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Exam 12: Financial Planning and Forecasting Financial Statements

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Question 21

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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) ?

A) A sharp increase in its forecasted sales.
B) A switch to a just-in-time inventory system and outsourcing production.
C) The company reduces its dividend payout ratio.
D) The company switches its materials purchases to a supplier that sells on terms of 1/5, net 90, from a supplier whose terms are 3/15, net 35.
E) The company discovers that it has excess capacity in its fixed assets.

F) All of the above
G) A) and D)

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Question 22

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A firm will use spontaneous funds to the extent possible; however, due to credit terms, contracts with workers, and tax laws there is little flexibility in their usage.

A) True
B) False

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Question 23

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Two firms with identical capital intensity ratios are generating the same amount of sales. However, Firm A is operating at full capacity, while Firm B is operating below capacity. If the two firms expect the same growth in sales during the next period, then Firm A is likely to need more additional funds than Firm B, other things held constant.

Spontaneous funds are generally defined as follows:

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are not large, sales forecast accuracy is not critical to the well-being of the firm.

A typical sales forecast, though concerned with future events, will usually be based on recent historical trends and events as well as on forecasts of economic prospects.

Which of the following assumptions is embodied in the AFN equation?

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.

Last year Emery Industries had $450 million of sales and $225 million of fixed assets, so its FA/Sales ratio was 50%. However, its fixed assets were used at only 65% of capacity. If the company had been able to sell off enough of its fixed assets at book value so that it was operating at full capacity, with sales held constant at $450 million, how much cash (in millions) would it have generated?

Chua Chang & Wu Inc. is planning its operations for next year, and the CEO 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?

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 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.

Last year Jain Technologies had $250 million of sales and $100 million of fixed assets, so its FA/Sales ratio was 40%. 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?

Last year Handorf-Zhu Inc. had $850 million of sales, and it had $425 million of fixed assets that were used at only 60% of capacity. What is the maximum sales growth rate the company could achieve before it had to increase its fixed assets?

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.

The capital intensity ratio is the amount of assets required per dollar of sales and it has a major impact on a firm's capital requirements.

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.

One of the necessary steps in the financial planning process is a forecast of financial statements under each alternative version of the operating plan in order to analyze the effects of different operating procedures on projected profits and financial ratios.