Key steps in the development of pro forma financial statement

Question 1 of 20

The percentage of sales method is based on which of the following assumptions?

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

B. b. Most balance sheet accounts are tied directly to sales.

C. c. The current level of total assets is optimal for the current sales level.

D. d. Answers a and c above.

E. e. Answers b and c above.

Question 2 of 20

The percentage of sales method produces accurate results unless which of the following conditions is (are) present?

A. a. Fixed assets are “lumpy.”

B. b. Strong economies of scale are present.

C. c. Excess capacity exists because of a temporary recession.

D. d. Answers a, b, and c all make the percentage of sales method inaccurate.

E. e. Answers a and c make the percentage of sales method inaccurate, but, as the text explains, the assumption of increasing economies of scale is built into the percentage of sales method.

Question 3 of 20

Which of the following statements is correct?

A. a. One of the key steps in the development of pro forma financial statements is to identify those assets and liabilities which increase spontaneously with net income.

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

C. c. Pro forma financial statements as discussed in the text are used primarily to assess a firm’s historical performance.

D. d. The capital intensity ratio reflects how rapidly a firm turns over its assets and is the reciprocal of the fixed assets turnover ratio.

E. e. The percentage of sales method produces accurate results when fixed assets are lumpy and when economies of scale are present

Question 4 of 20

Considering each action independently and holding other things constant, which of the following actions would reduce a firm’s need for additional capital?

A. a. An increase in the dividend payout ratio.

B. b. A decrease in the profit margin.

C. c. A decrease in the days sales outstanding.

D. d. An increase in expected sales growth.

E. e. A decrease in the accrual accounts (accrued wages and taxes).

Question 5 of 20

Which of the following statements is correct?

A. a. Since accounts payable and accruals must eventually be paid, as these accounts increase, AFN also increases.

B. b. Suppose a firm is operating its fixed assets below 100 percent capacity but is at 100 percent with respect to current assets. If sales grow, the firm can offset the needed increase in current assets with its idle fixed assets capacity.

C. c. If a firm retains all of its earnings, then it will not need any additional funds to support sales growth.

D. d. Additional funds needed are typically raised from some combination of notes payable, long-term bonds, and common stock. These accounts are nonspontaneous in that they require an explicit financing decision to increase them.

E. e. All of the statements above are false.

Question 6 of 20

Which of the following statements is correct?

A. a. Any forecast of financial requirements involves determining how much money the firm will need and is obtained by adding together increases in assets and spontaneous liabilities and subtracting operating income.

B. b. The percentage of sales method of forecasting financial needs requires only a forecast of the firm’s balance sheet. Although a forecasted income statement helps clarify the need, it is not essential to the percentage of sales method.

C. c. Because dividends are paid after taxes from retained earnings, dividends are not included in the percentage of sales method of forecasting.

D. d. Financing feedbacks describe the fact that interest must be paid on the debt used to help finance AFN and dividends must be paid on the shares issued to raise the equity part of the AFN. These payments would lower the net income and retained earnings shown in the projected financial statements.

E. e. All of the statements above are false.

Question 7 of 20

Which of the following statements is correct?

A. a. Inherent in the AFN formula is the assumption that each asset item must increase in direct proportion to sales increases and that spontaneous liability accounts also grow at the same rate as sales.

B. b. If a firm has positive growth in its assets, but has no increase in retained earnings, AFN for the firm must be positive.

C. c. Using the AFN formula, if a firm increases its dividend payout ratio in anticipation of higher earnings, but sales actually decrease, the firm will automatically experience an increase in additional funds needed.

D. d. Higher sales usually require higher asset levels. Some of the increase in assets can be supported by spontaneous increases in accounts payable and accruals, and by increases in certain current asset accounts and retained earnings.

E. e. Dividend policy does not affect requirements for external capital under the AFN formula method.

 

Question 8 of 20

Jill’s Wigs Inc. had the following balance sheet last year:

Cash 800 Accounts Payable 350

Accounts Receivable 450 Accrued Wages 150

Inventories 950 Notes Payable 2,000

Fixed Assets 34,000 Mortgage 26,500

Common Stock 3,200

Retained earnings 4,000

Total Assets 36,200 Total liabilites and equity 36,200

Jill has just invented a non-slip wig for men which she expects will cause sales to double from $10,000 to $20,000, increasing net income to $1,000. She feels that she can handle the increase without adding any fixed assets. (1) Will Jill need any outside capital if she pays no dividends? (2) If so, how much?

A. a. No; zero

B. b. Yes; $7,700

C. c. Yes; $1,700

D. d. Yes; $700

E. e. No; there will be a $700 surplus.

Question 9 of 20

Brown & Sons recently reported sales of $100 million, and net income equal to $5 million. The company has $70 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 $2 million. If the company’s sales increase, its profit margin will remain at its current level. The company’s dividend payout ratio is 40 percent. Based on the formula, how much additional capital must the company raise in order to support the 20 percent increase in sales?

A. a. $ 2.0 million

B. b. $ 6.0 million

C. c. $ 8.4 million

D. d. $ 9.6 million

E. e. $14.0 million

Question 10 of 20

Splash Bottling’s December 31st balance sheet is given below:

Cash 10 Accounts payable 15

Accounts Receivable 25 Notes payable 20

Inventories 40 Accrued wages and taxes 15

Net fixed assets 75 Long-term debt 30

Common equity 70

Total assets 150 Total liabilities and equity 150

Sales during the past year were $100, and they are expected to rise by 50 percent to $150 during next year. Also, during last year fixed assets were being utilized to only 85 percent of capacity, so Splash could have supported $100 of sales with fixed assets that were only 85 percent of last year’s actual fixed assets. Assume that Splash’s profit margin will remain constant at 5 percent and that the company will continue to pay out 60 percent of its earnings as dividends. To the nearest whole dollar, what amount of nonspontaneous, additional funds (AFN) will be needed during the next year?

A. a. $57

B. b. $51

C. c. $36

D. d. $40

E. e. $48

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