13 x11 financial management a financial planning & strategies

Financial Management(A. Financial Planning & Strategies)

MODULE 11

FINANCIAL MANAGEMENT

A. FINANCIAL PLANNING AND STRATEGIES

THEORIES:Business plan3. The typical outline of the component parts of a business plan would be the

A. mission and strategy statements. C. financial projections. B. operations of the business. D. All of the above.

Financial planning process2. Planning for future growth is called:

A. capital budgeting C. financial forecastingB. working capital management D. none of the above

1. The ideal financial planning process would beA. top-down planning. B. bottom-up planning. C. a combination of top-down and bottom-up planning. D. none of the above.

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.B. Financial planning should not proceed by trial and error.C. Many different strategies may be projected under a range of assumptions about the future

before one strategy is finally chosen.D. The dozens of separate projections that may be made during this trial-and-error process

generate a heavy load of arithmetic and paperwork.

Financing policyMaturities matching23. When a firm finances long-term assets with short-term sources of funding, it:

A. reduces the risk of cash shortageB. will have higher interest expensesC. improves the leverage ratioD. is ignoring the principle of matched maturities

Short-term financing

14. The type of company most likely to need short-term financing is one thatA. has no seasonality and no growth in sales from year to yearB. sells only for cashC. has a high degree of seasonalityD. has lower total fixed costs than total variable costs

25. Common sources of short-term financing include:A. Stretching payables C. Reducing inventoryB. Issuing bonds D. All of the above

24. How does long-term financing policy affect short-term financing requirements?A. The nature of the firm's short-term financial planning problem is determined by the amount

of long-term capital it raises.B. A firm that issues large amounts of long-term debt or common stock, or that retains a

large part of its earnings, may find that it has permanent excess cash. Other firms raise relatively little long-term capital and end up as permanent short-term debtors.

C. Most firms attempt to find a golden mean by financing all fixed assets and part of current assets with equity and long-term debt. Such firms may invest cash surpluses during part of the year and borrow during the rest of the year.

D. All of the above affect short-term financing.

Judgmental approach21. Under the judgmental approach for developing a pro forma balance sheet, the “plug” figure

required to bring the statement into balance may be called theA. retained earnings C. suspense accountB. accounts receivable D. required new financing

Percent of sales method6. 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.

4. Which of the following is the major independent variable in constructing pro forma income statements and balance sheets?A. total assets C. dividend payoutB. net income D. sales

7. The first step in developing a pro forma income statement is to:

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A. build a sales forecast C. determine the cost of goods soldB. determine the production schedule D. none of the above

20. The percent-of-sales method of preparing the projected income statement assumes that all costs are:A. Constant C. VariableB. Fixed D. Independent

22. Utilizing past cost and expense ratios (percent-of-sales method) when preparing pro forma financial statements will tend toA. 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.

Additional funds needed5. Additional funds needed are best defined as:

A. Funds that are obtained automatically from routine business transactions.B. Funds that a firm must raise externally through borrowing or by selling new common or

preferred stock.C. The amount of assets required per peso of sales.D. A forecasting approach in which the forecasted percentage of sales for each item is held

constant.

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. 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 incomeB. Growth in assets minus the current year's retained earningsC. 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

15. A company that has rapidly growing sales will probablyA. need additional long-term financing C. have increasing asset requirementsB. have a financing gap D. find that all of the above are true

17. Which of the following statements is most correct?A. Since accounts payable and accrued liabilities must eventually be paid, as these accounts

increase, required new financing also increases.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. If a firm retains all of its earnings, then it will not need any additional funds to support sales growth.

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.

Growth19. 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.

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.

Sensitivity analysis9. 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 paidB. 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 company’s profit margin increases.

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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 company’s 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 equityB. A higher debt-to-asset ratio D. A higher return on assets

Sustainable growth rate16. The sustainable growth rate is best described by which of the following?

A. The rate of sales growth that will sustain the assets of the company. B. The rate of earnings growth needed to avoid external financing. C. The maximum rate of sales growth of a company without using external debt. D. The maximum rate of sales growth of a company without raising external funds from the

sale of stock.

PPROBLEMS:Percent-of-sales methodTotal assets requirements1. 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 beA. P 40,500 C. P115,500B. P240,000 D. P270,000

Additional Financing NeededTotal assets2. Calculate the total assets of Premiere Company given the following information:

Sales this year P3,000,000Sales increase projected for next year 20 percentNet income this year P 250,000

Dividend payout ratio 40 percentProjected excess funds available next year P 100,000Accounts payable P 600,000Notes payable P 100,000Accrued wages and taxes P 200,000

Except for the accounts noted, there were no other current liabilities. Assume that the firm’s profit margin remains constant and that the company is operating at full capacity.A. P3,000,000 C. P2,000,000B. P2,200,000 D. P1,200,000

Addition to retained earnings3. Almond Corporation recently reported the following income statement for 2006 (in P’000):

Sales P7,000Operating costs 3,000EBIT P4,000Interest 200Earnings before taxes (EBT) P3,800Taxes (40%) 1,520Net income to common shareholders P2,280

The company forecasts that its sales will increase by 10 percent in 2007 and its operating costs will 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 forecasted addition to retained earnings for 2007?A. P1,140 C. P1,440B. P1,260 D. P1,790

Additional financing needed4. 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 funds?A. P 200,000 C. P 800,000B. P 600,000 D. P1,200,000

4 . Answer: CCapital budget 2,000,000Increase in retained earnings (3M x 0.4) 1,200,000External funds needed 800,000

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5. 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 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 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 8,400,000B. P 6,000,000 D. P 9,600,000

6. Leverage Company’s December 31, 2006 balance sheet (in P’000,000) is given below:Cash P 10 Accounts payable P 15Accounts receivable 25 Notes payable 20Inventories 40 Accrued expenses 15

Long-term debt 30Net fixed assets 75 Common stock 70Total 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 year’s actual fixed assets. Assume that Leverage’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. What amount of nonspontaneous, required new financing (RNF), will be needed during the next year?A. P55,500,000 C. P49,500,000B. P52,500,000 D. P40,125,000

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.

Balance Sheet(In million pesos)

Assets Liabilities and Stockholders’ EquityAccounts payable and accruals P25

Current assets P50 Notes payable – long term 30Common stock 15

Fixed assets 40 Retained earnings 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 isA. P4,850,000 C. P2,650,000B. P3,000,000 D. P5,000,000

New Long-term debt8. Hello Company has the following balance sheet as of December 31, 2006.

Current assetsP 600,000

Fixed assets 400,000 Total Assets P1,000,000

Accounts payable P 100,000Accrued liabilities 100,000Notes payable 100,000Long-term debt 300,000Total common equity 400,000 Total Liabilities and Equity P1,000,000

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 92,000B. P 88,000 D. P112,000

Maximum sales8 . Answer: D

Increase in total assets (1M x 0.2) 200,000Increase in liabilities (200,000 x 0.2) 40,000 Increase in net spontaneous assets 160,000Increase in retained earnings (6M x 0.02 x 0.4) 48,000 Increase in long-term debt (RNF) 112,000

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9. Indo Industries has P2.5 million in sales and P0.8 million in fixed assets. Currently, the company’s 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. P3,000,000B. P3,333,333 D. P3,125,575

Maximum growth rate10. 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 percentB. 4.8 percent D. 9.6 percent

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

1 . Answer: CCash P 10,000Accounts receivable (0.25 x P100,000) 25,000Inventory (0.1 x P100,000 x 0.55) 5,500Fixed assets 75,000Total assets required P115,500

2 . Answer: DThe note payable is assumed to be a nonspontaneous liability.

Let A = Total Assets0.2A – (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 = -100,0000.2A = 240,000A = 1,200,000

3 . Answer: BSales forecast (P7M x 1.1) P7,700,000Operating costs (P3M x 1.1) 3,300,000EBIT P4,400,000Interest 200,000Earnings before tax P4,200,000Income tax P4,200,000 x 0.4) 1,680,000

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%

Net income P2,520,000Dividends (P2,520,000 x 0.5( 1,260,000Increase in Retained Earnings P1,260,000

11 . Answer: BThe 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) P120,0000 = 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 + 5,000g105,000g = 5,000g 4.8%

6 . Answer: DFixed required by P100M sales (P75M x 0.85) P63,750,000Total fixed assets required by P150M sales (150 ÷ 100 x P63,750,000) P95,625,000Deduct current level of fixed assets 75,000,000 Required increase in fixed assets 20,625,000Increase in net spontaneous assets 0.5 x (P75M – P30) 22,500,000 Total financing needed 43,125,000Deduct increase in retained earnings (P150M x 0.05 x 0.4) 3,000,000 Additional Financing Needed P40,125,000

7 . Answer: CRNF = (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 = 2,650,000Alternative Solution:

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Maximum dividend payout ratio12. 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%?A. Approximately 1% C. Approximately 12%B. Approximately 10% D. Approximately 20%

Financing PolicyConservative policy13. Wales Company has P8,000,000 in current assets, P3,500,000 of which are considered

permanent current assets. In addition, the firm has P6,000,000 invested in fixed assets. Wales Company wishes to finance all fixed assets and permanent current assets plus half of

RNF = (0.1 x 90M) – (0.1 x 25M) – (0.7 x 0.05 x 110M)= 2,650,000

SA = Spontaneous (variable) assetsSL = Spontaneous (variable) liabilitiesRE = Retained earnings∆S = Increase in sales

its temporary current assets with long-term financing costing 15 percent. Short-term financing currently costs 10 percent. Wales Company’s earnings before interest and taxes are P2,200,000. Income tax rate is 40 percent.How much would Wales Company’s earnings after taxes under this financing plan?A. P212,500 C. P225,000B. P127,500 D. P 85,000

Aggressive policy14. 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 20,000Accts receivable 66,000 25,000 47,000 88,000Inventory 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. P150,000B. P100,000 D. P155,625

5 . Answer: CAdditional assets (70M 0.2) 14,000,000Deduct: 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

9 . Answer: BAmount sales per capacity unit (2.5M ÷ 75) 23,333.33Amount of sales at 100% capacity: 100 x 33,333.33 3,333,333

10 . Answer: B1.6(X – 100,000,000) – 0.4(X – 100,000,000) – (0.55 x 0.10X) = 01.2(X – 100,000,000) – 0.055X = 01.2X - 120,000,000 - 0.055X = -1.145X = 120,000,000X = 104,803,493Growth: (104,803,493/100,000,000) – 1 = 4.8%

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12 . Answer: BEquity ratio: 1 ÷(1 + 0.5) 66.67%0 = 0.09 – (0.15 x 0.6667 x RR)0 = (0.09 – 0.1RR0.1RR = 0.09RR = 90%

13 . Answer: BLong-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) 2.25 M Total Long-term Financing 11.75 M

14 . Answer: CFixed assets 100,000Permanent 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.

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13 x11 financial management a financial planning & strategies

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