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13 x11 Financial Management A
13 x11 Financial Management A
MODULE 11
FINANCIAL MANAGEMENT
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
C. financial forecasting
D. none of the above
Judgmental approach
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.
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
105
Financial Management
(A. Financial Planning & Strategies)
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
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
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.
D. Overstate profits, no matter what the change in sales, as long as fixed costs are present.
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.
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.
106
Financial Management
(A. Financial Planning & Strategies)
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.
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
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
B. A decrease in accruals
D. All of the above
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
Financial Management
(A. Financial Planning & Strategies)
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
B. P52,500,000
7
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.
Assets
Current assets
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
D. P40,125,000
Fixed assets
Balance Sheet
(In million pesos)
Liabilities and Stockholders Equity
Accounts payable and accruals
P50
Notes payable long term
Common stock
40
Retained earnings
P25
30
15
20
Total
P90
Total
P90
Spark Company has an after-tax profit margin of 5 percent and a dividend payout ratio of 30
percent.
If sales grow by 10 percent next year, the required new financing (RNF) to finance the
expansion is
A. P4,850,000
C. P2,650,000
B. P3,000,000
D. P5,000,000
Leverage Companys December 31, 2006 balance sheet (in P000,000) is given below:
Cash
P 10 Accounts payable
P 15
Accounts receivable
25 Notes payable
20
Inventories
40 Accrued expenses
15
Long-term debt
30
Net fixed assets
75 Common stock
70
Total assets
P150 Total Liab & equity
P150
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
108
Fixed assets
Total Assets
P 600,000
400,000
P1,000,000
Accounts payable
Accrued liabilities
Notes payable
Long-term debt
Total common equity
Total Liabilities and Equity
P 100,000
100,000
100,000
300,000
400,000
P1,000,000
Financial Management
(A. Financial Planning & Strategies)
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
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
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 20,000
P 10,000
P 15,000
P 20,000
Accts receivable
66,000
25,000
47,000
88,000
Inventory
20,000
65,000
59,000
10,000
Total
P106,000
P100,000
P121,000
P118,000
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
11
. 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%
109
Answer: C
Cash
Accounts receivable
Inventory
Fixed assets
Total assets required
(0.25 x P100,000)
(0.1 x P100,000 x 0.55)
. 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
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
Answer: C
Capital budget
Increase in retained earnings (3M x 0.4)
External funds needed
Answer: C
Additional assets (70M 0.2)
Deduct:
Increase in spontaneous liabilities
Increase in retained earnings (120M x 0.05 x 0.6)
Additional capital
P 10,000
25,000
5,500
75,000
P115,500
2,000,000
1,200,000
800,000
14,000,000
2,000,000
3,600,000
5,600,000
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:
Answer: D
Increase in total assets
(1M x 0.2)
Increase in liabilities
(200,000 x 0.2)
Increase in net spontaneous assets
Increase in retained earnings
(6M x 0.02 x 0.4)
Increase in long-term debt (RNF)
Answer: B
Amount sales per capacity unit
Amount of sales at 100% capacity:
(2.5M 75)
100 x 33,333.33
10
11
. 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) P120,000
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%
12
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%
13
Answer: B
Long-term financing
Short-term financing
Interest costs
After tax income:
200,000
40,000
160,000
48,000
112,000
23,333.33
3,333,333
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%
(11.75M x 0.15
(2.25M x 0.10)
(2,200,000 1,987.000) .60
Financing Mix:
Fixed assets
Permanent level of current assets
1,762,500
225,000
1,987,500
127,500
6.00M
3.50M
(0.5 x 4.5M)
2.25M
11.75M
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.