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Exam 12: Corporate Valuation and Financial Planning

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Question 1

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Spontaneous funds are generally defined as follows:

A) A forecasting approach in which the forecasted percentage of sales for each item is held constant.
B) Funds that a firm must raise externally through short-term or long-term borrowing and/or by selling new common or preferred stock.
C) Funds that arise out of normal business operations from its suppliers, employees, and the government, and they include immediate increases in accounts payable, accrued wages, and accrued taxes.
D) The amount of cash raised in a given year minus the amount of cash needed to finance the additional capital expenditures and working capital needed to support the firm's growth.
E) Assets required per dollar of sales.

F) B) and C)
G) A) and B)

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Question 2

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A rapid build-up of inventories normally requires additional financing, unless the increase is matched by an equally large decrease in some other asset.

A) True
B) False

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Question 3

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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.

F.Marston, Inc.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) ?

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?

Decker Enterprises Below are the simplified current and projected financial statements for Decker Enterprises. All of Decker's assets are operating assets. All of Decker's current liabilities are operating li abilities. $\begin{array} { l c r } \text { Income statement } & \text { Current} & \text { Projected } \\ \text { Sales } & \text { na } & 1,500 \\ \text { Costs } & \text { na } & 1,080 \\ \text { Profit before tax } & \text { na } & 420 \\ \text { Taxes } ( 25 \% ) & \text { na } &\underline{ 105} \\ \text { Net income } & \text { na } & 315 \\ \text { Dividends } & \text { na } & 95 \end{array}$ $\begin{array} { l r r l r r } \text { Balance sheets } & \text { Current } & \text { Projected } & & \text { Current } & \text { Projected } \\ \text { Current assets } & 100 & 115 & \text { Current liabilities } & 70 & 81 \\ \text { Net fixed assets } & 1,200 & 1,440 & \text { Long-term debt } & 300 & 360 \\ & & & \text { Common stock } & 500 & 500 \\ & & & \text { Retained earnings } & 430 & 650 \end{array}$ -If Decker had a financing surplus, it could remedy the situation by

If a firm wants to maintain its ratios at their existing levels, then if it has a positive sales growth rate of any amount, it will require some amount of external funding.

Operating plans sketch out broad approaches for realization of the firm's strategic vision.These plans usually are developed for a period no longer than a 1-year time horizon because detail is "lost" by extending out the time horizon by more than 1 year.

As a firm's sales grow, its current assets also tend to increase.For instance, as sales increase, the firm's inventories generally increase, and purchases of inventories result in more accounts payable.Thus, spontaneous liabilities that reduce AFN arise from transactions brought on by sales increases.

Which of the following statements is CORRECT?

If a firm's capital intensity ratio (A₀*/S₀) decreases as sales increase, use of the AFN formula is likely to understate the amount of additional funds required, other things held constant.

Firms with high capital intensity ratios have found ways to lower this ratio permitting them to achieve a given level of growth with fewer assets and consequently less external capital.For example, just-in-time inventory systems, multiple shifts for labor, and outsourcing production are all feasible ways for firms to reduce their capital intensity ratios.

Firms pay a low interest rate on spontaneous liabilities so these funds are its cheapest source of capital.Consequently, the firm should make arrangements with its suppliers to use as much of this credit as possible.

In your internship with Lewis, Lee, & Taylor Inc.you have been asked to forecast the firm's additional funds needed (AFN) for next year.The firm is operating at full capacity.Data for use in your forecast are shown below.Based on the AFN equation, what is the AFN for the coming year? $\begin{array}{lcc}\text { Last year's sales }=\mathrm{S}_{0} & \$ 200,000 \text { Last year's accounts payable } & \$ 50,000 \\\text { Sales growth rate }=\mathrm{g} & 40 \% \text { Last year's notes payable } & \$ 15,000\\\text { Last year's total assets }=\mathrm{A}_{0} * & \$ 135,000 \text { Last year's accruals } & \$ 20,000 \\\text { Last year's profit margin }=\mathrm{PM} & 20.0 \% \text { Target payout ratio } & 25.0 \text { \% }\end{array}$

Daniel Sawyer, the CEO of the Sawyer Group, is initiating planning for the company's operations next year, and he wants you to forecast the firm's additional funds needed (AFN) .The firm is operating at full capacity.Data for use in your forecast are shown below.Based on the AFN equation, what is the AFN for the coming year? Dollars are in millions. $\begin{array} { l c c } \text { Last year's sales } = \mathrm { S } _ { 0 } & \$ 350& \text { Last year's accounts payable } & \$ 40 \\\text { Sal es growth rate } = \mathrm { g } & 30 \% &\text { Last year's notes payable } & \$ 50 \\\text { Last year's total assets } = \mathrm { An } ^ { * } & \$ 500 &\text { Last year's accruals } & \$ 30 \\\text { Last year's profit margin = PM } & 5 \%& \text { Target payout ratio } & 60 \%\end{array}$

Which of the following statements is CORRECT?

Companies with relatively high assets-to-sales ratios require a relatively large amount of new assets for any given increase in sales; hence, they have a greater need for external financing.There are currently no alternatives for these types of firms to lower their asset requirements.

Last year National Aeronautics had a FA/Sales ratio of 40%, comprised of $250 million of sales and $100 million of fixed assets.However, its fixed assets were used at only 75% of capacity.Now the company is developing its financial forecast for the coming year.As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full capacity.What target FA/Sales ratio should the company set?

A firm's AFN must come from external sources.Typical sources include short-term bank loans, long-term bonds, preferred stock, and common stock.

Decker Enterprises Below are the simplified current and projected financial statements for Decker Enterprises. All of Decker's assets are operating assets. All of Decker's current liabilities are operating li abilities. $\begin{array} { l c r } \text { Income statement } & \text { Current} & \text { Projected } \\ \text { Sales } & \text { na } & 1,500 \\ \text { Costs } & \text { na } & 1,080 \\ \text { Profit before tax } & \text { na } & 420 \\ \text { Taxes } ( 25 \% ) & \text { na } &\underline{ 105} \\ \text { Net income } & \text { na } & 315 \\ \text { Dividends } & \text { na } & 95 \end{array}$ $\begin{array} { l r r l r r } \text { Balance sheets } & \text { Current } & \text { Projected } & & \text { Current } & \text { Projected } \\ \text { Current assets } & 100 & 115 & \text { Current liabilities } & 70 & 81 \\ \text { Net fixed assets } & 1,200 & 1,440 & \text { Long-term debt } & 300 & 360 \\ & & & \text { Common stock } & 500 & 500 \\ & & & \text { Retained earnings } & 430 & 650 \end{array}$ -Based on the projections, Decker will have