Question 1

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.

Accepted Answer

Companies can implement strategies such as improving asset turnover, outsourcing, or adopting more efficient technologies to lower their asset requirements and reduce the need for external financing.

Question 2

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. 
$\begin{array}{l}
\begin{array}{lc}
\text { Last year's sales }=S_{0} & \$ 350 \text { Last year's accounts payab } \
\text { Sales growth rate }=g & 30 \% \text { Last year's notes payable } \
\text { Last year's total assets }=A_{0} * & \$ 500 \text { Last year's accruals } \
\text { Last year's profit margin }=\text { PM } & 5 \% \text { Target payout ratio }
\end{array}
\begin{array}{r}
\$ 40 \
\$ 50\
\$ 30 \
60 \%
\end{array}
\end{array}$

Accepted Answer

$\begin{array}{lr}
\text { Last year's sales }=S_{0} & \$350 \
\text { Sales growth rate }=g & 30 \% \
\text { Forecasted sales }=S_{0} \times(1+g) & \$455 \
\Delta S=\text { change in sales }=S_{1}-S_{0}=S_{0} \times g & \$ 105\
\text { Last year's total assets }=A_{0}{ }^{*}=A_{0}{ }^{*} \text { since full capacity } & \$ 500 \
\text { Last year's accounts payable } & \$ 40\
\text { Last year's notes payable. Not spontaneous, }\
\text {so does not enter AFN calculation }&\$50 \
\text { Last year's accruals}&\$30 \
\text { $ \mathrm{L}_{0}{ }^{*}= $ payables $ + $ accruals}&\$ 70 \
\text {Profit margin $ =M $ }&5.0 \% \
\text {Target payout ratio }&60.0 \%
\end{array}$
 
AFN = (A0*/S0)σS σ (L0*/S0)σS σ Profit margin × S1 × (1 σ Payout) AFN = $150.0 σ $21.0 σ $9.1 = $119.9

Question 3

Which of the following statements is CORRECT?

Accepted Answer

The statement that is correct is E. The sustainable growth rate is defined as the maximum growth rate that a firm can achieve without having to raise external funds. This means that the AFN will be zero at the sustainable growth rate. The other statements are incorrect. A firm can have a positive asset growth rate without an increase in retained earnings, and it is possible for the actual AFN to be lower than the previously calculated AFN if sales and earnings decrease. Also, if the firm retains all its profits, the AFN will not be zero because there will still be a need to finance some growth through external funds. Finally, the dividend policy can affect the requirement for external funds based on the AFN equation, especially if the firm needs to raise funds through equity financing.

Question 4

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.

Accepted Answer

The answer of A firm's profit margin is 5%, its...

Question 5

Which of the following statements is CORRECT?

Accepted Answer

AFN is the additional funds needed to support a firm's projected sales growth. To obtain AFN, the firm must usually raise funds through explicit financing decisions, such as increasing notes payable, long-term debt, or issuing common stock. Retaining earnings alone may not be sufficient to meet the AFN. Therefore, option B is incorrect. Options A and E are also incorrect because they do not provide accurate information about the AFN equation. Option D is incorrect because having a positive free cash flow doesn't necessarily mean that the firm has no AFN.

Question 6

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?
$\begin{array}{l}
\begin{array}{lc}
\text { Last year's sales }=S_{0} & \$ 200,000 \text { Last year's accounts payab } \
\text { Sales growth rate }=g & 40 \% \text { Last year's notes payable } \
\text { Last year's total assets }=A_{0} * & \$ 135,000 \text { Last year's accruals } \
\text { Last year's profit margin }=\text { PM } & 20.0\% \text { Target payout ratio }
\end{array}
\begin{array}{r}
\$ 50,000 \
\$ 15,000 \
\$ 20,000 \
25.0 \%
\end{array}
\end{array}$

Accepted Answer

$\begin{array}{lr}
\text { Last year's sales }=S_{0} & \$ 200,000 \
\text { Sales growth rate }=g & 40 \% \
\text { Forecasted sales }=S_{0} \times(1+g) & \$ 280,000 \
\Delta S=\text { change in sales }=S_{1}-S_{0}=S_{0} \times g & \$ 80,000 \
\text { Last year's total assets }=A_{0}{ }^{*}=A_{0}{ }^{*} \text { since full capacity } & \$ 135,000 \
\text { Last year's accounts payable } & \$ 50,000\
\text { Last year's notes payable. Not spontaneous, }\
\text {so does not enter AFN calculation }&\$ 15,000 \
\text { Last year's accruals}&\$ 20,000 \
\text { $ \mathrm{L}_{0}{ }^{*}= $ payables $ + $ accruals}&\$ 70,000 \
\text {Profit margin $ =M $ }&20.0 \% \
\text {Target payout ratio }&25.0 \%
\end{array}$
 
AFN = (A0*/S0)σS σ (L0*/S0)σS σ Profit margin × S1 × (1 σ Payout) AFN = $54,000 σ $28,000 σ $42,000 = σ$16,000

Question 7

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.

Accepted Answer

The statement correctly describes that the assumption of constant ratios may not hold true in certain situations and can be relaxed with the use of forecasted financial statements.

Question 8

A company expects sales to increase during the coming year, and it is using the AFN equation to forecast the additional capital that it must raise. Which of the following conditions would cause the AFN to increase?

Accepted Answer

The answer of A company expects sales to increase during...

Question 9

Which of the following statements is CORRECT?

Accepted Answer

Forecasting future sales is critical in determining the financial requirements of a company, as it determines the level of investment required in fixed assets, inventory, and accounts receivables.

Question 10

You have been asked to forecast the additional funds needed (AFN) for Houston, Hargrove, & Worthington (HHW), which is planning its operation for the coming year. The firm is operating at full capacity. Data for use in the forecast are shown below. However, the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 50%, which the firm's investment bankers have recommended. Based on the AFN equation, by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher levelσ All dollars are in millions. 
$\begin{array}{l}
\begin{array}{lc}
\text { Last year's sales }=S_{0} & \$ 300.0 \text { Last year's accounts payal } \
\text { Sales growth rate }=\mathrm{g} & 40 \% \text { Last year's notes payable } \
\text { Last year's total assets }=\mathrm{A}_{0}{ }^{*} & \$ 500.0 \text { Last year's accruals } \
\text { Last year's profit margin }=\text { PM } & 20.0 \% \text { Initial payout ratio }
\end{array}
\begin{array}{r}
\$ 50.0 \
\$ 15.0 \
\$ 20.0 \
10.0 \%
\end{array}
\end{array}$

Accepted Answer

$\begin{array}{lr} \text { Last year's sales }=S_{0} & \$ 300\ \text { Sales growth rate }=g & 40 \% \ \text { Forecasted sales }=S_{0} \times(1+g) & \$ 420 \ \Delta S=\text { change in sales }=S_{1}-S_{0}=S_{0} \times g & \$ 120 \ \text { Last year's total assets }=A_{0}{ }^{*}=A_{0}{ }^{*} \text { since full capacity } & \$500\ \text { Last year's accounts payable } & \$ 50\ \text { Last year's notes payable. Not spontaneous, }\ \text {so does not enter AFN calculation }&\$ 15 \ \text { Last year's accruals}&\$ 20 \ \text { $ \mathrm{L}_{0}{ }^{*}= $ payables $ + $ accruals}&\$ 70 \ \text {Profit margin $ =M $ }&20 \% \ \text {Initial payout ratio }&10\%\ \text { New pavout ratio }&50\%\ \end{array}$ AFN = (A₀^*/S₀)ΔS - (L₀^*/S₀)ΔS - Profit margin × S1 × (1 - Payout) Old AFN = $200.0 -$28.0 σ $75.6 = $96.4 New AFN = $200.0 - $28.0 - $42.0 = $130.0 Change in AFN = $33.6

Question 11

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.

Accepted Answer

The answer of If a firm's capital intensity ratio (A0*/S0)...

Question 12

Spontaneous funds are generally defined as follows:

Accepted Answer

Spontaneous funds are those that naturally arise from a company's day-to-day operations, such as accounts payable, accrued wages, and taxes, without the need for external financing.

Question 13

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.

Accepted Answer

Since Firm A is already operating at full capacity, it will need to invest more in capital to increase production and accommodate the expected growth in sales. Firm B, on the other hand, may be able to increase production without investing as much in additional capital since it is operating below capacity. Thus, Firm A will require more additional funds than Firm B.

Question 14

Which of the following assumptions is embodied in the AFN equation?

Accepted Answer

Accounts payable and accruals are tied directly to sales because they are both short-term liabilities that are incurred as a result of the firm's sales activities.

Question 15

F. Marston, Inc. has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN)?

Accepted Answer

Answer e is obviously correct. A switch to a just-in-time inventory system and outsourcing production would lower the firm's capital intensity ratio, which would lower AFN. Note that with a longer credit period (and all other terms held equal) offered by the new supplier, accounts payable will either go up or remain the same, but definitely not go down. Therefore, changing to the new supplier will not increase AFN.

Question 16

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.

Accepted Answer

The statement correctly describes ways in which firms can lower their capital intensity ratios and achieve growth with fewer assets and external capital.

Question 17

The term "additional funds needed (AFN)" is generally defined as follows:

Accepted Answer

"Additional funds needed (AFN)" refers to the funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations. Option A) is the only one that accurately defines AFN. Option B) refers to the asset turnover ratio, option C) refers to free cash flow, option D) refers to the percent of sales method, and option E) refers to spontaneous funds.

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A negative AFN indicates that the firm generates more internal funds and spontaneous liabilities than needed to finance the projected increase in assets, implying excess funds.

Question 19

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.

Accepted Answer

The answer of The minimum growth rate that a firm...

Question 20

The capital intensity ratio is generally defined as follows:

Accepted Answer

The capital intensity ratio is a measure of how much assets are required to generate a certain level of sales. It is calculated as the ratio of the amount of assets required per dollar of sales, or A0*/S0. Therefore, the correct choice is D.

Quiz 9: Corporate Valuation and Financial Planning

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

A company expects sales to increase during the coming year, and it is using the AFN equation to forecast the additional capital that it must raise. Which of the following conditions would cause the AFN to increase?

Which of the following statements is CORRECT?

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.

Spontaneous funds are generally defined as follows:

Which of the following assumptions is embodied in the AFN equation?

F. Marston, Inc. has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN) ?

The term "additional funds needed (AFN) " is generally defined as follows:

Which of the following statements is CORRECT?

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.

The capital intensity ratio is generally defined as follows: