Question 1

A bottom-up approach for forecasting revenues relies on projections of customer demand.

Accepted Answer

A bottom-up approach starts from the individual components or customers and builds up to the total revenue forecast. In this approach, customer demand is a key factor in forecasting revenues.

Question 2

Which of the following are steps in making a top-down forecast?
I.Forecasting prices.
II.Sizing the total market.
III.Determining market share.
IV.Estimating customer turnover.

A)I and II only.
B)I,II,and III only.
C)II,III,and IV only.
D)III and IV only.

B

Accepted Answer

Making a top-down forecast involves forecasting the overall market demand and then allocating it to specific products, regions, or market segments. The steps involved in making a top-down forecast typically include:

I. Forecasting prices - this is important to estimate the revenue potential of the market and to calculate the market size in dollars.

II. Sizing the total market - this involves estimating the size of the overall market demand in terms of units or dollars. It can be done by analyzing market research data, industry reports, and other sources of information.

III. Determining market share - this step involves estimating the percentage of total market demand that the company or product is likely to capture. This can be done by analyzing the company's historical sales data, competitive analysis, and other factors.

IV. Estimating customer turnover - this involves estimating the rate at which customers will switch from one brand or product to another over time. This can be done by analyzing customer behavior and trends, as well as other factors.

Therefore, the best choice is B, which includes all four steps.

Question 3

To forecast the balance sheet,it is best to first forecast invested capital and nonoperating assets and then forecast excess cash and sources of financing separately.

Accepted Answer

Forecasting invested capital and nonoperating assets first allows for a clearer understanding of the company's financial position before taking excess cash and sources of financing into account. Separating these components for forecasting purposes also allows for a more accurate and detailed plan for managing and investing cash and obtaining necessary financing.

Question 4

Which of the following is the best recommendation for forecasting performance?&#10;A)Use an explicit forecast period of two to five years and longer for cyclical companies or those experiencing very rapid growth.&#10;B)Use an explicit forecast period of two to five years and shorter for cyclical companies or those experiencing very rapid growth.&#10;C)Use an explicit forecast period of 10 to 15 years and longer for cyclical companies or those experiencing very rapid growth.&#10;D)Use an explicit forecast period of 10 to 15 years and shorter for cyclical companies or those experiencing very rapid growth.

Accepted Answer

The answer of Which of the following is the best...

Question 5

The recommended method to forecast taxes is as a percentage of earnings before taxes.

Accepted Answer

If you forecast the provision for income taxes as a percentage of earnings before taxes, ROIC and FCF in forecast years will inadvertently change as leverage and nonoperating income change. Instead, start with a forecast of operating taxes on EBITA, and adjust for nonoperating taxes.

Question 6

In industries where prices are changing or technology is advancing,forecasters should strictly use financial drivers such as revenue.

Accepted Answer

In industries where prices are changing or technology is advancing, forecasts should incorporate nonfinancial ratios, such as volume and productivity.

Question 7

The explicit forecast period must be long enough for the company to reach a steady state.Which of the following is NOT a desirable property of that steady state?&#10;A)The growth rate rises above the required return on capital.&#10;B)The company earns a constant rate of return on existing capital.&#10;C)The company earns a constant rate of return on new capital invested.&#10;D)The company reinvests a constant proportion of its operating profits into the business each year.

Accepted Answer

If the growth rate rises above the required return on capital, the company may be taking on too much risk or investing in projects that are not profitable. A desirable steady state would include earning a constant rate of return on existing and new capital invested, and reinvesting a constant proportion of its operating profits into the business each year to ensure sustained growth.

Question 8

Large Corporation owns less than 20 percent of Small Corporation.Which of the following are true?
I.Large Corp.records asset sales of Small Corp.
II.The investment in Small Corp.is marked to market.
III.Large Corp.records dividends received from Small Corp.
IV.In forecasting entries for Small Corp. ,Large Corp.should use a traditional driver like cash flows.

A)I and II only.
B)I and III only.
C)II and III only.
D)III and IV only.

Accepted Answer

Option I is true because Large Corporation owns less than 20% of Small Corporation, it is not considered a controlling interest. Therefore, any sales of assets by Small Corporation would not be consolidated within Large Corporation's financial statements. 
Option II is true because when an investor owns less than 20% of a company, the investment is classified as available-for-sale and is marked-to-market, meaning that any changes in the value of the investment are recorded in Large Corporation's financial statements. 
Option III is true because any dividends received from Small Corporation would be recognized as investment income in Large Corporation's financial statements. 
Option IV is false because forecasting entries for Small Corporation should be based on operational drivers, not traditional drivers such as cash flows.

Question 9

It is recommended in the financial modeling process to collect raw data on a separate worksheet and record the data as originally reported.

Accepted Answer

It is recommended to keep raw data on a separate worksheet and record it as originally reported to maintain transparency and traceability in the financial modeling process.

Question 10

In forecasting the income statement,it is recommended to tie all items directly to revenue.

Accepted Answer

For most line items, forecasts will be tied directly to revenues; however, some line items will be economically tied to a specific asset or liability.

Question 11

Complete the following table by entering the typical forecast driver in the third column and the typical forecast ratio in the last column.&#10;

Accepted Answer

The answer of Complete the following table by entering the...

Question 12

Which of the following is NOT one of the steps in the forecast of individual line items related to the income statement?&#10;A)Determine the economic relationships that drive the model.&#10;B)Model the business cycle.&#10;C)Estimate the forecast ratios.&#10;D)Forecast the drivers and multiply times the respective ratios.

Accepted Answer

The answer of Which of the following is NOT one...

Question 13

The explicit forecast period must be long enough for the company to reach a steady state.List the two characteristics that define that steady state.

Accepted Answer

The answer of The explicit forecast period must be long...

Question 14

List the three steps in making a top-down forecast of revenue and the three inputs for making a bottom-up forecast of revenue.

Accepted Answer

The answer of List the three steps in making a...

Question 15

When using PP&E as the forecast driver for depreciation,which of the following is most accurate?&#10;A)From both an ideal and a practical standpoint,the driver should be net PP&E.&#10;B)From both an ideal and a practical standpoint,the driver should be gross PP&E.&#10;C)Ideally,the driver should be net PP&E,but practically the driver should be gross PP&E.&#10;D)Ideally,the driver should be gross PP&E,but practically the driver should be net PP&E.

Accepted Answer

The answer of When using PP&E as the forecast driver...

Question 16

Which of the following is the best estimate of retained earnings in year t?&#10;A)Retained earningsT&#8330;&#8321; + Net incomeT-&#8321; - DividendsT-&#8321;&#10;B)Retained earningsT + Net incomeT&#8330;&#8321; - DividendsT-&#8321;&#10;C)Retained earningsT-&#8321; + Net incomeT - DividendsT&#10;D)Retained earningsT + Net incomeT + DividendsT

Accepted Answer

The answer of Which of the following is the best...

Question 17

The recommended approach for forecasting cash flows of a parent company arising from investments in subsidiaries where the parent owns less than 20 percent of the subsidiary is to use the relationship between income from these subsidiaries and overall firm revenues.

Accepted Answer

The answer of The recommended approach for forecasting cash flows...

Question 18

Which of the following are true concerning forecasting interest income?
I.It is a nonoperating measure.
II.Its typical forecast driver is revenue.
III.It is typically the same from year to year for firms that generate high cash flow.
IV.The typical forecast ratio is interest income in the current period divided by excess cash in the previous period.

A)I and II only.
B)I and IV only.
C)II and III only.
D)III and IV only.

Accepted Answer

The answer of Which of the following are true concerning...

Question 19

The top-down approach cannot be applied to companies in mature industries.

Accepted Answer

The answer of The top-down approach cannot be applied to...

Question 20

If a company forecasts that its capital expenditures will be smooth,then in forecasting depreciation,it is better to use the percentage of revenues approach than the percentage of property,plant,and equipment (PP&E )approach.

Accepted Answer

The answer of If a company forecasts that its capital...

Question 21

Since severance costs are a cost of doing business,they should be forecast within free cash flows.

Accepted Answer

The answer of Since severance costs are a cost of...

Question 22

In industries where prices are changing or technology is advancing,forecasters should:&#10;A)Use only financial drivers such as revenue.&#10;B)Use only nonfinancial drivers such as productivity and volume.&#10;C)Use both financial and nonfinancial drivers.&#10;D)Use national real aggregates such as real GDP.

Accepted Answer

The answer of In industries where prices are changing or...

Question 23

Which of the following is the recommended approach to forecast COGS,and why?&#10;A)Forecast COGS based on revenue growth,since it provides flexibility in the model.&#10;B)Forecasting COGS based on the forecast ratio of COGS to sales allows for possible improvements in COGS relative to sales.&#10;C)Forecast COGS based on revenue growth since COGS and revenues have a direct relationship.&#10;D)Forecasting COGS based on inventory is recommended because inventory prices and COGS are correlated.

Accepted Answer

The answer of Which of the following is the recommended...

Question 24

Which of the following is the preferred method to forecast the financing items on the balance sheet?&#10;A)Assume that debt and equity are constant.Sum all forecasted assets except excess cash,and all liabilities and existing debt and equity.Plug the model using newly issued debt or excess cash.&#10;B)Financing items should be forecasted first,taking into consideration the future funding needs of the company.Correspondingly,the assets that the raised capital will fund should then be adjusted.&#10;C)Assume that all liabilities and equity will grow at the same rate as revenue growth.&#10;D)Assume that debt and equity will grow at the same constant rate in all years going forward.

Accepted Answer

The answer of Which of the following is the preferred...

Question 25

Changing the dividend payout ratio will change the value of the firm and the firm's equity.

Accepted Answer

The answer of Changing the dividend payout ratio will change...

Question 26

Which is the recommended way to forecast items such as inventory and accounts payable?&#10;A)Inventory and accounts payable should be forecasted based on revenues,since most other working capital items are forecasted based on revenues.&#10;B)Inventory and accounts payable should be forecasted based on COGS,because these items are more correlated with input prices than with output prices.&#10;C)Inventory and accounts payable should be the plug once total operating assets and operating liabilities have been forecasted.&#10;D)Inventory and accounts payable should be forecasted based on total assets,as these tend to scale together.

Accepted Answer

The answer of Which is the recommended way to forecast...

Deck 11: Forecasting Performance