Exam 12: Corporate valuation and financial planning

The fact that long-term debt and common stock are raised infrequently and in large amounts lessens the need for the firm to forecast those accounts on a continual basis.

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?

Which of the following statements is CORRECT?

A firm's AFN must come from external sources.Typical sources include short-term bank loans, long-term bonds, preferred stock, and common stock.

One of the first steps in arriving at a firm's forecasted financial statements is a review of industry-average operating ratios relative to these same ratios for the firm to determine whether changes to the ratios need to be made.

As a firm's sales grow, its current assets also tend to increase.For instance, as sales increase, the firm's inventories generally increase, and purchases of inventories result in more accounts payable.Thus, spontaneous liabilities that reduce AFN arise from transactions brought on by sales increases.

Spontaneous funds are generally defined as follows:

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?

If a firm's capital intensity ratio (A?*/S?)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?

Last year National Aeronautics had a FA/Sales ratio of 40%, comprised of $250 million of sales and $100 million of fixed assets.However, its fixed assets were used at only 75% of capacity.Now the company is developing its financial forecast for the coming year.As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full capacity.What target FA/Sales ratio should the company set?

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.

To determine the amount of additional funds needed (AFN), you may subtract the expected increase in liabilities, which represents a source of funds, from the sum of the expected increases in retained earnings and assets, both of which are uses of funds.

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)?

If a firm wants to maintain its ratios at their existing levels, then if it has a positive sales growth rate of any amount, it will require some amount of external funding.

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.

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.

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.

Which of the following statements is CORRECT?