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Exam 9: Corporate Valuation and Financial Planning

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Question 21

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Which of the following statements is CORRECT?

A) Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no excess current assets. Based on the AFN equation, its AFN will be larger than if it had been operating with excess capacity in both fixed and current assets.
B) If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth.
C) Additional funds needed (AFN) are typically raised using a combination of notes payable, long-term debt, and common stock. Such funds are non-spontaneous in the sense that they require explicit financing decisions to obtain them.
D) If a firm has a positive free cash flow, then it must have either a zero or a negative AFN.
E) Since accounts payable and accrued liabilities must eventually be paid off, as these accounts increase, AFN as calculated by the AFN equation must also increase.

F) C) and D)
G) None of the above

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Question 22

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Which of the following is NOT one of the steps taken in the financial planning process?

A) Monitor operations after implementing the plan to spot any deviations and then take corrective actions.
B) Determine the amount of capital that will be needed to support the plan.
C) Develop a set of forecasted financial statements under alternative versions of the operating plan in order to analyze the effects of different operating procedures on projected profits and financial ratios.
D) Consult with key competitors about the optimal set of prices to charge, i.e., the prices that will maximize profits for our firm and its competitors.
E) Forecast the funds that will be generated internally. If internal funds are insufficient to cover the required new investment, then identify sources from which the required external capital can be raised.

F) None of the above
G) A) and B)

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Question 23

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Which of the following statements is CORRECT?

Firms pay a low interest rate on spontaneous liabilities so these funds are its cheapest source of capital.Consequently,the firm should make arrangements with its suppliers to use as much of this credit as possible.

The minimum growth rate that a firm can achieve with no access to external capital is called the firm's sustainable growth rate.It can be calculated by using the AFN equation with AFN equal to zero and solving for g.

Two firms with identical capital intensity ratios are generating the same amount of sales.However,Firm A is operating at full capacity,while Firm B is operating below capacity.If the two firms expect the same growth in sales during the next period,then Firm A is likely to need more additional funds than Firm B,other things held constant.

Daniel Sawyer,the CEO of the Sawyer Group,is initiating planning for the company's operations next year,and he wants you to forecast the firm's additional funds needed (AFN) .The firm is operating at full capacity.Data for use in your forecast are shown below.Based on the AFN equation,what is the AFN for the coming year? Dollars are in millions. $\begin{array}{lc}\text { Last year's sales }=S_{0} & \$ 350 \text { Last year's accounts payable } &\$40\\\text { Sal es growth rate }=g & 30 \% \text { Last year's notes payable }&\$50 \\\text { Last year's total assets }=A_{0} * & \$ 500 \text { Last year's accruals }&\$30 \\\text { Last year's pro fit margin }=\text { PM } & 5 \% \text { Target payout ratio }&60\%\end{array}$

The AFN equation assumes that the ratios of assets and liabilities to sales remain constant over time.However,this assumption can be relaxed when we use the forecasted financial statement method.Three conditions where constant ratios cannot be assumed are economies of scale,lumpy assets,and excess capacity.

A firm will use spontaneous funds to the extent possible; however,due to credit terms,contracts with workers,and tax laws there is little flexibility in their usage.

In your internship with Lewis,Lee,& Taylor Inc.you have been asked to forecast the firm's additional funds needed (AFN) for next year.The firm is operating at full capacity.Data for use in your forecast are shown below.Based on the AFN equation,what is the AFN for the coming year?

Companies with relatively high assets-to-sales ratios require a relatively large amount of new assets for any given increase in sales; hence,they have a greater need for external financing.There are currently no alternatives for these types of firms to lower their asset requirements.

A firm's profit margin is 5%,its debt/assets ratio is 56%,and its dividend payout ratio is 40%.If the firm is operating at less than full capacity,then sales could increase to some extent without the need for external funds,but if it is operating at full capacity with respect to all assets,including fixed assets,then any positive growth in sales will require some external financing.

The capital intensity ratio is generally defined as follows:

North Construction had $850 million of sales last year,and it had $425 million of fixed assets that were used at only 60% of capacity.What is the maximum sales growth rate North could achieve before it had to increase its fixed assets?

Last year Baron Enterprises had $350 million of sales,and it had $270 million of fixed assets that were used at 65% of capacity last year.In millions,by how much could Baron's sales increase before it is required to increase its fixed assets?

Firms with high capital intensity ratios have found ways to lower this ratio permitting them to achieve a given level of growth with fewer assets and consequently less external capital.For example,just-in-time inventory systems,multiple shifts for labor,and outsourcing production are all feasible ways for firms to reduce their capital intensity ratios.

As long as a firm does not pay out 100% of its earnings,the firm's annual profit that is retained in the business (i.e.,the addition to retained earnings)is another source of funds for a firm's expansion.

Operating plans sketch out broad approaches for realization of the firm's strategic vision.These plans usually are developed for a period no longer than a 1-year time horizon because detail is "lost" by extending out the time horizon by more than 1 year.

If a firm's capital intensity ratio (A₀*/S₀)decreases as sales increase,use of the AFN formula is likely to understate the amount of additional funds required,other things held constant.

Which of the following statements is CORRECT?