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Question (12-1) Define each of the following terms:

a. Mission statement; corporate scope; statement of corporate objectives; corporate


strategies
Mission statement:
The key components of 'strategic planning' include an understanding of the firm's vision,
mission, values and strategies. (Often a "Vision Statement" and a "Mission Statement" may
encapsulate the vision and mission). Vision: outlines what the organization wants to be, or how it
wants the world in which it operates to be (an "idealized" view of the world). It is a long-term
view and concentrates on the future. It can be emotive and is a source of inspiration. For
example, a charity working with the poor might have a vision statement which reads "A World
without Poverty." Mission: Defines the fundamental purpose of an organization or an enterprise,
succinctly describing why it exists and what it does to achieve its vision. For example, the
charity above might have a mission statement as "providing jobs for the homeless and
unemployed".

Corporate scope:
Corporate scope states that it is a parameter of the organization up to where it's business
operates. This parameter may be the limitation of any geographical areas of operation. It focuses
on the product and services with which the organization basically deals with. So it defines the
certain operation to satisfy the stake holders and to maximize the performance.

Statement of corporate objectives:


The statement which helps to set forth specific goals to guide the management is
statement of corporate objective. Most companies have multiple objectives. They revise the
statement of corporate objectives as per change in the environment to cope with it.
Corporate Strategies:
Corporate strategy is the methods or process which helps in developing the efficient
strategies to cope against the dynamic environment. It should be attainable and compatible with
the organization's purpose, scope and its objectives.

b. Operating plan; financial plan; sales forecast:


Operating Plan:
The developed plan which is intended to provide detailed implementation guidance,
based on the corporate strategy. This operating plan should help to achieve the organization
objective.
Financial Plan:
Financial plan can be defined as the work involving the estimation of additional
requirement of the funds in the future.

Sales Forecast:
The process of forecasting the company's sales in unit as well as in amount for the future
is called the sales forecast.

c. Spontaneous liabilities; profit margin; payout ratio:


Spontaneous Liabilities:
The process in which the liabilities changes in equal ratio with change in sales is called
spontaneous liabilities. Such as account payable, accruals.
For example if sales increase by 10%, then it will affect account payable. So account payable
also increases at same ratio.
Profit Margin:
Profit margin by definition is net income divided by total sales.
Payout ratio:
Payout ratio can be defined as dividend per share divided by earning per share. Assuming
one as hundred percent. One minus dividend payout ratio is retention ratio.

d. Additional funds needed (AFN); AFN equation; capital intensity ratio; self-supporting
growth rate;
Additional Funds Needed (AFN):
Additional funds needed can be defined as the funds that a firm must raise externally
through borrowing or by selling new common stock or preferred stock. Remaining other thing
constant, financial statement method is more reliable to make the business plans.
AFN equation:
AFN equation is the mathematical tool to calculate the additional fund needed for the
company. In AFN equation, AFN is equal to required increase in assets minus spontaneous
increase in liabilities minus increase in retained earnings.
Capital intensity ratio:
Capital intensity ratio states that it is the amount of assets in amount ($) of sales. This
ratio has a major impact on capital requirements. Companies with higher assets to sales ratios
require more assets for a given increase in sales. So for that high amount of external financing is
needed.
Self-supporting growth rate:
The maximum growth rate the firm can achieve without any external capital is called
self-supporting growth rate. The self-supporting growth rate can be denoted as 'g'.
e. Forecasted financial statement approach

It is one of the common methods of forecasting the financial statements. This is also
called percentage of sales method. In the forecasted financial statement approach, there are four
steps; they are forecasting income statement, forecasting the balance sheet, raising the additional
funds needed and financing the feedbacks.

f. Excess capacity; lumpy assets; economies of scale;


Excess capacity:
Excess capacity states less external financing to support increase in operations than what
actually would be needed if the firm previously operated at full capacity.
Lumpy assets:
Those assets that cannot be acquired smoothly rather require large additions.
Economics of scale:
Economics of scale is the process of producing larger amount of goods with low cost.

g. Full capacity sales; target fixed assets/sales ratio; required level of fixed assets
Full capacity sales:

Full capacity of sales can be defined as the condition on which the maximum level of
product is being produced at given time.
Target fixed assets/sales ratio:
Actual fixed assets divided by full capacity sales is called the target fixed assets/ sales
ratio.
Required level of fixed assets:
Target fixed assets to sales ratio multiplied by projected sales is called required level of
fixed assets.
i) Financing feedback effects:
The external funds raised to pay the new assets create additional expenses which must be
reflected on the income statement, and that lowers the initially forecasted additional earnings. So
the effects on the income statement and balance sheet of actions taken finance increase in assets.

Question (12.2) Some liability and net worth items increase spontaneously with increases in
sales. Put a check () by those items listed below that typically increase spontaneously:
Account payableMortgage bonds
Notes payable to banksCommon stock
Accrued wagesRetained earnings

Accrued taxes
Solution;
Account payable
Mortgage bonds X
Notes payable to banks X
Common stocks X
Accrued wages
Retained earnings
Accrued taxes

Question (12-3) The following equation is sometimes used to forecast financial


requirements:
AFN = (A0*/S0) (S) - (L0*/S0) (S) - MS1 (1-POR)
What key assumption do we make when using this equation? Under what conditions might
this assumption not hold true?

The AFN equation method, assumes that present assets level are optimal with respect to
present sales. Most items on the balance sheet increase in proportion to sales increase. The firms
profit margin remains constant.
There are certain limitations where the conditions might not hold true if, there is
economics of scale, lumpy assets and if there is excess capacity.

Question (12-4) Name five key factors that affect a firm's external financing requirements.
The five factors that affect a firm's external financing requirements are capital intensity
ratio, spontaneous liabilities to sales ratio, sales growth, profit margin ratio and retention ratio.

Question (12-5) What is meant by the term "self-supporting growth rate? How is this rate
related to the AFN equation, and how can that equation be used to calculate the selfsupporting growth rate?
The maximum growth rate the firm can achieve without any external capital is called
self-supporting growth rate. The self-supporting growth rate can be denoted as 'g'. We can use the
equation as below;
Self-supporting (g) = {M(1-POR) (SO)}/ {AO*-LO*-M(1-POR)SO }
When used in the AFN equation, substituting the value of S as gS0 and S1 as S0(1+g).
After that we can calculate the value of self-supporting growth rate i.e. g.

Question (12-6) Suppose a firm makes the policy changes listed below. If a change means
that external, non-spontaneous financial requirements (AFN) will increase, indicate this by
a (+), indicate decrease (-); and indicate no effect or an indeterminate effect by a (0). Think
in terms of the immediate, short-run effect on funds requirements.
Solution,
a. The dividend payout ratio is increased (+)
b. The firm decides to pay all suppliers on delivery, rather than after a 30-day delay, to
take advantage of discounts for rapid payments. (+)
c. The firm begins to offer credit to its customers, whereas previously all sales had been
on a cash basis. (+)
d. The firm's profit margin is eroded by increases competition, although sales hold
steady. (+)
e. The firm sells its manufacturing plants for cash to a contractor and simultaneously
signs an outsourcing contract to purchase from that contractor goods that the firm
formerly produced. (-)
f. The firm negotiates a new contractor with its union that lowers its labor costs without
affecting its output. (-)

Question (12-7) Assume that you recently received your MBA and now work as assistant to
the CFO of a relatively large corporation. Your boss has asked you to prepare a financial
forecast for the coming year, using an Excel model, and then to present your forecast to the
firm's executive committee. Describe how you would deal with the following issues.
a. Would you want to set up model with a number of scenarios whose results could be
presented to the executives?
While working as assistant to CFO after receiving my MBA, I would like to set up model
with a number of scenarios. Such scenario could be presented whose results could be presented
to the executives to make the effective and efficient decision regarding the financial forecasting.
Input for the status Quo scenario, Input for the best case scenario, input for the final scenario are
the some of the scenario technique which I would like to present to the executives.

b. What are "financing feedbacks, and what are the pros and cons of incorporating such
feedbacks into your model?
The external funds raised to pay the new assets create additional expenses which must be
reflected on the income statement, and that lowers the initially forecasted additional earnings. So
the effects on the income statement and balance sheet of actions taken finance increase in assets.

c. What are the pros and cons of assuming that all necessary outside funds are obtained
from a single source (such as a bank loan) versus assuming that a mix of funds is raised so
as to keep the capital structure at its target level?
If all necessary outside funds are obtained from a single source than it could reduce the
cost. But on the same time organizing the funds from single source, it could increase the risk.
Similarly, if the mix of fund is raised i.e. from various institutions, it could reduce the risk but it
may be burden for the executives to deal with various institutions.

d. What are the pros and cons of providing the capability to examine the results of
changing dividend policy and capital structure policy as well as various operating policies
such as credit policy, outsourcing policy, and so forth?
The pros of providing the capability to examine the results of changing dividend policy
and capital structure policy as well as various operating policies as well as various operating
policies such as credit policy, outstanding policy and so forth, it helps in making the effective
decision. While the cons may be it may be very complex process to examine the result for
changing dividend policy and capital structure policy.

e. What does the acronym GIGO stand for, and how important is this for someone who is
developing a financial model? For someone using a forecasting model? How might postaudits and incentive compensation plans help reduce GIGO?

The acronym GIGO stands for "Garbage in Garbage out". The importance of 'GIGO is, it
is made to forecast the revenue level to run the operation of the business. Using the post audits
helps reducing the error that comes while making the forecasting of revenue. On the other hand
using the incentive compensation plans helps to collect the reliable data by the employees.

References
Brigham, E. F., & Ehrhardt, M. C. (2013).Financial Management: Theory and
practice (13thed.). Mason, Ohio: South-Western Cengage Learning.