Financial Management

(A. Financial Planning & Strategies)

MODULE 11 D. is ignoring the principle of matched maturities

FINANCIAL MANAGEMENT Short-term financing

14. The type of company most likely to need short-term financing is one that
A. FINANCIAL PLANNING AND STRATEGIES A. has no seasonality and no growth in sales from year to year
B. sells only for cash
THEORIES: C. has a high degree of seasonality
Business plan D. has lower total fixed costs than total variable costs
3. The typical outline of the component parts of a business plan would be the
A. mission and strategy statements. C. financial projections. 25. Common sources of short-term financing include:
B. operations of the business. D. All of the above. A. Stretching payables C. Reducing inventory
B. Issuing bonds D. All of the above
Financial planning process
2. Planning for future growth is called: 24. How does long-term financing policy affect short-term financing requirements?
A. capital budgeting C. financial forecasting A. The nature of the firm's short-term financial planning problem is determined by the amount
B. working capital management D. none of the above of long-term capital it raises.
B. A firm that issues large amounts of long-term debt or common stock, or that retains a
1. The ideal financial planning process would be large part of its earnings, may find that it has permanent excess cash. Other firms raise
A. top-down planning. relatively little long-term capital and end up as permanent short-term debtors.
B. bottom-up planning. C. Most firms attempt to find a golden mean by financing all fixed assets and part of current
C. a combination of top-down and bottom-up planning. assets with equity and long-term debt. Such firms may invest cash surpluses during part
D. none of the above. of the year and borrow during the rest of the year.
D. All of the above affect short-term financing.
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. Judgmental approach
B. Financial planning should not proceed by trial and error. 21. Under the judgmental approach for developing a pro forma balance sheet, the “plug” figure
C. Many different strategies may be projected under a range of assumptions about the future required to bring the statement into balance may be called the
before one strategy is finally chosen. A. retained earnings C. suspense account
D. The dozens of separate projections that may be made during this trial-and-error process B. accounts receivable D. required new financing
generate a heavy load of arithmetic and paperwork.
Percent of sales method
Financing policy 6. The percent of sales method is based on which of the following assumptions?
Maturities matching A. All balance sheet accounts are tied directly to sales.
23. When a firm finances long-term assets with short-term sources of funding, it: B. Most balance sheet accounts are tied directly to sales.
A. reduces the risk of cash shortage C. There is considerably excessive asset level.
B. will have higher interest expenses D. Statements a and c above are correct.
C. improves the leverage ratio

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4. Which of the following is the major independent variable in constructing pro forma income C. The plan assumes that sales determine assets that determine the external funding
statements and balance sheets? needed.
A. total assets C. dividend payout D. The plan assumes that there is a varying relationship between sales, assets, and funds
B. net income D. sales needed.

7. The first step in developing a pro forma income statement is to: 11. Which of the following best describes a firm's external funding requirement?
A. build a sales forecast C. determine the cost of goods sold A. Growth in assets minus growth in liabilities minus net income
B. determine the production schedule D. none of the above B. Growth in assets minus the current year's retained earnings
C. Growth in assets minus growth in current liabilities minus net income
20. The percent-of-sales method of preparing the projected income statement assumes that all D. Growth in assets minus growth in current liabilities minus the year's retained earnings
costs are:
A. Constant C. Variable 15. A company that has rapidly growing sales will probably
B. Fixed D. Independent A. need additional long-term financing C. have increasing asset requirements
B. have a financing gap D. find that all of the above are true
22. Utilizing past cost and expense ratios (percent-of-sales method) when preparing pro forma
financial statements will tend to 17. Which of the following statements is most correct?
A. Understate profits when sales are decreasing and overstate profits when sales are A. Since accounts payable and accrued liabilities must eventually be paid, as these accounts
increasing. increase, required new financing also increases.
B. Understate profits, no matter what the change in sales, as long as fixed costs are present. B. Suppose a firm is operating its fixed assets below 100 percent capacity but is at 100 percent
C. Understate profits when sales are increasing and overstate profits when sales are with respect to current assets. If sales grow, the firm can offset the needed increase in current
decreasing. assets with its idle fixed assets capacity.
D. Overstate profits, no matter what the change in sales, as long as fixed costs are present. C. If a firm retains all of its earnings, then it will not need any additional funds to support sales
growth.
Additional funds needed D. Additional funds needed are typically raised from some combination of notes payable, long-
5. Additional funds needed are best defined as: term bonds, and common stock. These accounts are nonspontaneous in that they require an
A. Funds that are obtained automatically from routine business transactions. explicit financing decision to increase them.
B. Funds that a firm must raise externally through borrowing or by selling new common or
preferred stock. Growth
C. The amount of assets required per peso of sales. 19. Which of the following is incorrect regarding the effect of growth on the need for external
D. A forecasting approach in which the forecasted percentage of sales for each item is held financing?
constant. A. Higher growth rates will lead to a greater need for investments in fixed assets and working
capital.
8. Which of the following statements about forecasting external funding requirements via the B. The internal growth rate is the maximum rate that the firm can grow if it relies entirely on
percentage of sales method is true? reinvested profits to finance its growth, that is, the maximum rate of growth without
A. The plan assumes that sales are determined by assets that determine the external funds requiring external financing.
needed. C. The sustainable growth rate is the rate at which the firm can grow with the option of
B. The plan assumes that the external funds needed impact assets which in turn drive sales. flexibly changing its leverage ratio.

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D. One very simple starting point may be a percentage of sales model in which many key Total assets requirements
1
variables are assumed to be directly proportional to sales. . 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.
Sensitivity analysis Lamp has minimum cash balance of P10,000 and fixed assets are projected to be P75,000.
9. Holding all other variables constant, which of the following would increase a firm's external Total assets requirements would be
funding requirements in the planning period? A. P 40,500 C. P115,500
A. An increase in assets C. An increase in dividends paid B. P240,000 D. P270,000
B. A decrease in accruals D. All of the above
Additional Financing Needed
10. Which of the following is likely to increase the required new financing (RNF) in a given year? Total assets
A. The company reduces its dividend payout ratio. 2
. Calculate the total assets of Premiere Company given the following information:
B. The company’s profit margin increases. Sales this year P3,000,000
C. The company decides to reduce its reliance on accounts payable as a form of financing. Sales increase projected for next year 20 percent
D. The company is operating well below full capacity. Net income this year P 250,000
Dividend payout ratio 40 percent
12. Monument Corporation has developed a forecasting model to determine the additional funds it Projected excess funds available next year P 100,000
needs in the coming year. Other factors remaining unchanged, which of the following factors is Accounts payable P 600,000
likely to increase its additional financing requirement? Notes payable P 100,000
A. A sharp increase in its forecasted sales and the company’s fixed assets are at full capacity. Accrued wages and taxes P 200,000
B. A reduction in its dividend payout ratio. Except for the accounts noted, there were no other current liabilities. Assume that the firm’s profit
C. The company increases its reliance on trade credit that sharply raises its accounts payable. margin remains constant and that the company is operating at full capacity.
D. A new cost control produces more efficient costs. A. P3,000,000 C. P2,000,000
B. P2,200,000 D. P1,200,000
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 Addition to retained earnings
3
B. A higher debt-to-asset ratio D. A higher return on assets . Almond Corporation recently reported the following income statement for 2006 (in P’000):
Sales P7,000
Sustainable growth rate Operating costs 3,000
16. The sustainable growth rate is best described by which of the following? EBIT P4,000
A. The rate of sales growth that will sustain the assets of the company. Interest 200
B. The rate of earnings growth needed to avoid external financing. Earnings before taxes (EBT) P3,800
Taxes (40%) 1,520
C. The maximum rate of sales growth of a company without using external debt.
Net income to common shareholders P2,280
D. The maximum rate of sales growth of a company without raising external funds from the
The company forecasts that its sales will increase by 10 percent in 2007 and its operating costs will
sale of stock.
increase in proportion to sales. The company’s 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
PPROBLEMS:
forecasted addition to retained earnings for 2007?
Percent-of-sales method

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A. P1,140 C. P1,440 7
. Spark Company has plants in 3 major cities. Sales for last year were P100 million, and the
B. P1,260 D. P1,790 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
Additional financing needed directly with sales. Spark Company is already using assets at full capacity.
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 Balance Sheet
funds? (In million pesos)
A. P 200,000 C. P 800,000 Assets Liabilities and Stockholders’ Equity
B. P 600,000 D. P1,200,000 Accounts payable and accruals P25
Current assets P50 Notes payable – long term 30
5
. Patio Company recently reported sales of P100 million, and net income equal to P5 million. Common stock 15
The company has P70 million in total assets. Over the next year, the company is forecasting a Fixed assets 40 Retained earnings 20
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, Total P90 Total P90
spontaneous liabilities will increase by P2 million. If the company’s sales increase, its profit Spark Company has an after-tax profit margin of 5 percent and a dividend payout ratio of 30
margin will remain at its current level. The company’s dividend payout ratio is 40 percent. percent.
Based on the RNF formula, how much additional capital must the company raise in order to
If sales grow by 10 percent next year, the required new financing (RNF) to finance the
support the 20 percent increase in sales?
expansion is
A. P 2,000,000 C. P 8,400,000
A. P4,850,000 C. P2,650,000
B. P 6,000,000 D. P 9,600,000
B. P3,000,000 D. P5,000,000
6
. Leverage Company’s December 31, 2006 balance sheet (in P’000,000) is given below:
New Long-term debt
Cash P 10 Accounts payable P 15 8
. Hello Company has the following balance sheet as of December 31, 2006.
Accounts receivable 25 Notes payable 20
Current assets
Inventories 40 Accrued expenses 15
P 600,000
Long-term debt 30
Fixed assets 400,000
Net fixed assets 75 Common stock 70
Total Assets P1,000,000
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 Accounts payable P 100,000
percent of capacity, so Leverage Company could have supported P100,000,000 of sales with fixed Accrued liabilities 100,000
assets that were only 85 percent of last year’s actual fixed assets. Assume that Leverage’s profit Notes payable 100,000
margin will remain constant at 5 percent and that the company will continue to pay out 60 percent of Long-term debt 300,000
its earnings as dividends. What amount of nonspontaneous, required new financing (RNF), will be Total common equity 400,000
needed during the next year? Total Liabilities and Equity P1,000,000
A. P55,500,000 C. P49,500,000 In 2006, the company reported sales of P5 million, net income of P100,000, and dividends of
B. P52,500,000 D. P40,125,000 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.

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Assume the company uses the AFN formula and all additional funds needed (AFN) will come from A. Approximately 1% C. Approximately 12%
issuing new long-term debt. Given its forecast, how much long-term debt will the company have to B. Approximately 10% D. Approximately 20%
issue in 2007?
A. P 60,000 C. P 92,000 Financing Policy
B. P 88,000 D. P112,000 Conservative policy
13
. Wales Company has P8,000,000 in current assets, P3,500,000 of which are considered
Maximum sales permanent current assets. In addition, the firm has P6,000,000 invested in fixed assets.
9
. Indo Industries has P2.5 million in sales and P0.8 million in fixed assets. Currently, the company’s Wales Company wishes to finance all fixed assets and permanent current assets plus half of
fixed assets are operating at 75 percent of capacity. its temporary current assets with long-term financing costing 15 percent. Short-term
What level of sales could Indo Industries have obtained if it had been operating at full capacity? financing currently costs 10 percent. Wales Company’s earnings before interest and taxes
A. P2,800,000 C. P3,000,000 are P2,200,000. Income tax rate is 40 percent.
B. P3,333,333 D. P3,125,575
How much would Wales Company’s earnings after taxes under this financing plan?
A. P212,500 C. P225,000
Maximum growth rate
10 B. P127,500 D. P 85,000
. 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
Aggressive policy
that these ratios will remain constant and that all liabilities increase spontaneously with 14
. Luminous Co. has total fixed assets of P100,000 and no current liabilities. The table
increases in sales, what is the maximum growth rate Piere Company can achieve without
below displays its wide variation in current asset components.
having to employ nonspontaneous external funds?
A. 3.9 percent C. 7.8 percent 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
B. 4.8 percent D. 9.6 percent Cash P 20,000 P 10,000 P 15,000 P 20,000
Accts receivable 66,000 25,000 47,000 88,000
11
. The Ripley Company is trying to determine an acceptable growth rate in sales. While the firm Inventory 20,000 65,000 59,000 10,000
wants to expand, it does not want to use any external funds to support such expansion due to the Total P106,000 P100,000 P121,000 P118,000
particularly high interest rates in the market now. Having gathered the following data for the firm, If Luminous’ policy is to finance all fixed assets and half the permanent current assets with
what is the maximum growth rate it can sustain without requiring additional funds? long-term financing and rest with short-term financing, what is the level of long-term
 Capital intensity ratio = 1.2. financing?
 Profit margin = 10%. A. P 68,000 C. P150,000
 Dividend payout ratio = 50%. B. P100,000 D. P155,625
 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 debt-equity ratio of 50%, and an annual sales growth objective of
9%?

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1
. Answer: C
Cash P 10,000
Accounts receivable (0.25 x P100,000) 25,000
Inventory (0.1 x P100,000 x 0.55) 5,500
Fixed assets 75,000
Total assets required P115,500
2
. 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
3
. Answer: B
Sales forecast (P7M x 1.1) P7,700,000
Operating costs (P3M x 1.1) 3,300,000
EBIT P4,400,000
Interest 200,000
Earnings before tax P4,200,000
Income tax P4,200,000 x 0.4) 1,680,000
Net income P2,520,000
Dividends (P2,520,000 x 0.5( 1,260,000
Increase in Retained Earnings P1,260,000
4
. Answer: C
Capital budget 2,000,000
Increase in retained earnings (3M x 0.4) 1,200,000
External funds needed 800,000
5
. 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
6
. 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
7
. 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
8
. Answer: D
Increase in total assets (1M x 0.2) 200,000
Increase in liabilities (200,000 x 0.2) 40,000
Increase in net spontaneous assets 160,000
Increase in retained earnings (6M x 0.02 x 0.4) 48,000
Increase in long-term debt (RNF) 112,000
9
. Answer: B
Amount sales per capacity unit (2.5M ÷ 75) 23,333.33
Amount of sales at 100% capacity: 100 x 33,333.33 3,333,333
10
. 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
. 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 (11.75M x 0.15 1,762,500
Short-term financing (2.25M x 0.10) 225,000
Interest costs 1,987,500
After tax income: (2,200,000 – 1,987.000) .60 127,500

Financing Mix:
Fixed assets 6.00M
Permanent level of current assets 3.50M
 Temporary level of current assets (0.5 x 4.5M) 2.25M
Total Long-term Financing 11.75M
14
. 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.