Benefits of Pro Forma Statements

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					                                           LECTURE 2
                             Long-Term Financial Planning and Growth


I.   DEFINITIONS

PLANNING HORIZON
a  1. The long-range time period, usually the next two to five years, over which the financial
      planning process focuses is known as the:
   a. Planning horizon.
   b. Planning strategy.
   c. Planning agenda.
   d. Short run.
   e. Current financing period.

AGGREGATION
b  2. The process by which smaller investment proposals of each of a firm’s operational units are
      added up and treated as one big project is known as:
   a. Separation.
   b. Aggregation.
   c. Conglomeration.
   d. Appropriation.
   e. Striation.

PRO FORMA STATEMENTS
d  3. Pro forma financial statements are:
   a. Illegal.
   b. Accounting statements filed with the Securities and Exchange Commission (SEC).
   c. Accounting statements filed with the Internal Revenue Service (IRS).
   d. Projected accounting statements based on a sales forecast assumption.
   e. The most-recently compiled accounting statements of the firm released to the public.

PLUG VARIABLE
e  4. The designated source(s) of external financing required to make the pro forma balance sheet
      balance is called the:
   a. Retained earnings account.
   b. Common stock account.
   c. Debt-equity ratio.
   d. Cash flow variable.
   e. Plug variable.
CHAPTER 4


PERCENTAGE OF SALES APPROACH
a  5. The financial planning method in which accounts are varied depending on a firm’s predicted
      sales level is called the:
   a. Percentage of sales approach.
   b. Sales dilution approach.
   c. Sales reconciliation approach.
   d. Common-size approach.
   e. Time-trend approach.

DIVIDEND PAYOUT RATIO
c   6. The dividend payout financial ratio is calculated as:
    a. Net income minus additions to retained earnings.
    b. Cash dividends divided by shares outstanding.
    c. Cash dividends divided by net income.
    d. Net income minus cash dividends.
    e. One plus the retention ratio.

RETENTION RATIO
b  7. The retention ratio is calculated as:
   a. One plus the dividend payout ratio.
   b. Additions to retained earnings divided by net income.
   c. Additions to retained earnings divided by shares outstanding.
   d. Net income minus additions to retained earnings.
   e. Net income minus cash dividends.

CAPITAL INTENSITY RATIO
d  8. The capital intensity ratio is calculated as:
   a. Long-term debt times total assets.
   b. Net fixed assets divided by credit sales.
   c. Net fixed assets times total sales.
   d. Total assets divided by total sales.
   e. Total sales divided by total assets.

INTERNAL GROWTH RATE
c  9. The internal growth rate of a firm is best described as:
   a. The minimum growth rate achievable if the firm does not pay out any cash dividends.
   b. The minimum growth rate achievable if the firm maintains a constant equity multiplier.
   c. The maximum growth rate achievable without external financing of any kind.
   d. The maximum growth rate achievable without using any external equity financing, while
      maintaining a constant debt-equity ratio.
   e. The maximum growth rate achievable without any limits on the amount of debt financing used.




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SUSTAINABLE GROWTH RATE
d  10. The sustainable growth rate of a firm is best described as:
   a. The minimum growth rate achievable if the firm does not pay out any cash dividends.
   b. The minimum growth rate achievable if the firm maintains a constant equity multiplier.
   c. The maximum growth rate achievable without external financing of any kind.
   d. The maximum growth rate achievable without using any external equity financing, while
       maintaining a constant debt-equity ratio.
   e. The maximum growth rate achievable without any limits on the amount of debt financing used.


II.   CONCEPTS

CAPITAL BUDGETING
a  11. When a firm chooses to buy new fixed assets it is making a                decision.
   a. capital budgeting
   b. capital structure
   c. financing
   d. working capital
   e. dividend policy

WORKING CAPITAL
d 12. When a firm makes decisions regarding its investment in inventory and accounts receivable it
      is making a             decision.
  a. capital budgeting
  b. capital structure
  c. financing
  d. working capital
  e. dividend policy

CAPITAL STRUCTURE
b  13. When a firm makes decisions regarding the level of its long-term debt financing it is making a
                  decision.
   a. capital budgeting
   b. capital structure
   c. financing
   d. working capital
   e. dividend policy

FINANCIAL PLANNING
c  14. Among other things, a good financial plan should take into account:
   a. The interaction of firm operations and changes in economic interest rates.
   b. The expected future state of the economy.
   c. The linkages between different investment proposals.
   d. The feasibility of past capital budgeting decisions.
   e. The reliability and productivity of employees and management.




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PLUG VARIABLES
d  15. In creating pro forma statements, if we assume that costs, assets, and short-term debt vary
       directly with changes in sales, that the payout ratio is fixed, and that the change in long term
       debt only results from payments made as required on the debt contracts, then the “plug”
       required for the balance sheet to balance will probably be:
   a. Dividends.
   b. Total debt.
   c. Long-term debt.
   d. New equity sales.
   e. Retained earnings.

CAPITAL INTENSITY RATIO
e  16. All else the same, a firm’s capital intensity ratio will decrease if                   .
   a. accounts payable decrease
   b. net income increases
   c. cost of goods sold increase
   d. assets increase
   e. sales increase

EXTERNAL FINANCING NEEDED
d  17. Suppose a firm is working at full capacity and that assets, costs, and all liabilities are tied
       directly to the level of sales. In addition, the firm pays out all its earnings as dividends, and
       sales are expected to increase by 10% next period. The firm’s debt/equity ratio is 2. The
       external financing needed to support this growth:
   a. Is zero since all liabilities are tied directly to the level of sales.
   b. Depends on the profit margin.
   c. Is equal to half the dollar increase in assets.
   d. Is equal to half the dollar increase in liabilities.
   e. Is equal to the growth rate times total assets.

SUSTAINABLE GROWTH
a  18. Which of the following is NOT a factor in calculating sustainable growth?
   a. Current ratio
   b. Profit margin
   c. Asset turnover
   d. Equity multiplier
   e. Retention ratio

FINANCIAL PLANNING
b  19. Which of the following is not part of the financial planning process?
   a. Establish a planning horizon.
   b. Hire new management.
   c. Aggregate the firm’s investment projects.
   d. Create alternative sets of assumptions about important variables.
   e. Construct pro forma financial statements.




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PERCENTAGE OF SALES
a  20. If total assets increase by the same percentage as sales increase,
   I. the capital intensity ratio will remain constant.
   II. the larger the increase in sales, the less likely there will be a need for external financing.
   III. the firm is assumed to be operating at less than full capacity.
   a. I only
   b. III only
   c. I and III only
   d. II and III only
   e. I, II and III

FINANCIAL PLANNING
d  21. Which of the following is a basic policy element of financial planning?
   I. The inventory management decision
   II. The dividend policy decision
   III. The net working capital decision
   a. I only
   b. II only
   c. I and II only
   d. II and III only
   e. I, II and III

SALES FORECASTS
a  22. Any financial plan should contain            as a first step in analyzing scenarios and
       alternatives for capital budgeting purposes.
   a. pro forma sales forecasts
   b. pro forma income statements
   c. pro forma financial requirements
   d. pro forma balance sheets
   e. common size balance sheets

FINANCIAL PLAN BENEFITS
d  23. By developing a financial plan the firm benefits by being forced to:
   I. Analyze past performance criteria.
   II. Focus on best case scenarios.
   III. Set goals and establish priorities.
   a. I only
   b. I and II only
   c. I and III only
   d. III only
   e. II and III only




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SALES GROWTH
d  24. If your firm is currently operating at less than full capacity and you expect modest sales growth
       over the near term:
   a. Assets will likely increase at a rate faster than sales.
   b. Dividends should be reduced to conserve cash.
   c. No further financial planning should be performed until sales growth accelerates.
   d. External financing will likely not be needed.
   e. Retained earnings will likely decrease (if the firm has positive net income).

FINANCIAL PLANNING GOALS
c  25. In a financial plan, contingency planning and scenario analysis mitigates the firm’s risk from:
   a. Consistency issues.
   b. Horizon problems.
   c. Surprises and errors in assumptions.
   d. Linkages between investment proposals.
   e. Aggregation errors.

PERCENTAGE OF SALES
d  26. The percentage of sales approach to financial planning requires:
   a. All assets and liabilities change at the same rate as sales.
   b. The dividend policy remain unchanged from year to year.
   c. The firm be operating at full capacity.
   d. Separating accounts into those that vary with sales and those that do not.
   e. The firm’s sales to increase each year.

SUSTAINABLE GROWTH RATE
e  27. Which of the following is a determinant of the sustainable growth rate?
   a. Price/earnings ratio
   b. Quick ratio
   c. Inventory turnover ratio
   d. Cash coverage ratio
   e. Dividend payout ratio

FINANCIAL PLANNING
d  28. Which of the following is NOT a basic policy element of financial planning?
   a. The firm’s needed investment in new fixed assets.
   b. The degree of financial leverage a firm chooses to employ.
   c. The amount of cash the firm thinks is necessary and appropriate to pay shareholders.
   d. The level of sales growth the market will provide in future years.
   e. The amount of liquidity and working capital the firm needs on an ongoing basis.




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FINANCIAL PLANNING
b  29. Which of the following is a common element among financial planning models?
   I. Economic forecasts
   II. Pro forma statements
   III. Sales forecasts
   a. I only
   b. II and III only
   c. I and II only
   d. I and III only
   e. I, II, and III

SUSTAINABLE GROWTH RATE
a  30. All else the same, sustainable growth will increase with decreases in                 .
   a. dividend payouts
   b. net income
   c. total asset turnover
   d. profit margin
   e. debt outstanding

PLANNING HORIZON
b  31. For financial planning purposes, we generally define the short run as              , and the long
       run as              .
   a. 2 years;        3-5 years
   b. 1 year;         2-5 years
   c. 1 year;         2-6 years
   d. 2 years;        3-6 years
   e. 1 years;        2-4 years

FINANCIAL PLANNING
d  32. The “plug” figure in a financial plan is defined as the:
   a. Increase in assets necessary to support projected sales.
   b. Change in retained earnings attributable to projected sales.
   c. Level of new fixed assets contained in the financial plan.
   d. External financing needed to support the financial plan.
   e. Level of dividends the firm has paid over recent years.

CAPACITY USAGE
c  33. Which of the following is true regarding the capacity sales level of the firm?
   a. A firm that is operating at less than full capacity will never need external financing.
   b. For a firm that is operating at less than full capacity, fixed assets will typically increase at the
       same rate as sales.
   c. A firm with excess capacity has room to expand sales without increasing the investment in
       fixed assets.
   d. For a given increase in sales, firms operating at less than full capacity will experience more
       rapid asset growth than firms that operate at full capacity.
   e. Only firms operating at full capacity can grow rapidly.




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PERCENTAGE OF SALES
e  34. Jericom Inc.’s fixed assets are forecast to increase at the same rate as sales. It must be that:
   a. Jericom is utilizing its current assets at 100% efficiency.
   b. Jericom’s production level exceeds its sales level.
   c. Jericom has no excess working capital.
   d. Jericom can increase production without any external financing needed.
   e. Jericom is currently operating at full capacity.

GROWTH FACTORS
d  35. The determinants of growth include which of the following?
   I. Equity multiplier
   II. Receivables turnover
   III. Total asset turnover
   a. I only
   b. II only
   c. II and III only
   d. I and III only
   e. I, II and III

PERCENTAGE OF SALES
c  36. Which of the following is most likely to vary directly with sales?
   a. Notes payable
   b. Long-term debt outstanding
   c. Accounts payable
   d. Common stock
   e. Retatined earnings

EXTERNAL FINANCING NEEDED
b  37. All else the same, the level of external financing needed (EFN) decreases with increases in the:
   a. Price/earnings ratio.
   b. Retention ratio.
   c. Inventory turnover ratio.
   d. Capital intensity ratio.
   e. Payout ratio.

FIRM CAPACITY
b  38. Assume a firm is currently operating at full capacity. Sales are forecast to increase by 20%
       next year. Management could do each of the following EXCEPT:
   a. Attempt to restrain sales growth so that no new fixed assets are needed.
   b. Acquire more current assets in order to meet the added demand.
   c. Increase the firm’s investment in fixed assets to meet the added demand.
   d. Subcontract with other manufacturers to increase production and meet the added demand.
   e. Lease additional equipment to meet the added demand.




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CAPITAL INTENSITY RATIO
d  39. All else the same, which of the following would likely be associated with a firm which has a
        high capital intensity ratio, relative to other firms in the same industry?
   I. Higher fixed asset turnover ratio
   II. Higher return on assets (ROA) ratio
   III. Greater depreciation expense
   a. I and II only
   b. II only
   c. I and III only
   d. III only
   e. II and III only

GROWTH RATES
d  40. All else the same, a decrease in a firm’s dividend payout ratio will decrease its:
   I. Sustainable growth rate.
   II. Internal growth rate.
   III. External financing needed.
   a. I only
   b. II only
   c. I and II only
   d. III only
   e. II and III only

EFN AND SALES GROWTH
b  41. Which of the following regarding sales growth is false?
   a. It will typically lead to growth in current assets.
   b. It will automatically lead to increases in long term debt.
   c. It is among the most important items to forecast in the financial planning process.
   d. It will require additions to net fixed assets for firms operating at full capacity.
   e. Costs usually increase spontaneously with the sales growth.

SUSTAINABLE GROWTH
a  42. If a firm believes its costs and assets grow at the same rate as sales, the dividend payout ratio is
        fixed, no new equity is possible, and the current debt-equity ratio is optimal, then which of the
        following is true?
   I. The sustainable growth rate gives the maximum rate at which sales can grow.
   II. External financing will be zero.
   III. Asset growth must completely come from increases in accounts payable and retained earnings.
   IV. If the firm pays out all of its net income as dividends, sales can grow without limit.
   a. I only
   b. I, II, and III only
   c. I and IV only
   d. II, III, and IV only
   e. I, II, III, and IV




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PERCENTAGE OF SALES
a  43. The Limberger Institute is currently operating at full capacity. Which balance sheet items
        would most likely vary directly with sales?
   I. Fixed assets
   II. Long-term debt
   III. Common stock
   a. I only
   b. II only
   c. I and III only
   d. II and III only
   e. I, II and III


III. PROBLEMS

SUSTAINABLE GROWTH RATE
e  44. A firm has a return on equity of 16%, a dividend payout ratio of 40%, an equity multiplier of
       1.6, and a profit margin of 4.2%. What is the sustainable growth rate?
   a.   2.0%
   b.   2.9%
   c.   5.3%
   d.   8.7%
   e. 10.6%

RETENTION RATIO
c  45. A firm earns net income of $40,000 in a given year and the firm’s retained earnings increase
       $30,000 for that same year. The retention ratio is:
   a.   25%
   b.   60%
   c.   75%
   d.   85%
   e. 100%

FULL CAPACITY SALES
e  46. Suppose a firm has net income of $400 and a profit margin equal to 12%. If the firm is working
       at 2/3 capacity, then full capacity sales are:
   a. $2,222
   b. $3,333
   c. $3,667
   d. $4,333
   e. $5,000




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FULL CAPACITY SALES
d  47. If full-capacity sales level are $2,000,000 and the firm is currently operating at 70% of
       capacity, what is the current level of sales?
   a. $ 600,000
   b. $ 750,000
   c. $1,150,000
   d. $1,400,000
   e. $2,700,000

RETAINED EARNINGS
d  48. Given the following information: sales = $800, costs = $620, tax rate = 34%, retention ratio =
       40%, production = 100% of capacity, sales increase = 15%. What is the expected addition to
       retained earnings? (Assume costs change directly with sales.)
   a. $ 1.98
   b. $11.22
   c. $36.62
   d. $54.65
   e. $81.97

EXCESS CAPACITY AND EXTERNAL FINANCING NEEDED
a  49. Given the following information: current assets = $900; fixed assets = $2,500; accounts
       payable = $300; notes payable = $450; long-term debt = $1,550; equity = $1,100; sales = $750;
       costs = $600; tax rate = 34%. Suppose that current assets, costs, and accounts payable maintain
       a constant ratio to sales. If the firm is producing at 70% capacity, what is the total external
       financing needed if sales increase 25%? Assume the firm pays no dividends.
   a. $ 26.25
   b. $ 66.25
   c. $143.75
   d. $172.50
   e. $380.25

PERCENTAGE OF SALES
c  50. Given the following information: sales = $850; costs = $700; tax rate = 34%. Assuming costs
       run at a constant percentage of sales, if sales rise by 12% next year, what will net income be?
   a. $ 27.12
   b. $ 99.00
   c. $110.88
   d. $146.00
   e. $197.12




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SUSTAINABLE GROWTH RATE
d  51. Given the following information: profit margin = 10%; sales = $150; retention ratio = 30%;
       assets = $200; equity multiplier = 1.5. If the firm maintains a constant debt-equity ratio and no
       new equity is used, what is the maximum growth rate? (Assume a constant profit margin.)
   a. 1.52%
   b. 2.04%
   c. 2.68%
   d. 3.49%
   e. 4.93%

INTERNAL GROWTH RATE
d  52. Profit margin is 15% and the retention ratio is 60%. Last year, sales were $900 and total assets
       were $2,000. What is the internal growth rate?
   a. 1.7%
   b. 2.6%
   c. 3.7%
   d. 4.2%
   e. 5.9%

SUSTAINABLE GROWTH RATE
e  53. Profit margin is 6% and the retention ratio is 50%. Last year, sales were $2,000 and total assets
       were $3,000. The desired total debt ratio is 65%. What is the sustainable growth rate?
   a.   2.5%
   b. 11.5%
   c.   8.1%
   d.   4.3%
   e.   6.1%

EXTERNAL FINANCING NEEDED
c  54. The profit margin is 10% and the dividend payout is 30%. Last year’s sales were $50 million
       and total assets were $35 million. None of the liabilities vary directly with sales, but assets and
       costs do. If the sales growth rate is 15%, how much external financing is needed?
   a. $0.825 million
   b. $1.030 million
   c. $1.225 million
   d. $2.075 million
   e. $2.855 million




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EXTERNAL FINANCING NEEDED
c  55. Given the following information: assets = $500; accounts payable = $40; notes payable = $50;
       long-term debt = $110; equity = $300; sales = $250; costs = $200; tax rate = 35%; dividends =
       $13. Costs, assets, and accounts payable maintain a constant ratio to sales. How much external
       financing is needed if sales increase 20% and the dividend payout ratio is constant?
   a. $23
   b. $41
   c. $69
   d. $77
   e. $92

SUSTAINABLE GROWTH
d  56. Suppose a firm has net income of $100, dividends of $35, assets of $4,000 and a debt-equity
       ratio of 4.0. What is the sustainable growth rate?
   a.   1.5%
   b.   4.0%
   c.   6.9%
   d.   8.8%
   e. 13.1%

SUSTAINABLE GROWTH RATE
b  57. Assume a firm has sales of $2,750 on assets totaling $1,500, net income of $108, and dividends
       of $30. What is the sustainable growth rate if the equity has a value of $600?
   a. 22.9%
   b. 14.9%
   c. 11.1%
   d.   9.9%
   e.   1.3%

                Use the following information to answer questions #58 through #60.

     Net income = $400; Total assets = $3,000; Total liabilities = $1,200; Total asset turnover = 2.0

CAPITAL INTENSITY RATIO
b  58. What is the capital intensity ratio assuming dividends paid total $250?
   a. 0.00
   b. 0.50
   c. 0.25
   d. 4.00
   e. 2.00




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INTERNAL GROWTH RATE
c  59. What is the internal growth rate assuming dividends paid total $250?
   a. 1.1%
   b. 2.5%
   c. 5.3%
   d. 8.3%
   e. 9.1%

SUSTAINABLE GROWTH RATE
e  60. What is the sustainable growth rate assuming dividends paid total $100?
   a.   4.5%
   b.   8.6%
   c. 12.5%
   d. 15.0%
   e. 20.0%

                       Use the following to answer questions #61 through #64.

                                            WidgetWorld Co.
                                      Balance Sheet for Dec. 31, 2001

     Cash                       $50                  Accounts payable              $100
     Inventory                 $150                  Notes payable                  100
     Fixed assets              $600                  Long-term debt                 350
                                                     Equity                         250
     Total assets              $800                  Total liabilities & equity    $800

                                        Income statement for 2001

                                    Sales                   $800
                                    Costs                    600
                                    EBT                     $200
                                    Taxes (34%)               68
                                    Net income              $132


EXTERNAL FINANCING NEEDED
b  61. Suppose that current assets, costs, and accounts payable maintain a constant ratio to sales. The
       firm retains 40% of earnings. If the firm is producing at only 90% capacity, what is the total
       external financing needed if sales increase 25%?
   a.   $ 1
   b.   $34
   c.   $41
   d.   $47
   e.   $94




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INTERNAL GROWTH RATE
b  62. Suppose the firm retains 28% of earnings, while assets and costs maintain a constant
       percentage of sales. If the firm is producing at full capacity, what is the internal growth rate?
   a.   1.9%
   b.   4.8%
   c. 10.1%
   d. 13.5%
   e. 17.3%

SUSTAINABLE GROWTH RATE
c  63. Suppose that assets and costs maintain a constant ratio to sales. The firm retains 30% of
       earnings. If the firm is producing at full capacity, what is the maximum growth rate, assuming
       no equity sales, that will maintain a constant debt-equity ratio?
   a.   5.2%
   b. 15.6%
   c. 18.8%
   d. 21.0%
   e. 29.2%

SUSTAINABLE GROWTH RATE
c  64. Suppose the firm wishes to maintain a constant debt-equity ratio, retains 60% of net income,
       and raises no new equity. Assets and costs maintain a constant ratio to sales. What is the
       maximum increase in sales the firm can achieve?
   a. $ 88
   b. $249
   c. $371
   d. $429
   e. $580

                 Use the following information to answer questions #65 through #72.

                                          Illogicom Corporation
                                             Income Statement
                                               ($ in millions)

                                     Sales                  $300
                                     Costs                   250
                                     EBT                     $50
                                     Taxes (34%)              17
                                     Net income              $33
                                     Retained earnings       $22
                                     Dividends               $11




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                                         Illogicom Corporation
                                             Balance Sheet
                                             ($ in millions)

            Cash                 $ 5                    Accounts payable        $ 40
            Accounts receivables 40                     Notes payable             30
            Inventory             65                    Current liabilities      $70
            Current assets      $110                    Long-term debt           155
            Net plant & equip.   290                    Common stock              75
                                                        Retained earnings        100
            Total assets         $400                   Total liab. & equity   $400

PERCENTAGE OF SALES
c  65. Assuming a constant profit margin, what will Illogicom’s net income be if sales increase by
       10%?
   a. $33.0 million
   b. $34.5 million
   c. $36.3 million
   d. $39.6 million
   e. $60.0 million

RETAINED EARNINGS
b  66. What is Illogicom’s addition to retained earnings with a 10% increase in sales? Assume the
       dividend payout ratio and profit margin remain fixed.
   a. $22.0 million
   b. $24.2 million
   c. $26.4 million
   d. $29.7 million
   e. $39.0 million

TOTAL ASSETS
e  67. Assume Illogicom is operating at full capacity. What will total assets be if sales increase by
       10%? Assume costs, current liabilities and assets vary directly with sales and that the dividend
       payout ratio remains unchanged.
   a. $225.0 million
   b. $231.6 million
   c. $246.7 million
   d. $330.5 million
   e. $440.0 million




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FULL CAPACITY SALES
c  68. Assume Illogicom is utilizing its fixed assets at 90% capacity. Assume costs, current liabilities
       and current assets vary directly with sales, and that the dividend payout ratio remains
       unchanged. If sales increase by 20%, what will total fixed assets be?
   a. $256 million
   b. $286 million
   c. $313 million
   d. $359 million
   e. $470 million

EXTERNAL FINANCING NEEDED
e  69. How much external financing is needed for a 20% increase in sales if the firm is currently
       operating at full capacity? Assume assets and costs vary directly with sales but no current
       liabilities increase with sales and that the dividend payout ratio remains fixed.
   a. $0
   b. $23.2 million
   c. $27.6 million
   d. $37.4 million
   e. $53.6 million

INTERNAL GROWTH RATE
c  70. What is the addition to retained earnings if Illogicom grows at the internal growth rate?
       (Assume the dividend payout ratio is fixed.)
   a. $ 5.8 million
   b. $13.3 million
   c. $23.3 million
   d. $24.9 million
   e. $33.0 million

SUSTAINABLE GROWTH RATE
e  71. What is Illogicom’s addition to total assets if they grow at the sustainable growth rate?
       (Assume the dividend payout ratio is fixed.)
   a. $15 million
   b. $23 million
   c. $32 million
   d. $44 million
   e. $57 million




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               Use the following information to answer questions #72 through #80.

                                          Xanthus Group
                           Balance Sheet for Year Ending 2000 and 2001
                                          ($ in millions)

                         2000       2001                                    2000   2001
    Cash                $ 75      $ 135           Accounts payable        $ 89    $110
    Accounts receivable 230         214           Notes payable             227    442
    Inventory            240        188           Current liabilities       316    552
    Current assets       545        537           Long-term debt            615    440
    Fixed assets         788        890           Common stock               55     55
                                                  Retained earnings         347    380
    Total assets        $1,333   $1,427           Total liab. & equity   $1,333 $1,427

                                         Xanthus Group
                                      2001 Income Statement
                                          ($ in millions)

                          Net sales                              $905
                          Less: Cost of goods sold                522
                          Less: General & adm. expenses            93
                          Less: Depreciation                      110
                          Earnings before interest and taxes      180
                          Less: Interest paid                      61
                          Earnings before taxes                   119
                          Less: Taxes                              30
                          Net income                             $ 89

RETENTION RATIO
a  72. What is Xanthus’ earnings retention ratio for 2001?
   a. 0.37
   b. 0.49
   c. 0.63
   d. 0.89
   e. 0.92




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DIVIDENDS
d   73. Suppose Xanthus is projecting a 20% increase in sales for the coming year, and that cost of
        goods sold and general/administrative expenses remain a constant percentage of sales. Also
        assume that depreciation, interest paid, and the firm’s tax rate remain unchanged. What will the
        firm pay out in dividends in 2002? Assume the firm’s dividend payout is 40%.
    a. $30
    b. $32
    c. $48
    d. $53
    e. $67

CAPITAL INTENSITY
e  74. Based on the 2001 data, what is Xanthus’ capital intensity ratio?
   a. 1.20
   b. 1.23
   c. 1.35
   d. 1.47
   e. 1.58

FULL CAPACITY SALES
d  75. Suppose Xanthus is currently operating at 70% of capacity. What are full capacity sales?
   a. $ 271
   b. $ 633
   c. $ 986
   d. $1,293
   e. $3,017

EXTERNAL FINANCING NEEDED
b  76. Assume Xanthus is projecting a 20% increase in sales for the coming year, and that assets, all
       costs, and current liabilities are proportional to sales. Long-term debt is not proportional to
       sales. Assume the firm’s tax rate remains unchanged and the dividend payout is 40%. What is
       the external financing needed (EFN) for 2002?
   a. $ 64.1
   b. $110.9
   c. $132.3
   d. $146.7
   e. $152.9




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EXTERNAL FINANCING NEEDED
a  77. Assume Xanthus is projecting a 20% increase in sales for the coming year, with current assets,
       all costs, and current liabilities proportional to sales. Long-term debt is not proportional to
       sales. If the firm’s tax rate remains unchanged, the dividend payout is 40%, and Xanthus is
       operating at 70% of capacity, what is the external financing needed (EFN) for 2002?
   a. EFN is negative
   b. $21.94
   c. $48.31
   d. $76.32
   e. $89.85

DETERMINANTS OF GROWTH
a  78. Which of the following describes the components of Xanthus’ 2001 ROE from the Du Pont
       identity?
   a. .098; .634; 3.28
   b. .098; .679; 3.28
   c. .098; .679; 3.06
   d. .098; .634; 3.06
   e. .098; .679; 3.76

INTERNAL GROWTH RATE
a  79. Based on the 2001 financial statement data, Xanthus’ internal growth rate is       . (Assume the
       dividend payout ratio is fixed.)
   a. 2.4%
   b. 2.5%
   c. 4.1%
   d. 8.2%
   e. 9.5%

SUSTAINABLE GROWTH RATE
d  80. Based on the 2001 financial statement data, Xanthus’ sustainable growth rate is        .
       (Assume the dividend payout ratio is fixed.)
   a. 2.4%
   b. 2.5%
   c. 4.1%
   d. 8.2%
   e. 9.5%


IV. ESSAYS

ROE AND DUPONT
81. Between 1989 and the end of 1993, General Motors’ return on equity rose from 12.1% to 44.1%.
    During that same time, the profit margin actually declined as did the return on assets. What are the
    factors that could have caused this apparent contradiction in results? Would you say, based on these
    numbers, that GM’s profitability has increased substantially?




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     GM restated its balance sheet to reflect its pension liability, thereby almost wiping out its equity,
     driving its equity multiplier way up. The only other factor of Du Pont unaccounted for was the total
     asset turnover which (since the ROA declined), may have declined, remained unchanged, or
     increased slightly. In any event, GM’s apparent increase in profitability was simply a result of an
     accounting oddity. The increase in ROE could also have developed from repurchasing substantial
     amounts of equity, which would certainly put a better spin on the interpretation of the results.

FINANCIAL PLANNING
82. The authors state that “conventional business wisdom holds that financial plans don’t work, but
    financial planning does.” What is meant by this? Ignoring the accuracy of the numbers in a financial
    plan (which can only be determined after the fact anyway), what does the process of financial
    planning accomplish?

     An underlying theme of the chapter is that, while no one can predict future events, the act of
     planning for various contingencies forces decision-makers to consider what might happen, as well
     as the interactions between investment and financing decisions and the implications of their
     decisions on other aspects of firm performance. In other words, alert students will pick up on the
     integrative nature of financial planning.

SALES GROWTH
83. It is stated in the text that the planner’s assumptions about future sales growth serves as the “driver”
    for the financial plan. What factors and/or types of decisions determine how much sales growth the
    firm can accommodate?

     This is an open-ended question which really gets to the heart of the financial planning process; i.e.,
     the management of growth. Some instructors may wish to emphasize in their lectures that (to
     paraphrase Higgins) a firm can “grow itself out of business”. In other words, rapid, unexpected sales
     increases can result in poor capital budgeting, financing, or working capital decisions. By
     understanding what factors contribute to the firm’s internal and sustainable growth rates, students
     can better understand the nature of the decisions necessary to accommodate growth.

SUSTAINABLE GROWTH
84. State the assumptions that underlie the sustainable growth rate and interpret what the sustainable
    growth rate means.

     The usual assumptions are: Costs and assets increase proportionately with sales, the dividend payout
     ratio is fixed (or is given), the current debt-equity ratio is optimal, no new equity sales are possible.
     The sustainable growth rate is the maximum rate at which sales can increase with the restriction that
     no new equity sales are possible and long-term debt increases only in an amount that keeps the debt-
     equity ratio fixed.




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NEGATIVE EFN
85. Suppose a firm calculates its EFN and finds that it is negative. What are the firm’s options in this
    case?

     With negative EFN, the firm has a surplus of funds that it can use to reduce current liabilities,
     reduce long-term debt, buy back common stock, or increase dividends. As a least-best alternative,
     the firm could choose to add assets, but this requires some additional assumptions about NPVs, etc.

INTERPRETING GROWTH
86. Consider a firm which forecasts that costs, assets, and current liabilities will all change
    proportionately with sales and the dividend payout ratio will remain fixed. How will the firm’s
    ROE change as a result of a forecasted 30% increase in sales? How will the individual components
    of ROE (the Du Pont identity) change? Why?

     The ROE and all of its components—profit margin, total asset turnover, and equity multiplier—will
     all remain unchanged. This is the essence of the percentage of sales approach to forecasting.




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