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Exam 12: Corporate Valuation and Financial Planning

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Question 1

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The Besnier Company had $250 million of sales last year, and it had $75 million of fixed assets that were being operated at 80% of capacity.In millions, how large could sales have been if the company had operated at full capacity?

A) $312.5
B) $328.1
C) $344.5
D) $361.8
E) $379.8

F) B) and D)
G) C) and D)

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Question 2

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Which of the following statements is CORRECT?

A) If a firm's assets are growing at a positive rate, but its retained earnings are not increasing, then it would be impossible for the firm's AFN to be negative.
B) If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually decrease, then the firm's actual AFN must, mathematically, exceed the previously calculated AFN.
C) Higher sales usually require higher asset levels, and this leads to what we call AFN.However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have a zero dividend payout ratio.
D) Dividend policy does not affect the requirement for external funds based on the AFN equation.
E) The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external funds.In other words, it is the growth rate at which the firm's AFN equals zero.

F) A) and C)
G) A) and D)

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Question 3

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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?

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

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?

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.

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.

Below are the simplified current and projected financial statements for Decker Enterprises. All of Decker's assets are operating assets. All of Decker's current liabilities are operating liabilities. $\begin{array}{l}\begin{array} { l c r } \text { Income statement } & \text { CurrentProjected } \\\text { Sales } & \text { na } & 1,500 \\\text { Costs } & \text { na } &\underline{ 1,080} \\\cline { 2 - 3 } \text { Profit before tax } & \text { na } & 420 \\\text { Taxes } ( 25 \% ) & \text { na } & \underline{105 }\\\cline { 2 - 3 } \text { Net income } & \text { na } & 315 \\\text { Dividends } & \text { na } & 95\end{array}\\\begin{array} { l c r l r r } \text { Balance sheets } & \text { Current } & \text { Projected } & & \text { Current } & \text { Projected } \\\text { Current assets } & 100 & 115 & \text { Current liabilities } & 70 & 81 \\\text { Net fixed assets } & 1,200 & 1,440 & \text { Long-term debt } & 300 & 360 \\& & & \text { Common stock } & 500 & 500 \\& & & \text { Retained earnings } & 430 & 650\end{array}\end{array}$ -If Decker had a financing deficit, it could remedy the situation by

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.

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.

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.

The capital intensity ratio is generally defined as follows:

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.

One of the necessary steps in the financial planning process is a forecast of financial statements under each alternative version of the operating plan in order to analyze the effects of different operating procedures on projected profits and financial ratios.

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.

The capital intensity ratio is the amount of assets required per dollar of sales and it has a major impact on a firm's capital requirements.

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.

Spontaneous funds are generally defined as follows:

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.

Which of the following statements is CORRECT?