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Financial Management (A.

Financial Planning & Strategies)

MODULE 11 FINANCIAL MANAGEMENT A. FINANCIAL PLANNING AND STRATEGIES THEORIES: Business plan 3. The typical outline of the component parts of a business plan would be the A. mission and strategy statements. C. financial projections. B. operations of the business. D. All of the above. Financial planning process 2. Planning for future growth is called: A. capital budgeting C. financial forecasting B. working capital management D. none of the above 1. The ideal financial planning process would be A. top-down planning. B. bottom-up planning. C. a combination of top-down and bottom-up planning. D. none of the above. 18.Which of the following is incorrect regarding the construction of financial planning models? A. There is no theory or model that leads straight to the optimal financial strategy. B. Financial planning should not proceed by trial and error. C. Many different strategies may be projected under a range of assumptions about the future before one strategy is finally chosen. D. The dozens of separate projections that may be made during this trial-and-error process generate a heavy load of arithmetic and paperwork.

Financing policy Maturities matching 23.When a firm finances long-term assets with short-term sources of funding, it: A. reduces the risk of cash shortage B. will have higher interest expenses C. improves the leverage ratio D. is ignoring the principle of matched maturities Short-term financing 14.The type of company most likely to need short-term financing is one that A. has no seasonality and no growth in sales from year to year B. sells only for cash C. has a high degree of seasonality D. has lower total fixed costs than total variable costs 25.Common sources of short-term financing include: A. Stretching payables C. Reducing inventory B. Issuing bonds D. All of the above 24.How does long-term financing policy affect short-term financing requirements? A. The nature of the firm's short-term financial planning problem is determined by the amount of long-term capital it raises. B. A firm that issues large amounts of long-term debt or common stock, or that retains a large part of its earnings, may find that it has permanent excess cash. Other firms raise relatively little long-term capital and end up as permanent short-term debtors. C. Most firms attempt to find a golden mean by financing all fixed assets and part of current assets with equity and long-term debt. Such firms may invest cash surpluses during part of the year and borrow during the rest of the year. D. All of the above affect short-term financing. Judgmental approach

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Financial Management (A. Financial Planning & Strategies)

21.Under the judgmental approach for developing a pro forma balance sheet, the plug figure required to bring the statement into balance may be called the A. retained earnings C. suspense account B. accounts receivable D. required new financing Percent of sales method 6. The percent of sales method is based on which of the following assumptions? A. All balance sheet accounts are tied directly to sales. B. Most balance sheet accounts are tied directly to sales. C. There is considerably excessive asset level. D. Statements a and c above are correct. 4. Which of the following is the major independent variable in constructing pro forma income statements and balance sheets? A. total assets C. dividend payout B. net income D. sales 7. The first step in developing a pro forma income statement is to: A. build a sales forecast C. determine the cost of goods sold B. determine the production schedule D. none of the above 20.The percent-of-sales method of preparing the projected income statement assumes that all costs are: A. Constant C. Variable B. Fixed D. Independent 22.Utilizing past cost and expense ratios (percent-of-sales method) when preparing pro forma financial statements will tend to A. Understate profits when sales are decreasing and overstate profits when sales are increasing. B. Understate profits, no matter what the change in sales, as long as fixed costs are present. C. Understate profits when sales are increasing and overstate profits when sales are decreasing.
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D. Overstate profits, no matter what the change in sales, as long as fixed costs are present. Additional funds needed 5. Additional funds needed are best defined as: A. Funds that are obtained automatically from routine business transactions. B. Funds that a firm must raise externally through borrowing or by selling new common or preferred stock. C. The amount of assets required per peso of sales. D. A forecasting approach in which the forecasted percentage of sales for each item is held constant. 8. Which of the following statements about forecasting external funding requirements via the percentage of sales method is true? A. The plan assumes that sales are determined by assets that determine the external funds needed. B. The plan assumes that the external funds needed impact assets which in turn drive sales. C. The plan assumes that sales determine assets that determine the external funding needed. D. The plan assumes that there is a varying relationship between sales, assets, and funds needed. 11.Which of the following best describes a firm's external funding requirement? A. Growth in assets minus growth in liabilities minus net income B. Growth in assets minus the current year's retained earnings C. Growth in assets minus growth in current liabilities minus net income D. Growth in assets minus growth in current liabilities minus the year's retained earnings 15.A company that has rapidly growing sales will probably A. need additional long-term financing C. have asset requirements increasing

Financial Management (A. Financial Planning & Strategies)

B. have a financing gap true

D. find that all of the above are

B. A decrease in accruals

D. All of the above

17.Which of the following statements is most correct? A. Since accounts payable and accrued liabilities must eventually be paid, as these accounts increase, required new financing also increases. 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. If a firm retains all of its earnings, then it will not need any additional funds to support sales growth. 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. Growth 19.Which of the following is incorrect regarding the effect of growth on the need for external financing? A. Higher growth rates will lead to a greater need for investments in fixed assets and working capital. B. The internal growth rate is the maximum rate that the firm can grow if it relies entirely on reinvested profits to finance its growth, that is, the maximum rate of growth without requiring external financing. C. The sustainable growth rate is the rate at which the firm can grow with the option of flexibly changing its leverage ratio. D. One very simple starting point may be a percentage of sales model in which many key variables are assumed to be directly proportional to sales. Sensitivity analysis 9. Holding all other variables constant, which of the following would increase a firm's external funding requirements in the planning period? A. An increase in assets C. An increase in dividends paid
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10.Which of the following is likely to increase the required new financing (RNF) in a given year? A. The company reduces its dividend payout ratio. B. The companys profit margin increases. C. The company decides to reduce its reliance on accounts payable as a form of financing. D. The company is operating well below full capacity. 12.Monument Corporation has developed a forecasting model to determine the additional funds it needs in the coming year. Other factors remaining unchanged, which of the following factors is likely to increase its additional financing requirement? A. A sharp increase in its forecasted sales and the companys fixed assets are at full capacity. B. A reduction in its dividend payout ratio. C. The company increases its reliance on trade credit that sharply raises its accounts payable. D. A new cost control produces more efficient costs. 13.Which of the following will not permit a higher internal growth rate, other things equal? A. A higher plowback ratio C. A higher return on equity B. A higher debt-to-asset ratio D. A higher return on assets Sustainable growth rate 16.The sustainable growth rate is best described by which of the following? A. The rate of sales growth that will sustain the assets of the company. B. The rate of earnings growth needed to avoid external financing. C. The maximum rate of sales growth of a company without using external debt. D. The maximum rate of sales growth of a company without raising external funds from the sale of stock.

Financial Management (A. Financial Planning & Strategies)

PPROBLEMS: Percent-of-sales method Total assets requirements 1 . Lamp has projected sales of P100,000, a gross profit margin of 45%, a return on sales of 15%. Accounts receivable has been 25% of sales while inventory has been 10% of cost of sales. Lamp has minimum cash balance of P10,000 and fixed assets are projected to be P75,000. Total assets requirements would be A. P 40,500 C. P115,500 B. P240,000 D. P270,000 Additional Financing Needed Total assets 2 . Calculate the total assets of Premiere Company given the following information: Sales this year P3,000,000 Sales increase projected for next year 20 percent Net income this year P 250,000 Dividend payout ratio 40 percent Projected excess funds available next year P 100,000 Accounts payable P 600,000 Notes payable P 100,000 Accrued wages and taxes P 200,000 Except for the accounts noted, there were no other current liabilities. Assume that the firms profit margin remains constant and that the company is operating at full capacity. A. P3,000,000 C. P2,000,000 B. P2,200,000 D. P1,200,000 Addition to retained earnings 3 . Almond Corporation recently reported the following income statement for 2006 (in P000): Sales P7,000 Operating costs 3,000 EBIT P4,000 Interest 200 Earnings before taxes (EBT) P3,800
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Taxes (40%) 1,520 Net income to common shareholders P2,280 The company forecasts that its sales will increase by 10 percent in 2007 and its operating costs will increase in proportion to sales. The companys interest expense is expected to remain at P200,000, and the tax rate will remain at 40 percent. The company plans to pay out 50 percent of its net income as dividends, the other 50 percent will be additions to retained earnings. What is the forecasted addition to retained earnings for 2007? A. P1,140 C. P1,440 B. P1,260 D. P1,790 Additional financing needed 4 . If a firm uses external financing as a plug item, has a new capital budget of P2 million, a net income of P3 million, and a plowback ratio of 40%, how much should be raised in external funds? A. P 200,000 C. P 800,000 B. P 600,000 D. P1,200,000
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. Patio Company recently reported sales of P100 million, and net income equal to P5 million. The company has P70 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 P2 million. If the companys sales increase, its profit margin will remain at its current level. The companys dividend payout ratio is 40 percent. Based on the RNF formula, how much additional capital must the company raise in order to support the 20 percent increase in sales? A. P 2,000,000 C. P 8,400,000 B. P 6,000,000 D. P 9,600,000 . Leverage Companys December 31, 2006 balance sheet (in P000,000) is given below: Cash P 10 Accounts payable P 15 Accounts 25 Notes payable 20 receivable

Financial Management (A. Financial Planning & Strategies)

Accrued expenses 15 Long-term debt 30 Net fixed assets 75 Common stock 70 Total assets P150 Total Liab & P150 equity Sales during the past year were P100,000,000 and they are expected to rise by 50 percent to P150,000,000 during 2007. Also, during last year fixed assets were being utilized to only 85 percent of capacity, so Leverage Company could have supported P100,000,000 of sales with fixed assets that were only 85 percent of last years actual fixed assets. Assume that Leverages profit margin will remain constant at 5 percent and that the company will continue to pay out 60 percent of its earnings as dividends. What amount of nonspontaneous, required new financing (RNF), will be needed during the next year? A. P55,500,000 C. P49,500,000 B. P52,500,000 D. P40,125,000
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Inventories

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B. P3,000,000

D. P5,000,000

New Long-term debt 8 . Hello Company has the following balance sheet as of December 31, 2006. Current assets P 600,000 Fixed assets 400,000 Total Assets P1,000,000 Accounts payable P 100,000 Accrued liabilities 100,000 Notes payable 100,000 Long-term debt 300,000 Total common equity 400,000 Total Liabilities and Equity P1,000,000 In 2006, the company reported sales of P5 million, net income of P100,000, and dividends of P60,000. The company anticipates its sales will increase 20 percent in 2007 and its dividend payout will remain at 60 percent. Assume the company is at full capacity, so its assets and spontaneous liabilities will increase proportionately with an increase in sales. Assume the company uses the AFN formula and all additional funds needed (AFN) will come from issuing new long-term debt. Given its forecast, how much long-term debt will the company have to issue in 2007? A. P 60,000 C. P 92,000 B. P 88,000 D. P112,000 Maximum sales 9 . Indo Industries has P2.5 million in sales and P0.8 million in fixed assets. Currently, the companys fixed assets are operating at 75 percent of capacity. What level of sales could Indo Industries have obtained if it had been operating at full capacity? A. P2,800,000 C. P3,000,000 B. P3,333,333 D. P3,125,575

. Spark Company has plants in 3 major cities. Sales for last year were P100 million, and the balance sheet at year-end is similar in percentage of sales to that of previous years (and this will continue in the future). All assets (including fixed assets) and current liabilities will vary directly with sales. Spark Company is already using assets at full capacity. Balance Sheet (In million pesos) Liabilities and Stockholders Equity Accounts payable and accrualsP25 P50 Notes payable long term 30 Common stock 15 40 Retained earnings 20 P90 Total P90 has an after-tax profit margin of 5 percent and a ratio of 30 percent. 10 percent next year, the required new financing the expansion is C. P2,650,000
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Assets Current assets Fixed assets Total Spark Company dividend payout If sales grow by (RNF) to finance A. P4,850,000

Financial Management (A. Financial Planning & Strategies)

Maximum growth rate 10 . Pierre Company has the following ratios: A*/S = 1.6; L*/S = 0.4; profit margin = 0.10; and dividend payout ratio = 0.45, or 45 percent. Sales last year were P100 million. Assuming that these ratios will remain constant and that all liabilities increase spontaneously with increases in sales, what is the maximum growth rate Piere Company can achieve without having to employ nonspontaneous external funds? A. 3.9 percent C. 7.8 percent B. 4.8 percent D. 9.6 percent
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wishes to finance all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing costing 15 percent. Short-term financing currently costs 10 percent. Wales Companys earnings before interest and taxes are P2,200,000. Income tax rate is 40 percent. How much would Wales Companys earnings after taxes under this financing plan? A. P212,500 C. P225,000 B. P127,500 D. P 85,000 Aggressive policy 14 . Luminous Co. has total fixed assets of P100,000 and no current liabilities. The table below displays its wide variation in current asset components. 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Cash P P P P 20,000 10,000 15,000 20,000 Accts 66,000 25,000 47,000 88,000 receivable Inventory 20,000 65,000 59,000 10,000 Total P106,000 P100,00 P121,00 P118,00 0 0 0 If Luminous policy is to finance all fixed assets and half the permanent current assets with long-term financing and rest with short-term financing, what is the level of long-term financing? A. P 68,000 C. P150,000 B. P100,000 D. P155,625

. The Ripley Company is trying to determine an acceptable growth rate in sales. While the firm wants to expand, it does not want to use any external funds to support such expansion due to the particularly high interest rates in the market now. Having gathered the following data for the firm, what is the maximum growth rate it can sustain without requiring additional funds? Capital intensity ratio = 1.2. Profit margin = 10%. Dividend payout ratio = 50%. Current sales = P100,000. Spontaneous liabilities = P10,000. A. 3.6% C. 5.2% B. 4.8% D. 6.1%

Maximum dividend payout ratio 12 . What is the maximum dividend payout ratio consistent with not requiring external funds for a firm with an ROE of 15%, a debtequity ratio of 50%, and an annual sales growth objective of 9%? A. Approximately 1% C. Approximately 12% B. Approximately 10% D. Approximately 20% Financing Policy Conservative policy 13 . Wales Company has P8,000,000 in current assets, P3,500,000 of which are considered permanent current assets. In addition, the firm has P6,000,000 invested in fixed assets. Wales Company
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Answer: C Cash Accounts receivable Inventory Fixed assets Total assets required

(0.25 x P100,000) (0.1 x P100,000 x 0.55)

P 10,000 25,000 5,500 75,000 P115,500

. Answer: D The note payable is assumed to be a nonspontaneous liability. Let A = Total Assets 0.2A (800,000 x 0.2) (3,000,000 x 1.2 x 0.0833 x 0.6) = -100,000) 0.2A 160,000 180,000 = -100,000 0.2A = 240,000 A = 1,200,000 . Answer: B Sales forecast (P7M x 1.1) Operating costs (P3M x 1.1) EBIT Interest Earnings before tax Income tax P4,200,000 x 0.4) Net income Dividends (P2,520,000 x 0.5( Increase in Retained Earnings Answer: C Capital budget Increase in retained earnings (3M x 0.4) External funds needed P7,700,000 3,300,000 P4,400,000 200,000 P4,200,000 1,680,000 P2,520,000 1,260,000 P1,260,000 2,000,000 1,200,000 800,000

Answer: C Additional assets (70M 0.2) 14,000,000 Deduct: Increase in spontaneous liabilities 2,000,000 Increase in retained earnings (120M x 0.05 x 0.6) 3,600,000 5,600,000 Additional capital 8,400,000 Answer: D Fixed required by P100M sales (P75M x 0.85) P63,750,000 Total fixed assets required by P150M sales (150 100 x P63,750,000) P95,625,000 Deduct current level of fixed assets 75,000,000 Required increase in fixed assets 20,625,000 Increase in net spontaneous assets 0.5 x (P75M P30)22,500,000 Total financing needed 43,125,000 Deduct increase in retained earnings (P150M x 0.05 x 0.4) 3,000,000 Additional Financing Needed P40,125,000 Answer: C RNF = (SA/S0 x S) ( SL/S0 x S) - RE (0.90 x 10 M) ( .25 x 10 M) (.70 x .05 x 110 M)

6,500,000 3,850,000 = 2,650,000 Alternative Solution: RNF = (0.1 x 90M) (0.1 x 25M) (0.7 x 0.05 x 110M)= 2,650,000 SA = Spontaneous (variable) assets SL = Spontaneous (variable) liabilities RE = Retained earnings S = Increase in sales
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Answer: Increase Increase Increase Increase Increase

D in in in in in

total assets (1M x 0.2) liabilities (200,000 x 0.2) net spontaneous assets retained earnings long-term debt (RNF)

200,000 40,000 160,000 (6M x 0.02 x 0.4) 112,000 (2.5M 75) 100 x 33,333.33

48,000

Answer: B Amount sales per capacity unit Amount of sales at 100% capacity:

23,333.33 3,333,333

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Answer: B 1.6(X 100,000,000) 0.4(X 100,000,000) (0.55 x 0.10X) = 0 1.2(X 100,000,000) 0.055X = 0 1.2X - 120,000,000 - 0.055X = 1.145X = 120,000,000 X = 104,803,493 Growth: (104,803,493/100,000,000) 1 = 4.8%

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. Answer: B The solution may use the RNF formula. [g(A* L*)] (RR x ROS x S1) *Refer to spontaneous or variable assets and liabilities. Total assets based on intensity ratio: (100,000 x 1.2) 0 = g(120,000 10,000) [0.1 x 0.5 x 100,000 x (1+g)] 0 = 110,000g 5,000 x (1 + g) 0 = 110,000g 5,000 + 5,000g 105,000g = 5,000 g 4.8% . Answer: B Equity ratio: 1 (1 + 0.5) 66.67% 0 = 0.09 (0.15 x 0.6667 x RR) 0 = (0.09 0.1RR 0.1RR = 0.09 RR = 90%

P120,000

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Answer: B Long-term financing (11.75M x 0.15 1,762,500 Short-term financing (2.25M x 0.10) Interest costs 1,987,500 After tax income: (2,200,000 1,987.000) .60 127,500

225,000

Financing Mix: Fixed assets Permanent level of current assets Temporary level of current assets Total Long-term Financing
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6.00M 3.50M (0.5 x 4.5M) 11.75M 2.25M

Answer: C Fixed assets 100,000 Permanent current assets (100,000 x 0.5) 50,000 Total Permanent Financing 150,000 Permanent current assets represent the lowest level of current assets during the year.