Which of the following statements is CORRECT?

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Question 1

  1. Which of the following statements is CORRECT?

    Answer

    When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner.
    When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow.
    Firms whose fixed assets are “lumpy” frequently have excess capacity, and this should be accounted for in the financial forecasting process.
    For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.
    There are economies of scale in the use of many kinds of assets.  When economies occur the ratios are likely to remain constant over time as the size of the firm increases.  The Economic Ordering Quantity model for establishing inventory levels demonstrates this relationship.

2 points

Question 2

  1. Spontaneous funds are generally defined as follows:

    Answer

    Assets required per dollar of sales.
    A forecasting approach in which the forecasted percentage of sales for each item is held constant.
    Funds that a firm must raise externally through short-term or long-term borrowing and/or by selling new common or preferred stock.
    Funds that arise out of normal business operations from its suppliers, employees, and the government, and they include immediate increases in accounts payable, accrued wages, and accrued taxes.
    The amount of cash raised in a given year minus the amount of cash needed to finance the additional capital expenditures and working capital needed to support the firm’s growth.

2 points

Question 3

  1. Which of the following is NOT a key element in strategic planning as it is described in the text?

    Answer

    The mission statement.
    The statement of the corporation’s scope.
    The statement of cash flows.
    The statement of corporate objectives.
    The corporation’s strategies.

2 points

Question 4

  1. 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?

    Answer

    The company previously thought its fixed assets were being operated at full capacity, but now it learns that it actually has excess capacity.
    The company increases its dividend payout ratio.
    The company begins to pay employees monthly rather than weekly.
    The company’s profit margin increases.
    The company decides to stop taking discounts on purchased materials.

2 points

Question 5

  1. Which of the following statements is CORRECT?

    Answer

    Since accounts payable and accrued liabilities must eventually be paid off, as these accounts increase, AFN as calculated by the AFN equation must also increase.
    Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no excess current assets.  Based on the AFN equation, its AFN will be larger than if it had been operating with excess capacity in both fixed and current assets.
    If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth.
    Additional funds needed (AFN) are typically raised using a combination of notes payable, long-term debt, and common stock.  Such funds are non-spontaneous in the sense that they require explicit financing decisions to obtain them.
    If a firm has a positive free cash flow, then it must have either a zero or a negative AFN.

2 points

Question 6

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

    Answer

    None of the firm’s ratios will change.
    Accounts payable and accruals are tied directly to sales.
    Common stock and long-term debt are tied directly to sales.
    Fixed assets, but not current assets, are tied directly to sales.
    Last year’s total assets were not optimal for last year’s sales.
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