MODULE 11 Short-term financing

FINANCIAL MANAGEMENT 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
A. FINANCIAL PLANNING AND STRATEGIES B. sells only for cash
C. has a high degree of seasonality
THEORIES: D. has lower total fixed costs than total variable costs
Business plan 25. Common sources of short-term financing include:
3. The typical outline of the component parts of a business plan would be A. Stretching payables C. Reducing inventory
the B. Issuing bonds D. All of the above
A. mission and strategy statements. C. financial projections. 24. How does long-term financing policy affect short-term financing
B. operations of the business. D. All of the above. requirements?
Financial planning process A. The nature of the firm's short-term financial planning problem is
2. Planning for future growth is called: determined by the amount of long-term capital it raises.
A. capital budgeting C. financial forecasting B. A firm that issues large amounts of long-term debt or common stock, or
B. working capital management D. none of the above that retains a large part of its earnings, may find that it has permanent
1. The ideal financial planning process would be excess cash. Other firms raise relatively little long-term capital and end up
A. top-down planning. as permanent short-term debtors.
B. bottom-up planning. C. Most firms attempt to find a golden mean by financing all fixed assets and
C. a combination of top-down and bottom-up planning. part of current assets with equity and long-term debt. Such firms may invest
D. none of the above. cash surpluses during part of the year and borrow during the rest of the
18. Which of the following is incorrect regarding the construction of financial year.
planning models? D. All of the above affect short-term financing.
A. There is no theory or model that leads straight to the optimal financial Judgmental approach
strategy. 21. Under the judgmental approach for developing a pro forma balance
B. Financial planning should not proceed by trial and error. sheet, the plug figure required to bring the statement into balance may be
C. Many different strategies may be projected under a range of assumptions called the
about the future before one strategy is finally chosen. A. retained earnings C. suspense account
D. The dozens of separate projections that may be made during this trial- B. accounts receivable D. required new financing
and-error process generate a heavy load of arithmetic and paperwork. Percent of sales method
Financing policy 6. The percent of sales method is based on which of the following
Maturities matching assumptions?
23. When a firm finances long-term assets with short-term sources of A. All balance sheet accounts are tied directly to sales.
funding, it: B. Most balance sheet accounts are tied directly to sales.
A. reduces the risk of cash shortage C. There is considerably excessive asset level.
B. will have higher interest expenses D. Statements a and c above are correct.
C. improves the leverage ratio 4. Which of the following is the major independent variable in constructing
D. is ignoring the principle of matched maturities pro forma income statements and balance sheets?
A. total assets C. dividend payout 11. Which of the following best describes a firm's external funding
B. net income D. sales requirement?
7. The first step in developing a pro forma income statement is to: A. Growth in assets minus growth in liabilities minus net income
A. build a sales forecast C. determine the cost of goods sold B. Growth in assets minus the current year's retained earnings
B. determine the production schedule D. none of the above C. Growth in assets minus growth in current liabilities minus net income
20. The percent-of-sales method of preparing the projected income D. Growth in assets minus growth in current liabilities minus the year's
statement assumes that all costs are: retained earnings
A. Constant C. Variable 15. A company that has rapidly growing sales will probably
B. Fixed D. Independent A. need additional long-term financing C.have increasing asset requirements
22. Utilizing past cost and expense ratios (percent-of-sales method) when B. have a financing gap D. find that all of the above are true
preparing pro forma financial statements will tend to 17. Which of the following statements is most correct?
A. Understate profits when sales are decreasing and overstate profits when A. Since accounts payable and accrued liabilities must eventually be paid,
sales are increasing. as these accounts increase, required new financing also increases.
B. Understate profits, no matter what the change in sales, as long as fixed B. Suppose a firm is operating its fixed assets below 100 percent capacity
costs are present. but is at 100 percent with respect to current assets. If sales grow, the firm
C. Understate profits when sales are increasing and overstate profits when can offset the needed increase in current assets with its idle fixed assets
sales are decreasing. capacity.
D. Overstate profits, no matter what the change in sales, as long as fixed C. If a firm retains all of its earnings, then it will not need any additional
costs are present. funds to support sales growth.
Additional funds needed D. Additional funds needed are typically raised from some combination of
5. Additional funds needed are best defined as: notes payable, long-term bonds, and common stock. These accounts are
A. Funds that are obtained automatically from routine business transactions. nonspontaneous in that they require an explicit financing decision to
B. Funds that a firm must raise externally through borrowing or by selling increase them.
new common or preferred stock. Growth
C. The amount of assets required per peso of sales. 19. Which of the following is incorrect regarding the effect of growth on the
D. A forecasting approach in which the forecasted percentage of sales for need for external financing?
each item is held constant. A. Higher growth rates will lead to a greater need for investments in fixed
8. Which of the following statements about forecasting external funding assets and working capital.
requirements via the percentage of sales method is true? B. The internal growth rate is the maximum rate that the firm can grow if it
A. The plan assumes that sales are determined by assets that determine the relies entirely on reinvested profits to finance its growth, that is, the
external funds needed. maximum rate of growth without requiring external financing.
B. The plan assumes that the external funds needed impact assets which in C. The sustainable growth rate is the rate at which the firm can grow with the
turn drive sales. option of flexibly changing its leverage ratio.
C. The plan assumes that sales determine assets that determine the D. One very simple starting point may be a percentage of sales model in
external funding needed. which many key variables are assumed to be directly proportional to sales.
D. The plan assumes that there is a varying relationship between sales, Sensitivity analysis
assets, and funds needed.
9. Holding all other variables constant, which of the following would increase 1. Lamp has projected sales of P100,000, a gross profit margin of 45%, a
a firm's external funding requirements in the planning period? return on sales of 15%. Accounts receivable has been 25% of sales while
A. An increase in assets C. An increase in dividends paid inventory has been 10% of cost of sales. Lamp has minimum cash balance
B. A decrease in accruals D. All of the above of P10,000 and fixed assets are projected to be P75,000. Total assets
10. Which of the following is likely to increase the required new financing requirements would be
(RNF) in a given year? A. P 40,500 C. P115,500
A. The company reduces its dividend payout ratio. B. P240,000 D. P270,000
B. The companys profit margin increases. Additional Financing Needed
C. The company decides to reduce its reliance on accounts payable as a Total assets
form of financing. 2. Calculate the total assets of Premiere Company given the following
D. The company is operating well below full capacity. information:
12. Monument Corporation has developed a forecasting model to determine Sales this year P3,000,000
the additional funds it needs in the coming year. Other factors remaining Sales increase projected for next year 20 percent
unchanged, which of the following factors is likely to increase its additional Net income this year P 250,000
financing requirement? Dividend payout ratio 40 percent
A. A sharp increase in its forecasted sales and the companys fixed assets Projected excess funds available next year P 100,000
are at full capacity. Accounts payable P 600,000
B. A reduction in its dividend payout ratio. Notes payable P 100,000
C. The company increases its reliance on trade credit that sharply raises its Accrued wages and taxes P 200,000
accounts payable. Except for the accounts noted, there were no other current liabilities.
D. A new cost control produces more efficient costs. Assume that the firms profit margin remains constant and that the company
13. Which of the following will not permit a higher internal growth rate, other is operating at full capacity.
things equal? A. P3,000,000 C. P2,000,000
A. A higher plowback ratio C. A higher return on equity B. P2,200,000 D. P1,200,000
B. A higher debt-to-asset ratio D. A higher return on assets Addition to retained earnings
Sustainable growth rate 3. Almond Corporation recently reported the following income statement for
16. The sustainable growth rate is best described by which of the following? 2006 (in P000):
A. The rate of sales growth that will sustain the assets of the company. Sales P7,000
B. The rate of earnings growth needed to avoid external financing. Operating costs 3,000
C. The maximum rate of sales growth of a company without using external EBIT P4,000
debt. Interest 200
D. The maximum rate of sales growth of a company without raising external Earnings before taxes (EBT) P3,800
funds from the sale of stock. Taxes (40%) 1,520
Net income to common shareholders P2,280
PPROBLEMS: The company forecasts that its sales will increase by 10 percent in 2007 and
Percent-of-sales method its operating costs will increase in proportion to sales. The companys
Total assets requirements 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 company will continue to pay out 60 percent of its earnings as dividends.
income as dividends, the other 50 percent will be additions to retained What amount of nonspontaneous, required new financing (RNF), will be
earnings. What is the forecasted addition to retained earnings for 2007? needed during the next year?
A. P1,140 C. P1,440 A. P55,500,000 C. P49,500,000
B. P1,260 D. P1,790 B. P52,500,000 D. P40,125,000
Additional financing needed 7. Spark Company has plants in 3 major cities. Sales for last year were
4. If a firm uses external financing as a plug item, has a new capital budget P100 million, and the balance sheet at year-end is similar in percentage of
of P2 million, a net income of P3 million, and a plowback ratio of 40%, how sales to that of previous years (and this will continue in the future). All
much should be raised in external funds? assets (including fixed assets) and current liabilities will vary directly with
A. P 200,000 C. P 800,000 sales. Spark Company is already using assets at full capacity.
B. P 600,000 D. P1,200,000 Balance Sheet (In million pesos)
5. Patio Company recently reported sales of P100 million, and net income Assets Liabilities and Stockholders Equity
equal to P5 million. The company has P70 million in total assets. Over the Accounts payable and accruals P25
next year, the company is forecasting a 20 percent increase in sales. Since Current assets P50 Notes payable long term 30
the company is at full capacity, its assets must increase in proportion to Common stock 15
sales. The company also estimates that if sales increase 20 percent, Fixed assets 40 Retained earnings 20
spontaneous liabilities will increase by P2 million. If the companys sales
increase, its profit margin will remain at its current level. The companys Total P90 Total P90
dividend payout ratio is 40 percent. Based on the RNF formula, how much Spark Company has an after-tax profit margin of 5 percent and a dividend
additional capital must the company raise in order to support the 20 percent payout ratio of 30 percent.
increase in sales? If sales grow by 10 percent next year, the required new financing (RNF) to
A. P 2,000,000 C. P 8,400,000 finance the expansion is
B. P 6,000,000 D. P 9,600,000 A. P4,850,000 C. P2,650,000
6. Leverage Companys December 31, 2006 balance sheet (in P000,000) is B. P3,000,000 D. P5,000,000
given below: New Long-term debt
Cash P 10 Accounts payable P 15 8. Hello Company has the following balance sheet as of December 31,
Accounts receivable 25 Notes payable 20 2006.
Inventories 40 Accrued expenses 15 Current assets P 600,000
Long-term debt 30 Fixed assets 400,000
Net fixed assets 75 Common stock 70 Total Assets P1,000,000
Total assets P150 Total Liab & equity P150
Sales during the past year were P100,000,000 and they are expected to rise Accounts payable P 100,000
by 50 percent to P150,000,000 during 2007. Also, during last year fixed Accrued liabilities 100,000
assets were being utilized to only 85 percent of capacity, so Leverage Notes payable 100,000
Company could have supported P100,000,000 of sales with fixed assets that Long-term debt 300,000
were only 85 percent of last years actual fixed assets. Assume that Total common equity 400,000
Leverages profit margin will remain constant at 5 percent and that the Total Liabilities and Equity P1,000,000
In 2006, the company reported sales of P5 million, net income of P100,000, A. 3.6% C. 5.2%
and dividends of P60,000. The company anticipates its sales will increase B. 4.8% D. 6.1%
20 percent in 2007 and its dividend payout will remain at 60 percent. Maximum dividend payout ratio
Assume the company is at full capacity, so its assets and spontaneous 12. What is the maximum dividend payout ratio consistent with not requiring
liabilities will increase proportionately with an increase in sales. external funds for a firm with an ROE of 15%, a debt-equity ratio of 50%,
Assume the company uses the AFN formula and all additional funds needed and an annual sales growth objective of 9%?
(AFN) will come from issuing new long-term debt. Given its forecast, how A. Approximately 1% C. Approximately 12%
much long-term debt will the company have to issue in 2007? B. Approximately 10% D. Approximately 20%
A. P 60,000 C. P 92,000 Financing Policy
B. P 88,000 D. P112,000 Conservative policy
Maximum sales 13. Wales Company has P8,000,000 in current assets, P3,500,000 of which
9. Indo Industries has P2.5 million in sales and P0.8 million in fixed assets. are considered permanent current assets. In addition, the firm has
Currently, the companys fixed assets are operating at 75 percent of P6,000,000 invested in fixed assets. Wales Company wishes to finance all
capacity. fixed assets and permanent current assets plus half of its temporary current
What level of sales could Indo Industries have obtained if it had been assets with long-term financing costing 15 percent. Short-term financing
operating at full capacity? currently costs 10 percent. Wales Companys earnings before interest and
A. P2,800,000 C. P3,000,000 taxes are P2,200,000. Income tax rate is 40 percent.
B. P3,333,333 D. P3,125,575 How much would Wales Companys earnings after taxes under this
Maximum growth rate financing plan?
10. Pierre Company has the following ratios: A*/S = 1.6; L*/S = 0.4; profit A. P212,500 C. P225,000
margin = 0.10; and dividend payout ratio = 0.45, or 45 percent. Sales last B. P127,500 D. P 85,000
year were P100 million. Assuming that these ratios will remain constant and Aggressive policy
that all liabilities increase spontaneously with increases in sales, what is the 15. Luminous Co. has total fixed assets of P100,000 and no current
maximum growth rate Piere Company can achieve without having to employ liabilities. The table below displays its wide variation in current asset
nonspontaneous external funds? components.
A. 3.9 percent C. 7.8 percent 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
B. 4.8 percent D. 9.6 percent Cash P 20,000 P 10,000 P 15,000 P 20,000
11. The Ripley Company is trying to determine an acceptable growth rate in Accts receivable 66,000 25,000 47,000 88,000
sales. While the firm wants to expand, it does not want to use any external Inventory 20,000 65,000 59,000 10,000
funds to support such expansion due to the particularly high interest rates in Total P106,000 P100,000 P121,000 P118,000
the market now. Having gathered the following data for the firm, what is the If Luminous policy is to finance all fixed assets and half the permanent
maximum growth rate it can sustain without requiring additional funds? current assets with long-term financing and rest with short-term financing,
Capital intensity ratio = 1.2. what is the level of long-term financing?
Profit margin = 10%. A. P 68,000 C. P150,000
Dividend payout ratio = 50%. B. P100,000 D. P155,625
Current sales = P100,000.
Spontaneous liabilities = P10,000.