Financial Management

(Financial Planning & Strategies)

FINANCIAL MANAGEMENT
A. FINANCIAL PLANNING AND STRATEGIES
THEORIES:
Business plan
3. 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 process
2. Planning for future growth is called:
A. capital budgeting
B. working capital management

C. financial forecasting
D. none of the above

1. The ideal financial planning process would be

A. 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 policy
Maturities matching
23. When a firm finances long-term assets with short-term sources of funding, it:
A. reduces the risk of cash shortage
B. will have higher interest expenses
C. improves the leverage ratio
D. is ignoring the principle of matched maturities

Short-term financing
14. The type of company most likely to need short-term financing is one that
A. has no seasonality and no growth in sales from year to year
B. sells only for cash
C. has a high degree of seasonality
D. has lower total fixed costs than total variable costs
25. Common sources of short-term financing include:
A. Stretching payables
C. Reducing inventory
B. 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 approach
21. Under the judgmental approach for developing a pro forma balance sheet, the plug figure
required to bring the statement into balance may be called the
A. retained earnings
C. suspense account
B. accounts receivable
D. required new financing
Percent of sales method
6. 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?

Financial Management
(Financial Planning & Strategies)

A. total assets
B. net income

C. dividend payout
D. sales

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

A. build a sales forecast
C. determine the cost of goods sold
B. 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. Variable
B. Fixed
D. Independent
22. Utilizing past cost and expense ratios (percent-of-sales method) when preparing pro forma
financial statements will tend to
A. 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 needed
5. 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 income
B. Growth in assets minus the current year's retained earnings
C. 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 probably
A. need additional long-term financing
C. have increasing asset requirements
B. 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, longterm bonds, and common stock. These accounts are nonspontaneous in that they require an
explicit financing decision to increase them.
Growth
19. 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.

Financial Management
(Financial Planning & Strategies)

Sensitivity analysis
9. 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 paid
B. 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 companys profit margin increases.
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 companys 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 equity
B. A higher debt-to-asset ratio
D. A higher return on assets
Sustainable growth rate
16. 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 method
Total assets requirements
i
. 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 be
A. P 40,500
C. P115,500
B. P240,000
D. P270,000
Additional Financing Needed
Total assets
ii
.Calculate the total assets of Premiere Company given the following information:
Sales this year
P3,000,000
Sales increase projected for next year
20 percent
Net income this year
P 250,000
Dividend payout ratio
40 percent
Projected excess funds available next year
P 100,000
Accounts payable
P 600,000
Notes payable
P 100,000
Accrued wages and taxes
P 200,000
Except for the accounts noted, there were no other current liabilities. Assume that the firms profit
margin remains constant and that the company is operating at full capacity.
A. P3,000,000
C. P2,000,000
B. P2,200,000
D. P1,200,000
Addition to retained earnings
iii
. Almond Corporation recently reported the following income statement for 2006 (in P000):
Sales
P7,000
Operating costs
3,000
EBIT
P4,000
Interest
200
Earnings before taxes (EBT)
P3,800
Taxes (40%)
1,520
Net 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 companys 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. P1,440
B. P1,260
D. P1,790
Additional financing needed

Financial Management
(Financial Planning & Strategies)
iv

. 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 800,000
B. P 600,000
D. P1,200,000

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 companys sales increase, its profit
margin will remain at its current level. The companys 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 8,400,000
B. P 6,000,000
D. P 9,600,000

.Leverage Companys December 31, 2006 balance sheet (in P000,000) is given below:
Cash
P 10 Accounts payable
P 15
Accounts receivable
25 Notes payable
20
Inventories
40 Accrued expenses
15
Long-term debt
30
Net fixed assets
75 Common stock
70
Total 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 years actual fixed assets. Assume that Leverages 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. P49,500,000
B. P52,500,000
D. P40,125,000

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.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.

Assets
Current assets
Fixed assets

Balance Sheet
(In million pesos)
Liabilities and Stockholders Equity
Accounts payable and accruals
P50
Notes payable long term
Common stock
40
Retained earnings

P25
30
15
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 is
A. P4,850,000
C. P2,650,000
B. P3,000,000
D. P5,000,000
New Long-term debt
viii
.Hello Company has the following balance sheet as of December 31, 2006.
Current assets
Fixed assets
Total Assets

P 600,000
400,000
P1,000,000

Accounts payable
P 100,000
Accrued liabilities
100,000
Notes payable
100,000
Long-term debt
300,000
Total 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 92,000

Financial Management
(Financial Planning & Strategies)

B. P 88,000

D. P112,000

Maximum sales
ix
.Indo Industries has P2.5 million in sales and P0.8 million in fixed assets. Currently, the companys
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. P3,000,000
B. P3,333,333
D. P3,125,575
Maximum growth rate
x
.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 percent
B. 4.8 percent
D. 9.6 percent
xi

.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
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%

Maximum dividend payout ratio

xii

.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 Policy
Conservative policy
xiii
.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
its temporary current assets with long-term financing costing 15 percent. Short-term
financing currently costs 10 percent. Wales Companys earnings before interest and taxes
are P2,200,000. Income tax rate is 40 percent.
How much would Wales Companys earnings after taxes under this financing plan?
A. P212,500
C. P225,000
B. P127,500
D. P 85,000
Aggressive policy
xiv
.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 20,000
Accts receivable
66,000
25,000
47,000
88,000
Inventory
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. P150,000
B. P100,000
D. P155,625

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