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CHAPTER 14

FINANCIAL PLANNING AND


FORECASTING FINANCIAL STATEMENTS

True/False

Easy:

(14.1) Pro forma statements Answer: b EASY


1
. Pro forma financial statements, as discussed in the text, are used
primarily to assess a firm's historical performance.

a. True
b. False

(14.2) Pro forma statements Answer: a EASY


2
. The first, and most critical, step in constructing a set of pro forma
financial statements is the sales forecast.

a. True
b. False

(14.2) Sales forecast Answer: a EASY


3
. 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.

a. True
b. False

(14.2) Sales forecast Answer: b EASY


4
. 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 firm.

a. True
b. False

(14.3) Spontaneously generated funds Answer: a EASY


5
. 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,
spontaneously generated funds arise from transactions brought on by
sales increases.

a. True
b. False

Chapter 14: Fin Plans, Forecasting True/False Page 199


(14.3) Spontaneously generated funds Answer: b EASY
6
. 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.

a. True
b. False

(14.3) Asset increase Answer: a EASY


7
. 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

(14.3) Additional funds needed Answer: b EASY


8
. 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.

a. True
b. False

(14.3) Additional funds needed Answer: b EASY


9
. 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.

a. True
b. False

(14.4) Pro forma statements Answer: a EASY


10
. One of the key steps in the development of pro forma financial
statements is to identify those assets and liabilities that increase
spontaneously with sales.

a. True
b. False

Medium:
(14.3) Additional funds needed Answer: a MEDIUM
11
. 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.

a. True
b. False

Page 200 True/False Chapter 14: Fin Plans, Forecasting


(14.3) Additional funds needed Answer: b MEDIUM
12
. 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.

a. True
b. False

(14.3) Capital intensity ratio Answer: a MEDIUM


13
. 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.

a. True
b. False

(14.3) Capital intensity ratio Answer: b MEDIUM


14
. If a firm's capital intensity ratio (A*/S0) decreases as sales increase,
use of the AFN formula is likely to understate the amount of additional
funds required, other things held constant.

a. True
b. False

(14.4) Financial forecasting Answer: b MEDIUM


15
. The fact that long-term debt and common stock are raised infrequently
and in large amounts lessens the need for the firm to forecast those
accounts on a continual basis.

a. True
b. False

(14.5) AFN formula and linear regression Answer: b MEDIUM


16
. When we use the AFN formula to forecast the additional funds needed
(AFN), we are implicitly assuming that all financial ratios are
constant. This means, for example, that if you plotted a graph of
inventories versus sales, the regression line would be linear and would
have a positive (non zero) Y-intercept.

a. True
b. False

Chapter 14: Fin Plans, Forecasting True/False Page 201


(14.5) AFN formula and linear regression Answer: a MEDIUM
17
. The AFN formula would be appropriate if, in a regression of each asset
and spontaneous liability on sales, the regression line was linear and
passed through the origin.

a. True
b. False

Multiple Choice: Conceptual

Easy:
(14.1) Strategic planning Answer: c EASY
18
. Which of the following is NOT a key element in strategic planning as it
is described in the text?

a. The mission statement.


b. The statement of the corporation’s scope.
c. The statement of cash flows.
d. The statement of corporate objectives.
e. The operating plan.

(14.4) AFN formula method Answer: b EASY


19
. Which of the following assumptions is embodied in the AFN formula
forecasting method?

a. All balance sheet accounts are tied directly to sales.


b. Accounts payable and accruals are tied directly to sales.
c. Common stock and long-term debt are tied directly to sales.
d. Fixed assets, but not current assets, are tied directly to sales.
e. Last year’s total assets were not optimal for last year’s sales.

Easy/Medium:
(14.3) Additional funds needed Answer: a EASY/MEDIUM
20
. 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 sharp reduction in its forecasted sales.
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.

Page 202 True/False Chapter 14: Fin Plans, Forecasting


(14.3) Additional funds needed Answer: b EASY/MEDIUM
21
. The term “additional funds needed (AFN)” is generally defined as
follows:

a. Funds that are obtained automatically from routine business


transactions.
b. Funds that a firm must raise externally from non-spontaneous
sources, i.e., by borrowing or by selling new stock, to support
operations.
c. The amount of assets required per dollar of sales.
d. The amount of internally generated cash in a given year minus the
amount of cash needed to acquire the new assets needed to support
growth.
e. A forecasting approach in which the forecasted percentage of sales
for each balance sheet account is held constant.

(14.3) Capital intensity ratio Answer: e EASY/MEDIUM


22
. The capital intensity ratio is generally defined as follows:

a. Sales divided by total assets, i.e., the total assets turnover


ratio.
b. The percentage of liabilities that increase spontaneously as a
percentage of sales.
c. The ratio of sales to current assets.
d. The ratio of current assets to sales.
e. The amount of assets required per dollar of sales, or A*/S0.

Medium:
(14.1) Financial planning Answer: e MEDIUM
23
. Which of the following is NOT one of the steps taken in the financial
planning process?

a. Forecast financial statements and use these projections to analyze


the likely effects of the operating plan on profits and various
financial ratios.
b. Forecast the funds that will be needed to support the 5-year plan.
c. Develop a cash budget for use in determining when funds will be
needed or when surplus funds will be available for investment.
d. Forecast sales over the planning horizon.
e. Consult with key competitors about the optimal set of prices to
charge, i.e., the prices that will maximize profits for our firm
and its competitors.

Chapter 14: Fin Plans, Forecasting True/False Page 203


(14.2) Forecasting concepts Answer: b MEDIUM
24
. Which of the following statements is CORRECT?

a. Perhaps the most important step when developing pro forma 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. Pro forma 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 method produces more accurate forecasts than the
forecasted financial statement method, especially if fixed assets
are lumpy and economies of scale exist.

(14.3) Spontaneously generated funds Answer: d MEDIUM


25
. Spontaneously generated funds are generally defined as follows:

a. The amount of assets required per dollar of sales.


b. A forecasting approach in which the forecasted percentage of sales
for each item is held constant.
c. Funds that a firm must raise externally through borrowing or by
selling new common or preferred stock.
d. Funds that are obtained automatically from normal operations, and
they include spontaneous increases in accounts payable and
accruals, plus additions to retained earnings.
e. 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.

(14.3) Additional funds needed Answer: b MEDIUM


26
. 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. The company previously thought its fixed assets were being operated
at full capacity, but now it learns that it actually has excess
capacity.
b. The company increases its dividend payout ratio.
c. The company begins to pay employees monthly rather than weekly.
d. The company’s profit margin increases.
e. The company decides to stop taking discounts on purchased
materials.

Page 204 True/False Chapter 14: Fin Plans, Forecasting


Medium/Hard:
(14.1) Operating plans and corporate strategies Answer: c MEDIUM/HARD
27
. Which of the following statements is CORRECT?

a. Once a firm has defined its purpose, scope, and objectives, it must
develop a strategy or strategies for achieving its goals. The
statement of corporate strategies sets forth detailed plans rather
than broad approaches.
b. A firm’s corporate purpose states the general philosophy of the
business and provides managers with specific operational
objectives.
c. Operating plans provide detailed guidance, consistent with the
corporate strategy, to help operating managers meet the corporate
objectives. These operating plans can be developed for any time
horizon, but many companies use a 5-year horizon.
d. A firm’s mission statement defines its lines of business and
geographic area of operations.
e. The corporate scope is a condensed version of the entire set of
strategic plans.

(14.3) Additional funds needed Answer: d MEDIUM/HARD


28
. Which of the following statements is CORRECT?

a. Since accounts payable and accrued liabilities must eventually be


paid off, as these accounts increase, AFN as calculated by the AFN
equation must also increase.
b. Suppose a firm is operating its fixed assets at below 100% of
capacity, but it has no excess current assets. Based on the AFN
equation, its AFN will be larger than if it had been operating with
excess capacity in both fixed and current assets.
c. If a firm retains all of its earnings, then it cannot require any
additional funds to support sales growth.
d. Additional funds needed (AFN) are typically raised using a
combination of notes payable, long-term debt, and common stock.
Such funds are non-spontaneous in the sense that they require
explicit financing decisions to obtain them.
e. If a firm has a positive free cash flow, then it must have either a
zero or a negative AFN.

Chapter 14: Fin Plans, Forecasting Conceptual Questions Page 205


(14.3) Additional funds needed Answer: d MEDIUM/HARD
29
. Which of the following statements is CORRECT?

a. Any forecast of financial requirements involves determining how


much money the firm will need, and this need is determined by
adding together increases in assets and spontaneous liabilities and
then subtracting operating income.
b. The AFN equation method for forecasting funds requirements requires
only a forecast of the firm’s balance sheet. Although a forecasted
income statement may help clarify the results, income statement
data are not essential because funds needed relate only to the
balance sheet.
c. Dividends are paid with cash taken from the accumulated retained
earnings account, hence dividend policy does not affect the AFN
forecast.
d. Financing feedbacks reflect the fact that interest and/or dividends
must be paid on new securities issued to help finance the AFN, and
these payments lower the initially forecasted net income, which in
turn reduces the retained earnings shown in the projected financial
statements. That chain of events results in a higher AFN than was
forecasted on the first pass.
e. If assets and spontaneously generated liabilities are not projected
to grow at the same rate as sales, then the AFN method will provide
more accurate forecasts than the projected financial statement
method.

(14.3) AFN formula method Answer: a MEDIUM/HARD


30
. Which of the following statements is CORRECT?

a. Inherent in the basic, unmodified AFN formula are these two


assumptions: (1) each asset item must grow at the same rate as
sales, and (2) spontaneous liability accounts must also grow at the
same rate as sales.
b. If a firm’s assets are growing at a positive rate, but its retained
earnings are not increasing, then it would be impossible for the
firm’s AFN to be negative.
c. If a firm increases its dividend payout ratio in anticipation of
higher earnings, but sales and earnings actually decrease, then the
firm’s actual AFN must, mathematically, exceed the previously
calculated AFN.
d. Higher sales usually require higher asset levels, and this leads to
what we call AFN. However, the AFN will be zero if the firm
chooses to retain all of its profits, i.e., to have a zero dividend
payout ratio.
e. Dividend policy does not affect the requirement for external funds
based on the AFN formula method.

Page 206 Conceptual Questions Chapter 14: Fin Plans, Forecasting


(14.5) Forecasting financial requirements Answer: c MEDIUM/HARD
31
. Which of the following statements is CORRECT?

a. When we use the AFN formula, we assume that the ratios of assets
and liabilities to sales (A*/S0 and L*/S0) vary from year to year in
a stable, predictable manner.
b. When fixed assets are added in large, discrete units as a company
grows, the assumption of constant ratios is more appropriate than
if assets are relatively small and can be added in small increments
as sales grow.
c. Firms whose fixed assets are “lumpy” frequently have excess
capacity, and this should be accounted for in the financial
forecasting process.
d. For a firm that uses lumpy assets, it is impossible to have small
increases in sales without expanding fixed assets.
e. A graph showing the relationship between assets and sales is always
linear if economies of scale exist.

Multiple Choice: Problems

Easy:
(14.4) Forecasting inventories--regression analysis Answer: d EASY
32
. 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.

a. $74.6
b. $78.5
c. $82.7
d. $87.0
e. $91.4

(14.5) Excess capacity and potential sales Answer: a EASY


33
. Last year Godinho Corp. had $250 million of sales, and it had $75
million of fixed assets that were being operated at 80% of capacity. In
millions, how large could sales have been if the company had operated at
full capacity?

a. $312.5
b. $328.1
c. $344.5
d. $361.8
e. $379.8

Chapter 14: Fin Plans, Forecasting Problems Page 207


Medium:
(14.4) Forecasting inventories and turnover Answer: a MEDIUM
34
. Fairchild Garden Supply expects $600 million of sales this year, and it
forecasts a 15% increase for next year. The CFO uses this equation to
forecast inventory requirements at different levels of sales:
Inventories = $30.2 + 0.25(Sales). All dollars are in millions. What
is the projected inventory turnover ratio for the coming year?

a. 3.40
b. 3.57
c. 3.75
d. 3.94
e. 4.14

(14.5) Excess capacity and sales growth Answer: c MEDIUM


35
. 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. $170.1
b. $179.0
c. $188.5
d. $197.9
e. $207.8

(14.5) Excess capacity and sales growth Answer: e MEDIUM


36
. 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?

a. 54.30%
b. 57.16%
c. 60.17%
d. 63.33%
e. 66.67%

(14.5) Finding the target fixed assets/sales ratio Answer: b MEDIUM


37
. 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?

a. 28.5%
b. 30.0%
c. 31.5%
d. 33.1%

Page 208 Problems Chapter 14: Fin Plans, Forecasting


e. 34.7%
Medium/Hard:
(14.3) Additional funds needed--positive AFN Answer: d MEDIUM/HARD
38
. Clayton Industries is planning its operations for next year, and Ronnie
Clayton, the CEO, wants you to forecast the firm's additional funds
needed (AFN). 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.

Last year's sales = S0 $350 Last year's accounts payable $40


Sales growth rate = g 30% Last year's notes payable (to bank) $50
Last year's total assets = A0 $500 Last year's accruals $30
Last year's profit margin = M 5% Target payout ratio 60%

a. $102.8
b. $108.2
c. $113.9
d. $119.9
e. $125.9

(14.3) Additional funds needed--negative AFN Answer: c MEDIUM/HARD


39
. 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).
Data for use in your forecast are shown below. Based on the AFN
equation, what is the AFN for the coming year?

Last year's sales = S0 $200,000 Last year's accounts payable $50,000


Sales growth rate = g 40% Last year's notes payable (to bank) $15,000
Last year's total assets = A0 $135,000 Last year's accruals $20,000
Last year's profit margin = M 20.0% Target payout ratio 25.0%

a. -$14,440
b. -$15,200
c. -$16,000
d. -$16,800
e. -$17,640

Chapter 14: Fin Plans, Forecasting Problems Page 209


(14.3) Additional funds needed--changing dividend payout Answer: b MEDIUM/HARD
40
. Howton & Howton Worldwide (HHW) is planning its operations for the
coming year, and the CEO wants you to forecast the firm's additional
funds needed (AFN). Data for use in the forecast are shown below.
However, the CEO is concerned about the impact of a change in the payout
ratio from the 10% that was used in the past to 50%, which the firm's
investment bankers have recommended. Based on the AFN equation, by how
much would the AFN for the coming year change if HHW increased the
payout from 10% to the new and higher level? All dollars are in
millions.

Last year's sales = S0 $300.0 Last year's accounts payable $50.0


Sales growth rate = g 40% Last year's notes payable (to bank) $15.0
Last year's total assets = A0 $500.0 Last year's accruals $20.0
Last year's profit margin = M 20.0% Initial payout ratio 10.0%
New payout ratio 50.0%

a. $31.9
b. $33.6
c. $35.3
d. $37.0
e. $38.9

Hard:
(14.5) Finding the target fixed assets/sales ratio Answer: b HARD
41
. 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?

a. $74.81
b. $78.75
c. $82.69
d. $86.82
e. $91.16

Page 210 Problems Chapter 14: Fin Plans, Forecasting


CHAPTER 14
ANSWERS AND SOLUTIONS

Chapter 14: Fin Plans, Forecasting Answers Page 211


1. (14.1) Pro forma statements Answer: b EASY

2. (14.2) Pro forma statements Answer: a EASY

3. (14.2) Sales forecast Answer: a EASY

4. (14.2) Sales forecast Answer: b EASY

5. (14.3) Spontaneously generated funds Answer: a EASY

6. (14.3) Spontaneously generated funds Answer: b EASY

7. (14.3) Asset increase Answer: a EASY

8. (14.3) Additional funds needed Answer: b EASY

9. (14.3) Additional funds needed Answer: b EASY

10. (14.4) Pro forma statements Answer: a EASY

11. (14.3) Additional funds needed Answer: a MEDIUM

12. (14.3) Additional funds needed Answer: b MEDIUM

13. (14.3) Capital intensity ratio Answer: a MEDIUM

14. (14.3) Capital intensity ratio Answer: b MEDIUM

15. (14.4) Financial forecasting Answer: b MEDIUM

16. (14.5) AFN formula and linear regression Answer: b MEDIUM

17. (14.5) AFN formula and linear regression Answer: a MEDIUM

18. (14.1) Strategic planning Answer: c EASY

19. (14.4) AFN formula method Answer: b EASY

20. (14.3) Additional funds needed Answer: a EASY/MEDIUM

Answer a is obviously correct. Also, note that with purchase terms of 1/5 net 90, the nominal cost of non-free trade
credit is only 4.28%, whereas with 3/15, net 35, the nominal cost of trade credit is over 56%. Therefore, the firm
should have been taking discounts originally, hence should have had few accounts payable, whereas it would
probably not take discounts and thus have more accounts payable with the new supplier. That change would lower
its AFN.

21. (14.3) Additional funds needed Answer: b EASY/MEDIUM

22. (14.3) Capital intensity ratio Answer: e EASY/MEDIUM

23. (14.1) Financial planning Answer: e MEDIUM

24. (14.2) Forecasting concepts Answer: b MEDIUM

25. (14.3) Spontaneously generated funds Answer: d MEDIUM

26. (14.3) Additional funds needed Answer: b MEDIUM

27. (14.1) Operating plans and corporate strategies Answer: c MEDIUM/HARD


28. (14.3) Additional funds needed Answer: d MEDIUM/HARD

29. (14.3) Additional funds needed Answer: d MEDIUM/HARD

30. (14.3) AFN formula method Answer: a MEDIUM/HARD

31. (14.5) Forecasting financial requirements Answer: c MEDIUM/HARD

32. (14.4) Forecasting inventories--regression analysis Answer: d EASY

Current year's sales $400.0


Growth rate 30%
Projected Sales $520.0

Required inventories = $22.0 + 0.125  Projected Sales


= $22.0 + 0.125  $520.0
= $87.0

33. (14.5) Excess capacity and potential sales Answer: a EASY

Sales $250.0
Fixed assets $75.0
% of capacity utilized 80.0%

Full capacity sales = Actual sales / % of capacity used = $312.5

34. (14.4) Forecasting inventories and turnover Answer: a MEDIUM

Current year's sales $600


Growth rate 15%
Projected Sales $69

Required inventories = $30.2 + 0.25  Projected Sales


= $30.2 + 0.25  $690.0
= $202.7

Inventory turnover = Sales/Inventories = 3.40

35. (14.5) Excess capacity and sales growth Answer: c MEDIUM

Sales $350
Fixed assets (not used in calculations) $270
% of capacity utilized 65%

Sales at full capacity = Actual sales/% of capacity used = $538


Additional sales without adding FA = full capacity sales – actual sales = $188.5

36. (14.5) Excess capacity and sales growth Answer: e MEDIUM

Sales $850
Fixed assets (not used in calculations) $425
% of capacity utilized 60%
Sales at full capacity = Actual sales/% of capacity used = $1,417
Additional sales without adding FA = full capacity sales – actual sales = $567
Percent growth in sales = additional sales/old sales = 66.67%

37. (14.5) Finding the target fixed assets/sales ratio Answer: b MEDIUM

Sales $250
Fixed assets $100
% of capacity utilized 75%

Sales at full capacity = Actual sales/% of capacity used = $333


Target FA/Sales ratio = Full capacity FA/Sales = FA/capacity sales = 30.0%

38. (14.3) Additional funds needed--positive AFN Answer: d MEDIUM/HARD

Last year's sales = S0 $350


Sales growth rate = g 30%
Forecasted sales = S0  (1 + g) $455
ΔS = change in sales = S1 – S0 = S0  g $105
Last year's total assets = A0 = A* since full capacity $500
Forecasted total assets = A1 = A0  (1 + g) $650
Last year's accounts payable $40
Last year's notes payable. Not spontaneous, so does not enter AFN calculation $50
Last year's accruals $30
L* = payables + accruals $70
Profit margin = M 5.0%
Target payout ratio 60.0%
Retention ratio = (1 – Payout) 40.0%

AFN = (A*/S0)ΔS – (L*/S0)ΔS – Margin  S1  (1 – Payout)


= $150 – $21 – $9.1 = $119.9

39. (14.3) Additional funds needed--negative AFN Answer: c MEDIUM/HARD

Last year's sales = S0 $200,000


Sales growth rate = g 40%
Forecasted sales = S0  (1 + g) $280,000
ΔS = change in sales = S1 – S0 = S0  g $80,000
Last year's total assets = A0 = A* since full capacity $135,000
Forecasted total assets = A1 = A0  (1 + g) $189,000
Last year's accounts payable $50,000
Last year's notes payable. Not spontaneous, so does not enter AFN calculation $15,000
Last year's accruals $20,000
L* = payables + accruals $70,000
Profit margin = M 20.0%
Target payout ratio 25.0%
Retention ratio = (1 – Payout) 75.0%

AFN = (A*/S0)ΔS – (L*/S0)ΔS – Margin  S1  (1 – Payout)


= $54,000 – $28,000 – $42,000 = -$16,000

40. (14.3) Additional funds needed--changing dividend payout Answer: b MEDIUM/HARD


Last year's sales = S0 $300
Sales growth rate = g 40%
Forecasted sales = S0  (1 + g) $420
ΔS = change in sales = S1 – S0 = S0  g $120
Last year's total assets = A0 = A* since full capacity $500
Forecasted total assets = A1 = A0  (1 + g) $700
Last year's accounts payable $50
Last year's notes payable. Not spontaneous, so does not enter AFN calculation $15
Last year's accruals $20
L* = payables + accruals $70
Profit margin = M 20%
Initial payout ratio 10%
New payout ratio 50%
Initial retention ratio = (1 – Payout) 90%
New retention ratio = (1 – Payout) 50%

AFN = (A*/S0)ΔS – (L*/S0)ΔS – Margin  S1  (1 – Payout)


Old AFN = $200.0 – $28.0 – $75.6 = $96.4
New AFN = $200.0 – $28.0 – $42.0 = $130.0

Change in AFN = $33.6

41. (14.5) Finding the target fixed assets/sales ratio Answer: b HARD

Sales $450
Fixed assets $225
% of capacity utilized 65%

Sales at full capacity = Actual sales/% of capacity used = $692


Target FA/Sales ratio = Full capacity FA/Sales = FA/capacity sales = 32.50%
Optimal FA = Sales  target FA/Sales ratio = $146.25
Cash generated = Actual FA – Optimal FA = $78.75