Financial Management Concepts and Applications Foerster 1st Edition Test Bank

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Financial Management Concepts and Applications Foerster 1st Edition Test Bank

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Financial Management: Concepts and Applications (Foerster)
Chapter 6 Projecting Financial Requirements and Managing Growth

6.1 Generating Pro Forma Income Statements

1) In chapter 6, Projecting Financial Requirements and Managing Growth, the author focuses on three critical questions to examine the firms financial future. Which of the following questions is NOT addressed by the author in this chapter?
A) How much and what type of financing will be required to meet goals and expectations?
B) How do we compensate mangers to attract and keep good executives?
C) How profitable do we expect the firm to be in the coming years?
D) What is the RIGHT amount of sales growth (as opposed to too little or too much)?
Answer: B
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Reflective Thinking

2) Which of the following equations represents a simple and effective way to think about anticipated external funding?
A) External funds required = assets liabilities equity
B) External funds required = assets + liabilities equity
C) External funds required = assets + liabilities + equity
D) External funds required = assets liabilities + equity
Answer: A
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Analytic Skills

3) Managers often begin with an estimate of ________ when beginning to develop pro forma financial statements.
A) net income
B) sales
C) assets
D) equity
Answer: B
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Reflective Thinking

4) When constructing pro forma income statements which of the following is the last item to be estimated?
A) sales
B) the change in retained earnings
C) depreciation expense
D) taxes
Answer: B
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Analytic Skills
5) When constructing a pro forma income statement, which of the following is likely to be calculated first among the items listed?
A) dividends
B) taxes
C) cost of goods sold
D) interest expense
Answer: C
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Analytic Skills

6) When constructing pro forma balance sheets, ________ becomes the plug figure to make the balance sheet balance.
A) new fixed assets required
B) addition to retained earnings
C) cash
D) external funding required
Answer: D
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Analytic Skills

7) Which of the following is NOT a potential source of outside financing for a corporation?
A) new bank loans
B) new long-term debt
C) sale of new equity
D) additions to retained earnings
Answer: D
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Reflective Thinking

8) Dunweiler Inc., is developing a pro forma income statement for the coming year. The chief financial officer estimates that sales will be $150,000,000. If gross profits are historically 36% of sales, what is the expected cost of goods sold (in dollars)?
A) $36,000,000
B) $54,000,000
C) $64,000,000
D) $96,000,000
Answer: D
Explanation: D) COGS = Sales * (1-.36) = $150,000,000 * (0.64) = $96,000,000.
Diff: 3
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Analytic Skills
9) Dunweiler Inc., is developing a pro forma income statement for the coming year. The chief financial officer estimates that sales will be $150,000,000. If selling, general, and administrative expenses (SGA) are historically 18% of sales, what are the expected SGA expenses (in dollars)?
A) $18,000,000
B) $27,000,000
C) $30,000,000
D) $41,000,000
Answer: B
Explanation: B) SGA =0.18 * (Sales) = 0.18 * $150,000,000 = $27,000,000.
Diff: 3
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Analytic Skills

10) Cantanna Inc., is developing a pro forma income statement for the coming year. The chief financial officer estimates that fixed assets are $70,000,000 and that sales will be $300,000,000. If depreciation is historically 20% of fixed assets, what is the expected amount of depreciation for the upcoming year (in dollars)?
A) $14,000,000
B) $20,000,000
C) $60,000,000
D) This figure cannot be reasonably estimated.
Answer: A
Explanation: A) Depreciation = .20 * (FA) = 0.0 * ($70,000,000) = $14,000,000.
Diff: 3
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Analytic Skills

11) Jensen Inc. has net earnings of $24,000,000 this year and a dividend payout policy of 40% of earnings. If the firm follows its regular payout policy what will be the addition to retained earnings this year?
A) $9,600,000
B) $12,000,000
C) $14,400,000
D) $16,000,000
Answer: C
Explanation: C) Addition to R/E = Net Earnings * (1- DPO ratio) = $24,000,000 * (1-0.40) = $14,400,000.
Diff: 3
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Analytic Skills

12) Pro forma financial statements are an accountants way of looking back to see what might have been.
Answer: FALSE
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Reflective Thinking
13) Past relationships among variables on the balance sheet and income statement are typically POOR predictors of the future.
Answer: FALSE
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Reflective Thinking

14) Pro forma income statements are primarily based on forecasted sales and assumed relationships related to sales.
Answer: TRUE
Diff: 2
Topic: 6.1 Generating Pro Forma Income Statements
AACSB: Reflective Thinking

6.2 Generating Pro Forma Balance Sheets

1) In constructing a pro forma balance sheet a manager can estimate the accounts receivable because:
A) managers typically construct a pro forma income statement prior to the balance sheet. Thus, an estimate of sales has already been made and this is critical to estimating accounts receivable.
B) if the firm has already made an estimate of expected sales, then it can also estimate average daily sales.
C) if the firm maintains similar credit standards it can use the current average age of accounts receivable to help estimate the anticipated average age of accounts receivable
D) if the firm has each piece of information as stated above THEN they can estimate accounts receivable for the pro forma balance sheet..
Answer: D
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

2) When developing a pro forma balance sheet which of the following is typically the LAST item to be estimated?
A) inventory
B) total assets
C) external financing
D) cash
Answer: C
Diff: 1
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

3) The ________ is the critical connection between the pro forma income statement and the pro forma balance sheet.
A) change in net working capital
B) change in cost of goods sold
C) change in dividends
D) change in retained earnings
Answer: D
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

4) In constructing a pro forma balance sheet, which of the following fills the role of being the plug figure to balance the balance sheet?
A) external financing
B) the change in retained earnings
C) accounts payable
D) accounts receivable
Answer: A
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

5) It is common to use the change in long-term debt as a plug figure in the construction of a pro forma balance sheet. However, if the firm does not have long-term debt, which of the following could substitute as the final plug figure?
A) changes in short-term debt
B) changes in new equity
C) changes in the cash balance
D) All of the above
Answer: D
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

6) Which of the following choices would NOT be found on a pro forma balance sheet?
A) forecasted sales
B) total liabilities
C) fixed assets
D) current assets
Answer: A
Diff: 1
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

7) A firms pro forma balance sheet typically starts with liabilities and equity and THEN proceeds to assets
Answer: FALSE
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

8) A pro forma balance sheet typically begins with liabilities and then we estimate the assets.
Answer: FALSE
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

9) A pro forma balance sheet typically begins with the assets and then we estimate the liabilites and equity.
Answer: TRUE
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking
10) A firms ending equity equals the firms beginning equity less any change in long-term debt.
Answer: FALSE
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

11) A firms ending equity equals the firms beginning equity plus any change in retained earnings.
Answer: TRUE
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

Table 6.1

Assumptions: ($000s)
Current Sales $136.36
Growth Rate in Sales 10.0%
Gross Profit (% of Sales) 36.0%
SGA Expenses (% of Sales) 18.0%
Depreciation (% of Beginning Fixed Assets) 20.0%
Interest Expenses (% of Current Loan) 10.0%
Tax Rate 40.0%
Dividends (% of Net Earnings) 40.0%
Current Loans $27.0
Beginning Fixed Assets $33.0
No New External Equity
Pro forma age of accounts receivable (days) 38.6

J W Bracken Pro Forma Income Statement ($000s) Year 1 Pro Forma
Sales $150.0
CGS $96.0
Gross Profit $54.0
SGA Expenses $27.0
Depreciation $6.6
EBIT $20.4
Interest $2.7
EBT $17.7
Taxes $7.1
Net Earnings (NE) $10.6

Dividends $4.2
Change in Retained Earnings $6.4


J W Bracken Balance Sheets ($000s) Year 0 Year 1 Pro Forma
Assets
Cash $8.0 $8.6 Given
Accounts Receivable $12.0 $15.9
Inventory $22.0 $24.6 Given
Total Current Assets $42.0 $49.1

Fixed Assets $33.0 $34.5 Given
Total Assets $75.0 $83.6

liabilities
Accounts Payable $14.0 $14.8 Given
Long-Term Debt $27.0 $28.4
Total liabilities $41.0 $43.2

Equity $34.0 $40.4
Total liabilities and Equity $75.0 $83.6

12) Use the information provided in Table 6.1 to complete the pro forma income statement and balance sheet for J. W. Bracken Inc.
Answer:
Table 6.1 Answers
Assumptions: ($000s)
Current Sales $136.36
Growth Rate in Sales 10.0%
Gross Profit (% of Sales) 36.0%
SGA Expenses (% of Sales) 18.0%
Depreciation (% of Beginning Fixed Assets) 20.0%
Interest Expenses (% of Current Loan) 10.0%
Tax Rate 40.0%
Dividends (% of Net Earnings) 40.0%
Current Loans $27.0
Beginning Fixed Assets $33.0
No New External Equity
Pro forma age of accounts receivable (days) 38.6

J W Bracken Pro Forma Income Statement ($000s) Year 1 Pro Forma
Sales $150.0
CGS $96.0
Gross Profit $54.0
SGA Expenses $27.0
Depreciation $6.6
EBIT $20.4
Interest $2.7
EBT $17.7
Taxes $7.1
Net Earnings (NE) $10.6

Dividends $4.2
Change in Retained Earnings $6.4


J W Bracken Balance Sheets ($000s) Year 0 Year 1 Pro Forma
Assets
Cash $8.0 $8.6 Given
Accounts Receivable $12.0 $15.9
Inventory $22.0 $24.6 Given
Total Current Assets $42.0 $49.1

Fixed Assets $33.0 $34.5 Given
Total Assets $75.0 $83.6

liabilities
Accounts Payable $14.0 $14.8 Given
Long-Term Debt $27.0 $28.4
Total liabilities $41.0 $43.2

Equity $34.0 $40.4
Total liabilities and Equity $75.0 $83.6

Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Reflective Thinking

13) An alternative method of projecting a firms future financial needs (such as bank loans ) involves creation of a pro forma cash budget. Would you consider a cash budget to be more appropriate for short-term or long-term projections? Why? How do monthly cash budgets aid in the development of an annual cash budget? Is a cash budget more helpful for firms with seasonal needs or for those with constant cash flow needs?
Answer: A CASH BUDGET is a more direct cash flow forecast, because its based on the assumption that a firm is often currently borrowing money and will need to increase or decrease its loan amount in the coming year. A cash budget forecasts the timing and amount of cash inflows and outflows, and it is often created based on monthly cash flows. This type of budget is particularly useful for firms that face seasonal financing needs. Thus, a cash budget is often more valuable as a short-term rather than a long-term financial forecasting vehicle.
Diff: 2
Topic: 6.2 Generating Pro Forma Balance Sheets
AACSB: Communication

6.3 Generating Pro Forma Cash Budgets

1) A pro forma ________ forecasts the timing and amount of cash inflows and cash outflows.
A) income statement
B) balance sheet
C) cash budget
D) annual report
Answer: C
Diff: 1
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Reflective Thinking

2) When estimating a cash budget, which of the following items should the firm NOT include in the process?
A) dividends
B) taxes paid by the firm
C) wages
D) All of the above should be included
Answer: D
Diff: 1
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Reflective Thinking

3) Which of the following is the primary source of cash inflows in a pro forma cash budget?
A) anticipated dividends
B) anticipated sales
C) anticipated equity
D) anticipated net earnings
Answer: B
Diff: 1
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Reflective Thinking
4) When estimating a cash budget, which of the following items should the firm NOT include in the process?
A) taxes paid by creditors
B) commission payments paid to sales personnel
C) utility bills
D) fixed cash expenses
Answer: A
Diff: 2
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Reflective Thinking

5) Which of the following choices would NOT be considered a cash outflow?
A) operational expenses
B) anticipated sales
C) selling, general, and administrative expenses
D) capital expenditures
Answer: B
Diff: 2
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Reflective Thinking

Table 6.2
On-The-Level Manufacturing
January February March
Purchases $40,000 $45,000 $60,000
Sales Billed $75,000 $85,000 $95,000

6) On -The-Level Manufacturing buys materials on credit at the start of the month and pays in 60 days. They also sell on credit, bill customers at the beginning of the month, and receive payment 30 days later. Using Table 6.2, what is the net cash flow from purchases and sales for the month of March?
A) There is NOT enough information to answer this question.
B) $40,000
C) $45,000
D) -$45,000
Answer: C
Explanation: C) March pay $40,000 of January purchases, and receives $85,000 from February sales for a net cash flow of $45,000.
Diff: 3
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Analytic Skills
7) On-The-Level Manufacturing buys materials on credit at the start of the month and pays in 60 days. They also sell on credit, bill customers at the beginning of the month, and receive payment 30 days later. Using Table 6.2, what is the net cash flow from purchases and sales for the month of February?
A) $40,000
B) $45,000
C) -$45,000
D) There is NOT enough information to answer this question.
Answer: D
Explanation: D) We need to know the amount of purchases from December to answer this question.
Diff: 3
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Analytic Skills

8) A cash budget is often more valuable as a SHORT-term rather than a LONG-TERM financial forecasting vehicle.
Answer: TRUE
Diff: 2
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Reflective Thinking

9) A cash budget is often more valuable as a LONG-term rather than a SHORT-TERM financial forecasting vehicle.
Answer: FALSE
Diff: 2
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Reflective Thinking

10) Forecasted net cash flows are the difference between forecasted cash inflows and forecasted cash outflows.
Answer: TRUE
Diff: 2
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Reflective Thinking

11) The generation of cash budgets and and pro forma financial statements are equivalent ways of forecasting financial needs.
Answer: TRUE
Diff: 2
Topic: 6.3 Generating Pro Forma Cash Budgets
AACSB: Reflective Thinking
6.4 Performing Sensitivity Analysis

1) The process of determining the effects of one key variable on the overall outcome of a pro forma income statement, for example, is known as:
A) ratio analysis.
B) scenario analysis.
C) sensitivity analysis.
D) form analysis.
Answer: C
Diff: 1
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Reflective Thinking

2) Because key variables are often related rather than isolated we often change our estimates for selected variables simultaneously when examining pro forma statements. We call this type of activity:
A) ratio analysis.
B) scenario analysis.
C) sensitivity analysis.
D) form analysis.
Answer: B
Diff: 1
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Reflective Thinking

3) Pro forma financial statements may be valuable for which of the following reasons?
A) To help us estimate how profitable a firm is expected to be
B) To help determine if and how much debt financing is required
C) To help banks determine if firms are likely to meet lending standards
D) All of the above
Answer: D
Diff: 1
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Reflective Thinking

4) Your firms sales are estimated to increase by 10% in the next year. However, soon after the beginning of the year it becomes apparent that the growth in sales is more likely to be 20%. If your cost of good sold consists of only variable expenses, and the relationship between revenues and costs remain the same, which of the following situations would you expect to be TRUE?
A) The percentage change in gross profit should be greater than the percentage change in sales.
B) The percentage change in gross profit should be less than the percentage change in sales.
C) The percentage change in gross profit should be zero because gross profit is not a function of sales if all CGS are variable.
D) The percentage change in gross profit should be the same as the percentage change in sales.
Answer: D
Diff: 3
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Analytic Skills

5) Your firms sales are estimated to increase by 10% in the next year. However, soon after the beginning of the year it becomes apparent that the growth in sales is more likely to be 20%. If your cost of good sold consists of both fixed and variable expenses, which of the following situations would you expect to be TRUE?
A) The percentage change in gross profit should be greater than the percentage change in sales.
B) The percentage change in gross profit should be less than the percentage change in sales.
C) The percentage change in gross profit should be zero because gross profit is not a function of sales if some CGS are fixed.
D) The percentage change in gross profit should be the same as the percentage change in sales.
Answer: A
Diff: 3
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Analytic Skills

6) Your firms sales are estimated to decrease by 10% in the next year. However, soon after the beginning of the year it becomes apparent that the reduction in sales is more likely to be 20%. If your cost of good sold consists of only fixed expenses, which of the following situations would you expect to be TRUE?
A) The percentage negative change in gross profit should be greater than the percentage change in sales.
B) The percentage negative change in gross profit should be less than the percentage change in sales.
C) The percentage change in gross profit should be zero because gross profit is not a function of sales if all CGS are fixed.
D) The percentage change in gross profit should be the same as the percentage change in sales.
Answer: A
Diff: 3
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Analytic Skills

7) Which of the following would NOT be a direct concern of working capital sensitivity?
A) accounts receivable collection period
B) inventory turnover
C) annual tax obligations
D) average age of accounts payable
Answer: C
Diff: 2
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Reflective Thinking

8) Which of the following choices will lead to a DECREASE in loan requirements?
A) an increased age of accounts receivable
B) an increased age of accounts payable
C) a shortened age of inventory
D) Each of the above will lead to a decrease in loan requirements.
Answer: C
Diff: 2
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Reflective Thinking
9) Pro forma estimates of cash flows are rarely if ever correct.
Answer: TRUE
Diff: 2
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Reflective Thinking

10) Sensitivity analysis highlights the impact of a change in one key variable on another key variable.
Answer: TRUE
Diff: 2
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Reflective Thinking

11) Unfortunately, one thing we know for certain about financial forecasts is that they are almost always wrong. If the preceeding statement is generally thought to be true, why do we spend so much time and money on financial forecasting?!
Answer: Perhaps one way to address this statement is to quote General Eisenhower: In preparing for battle I have always found that plans are useless, but planning is indispensable. We can take this to mean that by developing a plan we know may not work, we have considered other less likely outcomes and how we would react to those. Planning can help us think through situations and to prepare responses to possible outcomes.
Diff: 2
Topic: 6.4 Performing Sensitivity Analysis
AACSB: Reflective Thinking

6.5 Understanding Sustainable Growth and Managing Growth

1) The ________ is the maximum a firm can grow with internally generated equity and new borrowing sufficient to maintain the current long-term-debt to equity ratio.
A) internal growth rate
B) sustainable growth rate
C) return on equity
D) return on assets
Answer: B
Diff: 1
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

2) As an initial assumption, it is reasonable to assume that firms are reluctant to do all of the following EXCEPT:
A) purchase new fixed assets.
B) issue new equity.
C) change dividend policy.
D) change debt policy.
Answer: A
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking
3) Felton Financial Inc, had net earnings last year of $487,000. If the firm has a dividend payout policy of 30%, what was the addition to retained earnings?
A) $340,900
B) $487,000
C) $146,100
D) There is not enough information to answer this question.
Answer: A
Explanation: A) NE * (1-DPO) = $487,000 * (1-.30) = $340,900.
Diff: 3
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Analytic Skills

4) Craftsman Inc., has a profit margin of 8%, an asset turnover ratio of 2.3, a leverage ratio of 1.50 and a retention ratio of .60. What is the firms sustainable growth rate?
A) 3.13%
B) 8.70%
C) 16.56%
D) 46.00%
Answer: C
Explanation: C) Sustainable Growth = ROE * b = (8% * 2.3 * 1.5) * .60 = 16.56%
Diff: 3
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Analytic Skills

5) Dynamo Engines Inc., has an ROA of 10%, a profit margin of 6%, an assets to equity ratio of 1.30, and a retention ratio of 0.70. What is the firms sustainable growth rate?
A) 18.57%
B) 9.10%
C) 5.46%
D) 0.55%
Answer: B
Explanation: B) Sustainable Growth = ROE * b = (10% * 1.30) * 0.70 = 9.10%.
Diff: 3
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Analytic Skills

6) Eagle Enterprises Inc., has an asset turnover of 1.1, a financial leverage ratio of 1.67, a profit margin of 12% and a dividend payout ratio of 25%. What is the firms sustainable growth rate?
A) 29.39%
B) 14.07%
C) 5.51%
D) 16.53%
Answer: D
Explanation: D) Sustainable Growth = ROE * b = (12% * 1.1 * 1.67) * (1 0.25 ) = 16.53%
Diff: 3
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Analytic Skills
7) Gaston Grooming Inc., has a sustainable growth rate of 17.28%. If the retention ratio is .60, the leverage ratio is 1.2 and the asset turnover ratio is 1.6, what was the firms profit margin?
A) 15.0%
B) 13.6%
C) 12.1%
D) 11.4%
Answer: A
Explanation: A) PM = SGG/(ATO * LR * b) = 17.28%/(1.6 * 1.2 * .60) = 15.0%
Diff: 3
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Analytic Skills

8) Gremlin Media Inc. has realized tremendous growth in recent years. Last year the firm realized an ROE of 41.16%. If the firm was in a 40% marginal tax bracket, had an asset turnover ratio of 2.1, a profit margin of 14%, and a leverage ratio of 2, what was the firms retention ratio?
A) 0.70
B) 1.00
C) 0.50
D) There is not enough information to answer this question.
Answer: D
Explanation: D) You need the firms sustainable growth rate to answer this question.
Diff: 3
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Analytic Skills

9) Other things equal, a higher leverage ratio implies:
A) a higher ROA.
B) lower financial risk for shareholders.
C) greater financial risk for shareholders.
D) a lower ROE.
Answer: C
Diff: 1
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

10) It is not unusual for a successful firm to temporarily grow more rapidly than its sustainable growth rate if the firm is in the ________ phase of business.
A) swan song
B) start-up
C) cash cow
D) middle
Answer: B
Diff: 1
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking
11) If a firm is trying to grow more rapidly, which of the following identifies a non-financially-related course of action?
A) increase the retention ratio
B) reduce dividends
C) increase asset turnover
D) increase the debt to equity ratio
Answer: C
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

12) A firm that is growing more slowly than its sustainable growth rate may face which of the following scenarios if it generates excess cash rather than make greater investments in its own business?
A) Use the excess cash to acquire other businesses.
B) Use the excess cash to increase dividends.
C) Do nothing and become cash rich.
D) All of the above are realistic scenarios.
Answer: D
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

13) A firm that is growing more slowly than its sustainable growth rate may generates excess cash. If the firm chooses to keep the excess cash which of the following is NOT true?
A) Holding on to excess cash may signal OVER utilization of assets.
B) Holding on to excess cash often is a negative stock signal in that investors interpret the excess cash is a result of no attractive investment alternatives.
C) Holding on to excess cash may attract unwanted potential investors who are attracted to the excess cash for their own purposes.
D) Holding on to excess cash may signal UNDER utilization of assets.
Answer: D
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

14) Which of following is NOT a variable in the equation for sustainable growth?
A) profit ratio
B) net working capital ratio
C) asset turnover ratio
D) leverage ratio
Answer: B
Diff: 1
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking
15) The ________ is a two-edged sword in that as its value increases the ROE should increase, but the risk to shareholders also increases.
A) profit margin
B) ROA
C) leverage ratio
D) asset turnover ratio
Answer: C
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

16) Knowledge about the sustainable growth rate is important to all but one of the following groups or individuals.
A) The CEO
B) The CFO
C) Managers involved in a budgeting process
D) Knowledge about the sustainable growth rate is important to all of the above and others as well.
Answer: D
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

17) Corporations tend to be MORE reluctant to increase dividends than to cut them.
Answer: FALSE
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

18) Firms paying excess dividends may cause shareholders to pay taxes sooner and at a higher marginal tax rate than if the firm either held the excess funds, or found additional satisfactory investments.
Answer: TRUE
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

19) If sales growth is SLOWER than the sustainable growth rate then the ROE is also lower.
Answer: TRUE
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

20) A firm that grows too rapidly risks requiring too LITTLE financial leverage.
Answer: FALSE
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking
21) Consider the four components identified by the author in the sustainable growth equation. Which if nay of these components are heavily influenced by executive management?
Answer: Each of the four components is heavily influenced by management. The profit margin is a function of how well managers control expenses, the asset turnover is a function of which assets the manager has chosen to purchase for the firm and how well those assets generate revenues. Leverage is the third component and managers choose the firms capital structure, i.e., how to pay for the assets. Finally, the retention ratio is also a management decision.

Company policy about how to control expenses, the types of assets to buy, how to fund those assets, and how to distribute earnings to shareholders are all determined by executive management.
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Reflective Thinking

22) Dynamo Engines Inc., has an ROA of 10%, a profit margin of 6%, an assets to equity ratio of 1.30 and a retention ratio of 0.70. What is the firms sustainable growth rate?
Answer: Sustainable growth rate = ROE * b, where b is the retention ratio. = (.10 * 1.30) * (0.70) = 9.10%
Diff: 2
Topic: 6.5 Understanding Sustainable Growth and Managing Growth
AACSB: Analytic Skills

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