30, 2004

Cash $75,000 Accounts payable $ 400,000

Marketable securities 100,000 Long-term debt 300,000

Accounts receivable 300,000 Common stock 100,000

Inventory 250,000 Retained earnings 200,000

Total current assets 725,000 Total liabilities and

Fixed assets 275,000 stockholder’s equity $1,000,000

Total assets $1,000,000

The company expects sales of $250,000 for July. The company has observed that 25% of its sales is for cash and that the remaining 75% is collected in the following month. The company plans to purchase $400,000 of new clothing. Usually 40% of purchases is for cash and the remaining 60% of purchases is paid in the following month. Salaries are $100,000 per month, lease payments are $50,000 per month, and depreciation charges are $20,000 per month. The company plans to purchase a new building for $200,000 in July and sell its marketable securities for $100,000. If the company must maintain a minimum cash balance of $50,000, how much money must the company borrow in July?

Brookdale Clothing

Cash Budget for July 2004

Cash Inflows

Reduction in cash $25,000

Sale of marketable securities 100,000

Collection of accounts receivable 300,000

Cash sales (.25)($250,000) 62,500

Total cash inflows $487,500

Cash Outflows

Repayment of accounts payable $400,000

Cash purchases 160,000

Salaries 100,000

Lease payments 50,000

Purchase of building 200,000

Total cash outflows $910,000

Net inflow (outflows) ($422,500)

The company needs to borrow $422,500.

Difficulty: Hard

Keywords: projected financing needs, cash budget

1. The ZYX Corporation is planning to request a line of credit from its bank and wants to estimate its cash needs for the month of September. The following sales forecasts have been made for 2005:

July $500,000

August $400,000

September $300,000

October $200,000

November $100,000

Collection estimates were obtained from the credit collection department as follows: 20% collected within the month of sale; 70% collected the first month following the sale; and 10% collected the second month following the sale. Payments for labor and raw materials are typically made in the month in which these costs are incurred. Total labor and raw material costs each month are 50% of sales. General administrative expenses are $30,000 per month, lease payments are $10,000 per month, and depreciation charges are $20,000 per month. The corporation tax rate is 40%; however, no corporate taxes are paid in September. Prepare a cash budget for September.

ZYX Corporation

Pro Forma Income Statement

September 2005

Sales $300,000

Total cost of goods sold 150,000

Gross profit $150,000

Depreciation 20,000

General administrative expenses 30,000

Lease payments 10,000

Operating income $90,000

Taxes 36,000

Net income $54,000

ZYX Corporation

Cash Budget

September 2005

Cash Inflows

Collections from September sales $ 60,000

Collections from August sales 280,000

Collections from July sales 50,000

Total cash inflows $390,000

Cash Outflows

Labor and raw materials $150,000

General administrative expenses 30,000

Lease payments 10,000

Total cash outflow $190,000

Net cash inflow $200,000

Difficulty: Hard

Keywords: cash budget

1. Amalgamated Enterprises is planning to purchase some new equipment. With this new equipment, the company expects sales to increase from $8,000,000 to $10,000,000. A portion of the financing for the purchase of the equipment will come from a $1,000,000 new common stock issue. The company knows that current assets, fixed assets, accounts payable, and accrued expenses increase in direct proportion with sales. The company’s net profit margin on sales is 8%, and the company plans to pay 40% of its after-tax earnings in dividends. A copy of the company’s current balance sheet is given below:

Amalgamated Enterprises Balance Sheet

Current assets $ 3,000,000

Fixed assets 12,000,000

Total assets $15,000,000

Accounts payable $ 4,000,000

Accrued expenses 1,000,000

Long-term debt 3,000,000

Common stock 2,000,000

Retained earnings 5,000,000

Total liabilities and net worth $15,000,000

Prepare a pro forma balance sheet for Amalgamated for next year using the percent-of-sales method and the information provided above.

Amalgamated Enterprises

Pro Forma Balance Sheet

Projected

Present Percent Based on

Level of Sales of

(Mil) Sales $10 Mil

Current assets $2 .375 $3.75

Fixed assets 12 1.500 15.00

Total assets $15 $18.75

Accounts payable $4 .50 $5.00

Accrued expenses $1 .125 1.25

Long-term debt 3 a. 4.02d.

Common stock 2 a. 3.00b.

Retained earnings 5 a. 5.48c.

Total liabilities

and net worth $15 $18.75

Notes

a. Not applicable. These accounts are assumed not to vary directly

with sales.

b. The company issued $1 million in new common stock.

c. The increase in retained earnings is equal to net profit minus

dividends paid. Increase in retained earnings = (.08)($1M)(1 - .40)

= $.48M

d. The long-term debt on the projected balance sheet is equal to total

assets minus accounts payable, accrued expenses, common stock, and

retained earnings. Long-term debt = $18.75M = $5.0M + $1.25M +

$3.0M + $5.48M = $4.02M

Difficulty: Hard

Keywords: percent-of-sales method

1. Lindsey Insurance Co. has current sales of $10 million and predicts next year’s sales will grow to $14 million. Current assets are $3 million and fixed assets are $4 million. The firm’s net profit margin is 7% after taxes. Presently, Lindsey has $900,000 in accounts payable, $1.1 million in long-term debt, and $5 million (including $2.5 million in retained earnings) in common equity. Next year, Lindsey projects that current assets will rise in direct proportion to the forecasted sales, and that fixed assets will rise by $500,000. Lindsey also plans to pay dividends of $400,000 to common shareholders.

a. What are Lindsey’s total financing needs for the upcoming year?

b. Given the above information, what are Lindsey’s discretionary

financing needs?

a. Projected Financing Needs = Projected Total Assets = Projected

Current Assets + Projected Fixed Assets = ($3m/$10m) × $14m + $4m +

$.5m = $8.7m

b. DFN = Projected Current Assets + Projected Fixed Assets - Present

LTD - Present Owner’s Equity - [Projected Net Income - Dividends] -

Spontaneous Financing = ($3m/$10m) × $14m + $4.5m - $1.1m - $5m

- [.07 × $14m - $.4m] - ($.9m/$10m) × $14m

DFN = $4.2m + $4.5m - $6.1m - $.58m - $1.26m = $.76m

Difficulty: Moderate

Keywords: discretionary financing

1. Hardings’ Furniture provides a credit program to its retailers. Because only a portion of its retailers take advantage of this program, Hardings’ Furniture has an average collection period of 26 days.

a. Based upon estimated credit sales of $800,000, predict Hardings’

accounts receivable for the upcoming year.

b. If Hardings’ changes its credit terms, it expects the average

collection period to rise to 31 days. Estimate Hardings’ accounts

receivable balance based on the new credit terms and credit sales

of $800,000.

a. Avg. Col. Pd. = Accounts Rec./(Credit Sales/360)

26 days = Accounts Rec./($800,000/360)

Accounts Rec. = $57,778

b. Accounts Rec. = ($800,000/360 days) × 31 Days = $68,889

Difficulty: Moderate

Keywords: projected accounts receivable